Keystone Company produces two products: Regular and Premium. Regular is produced in high volumes through a robotic process with no hazardous waste. Premium’s production process generates large quantities of hazardous wastes. A competitor produces only one product very similar to Regular. Keystone Company sells Regular at its competitor’s price to maintain current volumes. Regular does not appear to be profitable, but Keystone Company has not dropped Regular because of its commitment to increase its sustainable management activities. Although another competitor produces Premium, Keystone sells Premium at a profit and its managers believe they can increase market share considerably.

Keystone uses a traditional costing system and allocates overhead costs based on direct labor hours. Annual production of Regular is 10,000 units and Premium is 1,500 units. Each product requires four direct labor hours per unit. However, Premium requires more machine setups and quality inspections than Regular. Premium is produced in small batches that are ordered and run much more frequently than Regular. Regular requires 10 components and Premium requires 5. Only 20% of the facility is devoted to Premium production, with the remainder used for Regular. Keystone’s manufacturing overhead costs total $2,070,000.

Direct material and labor costs for each product are as follows:

The managers of Keystone are considering adopting an activity based costing system with the following activities and cost drivers for manufacturing overhead costs:


QUESTION CONTINUE TO NEXT PAGE

Based on a special study, Keystone’s accountants determined that product-level costs of
$517,500 could be broken down even further as follows:
Research and development and maintenance ....$207,000
Environmental reporting requirements ........ 500
Environmental inspections ............ 60,000
Waste treatment costs on site ........... 100,000
Landfill disposal costs .............. 150,000
Total product-level costs .............$517,500

The special study also determined that the product research and development and maintenance costs can be properly allocated to products based on the number of components in the product. All of the environmental costs are associated with Premium.

REQUIRED
A. Assuming that Keystone uses the traditional cost accounting system:
1. Calculate the manufacturing overhead cost allocation rate.
2. Allocate manufacturing overhead to both products, and calculate the cost per unit of Regular and Premium.
B. Assuming that Keystone uses the activity based costing system without the special study:
1. Calculate the manufacturing overhead cost allocation rate for each activity cost pool.
2. Allocate manufacturing overhead costs to each type of product and calculate the cost per unit of Regular and Premium.
3. Compare the results of this allocation to the traditional allocation in part (A). Explain any differences.
C. Assuming that Keystone uses the special study to modify the activity based costing system:
1. Reallocate the product-level costs and calculate the cost per unit of Regular and Premium.
2. Compare the results of this allocation to the ABC allocation in part (B). Explain any differences.
D. How might a traditional versus an ABC costing system affect Keystone Company’s managers’ perceptions of the company’s competitive position?
E. Before making a decision about keeping or dropping one of these products, what additional information do you need? Would GPK or RCA information add value for this type of decision?Explain.

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Regular 300 100 Premium $ 200 100 Direct Materials Direct Labor (4 hours @ $25 per hour) Product Cost Driver Regular Premium Activity Unit Level: Machine costs Batch Level: Quality control Preparing for new batch Product Level: Product research and development, maintenance, and waste control Cost Machine Hours S 250,000 2,000 3,000 Quality Inspections 700,000 ,500 7,500 202,500 3375 6,750 Machine Setups 517,500 Number of Components Facility Level: Plant depreciation, property insurance, property taxes, and maintenance Not Applicable 400,000 Total manufacturing overhead cost $2,070,000