Video Options Ltd. manufactures two types of DVD players: standard and deluxe. It attempts to set selling prices based on a 50% markup on manufacturing costs to cover selling and administrative expenses and to earn an acceptable return for shareholders. Bill Merch, vice president—Marketing, is confused because the numbers provided by Terry Green, controller, indicate that standard DVD players should be priced at $150 per unit and deluxe DVD players at $300 per unit. The competition is selling comparable models for $145 and $525, respectively.Merch informs Green that there must be something wrong with the job costing system. He had recently attended a seminar where the speaker stated that “All production costs are not a function of how many units are produced, or of how many labor hours, labor dollars, or machine hours are expended.” He knows that the company uses direct labor dollars as its only cost allocation base. Bill thinks that perhaps this explains why the product costs and, therefore selling prices, are so different from those of the competitors.Currently, the costs per unit are determined as follows:  StandardDeluxeDirect Materials$30.00$50.00Direct Labor17.5037.50Factory Overhead$52.50$112.50Manufacturing cost per unit$100.00$200.00Factory overhead is currently applied using a plantwide rate based on direct labor cost. This year’s rate was computed as follows: Budgeted Factory Overhead Direct labor Support$300,000Machine Support400,000Setup Costs200,000Design Costs100,000Total$1,000,000Budgeted direct labor$333,333Budgeted Factory Overhead rate$1,000,000/$333,333=300% of direct labor  dollarsGreen, knowing that you had recently studied ABC in your cost accounting course, employs you as a consultant to determine what effect its usage would have on the product costs. You first gathered the following data:  StandardDeluxeTotalUnits Produced10,000200012000Direct labor hours60,00040,000100,000Machine hours30,00020,00050,000Machine setups2008001,000Design changes50200250From the data that you gathered, determine the best allocation base for each of the four components of factory overhead.Compute an overhead rate for each of the four components.Determine the new unit cost for standard and deluxe models using ABC.Why are the product costs so dramatically different when ABC is used?Would Video Options’ selling prices be closer to those of the competition if ABC were used?

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Asked Mar 15, 2019
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Video Options Ltd. manufactures two types of DVD players: standard and deluxe. It attempts to set selling prices based on a 50% markup on manufacturing costs to cover selling and administrative expenses and to earn an acceptable return for shareholders. Bill Merch, vice president—Marketing, is confused because the numbers provided by Terry Green, controller, indicate that standard DVD players should be priced at $150 per unit and deluxe DVD players at $300 per unit. The competition is selling comparable models for $145 and $525, respectively.

Merch informs Green that there must be something wrong with the job costing system. He had recently attended a seminar where the speaker stated that “All production costs are not a function of how many units are produced, or of how many labor hours, labor dollars, or machine hours are expended.” He knows that the company uses direct labor dollars as its only cost allocation base. Bill thinks that perhaps this explains why the product costs and, therefore selling prices, are so different from those of the competitors.

Currently, the costs per unit are determined as follows:

 

  Standard Deluxe
Direct Materials $30.00 $50.00
Direct Labor 17.50 37.50
Factory Overhead $52.50 $112.50
Manufacturing cost per unit $100.00 $200.00

Factory overhead is currently applied using a plantwide rate based on direct labor cost. This year’s rate was computed as follows:

 

Budgeted Factory Overhead  
Direct labor Support $300,000
Machine Support 400,000
Setup Costs 200,000
Design Costs 100,000
Total $1,000,000
Budgeted direct labor $333,333
Budgeted Factory Overhead rate $1,000,000/$333,333=300% of direct labor  dollars

Green, knowing that you had recently studied ABC in your cost accounting course, employs you as a consultant to determine what effect its usage would have on the product costs. You first gathered the following data:

 

  Standard Deluxe Total
Units Produced 10,000 2000 12000
Direct labor hours 60,000 40,000 100,000
Machine hours 30,000 20,000 50,000
Machine setups 200 800 1,000
Design changes 50 200 250
  1. From the data that you gathered, determine the best allocation base for each of the four components of factory overhead.
  2. Compute an overhead rate for each of the four components.
  3. Determine the new unit cost for standard and deluxe models using ABC.
  4. Why are the product costs so dramatically different when ABC is used?
  5. Would Video Options’ selling prices be closer to those of the competition if ABC were used?
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