Question

California Circuits Company (3C) manufactures a variety of components. Its Valley plant specializes in two electronic components used in circuit boards. These components serve the same function and perform equally well. The difference in the two products is the raw material. The XL-D chip is the older of the two components and is made with a metal that requires a wash prior to assembly. Originally, the plant released the wastewater directly into a local river. Several years ago, the company was ordered to treat the wastewater before its release, and it installed relatively expensive equipment. While the equipment is fully depreciated, annual operating expenses of $259,000 are still incurred for wastewater treatment.

Two years ago, company scientists developed an alloy with all of the properties of the raw materials used in XL-D that generates no wastewater. Some prototype components using the new material were produced and tested and found to be indistinguishable from the old components in every way relating to their fitness for use. The only difference is that the new alloy is more expensive than the old raw material. The company has been test-marketing the newer version of the component, referred to as XL-C, and is currently trying to decide its fate.

Manufacturing of both components begins in the Production Department and is completed in the Assembly Department. No other products are produced in the plant. The following provides information for the two components:

	XL-D	XL-C
Units produced	100,000	25,000
Raw material costs per unit	$12.90	$14.90
Direct labor-hours per unit—Production	0.1	0.1
Direct labor-hours per unit—Assembly	0.4	0.4
Direct labor rate per hour—all labor	$24.50	$24.50
Machine-hours per unit—Production	1.6	1.6
Machine-hours per unit—Assembly	0.4	0.4
Testing hours per unit (all in production)	3.0	3.0
Shipping weight per unit (pounds)	1.0	1.6
Wastewater generated per unit (gallons)	10.0	0.0

Annual overhead costs for the two departments follow:

	Production Department			Assembly Department
Supervision	$	109,000		$	249,000
Material handling		97,500			44,500
Testing		159,000			0
Wastewater treatment		259,000			0
Depreciation on equipment		409,000			109,000
Shipping		7,900			129,000
Total	$	1,041,400		$	531,500

The company president believes that it’s foolish to continue producing two essentially equivalent products. At the same time, the corporate image is somewhat tarnished because of a toxic dump found at another site (not the Valley plant). The president would like to be able to point to the Valley plant as an example of company research and development (R&D) working to provide an environmentally friendly product. The controller points out to the president that the company’s financial position is shaky, and it cannot afford to make products in any way other than the most cost-efficient one.

Required:

a. 3C’s current cost accounting system charges overhead to products based on direct labor cost using a single plantwide rate. What product costs will it report for the two products if the current allocation system is used?

b. The controller recently completed an executive education course describing the two-stage allocation procedure. Assume that the first stage allocates costs to departments and the second stage allocates costs to products. The controller believes that the costs will be more accurate if machine-hours are used to allocate Production Department costs and labor-hours are used to allocate Assembly Department costs. What product costs will be reported for the two products if the two-stage allocation process is used?

d. The president argues that an activity-based costing system would provide even better costs. The company decides to compute product costs assuming an ABC system is implemented only in the Production Department. Overhead in Assembly will continue to be allocated based on direct labor cost. The cost drivers selected for the activity-based costing system are as follows.
  

Overhead Item	Driver
Supervision	Direct labor-hours
Material handling	Material cost
Testing	Testing hours
Wastewater treatment	Wastewater generated
Depreciation on equipment	Machine-hours
Shipping	Weight

What product costs would be reported if this ABC system were implemented? Assume that the production mix and costs would remain as originally planned.

Answer 1

Total direct labor hours:

XL-D = 100,000*0.1+100,000*0.4 = 50,000 Hours

XL-C = 25,000*0.1+25,000*0.4 = 12,500 Hours

Total = 50,000+12,500 = 62,500 Hours

Total machine hours:

XL-D = 100,000*1.6+100,000*0.4 = 200,000 Hours

XL-C = 25,000*1.6+25,000*0.4 = 50,000 Hours

Total = 200,000+50,000 = 250,000 Hours

a.

Single plantwide rate = Estimated overhead cost / Estimated direct labor cost

Single plantwide rate = $1,041,400+531,500 / $1,531,250 (62,500*$24.50) * 100

Single plantwide rate = 102.72%

	XL-D	XL-C
Direct material cost	$1,290,000 (100,000*$12.90)	$372,500 (25,000*$14.90)
Direct labor cost	1,225,000 (50,000*$24.50)	306,250 (12,500*$24.50)
Overhead cost	1,258,320 (1,225,000*102.72%)	314,580 (306,250*102.72%)
Product costs	$3,773,320	$993,330

b.

Predetermined overhead rate:

Production department = $1,041,400 / 200,000 (100,000+25,000*1.6) = $5.207 per machine hour

Assembly department = $531,500 / 50,000 (100,000+25,000*0.4) = $10.63 per labor hour

	XL-D	XL-C
Direct material cost	$1,290,000 (100,000*$12.90)	$372,500 (25,000*$14.90)
Direct labor cost	1,225,000 (50,000*$24.50)	306,250 (12,500*$24.50)
Overhead cost:
Production department	833,120 (100,000*1.6*$5.207)	208,280 (25,000*1.6*$5.207)
Assembly department	425,200 (100,000*0.4*$10.63)	106,300 (25,000*0.4*$10.63)
Product costs	$3,773,320	$993,330

c.

	Overhead cost	Cost driver	Rate		XL-D	XL-C
Supervision	$358,000	62,500	$5.728	per direct labor hour	$286,400 (50,000*$5.728)	$71,600 (12,500*$5.728)
Material handling	142,000	1,662,500	0.085413	per material cost	110,183 (1,290,000*0.085413)	31,817 (372,500*0.085413)
Testing	159,000	375,000 (125,000*3)	0.424	per testing hours	127,200 (100,000*3*$0.424)	31,800 (25,000*3*$0.424)
Wastewater treatment	259,000	1,000,000 (100,000*10)	0.259	per gallon	259,000	0
Depreciation on equipment	518,000	250,000	2.072	per machine hour	414,400 (200,000*$2.072)	103,600 (50,000*$2.072)
Shipping	136,900	140,000 (100,000*1+25,000*1.6)	0.97785	per pound	97,785 (100,000*1*0.97785)	39,115 (25,000*1.6*0.97785)
Total					$1,294,968	$277,932

	XL-D	XL-C
Direct material cost	$1,290,000 (100,000*$12.90)	$372,500 (25,000*$14.90)
Direct labor cost	1,225,000 (50,000*$24.50)	306,250 (12,500*$24.50)
Overhead cost	1,294,968	277,932
Product costs	$3,809,968	$956,682