For many years, Richard Company manufactured a single product called a mono-relay. Then three years ago, the company automated a portion of its plant and at the same time introduced a second product, called a bi-relay, which has become increasingly popular. The bi-relay is a more complex product, requiring one hour of direct labor time per unit to manufacture and extensive machining in the automated portion of the plant. The mono-relay requires only 0.75 hours of direct labor time per unit and only a small amount of machining. Manufacturing overhead costs are currently assigned to products based on direct labor hours.

Despite the growing popularity of the company’s new bi-relay, profits have been declining steadily. Management is beginning to believe that there may be a problem with the company’s costing system. Material and labor costs per unit are as follows:

Mono Bi

Relay Relay

Direct materials $35 $48

Direct labor (0.75 hour and 1.0 hour @ $12 per hour) $9 $12

Management estimates that the company will incur $1,000,000 in manufacturing overhead costs during the current year and 40,000 units of the mono-relay and 10,000 units of the bi-relay will be produced and sold.

Management is considering using activity-based costing to apply manufacturing overhead costs to products for external financial reports. The activity-based costing system would have the following four activity cost pools.

Estimated Mono Bi

Activity Cost (and Activity Measure) Cost Total Relay Relay

Maintaining parts inventory (number of part types) $ 180,000 225 75 150

Processing purchase orders (number of orders) 90,000 1,000 800 200

Quality control (number of tests) 230,000 5,750 2,500 3,250

Machine-related (machine-hours) 500,000 10,000 4,000 6,000

Total overhead cost $1,000,000

Required:

1. Determine the unit product cost for each product using the traditional costing system.
2. Determine the unit product cost for each product using the activity-based costing system.
3. Explain the difference in the costs for the two products for the two different methods, the traditional costing system, and the activity-based costing system.