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Traditional costing and Activity Based Costing

Stellar Stairs Co. of Poway designs and builds factory-made premium wooden stairs for homes. The manufactured stair components (spindles, risers, hangers, hand rails) permit installation of stairs of varying lengths and widths. All are of white oak wood. Its budgeted manufacturing overhead costs for the year 2006 are as follows.

Overhead Cost Pools Amount
Purchasing $ 57,000
Handling materials 82,000
Production (cutting, milling, finishing) 210,000
Setting up machines 85,000
Inspecting 90,000
Inventory control (raw materials and finished goods) 126,000
Utilities 180,000
Total budget overhead costs $830,000

For the last 4 years, Stellar Stairs Co. has been charging overhead to products on the basis of machine hours. For the year 2006, 100,000 machine hours are budgeted. Heather Fujar, owner-manager of Stellar Stairs Co., recently directed her accountant, Lindsay Baker, to implement the activity-based costing system that she has repeatedly proposed. At Heather Fujar's request, Lindsay and the production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.

Activity Cost Pools Cost Drivers Expected Use of Cost Drivers
Purchasing Number of orders 600
Handling materials Number of moves 8,000
Production (cutting, milling, finishing) Direct labor hours 100,000
Setting up machines Number of setups 1,250
Inspecting Number of inspections 6,000
Inventory control (raw materials and finished goods) Number of components 168,000
Utilities Square feet occupied 90,000

Jason Dion, sales manager, has received an order for 280 stairs from Community Builders, Inc., a large housing development contractor. At Jason's request, Lindsay prepares cost estimates for producing components for 280 stairs so Jason can submit a contract price per stair to Community Builders. She accumulates the following data for the production of 280 stairways.
Direct materials $103,600
Direct labor $112,000
Machine hours 14,500
Direct labor hours 5,000
Number of purchase orders 60
Number of material moves 800
Number of machine setups 100
Number of inspections 450
Number of components 16,000
Number of square feet occupied 8,000

Instructions for a
A. Compute the predetermined overhead rate using traditional costing with machine hours as the basis.
(a) Predetermined...

$xxx ÷ xxx hrs. = $xx.xx per machine hour

Instructions for b
B. What is the manufacturing cost per stairway under traditional costing?
(b) Cost/stair $1,199.82

(b) Manufacturing cost per stair under traditional costing:

Direct materials $xxx,600
Direct labor  xxx,000
Overhead (xxx X $8.30)  xxx,350
Total cost of 280 stairs $xxx,950

Cost per stair ($xxx ÷ 280)  $1,199.82

Instructions for c
C. What is the manufacturing cost per stairway under the proposed activity-based costing? (Prepare all of the necessary schedules.)
(c) Cost/stair $1,055.54
(c) Manufacturing cost per stair under activity-based costing:

Computation of Activity-Based Overhead Rate

Activity Cost Pool Estimated
Overhead
÷ Total
Estimated Drivers
= Activity-Based
Overhead Rate

Purchasing
Handling materials
Production
Setting up machines
Inspecting
Inventory control
Utilities $  xxx
   xxx
   xxx
   xxx
   xxx
   xxx
   xxx
$830,000     600 Orders
  8,000 Moves
100,000 D/L Hours
  1,250 Setups
  6,000 Inspections
 168,000 Components
 90,000 Sq. ft. $xx per order
$xx.xx per move
$x.xx per D/L hour
$xx per setup
$xx per inspection
$.xx per component
$x per sq. ft.

Assignment of Overhead to Order of 280 Stairs

Activity Cost Pool Expected
Use of Driver
X Activity-Based
Overhead Rate
=
Cost Assigned

Purchasing
Handling materials
Production
Setting up machines
Inspecting
Inventory control
Utilities     60 Orders
   800 Moves
5,000 D/L Hours
   100 Setups
   450 Inspections
 16,000 Components
 8,000 Sq. ft. $xx
$xx.xx
$x.xx
$xx
$xx
$.xx
$x $  xxx
  xxx
  xxx
  xxx
  xxx
  xxx
  xxx
Total overhead assigned $65,950

Chapter 4 Problem 4-3A (Continued)

Total manufacturing cost per stair under ABC:

Direct materials $  xxx
Direct labor    xxx
Overhead    xxx
Total cost of 280 stairs $  281,550

Total cost per stair $xxx

Instructions for d
D. Which of the two costing systems is preferable in pricing decisions and why?

(d) The difference between the traditional cost and the activity-based cost per unit of $xxx or ($xxx vs. $xxx) is not great in amount but?xx.3%...

Chapter 4 Problem 4-4A
Assign overhead costs using traditional costing and ABC; compare results.
(SO 1, 4)
Mendocino Corporation produces two grades of wine from grapes that it buys from California growers. It produces and sells roughly 3,000,000 liters per year of a low-cost, high-volume product called CoolDay. It sells this in 600,000 5-liter jugs. Mendocino also produces and sells roughly 300,000 liters per year of a low-volume, high-cost product called LiteMist. LiteMist is sold in 1-liter bottles. Based on recent data, the CoolDay product has not been as profitable as LiteMist. Management is considering dropping the inexpensive CoolDay line so it can focus more attention on the LiteMist product. The LiteMist product already demands considerably more attention than the CoolDay line.

Tyler Silva, president and founder of Mendocino, is skeptical about this idea. He points out that for many decades the company produced only the CoolDay line, and that it was always quite profitable. wasn't until the company started producing the more complicated LiteMist wine that the profitability of CoolDay declined. Prior to the introduction of LiteMist, the company had simple equipment, simple growing and production procedures, and virtually no need for quality control. Because LiteMist is bottled in 1-liter bottles, it requires considerably more time and effort, both to bottle and to label and box than does CoolDay. The company must bottle and handle 5 times as many bottles of LiteMist to sell the same quantity as CoolDay. CoolDay requires 1 month of aging; LiteMist requires 1 year. CoolDay requires cleaning and inspection of equipment every 10,000 liters; LiteMist requires such maintenance every 600 liters. Tyler has asked the accounting department to prepare an analysis of the cost per liter using the traditional costing approach and using activity-based costing. The following information was collected.
CoolDay LiteMist
Direct materials per liter $0.40 $1.20
Direct labor cost per liter $0.25 $0.50
Direct labor hours per liter 0.05 0.09
Total direct labor hours 120,000 25,000

Activity Cost Pools Cost Drivers Estimated Overhead Expected Use of Cost Drivers Expected Use of Cost Drivers per Product
CoolDay LiteMist
Grape cart of $145,860 6,600 6.000 600
Processing grapes
Aging Total 396,000 6,600,000 3,000,000 3,600,000
Months
Bottling Number of
and bottles 270,000 900,000 600,000 300,000
corking
Labeling Number of
and boxing bottles 189,000 900,000 600,000 300,000
Maintain Number of
and inspections
inspect
equipment 240,800 800 350 450
$1,241,660

Instructions
Answer each of the following questions. (Round all calculations to three decimal places.)
Instructions for a

A. Under traditional product costing using direct labor hours, compute the total manufacturing cost per liter of both products.
(a) Cost/liter?C.D. $1.078

(a) Computation of...

Overhead cost per labor hour is $1,241,660 ÷ (145,000 + 25,000) = $8.563

Products

Manufacturing Costs CoolDay LiteMist

Direct materials
Direct labor
Overhead $x.xx
  .xx
 x.xx*
$1.078 $x.xx
 x.xx
 x.xx**
$2.471

*$8.563 X .05 **8.563 X .09

Instructions for b

B. Under ABC, prepare a schedule showing the computation of the activity-based overhead rates (per cost driver).

(b)
Activity Cost Pool Estimated
Overhead Expected Use
of Cost Drivers Activity-Based
Overhead Rate

Grape processing
Aging
Bottling and corking
Labeling and boxing
Maintenance and
  inspection of equipment   $xxx
   xxx
   xxx
   xxx

   xxx
$1,241,660     6,600
6,600,000
 900,000
 900,000

       800 $xx.xx per cart
$0.xx per month
$0.xx per bottle
$0.xx per bottle

$xxx per inspection

Instructions for c

C. Prepare a schedule assigning each activity's overhead cost pool to each product, based on the use of cost drivers. Include a computation of overhead cost per liter.
(c) Cost/liter?C.D. $.241
(c) CoolDay LiteMist

Activity Cost Pool Expected
Use of
Drivers

X
Overhead
Rate

=
Cost
Assigned Expected
Use of
Drivers

X
Overhead
Rate

=
Cost
Assigned

Grape processing
Aging
Bottling and corking
Labeling and boxing
Equipment mainte-
nance and inspection

Liters produced

Overhead cost per
  liter   6,000
3,000,000
600,000
600,000

    350 $xx.xx
$0.0x
$0.xx
$0.xx

$301 $xxx,600
  xxx,000
xxx,000
 xxx,000

  xxx,350
$723,950

 3,000,000

  $0.xx1      600
x,xxx,000
  xxx,000
  xxx,000

      450 $xx.xx
$0.0x
$0.xx
$0.xx

$301 $ xx,260
 xxx,000
 xx,000
 xx,000

 xxx,450
$517,710

 300,000

   $x.xx6

Instructions for d
D. Compute the total manufacturing cost per liter for both products under ABC.

(d) Products

Manufacturing Costs CoolDay LiteMist

Direct materials
Direct labor
Overhead $x.x00
  .x00
 0.xxx
$0.891 $x.x0
 x.50
 x.x2x
$3.426

Instructions for e:
E. Write a memo to Tyler Silva discussing the implications of your analysis for the company's plans. In this memo provide a brief description of ABC, as well as an explanation of how the traditional approach can result in distortions.

(e) To: Mr. Tyler Silva

From: Student

Subject: Product costs using traditional approach versus ABC

The student's memorandum should cover the following points:

(1) ABC allocates overhead costs...

(2) Traditional approaches that allocate costs as a function of volume tend to be...

(3) In the case of the Mendocino Wine Company, the LiteMist product...
(4) The total cost of the two products

CoolDay LiteMist

Traditional approach

ABC $1.0780

$0.891 $2.471

$3.426

Therefore, the relative profitability of...

Attachments

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Stellar Stairs Co. of Poway designs and builds factory-made premium wooden stairs for homes. The manufactured stair components (spindles, risers, hangers, hand rails) permit installation of stairs of varying lengths and widths. All are of white oak wood. Its budgeted manufacturing overhead costs for the year 2006 are as follows.

Overhead Cost Pools Amount
Purchasing $ 57,000
Handling materials 82,000
Production (cutting, milling, finishing) 210,000
Setting up machines 85,000
Inspecting 90,000
Inventory control (raw materials and finished goods) 126,000
Utilities 180,000
Total budget overhead costs $830,000

For the last 4 years, Stellar Stairs Co. has been charging overhead to products on the basis of machine hours. For the year 2006, 100,000 machine hours are budgeted. Heather Fujar, owner-manager of Stellar Stairs Co., recently directed her accountant, Lindsay Baker, to implement the activity-based costing system that she has repeatedly proposed. At Heather Fujar's request, Lindsay and the production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.
Activity Cost Pools Cost Drivers Expected Use of Cost Drivers
Purchasing Number of orders 600
Handling materials Number of moves 8,000
Production (cutting, milling, finishing) Direct labor hours 100,000
Setting up machines Number of setups 1,250
Inspecting Number of inspections 6,000
Inventory control (raw materials and finished goods) Number of components 168,000
Utilities Square feet occupied 90,000

Jason Dion, sales manager, has received an order for 280 stairs from Community Builders, Inc., a large housing development contractor. At Jason's request, Lindsay prepares cost estimates for producing components for 280 stairs so Jason can submit a contract price per stair to Community Builders. She accumulates the following data for the production of 280 stairways.
Direct materials $103,600
Direct labor $112,000
Machine hours 14,500
Direct labor hours 5,000
Number of purchase orders 60
Number of material moves 800
Number of machine setups 100
Number of inspections 450
Number of components 16,000
Number of square feet occupied 8,000

Instructions for a
A. Compute the predetermined overhead rate using traditional costing with machine hours as the basis.
(a) Predetermined...

$830,000 ÷ 100,000 hrs. = $8.30 per machine hour

Predetermined overhead is calculated by dividing the estimated overhead by the estimated base which is machine hours here

Instructions for b
B. What is the manufacturing cost per stairway under traditional costing?
(b) Cost/stair $1,199.82

(b) Manufacturing cost per stair under traditional costing:

Direct materials $103,600
Direct labor  112,000
Overhead (14,500 X $8.30)  120,350
Total cost of 280 stairs $335,950

Cost per stair ($xxx ÷ 280)  $1,199.82

Direct material and direct labor cost is given. Overhead is calculated as predetermined rate X actual machine hours

Instructions for c
C. What is the manufacturing cost per stairway under the proposed activity-based costing? (Prepare all of the necessary schedules.)
(c) Cost/stair $1,005.54
(c) Manufacturing cost per stair under activity-based ...

Solution Summary

The solution explains the calculation of product cost using traditional costing and activity based costing.

$2.19