Part One (cost driver and pre-determined overhead)

Memories, Inc. (MI) produces souvenir figurines that are sold wholesale to gift shops. They have created a new line of dolls representing historical figures. The company's goal is to produce and sell 350,000 dolls each year. MI plans to keep approximately a one-month supply of dolls in finished goods inventory.

MI will have 10 production lines. Each of the five workers on each line will be responsible for one of the five stages of production: molding, cleaning, painting, finishing, and packaging. Each of the 10 production lines can produce 20 dolls per hour.

MI deals exclusively with Quality Materials, Inc. to purchase raw materials and equipment. All materials (plastic, molds, paint, etc.) are delivered within two days of ordering and MI generally holds only a one- or two- day supply in raw materials inventory.

The projected materials costs are:

Material cost per doll
Plastic	$.12
Doll molds	.20
Varnish	.08
Paint	.30
Packaging	.04

Direct labor employees are paid on an hourly basis according to hours worked. Once production-line workers finish a day's scheduled production, they are sent home. They can work a maximum of 8 hours each day without earning overtime. The overtime premium is an additional 50% of the base hourly rate of $7.50 per hour. Supervisors and other indirect labor employees are salaried.

Labor Costs (estimated)
Rate for direct labor	$7.50 per hour (plus $2.50 per hour in fringe benefits)

During the first year of operations, Memories, Inc. estimated that they would produce 346,125 dolls but actually produced 336,033. Actual direct materials costs were $248,664 and actual direct labor costs were $840,082 for 84,008 hours worked. Estimated overhead costs for the year were $191,700 while actual overhead was $193,000.

Required:

What is an appropriate cost driver for allocating overhead to dolls in Year 1? (Explain your reasoning for choosing the driver.)

Calculate the predetermined overhead rate using the cost driver of units produced. HINT: POHR = Estimated OH / Estimated units produced

Using normal costing, compute the cost of one of the 336,033 dolls produced in Year 1. (Round to the nearest dollar.) HINT: DM+DL+applied OH (applied OH = POHR x actual units produced.

Was overhead over- or under-applied during the year? By how much? Why do you think this happened?

Part Two (COGS, COGM two products)

In its second year of operations, Memories, Inc. has decided to expand the product line by producing replicas of historic buildings. These replicas will require the purchase of new building molds at a cost of $.18 per replica. Of course, new doll molds will not be required. All other materials and prices will remain the same.

The replicas require additional processing time because of the details on the buildings that limits production to 18 replicas per hour per assembly line. The replicas are not expected to affect the sales of dolls. In the second year of operations, MI expects to produce and sell about 352,800 dolls and 25,200 replicas.

Increasing production is expected to increase overhead costs by 5% in Year 2. Direct labor costs per hour are not expected to change, but the number of labor hours is estimated to be 94,500. The costs of product promotion and advertising are expected to increase to $3,000 per month. All other selling and administrative costs are expected to remain the same as in Year 1.

Actual production in Year 2 was 345,132 dolls and 25,200 replicas. Direct material costs transferred to Work-in-Process were $259,000 for dolls and $15,624 for replicas. Direct labor costs were $862,830 for the dolls and $70,010 for replicas, representing 86,283 and 7,001 direct labor hours, respectively. Actual overhead costs were $203,600.

Required:

Can Memories, Inc. still allocate overhead in Year 2 using the same cost driver used in Year 1? If not, what appears to be the most logical cost driver to use? (Explain your answers and support your reasoning.)

Compute a predetermined overhead rate for MI in Year 2 using labor hours. (HINT: POHR = Estimated OH$/Estimated labor hours)

Using normal costing and the predetermined rate from B, compute the total manufacturing cost for 345,132 dolls and 25,200 replicas produced in Year 2, as well as the cost per doll and the cost per replica. Was overhead under- or over-applied? By how much? (HINT: DM+DL+OH applied (POHR x actual labor hours)

Part Three (ABC)

George Jefferson, the accounting manager at MI, has just returned from a conference on activity-based costing and thinks MI should consider implementing an ABC system. George has identified five primary activities taking place in the production facilities at MI, has traced Year 2 overhead costs to each activity, and has identified a cost driver for each activity as follows:

Estimated Year 2 Overhead Costs Using ABC
Activity	Monthly Overhead Cost	Cost Driver
Materials delivery and handling	$4,620	Number of shipments
Molding and cleaning	$3,150	Number of molds
Painting and finishing	$5,670	Direct labor hours
Packaging	$1,260	Number of figurines
Quality inspections	$2,100	Number of inspections

Based on information about production needs and the differences for each type of product (replicas are not uniform in size, dolls need more inspection, etc.) George has estimated the following activity for each cost driver:

	Dolls	Replicas	Total
Number of shipments	52	108	160
Direct labor hours	87,500	7,000	94,500
Number of figurines	352,800	25,200	378,000
Number of molds	2,500	500	3,000
Number of inspections	80,000	4,000	84,000

Required:

Using the preceding activities and cost drivers, calculate a predetermined overhead rate for each activity. HINT: Note you will have to annualize the OH costs

Using ABC, how much estimated overhead would be allocated to a doll? to a replica?

Compare the estimated overhead allocation using ABC to the estimated overhead allocation using direct labor hours (HINT: use POHR from Part 2B x actual labor hours above). What do you think is the cause of the differences?

What are some of the advantages and disadvantages of using ABC in this case?

Would you suggest that MI adopt an ABC system? Why or why not?

Does the information provided by the ABC system give you some insight into areas of possible cost reduction? What areas have the greatest potential for cost reduction, and what are the potential impacts on the business from these cost reductions?