Chapter 5, Problem 40P

1.

To determine

Compute the cost per set and the total production cost of the three customer groups of F Company using activity based costing.

Explanation of Solution

Activity Based Costing: Activity based costing is a method of costing adopted by a company. Under this method, the activities in production are identified and the cost of each activity is assigned to all their products and services. An activity based costing can be used to recognize the resources spent by the company on activities that are performed in manufacturing the product or providing a service.

Step 1: Compute the total levels of activity cost drivers of F Company.

Table (1)

Step 2: Compute total activity rates of F Company.

Table (2)

Working Notes:

(1) Compute the activity rate of F Company with respect to number of parts.

$\begin{array}{c}\text{Number of parts = }\frac{\text{Materials Handling}}{\text{Total parts}}\\ \text{=}\frac{\$349,600}{\$772,000}\\ =\$0.45\end{array}$

(2) Compute the activity rate of F Company with respect to number of production orders.

$\begin{array}{c}\text{Production orders = }\frac{\text{Product Scheduling}}{\text{Production orders}}\\ \text{=}\frac{\$160,000}{\$300}\\ =\$500\end{array}$

(3) Compute the activity rate of F Company with respect to number of setups.

$\begin{array}{c}\text{Number of setups = }\frac{\text{Setup labor}}{\text{Production setups}}\\ \text{=}\frac{\$216,000}{\$120}\\ =\$1,800\end{array}$

(4) Compute the activity rate of F Company with respect to machine hours.

$\begin{array}{c}\text{Machine hours = }\frac{\text{Automated machinery}}{\text{Total machine hours}}\\ \text{=}\frac{\$1,750,000}{\$89,000}\\ =\$19.66\end{array}$

(5) Compute the activity rate of F Company with respect to direct labor hours.

$\begin{array}{c}\text{Direct labor hours = }\frac{\text{Finishing}}{\text{Total labor hours}}\\ \text{=}\frac{\$619,500}{\$89,200}\\ =\$6.95\end{array}$

(6) Compute the activity rate of F Company with respect to number of orders shipped.

$\begin{array}{c}\text{Number of orders shipped = }\frac{\text{Pick and ship}}{\text{Orders shipped}}\\ \text{=}\frac{\$290,400}{\$3,300}\\ =\$88\end{array}$

Step 3:

Compute the unit and total cost of F Company.

Table (3)

2.

To determine

Compute the production cost of each of the three customer groups of F Company using the current volume based approach of the company.

Explanation of Solution

Compute the production cost of each of the three customer groups of F Company using the current volume based approach of the company.

Table (4)

3.

To determine

Compute the revised activity rate of F Company and provide information on the costing of products and its strategic planning using the additional information.

Explanation of Solution

Compute the revised activity rate of F Company and provide information on the costing of products and its strategic planning using the additional information.

Table (5)

A significant change is observed in the activity rates that were computed in the above requirement. This is due to a notable level of unused capacity in many activities. This additional information can be utilized by the management to compute the activity based costs by using practical capacity rates. The information regarding utilization of capacity can be used to help bring the spending of resources in line with the resource usage. Additional capacity will be required in the luxury segment since the firm has plans of further growth. Therefore, a careful plan will enable them to balance their planned future capacity needs against their current spending on such resources that may allow the reduction of capacities. The potential for overcapacity seems to be highest in the activity of product scheduling and pack and ship.

4.

To determine

Provide information on the competitive and strategic issues by comparing both the costing approaches.

Explanation of Solution

Compute the profitability of F Company with respect to their customer group.

Table (6)

Compute the budgeted activity based cost of F Company.

Table (7)

• The results obtained from activity based costing indicate that luxury group is expensive to produce for the company. However, the volume based approach failed to account for the activity usage of the luxury line of products and it resulted in direct under-costing.
• Activity based costing enables the company to understand how their costs will increase along with their increase in producing the luxury line of products. This will help them to understand the manner in which the company will have to adapt their pricing policies accordingly. Using volume based costing can undermine the profitability of the entire firm by underpricing the luxury line. This will happen if the continued use of volume based approach when the sales of the luxury line are increasing.
• From the calculated results, it is concluded that luxury group is marginally profitable out of the three customer groups.