Question

Churchill Products is considering updating its cost system to an activity-based costing system and is interested in understanding the effects. The company’s cost accountant has identified three overhead cost pools along with appropriate cost drivers for each pool.

Cost Pools	Costs			Activity Drivers
Utilities	$	290,000		58,000	machine-hours
Scheduling and setup		280,000		560	setups
Material handling		775,000		1,550,000	pounds of material

The company manufactures three models of water basins (Oval, Round, and Square). The plans for production for the next year and the budgeted direct costs and activity by product line are as follows.

	Products
	Oval			Round			Square
Total direct costs (material and labor)	$	80,000		$	90,000		$	80,000
Total machine-hours		30,000			10,000			18,000
Total number of setups		60			300			200
Total pounds of material		490,000			260,000			800,000
Total direct labor-hours		3,000			2,000			5,000
Number of units produced		4,200			2,200			5,500

Required:

a. The current cost accounting system charges overhead to products based on direct labor-hours. What unit product costs will be reported for the three products if the current cost system continues to be used?
c. What are the cost driver rates for the three cost pools identified by the cost accountant?
d. What unit product costs will be reported for the three products if the ABC system suggested by the cost accountant's classification of cost pools is used?
e. If management should decide to implement an activity-based costing system, what benefits should it expect?

Answer 1

Answer :

(a) unit product costs if the current cost system used

	Oval	Round	Square
Total direct labor cost	$ 80000	$ 90000	$ 80000
Overhead allocated ( overhead recovery rate*Total direct labor hour )	$ 403500 ( $ 134.50*3000)	$ 269000 ( $ 134.50*2000)	$ 672500 ( $ 134.50*5000)
Total cost (a)	$ 483500	$ 359000	$ 752500
units produced (b)	4200	2200	5500
unit product cost (a)/(b)	$ 115.12	$ 163.18	$ 136.82

( approx up to 2 decimal place )

Working note -1

Overhead recovery rate = Total overhead rate / Total direct labor hour

= $ 290000+ $ 280000+ $ 775000 / 3000+2000+5000

= $ 1345000 / 10000

= $ 134.50 per hour

(c) Computation of cost driver rates

	Utilities	Scheduling and setup	Material handling
Total cost (a)	$ 290000	$ 280000	$ 775000
Number of activity (b)	58000 machine hour	560 set up	1550000 pound of material
Cost driver rate (a) /(b)	$ 5 per machine hour	$ 500 per set up	$ 0.5 per pound

(d) unit product cost if ABC system used

	Oval	Round	Square
Total direct labor cost	$ 80000	$ 90000	$ 80000
Overhead allocated ( Cost driver rate* Number of activity )
Utilities	$ 150000 ( $ 5* 30000)	$ 50000 ( $ 5*10000)	$ 90000 ( $ 5*18000)
Scheduling and setup	$ 30000 ( $ 500*60)	$ 150000 ( $ 500*300)	$ 100000 ( $ 500*200)
Material handling	$ 245000 ( $ 0.50* 490000)	$ 130000 ( $ 0.50*260000)	$ 400000 ( $0.50*800000)
Total cost (a)	$ 505000	$ 420000	$ 670000
units produced (b)	4200	2200	5500
unit product cost (a)/(b)	$ 120.24	$ 190.91	$ 121.82

( approx up to 2 decimal place )

(e)  benefits of ABC

1. ABC will provide realistic  product cost of manufacturing for specific products.

2. ABC helps in better decision making to managemant.

3. ABC easily identify inefficient process and helps in tracing activity for cost object.

4. It calculate product margin more accurately compare to traditional costing system.