Question

Harvey Ltd. Produces three products: Fridges, Dishwashers and Washing machines. The company uses a single plant-wide factory overhead rate to all three products based on direct labour hours. The company currently uses plant-wide factory overhead allocation based on direct labour hours. The company also adds a 20% mark-up on the cost of production to cover administration cost and gross margin. The selling price per unit for the three products are as follows:

Fridge -                        $1043.85

Dishwasher                      $911.76

Washing machines             784.36

However, the company has noticed that of the three products the Fridges and Dishwashers are high in demand at the set price and are selling fast, but the Washing machines are not selling even if the quality is quite good. The management is asking you to find out the possible reasons for this. They suspect that there may be something wrong with their costing and pricing. They have heard that Activity Based Costing (ABC) is capable of producing more accurate costing and pricing. They supply you with the following information:

                                                Fridge                          Dishwasher                   Washing machines

Material cost (per unit)              $700.00                        $300.00                        $500.00

Labour cost (per units)               2.5 hours                       5 hours                         3.0 hours

                                                @ 40.00/hour                @ $40.00/hour             @ $50.00/hour

The total budgeted annual production overhead cost of the company is $1 400 000. The company has supplied you detailed information and breakdown about their overhead cost.

The company has determined the major activities and cost pools that account for the total overhead cost of the company. These activities, along with their budgeted activity costs, are as follows:

Activities                                                                     Budgeted Activity Cost

1. Machine Set Up                                                             $ 428 750
2. Production Control                                                        $ 245 000
3. Inspection and Quality Control                                       $ 183 750
4. Materials Handling                                                        $ 367 500
5. Indirect Labour                                                             $ 175 000

Total:                                                 $ 1 400 000

Sorrento Ltd has estimated the following activity-base usage and units produced for each of its three products:

Products               No. of           No. of         No. of         No of           No. of       Direct

                   units           Setups         Production Inspections         materials     Labour Hours

                                                                     orders                           moves

Fridge                   10 000          80                    80                    35          320              25 000

Dishwasher           2 000           40                    40                    40          400              10 000

Washing machine 50 000          5                      5                      0          30               140 000

Total                    62 000          125                   125                   75            750                   175 000

Required:

1. Using the single plant-wide factory overhead rate method determine the applied factory overhead cost per unit for the Fridge, Dishwasher and Washing machines.

2. Calculate the total unit cost of production for each product using the material and labour cost information provided to you and the overhead cost you have calculated in 1 (above).

3. Determine the factory overhead cost and total cost of production per unit for the Fridge, Dishwasher and Washing machines using the Activity Based Costing.

4. Which method provides more accurate product costing? Why?

5. Explain to the management of Harvey Ltd. why the Fridge and Dishwashers were selling fast and the Washing machines were not selling at the existing prices.

Answer 1

1. Single plant-wide factory overhead rate = $8 per labour hour [ $14,00,000/175,000]

2. Statement showing total unit cost of production for each product

                                                Fridge                          Dishwasher                   Washing machines

Material cost (per unit)            $700 $300 $500

Labour cost (per units) $100 $200 $150

Prime Cost $800 $500 $650

(+) Factory Overhead $20 (2.5 hour*$8) $40 (5 hour*$8) $24(3 hour*8)

Total cost of Production $820 $540 $674

(Per Unit)

3. Statement showing Activity cost and Activity cost driver rate

Activities                                   Budgeted Cost Driver Cost Driver Rate

Activity Cost

1. Machine Set Up                          $ 428 750 No of Setups- 125 $3430 per Setup
2. Production Control                      $ 245 000 No of Prod order-125 $1960 per Order
3. Inspection and Quality Control $ 183 750 No of Inspection-75 $2450 per Inspection
4. Materials Handling                      $ 367 500 No of DM moves-750 $490 per Material
5. Indirect Labour                            $ 175 000 Labour Hours-175000 $1 per Labour Hour

                                 Fridge                          Dishwasher                   Washing machines

Material cost (per unit)            $700 $300 $500

Labour cost (per units) $100 $200 $150

Prime Cost $800 $500 $650

(+) Factory Overhead

Machine Set Up $27.44 $68.6 $0.343

[($3430*80)/10000] [($3430*40)/2000] [($3430*5)/50000]

Production Control $15.68 $39.2 $0.196

[($1960*80)/10000] [($1960*40)/2000] [($1960*5)/50000]

Inspe and Quality Control $8.575 $49   $0

[($2450*35)/10000] [($2450*40)/2000] [($2450*0)/50000]

Materials Handling $15.68 $98 $0.294

[($490*320)/10000] [($490*400)/2000] [($490*30)/50000]

Indirect Labour $2.5 $5 $2.8

[($1*25000)/10000] [($1*10000)/2000] [($1*140000)/50000]

Total cost of Production $869.875 $ 759.8 $653.633

(Per Unit)

4. Activity Based Costing Method is the best method for allocation of Factory overheads as seperate rate is calculated for each activity and overhead are allocated on the basis of service used/taken by the product of an activity.

5. As Fridge and Dishwashers are basic or can say necessary needs of human being as required daily so their demand is high as compare to washing machine, due to which Fridge and Dishwashers were selling fast and the Washing machines were not selling at the existing prices:-