Question

Maryville Manufacturing designs and builds custom mudroom storage benches. All of the mudroom storage benches are constructed with rustic hickory. Its budgeted manufacturing costs for the 2018 year are as follows.

Overhead Cost Pools	Amount
Purchasing	$ 45,000
Handling materials	50,000
Production (cutting, milling, finishing)	130,000
Setting up machines	85,000
Inspecting	60,000
Inventory control (raw materials and finished goods)	80,000
Utilities	100,000
Total budgeted overhead costs	$550,000

For the last 5 years, Maryville Manufacturing has been charging overhead to products on the basis of materials cost. For the year 2018, materials cost of $500,000 were budgeted.

Jim Johnson, owner-manager of Maryville Manufacturing, recently directed his accountant, Ledger Kaufman, to implement the activity-based costing system that he has repeatedly proposed. At Jim’s request, Ledger and the production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.

Overhead Cost Pools	Activity Cost Drivers	Expected Use of Cost Drivers
Purchasing	Number of orders	500
Handling materials	Number of moves	5,000
Production (cutting, milling, finishing)	Direct labor hours	65,000
Setting up machines	Number of setups	1,000
Inspecting	Number of inspections	4,000
Inventory control (raw materials and finished goods)	Number of components	40,000
Utilities	Square feet occupied	50,000

Doug Russell, sales manager, has received an order for 12 custom mudroom storage benches from Homes by Kathy. At Doug’s request, Ledger prepares costs estimates for producing 12 mudroom storage benches so Doug can submit a contract price per mudroom storage bench to Homes by Kathy. He accumulates the following data for the production of 12 mudroom storage benches.

Direct materials	$5,200
Direct labor	$3,500
Direct labor hours	200
Number of purchase orders	3
Number of material moves	32
Number of machine setups	4
Number of inspections	20
Number of components	640
Number of square feet occupied	320

Required:

Compute the predetermined overhead rate using traditional costing with direct materials cost as the allocation base.

Compute the total cost of manufacturing one mudroom storage bench using direct materials cost as the allocation base for manufacturing overhead.

Compute the predetermined overhead rate using traditional costing with direct labor hours as the allocation base.

Compute the total cost of manufacturing one mudroom storage bench using direct labor hours as the allocation for manufacturing overhead.

Compute the predetermined overhead rate per cost driver for each of the overhead cost pools using the proposed activity-based costing system.

Compute the total cost of manufacturing one mudroom storage bench using the proposed activity-based costing system.

Which allocation base is preferable under traditional costing and why?

Which costing system (traditional or activity-based) is preferable in pricing decisions and why?

Answer 1

1. )Determination of predetermined overheads rate using traditional costing with direct material cost as the allocation base:

Overhead rate/ $ of direct material cost=Total overheads by company/Total direct material cost

=$ 5,50,000/ $500,000

=$ 1.1/for every $ of direct material

2) Computation of total cost of Manufacturing one mud room storage bench using direct material cost        as the allocation of manufacturing overheads

          Direct Materials-------------------$ 433.33

          Direct Labour----------------------$ 291.67

         Overheads( 433.33 *1.1)   ------$ 476.66

   Total cost/mud room bench---------$ 1201.66

3) Determination of predetermined overheads rate using traditional costing with direct labour hours as the allocation base:

Overhead rate/ direct labour hour=Total overheads incurred by company/Total direct lab hrs worked

                                                             =$ 5,50,000/ 65,000 hours

                                                              =$ 8.4615/hour= $ 8.46 /direct labour hour

            

4) Computation of total cost of Manufacturing one mud room storage bench using direct labour hours as the allocation of manufacturing overheads

          Direct Materials-------------------$ 433.33

          Direct Labour----------------------$ 291.67

         Overheads( 16.67 hours*8.46)-$ 141.03

   Total cost/mud room bench---------$866.03

5) Determination of predetermined overheads rate per cost driver for each overhead cost pool using Activity based costing as the allocation base:

Cost Pool	A Cost($)	B Cost Driver	Cost Driver Rate( $) C= A/B
Purchasing	45,000	Number of orders=500	90/order
Handling Materials	50,000	Number of moves=5000	10/move
Production(cutting, milling & finishing)	1,30,000	Direct labour hours= 65,000	2/direct lab hour
Setting up Machines	U85,000	Number of set ups=1,000	85/set up
Inspecting	60,000	Number of Inspections= 4,000	15/inspection
Inventory Control( Raw Materials& F.Goods)	80,000	Number of components=40,000	2/component
Utilities	1,00,000	Square feet occupied= 50,000	2/ sq feet

6) Compute the cost of one mud room bench using Activity Based Costing

Direct Material Cost ( $ 5200/12)	$ 433.33
Direct Labour Cost( $ 3500/12)	$ 291.67
Purchasing(90/order* 0.25)	$ 22.5
Handling( 10/move * 2.67)	$ 26.7
Production($ 2/DLH *16.67)	$33.34
Setting up( $ 85/set up *0.33)	$ 28.05
Inspection( $ 15/inspection * 1.67)	$ 25.05
Inventory Control( $2/component * 53.33)	$ 106.66
Utilities( $2/ square feet *26.67)	$ 53.34

Total cost of one mud room bench= $ 1020.64

7) Under Tradional Costing Direct labour hours as an allocation base is preferred because time hours i.e direct labour hours can be safely taken as a cost driver governing costs in all the departments.

8)

Activity based costing is preferred over Traditional Costing for pricing decisions fo the following reasons:

1. In the current scenario of the competitive environment and declining profit margins , ABC helps to estimate the cost of the product or service more accurately .This helps us to decide a marketing strategy.
2. There is an increase of products and customers. The resources consumed varies among products and customers. The profit of each product and customer can be reasonably arrived at based on the resources or input used by the customer or product. This has to be traced to the product and customer to arrive at more accurate pricing.