Tas Machinery manufactures two products, basic and superior, and applies overhea

Question

Tas Machinery manufactures two products, basic and superior, and applies overhead on the basis of direct labour hours. Anticipated overhead and direct labour time for the upcoming accounting period are $1,206,000 and 40,200 hours, respectively. Information about the company's products follows: Basic: Estimated product volume Direct material cost Direct labour per unit 4,400 units $20 per unit 3 hours at $16 per hour Superior: Estimated product volume Direct material cost Direct labour per unit 5,400 units $50 per unit 5 hours at $16 per hour Tas Machinery's overhead of $1,206,000 can be identified with three major activities: order processing ($256,000), machine processing ($840,000) and product inspection ($110,000). These activities are driven by number of orders processed, machine hours worked and inspection hours, respectively. Data relevant to these activities follow: Machine Hours Order Processed Worked 20,000 22,000 42,000 Inspection Hours 3,600 7.400 11,000 Basic Superior Total 470 330 800 Top management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in profit is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery was installed-machinery that was expected to produce significant operating efficiencies. Required 1. Assuming use of direct labour hours to apply overhead to production, calculate the unit manufacturing costs of the basic and superior products if the expected manufacturing volume is attained. 2. Assuming use of activity-based costing, calculate the unit manufacturing costs of the basic and superior if the expected manufacturing volume is attained. 3. Tas Machinery's selling prices are based heavily on cost. 1. (a) Using direct labour hours as an application base, which product is overcosted and which product is undercosted? Calculate the amount of the cost distortion for each product. 2. (b)Is it possible that overcosting and undercosting (i.e. cost distortion) and the subsequent determination of selling prices are contributing to the company's profit woes? Explain.

Explanation / Answer

1)Overhead rate =estimated overhead/ estimated DLH

       = 1206000/40200

        = $ 30 Per direct labor hours

2)

3)

a)using Direct labor hours ,product superior is overcosted as it cost $ 280 under traditional costing whereas cost $ 244.74 under ABC costing .

Product Basic is undercosted as it cost $ 158 under traditional costing whereas cost $ 201.27 under ABC costing

b)Yes ,Cost distortion may occur when the company determines its overhead application using either traditional method or activity based costing that result in lower cost resulting in higher profit .Determination of selling price based on cost will also lead to increased profit (a techinque company can use to show inflated profit)

Basic superior Direct material 20 50 Direct labor 16*3=48 16*5=80 overhead 30*3=90 30*5=150 Total manufacturing cost 158 280

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