Please explain the solution. The company is considering using an activity-based
ID: 2443446 • Letter: P
Question
Please explain the solution.The company is considering using an activity-based costing system to compute unit product costs for external financial reports instead of its traditional system based on direct labor hours. The activity-based costing system would use three activity cost pools. Data relating to these activities for the current period are given below.
Estimated
Activity Overhead Expected Activity
Cost Pool Costs Product C Product D Total
Machine setups $13,630 130 160 290
Purchase orders 85,750 750 1,000 1,750
General factory 67,760 4,000 2,160 6,160
$167,140
Use the data to answer the following questions.
1. Determine the unit product cost of each product for the current period using the activity-based costing approach.
2. Which cost method would you use to manage this business and why?
3. You are the product manager for product D and are evaluated based on product profitability. Which method would you prefer?
4. The government wants to buy product C and will pay the business for the cost of the product plus a fixed fee. Should you adopt the ABC system or keep the old plant-wide overhead system and why?
5. A customer has offered to buy a special order of 100 units of D for $60 each. This sale will not impact any other part of your business and you have excess capacity to produce this special order and will produce these extra units if you accept the order. How would this impact the business – would you be better off and by how much? Would you need other information to answer this question and, if so, what other information?
Explanation / Answer
I think you have missing information for unit cost
1. Determine the unit product cost of each product for the current period using the activity-based costing approach.
Product C Product D
Machine setups
$13,630 x 130/290 $6,110
$13,630 x 160/290 $7,520
Purchase Orders
$85,750 x 750/1750 $36,750
$85,750 x 1000/1750 $49,000
General factory
$67,760 x 4000/6160 $44,000
$67,760 x 2160/6160 $23,760
_________________________
Total $86,860 $80,280
Unit costs $43.43 $29.73 (missing ?)
Units produced 2,000 units 2700 units
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2. Which cost method would you use to manage this business and why?
I would prefer to use ABC costing method to manage this business. Traditional costing methods divide costs into product costs and period costs. The period costs include selling, general, and administrative items and are charged against income in the period incurred. Product costs are the direct materials, direct labor, and factory overhead. It can be argued that the cost of a finished product should include not only the cost of direct materials, but also a portion of the administrative cost necessary to buy the raw materials (e.g., many companies have a separate administrative unit in charge of all purchasing activity, like writing specifications, obtaining bids, issuing purchase orders, and so forth).
Activity-based costing attempts to overcome the perceived deficiencies in traditional costing methods by more closely aligning activities with products. This requires abandoning the traditional division between product and period costs, instead seeking to find a more direct linkage between activities, costs, and products. This means that products will be charged with the costs of manufacturing and nonmanufacturing activities. It also means that some manufacturing costs will not be attached to products. This is quite a departure from traditional thought.
3. You are the product manager for product D and are evaluated based on product profitability. Which method would you prefer?
I would prefer tradition approach. Under traditional approach, cost of Product D will reduce from $80,280 to $58,608 based on direct labor hours ($167,140 x 2,160/6,160).
4. The government wants to buy product C and will pay the business for the cost of the product plus a fixed fee. Should you adopt the ABC system or keep the old plant-wide overhead system and why?
I would prefer using old plant-wide overhead system. As it would increase cost from $86,860 under ABC approach to $108,532 under tardiotional approach ($167,140 x 4,000 / 6,160). This will bring addition profit $21,672 i.e. ($108,532 - $86,860)
5. A customer has offered to buy a special order of 100 units of D for $60 each. This sale will not impact any other part of your business and you have excess capacity to produce this special order and will produce these extra units if you accept the order. How would this impact the business – would you be better off and by how much? Would you need other information to answer this question and, if so, what other information?
Since the sale will not impact any other part of the business and we have excess capacity to produce this order, sale will definitely reduce the cost base to product C.