Question

Marine, Inc., manufactures a product that is available in both a flexible and a rigid model. The company has made the rigid model for years; the flexible model was introduced several years ago to tap a new segment of the market. Since introduction of the flexible model, the company’s profits have steadily declined, and management has become concerned about the accuracy of its costing system. Sales of the flexible model have been increasing rapidly.

Overhead is applied to products on the basis of direct labor-hours. At the beginning of the current year, management estimated that $741,000 in overhead costs would be incurred and the company would produce and sell 2,000 units of the flexible model and 9,000 units of the regular model. The flexible model requires 3.0 hours of direct labor time per unit, and the regular model requires 1.50 hours. Direct materials and labor costs per unit are given below:

	Flexible			Rigid
Direct materials cost per unit	$	100		$	75
Direct labor cost per unit	$	50		$	35

Required:   

1-a. Compute the predetermined overhead rate using direct labor-hours as the basis for allocating overhead costs to products.

1-b. Compute the unit product cost for one unit of each model.

2. An intern suggested that the company use activity-based costing to cost its products. A team was formed to investigate this idea. It came back with the recommendation that four activity cost pools be used. These cost pools and their associated activities are listed as follows:

				Expected Activity
Activity Cost Pool and Activity Measure	Estimated Overhead Cost			Flexible			Rigid			Total
Purchase orders (number of orders)	$	26,500			140			390		530
Rework requests (number of requests)		16,500			55			275		330
Product testing (number of tests)		300,000			650			1,750		2,400
Machine related (machine-hours)		398,000			1,100			2,880		3,980
	$	741,000

Compute the activity rate for each of the activity cost pools.     

3-a. Using activity-based costing, determine the total amount of overhead that would be assigned to each model for the year.

3-b. Using activity-based costing, compute the unit product cost for one unit of each model.

Answer 1

Solution :

(1a) Predetermined Overhead Rate using Direct Labor Hours :

Predetermined Overhead Rate = Total Overhead / Total Direct Labor Hours

Total Direct Labor Hours = (2,000 Units * 3 Hours) + (9,000 Units * 1.50 Hours)

= 19,500 Hours

= $ 741,000 / 19,500

= $ 38 per Direct Labor Hour

(1b) Unit Cost per Unit :

Particulars	Flexible	Rgid
Direct Material Cost per Unit	$ 100	$ 75
Direct Labor Cost per Unit	$ 50	$ 35
OH Cost per Units	$ 38 * 3 =$ 114	$ 38 * 1.50 =$ 57
Cost per Unit	$ 264	$ 167

(2) Activitiy Rate for Each Activity Cost Pool :

Activity (a)	Total Cost (b)	Total No. of Activity (c)	Activity Rate (d) = (b) / (c)
Purchases Oreders	$ 26,500	530 Orders	$ 50 per Order
Rework Request	$ 16,500	330 Requests	$ 50 per Request
Product Testing	$ 300,000	2,400 Tests	$ 125 per Test
Machine Related	$ 398,000	3,980 Machine Hours	$ 100 per Machine Hour

(3a) Total Overhead Allocation :

Particulars (a)	Activity Rate (b)	Flexible	Rigid
Total No of Activity (c)	Total Cost (d) = (b) * (c)	Total No of Activity (e)	Total Cost (f) = (b) * (e)
Purchases Orders	$ 50	140	$ 7,000	390	$ 19,500
Rework Requests	$ 50	55	$ 2,750	275	$ 13,750
Product Testing	$ 125	650	$ 81,250	1,750	$ 218,750
Machine Related	$ 100	1,100	$ 110,000	2,880	$ 288,000
Total Overhead Allocated			$ 201,000		$ 540,000

(3b) Unit Cost as per ABC Costing :

OH Rate per Unit for Flexible Model = $ 201,000 / 2,000 = $ 100.50 per Unit

OH Rate per Unit for Rigid Model = $ 540,000 / 9,000 = $ 60 per Unit

Particulars	Flexible	Rigid
Direct Material Cost per Unit	$ 100	$ 75
Direct Labor Cost per Unit	$ 50	$ 35
OH Cost per Units	$ 100.50	$ 60
Cost per Unit	$ 250.50	$ 170

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