Activity Replacing engines Expediting orders Repairing engines * All units are tested after assembly, and some are rejected because of engine failure. The failed engines are removed and replaced, with the supplier replacing any failed engine. The replaced engine is retested before being sold. Engine failure often causes collateral damage, and other parts often need to be replaced. Due to late or failed delivery of engines. *Repair work is for units under warranty and almost invariably is due to engine failure. Repair usually means replacing the engine. This cost plus labor, transportation, and other costs make warranty work very expensive. Cost $ 800,000 1,000,000 1,800,000 Watson Johnson Engines replaced by source Late or failed shipments 1,980 20 198 Warranty repairs (by source) 2,440 60
Activity-Based Supplier Costing
Levy Inc. manufactures tractors for agricultural usage. Levy purchases the engines needed
for its tractors from two sources: Johnson Engines and Watson Company. The Johnson
engine has a price of $1,000. The Watson engine is $900 per unit. Levy produces and
sells 22,000 tractors. Of the 22,000 engines needed for the tractors, 4,000 are purchased
from Johnson Engines, and 18,000 are purchased from Watson Company. The production manager, Jamie Murray, prefers the Johnson engine. However, Jan Booth, purchasing
manager, maintains that the price difference is too great to buy more than the 4,000
units currently purchased. Booth also wants to maintain a significant connection with
the Johnson source just in case the less expensive source cannot supply the needed quantities. Jamie, however, is convinced that the quality of the Johnson engine is worth the
price difference.
Frank Wallace, the controller, has decided to use activity costing to resolve the issue. The
following activity cost and supplier data have been collected:
Required:
1. CONCEPTUAL CONNECTION Calculate the activity-based supplier cost per engine
(acquisition cost plus supplier-related activity costs). (Round to the nearest cent.) Which
of the two suppliers is the low-cost supplier? Explain why this is a better measure of
engine cost than the usual purchase costs assigned to the engines.
2. CONCEPTUAL CONNECTION Consider the supplier cost information obtained in
Requirement 1. Suppose further that Johnson can only supply a total of 20,000 units.
What actions would you advise Levy to undertake with its suppliers?
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