Concept explainers
Reducir, Inc., produces two different types of hydraulic cylinders. Reducir produces a major subassembly for the cylinders in the Cutting and Welding Department. Other parts and the subassembly are then assembled in the Assembly Department. The activities, expected costs, and drivers associated with these two manufacturing processes are given below.
Note: In the assembly process, the materials-handling activity is a function of product characteristics rather than batch activity.
Other
Other production information concerning the two hydraulic cylinders is also provided:
Required:
- 1. Using a plantwide rate based on machine hours, calculate the total overhead cost assigned to each product and the unit overhead cost.
- 2. Using activity rates, calculate the total overhead cost assigned to each product and the unit overhead cost. Comment on the accuracy of the plantwide rate.
- 3. Calculate the global consumption ratios.
- 4. Calculate the consumption ratios for welding and materials handling (Assembly) and show that two drivers, welding hours and number of parts, can be used to achieve the same ABC product costs calculated in Requirement 2. Explain the value of this simplification.
- 5. Calculate the consumption ratios for inspection and engineering, and show that the drivers for these two activities also duplicate the ABC product costs calculated in Requirement 2.
1.
Compute the total overhead cost assigned to each product and the unit overhead cost using a plantwide rate based on machine hours for incorporation R.
Explanation of Solution
Plantwide overhead rate: Plantwide overhead rate is the rate a company uses to allocate its manufacturing overhead costs to products and cost centres.
Step 1: Calculate plantwide overhead rate based on machine hours.
Step 2: Determine the total overhead cost assigned to each product and the unit overhead cost.
For cylinder A,
Therefore, the total overhead cost assigned and unit overhead cost for cylinder A is $1,200,000 and $800 respectively.
For cylinder B,
Therefore, the total overhead cost assigned and unit overhead cost for cylinder B is $2,800,000 and $933.33 respectively.
2.
Determine the total overhead cost assigned to each product and the unit overhead cost using an activity rate for incorporation R and provide comment on the accuracy of the plantwide rate.
Explanation of Solution
Activity rates: Activity rates are calculated by dividing the budgeted activity costs by the amount of activity output as measured by the activity driver.
Step 1: Calculate activity rates.
Particulars | |
Cost of welding | $ 776,000 |
Divide: Welding hours | 4,000 hours |
Activity rate | $194.00 per welding hour |
Cost of machining | $ 450,000 |
Divide: Machine hours | 10,000 hours |
Activity rate | $45.00 per machine hour |
Cost of inspecting | $ 448,250 |
Divide: Number of inspections | 1,000 inspections |
Activity rate | $448.25 per inspection |
Cost of materials handling | $ 300,000 |
Divide: Number of batches | 12,000 |
Activity rate | $25.00 per move |
Cost of setups | $ 240,000 |
Divide: Number of setups | 100 |
Activity rate | $2,400.00 per batch |
Cost of changeover | $ 180,000 |
Divide: change over hours | 1,000 change over hours |
Activity rate | $180.00 per changeover hour |
Cost of rework | $ 61,750 |
Divide: Rework orders | 50 rework orders |
Activity rate | $1,235.00 per rework order |
Cost of testing | $ 300,000 |
Divide: Number of tests | 750 tests |
Activity rate | $400.00 per test |
Cost of materials handling | $ 380,000 |
Divide: Number of parts | 50,000 parts |
Activity rate | $7.60 per part |
Cost of engineering support | $ 130,000 |
Divide: Engineering hours | 2,000 hours |
Activity rate | $65.00 per engineering hour |
Cost of purchasing | $ 135,000 |
Divide: Purchase requisitions | 500 requisitions |
Activity rate | $270.00 per requisition |
Cost of receiving | $ 274,000 |
Divide: Receiving orders | 2,000 receiving orders |
Activity rate | $137.00 per receiving order |
Cost of paying suppliers | $ 225,000 |
Divide: Number of invoices | 1,000 invoices |
Activity rate | $225.00 per invoice |
Cost of providing space and utilities | $ 100,000 |
Divide: Machine hours | 10,000 machine hours |
Activity rate | $10.00 per machine hour |
Table (1)
Step 2: calculate the total overhead cost assigned to each product.
Particulars | Cylinder A ($) | Cylinder B ($) |
Welding | ||
Activity rate × welding hours | ||
$194 × 1,600 welding hours | $ 310,400 | |
$194 × 2,400 welding hours | $ 465,600 | |
Machining | ||
Activity rate × machine hours | ||
$45 × 3,000 machine hours | $ 135,000 | |
$45 * 7,000 machine hours | $ 315,000 | |
Inspecting | ||
Activity rate × number of inspections | ||
$448.25 × 500 inspections | $ 224,125 | |
$448.25 × 500 inspections | $ 224,125 | |
Materials handling | ||
Activity rate × number of moves | ||
$25 × 7,200 moves | $ 180,000 | |
$25 × 4,800 moves | $ 120,000 | |
Setups | ||
Activity rate × number of batches | ||
$2,400 × 45 batches | $ 108,000 | |
$2,400 × 55 batches | $ 132,000 | |
Change over | ||
Activity rate × change over hours | ||
$180 × 540 change over hours | $ 97,200 | |
$180 × 460 change over hours | $ 82,800 | |
Rework | ||
Activity rate × rework orders | ||
$1,235 × 5 rework orders | $ 6,175 | |
$1,235 × 45 rework orders | $ 55,575 | |
Testing | ||
Activity rate × number of tests | ||
$400 × 500 tests | $2,00,000 | |
$400 × 250 tests | $1,00,000 | |
Materials handling | ||
Activity rate × number of tests | ||
$7.60 × 40,000 parts | $ 304,000 | |
$7.60 × 10,000 parts | $ 76,000 | |
Engineering support | ||
Activity rate × Engineering hours | ||
$65 × 1,500 engineering hours | $ 97,500 | |
$65 × 500 engineering hours | $ 32,500 | |
Purchasing | ||
Activity rate × number of purchase requisitions | ||
$270 × 425 requisitions | $ 114,750 | |
$270 × 75 requisitions | $ 20,250 | |
Receiving | ||
Activity rate × number of receiving orders | ||
$137 × 1,800 receiving orders | $ 246,600 | |
$137 × 200 receiving orders | $ 27,400 | |
Paying suppliers | ||
Activity rate × number of invoices | ||
$225 × 650 invoices | $ 146,250 | |
$225 × 350 invoices | $ 78,750 | |
Providing space and utilities | ||
Activity rate × machine hours | ||
$10 × 3,000 machine hours | $ 30,000 | |
$10 × 7,000 machine hours | $ 70,000 | |
Total overhead costs | $ 2,200,000 | $ 1,800,000 |
Divide: Units produced | 1,500 units | 3,000 units |
Overhead per unit | $ 1,467 | $ 600 |
Table (2)
Thus, the overhead per unit for cylinder A and cylinder B is $1,467 and $600 respectively.
The overhead consumption patterns better than the machine hour pattern of the plantwide rate because, Cylinder B is overcosted, and Cylinder A is undercosted. The activity assignments obtain the cause-and-effect relationships.
3.
Compute global consumption ratio.
Explanation of Solution
Global consumption ratio: The global consumption ratio is the proportion of the total activity costs absorbed by a provided product or cost object.
Calculate global consumption ratio:
For Cylinder A:
For Cylinder B:
Therefore, the global consumption ratio for Cylinder A and Cylinder B is 0.55 and 0.45 respectively.
4.
Determine the consumption ratios for materials handling (Assembly) and welding and justify that two drivers, welding hours and several parts, can be used to achieve the same ABC product costs. Explain the value of this simplification.
Explanation of Solution
Overhead consumption ratio: The overhead consumption ratios simply estimate the proportion of each activity used by individual products. The overhead consumption ratio is mainly suitable to allocate the costs of a shared resource.
Compute the consumption ratios for materials handling (Assembly) and welding:
For Welding:
For Material handling (parts):
Set up two equations, where W’s represent the allocation rates:
Multiply second equation by -4:
By solving:
And thus,
Cost pools:
Activity rates:
Assign overhead for the two products:
Particulars | Cylinder A | Cylinder B |
Welding | ||
Activity rate × welding hours | ||
$625 × 1,600 welding hours | $ 1,000,000 | |
$625 × 2,400 welding hours | $ 1,500,000 | |
Material handling | ||
Activity rate × Number of parts | ||
$30 × 40,000 parts | $ 1,200,000 | |
$30 × 10,000 parts | $ 300,000 | |
Total overhead costs | $ 2,200,000 | $ 1,800,000 |
Divide: Units produced | 1,500 units | 3,000 units |
Overhead per unit | $1,467 (rounded) | $ 600 |
Table (3)
We can take a 14-driver system and decrease it to a two-driver system and obtain the same overhead cost assignments as the more complex system. This After-the-fact simplification has two major benefits:
(1) It assists nonfinancial managers to more easily read, understands, and interpret product cost reports
(2) The actual values only need to be obtained for two drivers instead of 14, producing considerable cost savings.
5.
Ascertain the consumption ratios for inspection and engineering, and prove that the drivers for these two activities also duplicate the ABC product costs.
Explanation of Solution
Compute the consumption ratios for inspection and engineering:
Construct two equations (w’s represent the allocation rates):
Subtract the second equation from the first:
And thus,
Cost pools:
Calculate the activity rates:
Therefore, the activity rate for inspection and engineering is $3,200 per inspection and $400 per hour respectively.
Assign the overhead for cylinder A and cylinder B:
Particulars | Cylinder A | Cylinder B |
Inspection | ||
Activity rate × Number of inspections | ||
$3,200 × 500 inspections | $ 1,600,000 | |
$3,200 × 500inspections | $ 1,600,000 | |
Engineering | ||
Activity rate × Engineering hours | ||
$400 × 1,500 engineering hours | $ 600,000 | |
$400 × 500 engineering hours | $ 200,000 | |
Total overhead costs | $ 2,200,000 | $ 1,800,000 |
Divide: Units produced | 1,500 units | 3,000 units |
Overhead per unit | $1,467.67 (rounded) | $ 600.00 |
Thus, the overhead per unit for Cylinder A and Cylinder B is $1,467.67 and $600 respectively.
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Chapter 4 Solutions
CORNERSTONES OF COST MANAGEMENT
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