Activity based costing

Wedig Diagnostics manufactures two laser photometers that are used in preparing DNA tests. The U.S. model is designed for use in the United States and the EU model is designed to meet the specifications in most of the European Union. Both models are manufactured in the United States. The EU models are shipped to Wedig's wholly owned European subsidiary, which sells them. All units manufactured are sold. The following table summarizes the selling prices, direct materials and labor, and number of units sold.

U.S. Model EU Model
Selling price/unit $2,500 $2,200
Direct materials/unit $235 $260
Direct labor $560 $500
Number of units sold annually $15,000 $16,800

The EU units are sold in U.S. dollars. Wedig has total manufacturing overhead of $39 million annually. This overhead is allocated to both U.S. and EU models using total direct labor dollars. Wedig transfers its EU model to its European subsidiary at full cost (direct materials and labor plus allocated overhead). Assume that Wedig pays U.S. taxes only on the profits it makes on sales in the United States and the Wedig EU subsidiary pays taxes only on the profits it makes on sales in the EU. The U.S. income tax rate is 30 percent and the Wedig European subsidiary has a tax rate of 15 percent. Wedig hires a consulting firm to perform an ABC analysis of its overhead costing methodology. This analysis reveals that the $39 million of overhead consists of three cost pools: batch-related costs ($12 million), parts-related costs ($9 million), and direct labor-related costs ($18 million). Each model is produced in batches, and batch-related costs consist of engineering, quality control, and machining costs that vary with the number of batches produced. The U.S. model is produced in 45 batches each year and the EU model is produced in 55 batches a year. The U.S. and EU models differ in terms of the number of different parts in each unit. The U.S. model has 40 different part numbers and the EU model has 80 different part numbers. Parts-related costs consist of the costs of operating the purchasing department (excluding the costs of the parts purchased, inspecting the parts upon arrival, inventorying the parts, and managing the parts inventory. Parts-related costs vary with the number of part numbers in each product. Finally, the direct labor-related costs consist of human resources, accounting, and other overhead costs that vary with the amount of direct labor in each model.

Required:

a. Calculate the unit manufacturing cost of the U.S. and EU models using total direct labor dollars to allocate the $39 million of manufacturing overhead.

b. Calculate the unit manufacturing cost of the U.S. and EU models using the ABC analysis to allocate the $39 million of manufacturing overhead.

c. Prepare income statements (including income tax expense) for Wedig and its European subsidiary using the unit manufacturing costs calculated in Part (a) (overhead is allocated using the ABC analysis).

d. Prepare income statements (including income tax expense) for Wedig and its European subsidiary using the unit manufacturing costs calculated in part (b)(overhead is allocated using the ABC analysis).

e. Discuss the advantages and disadvantages of using direct labor versus ABC to allocate the $39 million of overhead.