CMI Costing: Pricing Strategy and Activity-Based Costing

CMI has a problem of pricing its computer products due to inappropriate overhead allocations. The pricing strategy influences the sales volume and the contribution realized from the computers. CMI uses an overhead costing system, Just in time inventory management, and mark-up pricing method. The Cortland 1000 and Cortland 2000 computer models have different unit costs under the current overhead costing method and activity-based costing. Activity-based costing is recommended to provide accurate costs per unit.

Running head: CMI COSTING
CMI Costing
Name
Institution

CMI COSTING 2
1. Background
Cortland Manufacturing, Inc. (CMI) manufactures and sells different models of
computers to health systems and hospitals across the United States. CMI has
gained a competitive advantage against its critical rivals by manufacturing user-
friendly computers. For example superb graphical feature of the computers makes
them unique leading to higher sales volume. The computers are mostly used on the
nursing sections by nurses and physicians. The company manufacture its computers
in house using raw materials that are purchased from approved suppliers. Three
different machines are used in the manufacturing processes. The first process
involves testing the raw material to ascertain their conformity to CMI specifications
using the inspecting machines. Soldering machines are used during the second
process to solder different components together. The last process involves
assembling soldered components using assembly machines.
CMI uses an overhead costing system where all costs from different operational
overhead are summed up to obtained the total production cost. Sixty percent of the
company’s cost comes from receiving, inspecting and handling raw materials,
assembling and adjusting computers, and inspecting and packing finished
computers. On the other hand, 40% came from maintenance, depreciation, and
repair of assembled machines. CMI uses Just in time (JIT) inventory management
method to avoid overstocking at the end of every month. Currently CMI is
manufacturing Cortland 1000 and Cortland 2000 for the hospitals. Cortland 1000 is
sold in large quantities while Cortland 2000 is new complicated computer product
which is still unpopular with the buyers. Lastly, CMI uses a mark-up pricing method
to price its computers. A computer goes for 50 percent mark-up on top of the full cost
of a single unit.
2. Problem & issues
2.1. Problem recognition
CMI has a problem of pricing its computer products. The company relies on a
single mark-up price for its products which are to be sold in different markets. Steve
Works, the CEO, has been informed by the company accountant that overhead

CMI COSTING 3
allocations lead to inappropriate pricing. As a result, computers are under-priced and
over-priced in different markets. The CEO seeks to address the problem by revising
the pricing method.
2.2.The significant issues and rationales
The pricing strategy influences the sales volume and the contribution realized
from the computers. CMI is operating in a competitive market where other
companies that manufacture and sell similar computers as well. Although CMI has
successfully differentiated their computers, price remains a determinant factor of the
sales to be realised from the computers. Under-pricing of the computers would result
in a small contribution margin. Likewise, over-pricing of computers would reduce the
sales volume. Either way, CMI would not do not realise its full potential from selling
the products (Bragg, 2019).
Moreover, CMI relies on assumptions to estimate the cost associated with each
overhead cost. Considering that costs are influenced by external market factors,
estimation does not give the accurate cost of each overhead. Unfavourable
conditions lead to higher overheads compared to the company estimates. Likewise,
favourable conditions lead to lower overheads compared to the company estimates.
Such a scenario could easily lead to inappropriate pricing by CMI (Bragg, 2019).
3. Theoretical Analysis
The concept of contribution margin analysis is applicable in analysing the
problem facing CMI. Contribution margin analysis is derived from Cost/ Volume/
Profit (CVP) analysis, and it describes the number of sales a company would remain
with after deducting variable costs. The accountant of CMI is concerned about the
mark-pricing method used by the company. Inappropriate pricing of the computers
leads to either overpricing or under-pricing (Drury, 2013). CMI uses estimated
overheads to determine the prices of different computer models. Inaccuracy in
estimating the prices have an impact on the contribution margin. The inaccurate
values of contribution margin realised from the sales of computers gives a false
presentation of the company’s financial position. For example, higher cost estimates
would increase the selling price hence and increase in the contribution margin and
hence an increase in profit. However, the contribution margin would remain lower

CMI COSTING 4
when changes in the market are taken into consideration (Vanderbeck & Mitchell,
2015).
Likewise, the economic market has influenced the forces of demand and
supply. Consumers’ ability to buy increase when the price is low and decrease when
the price increase. When the amount of CMI computers is, compared to competitors,
the sales volume will reduce. The sales volume would increase when CMI’s prices
are lower compared to that of the competitors. CMI’s problem with pricing would
persist unless the company revises its pricing method (Lanen, 2016).
4. Calculations & Interpretations
4.1. Calculations
The calculations are based on exhibit 1, exhibit 2 and exhibit 3 presented in
CMI’s case study.
a) Current Overhead cost
Machine Hours= Soldering time + Assembly time
a) Cortland 1000
20000 *3 60000
10000 *1 10000
b) Cortland 2000
10000 *1 10000
10000 *1 10000
Total Machine hours 90000
Overhead rate = Total Overhead cost / Machine hours $ 196000000/ 90000
$2178
The current cost per unit is calculated as shown below.
Cortland 1000 ($) Cortland 2000 ($)
Direct Materials 1,000 2,500
Direct Labor 200 400
Manufacturing
overhead cost
2178*4 2178*2
8,712 4,356

CMI COSTING 5
Cost per Unit 9,912 7,256
50 % Mark up 4,956 3,628
Selling Price 14,868 10,884
b) Activity-Based Costing (ABC)
ABC can also be used to calculate the unit price of Cortland 1000 and Cortland
2000 computers. The first step for calculating the selling price under ABC is no
determine the activity rate.
Activity rates
Activity Units Total Amount ($) Calculation Rate ($)
Receive/ handle
materials
200 90000000 90000000/ 200 450,000 per
order
Adjust/ set up
machines
2000 12000000 12000000/ 2000 6,000 per
setup
Inspect, pack,
ship
500 60000000 60000000/ 500 120000 per
batch
Inspect raw
material
200000 10000000 10000000/
200000
50 per hour
Solder parts 200000 12000000 12000000/
200000
60 per hour
Assemble
computers
100000 12000000 12000000/
100000
120 per hour
Activity Cortland 1000 Cortland 2000
Raw Material orders 2 10
No. of batches 4 50
Machine setups 20 300
Receive/handle materials 900000 4500000
Adjust/set up machines 120000 1800000
Inspect, pack, ship 480000 6000000
Inspect raw material 1000000 500000
Solder parts 3600000 300000
Assemble computers 2400000 600000
Total Overhead 8500000 13700000
Overhead per computer 8500000/ 20000 13700000/ 5000
$ 425 $ 2740
Cost per Computer

CMI COSTING 6
Direct Materials 1000 2500
Direct Labor 200 400
Manufacturing overhead cost 425 2740
Cost per Unit 1625 5480
50 % Mark up 812.5 2740
Selling Price $ 2437.5 $ 8220
4.2. Calculations & Interpretations – Quantitative Analysis
The quantitative analysis for the pricing problem facing CMI is based on two
technique; the overhead based costing and activity-based costing. Overhead based
costing comprises of the overhead activities associated with manufacturing a
computer. On the other hand, activity-based costing is made up the costs associated
with the activities that were performed during the manufacturing process (Mason,
2019).
The quantitative analysis considered the overhead cost associated with
manufacturing a unit of Cortland 1000 and Cortland 2000 computers under each
costing method. The company incurred total manufacturing costs per unit of $ 9,911
and $7,256 for Cortland 1000 and Cortland 2000 respectively under the current
overhead based costing method. Likewise, the company would have incurred
overhead costs per unit of $ 1625 and $5,480 apiece for Cortland 1000 and Cortland
2000 under activity-based costing. The selling price is $14,868 and $10,884 for
Cortland 1000 and Cortland 2000 respectively under the current costing method. The
selling price would be $ 2,438 and $ 8, 220 for Cortland 1000 and Cortland 2000
respectively under the activity-based costing.
5. Recommendations
Steve Works seeks a costing method that would provide accurate/ appropriate
figures. The accountant had raised concerns about the inaccurate figures that were
obtained from the current overhead costing technique. Activity-based costing (ABC)
is recommended to the Steve Works. The recommendation is based on three
reasons. First, ABC provides realistic costs associated with production under
complex business environments. Second, ABC offers a better insight into factors that
influence overhead costs compared to the current method used by the company.

CMI COSTING 7
Third, ABC provides an accurate cost per unit leading to improved performance
management (Wildman, 2019).

CMI COSTING 8
6. References
Bragg, S. M. (2019). Cost Accounting Fundamentals: Sixth Edition: Essential
Concepts and Examples. Amazon Digital Services LLC: New York.
Bragg, S. M. (2019). Cost Accounting: Second Edition: A Decision-Making Guide.
New York: Amazon Digital Services LLC - Kdp Print Us.
Drury, C. M. (2013). Management and Cost Accounting. New York: Springer.
Lanen, W. N. (2016). Fundamentals of Cost Accounting. New York: McGraw-Hill
Education.
Mason, D. (2019). Exam Prep for: Bundle; Principles Of Cost Accounting. New
Jersey: Rico Publications.
Vanderbeck, E. J., & Mitchell, M. R. (2015). Principles of Cost Accounting. New
Jersey: Cengage Learning.
Wildman, J. R. (2019). Cost Accounting Problems. Sacramento, CA: Creative Media
Partners.