Question

(25 marks) Nilam Sdn. Bhd. manufactures two products, Standard and Enhanced, and applies overhead on the basis of direct-labor hours. The anticipated overhead and direct labor time for the upcoming period is RM800,000 and RM25,000 hours respectively. The information about the company's products follows: Estimated production volume Direct material cost Direct labor per unit Standard 3,000 units RM 25 per unit 3 hours at RM12 per hour Enhanced 4,000 units RM 40 per unit 4 hours at RM12 per hour Nilam's overhead cost of RM 800,000 can be identified with Ocec major activities as follows: / / Activities Order Processing Machine Processing Product Inspection 1 Overhead Cost RM150,000 RM560,000 RM90.000 Cost Pool No. of order processed Machine hours worked Inspection hours Data relevant to these activities follow Order processed / Ma 8 3 Standard Enhanced Total Inspection Hours 2,000 200 18.000 22.000 40,000 SOO 8.000 40,000 C 10,000 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 massive plant renovation during which new, highly automated machinery was installed- machinery that was expected to produce significant operating efficiencies. Required: a) Compute the manufacturing costs per unit for Standard and Enhanced products using direct-labor hours to apply overhead to production 1

Answer 1

(a): Compute unit manufacturing costs of Standard and Enhanced, assuming the use of direct labor hours to apply overhead.

Under traditional costing system cost of overhead is allocated to products based on direct labor hours or machine hours.

Applied Overhead Rate/unit = Budgeted Overhead / Budgeted Direct Labor Hours

Budgeted Overhead:  $800,000

Budgeted Direct Labor Hours:   25,000

Applied Overhead Rate/unit = 800,000 ÷ 25,000 = $32/DL

Standard                                  Enhanced

Direct Materials                                $ 25                                         $ 40

Direct Labor                                       36 (3x12)                                 48 (4x12)

Overhead                                            96 (3x32)                                 128 (4x32) Unit

Mfg Cost                                             $157                                        $216

(b):  Compute unit manufacturing costs of Standard and Enhanced using ABC

Activity-based costing is an accounting method that assigns costs to products or services based on the activities and resources that are used to make the overhead of manufacturing a product or providing a service, whereas traditional methods allocate production costs based on specific factors, such as labor, materials, marketing and other sources of overhead. Activity-based costing is more logical and efficient for companies making customized products because overhead costs are not spread evenly across all products. ABC uses such terms as cost pools, cost drivers, cost objects, activities, and activity analysis.

Activity                                    Cost                             Cost Driver                             Application Rate

Order processing                    $150,000                     500 Orders Proc                     $300/Order Proc

Machine processing               560,000                      40,000 MH                              14/MH

Product inspection                  90,000                                    10,000 Insp. Hr                                    9/Insp Hr

Standard                                  Enhanced

Order Processing                                           $  90,000 (300 x $300)                       $  60,000 (200 x $300)

Machine Processing                            252,000 (18,000 x $14)                      308,000 (22,000 x $14)

Product Inspection                             18,000 (2,000 x $9)                 72,000 (8,000 x $9)

Total                                                    $360,000                                $440,000

÷ units                                                            ÷ 3,000                                               ÷ 4,000

OH Cost/unit                                       $     120                                  $     110

Calculation of total manufacturing costs of two products Standard and Enhanced

Standard                                  Enhanced

Direct Materials                                 $    25                                      $     40

Direct Labor                                        36 (3 x 12)                              48 (4x12)

Mfg Overhead                                               120                                         110

Total Cost/Unit under ABC                 $ 181                                       $  198

(c): If direct labor hours is used to allocate overhead, determine which product is overcosted and which product is undercosted, and by what amount.

Standard                                  Enhanced

Cost/unit using direct labor hours      $157                                       $216

Cost/unit using ABC                            181                                         198

(undercosted)/overcosted                 $( 24)                                       $  18