Question

Maxey & Sons manufactures two types of storage cabinets—Type A and Type B—and applies manufacturing overhead to all units at the rate of $116 per machine hour. Production information follows.

	Type A			Type B
Anticipated volume (units)		23,200			43,500
Direct-material cost per unit	$	26		$	39
Direct-labor cost per unit		31			31

The controller, who is studying the use of activity-based costing, has determined that the firm’s overhead can be identified with three activities: manufacturing setups, machine processing, and product shipping. Data on the number of setups, machine hours, and outgoing shipments, which are the activities’ three respective cost drivers, follow.

	Type A			Type B			Total
Setups		136			96			232
Machine hours		46,400			65,250			111,650
Outgoing shipments		200			150			350

The firm’s total overhead of $12,951,400 is subdivided as follows: manufacturing setups, $2,825,760; machine processing, $7,770,840; and product shipping, $2,354,800.

Required:

1. Compute the unit manufacturing cost of Type A and Type B storage cabinets by using the company’s current overhead costing procedures.

2. Compute the unit manufacturing cost of Type A and Type B storage cabinets by using activity-based costing.

3. Is the cost of the Type A storage cabinet overstated or understated (i.e., distorted) by the use of machine hours to allocate total manufacturing overhead to production? By how much?

4. Assume that the current selling price of a Type A storage cabinet is $341.00 and the marketing manager is contemplating a $39 discount to stimulate volume. Is this discount advisable?

Answer 1

1. Cost sheet of Type A and Type B using current allocation method:

Particulars	Type A specs	Type A cost	Type B specs	Type B cost
Anticipated volume (units)	23200		43500
Direct material cost per unit ($)	26		39
Total direct material cost for product	23200 * 26	603,200	43500 * 39	1,696,500
Direct labour cost per unit ($)	31		31
Total direct labour cost for product	23200 * 31	719,200	43500 * 31	1,348,500
Total machine hours (hrs)	46400		65250
Manufacturing overhead per machine hour ($)	116		116
Manufacturing overheads for product	46400 * 116	5,382,400	65250 * 116	7,569,000
Total manufacturing cost ($)		6,704,800		10,614,000
Manufacturing cost per unit ($)	6704800 / 23200	289	10614000 / 43500	244

2.

For Manufacturing setups:

Number of setups	136		96		232
Total manufacturing setup overhead					2,825,760
% allocation to each product	136 / 232	58.62%	96 / 232	41.38%
Manufacturing setup cost for each product	58.62% * 2825760	1,656,460	41.38% * 2825760	1,169,300

For Machine processing:

Number of machine hours	46400		65250		111650
Total machine processing ($)					7,770,840
% allocation to each product	46400 / 111650	41.56%	65250 / 111650	58.44%
Manufacturing setup cost for each product	41.56% * 7770840	3,229,560	58.44% * 7770840	4,541,280

For Product Shipping costs:

Number of outgoing shipments	200		150		350
Total product shipping ($)					2,354,800
% allocation to each product	200 / 350	57.14%	150 / 350	42.86%
Manufacturing setup cost for each product	57.14% * 2354800	1,345,600	42.86% * 2354800	1,009,200

Cost sheet for Type A and Type B using activity-based costing:

Particulars	Type A specs	Type A cost	Type B specs	Type B cost
Anticipated volume (units)	23200		43500
Direct material cost per unit ($)	26		39
Total direct material cost for product	23200 * 26	603,200	43500 * 39	1,696,500
Direct labour cost per unit ($)	31		31
Total direct labour cost for product	23200 * 31	719,200	43500 * 31	1,348,500
Manufacturing setup cost		1,656,460		1,169,300
Machine processing cost		3,229,560		4,541,280
Product shipping cost		1,345,600		1,009,200
Total manufacturing cost ($)		7,554,020		9,764,780
Manufacturing cost per unit ($)	7554020 / 23200	325.60	9764780 / 43500	224.48

3. Using the current method os machine hours to allocate all manufacturing overheads, cost of Type A storage cabinet is understated by (325.6 - 289) $36.6 per unit.

4. A discount of $39 on sale price of $341, would lead to a new discounted price of $302.

Basis the current allocation by machine hour method, cost of manufacturing Type A cabinet is $289 and hence, the discount of $39 is advisable as the product would still yield a profit of $13 per unit (302 - 289)

However, basis the activity-based costing method, cost of manufacturing Type A cabinet is $325.6 per cabinet and therefore, a discounted price of $302 will not be advisable at it will lead incurring loss on sale of each unit.