Question

Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models, designated as standard, deluxe, and heavy-duty. The company uses a job-order cost-accounting system with manufacturing overhead applied on the basis of direct-labor hours. The system has been in place with little change for 25 years. Product costs and annual sales data are as follows:

  

	Standard Model					Deluxe Model					Heavy-Duty Model
Annual sales (units)		19,000					1,500					9,400
Product costs:
Raw material		$	18				$	33				$	46
Direct labor			10	(0.5 hr. at $20)				20	(1 hr. at $20)				20	(1 hr. at $20)
Manufacturing overhead*			65					130					130
Total product cost		$	93				$	183				$	196

*The calculation of the predetermined overhead rate is as follows:

Manufacturing-overhead budget:
Depreciation, machinery	$	1,350,000
Maintenance, machinery		110,000
Depreciation, taxes, and insurance for factory		200,000
Engineering		225,000
Purchasing, receiving and shipping		150,000
Inspection and repair of defects		350,000
Material handling		400,000
Miscellaneous manufacturing overhead costs		205,000
Total	$	2,990,000

Direct-labor budget:
Standard model:		10,000		hours
Deluxe model:		3,000		hours
Heavy-duty model:		10,000		hours
Total		23,000		hours

   

Predetermined overhead rate:	Budgeted overhead	=	$2,990,000	= $130 per hour
	Budgeted direct-labor hours		23,000 hours

  

For the past 10 years, the company’s pricing formula has been to set each product’s target price at 130 percent of its full product cost. Recently, however, the standard-model motor has come under increasing price pressure from offshore competitors. The result was that the price on the standard model has been lowered to $130.

The company president recently asked the controller, “Why can’t we compete with these other companies? They’re selling motors just like our standard model for 121 dollars. That’s only a buck more than our production cost. Are we really that inefficient? What gives?”

The controller responded by saying, “I think this is due to an outmoded product-costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my judgment, our product-costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean.”

Getting the president’s go-ahead, the controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each cost driver consumed by each product line.

			Product Lines
Activity Cost Pool		Cost Driver	Standard Model			Deluxe Model			Heavy-Duty Model
I.	Depreciation, machinery
	Maintenance, machinery	Machine time		38	%		15	%		47	%
II.	Engineering
	Inspection and repair of defects	Engineering hours		47	%		6	%		47	%
III.	Purchasing, receiving, and shipping
	Material handling	Number of material orders		47	%		8	%		45	%
IV.	Depreciation, taxes, and insurance for factory Miscellaneous manufacturing overhead	Factory space usage		40	%		19	%		41	%

Required:
1. Compute the target prices for the three models, based on the traditional, volume-based product-costing system.
2. Compute new product costs for the three products, based on the new data collected by the controller.
3. Calculate a new target price for the three products, based on the activity-based costing system.
  
(For all requirements, round your intermediate calculations and final answers to 2 decimal places.)

Answer 1

1. Computation of target prices for the three models, based on traditional, volume-based product-costing system:

Predetermined overhead rate = Budgeted overhead / Budgeted direct-labor hours

= $2,990,000 / 23,000 hours = $130 per hour

Under traditional costing, manufacturing overhead is applied on the basis of direct-labor hours.

Manufacturing overhead is applied to Standard Model = 0.50 Hr. x $130 = $65

Manufacturing overhead is applied to Deluxe Model = 1 Hr. x $130 = $130

Manufacturing overhead is applied to Heavy-Duty Model = 1 Hr. x $130 = $130

	Standard Model	Deluxe Model	Heavy-Duty Model
Raw materials	$18	$33	$46
Direct labor	$10	$20	$20
Manufacturing overhead	$65	$130	$130
Total product cost	$93	$183	$196
Profit margin (30% of product cost)	$27.90	$54.90	$58.80
Target Selling Price	$120.90	$237.90	$254.80

2. Computation of new product costs for the three products, based on the new data collected by the controller:

Manufacturing overhead cost per unit will be as follows:

Activity Cost Pool Model	Costs	Costs Driver	Standard Model	Deluxe Model	Heavy-Duty Model
Depreciation, machinery; Maintenance, machinery	$1,460,000	Machine time	$554,800 ($1,460,000 x 38%)	$219,000 ($1,460,000 x 15%)	$686,200 ($1,460,000 x 47%)
Engineering; Inspection and repair of defects	$575,000	Engineering hours	$270,250 ($575,000 x 47%)	$34,500 ($575,000 x 6%)	$270,250 ($575,000 x 47%)
Purchasing, receiving, and shipping; Material handling	$550,000	Number of material orders	$258,500 ($550,000 x 47%)	$44,000 ($550,000 x 8%)	$247,500 ($550,000 x 45%)
Depreciation, taxes, and insurance for factory; Miscellaneous manufacturing overhead	$405,000	Factory space usage	$162,000 ($405,000 x 40%)	$76,950 ($405,000 x 19%)	$166,050 ($405,000 x 41%)
Total	$2,990,000		$1,245,550	$374,450	$1,370,000
Direct labor-hours			10,000 hours	3,000 hours	10,000 hours
Manufacturing overhead per labor-hour			$124.56	$124.82	$137
Direct labor-hours required per unit			0.5	1	1
Manufacturing overhead per unit			$62.28	$124.82	$137

New product costs for three products will be as follows:

	Standard Model	Deluxe Model	Heavy-Duty Model
Raw materials	$18	$33	$46
Direct labor	$10	$20	$20
Manufacturing overhead	$62.28	$124.82	$137
Total product cost	$90.28	$177.82	$203

3. Calculation of new target price for the three products, based on the activity-based costing system:

	Standard Model	Deluxe Model	Heavy-Duty Model
Total product cost	$90.28	$177.82	$203
Profit margin (30% of product cost)	$27.08	$53.35	$60.90
Target Selling Price	$117.36	$231.17	$263.90