Question

Exercise 7.25 Whispering Products manufactures two component parts: AJ40 and AJ60. AJ40 components are being introduced currently, and AJ60 parts have been in production for several years. For the upcoming period, 1,100 units of each product are planned for manufacturing. Assume that the only relevant overhead cost is for engineering change orders (any requested changes in product design or the manufacturing process). AJ40 components are expected to require 4 change orders and AJ60 only 2. Each AJ40 requires 1 machine hour, and each AJ60 requires 1.5 machine hours. The cost of a change order is $600.

Estimate the cost of engineering change orders for AJ40 and AJ60 components if Whispering uses a traditional costing method and machine hours as the allocation base. (Round machine hour rate to 2 decimal places, e.g. 25.69 and final answers to 0 decimal places, e.g. 5,275.) Total allocated cost for AJ40 $ Total allocated cost for AJ60 $

Now suppose that Whispering uses an ABC system and allocates the cost of change orders by using as cost driver the number of change orders. Estimate the cost for change orders for each unit of AJ40 and AJ60. Total allocated cost for AJ40 $ Total allocated cost for AJ60 $

Calculate the difference in overhead allocated to each product. (Round answers to 0 decimal places, e.g. 5,275. Show an undercharge preceded by a minus sign, e.g. -256 or (256).) Overcharge (Undercharge) for AJ40 $ Overcharge (Undercharge) for AJ60 $

Answer 1

Calculation of total change orders cost = 6 change order * $600

= $3,600

This total cost shall be allocated on the basis of total production of each model and machine hours.

Total machine hours required for AJ40 = 1100 units * 1 hour per unit

= 1100 hours

Total machine hours required for AJ60 = 1100 units * 1.5 hour per unit

= 1650 hours

Total Machine hours required = 1100 hours + 1650 hours

= 2750 hours

Allocation of change order cost:

AJ40 = $3600 * 1100 hours / 2750 hours = $1,440

AJ60 = $3600 * 1650 hours / 2750 hours = $2,160

Under ABC Costing, allocation would be made on number of activities i.e number of change orders.

AJ40 requires 4 change orders while AJ60 requires 2 change orders.

Allocation to both models:

AJ40 = $3600 * 4 change orders / 6 change orders = $2,400

AJ60 = $3600 * 2 change orders / 6 change orders = $1,200

Difference in overheads allocated

AJ40 = $1,440 - $2,400 = ($960) (Undercharge)

AJ60 = $2,160 - $1,200 = $960 (Overcharge)