Holly Manufacturing Case

Holly Manufacturing Company produces two cello models. One is a standard acoustic cello that sells for $600 and is constructed
from medium-grade materials. The other model is a custom-made amplified cello with pearl inlays and a body constructed from special woods.
The custom cello sells for $900. Both cellos require 10 hours of direct labor to produce, but the custom cello is manufactured by more
experienced workers who are paid at a higher rate.
Most of Hollys sales come from the standard cello, but sales of the custom model have been growing. Following is the companys sales,
production, and cost information for last year:
Cello Standard Custom
Sales and production volume in units 900 100
Unit Selling Price $600.00 $900.00
Unit costs:
Direct materials $150.00 $375.00
Direct labor $180.00 $240.00
Manufacturing overhead* $135.00 $135.00
Total unit costs $465.00 $750.00
Unit Gross Profit $135.00 $150.00
Direct Labor Hours 10.00 10.00
Direct Labor Rate Per Hour $18.00 $24.00
*Manufacturing overhead costs:
Building depreciation $40,000
Maintenance 15,000.00
Purchasing 20,000.00
Inspection 12,000.00
Indirect materials 15,000.00
Supervision 30,000.00
Supplies 3,000.00
Total manufacturing overhead costs $135,000.00
These manufacturing overhead costs are fixed in nature: they do not vary with the volume of manufacturing activity.
The company allocates overhead costs using the traditional method. Its activity base is direct labor hours. The predetermined overhead rate,
based on 10,000 direct labor hours, is $13.50 ($135,000 10,000 direct labor hours).
Johann Brahms, president of Holly, is concerned that the traditional cost-allocation system the company is using may not be generating accurate
information and that the selling price of the custom cello may not be covering its true cost.
Questions To Be Answered
A. The cost-allocation system Holly has been using allocates 90% of overhead costs to the
standard cello because 90% of direct labor hours were spent on the standard model.

How much overhead was allocated to each of the two models last year?
Standard
Sales and production volume in
units
90%
Total manufacturing overhead
costs
135,000.00 $
Total overhead each model
121,500.00 $
Discuss why this might not be an accurate way to assign overhead costs to products.
B. How would the use of more than one cost pool improve Holly's cost allocation?
C. Holly's controller developed the following data for use in activity-based costing:
Manufacturing Standard
Overhead Cost Amount Cost Driver Cello
Building depreciation $40,000 Square footage 3,000
Maintenance $15,000 Direct labor hours 9,000
Purchasing $20,000 # of purchase orders 1,500
Inspection $12,000 # of inspections 400
Indirect materials $15,000 # of units manufactured 900
Supervision $30,000 # of inspections 400
Supplies $3,000 # of units manufactured 900
Total $135,000
Because by using the traditional method above, overhead rates are counted based on total manufacturing
can be easily manipulated by changing the production volume.

In fact, the major influence that differentiate between standard and custom cello is
method.
It will provide more accurate product costs by using more than one cost pool because
this case, the overhead costs should include direct materials and direct labor.


D. Use activity-based costing to allocate the costs of overhead per unit and in total to each model of cello.
Manufacturing
Overhead Cost Volume Amount
Cost Driver
Building depreciation 4,000 40,000 $ Square footage
Maintenance 10,000 15,000 $ Direct labor hours
Purchasing 2,000 20,000 $
# of purchase
orders
Inspection 1,000 12,000 $ # of inspections
Indirect materials 1,000 15,000 $
# of units
manufactured
Supervision 1,000 30,000 $ # of inspections
Supplies 1,000 3,000 $
# of units
manufactured
Total 20,000 135,000 $
E. Calculate the cost of a custom cello using activity-based costing.
Direct material $375.00
Direct labor $240.00
Overhead cost
for custom cello 435 $
Total
manufacturing
cost for custom
cello $1,050.00
F. Why is the cost different from the cost calculated using the traditional allocation method?
Compare the unit selling
price before and after using
activity-based method:
standard
Unit Selling Price 600.00 $
Traditional Method
The cost is different because the traditional method generalize the manufacturing overhead costs which in fact is different for each type


G. At the current selling price, is the company covering its true cost of production? Briefly discuss
H. What should Holly Manufacturing do about the situation?
I. What should Holly Manufacturing do if the quantity of custom cellos sold at the new price falls to 50 per year?
J. What should Holly Manufacturing do about the situation if the price of the custom cello cannot exceed $900?
K. At a selling price of $1,000 each, what is the breakeven unit volume for the custom cello?
L. What are the lessons learned from this case?
No, it's not. The company LOSES money with amount of $150.00 by selling the custom cello by $900.00.


Increase the price of custom cello by at least $1,050.00


Holly Manufacturing Company produces two cello models. One is a standard acoustic cello that sells for $600 and is constructed
from medium-grade materials. The other model is a custom-made amplified cello with pearl inlays and a body constructed from special woods.
The custom cello sells for $900. Both cellos require 10 hours of direct labor to produce, but the custom cello is manufactured by more
Most of Hollys sales come from the standard cello, but sales of the custom model have been growing. Following is the companys sales,
431.67 $ 1,050.00 $
$168.33 -$150.00
These manufacturing overhead costs are fixed in nature: they do not vary with the volume of manufacturing activity.
The company allocates overhead costs using the traditional method. Its activity base is direct labor hours. The predetermined overhead rate,
based on 10,000 direct labor hours, is $13.50 ($135,000 10,000 direct labor hours).
Johann Brahms, president of Holly, is concerned that the traditional cost-allocation system the company is using may not be generating accurate
information and that the selling price of the custom cello may not be covering its true cost.
A. The cost-allocation system Holly has been using allocates 90% of overhead costs to the
standard cello because 90% of direct labor hours were spent on the standard model.
Custom
10%
135,000.00 $
13,500.00 $
Discuss why this might not be an accurate way to assign overhead costs to products.
B. How would the use of more than one cost pool improve Holly's cost allocation?
C. Holly's controller developed the following data for use in activity-based costing:
Custom
Cello
1,000
1,000
500
600
100
600
100
Because by using the traditional method above, overhead rates are counted based on total manufacturing overhead cost (that fixed for both standard and custom cello) and
In fact, the major influence that differentiate between standard and custom cello is located on the direct material and direct labor. These factors are discounted on this
will provide more accurate product costs by using more than one cost pool because both of activities related to and not related to production volume can be measured. In
D. Use activity-based costing to allocate the costs of overhead per unit and in total to each model of cello.
Standard Custom
Cello Cello Standard Custom
3,000 1,000 10 $ 30,000 $ 10,000 $
9,000 1,000 2 $ 13,500 $ 1,500 $
1,500 500 10 $ 15,000 $ 5,000 $
400 600 12 $ 4,800 $ 7,200 $
900 100 15 $ 13,500 $ 1,500 $
400 600 30 $ 12,000 $ 18,000 $
900 100 3 $ 2,700 $ 300 $
Total Overhead
Cost 91,500 $ 43,500 $
Overhead Cost
per Cello 101.67 $ 435 $
F. Why is the cost different from the cost calculated using the traditional allocation method?
custom standard custom
900.00 $ 431.67 $ 1,050.00 $
Difference 168.33 $ (150.00) $
Unit cost/ cost
driver
Cost Assigned
Traditional Method ABC Method
the traditional method generalize the manufacturing overhead costs which in fact is different for each type of cello.
G. At the current selling price, is the company covering its true cost of production? Briefly discuss
I. What should Holly Manufacturing do if the quantity of custom cellos sold at the new price falls to 50 per year?
J. What should Holly Manufacturing do about the situation if the price of the custom cello cannot exceed $900?
K. At a selling price of $1,000 each, what is the breakeven unit volume for the custom cello?
LOSES money with amount of $150.00 by selling the custom cello by $900.00.