DETERMINING UNIT COSTS USING ABC
3. The cash sale of 90 percent of the merchandise completed during April at a total sales
The following information relates to the manufacturing operations of Fargo Development Co. dur- ing the month of July. The company uses job order costing.
a. Purchases of direct materials during the month amount to $100,000. (All purchases were made on account.)
b. Materials issued for various jobs in process during the month total $98,000.
c. Time cards of direct workers show 1,800 hours worked on various jobs during the month, for a total direct labor cost of $54,000.
d. Direct workers were paid $50,000 in July.
e. Actual overhead costs for the month amount to $110,000 (for simplicity, you may credit Accounts Payable).
f. Overhead is applied to jobs at a rate of $60 per direct labor hour.
PROBLEM 17.2B Job Order Costing:
Journal Entries and Cost Flows
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Confirming Pages
Problem Set B 795
g. Jobs with total accumulated costs of $222,000 were completed during the month.
h. During July, units costing $180,000 were sold for $288,000. (All sales were made on account.) Instructions
Prepare general journal entries to summarize each of these transactions in the company’s general ledger accounts.
Lincoln Estates manufactures log homes to customers’ specifications and uses job order costing. A predetermined overhead rate is used in applying manufacturing overhead to individual jobs. In the Cutting Department, overhead is applied on the basis of machine-hours. In the Assembly Depart- ment, overhead is applied on the basis of direct labor hours. At the beginning of the current year, management made the following estimates to assist in determining the overhead application rates:
PROBLEM 17.3B Job Order Costing:
A Comprehensive Problem
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Production of a home ordered by Cliff Newton (job no. 80) was started early in the year and completed at the end of the first quarter, on March 31. The records for this job show the following cost information:
Selected additional information for the first quarter is as follows:
Instructions
a. Compute the predetermined overhead rate for each department.
b. What is the total cost of the home produced for Cliff Newton?
c. Prepare the entries required to record the sale (on account) of the home to Cliff Newton. The sales price of the order was $602,000.
d. Determine the over- or underapplied overhead for each department at the end of the first quarter.
Monark Electronics uses job order costing and applies manufacturing overhead to individual jobs by using predetermined overhead rates. In Department A, overhead is applied on the basis of machine hours, and in Department B, on the basis of direct labor hours. At the beginning of the current year, management made the following budget estimates as a step toward determining the overhead application rates:
PROBLEM 17.4B Job Order Costing:
A Comprehensive Problem
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Cutting Assembly
Department Department
Direct labor hours—first quarter . . . 8,000 6,000 Machine-hours—first quarter . . . 7,000 3,000 Manufacturing overhead incurred in first quarter . . . $142,000 $87,000
Cutting Assembly
Annual Estimates Department Department Direct labor cost . . . $800,000 $960,000 Direct labor hours . . . 40,000 32,000 Manufacturing overhead . . . $600,000 $480,000 Machine-hours . . . 30,000 15,000
Cutting Assembly
Department Department
Job order for Cliff Newton ( job no. 80):
Direct materials cost . . . $100,000 $150,000 Direct labor cost . . . $10,000 $108,000 Direct labor hours . . . 500 3,600 Machine-hours . . . 400 300
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Production of 1,000 circuit boards (job no. 652) was started in the middle of January and com- pleted two weeks later. The cost records for this job show the following information:
Instructions
a. Determine the overhead rate that should be used for each department in applying overhead costs to job no. 652.
b. What is the total cost of job no. 652, and what is the unit cost of the product manufactured on this production order?
c. Prepare the journal entries required to record the sale (on account) of all 1,000 circuit boards to Computex Computers. The total sales price was $50,000.
d. Assume that actual overhead costs for the year were $800,000 in Department A and $615,000 in Department B. Actual machine-hours in Department A were 16,500, and actual direct labor hours in Department B were 24,000 during the year. On the basis of this information, deter- mine the over- or underapplied overhead in each department for the year.
Big Boomers makes custom clubs for golfers. The company also provides repair services for golf- ers with broken clubs. Most of the work is done by hand and with small tools used by craftsmen.
Customers are quoted a price in advance of their clubs being manufactured or repaired. To produce and repair clubs at a profit, management must have a thorough understanding of product costs.
Jeff Ranck, manager of the business, is considering using either direct labor hours or the num- ber of jobs as the basis for allocating overhead costs. He has estimated the following amounts for the coming year:
PROBLEM 17.5B Drivers for Drivers
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Instructions
a. Compute the overhead application rate based on (1) direct labor hours and (2) the number of jobs.
b. Shown below is information for two customer orders:
Job 1 Manufacture a full set of custom clubs. Direct materials used, $300; direct labor hours, 12; direct labor cost, $276.
Job 2 Repair broken putter and replace grips on a full set of irons. Direct materials used,
$100; direct labor hours, 3; direct labor cost, $60.
Determine the total cost of each job assuming that overhead costs are applied on the basis of:
1. Direct labor hours 2. Number of jobs
c. Discuss the results obtained in part b . Which overhead application method appears to provide more realistic results? Explain the reasoning behind your answer.
Annual Estimates Department A Department B Direct labor . . . $630,000 $450,000 Manufacturing overhead . . . $810,000 $620,000 Machine-hours . . . 16,200 3,000 Direct labor hours . . . 25,200 24,800
Department A Department B Job no. 652 (1,000 units of product):
Cost of materials used on job . . . $19,000 $1,750 Direct labor cost . . . $1,500 $750 Direct labor hours . . . 60 40 Machine-hours . . . 180 120
Estimated total overhead . . . $180,000 Estimated direct labor hours . . . 15,000 Estimated number of jobs . . . 2,500
Confirming Pages
Problem Set B 797
Logan Pharmaceutical produces two products: Caltrate and Dorkamine. The company uses activity-based costing (ABC) to allocate manufacturing costs to each product line. The costs incurred by the Quality Control Department average $5 million per year and constitute one of the largest components of the company’s total manufacturing overhead.
The Quality Control Department conducts routine inspections at two critical points. First, all raw materials are inspected before they are entered into the production process. Second, all com- pleted batches of product are inspected before being shipped to the finished goods warehouse.
The department’s costs are assigned to two activity cost pools: (1) preproduction inspections, and (2) postproduction inspections. Costs are assigned to the pools based on the number of employees engaged in each activity. Of the department’s 16 full-time employees, 4 are responsible for prepro- duction inspections and 12 are responsible for postproduction inspections.
Costs assigned to the preproduction pool are allocated to products based on the number of materials shipments received for each product line. Costs assigned to the postproduction pool are allocated to products based on the number of batches of each product produced.
For the upcoming year, Logan Pharmaceutical estimates the following activity levels:
PROBLEM 17.6B Applying Overhead Costs Using ABC P
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The materials used to produce Caltrate can be ordered only in small quantities and therefore must be ordered frequently. The company’s four preproduction inspectors devote a disproportion- ate amount of their time inspecting the 900 shipments of Caltrate materials. Dorkamine can be produced only in small batches and therefore must be produced frequently. Most of the problems associated with completed batches of Dorkamine can be traced to poor-quality materials. Very few problems are associated with the quality of Caltrate materials.
Instructions
a. Assign the Quality Control Department’s costs to the individual cost pools.
b. Allocate the preproduction cost pool to each product line.
c. Allocate the inspection cost pool to each product line.
d. Suggest how Logan Pharmaceutical might reassign responsibilities to make better use of its quality control inspectors.
Downhill Fast manufactures three ski products: boots, poles, and helmets. The company allocates manufacturing costs to each product line based on machine-hours. A large portion of its manufac- turing overhead cost is incurred by the Maintenance Department. This year, the department antici- pates that it will incur $250,000 in total costs. The following estimates pertain to the upcoming year:
PROBLEM 17.7B ABC versus Use of a Single Activity Base P
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Carol Safooma, the company’s cost accountant, suspects that unit costs are being distorted by using a single activity base to allocate Maintenance Department costs to products. She is consider- ing the implementation of an activity-based costing system (ABC).
Under the proposed ABC system, the maintenance costs would be allocated to the following activ- ity cost pools using the number of work orders as an activity base: (1) the equipment set-up pool, and (2) the custodial pool. Of the 2,400 work orders filed with the Maintenance Department each year, approximately 600 relate to equipment set-up activities, whereas 1,800 relate to custodial functions.
Equipment set-ups correlate with the number of production runs associated with each product line. Thus, the equipment set-up pool would be allocated based on the number of production runs required for each product. Custodial services correlate with square feet of production space and would be allocated based on the space required to produce each product line. The following table provides a summary of annual production activity and square footage requirements:
Total Caltrate Dorkamine
Shipments received . . . 1,200 900 300 Batches produced . . . 2,000 400 1,600
Estimated Estimated Units
Product Machine-Hours of Production Boots . . . 5,000 50,000
Poles . . . 10,000 200,000 Helmets . . . 35,000 20,000
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Instructions
a. Calculate the amount of Maintenance Department costs that would be allocated to each prod- uct line (on a per-unit basis) using machine-hours as a single activity base.
b. Calculate the amount of Maintenance Department costs that would be allocated to each product line (on a per-unit basis) using the proposed ABC system.
c. Are cost allocations currently being distorted using machine-hours as a single activity base?
Defend your answer.
Happy Cat, Inc., makes two lines of cat food: (1) Tabby Treat, and (2) Fresh n’ Fishy. The Tabby Treat line is a dry food that is processed almost entirely by an automated process. Fresh n’ Fishy is a canned food made with real carp from the Mississippi River. Each carp is filleted by hand before being tossed into an automated grinding and canning machine. Tabby Treat sells very well and is priced significantly below competitive brands. Sales of Fresh n’ Fishy have been on the decline, as the company has failed to keep the brand price competitive. Other information concerning each product line is provided below.
PROBLEM 17.8B ABC versus Use of a Single Activity Base LO6 P
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The company currently allocates manufacturing overhead to each product line on the basis of direct labor hours. Budgeted manufacturing overhead per month is $60,000, whereas budgeted direct labor hours amount to 15,000 per month.
Happy Cat recently hired a consultant to examine its cost accounting system. The consultant recommends that the company adopt activity-based costing to allocate manufacturing overhead.
He proposes that the following cost pools and cost drivers be used:
The amount of driver activity corresponding to each product line is as follows:
Estimated Estimated Square Product Production Runs Feet of Production Space
Boots . . . 500 9,000 Poles . . . 300 15,000 Helmets . . . 200 6,000
Tabby Fresh n’
Treat Fishy Number of units* produced and sold per month . . . 75,000 48,000 Direct materials cost per unit . . . $1 $3 Direct labor cost per hour . . . $16 $16 Direct labor hours per unit. . . 0.04 0.25
*Units for Tabby Treat refer to bags. Units for Fresh n’ Fishy refer to cases.
Cost Driver Tabby Treat Fresh n’ Fishy Kilowatt-hours . . . 200,000 kWh 50,000 kWh Machine set-ups . . . 70 mh 30 mh Square feet occupied . . . 42,000 sq. ft. 8,000 sq. ft.
Direct labor hours . . . 3,000 DLH 12,000 DLH
Amount Total Driver
Cost Pool Allocated Cost Driver Volume
Utilities $26,000 Kilowatt-hours 250,000 kWh
Maintenance 19,000 Machine set-ups 100 set-ups
Depreciation of plant and equipment 12,000 Square feet occupied 50,000 sq. ft.
Miscellaneous 3,000 Direct labor hours 15,000 DLH
Total allocation $60,000
Confirming Pages
Critical Thinking Cases 799
Instructions
a. Allocate manufacturing overhead costs to each product line using direct labor hours as a sin- gle cost driver.
b. Allocate manufacturing overhead costs to each product line using the activity-based costing approach recommended by the consultant.
c. Compute the total monthly manufacturing costs assigned to each product line when activity- based costing is used to allocate manufacturing overhead.
d. Assume that the company sets selling prices as a fixed percentage above the total manufacturing costs allocated to each product line. On the basis of your results from parts a and b, discuss a possible reason why sales of the Fresh n’ Fishy product line are currently experiencing a decline.
e. Discuss reasons why the company should adopt the recommendation of the consultant to implement an activity-based costing system.
Critical Thinking Cases
Classic Cabinets has one factory in which it produces two product lines. Walter manages the Wood Division, which produces wood cabinets, and Mary manages the Metal Division, which produces metal cabinets. Estimated unit production costs for the two types of cabinets are as follows:
CASE 17.1
Effect of Overhead Application on Performance Evaluation C
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At the end of the year, total overhead costs are allocated to each division based on direct labor hours used. A breakdown of estimated yearly overhead costs is as follows:
Demand for cabinets over the past several years has been steady and is not expected to change.
The Marketing Department estimates that approximately 10,000 wood cabinets and 7,500 metal cabinets will be sold each year for the foreseeable future. Each manager’s performance evaluation is based on the total production cost per unit for his or her product line. The manager that succeeds in reducing unit costs by the greatest amount from those estimated will earn a bonus.
Mary is considering purchasing a new machine for $500,000 that will last approximately 10 years and have no salvage value. If the machine is purchased, the direct labor hours required to produce a metal cabinet will be reduced to 2.5 hours.
Wood Metal Direct materials. . . $50.00 $35.00 Direct labor cost . . . 20.00 30.00 Manufacturing overhead . . . 16.30 24.45 Total production cost per unit . . . $86.30 $89.45 Selling price per unit . . . $180 $160 Direct labor hours required per unit . . . 2 3 Direct labor cost per hour . . . $10 $10
Salaries:
Walter . . . $ 50,000 Mary . . . 50,000 Maintenance . . . 20,000 Utilities . . . 16,000 Property taxes . . . 10,000 Annual straight-line depreciation:
Equipment, Wood Division . . . 80,000 Equipment, Metal Division . . . 120,000 Total overhead . . . $346,000
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Instructions
a. If the machine is purchased, what will be the total unit costs of production for each type of cabinet, assuming all other cost and production estimates are correct?
b. From Mary’s point of view, should the machine be purchased? Discuss whether Mary and Walter should be given sole authority over which equipment to purchase for their respective divisions.
c. What information do you think is necessary to decide whether to purchase the machine?
d. If the machine is purchased, do you think the performance evaluation of Walter and Mary will be accurate and fair under the current system?
Dave Miller is the controller of Mica Corporation. Mica produces five industrial cleaning products.
Miller recently decided to implement activity-based costing at Mica. In designing the system, he decided to identify heating costs as a separate cost pool. These costs will be allocated to products using the square feet of production space as a cost driver. Thus, the more square footage a particular product line requires, the greater its allocation of heating costs will be.
Miller has asked each production manager to submit an estimate of the production space occu- pied by their respective product lines. The figures he receives will be used to allocate the heating cost pool. The five production managers at Mica are paid an annual bonus based on their ability to control production costs traceable to their respective product lines.
Instructions
a. What ethical concern do you have regarding the method used to gather information about space utilization at Mica?
b. What suggestions do you have regarding how this information should be gathered?
Kendahl Plastics Corporation contracts with NASA to manufacture component parts used in communications satellites. NASA reimburses Kendahl on the basis of the actual manufacturing costs it incurs, plus a fixed percentage. Prior to being awarded a contract, Kendahl must submit a bid that details the estimated costs associated with each project. An examination of Kendahl’s job cost sheets reveals that actual costs consistently exceed cost estimates quoted during the bid- ding process. As a consequence, NASA ends up paying considerably more than the bids Kendahl submits.
A Kendahl representative was recently quoted as saying, “We really aren’t overcharging NASA for the work that we do. The actual costs shown on our job cost sheets seem high only because we are forced to understate our bid estimates in order to be awarded contracts. It’s a common practice, and everybody does it. The truth of the matter is companies that quote realistic bid prices are not awarded contracts.”
Instructions
Let us assume that it is common practice to purposely underestimate bids in order to win NASA contracts. Is it wrong for Kendahl to take part in this activity as long as it does not overstate the actual costs it incurs?
C. Erickson and Sons, Inc., is a Philadelphia-based construction company. Visit its home page at the following address:
www.cerickson.com
Instructions
a. Identify three projects and/or services provided by the company.
b. For each project or service identified, explain how cost accounting information would be use- ful to the company in providing the service or creating the project.
c. Which projects or services that you have identified would be most likely to benefit from job order costing and/or activity-based costing? Explain why.
CASE 17.2 Implementing ABC LO7
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CASE 17.3 The Bidding Wars
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INTERNET CASE 17.4
Costing Construction Work
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Critical Thinking Cases 801
Internet sites are time and date sensitive. It is the purpose of these exercises to have you explore the Internet. You may need to use the Yahoo! search engine http://www.yahoo.com (or another favorite search engine) to find a company’s current Web address.
Answers to Self-Test Questions
1. b 2. c 3. a 4. a 5. a, c, d 6. b 7. d
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Photo © Roberts Publishing Services. Product © Kellog Co.
Process Costing
A F T E R S T U D Y I N G T H I S C H A P T E R , Y O U S H O U L D B E A B L E TO :
Distinguish production procedures that match with process costing from those that correspond with job order costing.
Account for the physical flows and related cost flows when using process costing.
Demonstrate how to calculate equivalent units.
Use the costs of resources consumed to calculate the cost per equivalent unit of production.
Use the cost per equivalent unit to assign costs to the work completed during the period.
Create a process costing production report and use the report for decision making.
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Learning Objectiv es
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Located in Battle Creek, Michigan, Kellogg Company uses production methods that are ideal for process costing. William Kellogg’s accidental discovery of cereal in 1894 illustrates these methods. While experimenting with different food production techniques at the Battle Creek Sanatorium in Michigan, William and his brother, Dr. John Kellogg, decided to run boiled wheat dough through rollers, which enabled them to produce thin sheets of wheat. After a sudden interruption in their laboratory activities left cooked wheat exposed to the air for more than a day, the Kellogg brothers decided to run the wheat through the rollers despite the fact it was no longer fresh. To their amazement, instead of a single, large sheet of wheat, the rollers discharged a single flake for each wheat berry—and cereal flakes were born.
With net sales in excess of $12.5 billion, Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, frozen waffles, meat alternatives, pie crusts, and ice cream cones. Kellogg products are manufactured in 19 countries and marketed in more than 160 countries around the world. ■