Contrasting ABC and Conventional Product Costs (L02, L03, L04)

For many years, Zapro Company manufactured a single product called a mono-relay. Then three years ago, the company automated a portion of its plant and at the same time introduced a second product called a birelay that has become increasingly popular. The bi-relay is a more complex product, requiring one hour of direct labor time per unit to manufacture and extensive machining in the automated portion of the plant.

The mono-relay requires only 0.75 hour of direct labor time per unit and only a small amount of machining.

Manufacturing overhead costs are currently assigned to products on the basis of direct labor-hours.

Despite the growing popularity of the company's new bi-relay, profits have been declining steadily.

Management is beginning to believe that there may be a problem with the company's costing system.

Material and labor costs per unit are as follows:

Direct materials Mono-Relay $35 Bi-Relay $48 Direct labor (0.75 hour and 1 .0 hour @ $1 2 per hour) $12 . . . $9 Management estimates that the company will incur $ 1 ,000,000 in manufacturing overhead costs during the current year and 40.000 units of the mono-relay and 10.000 units of the bi-relay will be produced and sold.
Required:
1 . Compute the predetermined manufacturing overhead rate assuming that the company continues to apply manufacturing overhead cost on the basis of direct labor-hours. Using this rate and other data from the problem, determine the unit product cost of each product.

2. Management is considering using acth u> -based costing to apply manufacturing overhead cost to products for external financial reports. The activity-based costing system would have the following four acti\ ity cost pools:
Activity Cost Pool Activity Measure Maintaining parts inventory Number of part types Processing purchase orders Number of purchase orders Quality control Number of tests run Machine related Machine-hours Estimated Overhead Cost $ 180,000 90,000 230,000 500,000 $1 ,000,000 Expected Activity Activity Measure Mono-Relay Bi-Relay Number of part types 75 1 50 Number of purchase orders 800 200 Number of tests run 2,500 3,250 Machine-hours 4,000 6,000 Total 225 1,000 5,750 10,000 4.
Determine the activity rate (i.e., predetermined overhead rate) for each of the four activity cost pools.
Using the activity rates you computed in part (2) above, do the following:

a. Determine the total amount of manufacturing overhead cost that would be applied to each product using the activity-based costing system. After these totals have been computed, determine the amount of manufacturing overhead cost per unit of each product.

b. Compute the unit product cost of each product.
From the data you have developed in parts (1) through (3) above, identify factors that may account for the company's declining profits.