In: Accounting
Thomson Company manufactured a single product called LEC 40. Then three years ago, the company automated a portion of its plant and at the same time introduced a second product called LEC 90 that has become increasingly popular. The LEC 90 is a more complex product, requiring 0.60 hours of direct labor time per unit to manufacture and extensive machining in the automated portion of the plant. The LEC 40 requires only 0.20 hours of direct labor time per unit and only a small amount of machining. Manufacturing overhead costs are currently assigned to products on the basis of direct labor-hours.
Despite the growing popularity of the company’s new LEC 90, profits have been declining steadily. Management is beginning to believe that there may be a problem with the company’s costing system. Direct material and direct labor costs per unit are as follows:
LEC 40 | LEC 90 | |||
Direct materials | $ | 20.00 | $ | 46.00 |
Direct labor (0.20 hours and 0.60 hours @ $15.00 per hour) | $ | 3.00 | $ | 9.00 |
Management estimates that the company will incur $920,000 in manufacturing overhead costs during the current year and 80,000 units of the LEC 40 and 40,000 units of the LEC 90 will be produced and sold.
The total cost of LEC 40 is $ 27.60 per unit and that of LEC 90 is $ 68.80. It is not mentioned in the problem that the selling price of the two products. If the company maintained the same selling price for both product, then LEC 90 will make huge loss to the company. Working is given below:
LEC 40 | LEC 90 | ||||
Direct Labour Hour | 0.2 | 0.6 | |||
LEC 40 | LEC 90 | ||||
Production | Unit | 80000 | Unit | 40000 | |
DirectMaterial $ | 20 | 1600000 | 46 | 1840000 | |
Direct Labour @$15(80000*0.2*15) | 0.2 | 240000 | 0.6 | 360000 | |
Manufacturing Overhead | 920000 | 0.2 | 368000 | 0.6 | 552000 |
Total cost | 2208000 | 2752000 | |||
Per Unit cost(total cost/No. of units) | 27.60 | 68.80 | |||
Manufacturing overhead allocation on the basis of Direct labour Hours | |||||
Manufacturing Overhead ($) | 920000 | ||||
LEC 40 (80000x.20) | 16000 | 368000 | 92000*16000/40000 | ||
LEC 90(40000*.60) | 24000 | 552000 | 92000*24000/40000 | ||
Total | 40000 | 920000 |