Fairchild Inc. manufactures televisions that are designed for use in sports bars. The company has budgeted manufacturing overhead costs for the year as follows:

Type of Cost Cost Pools

Electric power .........$2,500,000

Inspection ...........1,500,000

Under a traditional cost system, the company estimated the budgeted capacity for machine hours to be 40,000 hours. The company is considering changing to an activity-based cost system. As part of its consideration of the new costing system, the company developed the following estimates:

Type of Cost Activity-Based Cost Drivers

Electric power .......50,000 kilowatt hours (KWH)

Inspection .........10,000 inspections (INSP)

The following information related to the production of 2,000 units of Model #1003 was accumulated:

Direct materials cost .........$50,000

Direct labor costs .........$75,000

Machine hours .......... 10,000

Direct labor hours .......... 5,000

Electric power—kilowatt hours ... 20,000

Number of inspections ....... 1,000

Based on the data, Fairchild’s accounting department provided management with the following report:

Activity-Based Costing System Estimate:

Required

A. Explain the difference between activity-based costing and traditional costing and describe how ABC might enhance the financial reporting of Fairchild.

B. If Fairchild were setting a sales price based on a 20 percent markup, how would profit be affected if the company did not change to an ABCsystem?

Transcribed Image Text:

Traditional Costing System Estimate: Overhead rate per machine hour $100.00 Manufacturing costs for 2,000 units: Direct materials $ 50,000 Direct labor 75,000 Applied overhead 1,000,000 Total cost $1,125,000 Cost per unit $562.50