Question

Problem 5-55 Activity-Based Costing (LO 5-1, 5-2, 5-4, 5-5)

Manchester Technology, Inc. manufactures several different types of printed circuit boards; however, two of the boards account for the majority of the company’s sales. The first of these boards, a television circuit board, has been a standard in the industry for several years. The market for this type of board is competitive and price-sensitive. Manchester plans to sell 73,000 of the TV boards in 20x1 at a price of $470 per unit. The second high-volume product, a personal computer circuit board, is a recent addition to Manchester’s product line. Because the PC board incorporates the latest technology, it can be sold at a premium price. The 20x1 plans include the sale of 48,000 PC boards at $860 per unit.

Manchester’s management group is meeting to discuss how to spend the sales and promotion dollars for 20x1. The sales manager believes that the market share for the TV board could be expanded by concentrating Manchester’s promotional efforts in this area. In response to this suggestion, the production manager said, “Why don’t you go after a bigger market for the PC board? The cost sheets that I get show that the contribution from a PC board is significantly larger than the contribution from a TV board. I know we get a premium price for the PC board. Selling it should help overall profitability.”

The cost-accounting system shows that the following costs apply to the PC and TV boards.

	PC Board			TV Board
Direct material	$	227		$	147
Direct labor		3.0	hr.		1.5	hr.
Machine time		1.5	hr.		1.5	hr.

  

Variable manufacturing overhead is applied on the basis of direct-labor hours. For 20x1, variable overhead is budgeted at $2,360,000, and direct-labor hours are estimated at 266,175. The hourly rates for machine time and direct labor are $36 and $44, respectively. The company applies a material-handling charge at 10 percent of material cost. This material-handling charge is not included in variable manufacturing overhead. Total 20x1 expenditures for direct material are budgeted at $21,627,000.

Andrew Fulton, Manchester’s controller, believes that before the management group proceeds with the discussion about allocating sales and promotional dollars to individual products, it might be worthwhile to look at these products on the basis of the activities involved in their production. Fulton has prepared the following schedule to help the management group understand this concept.

“Using this information,” Fulton explained, “we can calculate an activity-based cost for each TV board and each PC board and then compare it to the standard cost we have been using. The only cost that remains the same for both cost methods is the cost of direct material. The cost drivers will replace the direct labor, machine time, and overhead costs in the old standard cost figures.”

  

Budgeted Cost				Cost Driver	Budgeted Annual Activity for Cost Driver
Procurement	$	880,000		Number of parts		6,184,500	parts
Production scheduling		480,000		Number of boards		127,050	boards
Packaging and shipping		960,000		Number of boards		127,050	boards
Total	$	2,320,000
Machine setup	$	924,000		Number of setups		304,500	setups
Hazardous waste disposal		112,000		Pounds of waste		24,759	pounds
Quality control		1,168,000		Number of inspections		431,550	inspections
General supplies		156,000		Number of boards		127,050	boards
Total	$	2,360,000
Machine insertion	$	2,800,000		Number of parts		4,425,000	parts
Manual insertion		8,800,000		Number of parts		1,659,000	parts
Wave-soldering		304,000		Number of boards		127,050	boards
Total	$	11,904,000

  

Required per Unit	PC Board			TV Board
Parts:		71			34
Machine insertions		44			33
Manual insertions		27			1
Machine setups		3			2
Hazardous waste disposal, in lb.		.40			.06
Inspections		4			3

  

Required:

1. Identify at least four general advantages associated with activity-based costing.

2. On the basis of Manchester’s unit cost data given in the problem, calculate the total amount that each of the two product lines will contribute toward covering fixed costs and profit in 20x1.

3. Using activity-based costing, calculate the total amount that each of the two product lines will contribute toward covering fixed costs and profit in 20x1.

Answer 1

1. Advantages:

i) With proper overhead allocation based on Activity based costing, margins of the products and product lines can be determined and company can determine where to allocate resources of company to earn maximum margins.

ii) It comprehensively provides the view of each and every cost related to in house manufacturing of a product and will be useful for management to decide which product to be manufactured in house or outsourced so to earn higher profits.

iii) Using ABC system management get opportunities for cost saving and reductions.

iv) Problem of over and under costing of products gets eliminated.

2.

	PC	TV
Units (A)	48000	73000
SP/ unit ($) (B)	860	470
Sales C = A*B	41280000	34310000
Direct Material / Unit ($) (D)	227	147
Direct Material Cost E = A*D	10896000	10731000
Direct labor hour / unit (F)	3	1.5
Rate per direct labor hour ($) (G)	44	44
Direct labor hour cost ($) (H) = A*F*G	6336000	4818000
Machine hour/ Unit (I)	1.5	1.5
Rate per machine hour ($) (J)	36	36
Machine hour cost ($) K = A*I*J	2592000	3942000
Variable Overhead Cost / labour hour ($) (L)	2360000/ 266175 = $ 8.8663	2360000/ 266175 = $ 8.8663
Variable Overhead Cost ($) M = L * F * A	1276747.2000	970859.8500
Total Cost N= (E+H+K+M)	21100747.2000	20461859.8500
Contribution O=C-N	20179253	13848140

3.

Cost allocated on basis of ABC:

Budgeted Cost				Cost Driver	Budgeted Annual Activity for Cost Driver		Activity Rate	Activity Usage		Activity Cost Assigned
		(A)			(B)		C= A/B	PC (D)	TV (E)	PC (C * D)	TV (C * E)
Procurement	$	8,80,000		Number of parts	61,84,500	parts	0.1423	71	34	10.1027	4.8379
Production scheduling		4,80,000		Number of boards	1,27,050	boards	3.7780	1	1	3.7780	3.7780
Packaging and shipping		9,60,000		Number of boards	1,27,050	boards	7.5561	1	1	7.5561	7.5561
Total	$	23,20,000
Machine setup	$	9,24,000		Number of setups	3,04,500	setups	3.0345	3	2	9.1034	6.0690
Hazardous waste disposal		1,12,000		Pounds of waste	24,759	pounds	4.5236	0.4	0.06	1.8094	0.2714
Quality control		11,68,000		Number of inspections	4,31,550	inspections	2.7065	4	3	10.8261	8.1196
General supplies		1,56,000		Number of boards	1,27,050	boards	1.2279	1	1	1.2279	1.2279
Total	$	23,60,000
Machine insertion	$	28,00,000		Number of parts	44,25,000	parts	0.6328	44	33	27.8418	20.8814
Manual insertion		88,00,000		Number of parts	16,59,000	parts	5.3044	27	1	143.2188	5.3044
Wave-soldering		3,04,000		Number of boards	1,27,050	boards	2.3928	1	1	2.3928	2.3928
Total	$	119,04,000							Overhead Cost allocated as per ABC (Activity based costing)	217.8570	60.4384

Total Cost of a unit

	PC board ($)	TV board ($)
Direct Material	227.0000	147.0000
Cost allocated as per ABC	217.8570	60.4384
Total Cost	444.8570	207.4384

Total amount each of product will contribute :

	PC boards	TV boards
Sales	48000 units * $ 860 = $ 41,280,000	73000 * $ 470 = $ 34,310,000
Total Cost	48000 units * $ 444.8570 = $ 21,353,136.7676	73000 * $ 207.4384 = $ 15,142,999.5918
Contribution	$ 19,926,864	$ 19,167,000