(ABC; pricing) Perioto Inc. currently charges manufacturing overhead costs to products using machine hours. However, company management believes that the use of ABC would provide more realistic cost estimates and, in turn, give the company an edge in pricing over its competitors. Perioto’s accountant and production manager have pro vided the following budgeted information for 2011, given a budgeted capacity of 1,000,000machine hours:
|
Type of Manufacturing Cost |
Cost Amount |
|
Electric power |
$ 500,000 |
|
Work cells |
3,000,000 |
|
Material handling |
1,000,000 |
|
Quality control inspections |
1,000,000 |
|
Machine setups |
350,000 |
|
Total budgeted overhead costs |
$5,850,000 |
|
Type of Manufacturing Cost |
Activity Drivers |
|
Electric power |
200,000 kilowatt hours |
|
Work cells |
300,000 square feet |
|
Material handling |
200,000 material moves |
|
Quality control inspections |
50,000 inspections |
|
Machine setups |
25,000 setups |
A national construction company approached Pete Lang, the VP of marketing, about a bid for 2,500 doors. Lang asked the cost accountant to prepare a cost estimate for producing the 2,500 doors; he received the following data:
|
Direct material cost |
$ 50,000 |
|
Direct labor cost |
$150,000 |
|
Machine hours |
5,000 |
|
Direct labor hours |
2,500 |
|
Electric power—kilowatt hours |
500 |
|
Work cells—square feet |
1,000 |
|
Number of material handling moves |
20 |
|
Number of quality control inspections |
15 |
|
Number of setups |
6 |
a. What is the predetermined overhead rate if the traditional measure of machine hours is used?
b. What is the manufacturing cost per door as presently accounted for?
c. What is the manufacturing cost per door under the proposed ABC method?
d. If the two cost systems will result in different cost estimates, which cost accounting system is preferable as a pricing base and why?
e. If activity based management were implemented prior to an ABC system, which of the manufacturing overhead costs might be reduced or eliminated? Why?