Question

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Peabody Company has a single plant, and manufactures three products. The following table contains per unit data for the three products. A B 156 179 185 Raw materials ($) Direct labor ($) Machine hours 98 84 2.5 70 2.1 2.6 The following table contains aggregate data for the year for the three products. Budgeted production (units) Number of inspections Number of setups 25,000 250 8,000 180 60 22,000 220 90 100 Other information: Wage rate is $28/hour Budgeted overhead for the year is $13,896,000. Required: a) Assume that Peabody uses a traditional costing system, with overhead allocated based on direct labor hours. Compute the total cost per unit of the three products. b) Instead assume that Peabody uses an ABC system with three cost drivers: machine hours, inspections, and setups. Manufacturing overhead cost of $1,300,000 is due to setups, and $130,000 to inspections, with the rest allocated to m Compute the total cost per unit of the three products. c) Identify several possible advantages/disadvantages to Peabody of using the ABC system (limit 200 words).

Answer 1

a) Computation of cost per unit using traditional costing system
	A	B	C
Raw material cost	$3,900,000	$3,222,000	$4,070,000
Direct labour cost	$2,100,000	$1,764,000	$1,540,000
Direct overhead cost	$5,400,000	$4,536,000	$3,960,000
	$11,400,000	$9,522,000	$9,570,000
Units	25,000	18,000	22,000
Cost per unit	$456	$529	$435
Working notes
Budgeted production (units)	25,000	18,000	22,000
Raw material cost per unit	$156	$179	$185
Raw material cost	$3,900,000	$3,222,000	$4,070,000
Budgeted production (units)	25,000	18,000	22,000
Direct labour costs per unit	$84	$98	$70
Total direct labour costs	$2,100,000	$1,764,000	$1,540,000
Direct labour costs per unit	$84	$98	$70
Wage rate per hour	$28	$28	$28
Direct labour hours per unit	3	4	3
Budgeted production (units)	25,000	18,000	22,000
Total direct labour hours	75,000	63,000	55,000
Allocation of budgeted overheads
A	75,000	$5,400,000
B	63,000	$4,536,000
C	55,000	$3,960,000
	193,000	$13,896,000
b) Computation of cost per unit using ABC costing system
Computation of activity cost rates
	A	B	C	Total
Number of Setups	100	60	90
Budgeted units	25,000	18,000	22,000
	2,500,000	1,080,000	1,980,000	5,560,000
Number of Inspections	250	180	220
Budgeted units	25,000	18,000	22,000
	6,250,000	3,240,000	4,840,000	14,330,000
Machine Hours	2.50	2.60	2.10
Budgeted units	25,000	18,000	22,000
	62,500	46,800	46,200	155,500
Activity	Driver	Overhead Cost	Units	Rate
Manufacturing overhead cost	Setups	$1,300,000	5,560,000	$0.23
Manufacturing overhead cost	Inspections	$130,000	14,330,000	$0.01
Manufacturing overhead cost	Machine Hours	$12,466,000	155,500	$80.17
Total overjead cost per unit	$80.41
Computation of cost per unit using ABC costing system
	A	B	C
Raw material cost	$3,900,000	$3,222,000	$4,070,000
Direct labour cost	$2,100,000	$1,764,000	$1,540,000
Direct overhead cost	$2,010,252	$2,010,252	$2,010,252
	$8,010,252	$6,996,252	$7,620,252
Units	$25,000	$18,000	$22,000
Cost per unit	$320	$389	$346
Working notes
Budgeted production (units)	25,000	18,000	22,000
Raw material cost per unit	$156	$179	$185
Raw material cost	$3,900,000	$3,222,000	$4,070,000
Budgeted production (units)	25,000	18,000	22,000
Direct labour costs per unit	$84	$98	$70
Total direct labour costs	$2,100,000	$1,764,000	$1,540,000
Budgeted production (units)	25,000	18,000	22,000
Overhead rate per unit	$80	$80	$80
Total overhead costs	$2,010,252	$1,447,382	$1,769,022
c) Advantages and disadvantages of ABC costing method
Advantages of ABC costing method
(i) It provides realistic and accurate costs of manufacturing for the specified products
(ii) It allocates manufacturing overhead accurately to products and processes that use the activity
(iii) It identifies inefficient processes and target for improvements
(iv) It detremines the product profit margins more accurately
(v) It offers better understanding and justification of costs in manufacturing process
Disadvantages of ABC costing method
(i) Source data is not always readily available
(ii) Collection and preparation of data for ABC method is time consuming
(iii) Collection and preparation of data is time consuming
(iii) This method is not useful where the ratio of overhead costs is small in comparision to total costs