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    Molly company manufactures both standard and customized electrical control boards for automated manufacturing machinery. The company recently completed installation of a robotic assembly unit. This automated unit completely eliminates direct labor in the production of several types of standard electrical control boards.
    Molly uses a job costing system. Boards usually are produced in batches of 10 to several hundred units. Overhead is applied to products based on direct labor hours.
    Sally Seed, the controller of Molly Company, recently met with Sam Nut, the production supervisor, concerning the cost of producing several of the firm's products. The following discussion took place:

    Sam: "Sally, I'm perplexed by your most recent cost figures for products X,Y, and
    Z, our big sellers. Before we installed the robotic assembly unit, the
    following data applied. Products X and Y had identical unit costs, and
    product Z was the cheapest to produce.

    Product X Y Z
    Number of Parts 10 15 20
    Labor Hours 4 4 2
    Material $200 $200 $200
    Labor ($30/hour) 120 120 60
    Overhead 80 80 40
    Total Cost $400 $400 $300

    Sally: "That was correct, Sam. Our total budgeted overhead was $6000,000.
    Given our expected 30,000 hours of direct labor, we had an applied
    overhead rate of $20 per direct labor hour. You can see, then, how these
    costs were calculated, as our direct labor costs were $30 per hour."

    Sam: "According to your latest report, the first since we installed the new
    automated equipment, the following data apply"

    Product X Y Z
    Number of Parts 10 15 20
    Robot Hours 3 0 1
    Labor Hours 0 4 2
    Material $200 $200 $200
    Labor($30/hour) 0 120 60
    Overhead 0 200 100
    Total Cost $200 $520 $360

    "SALLY, I'm not so sure that these cost representations are believable.
    We purchased expensive automated equipment and overall eliminated
    almost a third of our labor cost, yet product Y, which does not use the
    new equipment, has increased more than 25 percent in cost. On the other
    hand, product X, which does use the new equipment, has decreased 50
    percent in cost."

    Sally: "Well Sam, our total budgeted overhead has increased to $1,000,000.
    But our expected hours of direct labor drop from 30,000 to 20,000.
    This gives an applied overhead rate of $50 per direct labor hours. You
    can see, then, how these costs were calculated, as our direct labor costs
    were $30 per hour."

    Sam: "Well, that may be, Sally but something just doesn't make sense about
    using direct labor as the only allocation base for all overhead items.
    There are other things beside labor that increase production cost.
    Consider parts per product, for example. We spent a lot of effort in
    material handling, and it seems to me that more parts make more work,
    which means to me that it costs more."

    Sally: "Sam, you may be right. I wanted to investigate activity-based costing,
    and this conversation has convinced me to do so. I'm going to collect
    some data and recomputed these cost figures using activity-based
    costing. I'll get back to you soon, and we can see if these new figures
    seem to make more sense."

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    Solution Summary

    The expert examines activity-based costing for Molly company.