Question

Traditional Product Costing versus Activity-Based Costing Ridgeland Inc, makes backpacks for large sporting goods chains that are sold under the customers' store brand names. The Accounting Department has identified the following overhead costs and cost drivers for next year: Overhead Item Expected Costs Cost Driver Maximum Quantity Setup costs.......... $489,600 Number of setups............ 7,200 Ordering costs ....... 130,000 Number of orders............ 65,000 Maintenance......... 920,000Number of machine hours.... 80,000 Power ........ 88,000 Number of kilowatt hours..... 440,000 Total predicted direct labor hours for next year is 42,500. The following data are for two recently completed jobs: Job 201 Job 202 Cost of direct materials........ Cost of direct labor. ..... Number of units completed.... Number of direct labor hours Number of setups.... Number of orders.... Number of machine hours....... Number of kilowatt hours. $10,500 $12,000 $18,600 $62,300 900 750 220270 15 19 2142 450 360 200 300 Required a. Determine the unit cost for each job using a traditional plantwide overhead rate based on direct labor hours. b. Determine the unit cost for each job using ABC. (Round answers to two decimal places.) c. As the manager of Ridgeland, is there additional information that you would want to help you evalu- ate the pricing and profitability of Jobs 201 and 202? d. Assuming the company has been using the method required in parta, how should management react to the findings in part b?

Answer 1

Ridgeland Inc. Requirement 1 Total overheads = 489,600 + 130,000 + 920,000 + 88,000 = 1,627,600 Overhead per hour based on direct labor hours = $1,627,600/42,500 hours = $38.29 per hour Overheads assigned to Job 201: $38.29 per hour x 220 hours = $8,424 Overheads assigned to Job 202: $38.29 per hour x 270 hours = $10,338 Unit cost of Job 201: [$10,500 + $18,600 + $8,424]/900 units = $41.69 per unit Unit cost of Job 202: ($12,000 + $62,300 + $10,338]/750 units = $112.85 per unit Requirement 2 Cost per setup = $489,600/7200 setups = $68 per setup Cost per ordering cost = $130,000/65,000 orders = $2 per order Maintenance cost = $920,000/80,000 machine hours = $11.5 per machine hour Power = $88,000/440,000 k.hours = $0.20 per kilowatt hour Overheads allocated to Job 201 as per ABC: (15 setups x $68] + [21 orders x $2] + [450 machine hours x $11.5] + [200 kilowatt hours x $0.20] $1,020 + $42 + $5,175 + $40 = $6,277 Overheads allocated to Job 202 as per ABC: (19 setups x $68] + [42 orders x $2] + [360 machine hours x $11.5] + [300 kilowatt hours x $0.20] $1,292 + $84 + $4,140 + $60 = $5,576 Unit cost of Job 201: [$10,500 + $18,600 + $6,277]/900 units = $39.31 per unit Unit cost of Job 202: ($12,000 + $62,300 + $5,576]/750 units = $106.50 per unit

Requirement 3 Yes, I would require the budgeted overhead costs that were made for the recent period when the jobs were done and also the budgeted direct labor hours for that period. These unit costs are calculated using the expected costs and direct labor hours for the next year, as recent period overhead information not given. Requirement 4 The traditional method of allocating the overhead costs using direct labor hours has its own limitations and will not help in correct costing and pricing. ABC method is a better method than the traditional method because it traces the costs with its respective cost drivers' activities for each job. Hence ABC method is superior. The management should switch immediately to ABC costing as it is more reliable, gives better correct costing and pricing.