Question

Lloyd and Harry, Inc. is a manufacturer of briefcases. The company produces and sells two products: Leather and Vinyl. Currently, the company uses a traditional costing system to allocate manufacturing overhead to production based on a predetermined manufacturing overhead rate of $100 per machine hour.

Management is considering switching to activity based costing to improve costing accuracy. In their analysis of manufacturing overhead, management has identified two activities and cost pools: Product Inspection and Machining. 80% of the total budgeted manufacturing overhead relates to the Product Inspection activity. The remainder relates to the Machining activity. Product Inspection overhead costs are driven by inspection hours logged. Machining overhead costs are driven by machine hours logged. All machine hours are logged in the machining department.

The projected production levels for the upcoming period are 1,000 Leather briefcases and 5,000 Vinyl briefcases. The following activity totals are expected:

	Leather	Vinyl
Inspection Hours	900 hours	1,500 hours
Machine Hours	200 hours	1,000 hours

1. By how much is the traditional costing system over/undercosting the Leather product line on a per unit basis? (indicate the amount and if it is over/undercosted)

b. In words, explain how you can use your answer from a. to determine if the Vinyl product line was over/undercosted and to quickly calculate the per unit amount of cost distortion.

Answer 1

Lloyd and Harry, Inc. is a manufacturer of briefcases. The company produces and sells two products: Leather and Vinyl. Currently, the company uses a traditional costing system to allocate manufacturing overhead to production based on a predetermined manufacturing overhead rate of $100 per machine hour.