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Harvey Company produces two models of blenders: the “Super Model” (priced at $400) and the “Special Model” (priced at $200). Recently, Harvey has been losing market share with its Special Model because of competitors offering blenders with the same quality and features but at a lower price. A careful market study revealed that if Harvey could reduce the price of its Special Model to $180, it would regain its former share of the market. Management, however, is convinced that any price reduction must be accompanied by a cost reduction of the same amount so that per-unit profitability is not affected. Earl Wise, company controller, has indicated that poor overhead costing assignments may be distorting management’s view of each product’s cost and, therefore, the ability to know how to set selling prices. Earl has identified the following overhead activities: machining, inspection, and rework. The three activities, their costs, and practical capacities are as follows: The consumption patterns of the two products are as follows: Harvey assigns overhead costs to the two products using a plantwide rate based on machine hours. Required: 1. Calculate the unit overhead cost of the Special Model using machine hours to assign overhead costs. Now, repeat the calculation using ABC to assign overhead costs. Did improving the accuracy of cost assignments solve Harvey’s competitive problem? What did it reveal? 2. Now, assume that in addition to improving the accuracy of cost assignments, Earl observes that defective supplier components are the root cause of both the inspection and rework activities. Suppose further that Harvey has found a new supplier that provides higher-quality components such that inspection and rework costs are reduced by 50 percent. Now, calculate the cost of the Special Model (assuming that inspection and rework times are also reduced by 50 percent) using ABC. The relative consumption patterns also remain the same. Comment on the difference between ABC and ABM.

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Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663

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BuyFindarrow_forward

Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663
Chapter 12, Problem 6E
Textbook Problem
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Harvey Company produces two models of blenders: the “Super Model” (priced at $400) and the “Special Model” (priced at $200). Recently, Harvey has been losing market share with its Special Model because of competitors offering blenders with the same quality and features but at a lower price. A careful market study revealed that if Harvey could reduce the price of its Special Model to $180, it would regain its former share of the market. Management, however, is convinced that any price reduction must be accompanied by a cost reduction of the same amount so that per-unit profitability is not affected. Earl Wise, company controller, has indicated that poor overhead costing assignments may be distorting management’s view of each product’s cost and, therefore, the ability to know how to set selling prices. Earl has identified the following overhead activities: machining, inspection, and rework. The three activities, their costs, and practical capacities are as follows:

Chapter 12, Problem 6E, Harvey Company produces two models of blenders: the Super Model (priced at 400) and the Special , example  1

The consumption patterns of the two products are as follows:

Chapter 12, Problem 6E, Harvey Company produces two models of blenders: the Super Model (priced at 400) and the Special , example  2

Harvey assigns overhead costs to the two products using a plantwide rate based on machine hours.

Required:

  1. 1. Calculate the unit overhead cost of the Special Model using machine hours to assign overhead costs. Now, repeat the calculation using ABC to assign overhead costs. Did improving the accuracy of cost assignments solve Harvey’s competitive problem? What did it reveal?
  2. 2. Now, assume that in addition to improving the accuracy of cost assignments, Earl observes that defective supplier components are the root cause of both the inspection and rework activities. Suppose further that Harvey has found a new supplier that provides higher-quality components such that inspection and rework costs are reduced by 50 percent. Now, calculate the cost of the Special Model (assuming that inspection and rework times are also reduced by 50 percent) using ABC. The relative consumption patterns also remain the same. Comment on the difference between ABC and ABM.

1.

To determine

Determine the unit overhead cost of the special model using machine hours to assign overhead costs and repeat the computation using ABC to assign overhead costs. Ascertain whether it improves the accuracy of cost assignments solve Company H’s competitive problem and what did it reveal.

Explanation of Solution

Step 1: Compute the unit overhead cost of the special model using machine hours to assign overhead costs

Calculate plantwide rate and unit overhead cost:

Plantwide overhead rate: Plantwide overhead rate is the rate a company uses to allocate its manufacturing overhead costs to products and cost centres’. Predetermined overhead rate is a measure used to allocate the estimated manufacturing overhead cost to the products or job orders during a particular period. This is generally evaluated at the beginning of each reporting period. The evaluation takes into account the estimated manufacturing overhead cost and the estimated allocation base that includes direct labor hours, direct labor in dollars, machine hours or direct materials.

Plantwide rate =Total overhead costMachine hours=($5,400,000+$3,600,000+$1,800,000)90,000machine hours=$120per machine hour

Unit overhead cost=(Plantwide rate ×machine hours for special model)Number of units =($120×50,000 machine hours)100,000units=$60

Step 2: Compute the unit overhead cost of the special model using ABC to assign overhead cost.

Compute activity rates:

Particulars 
Cost of machining$ 5,400,000
Divide: machine hours90,000 machine hours
Activity rate$60 per machine hour
  
Cost of inspection$ 3,600,000
Divide: inspection hours45,000 inspection hours
Activity rate$80 per inspection hour
  
Cost of rework$ 1,800,000
Divide: rework hours45,000 rework hours
Activity rate$40 per rework hour

Table (1)

Total overhead cost for specia

2.

To determine

Ascertain the cost of the special model using ABC by assuming that inspection and rework costs are also reduced by 50 percent, and distinguish the activity-based costing (ABC) and activity-based management (ABM).

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Chapter 12 Solutions

Cornerstones of Cost Management (Cornerstones Series)
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