Holly Manufacturing Case

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 Holly’s sales come from the standard cello, but sales of the custom model have been growing. Following is the company’s sales,
production, and cost information for last year:
Cello
Sales and production volume in unit
Unit Selling Price
Unit costs:
Direct materials
Direct labor
Manufacturing overhead*
Total unit costs
Unit Gross Profit
Direct Labor Hours
Direct Labor Rate Per Hour

*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

Standard
900
$600.00

Custom
100
$900.00

$150.00
$180.00
$135.00
$465.00
$135.00

$375.00
$240.00
$135.00
$750.00
$150.00

10.00
$18.00

10.00
$24.00

$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
1. 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?
Discuss why this might not be an accurate way to assign overhead costs to products.
2. How would the use of more than one cost pool improve Holly's cost allocation?
Use the data below for the questions which follow.
Holly's controller developed the following data for use in activity-based costing:
Manufacturing
Overhead Cost
Building depreciation
Maintenance
Purchasing
Inspection
Indirect materials
Supervision
Supplies
Total
3.

Amount
$40,000
$15,000
$20,000
$12,000
$15,000
$30,000
$3,000
$135,000

Standard
Cost Driver
Cello
Square footage
3,000
Direct labor hours
9,000
# of purchase orders
1,500
# of inspections
400
# of units manufacture
900
# of inspections
400
# of units manufacture
900

Custom
Cello
1,000
1,000
500
600
100
600
100

Use activity-based costing to allocate the costs of overhead per unit and in total to each model of cello.

4. Calculate the cost of a custom cello using activity-based costing.
5. Why is the cost different from the cost calculated using the traditional allocation method?
6. At the current selling price, is the company covering its true cost of production? Briefly discuss
7. What should Holly Manufacturing do about the situation?
8. What should Holly Manufacturing do if the quantity of custom cellos sold at the new price falls to 50 per year?
9. What should Holly Manufacturing do about the situation if the price of the custom cello cannot exceed $900?
10. At a selling price of $1,000 each, what is the breakeven unit volume for the custom cello?
11. What are the lessons learned from this case?