Trimester 2, 2017 | ACC804 Advanced Management Accounting

Week 4 Lecture Illustration Example

Conventional and activity-based product costing: Manufacturer

(Adapted from Langfield-Smith, 2012, p. 386)

Locket Storage Ltd manufactures two types of storage cabinets-Deluxe and Executive- and
applies manufacturing overhead to all units at the rate of $80 per machine hour. Production
information follows:

Deluxe Executive
Direct material cost $35 $60
Direct labour cost 20 20
Budgeted volume (units) 8,000 15,000

The management accountant, who is studying activity-based costing, has determined that the
firms overhead can be identified with three activities: manufacturing setups, machine processing
and product shipping. Data on the number of setups, machine hours and outgoing shipments,
which are the activities three respective cost drivers, follow:

Deluxe Executive Total

Setups 50 30 80
Machine hours 16,000 22,500 38,500
Outgoing shipments 100 75 175

The firms total overhead of $3,080,000 is subdivided as follows: manufacturing setups,

$672,000; machine processing, $1,848,000; and product shipping, $560,000.

Required:

1. Calculate the unit manufacturing cost of Deluxe and Executive cabinets by using the
companys current overhead costing procedures.
2. Calculate the unit manufacturing cost of Deluxe and Executive cabinets using activity-
based costing.
3. Is the cost of the Deluxe cabinet overstated or understated (i.e. distorted) by the use of
machine hours to allocate total manufacturing overhead to production? If so, by how
much?
4. Calculate the aggregate amount by which the Deluxe cabinet line is undercosted by the
companys current conventional overhead costing procedures. Then calculate the
aggregate amount by which the conventional system overcosts the Executive cabinet line.
5. Assume that the current selling price of a Deluxe cabinet is $260 and the marketing
manager is contemplating a $30 discount to stimulate sales. Is this discount advisable?
Briefly discuss.
 Solution:

Conventional and activity-based product costing: manufacturer

1 Deluxe manufacturing overhead cost:

16 000 machine hours $80 = $1 280 000
$1 280 000 8 000 units = $160 per unit
Executive manufacturing overhead cost:
22 500 machine hours $80 = $1 800 000
$1 800 000 15 000 units = $120 per unit
Deluxe Executive
Direct material $ 35 $ 60
Direct labour 20 20
Manufacturing overhead 160 120
Unit cost $215 $200

2 Activity-based application rates:

Activity Cost Activity driver Application rate
Manufacturing setups $ 672 000 80 setups (SU) = $8400 per SU
38 500 machine
Machine processing 1 848 000 hours (MH) = $48 per MH
175 outgoing
Product shipping 560 000 shipments (OS) = $3200 per OS

Manufacturing setup, machine processing and product shipping costs of a Deluxe unit and an Executive
unit:
Activity Deluxe Executive
Manufacturing setups:
50 SU $8400 $ 420 000
30 SU $8400 $ 252 000

Machine processing:
16 000 MH $48 768 000
22 500 MH $48 1 080 000

Product shipping:
100 OS $3 200 320 000
75 OS $3 200 240 000

Total .. $1 508 000 $1 572 000

Production volume (units) 8000 15 000
Cost per unit . $188.50* $104.80**
* $1 508 000 8000 units = $188.50
** $1 572 000 15 000 units = $104.80
The manufactured cost of a Deluxe cabinet is $243.50 and the manufactured cost of an Executive cabinet is
$184.80. The calculations follow:
Deluxe Executive
 Direct material $ 35.00 $ 60.00
Direct labour 20.00 20.00
Manufacturing setup, machine
processing, and outgoing shipments 188.50 104.80
Total cost . $243.50 $184.80
3 The Deluxe storage cabinet is understated. The use of machine hours produced a unit cost of $215; in
contrast, the more accurate activity-based costing approach shows a unit cost of $243.50. The difference
between these two amounts is $28.50.

4 Cost distortion:
The Deluxe cabinet product line is undercosted by $228 000, and the Executive cabinet product line is
overcosted by $228 000. Supporting calculations follow:
Deluxe Executive
$28.50* 8000 = $228 000 $(15.20) 15 000 = $(228 000)
*
$243.50 $215.00 $184.80 $200.00

5 No, the discount is not advisable. The regular selling price of $260, when compared against the more
accurate ABC cost figure, shows that each sale provides a profit to the firm of $16.50 ($260.00 $243.50).
However, a $30 discount will actually produce a loss of $13.50 ($243.50 $230.00), and the more units that
are sold, the larger the loss. Notice that with the less accurate, machine-hour-based figure ($215), the
marketing manager will be misled, believing that each discounted unit sold would boost income by $15 ($230
$215).