Morelli Case C8-46

A. INTRODUCTION OF THE CASE

Over the years, Morelli Electric Motor Corporation (MEMC) used job costing system with manufacturing overhead applied on the basis of direct labour hours. But, the conventional costing system is inappropriate to a business where product diversity has increased and cost structures have become more overhead intensive. Under these circumstances, the cost of high-volume, relatively simple products produced in large batches are likely to be overstated, and the cost of low-volume, speciality products produced in small batches are likely to be understated.

Indeed, this seemed to have happened to MEMC where their outdated costing systems imply their distorted product costs. In such circumstance, activity-based costing (ABC) system can be used to overcome problems that occur due to conventional costing systems. Furthermore, product cost computation via ABC system will be more accurate compared to current system as it identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each.

Regarding this case, raw material, direct labour, manufacturing overhead and non-manufacturing costs were analysed so that management could obtain useful information for managing activities right across the business.

B. CASE BACKGROUND

Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models assigned as standard, deluxe and heavy duty. Thus, the product costs and annual sales data are as a given below to evaluate Morelli company product costing system.

| Standard model | Deluxe model | Heavy-duty model |

Annual sales (units) | 20 000 | 1 000 | 10 000 |

Product costs : | | | |

Raw material | $ 10 | $ 25 | $ 42 |

Direct labour | $ 10 (0.5 hr @ $20) | $ 20(1 hr @ $20) | $ 20(1hr @ $20) |

Manufacturing overhead* | $ 85 | $ 170 | $ 170 |

Total product cost | $ 105 | $ 215 | $ 232 |

*...