Larsen Company produces two types of leather purses: standard and handcrafted. Both purses use equipment for cutting and stitching. The equipment also has the capability of creating standard designs. The standard purses use only these standard designs. They are all of the same size to accommodate the design features of the equipment. The handcrafted purses can be cut to any size because the designs are created manually.

Many of the manually produced designs are in response to specific requests of retailers.

The equipment must be specially configured to accommodate the production of a batch of purses that will receive a handcrafted design. Larsen Company assigns overhead using direct labor dollars. Merle Jones, sales manager, is convinced that the purses are not being costed correctly.

To illustrate his point, he decided to focus on the expected annual setup and machine-related costs, which are as follows:

The machine has the capability of supplying 100,000 machine hours over its remaining life.
Merle also collected the expected annual prime costs for each purse, the machine hours, and the expected production (which is the normal output for the company).

Required:
1. Do you think that the direct labor costs and direct materials costs are accurately traced to each type of purse? Explain.
2. The controller has suggested that overhead costs be assigned to each product using a plantwide rate based on direct labor dollars. Machine costs and setup costs are overhead costs. Assume that these are the only overhead costs. For each type of purse, calculate the overhead per unit that would be assigned using a direct labor dollars overhead rate. Do you think that these costs are traced accurately to each purse? Explain.
3. Now calculate the overhead cost per unit per purse using two overhead rates:
one for the setup activity and one for the machining activity. In choosing a driver to assign the setup costs, did you use number of setups or setup hours? Why?
As part of your explanation, define transaction and duration drivers. Do you think machine costs are traced accurately to each type of purse? Explain.

Transcribed Image Text:

Setup equipment $18,000 Depreciation 20,000* Operating costs 22,000 *Computed on a straight-line basis, book value at the beginning of the year was $100,000.