Question

Magnum Company manufactures two different products, A and B. In the past, the company has allocated its plant wide manufacturing overhead costs based on direct labour hours. The new controller suggests that the company consider assigning overhead costs to the products using either traditional activity-based costing or time-determined activity-based costing. After studying the manufacturing activities and costs, the controller collected the following data for last year:

Item	Product A	Product B
Units produced and sold	3,000	5,000
Direct labour hours used	25,000	75,000
Direct labour cost	$500,000	$1,500,000
Number of times handled	6,000	15,000
Number of cuts	3,000	10,000
Number of design changes	50	25
Number of product setups	200	100

The manufacturing overhead costs incurred last year were $175,000. 7,000 hours of support time were used. Other information is as follows:

Activity	Total Time %		Unit Time in Hours
Handling	50%		.1
Cutting	25%		.1
Design changes	15%		15
Setups	10%		3
Total	100%

The direct material cost for product A is $30 per unit, and $35 per unit for product B.

Required:

a.	Determine the unit cost of each product using traditional activity-based costing. Show your calculations.
b.	Determine the unit cost of each product using time-determined activity-based costing. Show your calculations.
c.	Explain why the unit costs differ between requirements a and b.
d.	Assume that Magnum Company produces 30 different products in a complex manufacturing environment involving many more than four activities. Which of the two costing methods would you recommend, and why?

Answer 1

a. Unit cost of each product using traditional activity based costing:-

Allocation of Manufacturing overhead using traditional activity based costing

Segregation of total support hours into different cost drivers:-

• Handling = 7000*50% = 3500 hours
• Cutting = 7000*25% =1750 hrs
• Design changes =7000*15% =1050 hrs
• Setups = 7000*10% = 700 hours

Support hours used by product A & B

	A	B
Handling	3500/(6000+15000)*6000=1000 hours	3500/21000*15000=2500hours
Cutting	1750/(3000+10000)*3000= 403.85 hours	1750/13000*10000=1346.15 hours
Design changes	1050/75*50=700 hours	1050/75*25=350 hours
Setips	700/300*200=466.67 hours	700/300*100=233.33 hours
Total hours	2570.52 hours	4429.48 hours

Predetermined Allocation of manufacturing overhead = 175000/7000 = 25

Allocation of manufacturing overhead in both products:-

1. Product A = 2570.52*25 =$64,263
2. Product B =4429.48*25=$110,737

So,Finally calculation of unit cost would be:-

	Product A	Product B
Direct Material	$30	$35
Direct labour	500000/3000=$166.66	1,500,000/5000=$300
Manufacturing overhead	64263/3000=$21.421	110,737/5000=$22.15
Total Unit Cost	$218.081	$357.15

a. Unit cost of each product using time determined activity based costing:-

Allocation of support hours in cost driver of products

	Product A	Product B
Handling	3000*0.1 =300	5000*0.1 =500
Cutting	3000*0.1=300	5000*0.1 =500
Design changes	50*15=750	25*15=375
Setups	200*3=600	100*3=300
Total hours	1950	1675

Predetermined Allocation of manufacturing overhead = 175000/7000 = $25

Allocation of manufacturing overhead in both products:-

1. Product A = 1950*25=$48,750
2. Product B =1675*25= $41,875

So,Finally calculation of unit cost would be:-

	Product A	Product B
Direct Material	$30	$35
Direct labour	500000/3000=$166.66	1,500,000/5000=$300
Manufacturing overhead	48,750/3000= $16.25	41875/5000=8.38
Total Unit Cost	$182.91	$343.38

c. Unit cost differ between both way of allocation of overhead, because in 2nd method exact how much support hours were using in products allocated. and afterwards manufacturing overhead were charged accordingly.

d.Time determined ABC costing is recommended because in this method we determine how much support hours are being used in each product and accordingly we can charge the exact amount of overhead into them.