Question

Company used to consider a traditional costing system based on machine hours; however, they are currently considering an activity-based costing (ABC) approach. The company estimates the usage of 50,000 direct labor hours (DLH) and 30,000 machine hours (MH) for the current year. The following data show the budgeted manufacturing overhead (OH):

Activity center	Cost driver	Activity driver	Cost
Material handling	# of parts handled	6,000,000	$720,000
Setup costs	# of setups	750	$315,000
Machining costs	# of machine hours	30,000	$540,000
Quality control	# of batches	500	$225,000

Cost, sales, and production data for one of the company’s products, product A, are as follows:

Direct materials	$4.40 per unit	Setups	2 per batch
Direct labor	$0.75 per unit	Total parts per finished unit	5 parts
Expected sales	20,000 units	Machine hours required	80 MHs per batch
Batch size	5,000 units

1. Compute the total OH that should be charged to each batch of product A using: (1) traditional costing system, and (2) ABC system.   (6 points)
2. Compute the cost per unit of product A using: (1) traditional costing system, and (2) ABC system. (3 points)
3. Assume the company wishes to have a gross profit rate of 40 percent. Determine the selling price per unit of product A using: (1) traditional costing system, and (2) ABC system. (1 point)

Answer 1

A) 1) Under traditional costing system: Activity Activity center Cost driver Cost driver Material handling # of parts handled 6,000,000 $720,000 Setup costs # of setups 750 $315,000 Machining costs # of machine hours 30,000 $540,000 Quality control # of batches 500 $225,000 Total overhead cost $1,800,000 Estimated total machine hours (MHs) 30,000 Overhead rate per DLH $60 ($1800000 / 30000 DLHs] Machine hours utilized by one batch of Product A 80 Total OH to be charged to each batch of product A $4,800 [80 MHS x $60]

2) Under activity-based (ABC) costing system: Activity center Cost driver Material handling # of parts handled Setup costs # of setups Machining costs # of machine hours Quality control # of batches Drivers 6,000,000 750 30,000 500 OH Cost $720,000 $315,000 $540,000 $225,000 Activity Rate $0.12 [$720000 / 6000000] $420.00 ($315000 / 750] $18.00 ($540000 / 30000] $450.00 ($225000 / 500] Activity Cost driver Overhead Activity center Cost driver Rate incurred assigned Material handling # of parts handled $0.12 25,000 $3,000 ($0.12 x 25000 (Parts per batch = 5,000 units x 5 parts = 25,000 parts)] Setup costs # of setups $420.00 2 $840 ($420 x 2] Machining costs # of machine hours $18.00 80 $1,440 ($18 x 80] Quality control # of batches $450.00 $450 ($450 x 1] Total OH to be charged to each batch of product A $5,730 [$30000 + $840 + $4500] 1

B) 1) Under traditional costing system: 2) Under activity-based (ABC) costing system: Direct material cost Direct labor cost Total OH cost Total product cost Number of units per batch Cost per unit of product A $22,000 (5000 units x $4.40] $3,750 [5000 units x $0.75] $4,800 [As calculated in Part-A] $30,550 ($22000 + $3750 + $4800] 5,000 $6.11 ($30550 / 5000 units] Direct material cost Direct labor cost Total OH cost Total product cost Number of units per batch Cost per unit of product A $22,000 (5000 units x $4.40] $3,750 [5000 units x $0.75] $5,730 [As calculated in Part-A] $31,480 ($22000 + $3750 + $5730] 5,000 $6.30 ($31480 / 5000 units = $6.296 = $6.30] C) Selling price per unit = Cost per unit x (1 + Gross profit % on cost) 1) Under traditional costing system: 2) Under activity-based (ABC) costing system: Cost per unit of product A $6.11 Gross profit % 40% Selling price per unit $8.55 [$6.11 x (1+40%) = $6.11 x (1+0.4) = $6.11 x 1.4 = $8.55] Cost per unit of product A $6.296 $6.30 [lf rounded-off unit cost is used] Gross profit % 40% 40% Selling price per unit $8.81 $8.82 [$6.296 x (1+40%) = $6.296 X (1+0.4) = $6.296 x 1.4 = $8.81] or