Part I: Activity-Based Costing

1.1 Unit Manufacturing Costs of Simple Desk and Corner Workstation

Under Activity-Based Costing (ABC) system, the calculated unit manufacturing costs of simple desk and
corner workstation are $257.50 and $1059.50 respectively (See Fig. 3). However, under simple costing, the
unit manufacturing cost of simple desk was higher ($315) while the unit manufacturing cost of corner
workstation is lower ($935). So, the simple desk was over cost while the corner workstation was under cost
using the simple costing system.

Product Data (Per unit)

Simple desk Corner Workstation
(per unit) (per unit)
Direct manufacturing labor hours
0.6 1.2
(720 hrs. ÷ 1200 ; 540 hrs. ÷ 450)
Number of components 2 7
Layered panels used (square feet)
7.1 38.5
(8520sq. feet ÷ 1200 units ; 17325 sq. feet ÷ 450 units)
Engineering hours
0.03333 0.26667
(40 hrs. ÷ 1200 units ; 120 hrs. ÷ 450 units)
Materials handling (batches)
0.05 0.1
(60 batches ÷ 1200 units ; 45 batches ÷ 450 units)
Machine set up hours
0.1 0.4
(120 hrs. ÷ 1200 units ; 180 hrs. ÷ 450 units)
Fig. 1

Budgeted Activity-based Costing Allocation Information

Cost Driver Quantity
Activity Total Activity Costs Cost Driver (Practical Capacity) Allocation Rate
(1) (2) (3) (4) (5) = (2) ÷ (4)

Design and plan the $375 per

$ 262500 Engineering hours 700
production process engineering hour

Make layered Square feet of $5 per sq. feet of

$ 861500 172300
panels layered panels layered panels
Handle material $ 88000 No. of batches 440 $200 per batch
Setup machine $40000 Setup hours 1600 $25 per hour
No. of units x no. of $26 per
Run machine $601250 23125
components per unit component
Inspect and package
$368000 No. of units 9200 $40 per unit
the product
Fig. 2

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 Unit Manufacturing Costs for Simple Desk and Corner Workstation under ABC system
Simple Desk Corner Workstation
(per unit) (per unit)
Direct Costs
Direct materials costs $96 $497
Direct manufacturing labor costs
$9 $18
($15 x 0.6 hr, 1.2 hrs)
Total direct costs $105 $515
Indirect costs of activities
Design and plan the production process $12.50 $100.00
($375 x 0.03333 engineering hrs., 0.26667 engineering hrs.)
Make layered panels $35.5 $192.5
($5 x 7.1 sq. feet, 38.5 sq.feet)
Handle material $10 $20
($200 x 0.05 batch, 0.1 batch)
Setup machine $2.5 $10
($25 x 0.1 setup hours, 0.4 setup hours)
Run machine $52 $182
($26 x 2 components, 7 components)
Inspect and package the product $40 $40
($40 per unit)
Total indirect costs allocated $152.50 $544.50
Total costs $257.50 $1059.50
Remarks: All calculations are rounded off to 2 decimal places.
Fig.3

1.2 Problems with Simple Costing

EyWood Furniture had a considerable amount of indirect costs and the use of a simple costing system would
lead to inaccurate product costs. Simple costing uses a single, plant-wide manufacturing overhead rate to
allocate costs. It uses broad averages (peanut butter costing) for assigning the cost of resources to cost
objects uniformly neglecting the fact that different individual products may use those resources in non-
uniform ways. Hence, the cost data obtained would be unreliable and product-cost cross-subsidization
usually occurs which means that one product is under cost and at the same time the other is over cost.
In the case of Eywood Furniture, simple desks and corner workstations use resources in a different way.
Under simple costing which uses direct manufacturing labour hours as the only allocation base, simple desks
were over cost while corner workstations were under cost due to the inaccurate cost data obtained. This
caused the selling price of simple desks being set too high leading to a loss of market share to its competitors
while the selling price for corner workstations were set lower than its competitors, wrongly creating a view
that the corner workstations are very competitive and profitable in the market.
1.3 Activity-Based Costing Solution
Activity-based costing (ABC) system might help tackling the problems of simple costing. ABC system is a
refined cost system that identifies individual activities as fundamental cost objects. Costs are assigned to cost
objects on the basis of the mix of activities required for the production of each product. As a result, multiple
cost pools are used.

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 In the case of Eywood Furniture, six activities are identified and there would be six cost pools. Costs would
be assigned to simple desks and corner workstations on the basis of the mix of activities required for each of
them. For each activity-cost pool, a cost-allocation base that has cause-and-effect relationship would be
sought. Therefore, the cost data for simple desks and corner workstations would be much more accurate.
2. Actions that Improve Company’s Profitability
First of all, EyWood Furniture should adopt ABC system instead of simple costing system and refine the
cost system so as to obtain a more accurate measurement of indirect costs required by various cost objects.
The management team should identify as many direct costs as possible in an economically feasible way so
that the extent to which costs have to be allocated would be minimized. The indirect cost pools should be
expanded until each cost pool is more homogeneous and the cost driver should be used as the cost allocation
base for each homogeneous indirect cost pool whenever possible.
Secondly, the pricing of simple desks and corner workstations and the focus on products should be adjusted.
For simple desks, the price should be set at $412 ($257.50 x 1.6) according to the company’s 60% mark-up
policy and this price would be lower than that of the competitors ($420). The gross margin ratio would be
37.5% (($412 - $257.50) ÷ $412 x 100%) which is still higher than 35%. EWF may even further increase the
price as $412 is $8 below the $420 competitors’ price to obtain a higher gross profit margin. However, this
depends on whether the increase in revenues due to the increase in price would exceed the loss in revenues
due to the decrease in sales level resulting from the higher price or not.
For the corner workstations, the price would be $1695.2 if the 60% mark-up policy is adopted and it would
be higher than the competitors’ price of $1650. This would reduce the competitiveness of the product and
lose market share. So, the price should be set at $1650 even though the gross profit margin would be lowered
so as to maintain competitiveness and market share. The lowered gross profit ratio of 35.79% (($1650 -
$1059.5) ÷ $1650 x 100%) is still higher than 35% so it is still ideal to earn a reasonable return for the
company. However, EWF should focus more on simple desks since they have a greater gross profit margin.
Thirdly, the management team should cut unnecessary costs of idling capacity so as to increase profitability.
For example, there are 400 idle setup hours (1600 practical capacity - 1200 actual usage) of the setup
machine activity wasted. One step of 400 setup hours (refer to Exhibit 5) could be cut. Then, the capacity
would be fully utilized without any wastage. Also, for the activity of inspect and package the product, 3700
units were wasted (9200 practical capacity - 5500 actual usage). One step of 3000 units (refer to Exhibit 5)
could be cut to reduce the wastage.
Part II: Decision Making
3. Introduction of Multi-Pack Desk with Shelves – The Financial Concern
Referring to Fig. 4, the total revenues of the 900 units of Multi-Pack Desk with Shelves is expected to be
$720000 while the total costs is expected to be $639750. One important point to note is that the additional
capacity for the activity of design and plan the production process needs to be purchased in order to produce
900 units of Multi-Pack Desk with Shelves. The practical capacity of other activities are large enough for the
extra 900 units of Multi-Pack Desk with Shelves. So, there would be no additional costs to be incurred for
these activities.
Therefore, revenues exceed costs for the 900 units of Multi-Pack Desk with Shelves and this would bring a
positive operating income of $80250. This indicates that EWF would have an $80250 profit increase if they
introduce this new product. If the financial concern is the only concern, EWF should introduce Multi-Pack
Desk with Shelves at a price of $800.

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 Budgeted Revenues and Costs of Multi-Pack Desk with Shelves
900 units
Multi-Pack Desk with Shelves
Total Per unit
(1) (2) = (1) ÷ 900
Revenues
$720000 $800
($800 x 900 units)
Direct costs
Direct materials costs
$315000 $350
($350 x 900 units)
Direct manufacturing labor costs
$13500 $15
($15 x 1hr. x 900 units)
Total direct costs $328500 $365
Purchase of additional capacity $131250 $145.83
Additional nonmanufacturing costs $180000 $200
Total costs $639750 $710.83
Operating income $80250 $89.17
Remarks: All calculations are rounded off to 2 decimal places.
Fig. 4

4. Introduction of Multi-Pack Desk with Shelves – Additional Factors to Consider

Other than the financial concern, there are a number of additional factors to consider before deciding
whether to add the Multi-Pack Desk with Shelves. Firstly, the factor of employees’ morale should be taken
into consideration. More work have to be done with the introduction of Multi-Pack Desk with Shelves. The
workload of employees would be greatly increased and they would feel more tiring. Their morale would thus
be adversely affected.
Secondly, it would be the consideration of production capacity. EWF should carefully assess the production
capacity like factories and other resources. The management team have to ensure that the factories are
capable of producing the extra new products and there are sufficient resources available to cope with the
increased inputs.
The third factor would be quality. The quality of other original products like simple desks and corner
workstations may fall. Workers may rush through work due to the increased workload resulting from the
introduction of Multi-Pack Desk with Shelves. EWF should take the quality factor into account.
Fourthly, it would be the issues regarding external suppliers that needs to be taken into account. EWF should
check with the suppliers in Malaysia, Indonesia and Taiwan to see if they are able to provide sufficient raw
materials (hardwood, veneers etc.) for the increased production. Also, EWF should have enough liquid
assets (e.g. cash) to pay off the increased debts owed to the suppliers resulting from the introduction of
Multi-Pack Desk with Shelves. If the company cannot repay the debts on time, the suppliers may terminate
the supply of raw materials or implement other punishing measurements. The relationship with external
suppliers may deteriorate leading to serious undesirable consequences. EWF should consider all these issues.
Finally, EWF has to consider the factor of market image. Introducing a new product usually impacts the
company’s image. For example, introducing the Multi-Pack Desk with Shelves may create a market image
of increased product diversity attracting more customers. So, the management team should consider the
effects of introducing the Multi-Pack Desk with Shelves on the market image, whether it poses positive
effects or negative effects.
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Part III: Ethics
5. Ethical Conducts and Recommended Actions
The primary commitment of the practitioners of accounting and management is to the organization and the
shareholders. They have an obligation to the public, the organization and the organization they serve. So,
they must remind themselves to maintain the highest standards of ethical conducts at all times. They must
never submit to pressure from anyone to manipulate financial and management information. Instead, they
must have the courage to stand against the corrupt personnel and report them.
Accountants must always act honestly, fairly, objectively and responsibly. According to the Institute of
Management Accountants (IMA), there are mainly four ethical conducts that an accountant must comply
with namely competence, confidentiality, integrity and credibility.
In Tracy’s case, she noticed that some managers have instructed the scale employees to deliberately “lowball”
the evaluations of the woods quantity and quality so as to reduce the purchasing cost and achieve the annual
budgeted profit numbers. The managers could then earn substantial bonuses. If Tracy chose to remain silent,
she would have violated the ethical conducts of competence, integrity and credibility.
For competence, Tracy should recognize and communicate professional limitations or other constraints that
would preclude responsible judgment or successful performance of an activity. She had noticed the actions
of the corrupt managers would harm the company and its shareholders with her professional knowledge. If
she kept silent, she would have been irresponsible and failed to perform her professional duties. Tracy
should use her professional knowledge wisely and bring the case to higher management levels. She should
notify the company of the possible harms and consequences of such actions so that the company could make
correct decisions and judgements with sufficient information and maintain its successful operation.
To maintain integrity, Tracy should refrain from engaging in any conduct that would prejudice carrying out
duties ethically and abstain from engaging in or supporting any activity that might discredit the profession.
Tracy knew the managers’ actions are unethical and they may even commit a crime. If she still remained
silent, she would have supported such unethical actions and put the company and shareholders into harm.
This kind of dishonest would discredit the company and her profession as well as encouraging duties to be
carried out unethically within the company. She would have violated the conduct of integrity and may even
face a prison term.
For credibility, Tracy should communicate information fairly and objectively, disclose all relevant
information that could reasonably be expected to influence an intended user’s understanding of the reports,
analyses, or recommendations and disclose delays or deficiencies in information, timeliness, processing, or
internal controls in conformance with organization policy and/or applicable law. The action of depressing
the evaluation of the woods would result in deficiencies in information and would influence the decision-
makers’ understanding of the relevant reports, analyses and recommendations. Inappropriate judgements and
decisions would be made leading to serious undesirable consequences. It is unfair for Tracy to stay silent and
she would have definitely violated the conduct credibility.
Therefore, it is recommended that Tracy to report the case to higher management levels such as talking to a
senior executive member. If the result is unsatisfactory, Tracy should report to even higher management
levels, for example the President Jackson Lee or even reviewing authorities like the board of directors,
owners, executive committee etc. Tracy could also report the case to the Ethics Committee. If the problem
still remained unaddressed, Tracy should have a confidential discussion with other impartial advisors and at
the same time consult legal advice concerning the legal obligations and rights. The worst situation would be
leaving the company if the problem became more and more serious and the company became corrupted.

5
 All in all, Tracy as the controller of the company should set a good example and encourage others to perform
duties ethically and professionally. She must comply with all ethical conducts and principles strictly at all
times. She must stand against any actions that are unethical and protect the benefits of the company and its
shareholders.
Part IV: Strategic Planning
6. Strategy in the Next Five Years for Profitabilty Growth
The competition in the furniture industry is very keen. Manufacturers from all over the world have come to
China to set up production facilities to take advantage of the low labour and land costs. Moreover, minimum
wage laws, labour shortages, appreciation of the RMB have all pushed the labour costs in China, especially
places like Guangdong and the Pearl River Delta. So, furniture is not an easy business to do.
For the next five years, EWF should exploit the China Market of huge potential, adopting a strategy of brand
building as well as cost control. The sales value of the furniture industry in China has reached RMB 137.5
billion in November, 20121. The industry is still expected to grow rapidly due to the soaring demand for
various furniture (home, hotel and guesthouse, office, institutional etc.) resulting from China’s economic
boom, rising consumption power, promising tourism and prosperous property market. China has a huge
population size and it is expected that many people would buy furniture or replace old furniture creating a
high demand. Also, Hong Kong furniture enjoys tariff-free treatment under CEPA. Thus, the China market
has a great potential and EWF should grasp the opportunity to capture the China market so as to increase
profits.
EWF needs to put more resources in brand-building because it is very hard to increase profitability when
involving in vigorous price competition. So, it is vital for EWF to build its own brand. The first step of
brand-building is to differentiate its products. Product differentiation could be done by enhancing quality.
According to a consumer survey conducted by the Hong Kong Trade Development Council (HKTDC),
respondents believed that “quality” and “style” are the most important factors2. So, consumers are paying a
high attention on quality and “price” is relatively not so important. Therefore, EWF should focus on high
end products and strive to improve the quality of furniture. This would help the products of EWF to
differentiate from the products of competitors and would help EWF to capture the mainland customers and
reap a greater profit.
The second step of brand-building is product diversification. EWF needs to build a brand that provides a
great variety of furniture so as to suit the tastes of different customers. A great variety and choices would
also make EWF different and stand out among the competitors. So, EWF should introduce a wide variety of
furniture to suit the demands from households, hotels, offices and various institutions.

6
1
HKTDC. (2013). China’s furniture market. HKTDC Research. Retrieved April 21, 2014 from http://china-trade-
research.hktdc.com/business-news/article/China-Consumer-Market/China-s-furniture-market/ccm/en/1/1X000000/1X002L63.htm
2
HKTDC. (2013). China’s furniture market. HKTDC Research. Retrieved April 21, 2014 from http://china-trade-
research.hktdc.com/business-news/article/China-Consumer-Market/China-s-furniture-market/ccm/en/1/1X000000/1X002L63.htm
For the choice of furniture materials, consumers tend to go for solid wood or wood veneer3. This trend is
beneficial to EWF as the company mainly produces wooden furniture. However, the furniture market now
has an increasing demand on modern classical furniture combining Chinese and Western elements4.
Transitional styles are also becoming popular5. These trends require a great diversity of wood materials and
designs. So, EWF should diversify and provide more types of furniture with different styles to deal with this
demand.
Other types of furniture like children and outdoor furniture should not be neglected too. The number of
children aged 0-14 reached 220 million, accounting for 16.6% of the total population of China and parents
become more aware of the importance of furniture to child development6. So, there would be a big market
demand for children furniture. Among children’s furniture market, beds and tables and chairs take up the
biggest shares, accounting for 38% and 35% respectively according to surveys7. EWF can thus introduce
some high quality wooden children chairs, tables and beds. For outdoor furniture, EWF could produce
corresponding furniture suiting private gardens of villas and hotels.
EWF could also introduce some innovative and interesting products as a form of product diversification. For
example, green and eco-friendly furniture. EWF has always been aware of environmental protection.
According to a HKTDC’s consumer survey, over 90% of the respondents are interested in using green, eco-
friendly materials and are willing to pay a premium of 14% on average in purchasing products made of green
materials8.
Finally, EWF should carefully control its costs in order to grow profitability. For example, EWF may assess
and monitor the production capacity frequently. Currently, there are quite a lot of idling production capacity
which are wasted since the practical capacity exceeds the actual usage. The company may try to produce
more different kinds of product products (diversify the products) to use up the production capacity and
reduce wastage or even cut some of the capacity.
Therefore, in view of various market trends and business environment factors, EWF should adopt a strategy
of brand building which includes product differentiation, quality enhancement and product diversification.
At the same time, the company should control the costs and reduce wastage of resources.

7
3
HKTDC. (2013). China’s furniture market. HKTDC Research. Retrieved April 21, 2014 from http://china-trade-
research.hktdc.com/business-news/article/China-Consumer-Market/China-s-furniture-market/ccm/en/1/1X000000/1X002L63.htm
4
HKTDC. (2013). China’s furniture market. HKTDC Research. Retrieved April 21, 2014 from http://china-trade-
research.hktdc.com/business-news/article/China-Consumer-Market/China-s-furniture-market/ccm/en/1/1X000000/1X002L63.htm
5
Style My Space. (2012). What Is The Most Popular Furniture In Homes Today?. Style My Space. Retrieved April 21, 2014
from http://stylemyspace1.wordpress.com/2012/10/26/what-is-the-most-popular-furniture-in-homes-today/
6
HKTDC. (2013). China’s furniture market. HKTDC Research. Retrieved April 21, 2014 from http://china-trade-
research.hktdc.com/business-news/article/China-Consumer-Market/China-s-furniture-market/ccm/en/1/1X000000/1X002L63.htm
7
HKTDC. (2013). China’s furniture market. HKTDC Research. Retrieved April 21, 2014 from http://china-trade-
research.hktdc.com/business-news/article/China-Consumer-Market/China-s-furniture-market/ccm/en/1/1X000000/1X002L63.htm
8
HKTDC. (2013). China’s furniture market. HKTDC Research. Retrieved April 21, 2014 from http://china-trade-
research.hktdc.com/business-news/article/China-Consumer-Market/China-s-furniture-market/ccm/en/1/1X000000/1X002L63.htm