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:
|
Cost Driver |
Costs Assigned |
Activity Level 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 |
|
|
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?
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?
c. How might the results from using activity based costing in requirement (a) help management understand Rodent’s declining profits?