Hobart Machines Ltd (HML) manufactures two products Standard and Enhanced, and applies overhead on the basis of direct labour hours. Anticipated overhead and direct labour time for the upcoming accounting period are $800 000 and 25 000 hours, respectively. Information about the company’s products follows:
Standard: _____________________________________________
Estimated product volume …………………………… 3 000 units
Direct material cost …………………………………. $25 per unit
Direct labor per unit ……………………. 3 hours at $12 per hour
Enhanced: ____________________________________________
Estimated product volume …………………………… 4 000 units
Direct material cost …………………………………. $40 per unit
Direct labor per unit ……………………. 4 hours at $12 per hour
HML’s overhead of $800 000 can be identified with three major activities: order processing also 000), machine processing ($560 000) and product inspection ($90 000). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively. Data relevant to these activities follow:
_____________ Order processed _______ Machine hours worked _______Inspection hours
Standard …………….. 300 ……………………… 18 000 ……………………… 2 000
Enhanced …………… 200 ……………………… 22 000 ……………………… 8 000
Total…………………. 500 ……………………….. 40 000 …………………….. 10 000
Top management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in profit is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery was installed-machinery that was expected to produce significant operating efficiencies.
Required:
1. Assuming use of direct labour hours to apply overhead to production, calculate the unit manufacturing costs of the Standard and Enhanced products if the expected manufacturing volume is attained.
2. Assuming use of activity-based costing, calculate the unit manufacturing costs of the Standard and Enhanced products if the expected manufacturing volume is attained.
3. HML’s selling prices are based heavily on cost.
(a) Using direct labour hours as an application base, which product is over costed and which product is under costed? Calculate the amount of the cost distortion for each product.
(b) Is it possible that over-costing and under-costing (i.e. cost distortion) and the subsequent determination of selling prices are contributing to the company’s profit woes? Explain.
4. Construct an Excel spreadsheet to solve requirements 1, 2 and 3 (a) above. Then show how the solution will change if the total overhead costs increase to $130 000 as a result of order processing costs increasing to $300 000 and product inspection costs increasing to $270 000?
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