Stellar Stairs C o. of Poway designs and builds factory-made premium wooden stai
ID: 2359849 • Letter: S
Question
Stellar Stairs Co. of Poway designs and builds factory-made premium wooden stairs for homes. The manufactured stair components (spindles, risers, hangers, hand rails) permit installation of stairs of varying lengths and widths. All are of white oak wood. Its budgeted manufacturing overhead costs for the year 2006 are as follows.
Overhead Cost Amount
Purchasing $ 57,000
Handling materials 82,000
Production (cutting, milling, finishing) 210,000
Setting up machines 85,000
Inspecting 90,000
Inventory control (raw materials and finished goods) 126,000
Utilities 180,000
Total budget overhead costs $830,000
For the last 4 years, Stellar Stairs Co. has been charging overhead to products on the basis of machine hours. For the year 2006, 100,000 machine hours are budgeted. Heather Fujar, owner-manager of Stellar Stairs Co., recently directed her accountant, Lindsay Baker, to implement the activity-based costing system that she has repeatedly proposed. At Heather Fujar’s request, Lindsay and the production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.
Activity Cost Pools Cost Drivers Expected Use of Cost Drivers
Purchasing Number of orders 600
Handling materials Number of moves 8,000
Production Direct labor hours 100,000
Setting up machines Number of setups 1,250
Inspecting Number of inspections 6,000
Inventory control (raw materials and finished goods) Number of components 168,000
Utilities Square feet occupied 90,000
Jason Dion, sales manager, has received an order for 280 stairs from Community Builders, Inc., a large housing development contractor. At Jason’s request, Lindsay prepares cost estimates for producing components for 280 stairs so Jason can submit a contract price per stair to Community Builders. She accumulates the following data for the production of 280 stairways.
Direct labor $112,000
Machine hours 14,500
Direct labor hours 5,000
Number of purchase orders 60
Number of material moves 800
Number of machine setups 100
Number of inspections 450
Number of components 16,000
Number of square feet occupied 8,000
Hint: (b) Cost/stair $1,199.82 (c) Cost/stair $1,055.54
Instructions
(a) Compute the predetermined overhead rate using traditional costing with machine hours as the basis.
(b) What is the manufacturing cost per stairway under traditional costing?
(c) What is the manufacturing cost per stairway under the proposed activity-based costing?(Prepare all of the necessary schedules.)
(d) Which of the two costing systems is preferable in pricing decisions and why?
Explanation / Answer
a) Predetermined overhead rate = $830,000 / 100,000 = $8.30 per machine hour
b) Manufacturing cost under Traditional costing
Direct Materials $103,600
Direct labor $112,000
Overheads 14,500 x $8.30 $120,350
Total manufacturing cost
for 280 stairway $335,950
Manufacturing cost per stairway = $335,950 / 280
= $1,199.82
c) Manufacturing cost under Activity-Based costing
Direct Materials $103,600
Direct labor $112,000
Overheads
Purchasing 57,000 x 60 / 600 5,700
Handling 82,000 x 800 / 8000 8,200
Production 210,000 x 5000/100000 10,500
Setup 85,000 x 100 / 1250 6,800
Inspection 90,000 x 450 / 6000 6,750
Inv. Control 126000x16000/168000 12,000
Utilities 180,000x8000/90000 16,000 $65,950
Total manufacturing cost
for 280 stairway $281,550
Manufacturing cost per stairway = $281,550 / 280
= $1,005.54
(d) Which of the two costing systems is preferable in pricing decisions and why?
ABC costing system is preferable in pricing decision as it has a value enhancing effect on pricing decisions and profit performance as ABC allows better price differentiation among products, customers and markets.
Under ABC the overhead cost is broken into segments according to the activity and for each activity related driver is also identified. Inseat of blanket rate activity based rate provides more accurate identification of costs rather than costs allocated on single rate for different activity. For example Utilities costs should be allocated on the basis of units consumed rather than allocating on the basis of MAchine hour or Direct labor hour.
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