# Cutler Products, Inc. - ABC and Traditional Costing

CASE 8-31 Contrasting Activity-Based Costing and Traditional Costing

"Wow! Is that X-20 model ever a loser! It's time to cut back its production and shift our resources toward the new Y-30 model," said Darrel Karter, executive vice president of Cutler Products, Inc. "Just look at this income statement I've received from accounting. The Y-30 is generating four times as much profit as the X-20, and it has only about one-sixth as much in sales.

Questions:

1- The company's traditional costing system applies manufacturing overhead to jobs using direct labor costs. Assume that the average direct labor rate is $15.00 per direct labor hour. Compute the overhead rate based on direct labor cost.

2- Assume that direct material and direct labor costs per unit for the two products are: direct materials are $45.00 for X-20 and $70.00 for Y-30, and direct labor cost are $30.00 for X-20 and $45.00 for Y-30. Using this data and the overhead rate computed in (1) above, determine the unit product cost of each product under the traditional costing system.

3- Assume that the company's $1,800,000.00 in manufacturing overhead costs can be assigned to six activity cost pool, as follows:

Cost Pool (activity measure) estimated cost total X-20 Y-30

Machine setup (number of setups) $160,000 1,600 1,100 500

Quality control (number of inspections) 350,000 10,000 4,000 6,000

Purchase order (number of orders) 100,000 1,500 1,000 500

Soldering (number of solder joints) 500,000 250,000 70,000 180,000

Shipments (number of shipments) 130,000 500 400 100

Machine related (machine-hours) 560,000 80,000 35,000 45,000

$1,800,000

From these data, would you support a recommendation to expand sales of Y-30? Explain, Why do you suppose the Y-30 "just seems to sell itself"? What strategy would you follow?

#### Solution Preview

CASE 8-31 Contrasting Activity-Based Costing and Traditional Costing

"Wow! Is that X-20 model ever a loser! It's time to cut back its production and shift our resources toward the new Y-30 model," said Darrel Karter, executive vice president of Cutler Products, Inc. "Just look at this income statement I've received from accounting. The Y-30 is generating four times as much profit as the X-20, and it has only about one-sixth as much in sales.

Questions:

1- The company's traditional costing system applies manufacturing overhead to jobs using direct labor costs. Assume that the average direct labor rate is $15.00 per direct labor hour. Compute the overhead rate based on direct labor cost.

From the problem, it takes two direct labor-hours to produce a unit of the X-20 and three direct labor-hours to produce a unit of the Y-30.

Since X-20 is sold for 30,000 units, it takes 30,000 units x 2 hrs. = 60,000 hours

Since Y-30 is sold for 5,000 units, it takes 5,000 units x 3 hrs. = 15,000 hours

Therefore, the total direct-labor hours used to produce = 75,000 hours

Since the company's traditional costing system applies manufacturing overhead to jobs using direct labor costs, the overhead rate based on direct labor hour will be equal to

$1,800,000/75,000 hours = $24 per direct-hour

2- Assume that direct material and direct labor costs per unit for the two products are: direct materials are $45.00 for X-20 and $70.00 for Y-30, ...

#### Solution Summary

This solution is comprised of a detailed explanation and calculation to contrast Activity-Based Costing and Traditional Costing for Cutler Products, Inc.