Question

Maglie Company manufactures two video game consoles: handheld and home. The handheld consoles are smaller and less expensive than the home consoles. The company only recently began producing the home model. Since the introduction of the new product, profits have been steadily declining. Management believes that the accounting system is not accurately allocating costs to products, particularly because sales of the new product have been increasing.

Management has asked you to investigate the cost allocation problem. You find that manufacturing overhead is currently assigned to products based on their direct labor costs. For your investigation, you have data from last year. Manufacturing overhead was $1,296,000 based on production of 360,000 handheld consoles and 94,000 home consoles. Direct labor and direct materials costs were as follows.

	Handheld			Home			Total
Direct labor	$	1,238,000		$	382,000		$	1,620,000
Materials		730,000			684,000			1,414,000

Management has determined that overhead costs are caused by three cost drivers. These drivers and their costs for last year are as follows.

				Activity Level
Cost Driver	Costs Assigned			Handheld	Home	Total
Number of production runs	$	550,000		45	5	50
Quality tests performed		551,000		13	16	29
Shipping orders processed		195,000		110	40	150
Total overhead	$	1,296,000

Required:

a. How much overhead will be assigned to each product if these three cost drivers are used to allocate overhead? What is the total cost per unit produced for each product?

b. How much overhead will be assigned to each product if direct labor cost is used to allocate overhead? What is the total cost per unit produced for each product?

Answer 1

Answer a)

Calculation of overhead cost assigned to each product if three cost drivers are used to allocate overhead

Cost Driver	Activity Rate (In $)	Activity Level	Assigned Cost (Activity Rates X Activity Level)       (In $)
Handheld	Home	Handheld	Home
Number of Production runs	$                                11,000.00	per production run	45	5	$                          495,000	$                 55,000
Quality tests performed	$                                19,000.00	per quality test	13	16	$                          247,000	$               304,000
Shipping orders processed	$                                  1,300.00	per shipping order processed	110	40	$                          143,000	$                 52,000
Total Overhead Cost	$                          885,000	$               411,000

Therefore total overhead cost assigned Handheld game console is $ 885,000 and Home game console is $ 411,000.

Working Note:

Calculation of activity rate for each cost driver

Cost Driver	Cost Assigned (In $)	Total Activity level	Activity Rate (Cost Assigned/ Total Activity Level) (In $)
Number of Production runs	$                                   550,000	50	Production runs	$        11,000.00	per production run
Quality tests performed	$                                   551,000	29	Quality tests	$        19,000.00	per quality test
Shipping orders processed	$                                   195,000	150	shipping orders processed	$           1,300.00	per shipping order processed
Total	1,296,000

Calculation of total overhead cost of each product

	Handheld	Home
Materials	$                                             730,000	$                        684,000
Direct labor	$                                          1,238,000	$                        382,000
Overhead Cost	$                                             885,000	$                        411,000
Total Cost	$                                          2,853,000	$                    1,477,000
Number of units produced	360,000	94,000
Total Cost per unit	$                                                  7.93	$                          15.71

  

Therefore total cost per unit for Handheld will be $ 7.93 and Home will be $ 15.71

Answer b)

Calculation of overhead cost assigned to each product if direct labor cost is used to allocate overhead

	Handheld	Home
Materials	$                                             730,000	$                        684,000
Direct labor	$                                          1,238,000	$                        382,000
Overhead Cost	$                                             990,400	$                        305,600
Total Cost	$                                          2,958,400	$                    1,371,600
Number of units produced	360,000	94,000
Total Cost per unit	$                                                    8.22	$                            14.59

Therefore total cost per unit of Handheld console is $ 8.22 and Home console is $ 14.59

Working Note:

Calculation of overhead rate based on direct labor cost

Overhead rate= Total budgeted overhead cost/ Total direct labor cost

                                            = $ 1,296,000/ $ 1,620,000

                                            = $ 0.80 per dollar of direct labor cost

Calculation of overhead Assigned to Handheld Console

Overhead cost assigned to handheld console = Direct labor cost of Handheld Console X Overhead rate

                                                                                   = $ 1,238,000 X $ 0.80 per dollar of direct labor cost   

                                                                                    = $ 990,400

Calculation of overhead Assigned to Home Console

Overhead cost assigned to Home console = Direct labor cost of Home Console X Overhead rate

                                                                                   = $ 382,000 X $ 0.80 per dollar of direct labor cost   

                                                                                    = $ 305,600