Activity-Based Costing: A Tool to Aid Decision Making (Exercises with Answers)

Activity-Based Costing: A Tool to Aid Decision Making 121. Cosgrove Company manufactures two products, Product K-7 and Product L-15. Product L-15 is of fairly recent origin, having been developed as an attempt to enter a market closely related to that of Product K-7. Product L-15 is the more complex of the two products, requiring 2.0 hours of direct labor time per unit to manufacture compared to 1.0 hour of direct labor time for Product K-7. Product L-15 is produced on an automated production line. Overhead currently is applied to the products on the basis of direct labor-hours. The company estimated it would incur $510,000 in manufacturing overhead costs and produce 10,000 units of Product L-15 and (40,000 units of Product K-7 during the current year. Unit costs for materials and labor are: x1m 40, στο hours 20,600 hrs. 60,000 ha Direct material.......... Direct labor. Required: X 2hrs Product K-7 Product L-15 511 $24 $510,000 $6 $12 2.50 per hour 60,000 hrs a. Compute the predetermined overhead rate under the current method) and determine the product cost of each product for the current year. unitt b. The company is considering the use of activity-based costing as an alternative to its traditional costing method for manufacturing overhead. Data relating to the company's activity cost pools for the current year are given below: ABC POHRE Numerator Activity Cost Pool Total Cost Product K-7 Total Activity Product L-15 Total Machine setups required. Purchase orders issued Machine-hours required. 5204,000 800 1,600 2.400 43.500 500 100 600 105,000 7,000 10,500 17.500 Maintenance requests issued 157.500 650 850 1,500 $510.000 85,00 persetup 72.50 por order 600 per hom 105,60 per request. 2+3 Using the data above, determine the unit product cost of each product for the current year. c. What items of overhead cost make Product L-15 so costly to produce according to the activity-based costing system? What influence might the activity-based costing data have on management's opinions regarding the profitability of Product L-15? a. The company expects to work 60,000 direct labor-hours during the current year, computed as follows: Product K-7: 40,000 units 1 hour. 40,000 hours Product L-15: 10,000 units 2 hours. 20.000 hours Total direct labor-hours 60,000 hours Using these hours as a base, the predetermined overhead using direct labor-hours would be: Predetermined overhead rate = Estimated overhead cost Estimated direct labor-hours = $510,000-60,000 hours = $8.50 per hour Using this overhead rate, the unit product cost of each product would be: Product K-7 Product L-15 Direct materials. $11.00 $24.00 Direct labor. 6.00 12.00 Manufacturing overhead: Product K-7, 1.0 hour. 8.50 Product L-15, 2.0 hours.... 17.00 Total unit product cost. $25.50 $53.00 b. The activity rates for each activity cost pool are as follows: Machine setups. Purchase orders. Machine-hours Maintenance requests. Total Cost Total Activity Activity Rate $204,000 2,400 setups $43,500 600 orders $85.00 $72.50 per setup per order $105,000 17,500 hours $6.00 per hour $157,500 1,500 requests $105.00 per request The overhead cost charged to Product K-7 is: Machine setups. Purchase orders. Machine-hours. Activity Rate $85.00 per setup 572.50 per order $6.00 per hour Activity 800 setups 500 orders ABC Cost $68,000 36,250 7,000 hours 42,000 Maintenance requests. $105.00 per request 650 requests 68.250 Total overhead cost $214.500 The overhead cost charged to Product L-15 is: Activity Rate ABC Cost Machine setups. $85.00 per setup 1,600 setups $136,000 Purchase orders. 572.50 per ordes 100 orders 7,250 Machine-hours. $6.00 per hour 10,500 hours 63,000 Maintenance requests. $105.00 per request 850 requests 89.250 Total overhead cost. 5295 500 Overhead cost per unit: Product K-7: $214,500+40,000 units = $5.3625 per unit Product L-15: $295,500+10,000 units = $29.5500 per unit Using activity based costing, the unit product cost of each product would be: Product K-7 Product L-15 Direct materials. $11.0000 $24.00 Direct labor. 6.0000 12.00 Manufacturing overhead. 5.3625 29.55 Total unit product cost. $22.3625 $65.55 c. Product L-15 accounts for 20% of the company's total product, but requires two-thirds of the total machine set-ups and sixty percent of the machine-hours worked in addition to more than half of the maintenance requests. These factors are concealed when direct labor-hours are used to assign overhead cost to product. Activity-based costing, however, assigns a larger amount of overhead cost to Product L-15. Indeed, Product. L-15 may be less profitable than the company has been led to believe under the traditional direct labor approach. Learning Objective: 06-01 Understand activity-based costing and how it differs from a traditional costing system. Learning Objective: 06-03 Compute activity rates for cost pools. Learning Objective: 06-04 Assign costs to a cost object using a second-stage allocation Level: 3 Hard Activity