Activity-Based Costing as an Alternative to Traditional Product Costing
Erte, Inc., manufactures two models of high-pressure steam valves, the XR7 model and the ZDS model. Data regarding the two products follow:
Product | Direct Labor-Hours | Annual Production | Total Direct Labor-Hours |
XR7 | 0.2 DLHs per unit | 20,000 units | 4,000 DLHs |
ZD5 | 0.4DLHs per unit | 40,000 units | 16,000 DLHs |
|
|
| 20,000 DLHs |
Additional information about the company follows:
a. Product XR7 requires $35 in direct materials per unit, and product ZDS requires $25.
b. The direct labor rate is $20 per hour.
c. The company has always used direct labor-hours as the base for applying manufacturing overhead cost to products. Manufacturing overhead totals $1,480,000 per year.
d. Product XR7 is more complex 10 manufacture than product ZD5 and requires the use of a special milling machine.
e. Because of the special work required in (d) above, the company is considering the use of activity-based costing to apply overhead cost to products. Three activity cost pooh haw been identified and the first-stage allocations have been completed. Data concerning these activity cost pools appear below:
|
|
| Estimated Total Activity | ||
Activity Cost Pool | Activity Measure | Estimated Total Cost | XR7 | ZD5 | Total |
Machine setups | Number of setups | $ 180,000 | 150 | 100 | 250 |
Special milling | Machine-hours | 300,000 | 1,000 | 0 | 1,000 |
General factory | Direct labor-hours | 1,000,000 | 4,000 | 16,000 | 20,000 |
|
| $1,480,000 |
|
|
|
Required:
1. Assume that the company continues to use direct labor-hours as the base for applying overhead cost to products.
a. Compute the predetermined overhead rate.
b. Determine the unit product cost of each product.
2. Assume that the company decides to use activity-based costing to apply overhead cost to products.
a. Compute the activity rate for each activity cost pool. Also, compute the amount of overhead cost that would be applied to each product.
b. Determine the unit product cost of each product.
3. Explain why overhead cost shifted from the high-volume product to the low-volume product under activity-based costing.
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