Comparison of two costing systems, original activity-based costs, implementing change The Redwood City plant of Crimson Components Company makes two types of rotators for automobile engines: R361 and R572. The old cost accounting system at the plant traced support costs to four cost pools:

Cost Pool Support Costs Cost Driver

S1 $1,176,000 Direct Labor Cost

S2 $1,120,000 Machine Hours

P1 $480,000 -

P2 $780,000 -

Totals $3,556,000

Pool S1 included service activity costs related to setups, production scheduling, plant administration, janitorial services, materials handling, and shipping. Pool S2 included activity costs related to machine maintenance and repair, rent, insurance, power, and utilities. Pools P1 and P2 included supervisors wages, idle time, and indirect materials for the two production departments, casting and machining, respectively.

The old accounting system allocated support costs in pools S1 and S2 to the two production departments using direct labor cost and machine hours, respectively, as the cost drivers. Then the accumulated support costs in pools P1 and P2 were applied to the products on the basis of direct labor hours. A separate rate was determined for each of the two production departments. The direct labor wage rate is $15 per hour in casting and $18 per hour in machining.

DIRECT LABOR HOURS (DLH)

Department R361 R572 Total Direct Labor Costs

Casting (P1) 60,000 20,000 80,000 $1,200,000

Machining (P2) 72,000 48,000 120,000 $2,160,000

Totals 132,000 68,000 200,000 $3,360,000

MACHINE HOURS (MH)

Department R361 R572 Total

Casting (P1) 30,000 10,000 40,000

Machining (P2) 72,000 48,000 120,000

Totals 102,000 58,000 160,000

Item R361 R572

Sales price per unit $19 $20

Sales and production units 500,000 400,000

Number of orders 1,000 1,000

Number of setups 2,000 4,000

Materials cost per unit $8 $10

Now the plant has implemented an activity-based costing system. The following table presents the amounts from the old cost pools that are traced to each of the new activity cost pools:

OLD COST POOLS:

Activity cost drivers S1 S2 P1 P2 Total

P1-DLH $120,000 $0 $120,000 $0 $240,000

P2-DLH $240,000 $0 0 $120,000 $360,000

Setup hours $816,000 $80,000 $240,000 $540,000 $1,676,000

P1-MH 0 $260,000 $120,000 $0 $380,000

P2-MH 0 $780,000 0 $120,000 $900,000

Total $1,176,000 $1,120,000 $480,000 $780,000 $3,556,000

Setups for R572 are 50% more complex than those for R361; that is, each R572 setup takes 1.5 times as long as one R361 setup.

Required:

(a) Determine the product costs per unit using the old system. Show all intermediate steps for allocations, including departmental cost driver rates and a breakdown of product costs into each of their components.

(b) Determine the product costs per unit using the new system.

(c) Explain the intuitive reason that the product costs differ under the two accounting systems.

(d) What should Crimson Components do to improve the profitability of its Redwood City plant? Include marketing and product-related changes among your recommendations.

(e) Describe how experienced production and sales managers are likely to react to the new product costs.