Band Case - RT8
The Band Company is a publicly traded corporation that produces different types of digital control systems.My name is Alan Smith and I have worked for this company for the last ten years in the controller's office.I was both an accounting and finance major in university.The company currently produces 300 products and does not anticipate any new products coming out over the next three years.I have previously mentioned to my superiors that it is not appropriate for our firm to use a traditional accounting system (where overhead costs are allocated across products at a rate of 500% of direct labor costs) when different products require different amounts of indirect resources. For example, under the traditional system all costs associated with testing of products for quality assurance purposes are part of overhead costs and therefore allocated across products based on direct labor costs.Yet, some of our products require as much as 5 hours of testing whereas some products require less than 1 minute of testing with no connection to direct labor costs.Given that traditional costing systems result in significant cost distortions when determining products costs and given that the firm now has revenues of over $800,000,000 a year, Band has decided to adopt activity-based costing over the next year or two.
Band's management has hired Sabley Consulting to help us implement activity-based costing.I will be acting as the liaison between our firm and Sabley.As part of the initial implementation phase, I have asked Sabley to derive the costs associated with two of our products, RT8 and FG7, so that these costs could be compared with the costs under our current traditional accounting system.I picked these products since Band management believe they have very different demands on indirect resources.Further, RT8 is sold in large quantities whereas FG7 is sold in small quantities and traditional accounting systems can cause large cost distortions in different directions for products sold in large and small quantities.
Current information from our existing system on a per unit basis is shown in Exhibit 1.
Exhibit 1 RT8 FG7 Direct material $6.00 $11.00 Direct labor hours 0.4 0.4 Direct labor cost per hour $40.00 $40.00 Sales price per unit $110.00 $115.00Exhibit 2 Total Costs Allocation Base Equipment setups M Number of setups Purchase orders $ 4,600,000 number of purchase orders Machining M number of machine hours Testing W number of testing hours Packaging W number of containers Total Overhead Costs $167,200,000 Total direct labor costs for the rm is $33,440,000. Value of Allocation Base 120,000 100,000 1 ,500,000 1 ,200,000 1 300,000 Although xed costs are lumped in with variable costs across the ve different cost pools, I am aware that machining related costs consists almost exclusively of depreciation costs. Hence, machining costs will be treated as entirely xed with respect to machine hours. Each machine is used in the production of multiple product lines. We will assume that costs associated with equipment setups, purchase orders, testing, and packaging are variable with respect to their respective allocation bases. Currently, we believe our assmnptions on cost behavior patterns are quite reasonable. All products are produced in batches, where the size of a batch differs across products. For example, if we produce 80 units of a product in batch sizes of 40, then the product will be produced in two batches. An equipment setup must be performed before producing each batch of a product. Hence, in the example above, two equipment setups would be performed. Units of product are packaged in containers and sent to distributors. Production volumes are set equal to sales volumes since the company only produces products that they have orders for. Consequently, the rm never has a beginning work in process inventory, or a beginning nished goods inventory. (Hence, the rm never has ending inventories.) Further information on our two products g provided in Exhibit 3 Exhibit 3 RT8 FG7 annual sales and production in units 160,000 number of units per batch 100 number of purchase orders 400 number of machine hours per unit 0.50 total number of testing hours 5,000 total number of containers 2,000 REQUIRED: All calculations should be to two decimal points. 1. Determine the unit product cost of RTS, and its cost components, using the traditional accounting system where overhead is applied at a rate of 500% of direct labor costs. All calculations should be rounded to the nearest cent. RT8 Direct material cost per unit Direct labor cost per unit Manufacturing overhead cost per unit Unit product cost2. Calculate the ve activity rates (predetermined overhead rates) under activity-based costing rounded to the nearest cent. 3. Determine the unit product cost of RTS, and its cost components, using activity-based costing. All calculations should be rounded to the nearest cent. RT8 Direct material cost per unit Direct labor cost per unit Equipment Setup cost per unit Purchase order cost per unit Machining cost per unit Testing cost per unit Packaging cost per unit Unit product cost 4. Under the traditional cost system, for each cost category listed below, compute the amount of that resource (cost) that is assumed to be used in total in the production of RTS as a percentage of the total amount of that resource used across all 300 products. (Hints: If you were to calculate the percentage for a given cost category and add up the percentages across all 300 of the rm's products on that one cost category, the sum w0uld equal 100%. Also, the sum of the percentages in the column below will not add up to 100%.) Then repeat this same question for the ABC system. (Hints: Again, if you were to calculate the percentage for any cost category and add up the percentages across all 300 of the rm's products on that one cost category, the sum would equal 100%. Also, the sum of the percentages in the column below will not add up to 100%.) TRADITIONAL ABC COST Equipment set-up % % Purchase Orders % % Machining % % Testing % % Packaging % % 5. Why is the unit cost assigned to RT8 lower under ABC than it is under the traditional cost accounting system? You must be as specic as possible. 6. Assume next year that the activity rates (predetermined overhead rates) remain the same as you calculated in question (2). Assume that the demand for RTS is expected to increase signicantly. Consequently, the firm expects to produce more batches of RT8 next year than this year and the rm plans to produce in batch sizes of 154 rather than 100. Calculate what the equipment setup cost per unit of RT8 will be next year if it can be calculated. If it cannot be calculated, then explain in words why the equipment setup cost per unit of RT8 cannot be determined in the absence of more information
