Concept explainers
Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models, designated as standard, deluxe, and heavy-duty. The company uses a
For the past 10 years, the company’s pricing formula has been to set each product’s target price at 110 percent of its full product cost. Recently, however, the standard-model motor has come under increasing price pressure from offshore competitors. The result was that the price on the standard model has been lowered to $110.
The company president recently asked the controller, “Why can’t we compete with these other companies? They’re selling motors just like our standard model for 106 dollars. That’s only a buck more than our production cost. Are we really that inefficient? What gives?”
The controller responded by saying, “I think this is due to an outmoded product-costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my judgment, our product-costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean.”
Getting the president’s go-ahead, the controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each cost driver consumed by each product line.
Required:
- 1. Compute the target prices for the three models, based on the traditional, volume-based product costing system.
- 2. Compute new product costs for the three products, based on the new data collected by the controller. Round to the nearest cent.
- 3. Calculate a new target price for the three products, based on the activity-based costing system. Compare the new target price with the current actual selling price for the standard-model electric motor.
- 4. Write a memo to the company president explaining what has been happening as a result of the firm’s traditional, volume-based product-costing system.
- 5. What strategic options does Morelli Electric Motor Corporation have? What do you recommend, and why?
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Managerial Accounting: Creating Value in a Dynamic Business Environment
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