For many years, Thomson Company manufactured a single product called LEC 40. Then three years ago, the company automated a portion of its plant and at the same time introduced a second product called LEC 90 that has become increasingly popular. The LEC 90 is a more complex product, requiring 0.80 hours of direct labour time per unit to manufacture and extensive machining in the automated portion of the plant. The LEC 40 requires only 0.40 hours of direct labour time per unit and only a small amount of machining. Manufacturing overhead costs are currently assigned to products on the basis of direct labour hours.

Despite the growing popularity of the company's new LEC 90, profits have been declining steadily. Management is beginning to believe that there may be a problem with the company's costing system. Direct material and direct labour costs per unit are as follows:

LEC40

LEC90

Direct materials

$30

$50

Direct labour(0.4 hours and 0.8 hours @ $15 per hour)

$6

$12

Management estimates that the company will incur $912,000 in manufacturing overhead costs during the current year and 60,000 units of the LEC 40 and 20,000 units of the LEC 90 will be produced and sold.

Required:

(a)Compute the predetermined manufacturing overhead rate assuming that the company continues to apply manufacturing overhead cost on the basis of direct labour hours hours.(2 marks)

(b)Use the rate obtained in (a) to determine the unit product cost of each product.(2 marks)

(c)Management is considering using activity-based costing to assign manufacturing overhead cost to products. The activity-based costing system would have the following four activity cost pools:

Expected and actual activity

Activity Measure

LEC40

LEC90

Number of part types

600

900

Number of purchase orders

2 000

800

Number of tests run

500

1 750

Machine hours

1 600

8 400

Activity cost pool

Activity measure

Estimated overhead costs

Maintaining parts inventory

Number of part types

$225 000

Processing purchase orders

Number of purchase orders

$182 000

Quality control

Number of tests run

$45 000

Machine related

Machine hours

$460 000

Using activity based costing compute the unit product cost of each product.(5 marks)

(d)Discuss the reasons that may account for the company's declining profits. What actions should Thompson Company take?(3 marks)