The board of directors of Mercury Manufacturing Company recently approved the co
ID: 2491488 • Letter: T
Question
The board of directors of Mercury Manufacturing Company recently approved the company’s budget and production plan for its coming fiscal year (FY). The company manufactures two products – door latches and door hinges – from a single plant that comprises four activities – machine setup, fabrication, assembly, and plant administration. The company uses the same resources (including machinery and equipment, supervision and administrative services) to manufacture both products. Management uses the traditional approach to allocate manufacturing overhead (MOH) costs, based on direct labor hours (DLH) incurred in its two production departments, to determine the unit cost of each product. The company’s budget includes the following MOH allocation and related computations:
Per unit:
Door latches
Door hinges
Selling price (SP)
$24.75
$11.98
Product costs:
Direct material (DM)
$ 7.20
$ 2.90
Direct labor (DL)
7.50
5.00
MOH (A) x (B)
3.87
2.58
Total
$18.57
$10.48
Gross profit (GP)
$ 6.18
$ 1.50
Gross margin (GM) GM = GP / SP (see Note 1 below)
25.0%
12.5%
Budgeted total units of production for fiscal year (FY)
50,000
150,000
Budgeted batch size (units per batch)
200
1,000
(A) Direct labor hours (DLH) per unit
0.30
0.20
(B) MOH cost per direct labor hour (DLH)
(C)
$12.90
(C)
$12.90
(C) Budgeted FY total MOH cost, $580,000 / Budgeted FY total DLHs, 45,000
Note 1 – Management set the selling prices for its products to achieve gross margins of 25 percent on latches and 12.5 percent on hinges, based on its analysis of competitors’ prices and the targeted return on equity capital set by the company’s board.
Management is considering adopting the Activity-based Costing (ABC) method to determine its product unit costs.
Using the information included in the table below (taken from the company’s budget and production plan) complete the table according to the ABC method to compute the per-unit MOH cost, total cost, gross profit, and gross margin of each product.
Describe briefly the apparent effect that managers’ use of the traditional MOH allocation method has had on its pricing decisions, compared to using the ABC method.
The budget and production plan reflect normal levels of production resource availability and capacity utilization (i.e., activity resource consumption) for the company.
a.
Activity
Budgeted MOH cost (Note A)
Activity cost driver (Driver type)
Budgeted level or volume of cost driver
MOH driver rate (dollars)
Consumption of cost driver
Door latches
Door hinges
Hours
Cost
Hours
Cost
Service depts.:
Machine setup
$130,000
Setup hrs (Batch)
1,300
$
4.0
$
2.0
$
Plant admin.
225,000
DLH in both prod. depts. (Unit)
$
0.30
$
0.20
$
Production depts.:
Fabrication
125,000
Machine hrs (Unit)
12,500
$
0.10
$
0.05
$
Assembly
100,000
DLH (Unit)
25,000
$
0.20
$
0.10
$
Total
$580,000
MOH costs:
Total batch-related (above)
$
$
Divide: Budgeted batch size (units)
Batch-related costs per unit
$
$
Total unit-related costs (above)
$
$
Total MOH cost per unit
$
$
Selling price (SP)
$
$
Product costs:
Direct material (DM)
$
$
Direct labor (DL)
$
$
MOH (from above)
$
$
Total
$
$
Gross profit (GP)
$
$
Gross margin (GM)
%
%
Note A: MOH costs include:
Machine setup: Indirect labor of setup employees and supervision
Plant administration: Indirect labor of plant manager; human resources and accounting employees; office equipment and supplies, telecommunications, and contract payroll services
Fabrication: Primarily, costs of machinery and equipment (depreciation, rent, refurbishments, property taxes, and insurance)
Assembly: Primarily, indirect supervisory labor of Assembly department production employees
b. (Limit the length of your response to 100 words)
Replace this text with your response.
Per unit:
Door latches
Door hinges
Selling price (SP)
$24.75
$11.98
Product costs:
Direct material (DM)
$ 7.20
$ 2.90
Direct labor (DL)
7.50
5.00
MOH (A) x (B)
3.87
2.58
Total
$18.57
$10.48
Gross profit (GP)
$ 6.18
$ 1.50
Gross margin (GM) GM = GP / SP (see Note 1 below)
25.0%
12.5%
Budgeted total units of production for fiscal year (FY)
50,000
150,000
Budgeted batch size (units per batch)
200
1,000
(A) Direct labor hours (DLH) per unit
0.30
0.20
(B) MOH cost per direct labor hour (DLH)
(C)
$12.90
(C)
$12.90
(C) Budgeted FY total MOH cost, $580,000 / Budgeted FY total DLHs, 45,000
Note 1 – Management set the selling prices for its products to achieve gross margins of 25 percent on latches and 12.5 percent on hinges, based on its analysis of competitors’ prices and the targeted return on equity capital set by the company’s board.
Explanation / Answer
(A)
Working Note 1:
(B) After applying activity based costing we get to know the actual cost of the product to take the right decision. We got to the know the actual profit percentage that each product generate. Before ABC according to management latches make more profit in comparison to hinges with a high difference. But after applying ABC they came to know the actual profits for each department.
No. of Batches = No. of units/ Units per batch 50000/200 = 250 Batch 150000/1000 = 150 Batches MOH costs: Total Batch related (Working Note 1) $1060 $2100 Divide: Budgeted Batch size (units) 200 1000 Batch Related Cost per Unit $5.3 $2.1 Total Units Related Costs $5.3 x 50000 units = $265000 $2.1 x 150000 units = $315000 Total MOH cost per unit $5.3 $2.1 Selling Price (SP) $24.75 $11.98 Product Cost: Direct Materials (DM) $7.20 $2.90 Direct Labor (DL) $7.50 $5.00 MOH (from above) $5.3 $2.1 Total $20 $10 Gross Profits(GP) ($24.75 - $20) x 50000 units = $237500 ($11.98 - $10) x 150000 units = $297000 Gross Margin (GM) 19.19% 16.52%Related Questions
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