Question

Schultz Electronics manufactures two ultra high-definition television models: the Royale which sells for $1,480, and a new model, the Majestic, which sells for $1,270. The production cost computed per unit under traditional costing for each model in 2017 was as follows.

Traditional Costing		Royale		Majestic
Direct materials		$650		$420
Direct labor ($20 per hour)		120		100
Manufacturing overhead ($42 per DLH)		252		210
Total per unit cost		$1,022		$730

In 2017, Schultz manufactured 25,000 units of the Royale and 10,000 units of the Majestic. The overhead rate of $42 per direct labor hour was determined by dividing total expected manufacturing overhead of $8,449,220 by the total direct labor hours (200,000) for the two models.

Under traditional costing, the gross profit on the models was Royale $458 ($1,480 – $1,022) and Majestic $540 ($1,270 – $730). Because of this difference, management is considering phasing out the Royale model and increasing the production of the Majestic model.

Before finalizing its decision, management asks Schultz’s controller to prepare an analysis using activity-based costing (ABC). The controller accumulates the following information about overhead for the year ended December 31, 2017.

Activity Cost Pools		Cost Drivers		Estimated Overhead		Expected Use of Cost Drivers		Activity-Based Overhead Rate
Purchasing		Number of orders		$1,261,700		40,700		$31/order
Machine setups		Number of setups		874,120		16,810		$52/setup
Machining		Machine hours		5,440,500		120,900		$45/hour
Quality control		Number of inspections		872,900		30,100		$29/inspection

The cost drivers used for each product were:

Cost Drivers		Royale		Majestic		Total
Purchase orders		17,600		23,100		40,700
Machine setups		4,510		12,300		16,810
Machine hours		75,300		45,600		120,900
Inspections		11,900		18,200		30,100

Answer 1

We would calculate manufacturing overhead cost per unit under each product and then determine the gross profit on models
Calculation of manufacturing cost for Royale
Cost drivers	Cost drivers used	Activity rate	Total overhead cost allocated
Purchasing	17600	$31.00	$545,600.00
Machine setups	4510	$52.00	$234,520.00
Machining	75300	$45.00	$3,388,500.00
Quality control	11900	$29.00	$345,100.00
Total overhead costs			$4,513,720.00
Units manufactured			25000
Overhead cost per unit			$180.55
Calculation of manufacturing cost for Majestic
Cost drivers	Cost drivers used	Activity rate	Total overhead cost allocated
Purchasing	23100	$31.00	$716,100.00
Machine setups	12300	$52.00	$639,600.00
Machining	45600	$45.00	$2,052,000.00
Quality control	18200	$29.00	$527,800.00
Total overhead costs			$3,935,500.00
Units manufactured			10000
Overhead cost per unit			$393.55
Calculation of gross profit for each model
	Royale	Majestic
Sale price	$1,480.00	$1,270.00
Less: Manufacturing costs
Direct material	$650.00	$420.00
Direct labor	$120.00	$100.00
Manufacturing overhead	$180.55	$393.55
Gross profit	$529.45	$356.45
The gross profit based on traditional costing is inaccurate as in reality the gross profit of Royale is higher than Majestic.
Thus, company should not phase out Royale product.
Activity based costing accurately allocates costs to products.