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Chapter 06 - Fundamentals of Product and Service Costing

Chapter 06 - Fundamentals of Product and Service Costing

Chapter 6 Fundamentals of Product and Service CostingSolutions to Review Questions

Cost allocation is the assignment of costs in cost pools to cost objects. The cost objects may be products, services, customers, processes, or anything for which we want to know the cost. Product costing uses cost allocation to calculate product costs. Product costing is an application of cost allocation where products are the cost objects.

Cost management systems should satisfy the following criteria: Cost systems should have a decision focus. Different cost information is used for different purposes. Cost information for managerial purposes must meet the cost-benefit test.

Cost flow diagrams serve two purposes. First, they help describe how a cost management system works, just like a flow chart helps you understand how a process works. Second, cost flow diagrams help managers identify and understand quickly the effect of changes in the system design on reported costs.

A job costing accounting system traces costs to individual units or to specific jobs (typically custom products). A process costing accounting system is used when identical units are produced through a series of uniform production steps. Operation costing is used when goods have some common characteristics (process costing) and some individual characteristics (job costing).

The predetermined overhead rate is the value at which overhead is applied to one unit of the cost allocation base. It is used in product costing to apply the overhead to the units produced.

It would be ideal, but unlikely, that an allocation base would reflect direct causality between the activity and the overhead cost.

Continuous flow processing is used when a single product is mass produced in a continuing process. Examples would include products such as paint, gasoline, paper, or any others that are mass produced in a continuing process.

The basic cost flow model appears as follows:Beginning balance + Transfers in Transfers out = Ending balanceBeginning balance is the balance of inventory at the beginning of the period. Transfers in represent inventory purchased or transferred in from another department (for example, raw materials would be goods transferred in to work in process) for the period. Transfers out are goods transferred from one department to another (for example, work in process would be transferred out to finished goods). Ending balance represents the amount of inventory in a department at the end of the accounting period.Solutions to Critical Analysis and Discussion Questions

Although there may be no one correct way to allocate cost, cost allocation can provide managers with information about the costs of the resources they use. Ignoring costs that cannot be directly assigned leads to the possibility that managers forget that it is a real resource that is being used.

There are three important points to consider:1.The cost system should meet the needs of the users (the decision makers).2.The cost system must provide the appropriate data for its intended purpose. Different cost information is used for different purposes.3.Cost information for managerial purposes must meet the cost-benefit test. The costs of implementing the system should be less than the benefits derived from the system (i.e. better decisions).

The basic cost flow model is as follows:Beginning balance + Transfers in Transfers out = Ending balance

This model is used for finding one unknown or for comparing perpetual inventory system output to a physical inventory count. An example of finding one unknown is if the beginning balance is known (from the previous period ending balance), transfers in are known, and ending inventory is counted physicallyand we are asked to find the cost of goods sold for the period (transfers out).

It is sometimes difficult (and frustrating) for managers when the cost accountant says that the cost depends on the decision being made. Many people feel that there is one cost that is correct. However, as we saw in Chapter 2, costs behave in different ways and this behavior is affected by the decision being made.

Reasons to agree with approach: If the products are not contributing to company profits, then the products should be eliminated. This will increase overall company profits.Reasons not to agree with approach: The reported product costs and the associated product profits depend on the allocation of indirect costs. Under a different allocation process, the results could be very different. In addition, many of the indirect costs are unavoidable. If the products are eliminated, the costs will be allocated to the remaining products.

The way the products are defined will depend, at least in part, on the decision the dean is interested in making. They may be defined as degree programs vs. non-degree programs. They may be the different degree programs. They might be the credit hour (although it is unlikely you would be able to get much information at this level).You might ask about the time frame of the analysis (to determine fixed and variable costs), the source of the data, and how to treat costs that the school does not directly pay for but where the school consumes the resources (e.g., university buildings).This is a very difficult analysis in a university setting because of the high proportion of common costs and the difficulty in defining products.

Answers will vary. Common answers include the number of students, the number of credit hours, number of classes, number of class sessions, and so on.

The two most important criteria in determining an allocation base are (1) causality and (2) measurability. We would like an allocation base that causes costs. This is rarely possible, but it is a good criterion to use. Second, we need to be able to measure the allocation base at reasonable cost.

Although it would be ideal for the cost allocation base to have cause-and-effect relation with overhead costs, it is unlikely to happen for several reasons. One reason is that some of the overhead is fixed and therefore does not depend on volume (at least within certain volume ranges). This does not make the choice of the allocation base unimportant. First, it is helpful to have an intuitive link between the allocation base (machine hours, for example) and overhead resource (machine depreciation). It serves as a reminder of the service being provided. Second, it is often the case that the cost is not solely fixed and there might be some variable component. Finally, cost might be fixed over a certain range, but not over the entire relevant range.

The allocation base determines the costs assigned to the cost objects. If these costs are used to make decisions and if they are based on inappropriate or improper allocation bases, they could lead the manager to make bad decisions.

There are many reasons why two companies may have different cost systems. First, firms may be pursuing different strategies (cost containment versus product differentiation) and want different information from the cost system. A second reason is that some firms may be subject to regulations (for example, utilities) and the regulations dictate the information needed from the cost system.

A firm can have a two-stage system and use the same allocation base to allocate costs in the second stage. There will be different costs reported if the allocation base (direct labor, say) is used differently by the products in the second stage cost pools.

Solutions to Exercises(20 min.)Basic Cost Flow Model: Office Mart.a.$300,000 (see item 5)b.$1,240,000 = $1,200,000 + $40,000 (see items 2 & 3)c.$200,000 (see item 5)d.$1,340,000. BB + TI TO = EB$300,000 + $1,240,000 X = $200,000X = $300,000 + $1,240,000 $200,000X = $1,340,000

(20 min.) Basic Cost Flow Model: Generic Electric.a.$100.5 million = $24.0 million + $40.5 million + (.8 x $45.0 million)b.$72.36 million = .72 x $100.5 millionc.BB + TI TO = EB0 + $100.5 million $72.36 million = EBEB = $28.14 million(20 min.) Basic Cost Flow Model.Based on the basic formula:

BB+TITO=EB

a.$51,000+X$57,000=$48,000

X=$54,000

b.$28,400+$88,000X=$24,800

X=$88,000 + $28,400 $24,800

X=$91,600

c.$67,000+X$170,000=$56,000

X=$56,000 + $170,000 $67,000

X=$159,000

(20 min.) Basic Cost Flow Model.Based on the basic formula:

BB+TITO=EB

A.X+$260,000$270,000=$250,000

X=$250,000 + $270,000 $260,000

X=$260,000

B.$7,100+$22,000X=$6,200

X=$7,100 $6,200 + $22,000

X=$22,900

C.$156,000+X$280,000=$128,000

X=$128,000 + $280,000 $156,000

X=$252,000

(20 min.) Basic Cost Flow Model.Based on the basic formula:

BB+TITO=EB

A.X+$18,000$27,000=$21,000

X=$21,000 + $27,000 $18,000

X=$30,000

B.$30,000+$110,000X=$31,000

X=$30,000 + $110,000 $31,000

X=$109,000

C.$260,000+X$920,000=$120,000

X=$120,000 + $920,000 $260,000

X=$780,000

(10 min.)Basic Product Costing: Enviro Corporation.

Materials$714,000

Labor61,200

Manufacturing overhead244,800

Total cost$1,020,000

Gallons produced 850,000

= Cost per gallon$1.20

(10 min.)Basic Product Costing: Poguess Pops.

Materials$650,000

Labor110,000

Manufacturing overhead2,940,000

Total cost$3,700,000

Liters produced 10,000,000

= Cost per liter$0.37

(10 min.)Basic Product Costing: Big City Bank.

Labor$ 35,000

Manufacturing overhead77,000

Total$ 112,000

Checks processed 2,800,000

= Cost per check$0.04

(20 min.) Basic Product Costing: Kim and Smith Refiners.

Totala.

Soldb.Work-in-Process, March 31

Production:

Gallons450,000400,00050,000

Percentage complete100%80%

Equivalent gallons440,000a400,00040,000

Costs:

Materials$188,000

Labor48,400

Manufacturing overhead98,000

Total cost incurred$334,400

Cost per equivalent gallon$0.76b

Cost assigned to product$334,400$304,000c$30,400d

a 440,000 equivalent units = 400,000 gallons completed + 80% x 50,000 gallons in process.b $0.76 = $334,400 440,000 equivalent units.c $304,000 = 400,000 equivalent units x $0.76.d $30,400 = 40,000 equivalent units x $0.76.

(20 min.) Basic Product CostingEthical Issues: Old Tyme Soda.a. and b.

Totala.

Soldb.Work-in-Process, November 30

Production:

Barrels10,0008,8001,200

Percentage complete100%30%

Equivalent barrels9,160a8,800360

Costs:

Materials$18,072

Manufacturing overhead20,400

Total cost incurred$38,472

Cost per equivalent barrel$4.20b

Cost assigned to product$38,472$36,960c$1,512d

a 9,160 equivalent units = 8,800 barrels sold + 30% x 1,200 barrels in process.b $4.20 = $38,472 9,160 equivalent units.c $36,960 = 8,800 equivalent units x $4.20.d $1,512 = 360 equivalent units x $4.20.

c. (1) He would raise the estimated degree of completion. The change in the estimate will cause more cost to be assigned to work-in-process inventory and less to finished goods. As the finished goods are sold, cost of goods will be lower and income higher.(2) Unless the production supervisors estimates are incorrect, the controller should not change the estimates. He or she has an ethical (and legal) obligation to ensure that the estimates reflect fairly the results of operations.

(15 min.) Process Costing: Van Goe.

TotalTransferred to Finished GoodsWork-in-Process, January 31

Production:

Gallons300,000240,00060,000

Percentage complete100%80%

Equivalent gallons288,000a240,00048,000

Costs:

Materials$411,000

Conversion costs525,000

Total cost incurred$936,000

Cost per equivalent gallon$3.25b

Cost assigned to product$936,000$780,000c$156,000d

a 288,000 equivalent units = 240,000 gallons completed + 80% x 60,000 gallons in process.a $3.25 = $936,000 288,000 equivalent units.b $780,000 = 240,000 equivalent units x $3.25.c $156,000 = 48,000 equivalent units x $3.25.

(15 min.) Process Costing: Opech, Inc.

Total

ShippedWork-in-Process, May 31

Production:

Barrels (millions)30027030

Percentage complete100%70%

Equivalent barrels (millions)29127021

Costs:

Materials (millions)$5,000

Conversion costs (millions)6,640

Total cost incurred (millions)$11,640

Cost per equivalent barrel$40a

Cost assigned to product$11,640$10,800b$840c

a 291 equivalent units = 270 barrels shipped + 70% x 30 barrels in process.a $40 = $11,640 291 equivalent units.b $10,800 = 270 equivalent units x $40.c $840 = 21 equivalent units x $40.

(15 min.) Process Costing: Oholics, Ltd.

Total

CompletedWork-in-Process, April 30

Production:

Pounds20,00019,0001,000

Percentage complete100%60%

Equivalent pounds19,600a19,000600

Costs:

Materials$29,700

Conversion costs36,940

Total cost incurred$66,640

Cost per equivalent pound$3.40b

Cost assigned to product$66,640$64,600c$2,040d

a 19,600 equivalent units = 19,000 pounds completed + 60% x 1,000 pounds in process.b $3.40 = $66,640 19,600 equivalent units.c $64,600 = 19,000 equivalent units x $3.40.d $2,040 = 600 equivalent units x $3.40.

(15 Minutes) Predetermined Overhead Rates: Tiger Furnishings.Predetermined overhead rate = $34.82 per direct labor hour.

BasicDominatorTotal

Units produced1,0002501,250

Machine-hours4,0002,0006,000

Direct labor-hours3,0002,0005,000

Direct materials$10,000 $3,750 $13,750

Direct labor64,50035,500100,000

Manufacturing overhead174,100

Total Costs$287,850

Burden Rate:

Total overhead$174,100

Direct labor-hours 5,000= $34.82

(15 Minutes) Predetermined Overhead Rates: Tiger Furnishings.

Predetermined overhead rate = 174.1% of direct labor cost.

BasicDominatorTotal

Units produced1,0002501,250

Machine-hours4,0002,0006,000

Direct labor-hours3,0002,0005,000

Direct materials$10,000 $3,750 $13,750

Direct labor64,50035,500100,000

Manufacturing overhead174,100

Total Costs$287,850

Burden Rate:

Total overhead$174,100

Direct labor cost $100,000=174.1%

(15 Minutes) Predetermined Overhead Rates: Tiger Furnishings.Predetermined overhead rate = $29.0167 per machine-hour (rounded).

BasicDominatorTotal

Units produced1,0002501,250

Machine-hours4,0002,0006,000

Direct labor-hours3,0002,0005,000

Direct materials$10,000 $3,750 $13,750

Direct labor64,50035,500100,000

Manufacturing Overhead174,100

Total Costs$287,850

Burden Rate:

Total overhead$174,100

Machine-hours 6,000=$29.0167

(20 Minutes) Predetermined Overhead Rates Tiger Furnishings.

(30 Minutes) Operations Costing: Howrley-David, Inc.The unit costs are:Fatboy:$4,000

Screamer:$5,000

FatboyScreamerTotal

Number of units2,0004,0006,000

Materials cost per unit $2,000 $3,000

Costs$ 4,000,000$12,000,000$16,000,000

Conversion costs:

Direct Labor$ 6,000,000

Indirect materials 1,800,000

Other overhead 4,200,000

Total operation cost$12,000,000

Conversion cost per unit in plant($12,000,000 6,000 units) = $2,000 per unit.

Operation cost (@ $2,000 per unit)$4,000,000a$8,000,000b$12,000,000

Material cost4,000,00012,000,000

Total cost$8,000,000$20,000,000

Number of units 2,000 4,000

Unit cost$4,000$5,000

a $4,000,000 = 2,000 units x $2,000 per unit.b $8,000,000 = 4,000 units x $2,000 per unit.

(30 Minutes) Operations Costing: S. Lee Enterprises.The unit costs are:SL1:$2,200

SL2:$2,700

SL1SL2Total

Number of units1,3001,8003,100

Materials cost per unit $900 $1,400

Costs$ 1,170,000$2,520,000$3,690,000

Conversion costs:

Direct Labor$ 1,200,000

Indirect materials 480,000

Other overhead 2,350,000

Total operation cost$4,030,000

Conversion cost per unit in plant($4,030,000 3,100 units) = $1,300 per unit.

Operation cost (@ $1,300 per unit)$1,690,000a$2,340,000b$4,030,000

Material cost1,170,0002,520,000

Total cost$2,860,000$4,860,000

Number of units 1,300 1,800

Unit cost$2,200$2,700

a $1,690,000 = 1,300 units x $1,300 per unit.b $2,340,000 = 1,800 units x $1,300 per unit.

(30 Minutes) Operations Costing: Organic Grounds.The unit costs are:Star:$10.60

Bucks:$12.60

StarBucksTotal

Number of pounds5,00020,00025,000

Materials cost per pound $4.00 $6.00

Costs$20,000$120,000$ 140,000

Conversion costs:

Direct Labor$ 50,000

Indirect materials 15,000

Other overhead 100,000

Total operation cost$165,000

Cost per pound in plant($165,000 25,000 pounds) = $6.60 per pound.

Conversion cost (@ $6.60 per pound)$33,000a$132,000b$165,000

Material cost20,000120,000

Total cost$53,000$252,000

Number of pounds 5,000 20,000

Cost per pound$10.60$12.60

a $33,000 = 5,000 units x $6.60 per pound.b $132,000 = 20,000 units x $6.60 per pound.

Solutions to Problems(30 Minutes) Product Costing: Tiger Furnishings.The unit costs are: Basic: $186.80 and Dominator: $404.22

BasicDominatorTotal

Direct materials$10,000 $3,750 $13,750

Direct labor64,50035,500100,000

Manufacturing overhead (@174.1% of Direct labor cost)a 112,295 61,805 174,100b

Total costs$186,795 $101,055 $287,850b

Units produced 1,000 250

Unit cost$186.80 $404.22

a 174.1% = $174,100 $100,000.b Adjusted for rounding error.

(30 Minutes) Product Costing: Tiger Furnishings.The unit costs are: Basic: $190.57 and Dominator: $389.13

BasicDominatorTotal

Direct materials$ 10,000 $3,750 $13,750

Direct labor64,50035,500100,000

Manufacturing overhead (@29.0167 per machine-hour) a116,067b 58,033c 174,100

Total costs$ 190,567 $97,283 $287,850

Units produced 1,000 250

Unit cost$ 190.57 $389.13

a $29.0167 per machine-hour = $174,100 6,000 machine-hours.b $116,067 = 4,000 machine-hours x $29.0167 per machine-hour.c $58,033 = 2,000 machine-hours x $29.0167 per machine-hour.

(30 Minutes) Product CostingEthical Issues: Tiger Furnishings.a.The unit costs are different because the two products use the machine hours and direct labor costs in different proportions. The Basic model is more machine intensive (it uses relatively more machine hours than labor compared to the Dominator model). This means that when the company moves to machine hours to allocate costs, the Basic model will be assigned more overhead costs resulting in higher reported product costs.b. Without knowing more about the production process at Tiger Furnishings, it is not possible to say which of these is better. Because you get different results, it may pay to use a two stage system to split overhead between that which is driven more by machine hours and that driven more by direct labor.c.The allocation base should be chosen on the basis of how overhead is related to cost. Income is the result of this decision and not the basis for the decision.(30 Minutes) Two-Stage Allocation and Product Costing: Mets Products.a.The overhead rates are $13.50 per machine hour and 45% of direct-materials cost.

AccountMachine-Hour RelatedMaterials Related

Utilities .$ 6,000

Supplies $4,200

Machine depreciation and maintenance 13,200

Purchasing and storing materials 4,800

Miscellaneous 5,100

Total overhead $ 24,300$ 9,000

Total machine hours 1,800 hours

Total materials cost $20,000

Overhead rate $13.50 / hour45%

b.The cost per unit of output is $3.49 for baseball caps and $4.96 for T-shirts.

Baseball CapsT-shirtsTotal

Machine hours used1,0008001,800

Direct materials costs .$12,000$8,000$20,000

Direct labor costs 4,000 2,4006,400

Manufacturing overhead costs .

Machine-hour related overheada13,50010,80024,300

Materials-related overheadb 5,400 3,600 9,000

Total cost$34,900$24,800$59,700

Units produced .. 10,000 5,00015,000

Cost per unit$3.49$4.96

a $13,500 = 1,000 machine hours x $13.50 per machine hour; $10,800 = 800 machine hours x $13.50 per machine hour.b$5,400 = $12,000 materials cost x 45%;$3,600 = $8,000 materials cost x 45%.

(30 Minutes) Two-Stage Allocation and Product Costing: Owl-Eye Radiologists.a.The overhead rates are $46 per equipment hour and $50 per direct labor hour.

AccountEquipment-Hour RelatedDirect-Labor Hour Related

Utilities .$ 4,800

Supplies $12,600

Indirect labor and supervision 20,400

Equipment depreciation and maintenance 8,400

Miscellaneous 3,360

Total overhead $ 16,560$ 33,000

Total equipment hours 360 hours

Total labor hours 660 hours

Overhead rate $46 per hour$50 per hour

b.The costs per patient are $114.75 per hospital patient hour and $29.44 per other patient.

Hospital PatientsOther PatientsTotal

Equipment hours used240120360

Direct labor-hours480180660

Direct labor costs $38,400 $10,800$49,200

Overhead costs .

Equipment-hour related overheada11,0405,52016,560

Direct labor-hours related overheadb 24,000 9,000 33,000

Total cost$73,440$25,320$98,760

Patients .. 640 8601,500

Cost per patient$114.75$29.44

a $11,040 = 240 equipment hours x $46 per equipment hour; $5,520 = 120 equipment hours x $46 per equipment hour.b$24,000 = 480 direct labor-hours x $50 per direct labor-hour;$9,000 = 180 direct labor-hours x $50 per direct labor-hour.(30 Minutes) Operations Costing: Vermont Instruments.The unit costs are:Fin-X:$28

Sci-X:$33

Fin-XSci-XTotal

Number of units10,00040,00050,000

Parts cost per unit$25$30

Costs$250,000$1,200,000$ 1,450,000

Operation costs:

Direct Labor62,000

Indirect materials 17,500

Overhead 70,500

Total operation cost$ 150,000

Cost per unit in plant($150,000 50,000 units) = $3 per unit.

Operation cost (@ $3 per unit)$ 30,000a$ 120,000b$150,000

Material cost250,0001,200,000

Total cost$ 280,000$1,320,000

Number of units 10,000 40,000

Unit cost$28$33

a $30,000 = 10,000 units x $3 per unit.b $120,000 = 40,000 units x $3 per unit. (45 Minutes) Account Analysis, Two-Stage Allocation, and Product Costing: Tiger Furnishings.a. Cost Flow Diagram

6-47. (continued)b. Basic$188

Dominator$400

BasicDominatorTotal

Units Produced1,0002501,250

Machine hours4,0002,0006,000

Direct labor hours3,0002,0005,000

Direct materials$10,000 $3,750 $ 13,750

Direct labor64,50035,500100,000

Manufacturing OverheadMachine-hourrelatedDirect labor cost related

Utilities$1,800$0$1,800

Supplies05,0005,000

Training010,000 10,000

Supervision025,800 25,800

Machine depreciation32,000 032,000

Plant depreciation14,200 014,200

Miscellaneous 085,30085,300

Total$48,000$126,100174,100

Total Costs$287,850

Burden Rates

Machine hour rate($48,000 6,000 hours) = $8.00

Direct labor cost rate($126,100 $100,000) = 126.1%

6-47. (continued)

Product Costing

Direct material$ 10,000 $ 3,750 $ 13,750

Direct labor 64,500 35,500 100,000

Overhead

Machine-related (@$8 per machine-hour)32,000a 16,000b 48,000

Labor-related (@126.1% direct labor cost) 81,335c 44,765d 126,100

Total overhead$113,335 $60,765 $174,100

Total cost$187,835 $100,015 $287,850

Units produced 1,000 2501,250

= Unit cost (rounded)= $188 = $400

a $32,000 = 4,000 machine-hours x $8 per machine-hour.b $16,000 = 2,000 machine-hours x $8 per machine-hour.c $81,335 = $64,500 x 126.1% direct labor cost.d $44,765 = $35,500 x 126.1% direct labor cost

Solutions to Integrative Case6-48. (45 Minutes) Product Costing, Cost Estimation, and Decision Making: Dolan Products.a. To determine product costs and margins, first calculate the Year 1 overhead rate:

Overhead rate=Total overheadTotal direct labor hours

=$750,000(5,000 x 2.0 + 10,000 x 1.0 + 20,000 x 0.5)

=$750,00030,000 hours

=$25 per direct labor hour

The product costs are:

RedYellowGreen

Direct materials $70.00$50.00$30.00

Direct labor (@$20)40.0020.0010.00

Manufacturing overhead (@$25) 50.00 25.00 12.50

Product cost$160.00$95.00$52.50

The product margins are:

RedYellowGreen

Price $150.00$100.00$75.00

Product cost160.0095.0052.50

Product margin$(10.00)$5.00$22.50

6-48. (continued)

b. To determine product costs and margins, first calculate the Year 2 overhead rate:

Overhead rate=Total overheadTotal direct labor hours

=$650,000(10,000 x 1.0 + 20,000 x 0.5)

=$650,00020,000 hours

=$32.50 per direct labor hour

The product costs are:

YellowGreen

Direct materials $50.00$30.00

Direct labor (@$20)20.0010.00

Manufacturing overhead (@$32.50) 32.50 16.25

Product cost$102.50$56.25

The product margins are:

YellowGreen

Price $100.00$75.00

Product cost102.5056.25

Product margin$(2.50)$18.75

6-48. (continued)

c. Dolan should not drop Yellow.The problem is that some of the manufacturing overhead is fixed and when a product is dropped, that cost is not avoided, but added to the overhead allocated to the remaining products. We know that not all the overhead is fixed, however, because overhead declined from $750,000 to $650,000 when Dolan dropped Red.

We can use the high-low method from Chapter 5 to estimate the fixed overhead component and the variable overhead rate. We only have two observations, so these serve as the high and low observations.

Variable cost =Cost at highest activity cost at lowest activity

Highest activity lowest activity

=$750,000 $650,000

30,000 20,000

= $10.00 per direct labor hour

Fixed costs=Total costs variable costs

=$750,000 ($10.00 x 30,000)

=$450,000

or

Fixed costs=$650,000 ($10.00 x 20,000)

=$450,000

Considering only financial considerations, the variable cost of Yellow is $50 for materials, $20 for direct labor, and $10 for variable overhead (because Yellow requires one hour of direct labor). Therefore, the total variable cost of Yellow is $80 (= $50 + $20 +$10) and the unit contribution margin is $20 (=$100 $80). If Dolan drops Yellow, the firm will lose $200,000 (= 10,000 units x $20 unit contribution margin) and profit.

6-49. (45 Minutes) Product Costing and Decision Making: Brunswick Parts.

This problem is designed to get students to understand the effect that cost systems can have on decisions by showing what happens when product cost information is used to schedule production when plants have very different ages (hence, very different depreciation expense).

a.

The reported product costs include direct materials, direct labor, and manufacturing overhead.

First, compute the plant-wide overhead rates used to allocate manufacturing overhead. (Note that the corporate administration overhead is irrelevant in the product-costing question. It is used for performance evaluation only.)

MonctonFredericton

Estimated plant overhead$1,000,000$600,000

Estimate production 100,000 labor hours 150,000 labor hours

= Overhead rate= $10 / labor hour=$4 / labor hour

The reported product costs of P28 in each plant can then be determined as follows:

MonctonFredericton

Direct material$25$25

Direct labor3 hrs. @ $9 = 274 hrs @ $10 = 40

Manufacturing overhead3 hrs @ $10 = 304 hrs @ $4 = 16

Total $82$81

b.

Based on the reported product costs, it appears that Fredericton is the plant where P28 should be produced. However, the Moncton plant is more efficient (it requires only 3 hours of direct labor compared to 4 hours at Fredericton). The distortion is caused by the fact that the Fredericton plant is almost fully depreciated whereas the Moncton plant is new and probably much more automated.

6-2 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

6-1 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.OverheadMachine-Related OverheadDirect Labor Cost Related OverheadDominatorBasicMachine HoursDirect Labor CostFirst StageSecond Stage