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 $80 per machine hour. Production information follows.

	Type A			Type B
Anticipated volume (units)		8,000			15,000
Direct-material cost per unit	$	35		$	60
Direct-labor cost per unit		20			20

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		50			30			80
Machine hours		16,000			22,500			38,500
Outgoing shipments		100			75			175

The firm’s total overhead of $3,080,000 is subdivided as follows: manufacturing setups, $672,000; machine processing, $1,848,000; and product shipping, $560,000.

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 $260 and the marketing manager is contemplating a $30 discount to stimulate volume. Is this discount advisable?

Answer 1

Answer- 1:

If the company uses current method of overhead allocation i.e. based on machine hours; the unit cost for cabinets i.e. Type A and Type B will be calculated as below:

Type A: Direct Material cost + Direct labor cost + Overhead charge
= $ 35 + $20 + (2 hours * $80 per hour)

= $215

(It should be noted that company has spent 16,000 machine hours for production of 8000 Type A units which means 2 hours per unit; since overhead rate is $80 per hour, overhead per unit of Type A will be $160)

Type B: Direct Material cost + Direct labor cost + Overhead charge
= $ 60 + $20 + (1.5 hours * $80 per hour)

= $200

(It should be noted that company has spent 22,500 machine hours for production of 15000 Type B units which means 1.5 hours per unit; since overhead rate is $80 per hour, overhead per unit of Type B will be $120)

Answer- 2:

Let’s calculate overhead charge by Activity based costing method:

With use of Overhead per unit from above table, we can infer the unit cost for both the cabinets:

Type A: Direct Material cost + Direct labor cost + Overhead charge
= $ 35 + $20 + $188.5

= $243.5

Type B: Direct Material cost + Direct labor cost + Overhead charge
= $ 60 + $20 + $104.8

= $184.8

Answer -3:

If we compare the unit cost under the current method and the ABC costing method, we can infer that the Cost for Type A product is understated if the company continues to charge overhead based on machine hours rate of $80 per hour. For Type A cabinet, the cost is $243.5 asper ABC method while the current method brings the cost to $215.

On an overall basis, the cost for product A is understated by $28.5 if the machine hours allocation method is used.

Answer- 4:

After discount, net sales price realized to company will be $230 ($260 - $30) which is lower than the unit cost of $243.5 (activity based costing method). If the discount of $30 is provided, the company will incur a loss of $13.5 per unit of product Type A.

Hence Discount is not advisable.