Ontario, Inc. manufactures two products, Standard and Enhanced, and applies overhead on the basis of direct-labor hours. Anticipated overhead and direct-labor time for the upcoming accounting period is $800,000 and 25,000 hours, respectively. Information about the company's products follows.
Estimated production volume 3,000 units 4,000 units
Direct-material cost $25 per unit $40 per unit
Direct labor per unit 3 hours at $12 per hour 4 hours at $12 per hour
Ontario's overhead of $800,000 can be identified with three major activities: order processing ($150,000), machine processing ($560,000), and product inspection ($90,000). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively.
Data relevant to these activities follow:
Orders Processed Machine Hours Worked Inspection Hours
Standard 300 18,000 2,000
Enhanced 200 22,000 8,000
Total 500 40,000 10,000
Top management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in income is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery was installedâ?"machinery that was expected to produce significant operating efficiencies.
Using a Microsoft Excel format for calculations, complete the following:
â?¢ Assuming use of direct-labor hours to apply overhead to production, calculate the unit manufacturing costs of the standard and enhanced products if the expected manufacturing volume is attained.
â?¢ Assuming the use of activity-based costing, calculate the unit manufacturing cost of the standard and enhanced products if the expected manufacturing volume is attained.
â?¢ Ontario's selling price is based heavily on cost:
o Calculate which product is over cost and which is under cost by using direct-labor hours as an application base.
o Explain if it is possible that this over costing and under costing is responsible for the profit issues the company is facing.
â?¢ Illustrate how the solution will change if the following data changes:
o The overhead associated with order processing is $300,000 and the overhead associated with product inspection is $270,000.
Your tutorial is attached in excel. You can see how to approach this problem.
Using labor hours, enhanced gets much more of the overhead (they use much more of the labor). However, this over-costs enhanced. Why? They don't use overhead ...
Your tutorial shows the overhead under traditional and activity based costing as well as giving you some ideas on why the differences occur. This is a head start in trying to think through how costing choices impact sales and profits.