Problem:
A Company has used a two-stage cost allocation system for many years. In the first stage, plant overhead costs are allocated to two production departments, P1 and P2 based on machine hours. In the second stage, the company uses direct labor hours to assign overhead costs from the production departments to individual products A and B.
Budgeted factory overhead costs for the year are $300,000. Both the budgeted and actual machine hours in P1 and P2 are 12,000 and 28,000 hours, respectively.
After attending a seminar to learn the potential benefits of adopting an activity-based costing system (ABC), Ted Norris, the president of the Company, is considering implementing an ABC system. Upon his request, the controller at the Company has compiled the following information for analysis:
|
|
Factory
|
Activity cost
|
Expected
|
|
Cost Pool
|
overhead costs
|
driver
|
activity level
|
|
Machine setup
|
$100,000
|
Setup hours
|
1,000
|
|
Inspection
|
50,000
|
Inspection hours
|
2,500
|
|
Power
|
50,000
|
Kilowatt hours
|
25,000
|
|
Supervision
|
100.000
|
Direct labor hours
|
10,000
|
|
Total overhead cost
|
$300.000
|
|
|
They manufactures two types of product A and B, for which the following information is available:
|
|
A
|
B
|
|
Units produced and sold
|
5,000
|
10,000
|
|
Direct materials
|
$200,000
|
$250,000
|
|
Direct labor costs
|
$80,000
|
150,000
|
|
Direct labor hours in PI
|
1,500
|
3,000
|
|
Direct labor hours in P2
|
1,500
|
4,000
|
|
Setup hours
|
700
|
300
|
|
Inspection hours
|
1,500
|
1,000
|
|
Power (kilowatt hours)
|
12,500
|
12,500
|
Required:
(1) Determine the unit cost for each of the two products using the traditional two-stage allocation method.
(2) Determine the unit cost for each of the two products using the proposed ABC system.
(3) Compare the unit manufacturing costs for product A and product B computed in requirements a and b.
(4) Why do two the cost systems differ in their total cost for each product?
(5) Why might these differences be important to the Company?