CitySpan's dilemma of Traditional Costing versus Activity Based Costing

CitySpan Manufacturing Corporation manufactures various electronics products and follows a traditional (job-order) costing system in which it applies manufacturing overhead to its products using a predetermined overhead rate based on direct labour-hours (DLHs). The company has two products, 2009L and 2010V, about which it has provided the following data:

2009L 2010V

Direct materials per unit $10.20 $50.50

Direct labour per unit $8.40 $25.20

Direct labour hours per unit 0.40 1.20

Annual production 30,000 10,000

The company's estimated total manufacturing overhead for the year is $1,464,480 and the company's estimated total direct labour-hours for the year is 24,000.

The company is considering using a variation of activity-based costing to determine its unit product costs for external reports. Data for this proposed activity-based costing system appear below:

Activities and Activity Measures Estimated Overhead Cost

Supporting direct labour (DLHs) $552,000

Setting up machines (setups) 132,480

Parts administration (part types) 780,000

Total $1,464,480

Activities 2009L 2010V Total

Supporting direct labour 12,000 12,000 24,000

Setting up machines 864 240 1,104

Part administration 600 960 1,560

Jackson is the controller of the Company, is currently overseeing the project to switch from traditional costing to Activity-Based costing. He is in a meeting with the Cost Accountant of the company. The Controller goes over the data and makes the following comments:

Activity-Based Costing is a revelation in the modern-day world of manufacturing Industry. If we are correctly able to categorize the various nature of work into essential levels, then we can dramatically trace the precise nature of the overheard activity.

Jordan, the Cost Accountant, quips, "how can we classify those levels of activities? Do we have some mechanism to identify them?"

Jackson responds, "Yes! We do." Jordan then laments the pitfalls of the job order costing system, The production report will be out soon and usually, the allocation bases (including overhead allocations in job-order costing systems) are not entirely accurate. Jackson, with a pause, "That is exactly why we may eventually need to switch to the Activity-Based costing though it is comparatively difficult to implement with the cost and operations limitations involved in it.

Jordan states, Another consideration to evaluate is the relationship between the cost of maximum (budgeted) capacity and idle capacity, since the company is likely to operate at maximum capacities during the time of peak demand. Also, our long-term goals of stable cost predictions and waste minimizations should also be kept in mind.

Let us calculate and analyze the quantitative and qualitative aspects of the data and other factors and prepare the preliminary report.

How to calculate the following:

a. Determine the manufacturing overhead cost per unit of each of the company's two products under the traditional costing system.

b. Determine the manufacturing overhead cost per unit of each of the company's two products under activity-based costing system.

c. Compare the results in part A and B under both costing systems and specify the differences in both systems.

d. What is the significance of the Activity Costing System that Jackson might be referring to?

e. How is ABC system different from traditional costing system?

f. The use of which activity level, budgeted (same as expected) or maximum capacity, is consistent with ABC? Explain.

g. How might the use of ABC based on maximum capacity activity level enhance a firm's ability to compete on price? Explain.

h. If you were to recommend one of the costing systems for CitySpan Inc., which one

would you pick and why?