Concept explainers
Knickknack, Inc. manufactures two products: Odds and Ends. The firm uses a single, plantwide overhead rate based on direct-labor hours. Production and product-costing data are as follows:
Calculation of predetermined overhead rate:
Manufacturing overhead budget:
Predetermined overhead rate:
Knickknack, Inc. prices its products at 120 percent of cost, which yields target prices of $199.20 for Odds and $298.80 for Ends. Recently, however, Knickknack has been challenged in the market for Ends by a European competitor, Bricabrac Corporation. A new entrant in this market, Bricabrac has been selling Ends for $220 each. Knickknack’s president is puzzled by Bricabrac’s ability to sell Ends at such a low cost. She has asked you (the controller) to look into the matter. You have decided that Knickknack’s traditional, volume-based product-costing system may be causing cost distortion between the firm’s two products. Ends are a high-volume, relatively simple product. Odds, on the other hand, are quite complex and exhibit a much lower volume. As a result, you have begun work on an activity-based costing system.
Required:
- 1. Let each of the overhead categories in the budget represent an activity cost pool. Categorize each in terms of the type of activity (e.g., unit-level activity).
- 2. The following cost drivers have been identified for the four activity cost pools.
You have gathered the following additional information:
- Each Odd requires 4 machine hours, whereas each End requires 1 machine hour.
- Odds are manufactured in production runs of 50 units each. Ends are manufactured in 250-unit batches.
- Three-quarters of the engineering activity, as measured in terms of change orders, is related to Odds.
- The plant has 1,920 square feet of space, 80 percent of which is used in the production of Odds.
For each activity cost pool, compute a pool rate. (Hint: Regarding the pool rate refer to Exhibit 5–6.)
- 3. Determine the unit cost, for each activity cost pool, for Odds and Ends.
- 4. Compute the new product cost per unit for Odds and Ends, using the ABC system.
- 5. Using the same pricing policy as in the past, compute prices for Odds and Ends. Use the product costs determined by the ABC system.
- 6. Show that the ABC system fully assigns the total budgeted
manufacturing overhead costs of $816,000. - 7. Show how Knickknack’s traditional, volume-based costing system distorted its product costs. (Refer to Exhibit 5–10 for guidance.)
1.
Categorize each in terms of the type of activity.
Explanation of Solution
Activity-based costing: It is a method that helps in finding the activities performed by a company and it tracks the indirect costs to the activities of the company that consumes resources.
Categorize each in terms of the type of activity are shown below:
Activity Cost Pool | Type of Activity |
I: Machine related costs | Unit-level |
II: Setup and inspection | Batch- level |
III: Engineering | Product-sustaining-level |
IV: Plant-related costs | Facility-level |
Table (1)
2.
Calculate pool rate of each activity cost pool.
Explanation of Solution
Activity Cost Pool | Cost (A) | Cost drivers (B) | Pool rate (A ÷ B) |
I: Machine related costs | $450,000 | 9,000 machine hours | $50 per machine hour |
II: Setup and inspection | $180,000 | 40 runs | $4,500 per run |
III: Engineering | $90,000 | 100 change orders | $900 per change order |
IV: Plant-related costs | $96,000 | 1,920 square feet | $50 square feet |
Table (2)
3.
Calculate unit cost for each activity cost pool for odds and ends.
Explanation of Solution
Calculate unit cost for machine related costs for odds.
Calculate unit cost for machine related costs for ends.
Calculate unit cost for setup and inspection costs for odds.
Calculate unit cost for setup and inspection cost for ends.
Calculate unit cost for engineering for odds.
Calculate unit cost for engineering for ends.
Calculate unit cost for plant related costs of Odds.
Calculate unit cost for plant related cost of ends.
4.
Calculate the new product cost per unit for odds and ends using activity based costing.
Explanation of Solution
Calculate the new product cost per unit for odds and ends using activity based costing are given below:
Particulars | Odds | Ends |
Direct materials | $40 | $60 |
Direct labor | $30 | $45 |
Manufacturing overhead: | ||
Machine related | $200 | $50 |
Setup and inspection | $90 | $18 |
Engineering | $67.50 | $4.50 |
Plant related | $76.80 | $3.84 |
Total cost per unit | $504.30 | $181.34 |
Table (3)
5.
Calculate the product costs using the same pricing policy as in the past for odds and ends.
Explanation of Solution
Calculate the product costs using the same pricing policy as in the past for odds and ends.
Particulars | Odds | Ends |
New product cost (ABC) (A) | $504.30 | $181.34 |
Pricing policy (B) | 120% | 120% |
New target price (A × B) | $605.16 | $217.61 |
Table (4)
6.
Display that the activity based costing system fully assigns the total budgeted manufacturing overhead costs of $816,000.
Explanation of Solution
Particulars | Odds | Ends | Total |
Manufacturing overhead costs: | |||
Machine related | $200 | $50 | |
Setup and inspection | $90 | $18 | |
Engineering | $67.50 | $4.50 | |
Plant-related | $76.80 | $3.84 | |
Total overhead cost per unit (A) | $434.30 | $76.34 | |
Production volume (B) | 1,000 | 5,000 | |
Total overhead cost assigned | $434,300 | $381,700 | $816,000 |
Table (5)
7.
Prepare a table showing traditional based product costing system distorts the product costs of odds and evens.
Explanation of Solution
Prepare a table showing traditional based product costing system distorts the product costs of odds and evens.
Particulars | Product G | Product T |
Traditional based costing system - reported cost system | $166.00 | $249.00 |
Less: Activity based costing system - Reported cost system | $504.30 | $181.34 |
Traditional system Over costs (Under costs) per unit (A) | ($338.30) | $67.66 |
Product volume (B) | 1,000 | 5,000 |
Total amount of cost distortion for entire product line (A × B) | ($338,300) | $338,300 |
Table (1)
Traditional system overcosts ends by $67.66 per unit, and traditional system undercosts odds by $338.30 per unit.
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Chapter 5 Solutions
Connect 1-Semester Access Card for Managerial Accounting: Creating Value in a Dynamic Business Environment (NEW!!)
- Douglas Davis, controller for Marston, Inc., prepared the following budget for manufacturing costs at two different levels of activity for 20X1: During 20X1, Marston worked a total of 80,000 direct labor hours, used 250,000 machine hours, made 32,000 moves, and performed 120 batch inspections. The following actual costs were incurred: Marston applies overhead using rates based on direct labor hours, machine hours, number of moves, and number of batches. The second level of activity (the right column in the preceding table) is the practical level of activity (the available activity for resources acquired in advance of usage) and is used to compute predetermined overhead pool rates. Required: 1. Prepare a performance report for Marstons manufacturing costs in the current year. 2. Assume that one of the products produced by Marston is budgeted to use 10,000 direct labor hours, 15,000 machine hours, and 500 moves and will be produced in five batches. A total of 10,000 units will be produced during the year. Calculate the budgeted unit manufacturing cost. 3. One of Marstons managers said the following: Budgeting at the activity level makes a lot of sense. It really helps us manage costs better. But the previous budget really needs to provide more detailed information. For example, I know that the moving materials activity involves the use of forklifts and operators, and this information is lost when only the total cost of the activity for various levels of output is reported. We have four forklifts, each capable of providing 10,000 moves per year. We lease these forklifts for five years, at 10,000 per year. Furthermore, for our two shifts, we need up to eight operators if we run all four forklifts. Each operator is paid a salary of 30,000 per year. Also, I know that fuel costs about 0.25 per move. Assuming that these are the only three items, expand the detail of the flexible budget for moving materials to reveal the cost of these three resource items for 20,000 moves and 40,000 moves, respectively. Based on these comments, explain how this additional information can help Marston better manage its costs. (Especially consider how activity-based budgeting may provide useful information for non-value-added activities.)arrow_forwardBusiness Specialty, Inc., manufactures two staplers: small and regular. The standard quantities of direct labor and direct materials per unit for the year are as follows: The standard price paid per pound of direct materials is 1.60. The standard rate for labor is 8.00. Overhead is applied on the basis of direct labor hours. A plantwide rate is used. Budgeted overhead for the year is as follows: The company expects to work 12,000 direct labor hours during the year; standard overhead rates are computed using this activity level. For every small stapler produced, the company produces two regular staplers. Actual operating data for the year are as follows: a. Units produced: small staplers, 35,000; regular staplers, 70,000. b. Direct materials purchased and used: 56,000 pounds at 1.5513,000 for the small stapler and 43,000 for the regular stapler. There were no beginning or ending direct materials inventories. c. Direct labor: 14,800 hours3,600 hours for the small stapler and 11,200 hours for the regular stapler. Total cost of direct labor: 114,700. d. Variable overhead: 607,500. e. Fixed overhead: 350,000. Required: 1. Prepare a standard cost sheet showing the unit cost for each product. 2. Compute the direct materials price and usage variances for each product. Prepare journal entries to record direct materials activity. 3. Compute the direct labor rate and efficiency variances for each product. Prepare journal entries to record direct labor activity. 4. Compute the variances for fixed and variable overhead. Prepare journal entries to record overhead activity. All variances are closed to Cost of Goods Sold. 5. Assume that you know only the total direct materials used for both products and the total direct labor hours used for both products. Can you compute the total direct materials and direct labor usage variances? Explain.arrow_forwardJohn Sheng, a cost accountant at Starlet Company, is developing departmental factory overhead application rates for the companys Tooling and Fabricating departments. The budgeted overhead for each department and the data for one job are as follows: Using the departmental overhead application rates, total overhead applied to Job 231 in the Tooling and Fabricating departments will be: a. 225. b. 303. c. 537. d. 671.arrow_forward
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