Activity-Based Costing as an Alternative to Traditional Product Costing Rehm Company manufactures a product that is available in both a deluxe model and a regular model. The company has manufactured the regular model for years. The deluxe model was introduced several years ago to tap a new segment of the market. Since introduction of the deluxe model, the company's profits have steadily declined, and management has become increasingly concerned about the accuracy of its costing system. Sales of the deluxe model have been increasing rapidly.
Manufacturing overhead is assigned to products on the basis of direct labor-hours. For the current year, the company has estimated that it will incur $6,000,000 in manufacturing overhead cost and produce 15,000 units of the deluxe model and 120,000units of the regular model. The deluxe model requires 1.6 hours of direct labor time per unit, and the regular model requires 0.8 hours. Material and labor costs per unit are as follows:
Model
Deluxe Regular
Direct materials $154 $112
Direct labor $16 $8
Required:
I. Using direct labor-hours as the base for assigning manufacturing overhead cost to products, compute the predetermined overhead rate. Using this rate and other data from the problem, determine the unit product cost of each model.
2. Management is considering using activity-based costing to apply manufacturing overhead costs to products for external financial reports. The activity-based costing system would have the following four activity cost pools:
Activity Cost Pool Activity Measure Estimated Overhead Costs
Purchase orders Number of purchase orders $ 252,000
Scrap/rework orders Number of scrap/rework orders 648,000
product testing Number of tests 1,350,000
Machine related Machine-hours 3,750,000
Total overhead cost 56,000,000
Expected Activity
Activity Measure Deluxe Regular Regular Total
Number of purchase orders 400 800 1.200
Number of scrap/rework orders 500 400 900
Number of tests 6,000 9,000 15,000
Machine-hours 20,000 30,000 50,000
Using Exhibit 7- 6 as a guide, compute the predetermined overhead rates (i. e., activity rates) for each of the four activity cost pools.
3. Using the predetermined overhead rates computed in part (2) above, do the following:
a. Compute the total amount of manufacturing overhead cost that would be applied to each model using the activity-based costing system. After these totals haw been computed, determine the amount of manufacturing overhead cost per unit for each model.
b. Compute the unit product cost of each model (materials. labor. and manufacturing overhead).
4. From the data you have developed in (l) through (3) above, identify factors that may account for the company’s declining profits.