COST ACCOUNTING QUESTION Activity-based costing, manufacturing. Fancy Doors, Inc
ID: 2423377 • Letter: C
Question
COST ACCOUNTING QUESTION
Activity-based costing, manufacturing. Fancy Doors, Inc., produces two types of doors, interior and exterior. The company's simple costing system has two direct cost categories (materials and labor) and one indirect cost pool. The simple costing system allocates indirect costs on the basis of machine-hours. Recently, the owners of Fancy Doors have been concerned about a decline in the market share for their interior doors, usually their biggest seller. Information related to Fancy Doors production for the most recent year follows: The owners have heard of other companies in the industry that are now using an activity-based costing system and are curious how an ABC system would affect their product costing decisions. After analyzing the indirect cost pool for Fancy Doors, the owners identify six activities as generating indirect costs: production scheduling, material handling, machine setup, assembly, inspection, and marketing. Fancy Doors collected the following data related to the indirect cost activities: Marketing costs were determined to be 3% of the sales revenue for each type of door. Calculate the cost of an interior door and an exterior door under the existing simple costing system. Calculate the cost of an interior door and an exterior door under an activity-based costing system. Compare the costs of the doors in requirements 1 and 2. Why do the simple and activity-based costing systems differ in the cost of an interior and exterior door? How might Fancy Door, Inc., use the new cost information from its activity-based costing system to address the declining market share for interior doors?Explanation / Answer
Part - 1 :
Cost of Interior Door and Exterior Door under the existing simple costing method :
Interior Exterior
Direct material cost 192000 (60*3200) 162000 (90*1800)
Labour Cost 153600 (32*1.5*3200) 129600 (32*2.25*1800)
Indirect Cost ( Refer Note 1 below) 256300 (5500*46.6) 209700 (4500*46.6)
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Total Cost 601900 501300
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Note 1 :
Calculation of Indirect Cost per MHR :
Total Indirect Cost = $ (190000+90000+50000+120000+16000)
= $ 466000
Total MHR of Interior and Exterior = ( 5500 +4500 ) MHR
= 10000 MHR
Therefore , Indirect Cost / MHR = 466000 / 10000
= $ 46.6 / MHR
Part - 2 :
Cost of Interior Door and Exterior Door under the an Activity Based Costing :
Interior Exterior
Direct material cost 192000 (60*3200) 162000 (90*1800)
Labour Cost 153600 (32*1.5*3200) 129600 (32*2.25*1800)
Indirect Cost ( Refer Note 1 below )
Production Scheduling 60800 (1520*40 ) 129200 (1520*85)
Material Handling 27000 (375*72) 63000 (375*168)
Machine Setup 11250 (250 * 45 ) 38750 ( 200*155)
Assembly 66000 ( 12 * 5500) 54000 ( 12 * 4500)
Inspection 10000 ( 40 * 250) 6000 (40*150)
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Total Cost 520650 582550
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Note 1 :
Calculation of Indirect Cost as per ABC System :
Total Production Run = 40+85 = 125
Total Material Moves = 72+168 = 240
Total Machine Setups = 45+155 = 200
Total Machine Hours = 5500+4500= 10000
Total Number of Inspections = 250+150 = 400
Calculation of Rate of active per activity cost driver :
Production Scheduling = 190000 / 125 = $ 1520 / Production Run
Material Handling = 90000 / 240 = $ 375 / Material Moves
Machine Setup = 50000 / 200 = $250 / Machine Setup
Assembly = 120000 / 10000 = $ 12 / Machine Hours
Inspection = 16000 / 400 = $ 40 / Inspection
Part - 3 :
Comparison between cost of Doors in Requirement 1 and 2 :
Interior Exterior
Requirement 1 601900 501300
Requirement 2 520650 582550
Interior cost decreased in Requirement 2 whereas Exterior cost increased in Requirement 2 where ABC method was used , in comparison to Requirement 1 in which simple costing was used.
This is because the cost is included activity wise and arise with the direct use of the activity with respect to the product.
Part - 4 :
The new information after the application of ABC System might be used to control the declining market share of Interior Doors after effecting the reduction in total Cost that arise after change in costing system.