Question

FireWorks produces mild-steel outdoor products, including two firepit models. The bulk of firepit sales come from their standard firepit – a basic half-sphere design. FireWorks’ custom firepit involves innovative designs and some intricate cutting work and, although sales volume is low, custom firepits generate a significantly higher sales price. Increasingly, FireWorks has been struggling competitively on price with its standard product although its custom firepits are a flaming success. Currently, FireWorks uses a simple job-costing system and allocates overhead based on machine hours. An attempt is underway to introduce an activity-based job-costing system. Total budgeted costs in each indirect cost pool and the budgeted quantity of activity driver are as follows:

	Budgeted Overhead	Activity Driver	Budgeted Quantity of Activity Driver
Machine maintenance Product inspection Design	$50,000 10,000 30,000	Machine-hours Number of inspections Number of designs	5,000 250 100
Total	$90,000

Information related to two jobs for Standard and Custom firepits follows.

	Standard	Custom
Machine hours Number of inspections Number of designs Units produced	80 4 1 20	40 12 4 10

Required (show your work):

1. Compute the total overhead allocated to each job under a simple costing system, where overhead is allocated based on machine-hours. Also, compute the overhead cost per unit for each job.
2. Compute the total overhead allocated to each job under an activity-based costing system using the appropriate activity drivers. Also, compute the overhead cost per unit for each job.
3. Comment on your calculations. What problem with the simple costing system do you observe? Explain this problem.
4. Identify the cost hierarchy category/level for machine maintenance, product inspection, and design. How is the cost hierarchy helpful to FireWorks in managing its business?
5. Discuss three different ways FireWorks can apply ABC information in its decision making.

Answer 1

1)
Overhead allocation using a simple job-costing system, where overhead is allocated basedon machine hours:
Overhead allocation rate = $90,000 /5,000 machine-hours	$       18.00	per machine-hour
	Standard	Custom
Overhead allocated ($18 per machine-hour × 80 hours; 40 hours	$  1,440.00	$                            720.00
2) Overhead allocation using an activity-based job-costing system:
	Budgeted Overhead (1)	Activity Driver (2)	Budgeted Quantity of Activity Driver (3)	Activity Rate(4) = (1) /(3)
Machine maintenance	$50,000	Machine-hours	5,000	$10
Product inspection	10,000	Number of inspections	250	$40
Design	30,000	Number of designs	100	$300
Total	$90,000
Overhead allocated:
	Standard	Custom
Machine maintenance	$800	$400
Product inspection	$160	$480
Design	$300	$1,200
Total	$1,260	$2,080
3)
Under simple costing Standard Job has higher overhead cost as compared to custom job while under ABC costing Standard job has lower overhead cost as compared to Custom Job.Simple Costing adds an average overhead rate to the direct costs of manufacturing products. The overhead rate gets applied on the basis of a cost driver, such as number of labor hours or machine hours  required to make a product . It does not give managers an accurate picture of product costs because the application of overhead burden rates is arbitrary and applied equally to the cost of all products.
4)
Output unit-level costs	Machine maintenance
Batch-level costs	Product inspection
Service-sustaining cost	Design
Using the cost hierarchy to calculate activity-based costs can help fireworks to identify both the costs of individual activities and the cost of activities demanded by individual products.
5)
1) Fire works  can use its ABC systems and cost hierarchy information to plan and manage activities. What activities should be performed in the period and at what cost?
2) Fire works management can identify and evaluate new designs to improveperformance by analyzing how product and process designs affect activities and costs.
3) Fireworks can use information about the costs of different activities to improve processes and reduce costs of the different activities.
4) Pricing and product mix decisions emphasize its more profitable products