Rubrics Corporation

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CASE STUDY REPORT BY GROUP 3
Ho Phuong Huyen

Hoang Cong Minh Khang

Hoang Thi Thu Thao

Tran Phuoc Lam Huy

Nguyen Duy Tung

Nguyen Thao Ly

Nguyen Ngoc Huyen

College of Business and Management, VinUniversity

ACCT2020: Introduction to Managerial Accounting

Professor: Alex Nguyen

Teaching Assistant: Tien Tran

SCAN THE QR CODE FOR THE APPENDIX

November 4th, 2022

I. EXECUTIVE SUMMARY
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Rubrics Corporation is a midsize hardware manufacturing firm with four main products:
widgets, gadgets, smidgets, and smadgets. The CFO of Rubrics Corporation had become aware
of the ongoing imbalance between the product's budgeted and the actual cost. Due to the
inaccuracy of the traditional costing method that the company normally use, the CFO of Rubrics
Corporation is considering implementing an activity-based costing system (ABC) to improve the
product pricing. Currently, Rubrics Corporation is allocating their cost as following:

Concern about (1) Overhead costs per product, total costs per product of both traditional
costing method and ABC methods and (2) the difficulties of traditional costing and its possible
solutions will be reported in this report. Moreover, this report also addresses (3) the comparison
of the total cost of both traditional costing method and activity-based costing method.

II. PRODUCT COST UNDER TRADITIONAL COSTING METHOD

PRODUCT COST
Widgets Gadgets Smidgets Smadgets
Allocated Overhead Cost $200,000 $600,000 $800,000 $400,000
Number of Units 1,000 1,000 1,000 1,000
Overhead Cost per Product $200 $600 $800 $400
Total Product Cost $400,000 $1,100,000 $1,350,000 $850,000
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Based on the given rate, the assigned overhead cost for Widgets, Gadgets, Smidgets and
Smadgets can be calculatd to be $200,000; $600,000; $800,000 and $400,000 respectively.
Divide these number by 1000, the number of units for each product, we can come up with the
Overhead Cost per Product.

The total product cost for any single product type can be expressed as: Direct Labour
Cost + Direct Material Cost + Overhead cost. Thus, the total product cost for Widgets, Gadgets,
Smidgets and Smadgets are $400,000; $1,100,000; $1,350,000; $850,000.

III. PRODUCT COST UNDER ACTIVITY-BASED COSTING (ABC) METHOD

Overhead cost drivers
Cost allocation bases Total costs Quantity of CAB Physical Units ABC Rate
Depreciation $300,000 3000 Machine hours $100
Set-up $700,000 1000 Set-up hours $700
Rent $1,000,000 100000 Square feet $10

PRODUCT COST
Widgets Gadgets Smidgets Smadgets
Depreciation $50,000 $90,000 $40,000 $120,000
Set-up $140,000 $210,000 $70,000 $280,000
Rent $200,000 $300,000 $100,000 $400,000
Total Overhead cost $390,000 $600,000 $210,000 $800,000
Total Cost $590,000 $1,100,000 $760,000 $1,250,000

Under ABC costing method, the main cost drivers of this technology company are
modified. Instead of relying solely on the labor force, the overhead cost is now driven by
machinery, timing and working area. Each activity rate can be calculated by dividing the total
activity cost by the quantity of compatible units. Therefore, the activity rate for depreciation, rent
and set up are $100, $700 and $10 respectively.
To calculate the total activity cost for each product, we use: Activity-based rate x
Number of correspondent units. Afterwards, the number of the three cost pools are added up
together to find out total overhead cost of each product. Thus, the total cost for Widgets,
Gadgets, Smidgets and Smadgets are $590,000; $1,100,000; $760,000 and $1,250,000 as
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summations of Direct Labour Cost, Direct Material Cost and Total overhead cost.

IV. CONSEQUENCES RESULT FROM INCORRECTLY BUDGETED PRODUCTS

Figure 3: Overhead cost under Traditional and ABC Costing Method

Based on the provided calculations of the ABC costing method, it is apparent that 3
devices, namely Widgets, Smidgets and Smadgets were imprecisely priced.
1. Misleading cost optimization
In terms of the inexact cost optimization, traditional calculating methods created a wrong
impression on the performance of the product line, and therefore, leading to incorrect managerial
decisions in case the enterprise decided to discontinue/stop selling a product line since its total
cost is excessive in the traditional costing method. This also limits the resource of potential
product lines, as the company would apply another method of marketing, which may not focus
on the leading device, or change to a different supplier that lowers the quality of the product.
2. Wrong allocation of sales mix for each product line
According to our analysis, the sales mix for each product line of the company is
currently 1:1:1:1 based on traditional costing method. This may not optimize the budget of the
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company, as Rubrics can not be able to emphasize on their most optimal device and may apply
the same method of marketing or management on every product line.
3. Reduction in the number of customers
Considering that the market is rather competitive with various companies and investors
have elastic demand, wrongly budgeted products may cause the deduction in the number of
customers, as there are various alternatives for Rubrics’ devices at a more reasonable price. This
is in case that the company has a higher price compared to its competitors.

V. SUGGESTED ACTIONS TO RESOLVE MISPRICED PRODUCTS

As the activity-based approach has revealed big flaws in traditional cost calculation of
widgets, smidgets and smadgets which might also lead to miscalculation of the price, some
actions must be considered to ensure the company’s profitability. To do that, first, our team
assumes that the company has been using a cost-based pricing method with the price being 50%
higher than the traditional cost. From that, we can calculate the price. As we place the ABC cost
into the price set by traditional method, problem start to emerge:

Widgets Smidgets Smadgets

Cost per unit $590 $760 $1.250

Price per unit $600 $2.025 $1.275

Profit per unit $10 $1.265 $25

From the figure above, we can see that widgets’ and smadgets’ profit is incredibly small ($10
and $25 respectively) due to the increase in cost calculated by ACB methods. In contrast,
smidget’s profit accounts for ~50% of the price. To resolve this issue, our team would approach
in two steps: (1) financial adjustments based on ABC method, (2) non-financial adjustment.
1. Financial adjustments
First, we propose holding the price 50% higher than the activity-based costs which would
rebalance the profitability of products:
Widgets Smidgets Smadgets

Cost per unit $590 $760 $1.250

Price per unit $885 $1.140 $1.875

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Profit per unit $295 $380 $625

2. Non-financial adjustments
Though the above adjustments would financially increase the balance of profit, it has
disregarded the competitor and customer factors that would affect the sale unit of products. To be
more specific, the increase in price of widgets and smadgets would decrease sales as customers
would move to alternative solutions. Some non-financial analysis must be done to define how
these changes in sales would occur. Our team considers market elasticity of each product is the
crucial factor leading to fluctuation in sales.
The business intelligence team should conduct market research defining the level of
willingness of customers to move to alternative products as the price goes up and to consume
more products as the price decreases. Besides that, product prices of other competitors should
also be collected and compared. For instance, we can assume that smidgets' decrease in price
would only lead to a 10% increase in sale units (from 600 to 660 units) due to the limited
demand of customers and existing alternatives products with similar low price. In that case, the
profitability before price decrease would be $154.200 higher than that after price change:
Smidgets Before price decrease After price decrease

Units sold 600 660

Profit per unit $675 $380

Total profit $405.000 $250.800

Therefore, our team proposes not changing the price of smidgets regardless of the new
costing method. In general, the higher the elasticity is, the higher you should set the price and
vice versa. However specific details in how elasticities would affect the price of each product
require more data to better adjust the prices of products.

VI. COMPARISON BETWEEN COSTS PER PRODUCT UNDER BOTH METHODS

1. Cost comparison and analysis
Under Traditional and ABC Costing Method, it can be seen in above Figure 1 that total
cost of two product lines - Smidgets and Smadgets show considerable discrepancy ($1,350,000
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vs $760,000 and $850,000 vs $1,250,000, respectively). Smidgets consume highest direct labor
cost resulting highest overhead cost ($800,000) under traditional costing method whereas under
ABC cost system, the product line allocates lower overhead cost ($210,000) due to lower
anticipated manufacturing resources (activity cost drivers). A reverse tendency could be
witnessed in Smadgets. With regard to Widgets, overhead (and total cost) under traditional
costing method was allocated $190,000 lower than under ABC cost system (from $200,000 to
$390,000). It is possibly seen that direct labor contributes to the overhead cost as significant as
activity cost drivers in product line Gadgets, thereby making no change in the overhead cost at
$600,000.

2. Reasons for cost difference

Regardings Rubrics Coporation’s traditional cost system, the overhead costs are also calculated
based on an allocation base (single cost driver) – direct labor, which may not reflect what
actually contribute to the costs. Furthermore, all of manufacturing overhead costs were allocated
using the same overhead rate for all product line. Conversely, in the ABC cost system, each
product line has unique rate based on multiple cost drivers and the selected cost drivers in the
overhead cost pool (depreciation, set-up and rent) reflect accurate cost allocation of a
manufacturing company. The result is that traditional cost systems overcost products requiring
less maintanence, square footage and simultaneously undercost products consuming more
aforementioned resources.

VII. CIRCUMSTANCES FOR EQUAL RESULTS FROM TWO COSTING

METHODS
Taking into consideration the reasons why activity-based costing may change the total
cost assigned to each product, there are two circumstances that can even out the results from
ABC costing and traditional costing methods.
1. Multiple Predetermined Overhead Rates
Rubrics manager is now using a Plantwide Overhead Rate to allocate all of its
manufacturing overhead costs to products. This approach can be inaccurate as the amount of
overhead for Rubrics is large (2.000.000) in comparison with 1.700.000 of total direct labor and
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material cost). Thus, the company should spend more effort to allocate these costs, given that its
product lines are also diverse and different in term of the production process.
Under our team's first circumstance, Rubrics manager can instead use Multiple
Predetermined Overhead Rates. Each production department will have its own predetermined
overhead rate as calculated in Table 3 (Appendix).
By using Multiple Predetermined Overhead Rates, the managers can involve the
difference in cost drivers due to different processes and characteristics of each department
(labor-based or machine-based).
Department 1 Department 2 Department 3 Department n Overhead cost
Overhead rate 250 500 200 200
Widgets process time 0 500 700 390.000
Gadgets process time 1000 0 800 950 600.000
Smidgets process time 200 300 50 210.000
Smadgets process time 800 1200 0 0 800.000

After that, they can multiply the rate by the number of hours each product line spends in
each department and sum up all the products to get the final overhead cost for each product line.
2. Machine-hour as cost driver
Rubrics is a hardware manufacturing company, which means it relies a lot on machines.
The manager should examine more carefully to find out the most suitable cost driver for such a
large amount of overhead cost. As the contributors of this amount are mostly due to machine
depreciation, machine set-up time, and renting (we assume that most area is used for machines).
Thus, it will be much more logical if Rubrics use machine hours as the cost driver for
manufacturing overhead cost.
Widgets Gadgets Smidgets Smadgets Total

Machine hour 500 900 400 1200 3.000

Total overhead 2.000.000

Overhead rate 667

Overhead cost 333.333 600.000 266.667 800.000 2.000.000

This cost driver makes the overhead cost more accurate and closer to the result we get
from ABC costing method.
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