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139. Demski Company has used a two-stage cost allocation system for many years. In the first
stage, plant overhead costs are allocated to two production departments, P1 and P2, based on
machine hours. In the second stage, Demski uses direct labor hours to assign overhead costs
from the production departments to individual products A and B.
Budgeted factory overhead costs for the year are $300,000. Both the budgeted and actual
machine hours in P1 and P2 are 12,000 and 28,000 hours, respectively.
After attending a seminar to learn the potential benefits of adopting an activity-based costing
system (ABC), Ted Demski, the president of Demski Company, is considering implementing an
ABC system. Upon his request, the controller at Demski Company has compiled the following
information for analysis:
Cost Pool Factory overhead costs Activity cost driver Expected activity level
Machine setup $100,000 Setup hours 1,000
Inspection 50,000 Inspection hours 2,500
Power 50,000 Kilowatt hours 25,000
Supervision 100,000 Direct labor hours 10,000
Total overhead cost $300,000
Demski manufactures two types of product, A and B, for which the following information is
available:
A B
Units produced and sold 5,000 10,000
Direct materials $200,000 $250,000
Direct labor costs $80,000 150,000
Direct labor hours in P1 1,500 3,000
Direct labor hours in P2 1,500 4,000
Setup hours 700 300
Inspection hours 1,500 1,000
Power (kilowatt hours) 12,500 12,500
Required:
1. Determine the unit cost for each of the two products using the traditional two-stage allocation
method. Round calculations to 2 decimal places.
2. Determine the unit cost for each of the two products using the proposed ABC system.
3. Compare the unit manufacturing costs for product A and product B computed in requirements
1 and 2.
(a) Why do two the cost systems differ in their total cost for each product?
(b) Why might these differences be important to the Demski Company?
A B
140. Swenson Company manufactures 4,000 units of Deluxe Product and 20,000 units of
Regular Product each year. The company currently uses direct labor-hours to assign overhead
cost to products. The pre-determined overhead rate is:
Manufacturing overhead cost = $20/DLH
Direct labor hours
Deluxe Regular
Direct materials $40.00 $30.00
Direct labor 20.00 15.00
Factory overhead:
2.5 DLH × $20/DLH 50.00
2.0 DLH × $20/DLH 40.00
Total cost per unit $110.00 $85.00
Suppose, however, that factory overhead costs are actually caused by the five activities listed
below:
Activity Costs
Machine setups $300,000
Quality Inspections 200,000
Production orders 90,000
Machine-hours worked 330,000
Material receipts 80,000
Total $1,000,000
Also suppose the following transaction data has been collected:
Number of Transactions
Activity Total Deluxe Regular
Machine setups 5,000 3,000 2,000
Quality inspections 8,000 5,000 3,000
Production orders 600 200 400
Machine-hours worked 33,000 10,000 23,000
Material receipts 800 200 600
Required:
Using the activity-based costing method to calculate unit costs of Deluxe and Regular products,
and compare them with the current direct labor hours-based costing system.
141. Moss Manufacturing has just completed a major change in its quality control (QC)
process. Previously, products had been reviewed by QC inspectors at the end of each major
process, and the company's ten QC inspectors were charged as direct labor to the operation or
job. In an effort to improve efficiency and quality, a computerized video QC system was
purchased for $250,000. The system consists of a minicomputer, 15 video cameras, other
peripheral hardware, and software.
The new system used cameras stationed by QC engineers at key points in the production
process. Each time an operation changes or there is a new operation, the cameras are moved,
and a new master picture is loaded into the computer by a QC engineer. The camera takes
pictures of the units in process, and the computer compares them to the picture of a "good" unit.
Any differences are sent to a QC engineer who removes the bad units and discusses the flaws
with the production supervisors. The new system has replaced the ten QC inspectors with two
QC engineers.
The operating costs of the new QC system, including the salaries of the QC engineers, have been
included as factory overhead in calculating the company's volume-based factory overhead rate
which is based on direct labor dollars.
The company's president is confused. His vice president of production has told him how efficient
the new system is, yet there is a large increase in the factory overhead rate. The computation of
the rate before and after automation is shown below.
Before After
Budgeted overhead $1,900,000 $2,100,000
Budgeted direct labor 1,000,000 700,000
Budgeted overhead rate 190% 300%
"Three hundred percent," lamented the president, "How can we compete with such a high
factory overhead rate?"
Required:
1. a. Define factory overhead, and cite three examples of typical costs that would be included in
factory overhead.
b. Explain why companies develop factory overhead rates.
2. Explain why the increase in the overhead rate should not have a negative financial impact on
Moss Manufacturing.
3. Explain, in the greatest detail possible, how Moss Manufacturing could change its overhead
accounting system to eliminate confusion over product costs.
142. The controller for Ocean Sailboats Inc., a company which uses an automated process to
make sailboats, established the following overhead cost pools and cost drivers:
Overhead Cost Pool Budgeted
Overhead Cost Driver Estimated
Cost Driver Level
Machine setups $250,500 # of setups 500 setups
Quality control 419,500 # of inspections 2,500 inspections
Other overhead cost 180,000 # of machine hrs 20,000 machine hrs
A recent order for sailboats used:
Machine setups 50 setups
Quality inspections 305 inspections
Machine hours 2,024 machine hours
Required:
1. What is the overhead rate per machine hour if the number of machine hours is used as a
single cost driver under traditional costing system?
2. Utilizing traditional costing, how much overhead is assigned to the order based on machine
hours as a single cost driver?
3. Utilizing ABC, how much total overhead is assigned to the order?
143. Skateline Inc. designs and manufactures roller skates. The following data pertain to two
of its major customers: FantasticSkates and SkateToday.
FantasticSkatesSkateToday
Total sales $1,500,000 $1,450,000
Sales discount 4% 3%
Sales terms 2/10, n/30 2/10, n/30
Sales returns 5% 2%
Assume sales discounts are taken on total invoice amount and that returns occur within 10 days of the sale.
Required:
Compare the net proceeds from each customer to Skateline Inc. 30 days after sale. (rounded to
nearest dollar for each step where applicable).
144. Certo Health Products was formed two years ago to produce and distribute a newly-
patented protein supplement. Two variations of the original supplement have since been
developed and introduced for general sale. The three products are processed in essentially the
same way, but Ann Marshall, the owner of Certo, anticipates that a half-dozen new products will
be developed for sale in the next two years. These products will not be variations of the patented
supplement, and will require a different production process other than the one currently used.
Ann has asked you to review the current use of a single volume-based rate and explain the
arguments for using departmental rates with activity-based drivers.
145. Cost Pools and Cost Drivers: Based on a recent study of its manufacturing operations
Johnston Manufacturing Corporation has identified six resource consumption cost drivers. These
cost drivers and their budgeted activity levels for the coming year are:
Cost Driver Activity Level
Number of purchase orders 6
Number of production runs (2,500 units per production run) 40
Machine-hours 100,000
Factory space (square feet) 24,000
Units of production 100,000
Engineering hours 20,000
The firm has budgeted the following costs for the year:
Engineering design $600,000
Depreciation—building 50,000
Depreciation—machine 40,000
Electrical power (for factory building) 6,000
Electrical power (for machining) 30,000
Insurance 20,000
Property taxes 15,000
Machine maintenance—labor 11,000
Machine maintenance—materials 9,000
Natural gas (for heating) 8,000
Inspection of finished goods 7,000
Setup wages 20,000
Receiving 10,000
Inspection of direct materials on receiving 3,000
Purchasing 20,000
Custodial labor 51,000
With the exception of the factory space cost pool, which uses machine-hours as the activity
consumption cost driver, other cost pools have identical resource and activity consumption cost
drivers.
Required:
1. Identify the most appropriate activity cost pool for each of the cost items and cost driver for
each activity cost pool you identified.
2. Johnston has received a request to quote the price for 4,000 units of a new product. The
production will require 100 engineering-hours and 4,250 machine-hours. What is the
manufacturing overhead per unit the firm should use in determining the price?
