Chapter 4, Problem 1PSA

To determine

Concept introduction:

Activity based costing:

Activity based costing is the method of cost allocation of overhead expenses by first identifying the costs pool for any specific overhead and then identifying the costs related to a particular product.

Manufacturing overheads allocation:

Manufacturing overheads are the overheads incurred in manufacturing plants for manufacturing a product. Enterprises use several methods of allocating these factory overheads like on direct labor hours, activity based method etc. In overhead cost allocation using direct labor hours, the total direct labor hours incurred are identified and the costs are allocated between products using the direct labor hours incurred in manufacturing the particular product. The formula for cost allocation for a particular product based on direct labor hours would be as follows
$\frac{Totaloverheadcosttobeallocated}{Totaldirectlaborhours}*Directlaborhoursusedformanufacturingaparticularproduct$

Requirement 1:

The manufacturing cost and the gross profit per unit for the given products using overhead rates based on direct labor hours.

Answer to Problem 1PSA

The manufacturing cost per unit for Product A is $26.37 and for Product B is $84.65 if overhead costs are assigned based on direct labor hours.

The gross profit per unit of product A is $ 3.63 and product B is $ 35.35

Explanation of Solution

	Product A	Product B	Total
Direct material cost per unit (a)	15	24
Direct labor hours	0.3	1.6
Direct labor cost per unit @$20 per DLH (b)	$0.3*\$20=\$6$	$1.6*\$20=\$32$
Total direct labor hours = $DLHperunit*totalunitsproduced$	$0.3*10,000=3,000$	$1.6*2,000=3,200$	6, 200
Total overhead cost allocated	$\frac{111,000}{6,200}*3,000=53,710$	$\frac{111,000}{6,200}*3,200=57,290$
Total overhead cost allocated per unit (c )	$\frac{53,710}{10,000}=\$5.371$	$\frac{57,290}{2,000}=\$28.645$
Total production cost (a+b+c)	$26.37	$84.65
Market price	$30	$120
Gross profit = $Marketprice-Totalproductioncost$	$3.63	$35.35

Total indirect manufacturing cost/production overhead

Engineering support	24, 500
Electricity	34, 000
Setup costs	52, 500
Total production overheads	$111, 000

Thus, per unit manufacturing cost and gross profit of each product using direct labor hours as the basis of overhead allocation have been computed.

To determine

Concept introduction:

Activity based costing:

Activity based costing is the method of cost allocation of overhead expenses by first identifying the costs pool for any specific overhead and then identifying the costs related to a particular product.

Manufacturing overheads allocation:

Manufacturing overheads are the overheads incurred in manufacturing plants for manufacturing a product. Enterprises use several methods of allocating these factory overheads like on direct labor hours, activity based method etc. In overhead cost allocation using direct labor hours, the total direct labor hours incurred are identified and the costs are allocated between products using the direct labor hours incurred in manufacturing the particular product. The formula for cost allocation for a particular product based on direct labor hours would be as follows

$\frac{Totaloverheadcosttobeallocated}{Totaldirectlaborhours}*Directlaborhoursusedformanufacturingaparticularproduct$

Requirement 2:

The gross profit generated by each customer of product A and Product B using direct labor hours as basis of overhead allocation and cost of providing customer service to each customer.

Answer to Problem 1PSA

The gross profit generated by each customer for product A is $ 72.60 and for product B is $176.75

The cost of servicing each customer is $ 90. This implies that the net loss from each customer for product A is $17.4 and net profit from each customer for product B is $86.75.

Explanation of Solution

	Product A	Product B	Total
Gross profit per unit	$3.63	$35.35
Number of units sold	10, 000 units	2, 000 units
Total gross profit earned	$36, 300	$70, 700	$107, 000
Number of customers	500	400	900
Gross profit for each customer	$72.60	$176.75	$118.89
Cost of servicing each customer	$90	$90
Net profit/(loss from each customer)	$(17.4)	86.75

Total customer service charges=$81, 000

Total number of customer=900

So, cost of servicing each customer = $\frac{81,000}{900}=\$90$

To determine

Concept introduction:

Activity based costing:

Activity based costing is the method of cost allocation of overhead expenses by first identifying the costs pool for any specific overhead and then identifying the costs related to a particular product.

Manufacturing overheads allocation:

Manufacturing overheads are the overheads incurred in manufacturing plants for manufacturing a product. Enterprises use several methods of allocating these factory overheads like on direct labor hours, activity based method etc. In overhead cost allocation using direct labor hours, the total direct labor hours incurred are identified and the costs are allocated between products using the direct labor hours incurred in manufacturing the particular product. The formula for cost allocation for a particular product based on direct labor hours would be as follows

$\frac{Totaloverheadcosttobeallocated}{Totaldirectlaborhours}*Directlaborhoursusedformanufacturingaparticularproduct$

Requirement 3:

The manufacturing cost and gross profit per unit of each product line using ABC.

Answer to Problem 1PSA

The manufacturing cost per unit for Product A is $24.30 and for Product B is $95.03 if overhead costs are assigned based on ABC.

The gross profit per unit of product A is $ 5.70 and product B is $ 24.97

Explanation of Solution

	Product A	Product B	Total
Direct material cost per unit (a)	15	24
Direct labor hours	0.3	1.6
Direct labor cost per unit @$20 per DLH (b)	$0.3*\$20=\$6$	$1.6*\$20=\$32$
Total direct labor hours = $DLHperunit*totalunitsproduced$	$0.3*10,000=3,000$	$1.6*2,000=3,200$	6, 200
Machine hours per unit	0.1 MH	1.2 MH
Total Machine hours required	$0.1*10,000=1,000$	$1.2*2,000=2,400$	3, 400
Total engineering modifications	12	58	70
Number of batches	125	225	350
Engineering support cost allocated (c )	$\frac{24,500}{70}*12=\$4,200$	$\frac{24,500}{70}*58=\$20,300$	24, 500
Total electricity cost allocated(d)	$\frac{34,000}{3,400}*1,000=\$10,000$	$\frac{34,000}{3,400}*2,400=\$24,000$	$34, 000
Total setup costs allocated (e)	$\frac{52,500}{350}*125=\$18,750$	$\frac{52,500}{350}*225=\$33,750$	$52, 500
Total production overhead cost allocated (c+d+e)	$32, 950	$78, 050	$111, 000
Production overhead per unit (f)	$\frac{32,950}{10,000}=\$3.295$	$\frac{78,050}{2,000}=\$39.025$
Total production cost (a+b+f)	$24.30	$95.025
Market price	$30	$120
Gross profit = $Marketprice-Totalproductioncost$	$5.70	$24.975

To determine

Concept introduction:

Activity based costing:

Activity based costing is the method of cost allocation of overhead expenses by first identifying the costs pool for any specific overhead and then identifying the costs related to a particular product.

Manufacturing overheads allocation:

Manufacturing overheads are the overheads incurred in manufacturing plants for manufacturing a product. Enterprises use several methods of allocating these factory overheads like on direct labor hours, activity based method etc. In overhead cost allocation using direct labor hours, the total direct labor hours incurred are identified and the costs are allocated between products using the direct labor hours incurred in manufacturing the particular product. The formula for cost allocation for a particular product based on direct labor hours would be as follows

$\frac{Totaloverheadcosttobeallocated}{Totaldirectlaborhours}*Directlaborhoursusedformanufacturingaparticularproduct$

Requirement 4:

The gross profit generated by each customer of product A and Product B using ABC as basis of overhead allocation and to determine if gross profit per customer adequate.

Answer to Problem 1PSA

The gross profit generated by each customer for product A is $ 114 and for product B is $124.88

The cost of servicing each customer is $ 90. This implies that the net profit from each customer for product A is $24 and net profit from each customer for product B is $34.88.

Explanation of Solution

	Product A	Product B	Total
Gross profit per unit	$5.70	$24.975
Number of units sold	10, 000 units	2, 000 units
Total gross profit earned	$57, 000	$49, 950
Number of customers	500	400	900
Gross profit for each customer	$114	$124.88
Cost of servicing each customer	$90	$90
Net profit/(loss from each customer)	$24	$34.88

Total customer service charges=$81, 000

Total number of customer=900

So, cost of servicing each customer = $\frac{81,000}{900}=\$90$

To determine

Requirement 5:

To select:

The method of product costing which provides better information to the managers of the company and reasons for the same.

Answer to Problem 1PSA

Activity based costing gives better information to the managers of the company when compared with the traditional basis of allocation based on direct labor hours.

By using activity based costing, the major cost driver for allocating a particular overhead has been identified and the costs have been allocated to the product based on these cost drivers which provides more accurate costing data.

Explanation of Solution

When overhead are allocated based on direct labor hours, total production overhead may be clubbed and then allocated to the products based on direct labor hours used in the production process, which is a random method of allocation

However, in activity based costing, the major cost driver of each overhead expense is identified and the costs are allocated based on the data available for these cost drivers which implies a more detailed and accurate allocation of costs.