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Activity-Based vs. Conventional Product Costs for World Inc.

World, Inc. manufactures two models of television sets, the N800 XL model and the N 500 model. Data regarding the two products follow:

Direct Labor-hours per unit Annual Production Total Direct Labor-Hours
Model N 800 XL 3 3,000 units 9,000
Model N 500 1 12,000 units 12,000
21,000

Additional information about the company follows:

a.) Model N 800 XL requires $75 in direct materials per unit, and Model N 500 requires $25.
b.) The direct labor wage rate is $18 per hour.
c.) The company has always used direct labor-hours as the base for applying manufacturing overhead cost to products
d.) Model N 800 XL is more complex to manufacture then Model N 500 and requires the use of special equipment. Consequently, the company is considering the use of activity-based costing to apply manufacturing overhead cost to products. Three activity cost pools have been identified as follows:
Activity Cost Pool Activity Measure Estimated Overhead Cost
Machine setups Number of setups $360,000.00
Special processing Machine-hours $165,000.00
General Factory Direct labor-hours $1,260,000.00
$1,785,000.00

Expected Activity
Activity Measure Model N 800 XL Model N 500 Total
number of setups 100 200 300
machine-hours 16,500 0 16,500
direct labor-hours 9,000 12,000 21,000

Required:

1.) Assume the company continues to use direct labor-hours as the base for applying overhead cost to products.
a.) Compute the predetermined overhead rate
b.) Compute the unit product cost of each model

2.) Assume that the company decides to use activity-based costing to apply manufacturing overhead cost to products.
a.) Compute the predetermined overhead rate for each activity cost pool and determine the amount of overhead cost that would be applied to each model using the activity-based costing system.
b.) Compute the unit product cost of each model.

3.) Explain why manufacturing overhead cost shifts from Model N 500 to Model N 800 XL under activity-based costing.

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Solution Summary

The solution computes predetermined overhead rates and unit product costs. Contrast activity-based costing and conventional product costs are examined.

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