Churchill Products is considering updating its cost system to an activity-based
ID: 2548258 • Letter: C
Question
Churchill Products is considering updating its cost system to an activity-based costing system and is interested in understanding the effects. The company’s cost accountant has identified three overhead cost pools along with appropriate cost drivers for each pool.
The company manufactures three models of water basins (Oval, Round, and Square). The plans for production for the next year and the budgeted direct costs and activity by product line are as follows:
Required:
a. The current cost accounting system charges overhead to products based on direct labor-hours. What unit product costs will be reported for the three products if the current cost system continues to be used? (Do not round intermediate calculations. Round "Per unit cost" answers to 2 decimal places.)
c. What are the cost driver rates for the three cost pools identified by the cost accountant? (Round your answers to 2 decimal places.)
d. What unit product costs will be reported for the three products if the ABC system suggested by the cost accountant's classification of cost pools is used? (Do not round intermediate calculations. Round "Per unit cost" answers to 2 decimal places.)
e. If management should decide to implement an activity-based costing system, what benefits should it expect? (Select the correct answer from the following options)
A. If management implemented an activity-based costing system it should be provided with a more thorough understanding of product costs.
B. If management implemented an activity-based costing system it will increase the sales of the company.
Explanation / Answer
Churchill Products
Determination of unit product costs to be reported for the three products using the current cost system of charging overhead to products based on direct labor hours:
Oval
Round
Square
total cost
$560,000
$280,000
$790,000
cost per unit
$140
$155.55
$131.67
Working –
Determination of overhead cost per direct labor hour –
Total overhead costs = $335,000 + $290,000 + $775,000 = $1,400,000
Total direct labor hours = 3,500 + 1,500 + 5,000 = 10,000
Overhead cost per direct labor hour = $1,400,000/10,000 = $140 per hour
Oval
Round
Square
direct costs
$70,000
$70,000
$90,000
Overhead costs
$490,000
$210,000
$700,000
Total costs
$560,000
$280,000
$790,000
number of units produced
4,000
1,800
6,000
cost per unit
$140
$155.55
$131.67
Determination of cost driver rates for the three cost pools:
cost pools
total cost
cost drivers
cost driver rate
Utilities
$335,000
67,000 machine hours
$5 per machine hour
Scheduling and setup
$290,000
580 setups
$500 per setup
Material handling
$775,000
1,550,000 pounds of material
$0.50 per pound
Cost driver rate = total cost/cost driver
For utilities, cost driver rate = $335,000/67,000 machine hours = $5 per MH
For Scheduling and setup, cost driver rate = $290,000/580 setups = $500 per setup
For Material handling, cost driver rate = $775,000/1,550,000pounds = $0.50 per pound of material
Allocation of costs and determination of unit costs for the three products using ABC system:
Oval
Round
Square
Total cost
$515,000
$405,000
$710,000
cost per unit
$128.75
$225
$118.33
Workings –
Total cost for Oval -
cost pool
cost driver rate
cost driver
Total cost
Utilities
$5 per MH
35,000 MHs
$175,000
Scheduling and setup
$500 per setup
80 setups
$40,000
Material handling
$0.50 per pound
460,000 pounds
$230,000
total direct costs
$70,000
total cost
$515,000
number of units
4,000
cost per unit
$128.75
Total cost for Round -
cost pool
cost driver rate
cost driver
Total cost
Utilities
$5 per MH
8,000 MHs
$40,000
Scheduling and setup
$500 per setup
300
$150,000
Material handling
$0.50 per pound
290,000 pounds
$145,000
total direct costs
$70,000
total cost
$405,000
number of units
1,800
cost per unit
$225.00
Total cost for Square -
cost pool
cost driver rate
cost driver
Total cost
Utilities
$5 per MH
24,000 MHs
$120,000
Scheduling and setup
$500 per setup
200
$100,000
Material handling
$0.50 per pound
800,000 pounds
$400,000
total direct costs
$90,000
total cost
$710,000
number of units
6,000
cost per unit
$118.33
If management should decide to implement an activity-based costing system, what benefits should it expect?
If management implemented an activity-based costing system it should be provided with a more thorough understanding of product costs.
Comparing the total costs and unit costs of the three products – Oval, Round and Square we observe that costs under activity-based costing system represent more accurate allocation since costs are assigned based on their usage of respective cost pools.
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