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Accounting: Activity based costing.

Problem/Scenario is attached.

The management of Magnet Diversified Corporation is concerned about overhead cost allocations. The corporation has been using the plant-wide rate based on direct labor costs since it began operations. The CEO, Gogo McDermitt, has been hearing a lot about Activity Based Costing and is beginning to think the Corporation needs to adopt such a system. He has asked you, as a consultant, to evaluate overall overhead allocation system and prepare recommendations.

He tells you that a number of problems have arisen in the past few months. Several large, potentially profitable specialty jobs have been lost due to underbidding by the competition. There also seems to erosion in the market share of the generic sprockets as competitors are beginning to undercut the company's current selling price. The costs to produce the generic sprockets also have risen in the past few years so the profit margin is really being squeezed.

In addition, some of the specialty jobs that have been won do not seem to be improving the bottom line as much as anticipated. In total, profits in the past three years have been gradually eroding. Since prime costs are fairly standard and stable for the industry, the CEO is beginning to suspect that the overhead costs are not being allocated in the proper manner and/or may be out of line with the competition.

The costs for the jobs using plantwide rate are as follows:

Functional basis using plantwide rates
Generic Job 18 Job 19 Job 20
DM 357,000 7,000 42,000 28,000
DL 168,000 2,000 12,000 8,000
OH 840,000 10,000 60,000 40,000
Total costs 1,365,000 19,000 114,000 76,000

Unit produced 420,000 5,000 30,000 20,000

Assume the following four cost pools exist in the Magnet Diversified Corp.

Activity Cost Cost driver
Maintenance $3,650,000 150,000 Machine hours
Material handling 879,000 350 Material moves
Setups 7,750,000 120 Number of setups
Inspections 2,721,000 12,500 Inspection hours

Using the jobs above, compute the total costs assigned using ABC to allocate the overhead. The following information provides the cost drivers amounts to be used.

Generic Job 18 Job 19 Job 20
Machine hours 9,000 100 600 400
Material moves 6 1 3 2
Setups 1 1 1 1
Inspections hours 750 60 120 80

1. Prepare a schedule showing total cost per activity and the activity rates.

2. Prepare another schedule showing the total costs attached to each of the jobs above using the activity rates above to apply the overhead and the prime costs in the first schedule above.

3. Prepare a chart (graph) comparing the costs assigned for overhead for the two methods evaluated.

Sales Units produced Per unit selling price Sales COGS GP per job
Generic 420,000 $5.00 $ 2,100,000 $ 1,365,000 $ 735,000
Job 18 5,000 $ 6.25 31,250 19,000 12,250
Job 19 30,000 $ 6.25 187,500 114,000 73,500
Job 20 20,000 $ 6.25 125,000 76,000 49,000
$ 2,443,750 $ 1,574,000 $ 869,750
Income statement
Sales $ 2,443,750
COGS 1,574,000
Gross profit 869,750
Sell/Administrative expenses 453,000
Operating income $ 416,750

4. Compare the gross profit per job using ABC to the information presented above for the functional based method.

5. Prepare a second income statement using ABC cost information and the period expenses presented above in the given income statement.

6. Discuss, in memo format, the impact on the costs and bids using the plantwide rate and activity based costing. Include the recommendation for one of these two methods. Be sure to include proper rationale.


Solution Summary

The problem set deals with estimating the costs, under activity based costing and determining gross profit.