Question

cost management

A strategic Emphasis seventh edition book

chapter 5 question 41 parts 1,2,3

Volume-based costing versus ABC Eastern Chemica Company produces three products. The operating results of the current year are:

Product Sales Quantity Target Price Actual Price Difference

A 1,000 $285.50 $286.00 $1.00

B 5,000 297.60 255.60 (42.00)

C 500 202.50 310.00 $107.50

The firm sets the target price of each product at 150% of the product's total manufacturing cost. Recognizing that the firm was able to sell Product C at a much higher price then the target price of the product and lost money on Product B, Tom Watson, CEO, wants to promote Product C much more aggressively and phase out Product B. He believes that the information suggests that Product C has the greatest potential among the firm's three products since the actual selling price of Product C was almost 50% higher then the target price while the firm was forced to sell Product B at a price below the target price.

Both the budgeted and actual factory overheads for the current year are $510,000. The actual units sold for each product also are the same as the budgeted units. The firm uses direct labor dollars to assign manufacturing overhead costs. The direct materials and direct labor costs per unit for each product are:

Product A Product B Product C

Direct materials $50.00 $114.40 $65.00

Direct labor 20.00 12.00 10.00

Total Prime cost $70.00 $126.40 $75.00

The controller noticed not all products consumed factory overhead similarly. Upon further investigations, she identified the following usage of factory overhead during the year:

Product A Product B Product C Total Overhead

Number of setups 2 5 3 $9,000

Weight of direct materials(lbs) 400 250 350 110,000

Waste & hazardous disposals 25 45 30 250,000

Quality inspections 30 35 35 75,000

Utilities (machine hours) 2,000 7,000 1,000 66,000

Total $510,000

Required

1. Determine the manufacturing cost per unit for each of the products using the volume-based method.

2. What is the least profitable and the most profitable product under both the current and the ABC costing systems?

3. What is the new target price for each product based on 150% of the new costs under the ABC system? Compare this price with the actual selling price

4. Comment on the result from a competitive and strategic perspective. As a manager of Eastern Chemical, describe what actions you would take based on the information provided by the activity-based unit costs.

Answer 1

ANSWER

1. Determination of Manufacturing Cost per Unit under volume based method It is said that the Manufacturing Overhead of $ 510,000 is allocated on basis of Direct Labor in Dollars. Do, first we shall calculate manufacturing overhead per dollar of direct labor to allocate the cost a. Determination of the Total Direct Labor Cost Particulars A В C Total Direct Labor per Unit No. of Units Total Direct Labor Cost 12 $ $ 20 $ 10 1,000 5,000 500 5,000 $85,000 20,000 $ 60,000 $ b. Manufacturing Overhead per Dollar of Labor Cost: Manufacturing Overhead $ 510,000 $ 85,000 Manufacturing Overhead $ 6.00 c. Manufacturing Cost per Unit: Particulars A В C Direct Materials Direct Labor Manufacturing Overhead 114.40 $ 12.00 $ 72.00 $ 198.40 $ 135.00 50.00 $ $ 20.00 $ $ 120.00 $ $ 190.00 $ 00 10.00 60.00 2. Determination of Manufacturing Cost under ABC System A. Manufacturing Cost per Unit Particulars A В C Direct Materials Direct Labor Manufacturing Overhead - Setup Cost - Material Handling - Hazardous Control - Quality Control - Utilities 50.00 $ $ 20.00 $ 114.40 $ 12.00 $ 65.00 10.00 0.90 $ 1.80 $ 44.00 $ 5.40 5.50 $ 22.50 $ 150.00 5.25 $ 9.24 $ 169.79 $373.10 77.00 62.50 $ 22.50 $ $ 13.20 $ $ 214.00 $ 52.50 13.20

B. Determination of Overhead Costs: Setup Cost Cost per Setup $9,000 / (2+5+3) = $ 900 per Setup Particulars No. of Setups Cost per Setup Setup Cost No. of Units Unit Cost A В C 2 3 900 $ 900 $ 4,500 $ 5,000 $ 0.90 $ $ 900 1,800 $ 1,000 $ 1.80 $ 2,700 500 5.40 Material Handling Cost per pound $ 110,000 (400+250+350) $ 110 Particulars В C No. of Pounds Cost per Pound Material Handling Cost No. of Units Unit Cost 350 400 250 110 $ 27,500 $38,500 5,000 $ 5.50 $ 110 $ 44,000 $ 1,000 $ 44.00 $ 110 500 $ 77.00 Hazardous Control Cost per Disposal $ 250,000 / (25+45+30) = $ 2,500 Particulars A В C No.of Disposals Cost per Disposal Disposal Cost No. of Units Unit Cost 25 45 30 2,500 $ 2,500 $ $ 2,500 62,500 112,500 $ 75,000 1,000 $ 62.50 $ 5,000 $ 22.50 $ 150.00 500 Quality Control Cost per Inspection $75,000/ (30+35+35) $750 Particulars A В C No.of Inspections Cost per Inspection Quality Control Cost No. of Units Unit Cost 30 35 35 750 $ 26,250 26,250 5,000 $ 5.25 $ 750 $ $ 750 22,500 $ 1,000 $ 22.50 $ 500 52.50 LO

Utilities Cost per Machine Hour $ 66,000 / (2000+7000+1000) $6.60 Particulars A В C No. of Machine Hours Cost per MH Utilities Cost No. of Units Unit Cost 1,000 2,000 7,000 $ 6.60 $ 13,200 $ 6.60 $ 6.60 46,200 $ 5,000 $ 9.24 $ 6,600 1,000 $ $ 500 13.20 $ $ 13.20 C. Determination of Least profitable and highest profitable under both current ansd ABC Systems Current System Particulars Sales Price Less Manufacturing Cost $ (190.00) $ (198.40) $ (135.00) Gross Profit Gross Profit% A В C 286.00 $ 255.60 $ 310.00 $ 96.00 $ 57.20 175.00 $ 33.57% 22.38% 56.45% Particulars Product Most Profitable Least Profitable C В ABC System Particulars A В C Sales Price 286.00 $ 255.60 $ 310.00 $ Less Manufacturing Cost $ (214.00) $ (169.79) $ (373.10) Gross Profit Gross Profit % 85.81 (63.10) 72.00 $ 20.35% 25.17% 33.57% Particulars Product Most Profitable Least Profitable в C

3. Determination of the New Target Price for each produft Particulars Cost under ABC System Add Gross Margin New Target Price A В C 214.00 $ 169.79 373.10 84.90 $ 186.55 254.69 $559.65 $ 107.00 $ $ 321.00 $ Comparison with the Actual Selling Price Particulars A В C Sales Price Less New Target Price Gross Profit Gross Profit % 286.00 $ 255.60 $ 310.00 $ $ (321.00) (35.00) $ (559.65) (254.69) 0.91 (249.65) 0.36% -80.53% -12.24% 4. Comment on the Results: Product C under the current (direct labor cost) based overhead costing system will affect the firm's profit capability. This is because, under the activity-based costing system shows that the manufacturing cost of Product C is $ 373.10 per unit and, at the current selling price, the firm suffers a $63.10 loss for every unit.