Question

Environmental costs, activity-based costing

Bevans Co. makes two products, Product X, and Product Y. Bevans has produced Product X for many years without generating any hazardous wastes. Recently, Bevans developed Product Y, which is superior to Product X in many respects. However, production of Product Y generates hazardous wastes. Because of the hazardous wastes, Bevans now must deal with hazardous waste disposal, governmental environmental reports and inspections, and safe handling procedures. Bevans Co. uses an indirect cost rate based on machine hours to assign manufacturing support costs to its two products. Because of concerns about the accuracy of the product costing system, Joel Dempsey, the controller, undertook an activity-based costing analysis of the manufacturing support costs, including an analysis of the support costs related to Product Y's generation of hazardous wastes. The resulting cost information, as well as machine hours and a number of units, is summarized in the following table:

                                                PRODUCT X                         PRODUCT Y

Direct costs (material plus labor)                                               9,000,000                            $4,000,000

Environmental support costs                                                       -----------                               $14,000,000

Nonenvironmental support costs                                              $22,000,000                        $29,000,000

Total machine hours                                                                       10,000,000                           6,000,000

Number of units                                                                               100,000,000                        40,000,000

Required

Compute product costs per unit for Products X and Y using the current indirect cost rate based on machine hours for manufacturing support costs.

Compute product costs per unit for Products X and Y using the activity-based costing figures provided in the table.

Explain the reasons for the differences in cost for each product using the two cost systems.

Bevans has been selling products X and Y at a price equal to 1.5 times the product cost computed using the machine-hour-based cost driver rate for manufacturing support costs. Compute these prices and provide recommendations to Bevan’s management concerning profit improvement through pricing changes and cost reduction through manufacturing improvements.

Answer 1

There is differences in cost for each product using the two cost systems because in machine hour basis cost charged to both the product and in activity based costing it is charge to product which actually incurring this cost.

Computation of Sale price and profit under both cost systems :

Product X having higher profit and sale price. Its beneficial to produce more units of product X to increase profit. And sale price of product also need to be change. It should be 150 % of product cost using activity cost basis.