Question

Magic Company makes three types of radios for small aircraft-model A, model B, and model C. The manufacturing operations are mechanized and there is no direct labor. Manufacturing overhead costs are significant, and Orlando has adopted an activity-based costing system. Direct materials costs per unit for each model are as follows:

Model A                                             $28

Model B                                             $32

Model C                                             $40

Magic Company has three activities-assembly, materials management, and testing. The cost driver for assembly is machine hours. The cost driver for materials management is number of parts, and the cost driver for testing is the number of units of product. Total costs and production volumes for the year 2012 were estimated as follows:

Activities	Total cost of activities	Cost Allocation Base of Each Activity	Total Numbers of Cost Drivers
Assembly	$780,000	Machine hours	120,000
Materials management	$120,000	Parts	80,000
Testing	$22,500	Units	5,000

The Model A radio requires 12 parts to construct, and also requires 16 machine hours of processing.

The Model B radio requires 15 parts to construct, and also requires 18 machine hours of processing.

The Model C radio requires 19 parts to construct, and also requires 20.5 machine hours of processing.

Requirements:

1. Calculate the cost allocation rate for each activity.
2. Calculate the indirect cost allocated to one unit of Model A, Model B, and Model C under ABC system.
3. What is the total manufacturing cost to make one unit of Model A, Model B, and Model C under ABC system?
4. Suppose that instead of an ABC System Company has a traditional product costing system that allocates indirect costs on the basis of machine hours (total machine hours of the period are 120.000). Calculate allocation rate (round to the nearest dollar) and total manufacturing cost under traditional costing system.

Answer 1

Part (1)

In case of activity based costing, cost of each activity is allocated to the product based on the cost driver allocated of the said activity.

In the given case, rate of allocation should be based on the cost drivers:

Activities	Total cost of activities(A)	Cost Allocation Base of Each Activity	Total Numbers of Cost Drivers(B)	Rate of Cost Allocation (A/B)
Assembly	$780,000	Machine hours	120,000	6.5 per Machine hour
Materials management	$120,000	Parts	80,000	1.5 per Part
Testing	$22,500	Units	5,000	4.5 per unit

Part (2)

Indirect costs have to be allocated on the basis of cost driver consumed on each product:

Product	Assembly Cost (A) (Rate of allocation * Machine Hours Incurred)	Materials Management Cost (B) (Rate of allocation * Parts incurred)	Testing Cost (C) (Rate of allocation * 1 unit)	Total Indirect Cost (A+B+C)
Model A	6.5 * 16 = 104	1.5 * 12 = 18	4.5	126.5
Model B	6.5 * 18 = 117	1.5 * 15 = 22.5	4.5	144
Model C	6.5 * 20.5 = 133.25	1.5 * 19 = 27.5	4.5	165.25

Part (3)

Total manufacturing cost for one unit

Product	Direct Material Cost (A)	Indirect Costs (B) (As per Part (2))	Total Costs (A+B)
Model A	28	126.5	154.5
Model B	32	144	176
Model C	40	165.25	205.25

Part (4)

In case of traditional costing all the costs are allocated on a single basis as decided by entity. In the given case allocation of costs of Assembly, Material management and Testing will be done on the basis of machine hours.

Allocation Rate = Total Indirect Costs/Macine Hours

= (780000 + 120000 + 22500)/120000hrs

= 7.6875 per machine hour or 8 per machine hour

Total manufacturing cost under traditional costing approach :

Product	Direct Material Cost (A)	Indirect Costs (B) (Rate of allocation * Machine Hours)	Total Costs (A+B)
Model A	28	8 * 16 = 128	156
Model B	32	8 * 18 = 144	176
Model C	40	8 * 20.5 = 164	204