# Question: Video Options Ltd manufactures two types of DVD players standard

Video Options Ltd. manufactures two types of DVD players: standard and deluxe. It attempts to set selling prices based on a 50% markup on manufacturing costs to cover selling and administrative expenses and to earn an acceptable return for shareholders. Bill Merch, vice president—Marketing, is confused because the numbers provided by Terry Green, controller, indicate that standard DVD players should be priced at \$150 per unit and deluxe DVD players at \$300 per unit. The competition is selling comparable models for \$145 and \$525, respectively. Merch informs Green that there must be something wrong with the job costing system. He had recently attended a seminar where the speaker stated that “All production costs are not a function of how many units are produced, or of how many labor hours, labor dollars, or machine hours are expended.” He knows that the company uses direct labor dollars as its only cost allocation base. Bill thinks that perhaps this explains why the product costs and, therefore selling prices, are so different from those of the competitors. Currently, the costs per unit are determined as follows:
Factory overhead is currently applied using a plantwide rate based on direct labor cost. This year’s rate was computed as follows:
Direct labor support............................................................ \$ 300,000
Machine support ............................................................... 400,000
Setup costs..................................................................... 200,000
Design costs.................................................................... 100,000
Total.............................................................................. \$1,000,000
Budgeted direct labor cost is \$333,333.
Budgeted factory overhead rate ¼ \$1,000,000/\$333,333 ¼ 300% of direct labor dollars
Green, knowing that you had recently studied ABC in your cost accounting course, employs you as a consultant to determine what effect its usage would have on the product costs. You first gathered the following data:
Required:
1. From the data that you gathered, determine the best allocation base for each of the four components of factory overhead.
2. Compute an overhead rate for each of the four components.
3. Determine the new unit cost for standard and deluxe models using ABC.
4. Why are the product costs so dramatically different when ABC is used?
5. Would Video Options’ selling prices be closer to those of the competition if ABC were used?

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