Camelback Communications

Danielle Burnett

Statement of the Problem The production costs for CCIs products seem to make some products extremely profitable while others are moderately profitable. The problem lies within the cost accounting system as concluded by the outside management consultant, Peterzon, who was hired to analyze the firms cost system. The problem with the cost accounting systems model, as it stands, is that fixed costs are assigned to the allocation rate in such a way that they drive up the rate per hour, independent of the variable costs. Executive Summary The question is which costs ought to be used in order to set prices that are competitive while allowing for CCIs profit requirements. The fixed costs must be dealt with in a different fashion if any product mix is to be agreed upon which will allow cost-based pricing at competitive rates. The variable overhead costs needs to be tied to each individual product in a way that seems reasonable. Keeping the existing cost system but differentiating between variable and fixed costs with an emphasis on maximizing contributions, is the solution since it allows CCI to keep all existing products. Analysis With the new allocation rate set at $10.36 per hour, the price CCI will have to charge to reach a 40% mark-on are as follows: o Product B o Product C o Product D $28.51 $78.51 $50.01

This would allow only Product B to be sold at its industry standard price of $38.50. However, adding mark-ons of 25% produces the following prices: o Product B o Product C o Product D $25.45 $70.10 $44.65

This would also allow Product D to be sold at industry standard of $49.00. Product C, in this case, would have to be dropped. If Product C were dropped and the allocation rates were refigured at $15.00, the following prices would have to be charged to reach the 40% mark-on: o Product B o Product D $35.00 $63.00.

This would allow only Product B to be sold at its industry standard price of $38.50. By adding mark-ons of only 25%, Product D would still have to be dropped since it could not be sold at its industry price as shown below:

Camelback Communications

Danielle Burnett

o Product B o Product D

$31.25 $56.25.

The problem with the current costing model is that fixed costs are assigned to the allocation rate in such a way that they inadvertently drive up the rate per hour, without interfering with the variable costs. As a result the fixed overhead of $45,000 is reflected in the allocation rate no matter the product mix. All prices are high in order to cover these fixed costs. The fixed costs must be dealt with in a different fashion if any product mix is to be decided upon which will allow cost-based pricing at competitive rates. Another issue is that the variable overhead costs do not seem to be tied to each individual product in any reasonable way. If the firm keeps the existing cost system but differentiates between variable and fixed costs and maximizes contributions, the fixed costs would no longer be a part of the allocation rate. The revised costs and the new prices would be dependent only on the variable costs. Under this scenario, the new prices would result with mark-ons of 140%: o o o o Product A Product B Product C Product D $87.50 $18.09 $47.25 $29.17

Here all the products may be sold at, or above, these prices and still be in line with industry standard pricing. These prices do not allow CCI to recapture all associated costs, since the fixed costs are not reflected in this pricing. If the fixed costs were allocated with the current system, but the variable costs were changed so that the costs were accurately tied to the products, the resulting pricing would be as follows with the 40% mark-ons: o o o o Product A Product B Product C Product D $115.50 $29.75 $57.75 $42.00

Under this allocation system, Product A would have to be dropped. Even with a 25% mark-on, Product A would still be dropped. The last modification of the cost system is to divide the products into A/B and C/D pools and allocating according to the proportions of direct labor hours. In doing that, the following are the prices with 40% mark-on: o o o o Product A Product B Product C Product D $114.06 $22.49 $66.50 $42.00

Camelback Communications

Danielle Burnett

When the mark-on is dropped to 25%, the pricing would be: o o o o Product A Product B Product C Product D $101.79 $20.09 $59.38 $37.50

Product A would have to be dropped according to these calculations with both mark-on calcualtions.