Question

FINANCIAL INFORMATION CMI's budgeted direct-labor costs were $60 million. Based on expected sales, the company estimated that its raw material purchases and use would total $300 million. Manufacturing overhead was budgeted at $196 million, and currently was assigned to each computer on the basis of machine hours. As indicated above, computers were priced at full production cost plus a markup of 50 percent. Exhibit 1 shows the expected direct manufacturing cost for two of the company's computers. The Cortland 1000 was a very popular computer with a large production and sales volume. By contrast, the quantity of Cortland 2000s manufactured and sold was expected to be much lower than any of the company's other computers. Nevertheless, Mr. Works had thought that, when all manufacturing costs were considered, the Cortland 2000 would contribute a reasonable amount of money to CMI's selling, general, and administrative costs, and hence to the company's overall profits. Mr. Works' concern had arisen because CMI's accountant had told him that he thought the company's traditional product-costing system was providing misleading cost information. He had developed an analysis of the budgeted manufacturing overhead costs, shown in Exhibit 2. Data for the annual production of Cortland 1000 and Cortland 2000 computers are shown in Exhibit 3. Mr. Works commented: I don't know quite what to make of all of these data. Clearly some analysis is called for. I guess what I really need is a sense of the true manufacturing cost of each of these computers. Even though we can't change the prices this year, we at least need to know if we're covering our full production cost on the Cortland 2000 and have something left to contribute to the company's selling, general, and administrative costs. I had thought this was the case, but now I'm not so sure.

1. Determine the full product cost and selling prices for one Cortland 1000 and one Cortland 2000 under an activity-based costing system.

Answer 1

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Cortland Manufacturing Company
Calculation of activity based manufacturing overhead rates		A	B	C=A/B
Activity	Cost Driver	Estimated cost	Cost Driver	ABC Rates
Raw Material Handling	Received orders	90,000,000.00	200.00	450,000.00
Machine adjusting	Setups	12,000,000.00	2,000.00	6,000.00
Packing	Batches	60,000,000.00	500.00	120,000.00
Raw Material Inspecting	Inspecting hours	10,000,000.00	200,000.00	50.00
Soldering	Soldering hours	12,000,000.00	200,000.00	60.00
Assembly	Assembly hours	12,000,000.00	100,000.00	120.00
Total manufacturing overhead Cost		196,000,000.00
Calculation of cost driver	Cortland 1000	Cortland 2000		Note
Budgeted production	20,000.00	5,000.00		D
Received orders size	10,000.00	500.00		E
No. of Received orders	2.00	10.00		F=D/E
Budgeted production	20,000.00	5,000.00		D
Batch size	5,000.00	100.00		G
No. of Batches	4.00	50.00		H=D/G
Machine Setup per batch	5.00	6.00		I
No. of Batches	4.00	50.00		See H
No. of Setups	20.00	300.00		J=I*H
Budgeted production	20,000.00	5,000.00		D
Inspecting hour per computer	1.00	2.00		K
No. of Inspecting hours	20,000.00	10,000.00		L=D*K
Budgeted production	20,000.00	5,000.00		D
Soldering hour per computer	3.00	1.00		M
No. of Soldering hours	60,000.00	5,000.00		N=D*M
Budgeted production	20,000.00	5,000.00		D
Assembly hours per computer	1.00	1.00		O
No. of Assembly hours	20,000.00	5,000.00		P=D*O
Allocation of manufacturing overhead Cost		See C	O	P=O*C	Q	R=Q*C
			Cortland 1000		Cortland 2000		Note
Activity	Cost Driver	ABC Rates	Cost Driver	Amount $	Cost Driver	Amount $
Raw Material Handling	Received orders	450,000.00	2.00	900,000.00	10.00	4,500,000.00
Machine adjusting	Setups	6,000.00	20.00	120,000.00	300.00	1,800,000.00
Packing	Batches	120,000.00	4.00	480,000.00	50.00	6,000,000.00
Raw Material Inspecting	Inspecting hours	50.00	20,000.00	1,000,000.00	10,000.00	500,000.00
Soldering	Soldering hours	60.00	60,000.00	3,600,000.00	5,000.00	300,000.00
Assembly	Assembly hours	120.00	20,000.00	2,400,000.00	5,000.00	600,000.00
Manufacturing overhead Cost allocated				8,500,000.00		13,700,000.00	S
Budgeted production				20,000.00		5,000.00	See D
Manufacturing overhead Cost per unit				425.00		2,740.00	T=S/D
Calculation of full product cost	Cortland 1000	Cortland 2000	Note
Raw Material	1,000.00	2,500.00
Direct Labor	200.00	400.00
Manufacturing overhead	425.00	2,740.00	See T
Product cost	1,625.00	5,640.00	U
Calculation of selling prices	Cortland 1000	Cortland 2000
Product cost	1,625.00	5,640.00	See U
Markup @ 50%	812.50	2,820.00	V=U*50%
Selling price	2,437.50	8,460.00	W=U+V