Chapter 9, Problem 54P

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

1. 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?
2. b.      A consulting firm has recommended using an activity-based costing system, with the activities based on the cost pools identified by the cost accountant. Prepare a cost flow diagram of the proposed ABC system.
3. c.       What are the cost driver rates for the three cost pools identified by the cost accountant?
4. 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?
5. e.       If management should decide to implement an activity-based costing system, what benefits should it expect?

To determine

Determine the unit product costs according to the information given in the question.

Explanation of Solution

Activity-based costing:

Activity-based costing refers to the method of costing where the overhead cost is assigned to various products. This costing method identifies the relationship between the manufacturing overhead costs and the activities. This relationship is then used to allocate indirect costs to the products.

Compute the unit cost:

Particulars	Oval	Round	Square
Direct costs	$240,000	$240,000	$240,000
Add: Overhead $\left(\text{Burden rate }\times \text{ Direct labor hours}\right)$	$2,016,000	$1,134,000	$3,150,000
Total costs	$2,256,000	$1,374,000	$3,390,000
Number of units	6,000	3,000	9,000
Unit cost $\left(\frac{\text{Total costs}}{\text{Number of units}}\right)$	$376	$458	$377

Table: (1)

Compute the burden rate:

$\begin{array}{c}\text{Burden rate = }\frac{\text{Total overhead costs}}{\text{Total direct labor-hours}}\\ =\frac{\$1,350,000+\$1,350,000+\$3,600,000}{4,800+2,700+7,500}\\ =\frac{\$6,300,000}{15,000}\\ =\$420\end{array}$

To determine

Prepare a cost flow diagram according to the information given in the question.

Explanation of Solution

Activity-based costing:

Activity-based costing refers to the method of costing where the overhead cost is assigned to various products. This costing method identifies the relationship between the manufacturing overhead costs and the activities. This relationship is then used to allocate indirect costs to the products.

Cost flow diagram:

Cost flow diagram determines the flow of the cost of the operations through working dynamics of the cost flow system.

Figure (1)

To determine

Determine the cost driver rate according to the information given in the question.

Explanation of Solution

Activity-based costing:

Activity-based costing refers to the method of costing where the overhead cost is assigned to various products. This costing method identifies the relationship between the manufacturing overhead costs and the activities. This relationship is then used to allocate indirect costs to the products.

Determine the cost drivers and cost drivers rate:

Particulars	Cost	Cost driver	Cost per cost driver $\left(\frac{\text{Cost}}{\text{Cost driver}}\right)$
Utilities	$1,350,000	90,000 machine hours	$15
Scheduling and setup	$1,350,000	900 setups	$1,500
Material handling	$3,600,000	2,400,000 lbs.	$1.50

Table: (2)

To determine

Determine the unit product costs according to the information given in the question.

Explanation of Solution

Activity-based costing:

Activity-based costing refers to the method of costing where the overhead cost is assigned to various products. This costing method identifies the relationship between the manufacturing overhead costs and the activities. This relationship is then used to allocate indirect costs to the products.

Compute the unit cost:

Particulars	Oval	Round	Square
Direct costs	$240,000	$240,000	$240,000
Add:Overhead:
Utilities $\left(\begin{array}{l}\text{Hourly rate }\\ \times \text{ Number of machine hours}\end{array}\right)$	$675,000	$225,000	$450,000
Scheduling and setup $\left(\begin{array}{l}\text{Rate per setup}\\ \times \text{ Number of setup}\end{array}\right)$	$180,000	$675,000	$495,000
Material handling $\left(\begin{array}{l}\text{Rate per lb }\\ \times \text{ Number of lbs}\end{array}\right)$	$1,125,000	$675,000	$1,800,000
Total costs	$2,220,000	$1,815,000	$2,985,000
Number of units	$6,000	$3,000	$9,000
Unit cost $\left(\frac{\text{Total cost}}{\text{Number of units}}\right)$	$370	$605	$332

Table: (3)

To determine

Determine the effect of implementing activity-based costing system.

Explanation of Solution

Activity-based costing (ABC):

Activity-based costing refers to the method of costing where the overhead cost is assigned to various products. This costing method identifies the relationship between the manufacturing overhead costs and the activities. This relationship is then used to allocate indirect costs to the products.

The relevance of the ABC system according to the information given in the question:

The implementation of the ABC system would make the understanding of product costs. The cost drivers would be determined by breaking down the costs with respect to the cost drivers. The determination and analysis of the product complexity, product cost, and product volume would provide the correlation between the three. This vital information would be critical for pricing decisions and profitability strategies.