1
Predetermined overhead rate
The allocation rate which is calculated to allocate overhead or indirect cost to various cost objects is called predetermined overhead rate.
Unit product cost
It is the total cost incurred to produce a single unit and it is obtained by the division of total cost incurred and total number of units manufactured.
To calculate: The predetermined overhead rate by using direct labor hours (DLHs) and unit product cost.
1
Answer to Problem 15P
Predetermined overhead rate is $50 per DLH.
Unit product cost of flexible model is $240and unit product cost of regular model is $145.
Explanation of Solution
Predetermined overhead rate based on DLHs will be calculated as:
Here, total expected overhead cost is $6,00,000 and total direct labor hours will be calculated by using the following formula:
So, predetermined overhead rate will be:
Now, unit product cost will be calculated as follows:
Particulars | Flexible model(in $) | Regular model(in $) |
Direct material cost (per unit) | 110 | 80 |
Direct labor cost (per unit) | 30 | 15 |
Overhead cost (per unit) (Calculated below) | 100 | 50 |
Total product cost (per unit) | 240 | 145 |
Overhead cost per unit will be calculated as:
For flexible model overhead cost (per unit) will be:
For regular model overhead cost (per unit) will be:
2
Activity based costing:
ABC is a system that identifies every task performed by the organization as an activity and then cost of every activity is assigned to all the products. Allocation of cost is done by creating a relationship among activity, costs and products.
Activity cost pool:
An activity cost pool represents the aggregate cost incurred by a company while performing one manufacturing process or task.
An activity rate for each activity cost pool.
2
Answer to Problem 15P
Activity rate:
For purchase orders is $50 per order,
For rework requests is $50 per request,
For product testing is $100 per test and
For machine related activities is $90 per MH.
Explanation of Solution
Activity rates are calculated with the help of following formula:
So, activity rates will be calculated as follows:
Activity cost pool | Activity measure | Expected value of overheads (X)(in $) | Total expected activity (Y) | Activity rate (X/Y)(in $) |
Purchase orders | Orders | 20,000 | 400 | 50 per order |
Rework requests | Requests | 10,000 | 200 | 50 per request |
Product testing | Tests | 210,000 | 2,100 | 100 per test |
Machine related | Machine hours (MHs) | 360,000 | 4,000 | 90 per MH |
Activity rate of purchase orders is $50 per order, for rework requests is $50 per request, product testing is $100 per test and machine related activities is $90 per MH.
3
Overhead cost allocation:
Overhead costs are the indirect costs (not directly related to products) which are incurred to support the general operations within an organization. Total overhead cost incurred is allocated to all the products using the correct measure.
Unit product cost
Unit product cost represents the total cost incurred for producing a single unit. Calculation for this cost is done by dividing total amount of cost by total number of units produced.
Total overhead cost that will be allocated to each product and cost of one unit.
3
Answer to Problem 15P
Overhead cost allocated to flexible model is $233,000 and to rigid model is $367,000.
Unit product cost of flexible model is $373 and unit product cost of rigid model is $131.7.
Explanation of Solution
Under the ABC system, overhead costs are allocated to each product according to the consumption of each activity by every product. So firstly, consumption ratio for each activity will be calculated.
Calculation of ratio:
Particulars | Flexible model | Rigid model | RatioFlexible: Rigid |
Purchase orders | 100 | 300 | 1:3 |
Rework requests | 60 | 140 | 6:14 or 3:7 |
Product testing | 900 | 1,200 | 9:12 or 3:4 |
Machine related | 1,500 | 2,500 | 15:25 or 3:5 |
Now, overhead costs will be allocated as follows:
Activity cost pool | Overhead expense(in $) | Ratio | Flexible model(in $) | Rigid model (in $) |
Purchase orders (orders) | 20,000 | 1:3 | 5,000 | 15,000 |
Rework requests (requests) | 10,000 | 3:7 | 3,000 | 7,000 |
Product testing (tests) | 210,000 | 3:4 | 90,000 | 120,000 |
Machine related (machine hours) | 360,000 | 3:5 | 135,000 | 225,000 |
Total overhead cost | 233,000 | 367,000 |
So, total overhead cost allocated to flexible model is $233,000 and to rigid model is $367,000.
Calculation for unit product cost will be done as follows:
Particulars | Flexible model ($) | Rigid model ($) |
Total direct material cost | $110* 1000 = 110,000 | $80 *10,000= 800,000 |
Total direct labor cost | $30 *1000 = 30,000 | $15* 10,000 = 150,000 |
Total overhead cost | 233,000 | 367,000 |
Total product cost | 373,000 | 1,317,000 |
Number of units | 1,000 | 10,000 |
Unit product cost | 373.00 | 131.70 |
4
Traditional method
In this method, a single measure or base is used to distribute the total overhead cost to all the products.
ABC method
In ABC method, different measures or bases are used in the allocation process.
To explain: Why profit differs or decline when different methods are used.
4
Explanation of Solution
Amount of profits differ in both the methods and generally, it is less when ABC system is used. This different occurs because cost allocation method in both the methods is different.
Conventional method uses a single or uniform measure to allocate the overhead cost to products and ABC method uses different measures to allocate the overhead costs. Different activity measures are applied for different cost pools. Because of different methods, overhead cost allocated to products differ in both the methods which leads to different profits.
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Chapter 4 Solutions
MANAGERIAL ACCOUNTING
- Segment variable costing income statement and effect on operating income of change in operations Valdespin Company manufactures three sizes of camping tentssmall (S), medium (M), and large (L). The income statement has consistently indicated a net loss for the M size, and management is considering three proposals: (1) continue Size M, (2) discontinue Size M and reduce total output accordingly, or (3) discontinue Size M and conduct an advertising campaign to expand the sales of Size S so that the entire plant capacity can continue to be used. If Proposal 2 is selected and Size M is discontinued and production curtailed, the annual fixed production costs and fixed operating expenses could be reduced by 46,080 and 32,240, respectively. If Proposal 3 is selected, it is anticipated that an additional annual expenditure of 34,560 for the rental of additional warehouse space would yield an additional 130% in Size S sales volume. It is also assumed that the increased production of Size S would utilize the plant facilities released by the discontinuance of Size M. The sales and costs have been relatively stable over the past few years, and they are expected to remain so for the foreseeable future. The income statement for the past year ended June 30, 20Y9, is as follows: Instructions 1. Prepare an income statement for the past year in the variable costing format. Use the following headings: Data for each size should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin, as reported in the Total column, to determine operating income. 2. Based on the income statement prepared in (1) and the other data presented, determine the amount by which total annual operating income would be reduced below its present level if Proposal 2 is accepted. 3. Prepare an income statement in the variable costing format, indicating the projected annual operating income if Proposal 3 is accepted. Use the following headings: Data for each style should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin as reported in the Total column. For purposes of this problem, the expenditure of 34,560 for the rental of additional warehouse space can be added to the fixed operating expenses. 4. By how much would total annual operating income increase above its present level if Proposal 3 is accepted? Explain.arrow_forwardManufacturing builds and sells switch harnesses for glove boxes. The sales price and variable cost for each follows: Their sales mix is reflected in the ratio 4:4:1. If annual fixed costs shared by the three products are $1 8840 how many units of each product will need to be sold in order forJj to break even?arrow_forwardKimball Company has developed the following cost formulas: Materialusage:Ym=80X;r=0.95Laborusage(direct):Yl=20X;r=0.96Overheadactivity:Yo=350,000+100X;r=0.75Sellingactivity:Ys=50,000+10X;r=0.93 where X=Directlaborhours The company has a policy of producing on demand and keeps very little, if any, finished goods inventory (thus, units produced equals units sold). Each unit uses one direct labor hour for production. The president of Kimball Company has recently implemented a policy that any special orders will be accepted if they cover the costs that the orders cause. This policy was implemented because Kimballs industry is in a recession and the company is producing well below capacity (and expects to continue doing so for the coming year). The president is willing to accept orders that minimally cover their variable costs so that the company can keep its employees and avoid layoffs. Also, any orders above variable costs will increase overall profitability of the company. Required: 1. Compute the total unit variable cost. Suppose that Kimball has an opportunity to accept an order for 20,000 units at 220 per unit. Should Kimball accept the order? (The order would not displace any of Kimballs regular orders.) 2. Explain the significance of the coefficient of correlation measures for the cost formulas. Did these measures have a bearing on your answer in Requirement 1? Should they have a bearing? Why or why not? 3. Suppose that a multiple regression equation is developed for overhead costs: Y = 100,000 + 100X1 + 5,000X2 + 300X3, where X1 = direct labor hours, X2 = number of setups, and X3 = engineering hours. The coefficient of determination for the equation is 0.94. Assume that the order of 20,000 units requires 12 setups and 600 engineering hours. Given this new information, should the company accept the special order referred to in Requirement 1? Is there any other information about cost behavior that you would like to have? Explain.arrow_forward
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