Question 2 Activity Costing Exercise

We just cant seem to make any money, exclaimed the President. Profits are falling every month. This month we lost money. What is going on?

A quick look at the books revealed that the company had $250,000 in manufacturing overhead costs. The $250,000 had traditionally been applied based on Direct Labour hours. The company used 10,000 Direct Labour hours, so a pre-determined rate of $25 per Direct Labour Hour was used.

		Product Y		Product Z
Direct Materials	$10		$18
Direct Labour
(1 hour)	$20
(2 hours)			$40
Manufacturing Overhead	$25		$50
Total Cost	$55		$108

The company has been selling 5 of the cheaper product Y for each unit of Product Z. The company used a 40% markup to cover non-manufacturing operating costs.

		Product Y		Product Z
Selling Price	$77.00		$151.20

An in-plant study recently revealed that the $250,000 could be traced to the following activities:

Activity	Cost	Total Number for Year
Material moves	$30,000	15,000 moves
Inspections	$20,000	20,000 inspections
Machinery hours	$90,000	9,000 machine hours
Testing	$10,000	5,000 tests
Setups	$60,000	60,000 setups
Receiving	$40,000	10,000 orders processed
	$250,000

Further inspection revealed the following activities related to Products Y and Z.

	Product Y	Product Z
Material moves	3	4
Inspections	2	3
Machinery hours	2	1
Testing	3	3
Setups	4	6
Receiving	2	1

Required: 1. Advise the President on the cause and solution for the current dilemma.

2. Determine what the new selling prices should be for Products Y and Z.