Question

Marble, Inc. manufactures a product that is available in both a flexible and a rigid model. The company has made the rigid model for years; the flexible model was introduced several years ago to tap a new segment of the market. Since introduction of the flexible model, the company’s profits have steadily declined, and management has become concerned about the accuracy of its costing system. Sales of the flexible model have been increasing rapidly.

Overhead is applied to products on the basis of direct labor-hours. At the beginning of the current year, management estimated that $600,000 in overhead costs would be incurred and the company would produce and sell 1,000 units of the flexible model and 10,000 units of the regular model. The flexible model requires 2 hours of direct labor time per unit, and the regular model requires 1 hour. Direct materials and labor costs per unit are given below:

                                                                                                Flexible           Rigid

                        Direct materials cost per unit…………           $110.00           $80.00

                        Direct labor cost per unit……………..           $30.00           $15.00

Required:

1. (2 points) Compute the predetermined overhead rate using direct labor-hours as the basis for allocating overhead costs to products. Compute the unit product cost for one unit of each model.
2. (2 points) An intern suggested that the company use activity-based costing to cost its products. A team was formed to investigate this idea. It came back with the recommendation that four activity cost pools be used. These cost pools and their associated activities are listed as follows:

    Estimated                    Expected Activity            

Activity Cost Pool and Activity Measure    Overhead Cost          Flexible   Rigid   Total

Purchase orders (number of orders)………      $   20,000                    100         300         400        

Rework requests (number of requests)…...            10,000                      60         140         200

Product testing (number of tests)…………          210,000                    900      1,200      2,100

Machine related (machine-hours)………...           360,000                 1,500      2,500      4,000

                                                                            $600,000

Compute the activity rate for each of the activity cost pools.

3. Using activity-based costing, do the following:
   1. (2 points) Determine the total amount of overhead that would be assigned to each model for the year.
   2. (2 points) Compute the unit product cost for one unit of each model.
4. (2 points) Identify a possible explanation for the company’s declining profit based on an analysis of your results from requirements 1-3.

Answer 1

Part 1

Estimated overhead		$               600,000
Divided by: direct labor hours ((1000*2)+(10000*1))		12,000
Predetermined overhead rate		$                         50
Overhead cost per unit to Flexible (2*50)		$                       100
Overhead cost per unit to Rigid (1*50)		$                         50
	Flexible	Rigid
Direct materials	$        110.00	$                   80.00
Direct labor	$          30.00	$                   15.00
Overhead	$        100.00	$                   50.00
Unit product cost	$        240.00	$                 145.00

Part 2

Activity Centers	Cost Drivers	Activity Costs	Divided by : Activity Level	Activity rate
Purchase orders	Number of orders	$                 20,000	400	$             50
Rework requests	Number of requests	$                 10,000	200	$             50
Product testing	Number of tests	$               210,000	2,100	$           100
Machine related	Machine-hours	$               360,000	4,000	$             90

Model	Flexible
Activity Centers	Activity rate	Activity	Allocated cost
Purchase orders	$                50	100	$           5,000
Rework requests	$                50	60	$           3,000
Product testing	$              100	900	$         90,000
Machine related	$                90	1,500	$       135,000
Overhead assigned			$       233,000

Model	Rigid
Activity Centers	Activity rate	Activity	Allocated cost
Purchase orders	$                50	300	$         15,000
Rework requests	$                50	140	$           7,000
Product testing	$              100	1,200	$       120,000
Machine related	$                90	2,500	$       225,000
Overhead assigned			$       367,000

Model	Flexible	Rigid
Overhead assigned	$     233,000	$               367,000
Divided by: units produced	1,000	10,000
Overhead per unit	$        233.00	$                   36.70
	Flexible	Rigid
Direct materials	$        110.00	$                   80.00
Direct labor	$          30.00	$                   15.00
Overhead	$        233.00	$                   36.70
Unit product cost	$        373.00	$                 131.70

Company would consumed the more activity to produce the one unit of flexible model. This would be result in the higher overhead cost per unit for flexible model.