5-24 activity based costing manufacturing Fancy Doors, inc., produces 2 types of
ID: 2419740 • Letter: 5
Question
5-24 activity based costing manufacturing Fancy Doors, inc., produces 2 types of doors interior & exterior. The co.'s costing system has 2 direct cost categories (materials & labor) & one indirect cost pool. the simple costing system allocates indirect costs on the basis of machine-hours. Recently, the owners of Fancy Doors have been concerned about a decline in the market share for their interior doors, usually their biggest seller. Information related to Fancy Doors production for the most recent year follows: Units interior exterior unit sold 3200 1800 selling price 250 400 D Mat cost/unit 60 90 D Manf labor-cost /hour 32 32 D Manf labor hour/unit 1.50 2.25 production runs 40 85 material moves 72 168 machine setups 45 155 machine hours 5500 4500 # of inspections 250 150 the owners have heard of other Co. in the industry that are now using an activity-based costing system and are curious how an ABC system would affect their product costing decisions. After analyzing the indirect cost pool for fancy Doors, the owners identify 6 activities as generating indirect costs: production scheduling, material handling, machine setup, assembly, inspection, & marketing. Fancy Doors collected the following data related to the indirect cost activities: activity / active cost/ activ cost driver Product scheduling $190000 prod run material handling $90000 mat. move machine setup $50000 mach. setup assembly $120000 machine hours inspection $16000 # of inspections marking costs were determined to be 3% of the sales revenue for each type of door. 1. Calculate the cost of an interior door and an exterior door under the existing simple costing system. 2. Calculate the cost of an interior door a& an exterior door under an activity-based costing system. 3.Compare the costs of the doors in requirements 1 & 2. Why do the simple & activity-based costing systems differ in the cost of an interior & exterior door? 4. How might Fancy Door, Inc., use the new cost information from its activity-based costing system to address the declining market share for interior doors?
Explanation / Answer
Answer a. Simple Costing System Total Indirect Costs = 190000 + 90000 + 50000 + 120000 + 16000 + 3% {(3200 X 250) + (1800 X 400)} Total Indirect Costs = $511600 Total machime Hours = 5500 +4500 = 10000 hrs Indirect Cost per machine Hr. = 511600 / 10000 = $51.16 per machine hr Calculation of Cost per Unit unde Simple Costing Method. Interior Exterior Sales in Unit 3200 1800 Direct Materials 192,000.00 162,000.00 Direct Labour 153,600.00 129,600.00 Indirect Cost Allocated to each job 281,380.00 230,220.00 Total Costs 626,980.00 521,820.00 Total Cost per unit 195.93 289.90 Answer 2. Activity Based Costing Activity Total Cost of Activity Cost Driver Cost driver Quantity Allocation Rate Product scheduling 190000 production runs 125 1520 per production run Material Handling 90000 material Moves 240 375 per material move Machine Set up 50000 machine setups 200 250 per set up Assembly 120000 machine hours 10000 12 per machine hour Inspection 16000 inspection 400 40 per inspaction marketing selling price 0.03 per dollar of sales Calculation of Cost per Unit as per Activity Cost Interior Exterior Sales in Unit 3200 1800 Direct Materials 192,000 162,000 Direct Labour 153,600 129,600 Indirect Cost Allocated Product scheduling 60,800 129,200 Material Handling 27,000 63,000 Machine Set up 11,250 38,750 Assembly 66,000 54,000 Inspection 10,000 6,000 marketing 24,000 21,600 Total Costs 544,650 604,150 Cost Per unit 170.20 335.64 Answer 3. Interior Exterior Simple Costing Method 195.93 289.90 Activity Based Costing 170.20 335.64 Difference (Simple - Activity) 25.73 (45.74) Relative to the ABC system, the simple costing system overcosts interior doors and undercosts exterior doors. Under the simple costing system, the doors require a similar number of total machine hours (5,500 for interior and 4,500 for exterior), even though interior doors take fewer machine hours per unit. Under the simple costing system, the volume of the production of interior doors is driving the amount of overhead allocated to that product. The ABC study reveals that each exterior door requires more production runs, material moves, and setups. This is reflected in the higher indirect costs allocated to exterior doors in the ABC system Answer 4. Fancy Doors, Inc. can use the information revealed by the ABC system to change its pricing based on the ABC costs. Under the simple system, Fancy Doors was making an operating margin of 21.63% on each interior door (($250 – $195.93) ÷ $250) and 27.53% on each exterior door (($400 – $289.90) ÷ $400). But, the ABC system reveals that it is actually making an operating margin of about 31.92% (($250 – $170.2) ÷$250) on each interior door and about 16.09% (($400 – $335.64) ÷ $400) on each exterior door. Fancy Doors, Inc. should consider decreasing the price of its interior doors to be more competitive. Fancy Doors should also consider increasing the price of its exterior doors, depending on the competition it faces in this market. Fancy Doors can also use the ABC information to improve its own operations. It could examine each of the indirect cost categories and analyze whether it would be possible to deliver the same level of service, but consume fewer indirect resources, or find a way to reduce the perunit- cost-driver cost of some of those indirect resources. Making these operational improvements can help Fancy Doors to reduce costs, become more competitive, and reduce prices to gain further market share while increasing its profits.
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