Pitcarn Corporation makes pump housings of various sizes. The activities necessary to make a pump housing are casting, grinding, painting, inspecting, and testing. The casting department costs $120,000 per year for direct labor, the working supervisor, employee taxes, sand for molds, and fuel for

Question

Pitcarn Corporation makes pump housings of various sizes. The activities necessary to make a pump housing are casting, grinding, painting, inspecting, and testing. The casting department costs $120,000 per year for direct labor, the working supervisor, employee taxes, sand for molds, and fuel for the furnace. With this $120,000 per year, they can cast 36,000 pounds of pump housings, not including the price of the metal. If all pumps were of the same size and weight, the number of castings might be a good cost driver. Last year, the department cast 12,000 pump housings, which implies each pump should be charged $10 for casting department work ($120,000/12,000 pumps).

Accepted Answer

Suppose pump housings vary widely in weight, that is, by a factor of 2 or more. In that case, pounds per castings might be a better cost driver. A pump housing weighing 2 pounds would be charged $6.67 (2 pounds $120,000/36,000 pounds of castings). On the other hand, a 20-pound pump housing would be charged $66.67 (20 pounds × $120,000/36,000 pounds of castings).
Another possible cost driver is the number of hours it takes to cast a particular size pump. Last year, the casting department applied 6,000 labor hours to making castings. A pump housing that takes 15 minutes of casting labor would be charged $5 of casting department costs (1/4 hour × $120,000/6,000 labor hours), whereas a pump housing that takes 2 hours to cast would be charged $40 (2 hours × $120,000/6,000 hours).
Again ask, why are we doing this? What difference could it make? The reasons a company needs to understand their cost structure in depth include the following:

1. Identification of expensive operations so they can be re-engineered
2. To better understand the profitability of a particular product mix
3. For pricing decisions
4. To better understand what it takes to become a low-cost producer
Pitcarn Corporation’s management may want to employ activity-based costing to measure productivity, determine the optimum product mix, or determine whether costs could be reduced if processes were re-engineered or automation introduced. They might even be trying to decide whether they should subcontract out certain functions. To do that, they need to follow a number of rules so that their analyses provide consistent results. Two of these include

1. Cost of labor should include employer taxes, and ideally workers’ compensation costs (since it is illegal not to pay these costs) and fringe benefits, if any.
2. When departmental costs are being considered, the cost of working supervisors should be considered with their related employer taxes, workers’ compensation, and fringe benefits.

Question 17.1: Pitcarn Corporation makes pump housings of various sizes. Th...

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