Question

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Knickknack, Inc. manufactures two products: Odds and Ends. The firm uses a single, plantwide overhead rate based on direct-labor hours. Production and product-costing data are as follows:

	Odds			Ends
Production quantity		1,000	units		5,000	units
Direct material	$	40		$	60
Direct labor (not including setup time)		30	(2 hr. at $15)		45	(3 hr. at $15)
Manufacturing overhead		96	(2 hr. at $48)		144	(3 hr. at $48)
Total cost per unit	$	166		$	249

Manufacturing overhead budget:
Machine-related costs	$	450,000
Setup and inspection		180,000
Engineering		90,000
Plant-related costs		96,000
Total	$	816,000

Predetermined overhead rate:

Budgeted manufacturing overhead	=	$816,000	= $48 per direct-labor hour
Budgeted direct-labor hours		(1,000)(2) + (5,000)(3)

Knickknack, Inc. prices its products at 120 percent of cost, which yields target prices of $199.20 for Odds and $298.80 for Ends. Recently, however, Knickknack has been challenged in the market for Ends by a European competitor, Bricabrac Corporation. A new entrant in this market, Bricabrac has been selling Ends for $220 each. Knickknack’s president is puzzled by Bricabrac’s ability to sell Ends at such a low cost. She has asked you (the controller) to look into the matter. You have decided that Knickknack’s traditional, volume-based product-costing system may be causing cost distortion between the firm’s two products. Ends are a high-volume, relatively simple product. Odds, on the other hand, are quite complex and exhibit a much lower volume. As a result, you have begun work on an activity-based costing system.

  

Activity Cost Pool	Cost Driver	Budgeted Level of Cost Driver
Machine-related costs	Machine hours		9,000	hr.
Setup and inspection	Number of production runs		40	runs
Engineering	Engineering change orders		100	change orders
Plant-related costs	Square footage of space		1,920	sq. ft.

You have gathered the following additional information:

• Each odd requires 4 machine hours, whereas each end requires 1 machine hour.
• Odds are manufactured in production runs of 50 units each. Ends are manufactured in 250-unit batches.
• Three-quarters of the engineering activity, as measured in terms of change orders, is related to Odds.
• The plant has 1,920 square feet of space, 80 percent of which is used in the production of Odds.

7. Calculate the total amount of product cost distortion for entire product line caused by Knickknack’s traditional, volume-based costing system. (Round your intermediate calculations to 2 decimal places. Negative amount should be indicated by a minus sign.)

   

Answer 1

Please find below table useful to compute desired results: -

1 Ends 249 Odds 2 Product Cost (Traditional Volume-based costing system) 116 3 Product Cost (Activity-based costing system)* =B17 4 Amount of Cost Distortion per unit =B2-B3 5 Product Volume 1000 6 Total amount of cost distortion for entire product line 1=B4* B5 =C17 =C2-C3 5000 =C4*C5 8 *Calculation in case of Activity Based Costing Odds 9 Ends 40 30 45 10 Direct Material 11 Direct Labor 12 Manufacturing Overheads 13 Machine related costs 14 Setup and inspection 15 Engineering 16 Plant-related Costs 17 Total =450000/9000*4 =450000/9000*1 =(180000/40)/50 =((180000/40/250) =((90000/100*100*75%)/1000) =((90000/100*100*25%)/5000) =((96000/1920*1920*80%)/1000) =((96000/1920*1920*20%)/5000) =SUM(B10:B16) =SUM(C10:C16)

End results would be as follows: -

1 2 3 4 5 6 Product Cost (Traditional Volume-based costing system) Product Cost (Activity-based costing system)* Amount of Cost Distortion per unit Product Volume Total amount of cost distortion for entire product line BC Odds Ends 116 249 504.30 181.34 (388.30) 67.66 1,000 5,000 (388,300) 338,300 Ends 60 45 *Calculation in case of Activity Based Costing 9 Odds 10 Direct Material 40 11 Direct Labor 30 12 Manufacturing Overheads 13 Machine related costs 200 14 Setup and inspection 90 15 Engineering 67.50 16 Plant-related Costs 76.80 17 Total 504.30 18 4.50 3.84 181.34