Question

Ontario, Inc. manufactures two products, Standard and Enhanced, and applies overhead on the basis of direct-labor hours. Anticipated overhead and direct-labor time for the upcoming accounting period are $800,000 and 25,000 hours, respectively. Information about the company’s products follows.

Standard: Est. production volume, 3000 units

                    Direct-material cost, $25 per Unit

                    Direct Labor per unit, 3 hrs at $12 per hr

Enhanced: Est. production volume, 4000 units

                     Direct material cost, $40 per Unit

                     Direct Labor per unit, 4 hrs at $12 per hr

Ontario’s overhead of $800,000 can be identified with three major activities: order processing ($150,000), machine processing ($560,000), and product inspection ($90,000). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively. Data relevant to these activities follow.

                                                                Orders Processed            Machine Hrs Worked                     Inspection Hrs

Standard                                                              300                                         18000                                                    2000

Enhanced                                                            200                                         22000                                                    8000

                                                                                500                                         40000                                                    10000

Top management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in income is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery was installed—machinery that was expected to produce significant operating efficiencies.

2. Assuming use of activity-based costing, compute the unit manufacturing costs of the standard and enhanced products if the expected manufacturing volume is attained.

2. Activity-based overhead application rates:
		Activities Cost	Application
Activity	Cost	Driver	Rate
Order processing
Machine processing
Product inspection
Activity	Standard	Enhanced
Order processing
Machine processing
Product inspection
Total
Production volume (units)
Cost per unit
	Standard	Enhanced
Direct material
Direct labor
Order processing, etc
Total cost

Answer 1

2	Activity-based overhead application rate:
	Activity				Activities cost	Cost driver	Application rate
					a	b	a/b
	Order processing				150000	500	300	Per Order
	Machine processing				560000	40000	14	Per MH
	Product inspection				90000	10000	9	Per inspection hour
	Activity				Standard	Enhanced
	Order processing				90000	60000
	(Orders processed*Application rate)				(300*300)	(200*300)
	Machine processing				252000	308000
	(Machine hours*Application rate)				(18000*14)	(22000*14)
	Product inspection				18000	72000
	(Inspection hours*Application rate)				(2000*9)	(8000*9)
	Total			a	360000	440000
	Production volume (units)			b	3000	4000
	Cost per unit			a/b	120	110
					Standard	Enhanced
	Direct material				25	40
	Direct labor				36	48
					(3*12)	(4*12)
	Order processing,etc.				120	110
	Total cost				181	198