Problem 5-57

Knickknack, Inc. manufactures two products: Odds and Ends. The firm uses a single, plant wide overhead rate based on direct-labor hours. Production and product-costing data are as follows:

Odds Ends

Production quantity 1,000 unit 5,000 unit

Direct material $40 $60

Direct labor (not including setup time) 30 (2hr. at$15) 45(3hr. at $15)

Manufacturing overhead 96 (2hr.at$48) 144(3hr. at$48)

Total cost per unit $166 $249

Calculation of predetermined overhead rate

Manufacturing overhead budget

Machine related costs $450,000

Setup and inspection .180,000

Engineering ..90,000

Plant related costs .96,000

Total $816,000

Predetermined overhead rate:

Budgeted manufacturing overhead = $816,000

Budgeted direct-labor hours = (1,000)(2)+(5,000)(3) = $48 per direct labor hour

Knickknack, Inc. prices its products at 120 percent of cost, which yields target prices of $199.20 for Odds and $298.80 for Ends. Recently, however, Knickknack has been challenged in the market for Ends by a European competitor, Bricabrac Corporation. A new entrant in this market, Bricabrac has been selling Ends for $220 each. Knickknacks president is puzzled by Bricabracs ability to sell Ends at such a low cost She has asked you (the controller) to look rnto the matter You have decrded that Kntckknacks tradrtronal, volume-based product-costmg system may be causrng cost drstortron between the firms two products Ends are a hrgh-volume, relatrvely srmple product Odds, on the other hand, are qurte complex and exhrbrt a much lower volume As a result, you have begun work on an actrvrty-based costrng system

Required:

1. Let each of the overhead categories m the budget represent an activity cost pool Categorize each m terms of the type of activity (e g , unit-level activity)

2. The follow cost drivers have been identified for the four activity cost pools.

Activity Cost Pool Cost Driver Budgeted Level of Cost Driver

Machine-related costs Machine hours 9,000 hr.

Setup & inspection Number of production runs 40 runs

Engineering Engineering change orders 100 Change orders

Plant-related Square footage of space 1,920 sq. ft.

You have gathered the follow additional information

Each Odd requires 4 machine hours, whereas each End requires 1 machine hour

Odds are manufactured in production runs of 50 units each Ends are manufactured in 250-unit batches

Three-quarters of the engineering activity, as measured in terms of change orders, is related to Odds

The plant has 1,920 square feet of space, 80 percent of which is used in the production of Odds

For each activity cost pool, compute a pool rate. (Hint: Regarding the pool rate refer to Exhibit 5-6.)

3. Determine the unit cost, for each activity cost pool, for Odds and Ends

4. Compute the new product cost per unit for Odds and Ends, using the ABC system

5. Using the same pricing policy as in the past, compute prices for Odds and Ends Use the product costs determined by the ABC system

6. Show that the ABC system fully assigns the total budgeted manufacturing overhead costs of $816,000

7. Show how Knickknacks traditional; volume-based costing system distorted its product costs (Refer to Exhibit 5-10 for guidance.)