Cost Allocation and Environmental Processes-Ethical Issues

California Circuits Company (3C) manufactures a variety of components. Its Valley plant specializes in two electronic components used in circuit boards. These components serve the same function and perform equally well. The difference in the two products is the raw material. The XL- D chip is the older of the two components and is made with a metal that requires a wash prior to assembly. Originally, the plant released the wastewater directly into a local river. Several years ago, the company was ordered to treat the wastewater before its release, and it installed relatively expensive equipment. While the equipment is fully depreciated, annual operating expenses of $250,000 are still incurred for wastewater treatment.

Two years ago, company scientists developed an alloy with all of the properties of the raw materials used in XL-D that generates no wastewater. Some prototype components using the new material were produced and tested and found to be indistinguishable from the old components in every way relating to their fitness for use. The only difference is that the new alloy is more expensive than the old raw material. The company has been test-marketing the newer version of the component, referred to as XL-C, and is currently trying to decide its fate.

Manufacturing of both components begins in the Production Department and is completed in the Assembly Department. No other products are produced in the plant. The following provides information for the two components:

Units produced

Raw material costs per unit

Direct labor-hours per unit—Production

Direct labor-hours per unit—Assembly

Direct labor rate per hour—all labor

Machine-hours per unit—Production

Machine-hours per unit—Assembly

Testing hours per unit (all in production)

Shipping weight per unit (pounds)

Wastewater generated per unit (gallons)

XL-D XL-C

100,000 25,000

$12 $14

0.1 0.1

0.4 0.4

$20 $20

1.6 1.6

0.4 0.4

3.0 3.0

1.0 1.6

10.0 0.0

1

Annual overhead costs for the two departments follow:

Production Department Assembly Department

Supervision $ 100,000

Material handling 93,000

Testing 150,000

Wastewater treatment 250,000

Depreciation on equipment 400,000

Shipping 7,000

Total $ 1,000,000

$

$

240,000

40,000

0

0

100,000

120,000

500,000

The company president believes that it’s foolish to continue producing two essentially equivalent products. At the same time, the corporate image is somewhat tarnished because of a toxic dump found at another site (not the Valley plant). The president would like to be able to point to the Valley plant as an example of company research and development (R&D) working to provide an environmentally friendly product. The controller points out to the president that the company’s financial position is shaky, and it cannot afford to make products in any way other than the most cost-efficient one.

Required:
a. 3C’s current cost accounting system charges overhead to products based on direct labor cost using a single plantwide rate. What product costs will it report for the two products if the current allocation system is used?

b. The controller recently completed an executive education course describing the two-stage allocation procedure. Assume that the first stage allocates costs to departments and the second stage allocates costs to products. The controller believes that the costs will be more accurate if machine-hours are used to allocate Production Department costs and labor-hours are used to allocate Assembly Department costs. What product costs will be reported for the two products if the two-stage allocation process is used?

2

c. The company decides to compute product costs assuming an ABC system is implemented only in the Production Department. Overhead in Assembly will continue to be allocated based on direct labor cost. The cost drivers selected for the activity-based costing system are:

Overhead Item

Supervision

Material handling

Testing

Wastewater treatment

Depreciation on equipment

Shipping

Driver

Direct labor-hours

Material cost

Testing hours

Wastewater generated

Machine-hours

Weight

What product costs would be reported if this ABC system were implemented? Assume that the production mix and costs would remain as originally planned.

d. Please briefly discuss the advantages and disadvantages of the three cost allocation methods above, including traditional single plantwide rate cost allocation, two-stage departmental allocation, and activity-based costing. What is your suggestion for the president if you were the controller?

e. Because the two products are identical in their use, the controller argues that the decision should be made on cost alone. Do you agree? Explain.