Question
Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models, designated as standard, deluxe, and heavy-duty. The company uses a
Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models, designated as standard, deluxe, and heavy-duty. The company uses a job-order cost-accounting system with manufacturing overhead applied on the basis of direct-labor hours. The system has been in place with little change for 25 years. Product costs and annual sales data are as follows:
Standard Model | Deluxe Model | Heavy-Duty Model | |||||||||||||
Annual sales (units) | 19,000 | 1,500 | 9,400 | ||||||||||||
Product costs: | |||||||||||||||
Raw material | $ | 12 | $ | 27 | $ | 48 | |||||||||
Direct labor | 8 | (0.5 hr. at $16) | 16 | (1 hr. at $16) | 16 | (1 hr. at $16) | |||||||||
Manufacturing overhead* | 60 | 120 | 120 | ||||||||||||
Total product cost | $ | 80 | $ | 163 | $ | 184 | |||||||||
*The calculation of the predetermined overhead rate is as follows:
Manufacturing-overhead budget: | |||
Depreciation, machinery | $ | 1,310,000 | |
Maintenance, machinery | 110,000 | ||
Depreciation, taxes, and insurance for factory | 210,000 | ||
Engineering | 290,000 | ||
Purchasing, receiving and shipping | 230,000 | ||
Inspection and repair of defects | 280,000 | ||
Material handling | 360,000 | ||
Miscellaneous manufacturing overhead costs | 210,000 | ||
Total | $ | 3,000,000 | |
Direct-labor budget: | |||||
Standard model: | 11,000 | hours | |||
Deluxe model: | 3,000 | hours | |||
Heavy-duty model: | 11,000 | hours | |||
Total | 25,000 | hours | |||
Predetermined overhead rate: | Budgeted overhead | = | $3,000,000 | = $120 per hour |
Budgeted direct-labor hours | 25,000 hours |
For the past 10 years, the companys pricing formula has been to set each products target price at 110 percent of its full product cost. Recently, however, the standard-model motor has come under increasing price pressure from offshore competitors. The result was that the price on the standard model has been lowered to $110. The company president recently asked the controller, Why cant we compete with these other companies? Theyre selling motors just like our standard model for 94 dollars. Thats only a buck more than our production cost. Are we really that inefficient? What gives? The controller responded by saying, I think this is due to an outmoded product-costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my judgment, our product-costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean. Getting the presidents go-ahead, the controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each cost driver consumed by each product line.
Product Lines | ||||||||||||
Activity Cost Pool | Cost Driver | Standard Model | Deluxe Model | Heavy-Duty Model | ||||||||
I. | Depreciation, machinery | |||||||||||
Maintenance, machinery | Machine time | 38 | % | 15 | % | 47 | % | |||||
II. | Engineering | |||||||||||
Inspection and repair of defects | Engineering hours | 47 | % | 6 | % | 47 | % | |||||
III. | Purchasing, receiving, and shipping | |||||||||||
Material handling | Number of material orders | 47 | % | 8 | % | 45 | % | |||||
IV. | Depreciation, taxes, and insurance for factory Miscellaneous manufacturing overhead | Factory space usage | 40 | % | 19 | % | 41 | % | ||||
Required: 1. Compute the target prices for the three models, based on the traditional, volume-based product-costing system. 2. Compute new product costs for the three products, based on the new data collected by the controller. 3. Calculate a new target price for the three products, based on the activity-based costing system
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