Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 25

Activity-Based versus Traditional Costing

Rodent Corporation produces two types of computer mice, wired and wireless. The wired mice are designed as low-cost, reliable input devices. The company only recently began producing the higher-quality wireless 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 $330,000 based on production of 160,000 wired mice and 50,000 wireless mice. Direct labor and direct materials costs were as follows:

	Wired	Wireless	Total
Direct labor	$261,000	$ 99,000	$360,000
Materials	187,500	171,000	358,500

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

		Activity Level
Cost Driver	Costs Assigned	Wired	Wireless	Total
Number of production runs	$ 150,000	20	5	25
Quality tests performed	135,000	6	9	15
Shipping orders processed	45,000	50	25	75
Total overhead	$ 330,000			J

Required

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?

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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?

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c.How might the results from using activity-based costing in requirement (a) help management understand Rodent's declining profits?

Step 1 of 8

a.

Calculation of overhead cost assigned to each product based on three cost drivers i s shown below

Thus, total overhead cost for wired is $204,000 and for wireless is $126,000.