EXERCISE 1 Eastern Technologies produces two models of external computer hard drives: XM1 and XM2. Currently, manufacturing overhead of $460,000 is allocated using machine hours as the single allocation base for both products. Following is a breakdown of the machine hours used for the period to produce each product Traditional Costing XM1 XM2 Machine Hours 1,950 hrs 3,800 hrs Using this traditional allocation system, how much overhead would be allocated to each product Overhead Costs Quantity of Allocation Base Cost Allocation Rate S S per Machine hr Machine hrs Use the rate to allocate overhead and calculate a per unit amount: Activity Allocated #of Units Cost per Unit Actual Quantity of Activity Cost Allocation Rate Amount X $ 9,750 XM1 hrs per machine hr 14,475 XM2 hrs X $ per machine hr Complete the following analysis: Traditional Costing XM1 XM2 Selling Price per Unit $89.00 $149.00 Direct Costs: Direct Materials (per unit) Direct Labor (per unit) Allocated Overhead (per unit) (from above) 24.00 38.00 18.00 27.00 Total Cost per Unit: Gross Profit Per Unit (Price Total cost): Gross Profit Margin % (Gross Profit / Price) % % Because machine hours is the sing le allocation base for hard drives and the XM2 takes more machine hours to make, more overhead is being allocated to the XM2 hard drives. This costing is accurate only if machine hours are really the most accurate overhead cost driver AND only if XM2 drives really do cause more overhead than XM1 drives At the start of the previous period, Eastern's management accountants projected the following Gross Profit percentages for each product. Compare these budgeted percentages to the actual amounts you calculated above. XM1 XM2 49.8% Projected Gross Profit % 26.9% Actual Gross Profit % using a Single Rate System (previous page) % % Difference % Based on this analysis, do the XM2 drives appear to be OVERCOSTED or UNDERCOSTED? To gain more accuracy, Eastern decides to refine their costing system into an ABC Costing system. Follow these steps: 1. Identify the cost objects that will be allocated overhead costs (see completed analysis below): Allocation Cost Object Overhead Costs XM 1 $460,000 Cost Object XM 2 2. Pool all activities with the same cost driver (see completed analysis below). Match the following possible cost drivers to each activity. Remember, you are looking for a cause and effect relationship between the activity and cost driver. Machine Hours Design Hours Number of Setups Activity Pool Activity Type Coat Driver Number of Setups Batch-Level Setup Molding and Assembly Unit-Level Machine Hours Engineering costs Design Hours Product-Leyel 3. Compute the Cost Allocation Rate for each activity. Activity Overhead Costs Quantity of Allocation Base Cost Allocation Rate Setup 50 setups S $146,250 per setup Molding and Assembly S $208,750 1,670 Machine Hours per machine hr Engineering S $105,000 1,050 Design Hours per Design hr TOTAL $460,000 4. Allocate overhead costs to the cost object Use the rates calculated above along with the following breakdowns in activities to allocate overhead costs to each cost object. Calculate a Cost per Unit (round to the nearest cents). Activity of Units Activity Cost Allocation Rate Allocated Per Unit Setup X S XM1 30 per setup 9,750 X S 14,475 XM2 20 per setup Molding & Assembly X$ per machine hr 9,750 XM1 858 X $ 14.475 XM2 812 per machine hr Engineering X $ XM1 766 9,750 per design hr X S 14,475 XM2 284 per design hr S Prepare a Gross Profit Margin summary using the new allocations (ABC): Activity-Based Costing XM1 XM2 Selling Price per Unit $89.00 $149.00 Direct Costs: Direct Materials (per unit) 24.00 38.00 Direct Labor (per unit) 18.00 27.00 Allocated Overhead (ABC) Setup (per unit) Molding & Assembly (per unit) Engineering (per unit) Total Allocated Overhead (per unit) Total Cost per Hard Drive: (per unit) Gross Profit Per Unit (Price Total Cost) % Gross Profit Margin % (Gross Profit/ Price) Gross Profit Margin % Summary XM1 XM2 Traditional Costing (from earlier) % % % % Activity Based Costing (from schedule above) Cost Accountant Projections 26.9% 49.8% Which system (Traditional or ABC) resulted in a more accurate allocation of overhead based on the original cost accountant's projections