Question 2

Ayr Co. manufactures residential and commercial security alarms. The company has designed a new residential alarm that can connect to home Wi-Fi systems. This feature reduces the cost of installation and avoids the need for conventional telephone access to the system. Because it is advanced and innovative, the system has no direct competitors and, therefore, Ayr plans to use a cost-based price for this new product. The company policy is to mark up total manufacturing cost by 30% to set the product price.

Ayr is organized into three departments: stores, production, and assembly. The fixed cost structure in each department is as follows:

Department	Cost driver	Fixed manufacturing overhead	Practical capacity	Average activity level	Planned activity level
Stores	Materials cost	$ 200,000	$ 1,200,000	$ 900,000	$ 1,000,000
Production	Machine hours	1,200,000	10,000	7,000	8,000
Assembly	Labour hours	450,000	8,000	5,000	7,000

The variable costs in each department for this new product have been estimated as:

Stores:

Materials $35

Direct labour 0.15 hours @ $18 per hour

Variable overhead materials cost 20%

Production:

Materials $2.50

Direct labour 0.2 hours @ $22 per hour

Machine hours 0.15

Variable overhead machine hours $15

Assembly:

Materials $0.75

Direct labour 0.9 hours @ $28

Variable overhead labour hours $2 per hour

Ayrs current approach is to compute manufacturing costs for a product as all variable costs of that product plus an allocation of total plant fixed manufacturing overhead. The plantwide overhead rate is based on total direct labour hours. The current total amount worked in all departments is 20,000 hours.

Required:

Compute the suggested selling price for the new security alarm product based on the current policy for allocating fixed overhead.

Recalculate Ayrs suggested selling price under each of the following alternative assumptions:

The fixed manufacturing overhead rate is calculated using departmental practical capacity.

The fixed manufacturing overhead rate is calculated using the average departmental activity level.

The fixed manufacturing overhead rate is calculated using the planned departmental activity rate.

Which approach do you recommend, and why?