GB519 Unit 5 Activity-Based Costing Comparison Example

Spinal Braces on Five Activity Pools: A Unit 5 Activity-Based Costing Comparison at an Orthotics Lab

[Student Name]

Purdue University Global

GB519: Measurement and Decision Making

Unit 5 Activity-Based Costing Comparison

[Instructor Name]

[Date]

The lab and every figure are composite and illustrative; the sources cited are real.

The Lab and Its Lines

Fernhill Orthotic Lab makes three kinds of custom device for clinics:

Foot orthoses (FOs): 16,000 pairs a year at $88 a pair, with $36.60 of direct materials and labor.

Ankle-foot orthoses (AFOs): 4,200 a year at $420 each, with $140.60 of direct cost.

Spinal braces (TLSOs): 800 a year at $1,040 each, with $512.60 of direct cost, mostly 8.9 hours of skilled technician time.

The owner has been planning a marketing push for spinal braces, reasoning that each brace earns more above full cost than a pair of foot orthoses, and that the scoliosis program brings referrals for the other lines.

Table 1: The Traditional Allocation

Fernhill applies overhead at $50 per technician hour, the $1,500,000 annual budget divided by 30,000 hours.

FOs: 0.8 hours a pair, $40 of overhead, $640,000 in all; profit $11.40 a pair, 13.0 percent of price.

AFOs: 2.4 hours each, $120 of overhead, $504,000 in all; profit $159.40 each, 38.0 percent.

TLSOs: 8.9 hours each, $445 of overhead, $356,000 in all; profit $82.40 each, 7.9 percent.

On these figures, every line is profitable, and the braces' $65,920 of total profit looks worth growing.

Table 2: Five Activity Pools

Fernhill's operations manager traced the overhead budget to five activities, each with a driver that plausibly causes its cost:

Digital modeling ($360,000): engineers' time adjusting scans into printable models; driver, modeling hours, 6,500 in the year; rate $55.38 per hour.

Milling ($420,000): mill depreciation, tooling and maintenance; driver, mill hours, 12,000; rate $35 per hour.

Thermoforming ($240,000): oven power, molds and plastic handling; driver, oven cycles, 7,800; rate $30.77 per cycle. Foot orthoses are pressed eight pairs to a cycle; a spinal brace needs two cycles.

Fitting remakes ($300,000): rework when a device does not fit at the clinic; driver, remakes, 908; rate $330.40 per remake.

Order documentation ($180,000): checking prescriptions, measurement forms and the paperwork clinics need for insurance; driver, documentation hours, 4,080; rate $44.12 per hour.

The five pools add to $1,500,000, the same overhead as Table 1.

Table 3: Activity Use and the Side-by-Side Result

FOs used 1,600 modeling hours, 2,400 mill hours, 2,000 oven cycles, 480 remakes and 800 documentation hours, for $428,038 of overhead, or $26.75 a pair.

AFOs used 2,100 modeling hours, 5,880 mill hours, 4,200 cycles, 252 remakes and 1,680 documentation hours, for $608,716, or $144.93 each.

TLSOs used 2,800 modeling hours, 3,720 mill hours, 1,600 cycles, 176 remakes and 1,600 documentation hours, for $463,246, or $579.06 each.

Side by side, overhead per unit moves from $40 to $26.75 for FOs, from $120 to $144.93 for AFOs and from $445 to $579.06 for TLSOs. Profit per unit moves from $11.40 to $24.65 for FOs, from $159.40 to $134.47 for AFOs, and from $82.40 to a loss of $51.66 for TLSOs. Line profit moves from $182,400 to $394,362 for FOs, from $669,480 to $564,764 for AFOs, and from $65,920 to a loss of $41,326 for TLSOs. Total profit is $917,800 under both methods.

Spinal braces are 4 percent of the lab's devices but take 43 percent of modeling hours, 31 percent of mill hours and 39 percent of documentation hours, and the technician-hour rate hides all of it.

Why the Braces Move

Technician hours capture the braces' finishing time but not the work around it. A spinal brace begins with 3.5 hours of modeling to correct a scan of a curved spine, 4.65 mill hours, two oven cycles and two hours of insurance documentation, and 22 percent of braces return for a remake. Foot orthoses are the reverse: simple to model, pressed eight at a time and rarely remade. Cooper and Kaplan (1988) showed that volume-based allocation shifts cost from complex, low-volume products to simple, high-volume ones, and Fernhill's figures follow that pattern closely.

What the Owner Should Do

The comparison does not mean the brace line should be dropped. Some of the overhead it carries, such as the engineers' salaries and the mill lease, would remain if braces stopped. Kaplan and Anderson (2004) advise using activity costs to find which processes to fix and which prices to change before deciding which products to cut.

Three steps follow. First, set the brace price near $1,120 for new clinic contracts, which covers activity cost with a modest margin. Second, attack the remake rate: a 22 percent rate costs about $58,000 a year on this line alone, and a fitting checklist for clinics could halve it. Third, build modeling templates for common curve patterns, which could cut modeling hours per brace from 3.5 to about 2.5. Together these could return the line to profit within a year. The marketing push should wait until they do.

Limits

The drivers are estimates from one year of logs, and remake costs vary by device. Garrison et al. (2021) note that activity-based figures measure resources used, not necessarily cash that would be saved, so each step above should be judged on its own cash effect as well.

References

Cooper, R., & Kaplan, R. S. (1988). Measure costs right: Make the right decisions. Harvard Business Review, 66(5), 96-103.

Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2021). Managerial accounting (17th ed.). McGraw Hill.

Kaplan, R. S., & Anderson, S. R. (2004). Time-driven activity-based costing. Harvard Business Review, 82(11), 131-138.