Question

Check my work Ontario, Inc. manufactures two products, Standard and Enhanced, and applies overhead on the basis of direct-labor hours. Anticipated overhead and direct-labor time for the upcoming accounting period are $800,000 and 25,000 hours, respectively. Information about the company's products follows. Standard: Estimated production volume, 3,000 units Direct-material cost, $25 per unit Direct labor per unit, 3 hours at $12 per hour Enhanced: Estimated production volume, 4,000 units Direct-material cost, $40 per unit Direct labor per unit, 4 hours at $12 per hour Ontario's overhead of $800,000 can be identified with three major activities: order processing ($150,000), machine processing ($560,000), and product inspection ($90,000). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively. Data relevant to these activities follow. Standard Enhanced Total Orders Processed 300 200 500 Machine Hours Worked 18,000 22,000 40,000 Inspection Hours 2,000 8,000 10,000 Top management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in income is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery was installed-machinery that was expected to produce significant operating efficiencies. Required: 1. Assuming use of direct-labor hours to apply overhead to production, compute the unit manufacturing costs of the Standard and Enhanced products if the expected manufacturina volume is attained.
A. Assuming use of direct-labor hours to apply overhead to production, compute the unit manufacturing costs of the Standard and Enhanced products if the expected manufacturing volume is attained.

Manufacturing cost per unit: Standard $ ? and Enhanced $ ?

B. Assuming use of activity-based costing, compute the unit manufacturing costs of the Standard and Enhanced products if the expected manufacturing volume is attained.

Manufacturing cost per unit: Standard $ ? and Enhanced $ ?

C. By using direct-labor hours as an application base, which product is overcosted and which product is undercosted? Calculate the amount of the cost distortion for each product.

Standard: $ ? $ ?

Enhanced: $ ? $ ?

Is it possible that overcosting and undercosting (i.e., cost distortion) and the subsequent determination of selling prices are contributing to the company’s profit woes?

Answer 1

Part A

Predetermined overhead rate = Estimated overhead cost / Estimated direct labor hours

Predetermined overhead rate = $800,000 /25,000 = $32 per hour

	Standard	Enhanced
Direct material	$75,000 (3,000*$25)	$160,000 (4,000*$40)
Direct labor	108,000 (3,000*3*$12)	192,000 (4,000*4*$12)
Applied overhead	288,000 (3,000*3*$32)	512,000 (4,000*4*$32)
Total manufacturing costs	$471,000	$864,000
Units produced	3,000	4,000
Manufacturing cost per unit	$157	$216

Part B

Activity	Overhead cost	Cost driver	Activity rate	Standard	Enhanced
Order processing	$150,000	500	$300	per order processed	$90,000 (300*$300)	$60,000 (200*$300)
Machine processing	560,000	40,000	14	per machine hour	252,000 (18,000*$14)	308,000 (22,000*$14)
Product inspection	90,000	10,000	9	per inspection hour	18,000 (2,000*$9)	72,000 (8,000*$9)
Total	$800,000				$360,000	$440,000

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Total

$800,000

$360,000

$440,000

	Standard	Enhanced
Direct material	$75,000 (3,000*$25)	$160,000 (4,000*$40)
Direct labor	108,000 (3,000*3*$12)	192,000 (4,000*4*$12)
Applied overhead	360,000	440,000
Total manufacturing costs	$543,000	$792,000
Units produced	3,000	4,000
Manufacturing cost per unit	$181	$198

Part C

Enhanced product is over costed by traditional product costing system.

Standard product is undercosted by the traditional product costing system.

	Traditional	ABC
Standard	$157	$216
Enhanced	$181	$198

Part D

Obviously yes, when the selling price of company is heavily reliable on cost. An overcosted product will lead to an inflated selling price, which may prove to be detrimental in a highly competitive market. Customers may switch to substitute products affecting the profitability of company. The undercosted product may not be able to cover costs. It is also a troublesome situation and results in lower income.