Question

Albany Machinery manufactures two products, Basic and Superior, and applies overhead on the basis of direct labour hours. Anticipated (budgeted) overhead and direct labour time for the upcoming accounting period are $1,510,000 and 37,600 hours, respectively. Information about the company’s products follows:

Basic:
Estimated product volume	4 800 units
Direct material cost	$26 per unit
Direct labour per unit	3 hours at $13 per hour
Superior:
Estimated product volume	5 800 units
Direct material cost	$62 per unit
Direct labour per unit	4 hours at $13 per hour

Albany Machinery budgeted overhead of $1,510,000 has three major activities: order processing ($242,000), machine processing ($1,126,000) and product inspection ($142,000). The three activities are driven by; number of orders processed, machine hours worked, and inspection hours, respectively. Data relevant to these activities are as follows:

  

	Order Processed	Machine Hours Worked	Inspection Hours
Basic	510	21 800	4 000
Superior	290	34 400	6 000
Total	800	56 200	10 000

Top management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in profit is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery were installed. Machinery that was expected to produce significant operating efficiencies.

Required: Show all your workings.

1. Assuming the use of direct labour hours to apply overhead to production, calculate the unit total manufacturing costs of the Basic and Superior products if the expected manufacturing volume is attained.                                                                                                                                                                                                                                       (8 marks)

2. Assuming use of activity-based costing, calculate the unit total manufacturing costs of the basic and superior if the expected manufacturing volume is attained.                      (15 marks)

3. Discuss the effect of the difference costing calculated in (i) and (ii) will have and the selling price of the product and profit.                                                                          (4 marks)

Answer 1

Pre-determined overhead rate Total Manufacturing overheads Total Direct labor hours $1,510,000 37,600 $40.1596 Per direct labor hour Basic Superior Direct labor hours per unit Overhead absorption rate Overhead cost per unit $40.1596 $120.48 $40.1596 $160.64 A/B i) Total manufacturing cost per unit- Traditional Costing Basic Superior Direct Material $26.00 $62.00 Direct Labor $39.00 $52.00 Total Overhead allocated $120.48 $160.64 Total manufacturing cost per unit $185.48 $274.64 Calculation of Activity rates Activity Order processing Machine processing Product inspection Total budgeted indirect costs Total Overheads $242,000 $1,126,000 $142,000 $1,510,000 Total Activities 800 56,200 10,000 Activity rate $302.50 per order processing $20.04 per machine hour $14.20 per inspection hour Allocation of Overheads - ABC method Activity Activity rate $302.50 $20.04 $14.20 Activities used Basic Superior 510 290 21,800 34,400 6,000 Allocated Cost Basic Superior $154,275 $87,725 $436,776 $689,224 $56,800 $85,200 $647,851 $862,149|a 4,8001 5,800 b $134.97 $148.65 a/b Manufacturing setups Machine hours Outgoing shipments Total Overheads Total Volume Overhead cost per unit 4,000 ii) Total manufacturing cost per unit- ABC method Basic Direct Material $26.00 Direct Labor $39.00 Total Overhead allocated $134.97 Total manufacturing cost per unit $199.97 Superior $62.00 $52.00 $148.65 As per above working $262.65 iii) Comparison of Product Cost Cost per unit Traditional Costing ABC Costing (Under/Over Costing Comments Basic Superior $185.48 $274.64 $199.97 $262.65 -$14.49 $11.99 Under-Costing Over-Costing Basic model is under-costed based on traditional approach where as Superior is over-costed as per traditional approach The product cost as per traditional method is unreliable since single cost driver is used It leads to wrong decision making and product pricing and can have adverse impact on the firm for example: losing bids, etc Allocation of overhead as per direct labor hour method does not correlate the cost with activities consumed ABC method should be used because -It helps in accurate product costing - It helps in Product pricing - It helps in better cost management through cost control and cost reduction