CONSTRASTING ABC AND CONVENTIONAL PRODUCT COSTS

Marine, Inc., manufactures a product that is available in both a flexible and a rigid model. The company has made the rigid model for years: the flexible model was introduced several years ago to tap a new segment of the market. Since introduction of the flexible model, the companys profits have steadily declined, and management has become concerned about the accuracy of its costing system. Sales of the flexible model have been increasing rapidly.

Overhead is applied to products on the basis of direct labor-hours. At the beginning of the current year, management estimated that $600,000 in overhead costs would be incurred and the company would produce and sell 1,000 units of the flexible model and 10,000 units of the regular model. The flexible model requires 2.0 hrs. of direct labor time per unit, and the regular model requires 1.0 hours. Direct materials and labor costs per unit are given below:

Flexible Rigid

Direct materials cost per unit$110.00 $80.00

Direct labor cost per unit.$30.00 $15.00

REQUIRED:

Compute the predetermined overhead rate using direct labor-hours as the basis for allocating overhead costs to products. Compute the unit product cost for one unit of each model.

An intern suggested that the company use activity-based costing to cost its products. A team was formed to investigate this idea. It came back with the recommendation that four activity cost pools be used. These cost pools and their associated activities are listed as follows:

_ Expected Activity_

Activity cost pool and Activity measures Estimated

Overhead cost Flexible Rigid Total

Purchase orders (number of orders) .$20,000 100 300 400

Rework request (number of request) . 10,000 60 140 200

Product testing (number of tests) .210,000 900 1, 200 2,100

Machine related (machine hours) .360,000 1,500 2,500 4,000

TOTA $600,000

Compute the activity rate for each of the activity cost pools

3.using activity-based costing, do the following:

a. Determine the total amount of overhead that would be assigned to each model for the year.

b. Compute the unit product cost for one-unit model.

4.Can you identify a possible explanation for the companys declining profits? If so what is it?