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Approximately Relevant ABC Reducir, Inc., produces two different types of hydraulic cylinders. Reducir produces a major...

Approximately Relevant ABC

Reducir, Inc., produces two different types of hydraulic cylinders. Reducir produces a major subassembly for the cylinders in the Cutting and Welding Department. Other parts and the subassembly are then assembled in the Assembly Department. The activities, expected costs, and drivers associated with these two manufacturing processes are given below.

Process Activity Cost Activity Driver Expected Quantity
Cutting and Welding Welding $ 776,000    Welding hours 4,000
Machining 450,000    Machine hours 10,000
Inspecting 448,250    No. of inspections 1,000
Materials handling 300,000    No. of batches 12,000
Setups 240,000    No. of setups 100
$2,214,250
Assembly Changeover $ 180,000    Changeover hours 1,000
Rework 61,750    Rework orders 50
Testing 300,000    No. of tests 750
Materials handling 380,000    No. of parts 50,000
Engineering support 130,000    Engineering hours 2,000
$1,051,750

Other overhead activities, their costs, and drivers are listed below.

Activity Cost Activity Driver Quantity
Purchasing $ 135,000    Purchase requisitions 500
Receiving 274,000    Receiving orders 2,000
Paying suppliers 225,000    No. of invoices 1,000
Providing space and utilities 100,000    Machine hours 10,000
Total $ 734,000

Other production information concerning the two hydraulic cylinders is also provided:

Cylinder A Cylinder B
Units produced 1,500 3,000
Welding hours 1,600 2,400
Machine hours 3,000 7,000
Inspections 500 500
Moves 7,200 4,800
Batches 45 55
Changeover hours 540 460
Rework orders 5 45
No. of tests 500 250
Parts 40,000 10,000
Engineering hours 1,500 500
Requisitions 425 75
Receiving orders 1,800 200
Invoices 650 350
Process Activity Cost
Cutting and Welding Welding $ 2,000,000
Machining 1,000,000
Inspecting 50,000
Materials handling 72,000
Setups 400,000
$3,522,000
Assembly Changeover $ 28,000
Rework 50,000
Testing 40,000
Materials handling 60,000
Engineering support 70,000
$248,000

Other overhead activities:.

Activity                     Cost
Purchasing $ 50,000
Receiving 70,000
Paying suppliers 80,000
Providing space and utilities 30,000
$230,000

The per unit overhead cost using the 14 activity-based drivers is $1,108 and $779 for Cylinder A and Cylinder B, respectively.

Required:

1. Determine the percentage of total costs represented by the three most expensive activities.

85%

2. If required, round your interim calculations and final answers to the nearest dollar.
Allocate the costs of all other activities to the three activities identified in Requirement 1 in proportion to their individual activity costs.

Allocation
Welding $352,941
Machining $176,471
Setups $70,588

Calculate the total activity costs of all the three activities.

Cost pools
Welding $2,352,941
Machining $1,176,471
Setups $470,588
Activity Rates
Welding $588 per welding hour
Machining $118 per machine hour
Setups $4706 per batch

Now assign these total costs to the products using the drivers of the three chosen activities.

Cylinder A Cylinder B
Rate 1 (welding) $ $
Rate 2 (machining) $ $
Rate 3 (setups) $ $
Total overhead costs $ $
Unit overhead costs $ $

3. Using the costs assigned in Requirement 2, calculate the percentage error using the ABC costs as a benchmark. Round your answers to one decimal place. If an item is negative, use a minus (-) sign to indicate.

Percentage error
Cylinder A %
Cylinder B %

Solutions

Expert Solution

SOLUTION

1. Plantwide rate = ($2,214,250 + $1,051,750 + $734,000)/10,000

= $400 per machine hour

Cylinder A: Unit cost = $400 × 3,000 = $1,200,000

Unit overhead cost = $1,200,000/1,500 = $800.00

Cylinder B: $400 × 7,000 = $2,800,000

Unit overhead cost = $2,800,000/3,000 = $933.33

2. Rates:

Welding
Rate 1: $776,000/4,000 = $194.00 per welding hour

Machining

Rate 2: $450,000/10,000 = $45.00 per machine hour

Inspecting

Rate 3: $448,250/1,000    = $448.25 per inspection

Materials Handling

Rate 4: $300,000/12,000 = $25.00 per move

Setups

Rate 5: $240,000/100 = $2,400.00 per batch

Changeover

Rate 6: $180,000/1,000 = $180.00 per changeover hour

Rework

Rate 7: $61,750/50 = $1,235.00 per rework order

Testing

Rate 8: $300,000/750       = $400.00 per test

Materials Handling

Rate 9: $380,000/50,000 = $7.60 per part

Engineering Support

Rate 10: $130,000/2,000    = $65.00 per engineering hour

Purchasing

Rate 11: $135,000/500       = $270.00 per requisition

Receiving

Rate 12: $274,000/2,000    = $137.00 per receiving order

Paying Suppliers

Rate 13: $225,000/1,000    = $225.00 per invoice

Providing Space and Utilities

Rate 14: $100,000/10,000 = $10.00 per machine hour

Overhead assignment:

Cylinder A Cylinder B

Rate 1:

$194 × 1,600 welding hours $ 310,400

$194 × 2,400 welding hours $ 465,600

Rate 2:

$45 × 3,000 machine hours 135,000

$45 × 7,000 machine hours 315,000

Rate 3:

$448.25 × 500 inspections 224,125

$448.25 × 500 inspections 224,125

Rate 4:

$25 × 7,200 moves 180,000

$25 × 4,800 moves 120,000

Rate 5:

$2,400 × 45 batches 108,000

$2,400 × 55 batches 132,000

Rate 6:

$180 × 540 changeover hours 97,200

$180 × 460 changeover hours 82,800

Rate 7:

$1,235 × 5 rework orders 6,175

$1,235 × 45 rework orders 55,575

Rate 8:

$400 × 500 tests 200,000

$400 × 250 tests 100,000

Rate 9:

$7.60 × 40,000 parts 304,000

$7.60 × 10,000 parts 76,000

Rate 10:

$65 × 1,500 engineering hours 97,500

$65 × 500 engineering hours 32,500

Rate 11:

$270 × 425 requisitions 114,750

$270 × 75 requisitions 20,250

Rate 12:

$137 × 1,800 receiving orders 246,600

$137 × 200 receiving orders 27,400

Rate 13:

$225 × 650 invoices 146,250

$225 × 350 invoices 78,750

   Rate 14:

$10 × 3,000 machine hours 30,000

$10 × 7,000 machine hours 70,000

Total overhead costs $2,200,000 $1,800,000

Units produced ÷ 1,500 ÷ 3,000

Overhead per unit $ 1,467 $ 600

Using plantwide rate assignments, Cylinder A is undercosted, and Cylinder B is overcosted. The activity assignments capture the cause-and-effect relationships and thus reflect the overhead consumption patterns better than the machine hour pattern of the plantwide rate.

3. Global consumption ratios:

Cylinder A: $2,200,000/$4,000,000 = 0.55

Cylinder B: $1,800,000/$4,000,000 = 0.45

4. Welding: (1,600/4,000, 2,400/4,000) = (0.40, 0.60)

Materials handling (parts): (40,000/50,000, 10,000/50,000) = (0.80, 0.20)

Set up two equations (the w’s represent the allocation rates):

0.40w1 + 0.80w2 = 0.55

0.60w1 + 0.20w2 = 0.45

Solving (multiply the second equation by –4 and add to the first):

–2w1 = –1.25

    w1 = 0.625

  

and thus,

w2 = 0.375

Cost pools:

Welding: 0.625 × $4,000,000 = $2,500,000

Materials handling: 0.375 × $4,000,000 = $1,500,000

Activity rates:

Rate 1: Welding: $2,500,000/4,000 = $625 per welding hour

Rate 2: Materials handling (assembly): $1,500,000/50,000 = $30.00 per part

Overhead assignment:

Cylinder A Cylinder B

Rate 1:

$625 × 1,600 welding hours $ 1,000,000

$625 × 2,400 welding hours $ 1,500,000

Rate 2:

$30.00 × 40,000 parts 1,200,000

$30.00 × 10,000 parts 300,000

Total overhead costs $ 2,200,000 $ 1,800,000

Units produced ÷ 1,500 ÷ 3,000

Overhead per unit $ 1,466.67* $ 600.00

*Rounded to the nearest cent.

We are able to take a 14-driver system and reduce it to a 2-driver system and achieve exactly the same overhead cost assignments as the more complex system. This after-the-fact simplification has two major advantages: (1) it allows nonfinancial managers to more readily read, understand, and interpret product cost reports; and (2) the actual values only need to be collected for two drivers instead of 14, producing considerable cost savings.

5. Inspection: (500/1,000, 500/1,000) = (0.50, 0.50)

Engineering: (1,500/2,000, 500/2,000) = (0.75, 0.25)

Set up two equations (the w’s represent the allocation rates):

0.50w1 + 0.75w2 = 0.55

0.50w1 + 0.25w2 = 0.45

Solving (subtract the second equation from the first):

0.50w2 = 0.10

w2 = 0.20

and thus,

w1 = 0.80

Cost pools:

Inspection: 0.80 × $4,000,000 = $3,200,000

Engineering: 0.20 × $4,000,000 = $800,000

Activity rates:

Rate 1: Inspection: $3,200,000/1,000 = $3,200 per inspection

Rate 2: Engineering: $800,000/2,000 = $400 per hour

Overhead assignment:

Cylinder A Cylinder B

Rate 1:

$3,200 × 500 inspections $1,600,000

$3,200 × 500 inspections $1,600,000

Rate 2:

$400 × 1,500 engineering hours 600,000

$400 × 500 engineering hours 200,000

Total overhead costs $2,200,000 $1,800,000

Units produced ÷ 1,500 ÷ 3,000

Overhead per unit $ 1,467.67* $ 600.00

*Rounded to the nearest cent.


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