Problem 5-38 (pp170-171)

COLLABORATIVE LEARNING EXERCISE XXIII

The Tracy Corporation has a machining facility specializing in jobs for the
aircraft-components market. The previous job costing system had two direct-
cost categories (direct materials and direct manufacturing labor) and a single
indirect-cost pool (manufacturing overhead, allocated using direct
manufacturing direct-labor hours). The indirect-cost allocation rate of the
previous system for 2003 would have been $115 per direct manufacturing labor
hour.
Recently a team with members from production design, manufacturing and
accounting used an ABC approach to refine its job-costing system. The two
direct-cost categories were retained. The team decided to replace the single
indirect-cost pool with five indirect-cost pools. The cost pools represent five
activity areas at the facility, each with its own supervisor and budget
responsibility. Pertinent data are as follows:

Activity Area
Cost-Allocation Base
Cost-Allocation Rate
Material handling
Lathe work
Lathe turns
Milling Machine-hours
Grinding Parts
Testing Units

Information gathering technology has advanced to the point at which the data
necessary for budgeting in these five activity areas are collected automatically.
Two representative jobs processed under ABC system at the facility in the
most recent period had the following characteristics:
Per job
Direct materials
Direct manufacturing labor cost
Number of direct manufacturing labor-hours
Parts 500
Lathe turns
Machine-hours 150
Units (all tested)

An overview of the product-costing system is given above.

IE240 Levent Kandiller Spring 2008 Department of Industrial Engineering, Ç.U. IE240 Levent Kandiller Spring 2008 Department of Industrial Engineering, Ç.U. 1. Compute the manufacturing cost per unit under the previous job-costing
Job Order 410
Job Order 411
Direct manufacturing costs:
materials
manufacturing
Indirect manufacturing costs
Total manufacturing costs
Number of units
Manufacturing costs per unit
$ 1,332.50 $ 571.375
Compute the manufacturing
cost per unit under the previous
job-costing system.
Job Order 410
Job Order 411
Direct manufacturing costs:
materials
manufacturing
Indirect manufacturing costs:
Materials
handling
Grinding
Total manufacturing costs
$109,550
Number of units per job
Unit manufacturing cost per job

3. COMPARISON:

Job Order 410
Job Order 411
Number of units in job
Costs per unit with prior costing system $
Costs per unit with activity-based costing
Job order 410 has an increase in reported unit cost of % [($1,820 –
$1,332.50) ÷ $1,332.50], while job order 411 has a decrease in reported unit cost
of 4.1% [($ – $ ) ÷ $ ].
IE240 Levent Kandiller Spring 2008 Department of Industrial Engineering, Ç.U. A common finding when activity-based costing is implemented is that
low-volume products have increases in their reported costs while high-volume
products have decreases in their reported cost. This result is also found in
requirements 1 and 2 of this problem. Costs such as materials-handling costs
vary with the number of parts handled (a function of batches and complexity of
products) rather than with direct manufacturing labor-hours, an output-unit
level cost driver, which was the only cost driver in the previous job-costing
system.

The product cost figures computed in requirements 1 and 2 differ
because:
a. the job orders differ in the way they use each of five activity areas, and
b. the activity areas differ in their indirect cost allocation bases (specifically,
each area does not use the direct manufacturing labor-hours indirect cost
allocation base).

The following table documents how the two job orders differ in the way
they use each of the five activity areas included in indirect manufacturing
costs:

Usage Based on Analysis of
Usage Assumed with Direct Manuf.
Activity Area Cost Drivers
Labor-Hours as Application Base
Activity Area
Job Order 410
Job Order 411
Job Order 410
Job Order 411
Materials handling
Grinding

The differences in product cost figures might be important to Tracy
Corporation for product pricing and product emphasis decisions. The activity-
based accounting approach indicates that job order 410 is being costed
while job order 411 is being costed. Tracy Corporation may erroneously
push job order 410 and deemphasize job order 411. Moreover, by its actions,
Tracy Corporation may encourage a competitor to enter the market for job
order 411 and take market share away from it.

IE240 Levent Kandiller Spring 2008 Department of Industrial Engineering, Ç.U.

Source: http://academic.cankaya.edu.tr/~ipeks/eski/ie240spring08/ie240_coll_23.pdf