Question

Activity-Based Life-Cycle Costing

Kagle design engineers are in the process of developing a new “green” product, one that will significantly reduce impact on the environment and yet still provide the desired customer functionality. Currently, two designs are being considered. The manager of Kagle has told the engineers that the cost for the new product cannot exceed $500 per unit (target cost). In the past, the Cost Accounting Department has given estimated costs using a unit-based system. At the request of the Engineering Department, Cost Accounting is providing both unit- and activity-based accounting information (made possible by a recent pilot study producing the activity-based data).

Unit-based system:
Variable conversion activity rate: $110 per direct labor hour
Material usage rate: $15 per part

ABC system:
Labor usage: $25 per direct labor hour
Material usage (direct materials): $30 per part
Machining: $80 per machine hour
Purchasing activity: $150 per purchase order
Setup activity: $3,600 per setup hour
Warranty activity: $500 per returned unit (usually requires extensive rework)
Customer repair cost: $35 per repair hour (average)

Activity and Resource Information (annual estimates)
	Design A		Design B
Units produced	20,000		20,000
Direct material usage	320,000	parts	295,000	parts
Labor usage	55,000	hours	125,000	hours
Machine hours	55,000		65,000
Purchase orders	2,000		1,500
Setup hours	650		250
Returned units	1,100		300
Repair time (customer)	2,000		500

Required:

1. Select the lower-cost design using unit-based costing.

Are logistical and post-purchase activities considered in this analysis?

2. Select the lower-cost design using ABC analysis.

3. What if the post-purchase cost was an environmental contaminant and amounted to $10 per unit for Design A and $40 per unit for Design B? Compute the Post-purchase cost for each design.

	Post-Purchase Cost
Design A	$fill in the blank 4
Design B	$fill in the blank 5

Assume that the environmental cost is borne by society. Now which is the better design?

Answer 1

SOLUTION:

1. lower-cost design using unit-based costing. Are logistical and post-purchase activities considered in this analysis?

Particulars	Design A ($)	Design B ($)
Material ($ 15 per part)	(320,000*15)	(295,000*15)
	4,800,000	4,425,000
Variable conversion activity rate	(55000*110)	(125000*110)
($110 per direct labor hour)	6,050,000	13,750,000
Total Cost (A)	10,850,000	18,175,000
Units produced (B)	20,000	20,000
Cost per unit (A/B)	542.5	908.75

The lower cost design using unit based costing is Design A.

However the cost per unit $ 542.5 is greater than the target price $ 500 per unit

Logistical and post purchase activities are NOT considered in this analysis.

2. lower-cost design using ABC analysis.

ABC Analysis

Particulars	Design A ($)	Design B ($)
Material	(320,000*30)	(295,000*30)
($ 30 per part)	9,600,000	8,850,000
Labour	(55000*25)	(125000*25)
($25 per direct labor hour)	1,375,000	3,125,000
Machining	(80*55000)	(80*65000)
($ 80 per machine hour)	4,400,000	5,200,000
Purchasing	(2000*150)	(1500*150)
($150 per purchase order)	300,000	225,000
Setup	(3600*650)	(3600*250)
($ 3600 per setup hours)	2,340,000	900,000
Warranty Activity	(500*1100)	(500*300)
($ 500 per returned unit)	550,000	150,000
Customer repair Cost	(35*2000)	(35*500)
($35 per repair hour)	70,000	17,500
Total cost	18,635,000	18,467,500

USING ABC ANALYSIS, THE LOWER COST DESIGN IS DESIGN B.

3. POST PURCHASE COST :

Design A = 20,000 *10 per unit = $ 200,000

Design B = 20,000 *40 per unit = $ 800,000

After taking into consideration the post purchase cost the revised cost is as follows:

There will not be any impact on the cost because the post purchase cost is borne by the society.

Thus Design B is better.