Problem 3-13B ABC Cost Hierarchy [LO3-1] Problem 3-16A Contrasting ABC and Conve
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Problem 3-13B ABC Cost Hierarchy [LO3-1]
Problem 3-16A Contrasting ABC and Conventional Product Costs [LO3-2, LO3-3, LO3-4]
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For many years, Thomson Company manufactured a single product called LEC 40. Then three years ago, the company automated a portion of its plant and at the same time introduced a second product called LEC 90 that has become increasingly popular. The LEC 90 is a more complex product, requiring 0.60 hours of direct labor time per unit to manufacture and extensive machining in the automated portion of the plant. The LEC 40 requires only 0.20 hours of direct labor time per unit and only a small amount of machining. Manufacturing overhead costs are currently assigned to products on the basis of direct labor-hours.
Despite the growing popularity of the company’s new LEC 90, profits have been declining steadily. Management is beginning to believe that there may be a problem with the company’s costing system. Direct material and direct labor costs per unit are as follows:
Management estimates that the company will incur $1,024,000 in manufacturing overhead costs during the current year and 80,000 units of the LEC 40 and 40,000 units of the LEC 90 will be produced and sold.
For many years, Thomson Company manufactured a single product called LEC 40. Then three years ago, the company automated a portion of its plant and at the same time introduced a second product called LEC 90 that has become increasingly popular. The LEC 90 is a more complex product, requiring 0.60 hours of direct labor time per unit to manufacture and extensive machining in the automated portion of the plant. The LEC 40 requires only 0.20 hours of direct labor time per unit and only a small amount of machining. Manufacturing overhead costs are currently assigned to products on the basis of direct labor-hours.
Despite the growing popularity of the company’s new LEC 90, profits have been declining steadily. Management is beginning to believe that there may be a problem with the company’s costing system. Direct material and direct labor costs per unit are as follows:
Explanation / Answer
ABC Cost Hierarchy :
ABC Cost hierarchy catagorizes activity cost pools on the basis of different types of drivers for allcation of Manufacturing various overheads are:
1. Output unit-level costs - cost of activities performed on the individual unit of the product or service.
2. Batch level-costs - cost of activities from the whole group or product or services
3. Product-sustaining-costs - costs of activities performed to support individual products no matter what is the number of units or batches are.
4. Facility sustaining-costs - costs that apply to the whole organization and are not taceable to invidual units or batches.
Contrasting ABC and Conventional Product Costs:
Traditional costing systems apply indirect costs to products based on a predetermined overhead rate. Unlike ABC, traditional costing systems treat overhead costs as a single pool of indirect costs.
Activity based costing systems are more accurate than traditional costing systems because they provide a more precise breakdown of indirect costs. However, ABC systems are more complex and more costly to implement.
In the given problem, the best way is to apply ABC Analysis to allocate the Manufacturing overhead through the "Batch level-costs" overhead allocation:
The total prime cost of LEC40 is $29 * 80000 = $2320000 and of LEC90 is $56 * 40000 = $2240000 and the total prime cost is $4560000.
The Manufacturing expected overhead is $1024000. Using the prime cost (Batch) method, the allocation rate is
= $1024000 / $4560000 = 0.225 per $ of Prime cost
so, per unit manufacturing overhead cost is
LEC40 = 29 * 0.225 = $6.51 AND
LEC90 = 56 * 0.225 = $12.32
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