Chapter 9, Problem 37E

Activity-Based versus Traditional Costing

Maglie Company manufactures two video game consoles: handheld and home. The handheld consoles are smaller and less expensive than the home consoles. The company only recently began producing the home model. Since the introduction of the new product, profits have been steadily declining. Management believes that the accounting system is not accurately allocating costs to products, particularly because sales of the new product have been increasing.

Management has asked you to investigate the cost allocation problem. You find that manufacturing overhead is currently assigned to products based on their direct labor costs. For your investigation, you have data from last year. Manufacturing overhead was $1,440,000 based on production of 28,000 handheld consoles and 10,000 home consoles. Direct labor and direct materials costs were as follows:

Management has determined that overhead costs are caused by three cost drivers. These drivers and their costs for last year are as follows:

Required

1. a.      How much overhead will be assigned to each product if these three cost drivers are used to allocate overhead? What is the total cost per unit produced for each product?
2. b.      How much overhead will be assigned to each product if direct labor cost is used to allocate overhead? What is the total cost per unit produced for each product?
3. c.       How might the results from using activity-based costing in requirement (a) help management understand Maglie’s declining profits?