Concept explainers
Handbrain Inc. is considering a change to activity-based product costing. The company produces two products, cell phones and tablet PCs, in a single production department. The production department is estimated to require 2,000 direct labor hours. The total indirect labor is budgeted to be $200,000.
Time records from indirect labor employees revealed that they spent 30% of their time setting up production runs and 70% of their time supporting actual production.
The following information about cell phones and tablet PCs was determined from the corporate records:
- a. Determine the indirect labor cost per unit allocated to cell phones and tablet PCs under a single plantwide factory
overhead rate system using the direct labor hours as the allocation base. - b. Determine the budgeted activity costs and activity rates for the indirect labor under activity-based costing. Assume two activities—one for setup and the other for production support.
- c. Determine the activity cost per unit for indirect labor allocated to each product under activity-based costing.
- d. Why are the per-unit allocated costs in (a) different from the per-unit activity cost assigned to the products in (c)?
a.
Compute the indirect labor cost per unit allocated to cell phones and tablet under a single plant wide factory overhead rate system.
Explanation of Solution
Single plant-wide factory overhead rate: The rate at which the factory or manufacturing overheads are allocated to products is referred to as single plant-wide factory overhead rate.
Formula to compute single plant-wide overhead rate:
Activity-based costing (ABC) method: The costing method which allocates overheads to the products based on factory overhead rate for each activity or cost object, according to the cost pooled for the cost drivers (allocation base).
Formula to compute activity-based overhead rate:
Compute the indirect labor cost per unit allocated to cell phones and tablet under a single plant wide factory overhead rate system.
Types of Products |
Indirect labor cost (A) (2) |
Number of units (B) |
Indirect labor cost per unit |
Cell phones | $100,000 | 80,000 | $1.25 |
Tablets | $100,000 | 80,000 | $1.25 |
Table (1)
Working note (1):
Compute the single plant-wide overhead rate using direct labor hour (DLH) as the allocation base.
Working note (2):
Compute the total indirect labor cost for each product.
Types of Products | Indirect labor hours | × | Single Plant-Wide Overhead Rate (1) | = | indirect labor cost |
Cell phones | 1,000 | × | $100 per DLH | = | $100,000 |
Tablets | 1,000 | × | $100 per DLH | = | $100,000 |
Table (2)
b.
Compute the activity-based overhead rate for each of the given activities.
Explanation of Solution
Compute the activity-based overhead rates for each activity.
Computation of Activity-Based Overhead Rates | |||
Activity |
Activity Cost (C) |
Total Activity-Base Usage (D) |
Activity-Based Overhead Rates |
Setup | $60,000 (3) | 4,000 setups | $15 per setup |
Production support |
140,000 (4) | 2,000 DLH | $70 per DLH |
Table (3)
Working note (3):
Compute the activity cost for setup activity.
Working note (3):
Compute the activity cost for production support activity.
c.
Compute the activity-cost per unit of the each product.
Explanation of Solution
Compute the activity cost allocated per unit of cell phone.
Activity | Activity-Based Overhead Rates | × | Actual Use of Activity-Base (Cost Driver) | = | Activity Cost Allocated |
Setup | $15 per setup | × | 1,200 setups | = | $18,000 |
Production support | $70 per DLH | × | 1,000 DLH | = | 70,000 |
Total activity costs allocated to cell phones (E) | $88,000 | ||||
Number of units of cell phone (F) | 80,000 units | ||||
Activity-based overhead cost per unit of cell phone | $1.10 |
Table (4)
Note: Refer to Table (2) for the value and computation of activity allocation rates.
Compute the activity cost allocated per unit of tablet.
Activity | Activity-Based Overhead Rates | × | Actual Use of Activity-Base (Cost Driver) | = | Activity Cost Allocated |
Setup | $15 per setup | × | 2,800 setups | = | $42,000 |
Production support | $70 per DLH | × | 1,000 DLH | = | 70,000 |
Total activity costs allocated to tablets (G) | $112,00 | ||||
Number of units of tablet (H) | 80,000 units | ||||
Activity-based overhead cost per unit of tablet | $1.40 |
Table (5)
Note: Refer to Table (2) for the value and computation of activity allocation rates.
d.
Discuss the reason why the per unit allocated costs in single plant-wide overhead rate approach is different from the per unit allocated costs in the activity based costing.
Explanation of Solution
The product cost under single plant-wide overhead rate approach and ABC approach are different. The product cost is distorted in single plant-wide overhead rate approach because the time spent for setup production for cell phones and tablets is not in the same ratio as the direct labor hours used in support production for cell phones and tablets.
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Chapter 4 Solutions
Managerial Accounting
- Evans, Inc., has a unit-based costing system. Evanss Miami plant produces 10 different electronic products. The demand for each product is about the same. Although they differ in complexity, each product uses about the same labor time and materials. The plant has used direct labor hours for years to assign overhead to products. To help design engineers understand the assumed cost relationships, the Cost Accounting Department developed the following cost equation. (The equation describes the relationship between total manufacturing costs and direct labor hours; the equation is supported by a coefficient of determination of 60 percent.) Y=5,000,000+30X,whereX=directlaborhours The variable rate of 30 is broken down as follows: Because of competitive pressures, product engineering was given the charge to redesign products to reduce the total cost of manufacturing. Using the above cost relationships, product engineering adopted the strategy of redesigning to reduce direct labor content. As each design was completed, an engineering change order was cut, triggering a series of events such as design approval, vendor selection, bill of materials update, redrawing of schematic, test runs, changes in setup procedures, development of new inspection procedures, and so on. After one year of design changes, the normal volume of direct labor was reduced from 250,000 hours to 200,000 hours, with the same number of products being produced. Although each product differs in its labor content, the redesign efforts reduced the labor content for all products. On average, the labor content per unit of product dropped from 1.25 hours per unit to one hour per unit. Fixed overhead, however, increased from 5,000,000 to 6,600,000 per year. Suppose that a consultant was hired to explain the increase in fixed overhead costs. The consultants study revealed that the 30 per hour rate captured the unit-level variable costs; however, the cost behavior of other activities was quite different. For example, setting up equipment is a step-fixed cost, where each step is 2,000 setup hours, costing 90,000. The study also revealed that the cost of receiving goods is a function of the number of different components. This activity has a variable cost of 2,000 per component type and a fixed cost that follows a step-cost pattern. The step is defined by 20 components with a cost of 50,000 per step. Assume also that the consultant indicated that the design adopted by the engineers increased the demand for setups from 20,000 setup hours to 40,000 setup hours and the number of different components from 100 to 250. The demand for other non-unit-level activities remained unchanged. The consultant also recommended that management take a look at a rejected design for its products. This rejected design increased direct labor content from 250,000 hours to 260,000 hours, decreased the demand for setups from 20,000 hours to 10,000 hours, and decreased the demand for purchasing from 100 component types to 75 component types, while the demand for all other activities remained unchanged. Required: 1. Using normal volume, compute the manufacturing cost per labor hour before the year of design changes. What is the cost per unit of an average product? 2. Using normal volume after the one year of design changes, compute the manufacturing cost per hour. What is the cost per unit of an average product? 3. Before considering the consultants study, what do you think is the most likely explanation for the failure of the design changes to reduce manufacturing costs? Now use the information from the consultants study to explain the increase in the average cost per unit of product. What changes would you suggest to improve Evanss efforts to reduce costs? 4. Explain why the consultant recommended a second look at a rejected design. Provide computational support. What does this tell you about the strategic importance of cost management?arrow_forwardBig Mikes, a large hardware store, has gathered data on its overhead activities and associated costs for the past 10 months. Nizam Sanjay, a member of the controllers department, believes that overhead activities and costs should be classified into groups that have the same driver. He has decided that unloading incoming goods, counting goods, and inspecting goods can be grouped together as a more general receiving activity, since these three activities are all driven by the number of receiving orders. The 10 months of data shown below have been gathered for the receiving activity. Required: 1. Prepare a scattergraph, plotting the receiving costs against the number of purchase orders. Use the vertical axis for costs and the horizontal axis for orders. 2. 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