A Melbourne-based company Acacia is considering the adoption of an activity-based costing system because they suspect that their traditional costing system distorts the product costs. Acacia produces and sells two products A and B. Their traditional costing system uses direct labor hours as the allocation base for manufacturing overhead cost.

Additional information:

Product A Product B

Direct Material $38 per unit $28 per unit

Direct Labor $24 per unit $12 per unit

Units produced 50,000 units 200,000 units

The production managers decided that major activities DL labor support, Machine setups, and Parts administration and determined the costs for each activity. They also identified how many DLHs, setups, and parts each product requires as follows:

Activity Cost Product A Product B

Direct labor support (DLHs) $900,000 100,000 DLHs 200,000 DLHs

Machine setups (setups) $600,000 400 setups 100 setups

Parts administration (part types) $300,000 200 parts 200 parts

Total MOH $1,800,000

Compared with the unit product cost calculated by the ABC system, what is the distortion (difference) created by the traditional costing system for Product A?

The answer is Product A is undercosted by $6.60