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Activity-Based Costing: a tool to Aid Decision Making

The first step is to compute the overhead cost for each of the products ordered by the customer:

Standard Model

Activity Cost Pool

Activity Rate

Activity

ABC Cost

Manufacturing volume

$26

per direct labor-hour

527

direct labor-hours

$13,702

Order processing

$284

per order

1

order

$284

Custom design processing

$186

per custom design

0

custom designs

$0

Customer service

$379

per customer

Not applicable

Custom Design

Activity Cost Pool

Activity Rate

Activity

ABC Cost

Manufacturing volume

$26

per direct labor-hour

84

direct labor-hours

$2,184

Order processing

$284

per order

3

order

$852

Custom design processing

$186

per custom design

3

custom designs

$558

Customer service

$379

per customer

Not applicable

Exercise 8-5 (continued)

The second step is to compute the product margins for the two products:

Product Profitability Analysis

Standard Model

Custom Design

Sales

$37,000

$7,200

Costs:

Direct materials

$11,280

$1,902

Direct labor

10,277

1,638

Manufacturing volume

13,702

2,184

Order processing

284

852

Custom design processing

         0

 35,543

    558

 7,134

Product margin

$ 1,457

$    66

The final step is to compute the profitability of the customer:

Customer Profitability Analysis

Product margin of orders placed by customer:

Standard model

$1,457

Custom design

      66

Total product margins

1,523

Customer service overhead

    379

Customer margin

$1,144

Exercise 8-6 (30 minutes)

1. Under the traditional direct labor-hour based costing system, manufacturing overhead is applied to products using the predetermined overhead rate computed as follows:

*50,000 units of Model X100 @ 0.2 DLH per unit + 5,000 units of Model X200 @ 0.4 DLH per unit = 10,000 DLHs + 2,000 DLHs = 12,000 DLHs

Consequently, manufacturing overhead would be applied to the products as follows:

Model X100

Model X200

Total

Unit sales

50,000

5,000

Direct labor-hours per unit

0.2

0.4

Total direct labor-hours

10,000

2,000

12,000

Total manufacturing overhead applied @ $160 per direct labor-hour

$1,600,000

$320,000

$1,920,000

Manufacturing overhead per unit

$32

$64

Note that all of the manufacturing overhead cost is applied to the products under the company’s traditional costing system.

Exercise 8-6 (continued)

2. Under the activity-based costing system, overhead costs (both nonmanufacturing and manufacturing) would be applied to products as follows:

Model X100

Model X200

Total

Unit sales

50,000

5,000

Manufacturing overhead
applied

$1,340,000

$390,000

$1,730,000

Nonmanufacturing overhead applied

    160,000

 110,000

    270,000

Total overhead applied

$1,500,000

$500,000

$2,000,000

Manufacturing overhead per unit

$30

$100

3. Under activity-based costing, a total of $1,500,000 is assigned to Model X100 and a total of $500,000 is assigned to Model X200. This is in contrast to $1,600,000 for Model X100 and $320,000 for Model X200 under the traditional costing method. Also note that the total amount of overhead applied to both products is $2,000,000 under activity-based costing and $1,920,000 under the traditional costing method. A number of reasons exist for these differences. First, not all manufacturing overhead costs are assigned to products under activity-based costing. Apparently $190,000 (= $1,920,000 – $1,730,000) of manufacturing overhead consists of the costs of idle capacity and organization-sustaining costs that are not assigned to products under activity-based costing. Counterbalancing this, a total of $270,000 in nonmanufacturing costs are assigned to products under activity-based costing, but not under the traditional method. Additionally, manufacturing overhead costs have been shifted from Model X100, the high-volume product, to Model X200, the low-volume product under activity-based costing. This is probably due to the existence of batch-level or product-level costs that are more appropriately assigned under activity-based costing.

Per unit costs have changed under activity-based costing. This is partly due to the exclusion of some manufacturing overhead from product costs and the inclusion of nonmanufacturing overhead costs. But it is also due to shifting costs from the high-volume to the low-volume product. This has the predictable effect of increasing the per unit cost of the low-volume product more than the per unit cost of the high-volume product is decreased.

Exercise 8-7 (45 minutes)

1. The predetermined overhead rate is computed as follows:

The unit product costs under the company’s traditional costing system are computed as follows:

Deluxe

Standard

Direct materials

$60.00

$45.00

Direct labor

9.60

7.20

Manufacturing overhead (0.8 DLH × $5.80 per DLH;
0.6 DLH × $5.80 per DLH)

   4.64

   3.48

Unit product cost

$74.24

$55.68

2. The activity rates are computed as follows:

(a)

Estimated

(b)

Overhead

Total

(a) ÷ (b)

Activities

Cost

Expected Activity

Activity Rate

Supporting direct labor

$150,000

50,000

DLHs

$3

per DLH

Batch setups

$60,000

250

setups

$240

per setup

Safety testing

$80,000

100

tests

$800

per test

Exercise 8-7 (continued)

Manufacturing overhead is assigned to the two products as follows:

Deluxe Product:

Activity Cost Pool

(a)
Activity Rate

(b)
Activity

(a) × (b)
ABC Cost

Supporting direct labor

$3

per DLH

8,000

DLHs

$24,000

Batch setups

$240

per setup

200

setups

48,000

Safety testing

$800

per test

80

tests

   64,000

Total

$136,000

Standard Product:

Activity Cost Pool

(a)
Activity Rate

(b)
Activity

(a) × (b)
ABC Cost

Supporting direct labor

$3

per DLH

42,000

DLHs

$126,000

Batch setups

$240

per setup

50

setups

12,000

Safety testing

$800

per test

20

tests

   16,000

Total

$154,000