Question

Marine, Inc., manufactures a product that is available in both a flexible and a rigid model. The company has made the rigid model for years, the flexible model was introduced several years ago to tap a new segment of the market. Since introduction of the flexible model, the company's profits have steadily declined, and management has become concerned about the accuracy of its costing system. Sales of the flexible model have been increasing rapidly. Overhead is applied to products on the basis of direct labor-hours. At the beginning of the current year, management estimated that $370,000 in overhead costs would be incurred and the company would produce and sell 1,000 units of the flexible model and 8,000 units of the regular model. The flexible model requires 2.0 hours of direct labor time per unit, and the regular model requires 1.00 hours. Direct materials and labor costs per unit are given below: Direct materials cost per unit Direct labor cost per unit er unit Flexible Rigid $140 $ 70 $45 $ 30 Required: 1-a. Compute the predetermined overhead rate using direct labor-hours as the basis for allocating overhead costs to products. 1-b. Compute the unit product cost for one unit of each model. 2. An intern suggested that the company use activity based costing to cost its products. A team was formed to investigate this idea. It came back with the recommendation that four activity cost pools be used. These cost pools and their associated activities are listed as follows: Activity Cost Pool and Activity Measure Purchase orders (number of orders) Rework requests (number of requests) Product testing (number of tests) Machine related machine-hours) Expected Activity Estimated Overhead Cost Plexible Rigid Total $ 25,500 130 380 510 15,500 90 220 310 170,000 1,100 1,700 159,000 1,000 1,1202 , 120 $370,000 600 Compute the activity rate for each of the activity cost pools. 3-a. Using activity-based costing, determine the total amount of overhead that would be assigned to each model for the year. 3-b. Using activity-based costing, compute the unit product cost for one unit of each model.

Answer 1

1A. Predetermined overhead rate   [Refer working note 1]	$37
1B. Unit product cost for one unit of each model
	Unit product cost [Refer working note 3]
Flexible	$259
Rigid	$137

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2. Activity rate for the activity cost pools      [Refer working note 5]
Purchase orders	$50	per order
Rework requests	$50	per request
Product testing	$100	per test
Machine related	$75	per MH

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3A. Total amount of overhead assigned to each model under Activity Based Costing
	Total Amount of Overhead [Refer working note 6]
Flexible	$146,000
Rigid	$224,000

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3B. Unit product cost for one unit of each model
	Unit product cost [Refer working note 7]
Flexible	$331
Rigid	$128

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Working note 1 - Calculation of predetermined overhead rate
Estimated total overhead costs                                              (a)	$370,000
Estimated total direct labor hours    [Refer working note 2] (b)	10,000
Predetermined overhead rate                                               (a / b)	$37

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Working note 2 - Calculation of estimated total direct labor hours
	Estimated production (In units) (a)	Direct labor hours time per unit (b)	Total direct labor hours (a x b)
Flexible model	1,000	2	2,000
Rigid model	8,000	1	8,000
Estimated total direct labor hours             [2,000 + 8,000]			10,000

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Working note 3 - Unit product cost under traditional costing system
	Flexible	Rigid
Direct materials per unit                                         (a)	$140	$70
Direct labor per unit                                                (b)	$45	$30
Overhead per unit     [Refer working note 4]           (c)	$74	$37
Units cost                                                               (a + b + c)	$259	$137

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Working note 4 - Calculation of overhead cost per unit
	Flexible	Rigid
Direct labor hours per unit                                              (a)	2	1
Predetermined overhead rate [Refer working note 1]     (b)	$37	$37
Overhead cost per unit                                                      (a x b)	$74	$37

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Working note 5 - Calculation of Activity rate
Activity Cost Pool	Estimated overhead costs (a)	Total expected activity (b)		Activity rate (a / b)
Purchase orders	$25,500	510	orders	$50.00	Per order
Rework requests	$15,500	310	requests	$50.00	Per request
Product testing	$170,000	1,700	tests	$100.00	per test
Machine related	$159,000	2,120	machine hours	$75.00	per machine hour

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Working note 6 - Allocation of Estimated Overhead using activity rates:
Activity cost pool	Activity Rate [Refer working note 5]		Flexible			Rigid
			Activity		Allocation of activity's cost	Activity		Allocation of activity's cost
	(a)		(b)		(a x b)	(c)		(a x c)
Purchase orders	$50.00	Per order	130	orders	$6,500	380	orders	$19,000
Rework requests	$50.00	Per request	90	requests	$4,500	220	requests	$11,000
Product testing	$100.00	per test	600	tests	$60,000	1100	tests	$110,000
Machine related	$75.00	per machine hour	1000	machine hours	$75,000	1120	machine hours	$84,000
Total overhead					$146,000			$224,000
Units produced					1,000			8,000
Overhead cost per unit    [Total overhead / Units produced]					$146			$28

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Working note 7 - Unit product cost under activity-based costing
	Flexible	Rigid
Direct materials per unit                                         (a)	$140	$70
Direct labor per unit                                                (b)	$45	$30
Overhead costs per unit      [Refer working note 6]     (c)	$146	$28
Units cost                                                               (a + b + c)	$331	$128