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Activity based costing

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Jacobson Electronics manufactures two large-screen television models: the Royale which sells for $1,600, and a new model, the Majestic, which sells for $1,300. The production cost computed per unit under traditional costing for each model in 2008 was as follows.

Traditional Costing Royale Majestic
Direct materials $ 700 $420
Direct labor ($20 per hour) 120 100
Manufacturing overhead ($38 per DLH) 228 190
Total per unit cost $1,048 $710

In 2008, Jacobson manufactured 25,000 units of the Royale and 10,000 units of the Majestic. The overhead rate of $38 per direct labor hour was determined by dividing total expected manufacturing overhead of $7,600,000 by the total direct labor hours (200,000) for the two models.

Under traditional costing, the gross profit on the models was: Royale $552 or ($1,600 - $1,048), and Majestic $590 or ($1,300 - $710). Because of this difference, management is considering phasing out the Royale model and increasing the production of the Majestic model.

Before finalizing its decision, management asks Jacobson's controller to prepare an analysis using activity-based costing (ABC). The controller accumulates the following information about overhead for the year ended December 31, 2008.

Activities Cost Drivers Estimated Overhead Expected Use of Cost Drivers Activity-Based Overhead Rate
Purchasing Number of orders $1,200,000 40,000 $30/order
Machine setups Number of setups 900,000 18,000 50/setup
Machining Machine hours 4,800,000 120,000 40/hour
Quality control Number of inspections 700,000 28,000 25/inspection

The cost drivers used for each product were:

Cost Drivers Royale Majestic Total
Purchase orders 15,000 25,000 40,000
Machine setups 5,000 13,000 18,000
Machine hours 75,000 45,000 120,000
Inspections 9,000 19,000 28,000

Assign overhead to products using ABC and evaluate decision.

(a) Assign the total 2008 manufacturing overhead costs to the two products using activity-based costing (ABC).

(b) What was the cost per unit and gross profit of each model using ABC costing?

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Solution Summary

The solution explains how to assign the overhead costs and determine the product cost using activity based costing

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