Question

T&J manufacturing has a factory that produces custom kitchen cabinets. It has multiple product lines. Materials and labor for the cabinets are determined by each job. To simplify the assignment, we will assume the following average costs. The materials include $1,000 for the wood and other direct materials of $200. Both items listed are on a per job basis. It requires 20 hours of labor on average for a custom kitchen. The hourly rate is $10. The sales price will be set at a markup of 65%. The company estimates that it will have 16,000 direct labor hours in total for all product lines. It assumes 800 units are sold on average per year. A breakdown of estimated yearly costs related to the kitchen cabinets follows: Salaries- office & administrative $ 520,000 Salaries for factory personal: $ 220,000 Office Rent $ 125,000 Factory Rent $ 20,000 Office Utilities and Misc office expenses(based on units sold) $ 20,000 Sales Travel(based on units sold) $ 24,000 Insurance - office $ 12,000 Depreciation - office equipment $ 40,000 Depreciation for factory equipment $ 70,000 Advertising $ 20,000 Sales commissions(based on units sold) $ 45,000 Factory Property taxes: $ 10,000 Maintenance for factory equipment: $ 80,000

Assume another product line is also being considered – bookshelves. Only use this information for the questions listed directly below.  Higher skilled workers would be required which will result in paying them $15 per hour.  Additional MOH costs for the year will be $150,000. These costs will be in addition to the costs already being incurred. These costs are due to the additional product line and also related to the current product lines for additional production abilities. The two lines will share all MOH costs.

QUESTIONS:

1. Should the company consider using ABC? Discuss why or why not? Areas to include in the discussion but not limited to the following: impact on product cost, implications of not using the right allocation and its impact on price if any, etc….

2. How specifically would ABC help allocate MOH costs?

Answer 1

1. Yes company should consider allocation of MOH cost using ABC.

Company should consider using Activity based costing because ABC system is a method of accounting which is used to find the total cost of activities necessary to make a product. ABC assigns cost of each activity that goes into production.

When company is into different product lines it becomes difficult in pricing decisions. As pricing decisions are very crucial in business as it may lead to showing wrong profitability of different products also company as a whole. As pricing decisions are also important to sustain in a competitive market as slight changes in the prices may lead to gain or lose customers and survive in the market competition.

The ABC system shows you how overhead is used, which helps you determine whether certain activities are necessary for production. if you find that some activities cost more than they should, you can find new methods to do something. Or, you can cut out steps entirely.

2. ABC would specificallly help allocate MOH Cost

The specific allocation of costs also helps to set prices that produce a good profit margin. With an ABC system, cost can be assign to each activity in the production process, allowing to more accurately set a price that accounts for how much it costs to create a product.

It increases understanding of overheads and cost drivers and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them. ABC enables effective challenge of operating costs to find better ways of allocating and eliminating overheads. It also enables improved product and customer profitability analysis. It supports performance management techniques such as continuous improvement and scorecards.