# 3.0: Introduction

 Cindy (CEO): Ever since we introduced the Deluxe model our profits have taken a beating. I need some input on what we should do to get this turned around. Mary (Marketing Vice President): I’m not sure you can blame our salespeople. We’ve asked them to push the Deluxe model because of the high profit margins, and our sales force has really responded. Sales have steadily increased over the last couple of years, and customers seem to love our sailboats. Bob (Production Vice President): I don’t think the problem is with our products, and using our current costing system, we make $320 in profit for each Basic model and$850 for each Deluxe model. We need to take a close look at how the cost of each boat is determined. Overhead costs have increased significantly since we started producing the Deluxe boat—to about 45 percent of total production costs—and yet we use only one overhead rate based on direct labor hours to allocate these costs. I don’t see how this can lead to an accurate cost, and I assume we set the price based on the cost of each boat. Cindy: We certainly considered the cost in our pricing structure. Are you telling me the cost information I have isn’t accurate? John (Accountant): No, the cost information you have is fine for financial reporting, but not for pricing products. When we were producing only the Basic model, overhead allocation wasn’t an issue. All overhead costs were simply assigned to the one product. Now that we have two products, overhead is allocated based on direct labor hours as Bob stated. We are required to allocate overhead for financial reporting purposes, but I wouldn’t use this cost information for internal pricing purposes. Bob: I can tell you that the production process for the Deluxe model is much more complicated than the one for the Basic model, so I would expect to see significantly higher costs attached to the Deluxe boat. John: What I’m hearing is that we need better cost information. I think it’s time we move to a more sophisticated costing system called activitybased costing. Give me time to do some research. Let’s meet next week.