Question

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III Group Problem 1 Howell Manufacturing has identified activity centers to which overhead costs are assigned. The cost pools for these centers and their selected cost drivers for 1993 are as follows: Activity Centers Utilities Scheduling and setup Materials handling Total Overhead Cost Pools $278,000 $260,000 $640,000 $1,178,000 Selected Cost Drivers 60,000 machine hours 780 setups 1,600,000 lbs of materials The company's products and other operating statistics follow: Products Direct costs Machine hours Number of setups Pounds of materials Number of units produced Expected Direct labor hours Actual Direct Labor Hours A $80,000 30,000 130 500,000 40,000 36,000 38,000 $80,000 10,000 380 300,000 20,000 24,000 21,000 $90,000 20,000 270 800,000 60,000 65,000 58,000 Prior to installing an ABC system, Howell management had been pricing its products on the basis of conventional costing using direct labor hours to allocate total overhead. Because the firm operates in a competitive market, it sets prices on only a 20 percent markup on cost. Required: 1. Calculate unit costs based on traditional costing.

Answer 1

44 1. Calculate unit costs based on traditional costing. 45 46 Predetermined Overhead Rate Total Overheads No. of Direct Labor Hours 1,178,000 117,000 10.07 Per Labor Hour Direct costs Overheads Total Cost (A) Number of units Produced (B) Product Cost Per Unit (A/B) 80,000 382,598 462,598 40,000 11.56 80,000 211,436 291,436 20,000 14.57 90,000 583,966 673,966 60,000 11.23

Activity Budgeted Cost Driver Volume Cost Driver Budgeted Overhead Cost Activity Rate Utilities Scheduling and setup Material handling Machine hours No. of setups Pounds of material 278,000 260,000 640,000 60,000 780 1,600,000 4.63 Per machine hour 333.33 Per setup 0.40 Per Pound of material Expected Activity Assigned Overheads Activity (B) Utilities Scheduling and setup Material handling Total Overheads (A) Overhead Rate (D) 4.63 333.33 0.40 30000 130 500,000 10,000 380 300,000 (C) 20,000 270 800,000 (A*D) 139,000 43,333 200,000 382,333 (BD) 46,333 126,667 120,000 293,000 (CD) 92667 90000 320000 502,667 Direct costs Overheads Total Cost (A) Number of units Produced (B) Product Cost Per Unit (A/B) 80,000 382,333 462,333 40,000 11.56 80,000 293,000 373,000 20,000 18.65 90,000 502,667 592,667 60,000 9.88

61 3. Determine selling prices based on unit costs for traditional costing and for ABC. 62 63 Under Traditional Costing 11.23 Product Cost Per Unit Add Markup @ 20% Total Selling Price 11.56 2.31 13.88 14.57 2.91 17.49 2.25 13.48 Under ABC Costing А Product Cost Per Unit Add Markup @ 20% Total Selling Price 11.56 2.31 13.87 18.65 3.73 22.38 9.88 1.98 11.85 Discuss the problems related to setting prices based on traditional costing and explain how ABC improves the information. 76 Under Traditional method firm uses a single plant wide overhead rate based on direct labor hours which has been calculated on the basis of average rate This problem can be overcome by using ABC costing. It allocates overheads on the basis of activities consumed by the product. Therefore, it did not result in over allocation or under allocation of overheads