Question

A manufacturing business makes a product in two models. M1 and M2. Details of the two products are as follows:

                                                                                                             M1                           M2

Annual sales                                                                                  8,000 units               8,000 units

Number of sales orders                                                                         60                           250

Sales price per unit                                                                              ₵54                          ₵73

Direct material cost per unit                                                                 ₵11                           ₵21

Direct labour hours per unit                                                                2.0 hours                2.5 units

Direct labour rate per hour                                                                     ₵8                           ₵8

Special parts per unit                                                                              2                                8

Production batch size                                                                        2,000 units              100 units

Set-ups per batch                                                                                    1                               3

Production batch size                                                                               1                               1

Setups per batch:                                            ₵                                          cost driver

Issues of material for each batch                97,600                                   number of setups

Overhead analysis                                      42,000                                   number of batches

Setup costs                                                  50,000                                  number of special parts

Material handling costs                                31,000                                   number of sales orders

Special part handling costs                       108,000                                   direct labour hours

Customer invoicing costs                           328,600

A customer has indicated an interest in placing a large order for either model M1 or M2, and the sales manager wished to try to sell the higher-priced model M2.

Required

1. Calculate the profit using traditional absorption costing

Answer 1

Answer-

Working		M1	M2
A	No. of units	8,000	8,000
B	Batch Size	2,000	100
C = A/B	No. of batches	4	80
D	Setups per batch	1	3
E = C x D	No. of setups	4	240
F	Special parts per unit	2	8
G = A x F	No. of special parts	16,000	64,000
H	DLH per unit	2	3
I = A x H	Total DLHs	16,000	20,000

---Step 2: Calculation of activity rate per cost driver

			No. of cost drivers for
Activity Cost pool	Overhead cost	Cost drivers	M1	M2	Total no. of cost drivers	Activity Rate per cost driver
Setup costs	$    97,600.00	Setup	4	240	244	$        400.000	per Setup
Material handing cost	$    42,000.00	Batch	4	80	84	$        500.000	per Batch
Special part handling costs	$    50,000.00	Special part	16,000	64,000	80,000	$             0.625	per Special part
Invoicing	$    31,000.00	Sale Order	60	250	310	$        100.000	per Sale Order
Other overheads	$ 108,000.00	Direct labor hour	16,000	20,000	36,000	$             3.000	per Direct labor hour
Total	$ 328,600.00

---Step 3: Allocation of overhead to M1 using above activity rates

Overhead allocation to M1
	Activity Rate per cost driver	No. of cost driver for M1	Overheads allocated
Setup costs	$        400.000	per Setup	4	$           1,600.00
Material handing cost	$        500.000	per Batch	4	$           2,000.00
Special part handling costs	$             0.625	per Special part	16,000	$         10,000.00
Invoicing	$        100.000	per Sale Order	60	$           6,000.00
Other overheads	$             3.000	per Direct labor hour	16,000	$         48,000.00
Total Overheads allocated	$         67,600.00
Total M1 Units	8,000
Overhead cost per unit	$                    8.45

---Step 4: Allocation of overhead of M2 using activity rates

Overhead allocation to M2
	Activity Rate per cost driver	No. of cost driver for M1	Overheads allocated
Setup costs	$        400.000	per Setup	240	$         96,000.00
Material handing cost	$        500.000	per Batch	80	$         40,000.00
Special part handling costs	$             0.625	per Special part	64,000	$         40,000.00
Invoicing	$        100.000	per Sale Order	250	$         25,000.00
Other overheads	$             3.000	per Direct labor hour	20,000	$         60,000.00
Total Overheads allocated	$       261,000.00
Total M2 Units	8,000
Overhead cost per unit	$                 32.63

• Requirement (a): Answer, based on above

	M1	M2
Sale Price per unit	$            54.00	$            73.00
Per unit cost:
Direct material	$            11.00	$            21.00
Direct Labor	$            16.00	$            20.00
Overheads allocated	$               8.45	$            32.63
Total per unit cost	$            35.45	$            73.63
Net Profit per unit	$            18.55	$            (0.63)

Profit under traditional costing:-

	M1	M2
Direct material	11.00	21.00
Direct labor	16.00	20.00
Overhead cost per unit	18.26	22.83
Unit cost	45.26	63.83
Selling price	54.00	73.00
Profit	8.74	9.18