Calculating Costontario Inc Manufactures Two Products Stand

Calculating Costontario Inc Manufactures Two Products Standard And

Calculating Costontario Inc. manufactures two products, Standard and Enhanced, and applies overhead based on direct-labor hours. The anticipated overhead for the upcoming period is $800,000, with total direct-labor hours of 25,000. The company produces an estimated 3,000 units of Standard and 4,000 units of Enhanced. Data on direct material costs, labor per unit, and activity-based overhead costs are provided. The overhead is allocated via three main activities: order processing, machine processing, and product inspection, each driven by specific activity measures. The company faces profitability concerns despite increased sales and recent plant investments. The assignment involves calculating unit manufacturing costs using two different costing methods, assessing over- or under-costing, and analyzing how changes in activity-based overhead allocations influence cost and profitability perceptions.

Paper For Above instruction

To effectively analyze Costontario Inc.'s manufacturing costs and their impact on profitability, it is essential to approach the problem from different costing perspectives. First, I will calculate the unit manufacturing costs using traditional costing based on direct-labor hours. Then, I will use activity-based costing (ABC) to determine more accurate product costs by assigning overhead based on actual activities. Finally, I will compare the two methods to evaluate potential over- or under-costing issues and explore the implications of changing overhead allocations on cost and profitability assessments.

Traditional Costing Calculation

Traditional costing allocates overhead based on direct-labor hours, which simplifies overhead distribution but may distort product costs, especially when products consume overhead resources differently. The first step involves calculating the predetermined overhead rate: total overhead divided by total direct-labor hours.

Predetermined overhead rate = $800,000 / 25,000 hours = $32 per direct-labor hour

Next, compute the direct-labor cost per unit for each product:

  • Standard: 3 hours at $12/hour = $36
  • Enhanced: 4 hours at $12/hour = $48

Then, calculate the overhead applied per unit:

  • Standard: 3 hours × $32 = $96
  • Enhanced: 4 hours × $32 = $128

Finally, determine the total manufacturing cost per unit:

  • Standard: $25 (material) + $36 (labor) + $96 (overhead) = $157
  • Enhanced: $40 (material) + $48 (labor) + $128 (overhead) = $216

This traditional method may not accurately reflect the true resource consumption and activity involvement, especially as overhead activities are driven by varied factors beyond labor hours.

Activity-Based Costing (ABC) Calculation

The ABC approach assigns overhead based on specific activities: order processing, machine operation, and inspection, each with distinct cost drivers and overhead pools.

The total overhead costs are summarized as:

  • Order processing: $150,000
  • Machine processing: $560,000
  • Inspection: $90,000

The activity data provided are:

  • Orders processed: Standard 300, Enhanced 200
  • Machine hours: Standard 18,000, Enhanced 22,000
  • Inspection hours: Standard 2,000, Enhanced 8,000

Calculate the activity rates:

  • Order processing rate: $150,000 / 500 orders = $300 per order
  • Machine processing rate: $560,000 / 40,000 hours = $14 per machine hour
  • Inspection rate: $90,000 / 10,000 hours = $9 per inspection hour

Now, determine the overhead assigned per product:

  • Standard:
    • Order: 300 orders × $300 = $90,000
    • Machine: 18,000 hours × $14 = $252,000
    • Inspection: 2,000 hours × $9 = $18,000
    • Total overhead for standard: $90,000 + $252,000 + $18,000 = $360,000
  • Enhanced:
    • Order: 200 orders × $300 = $60,000
    • Machine: 22,000 hours × $14 = $308,000
    • Inspection: 8,000 hours × $9 = $72,000
    • Total overhead for Enhanced: $60,000 + $308,000 + $72,000 = $440,000

Calculate the per-unit overhead costs:

  • Standard: $360,000 / 3,000 units = $120 per unit
  • Enhanced: $440,000 / 4,000 units = $110 per unit

Determine total unit costs:

  • Standard: $25 (material) + $36 (labor) + $120 (ABC overhead) = $181
  • Enhanced: $40 (material) + $48 (labor) + $110 (ABC overhead) = $198

This approach typically provides more precise product costs, revealing cost distortions under traditional methods.

Over-Costing and Under-Costing Analysis

Comparing the two costing methods highlights that, under traditional costing, Standard costs are $157 per unit, which is lower than the ABC cost of $181. Conversely, Enhanced costs are $216 versus $198, indicating that traditional costing underestimates the cost of the Enhanced product while overestimating Standard's cost.

This misallocation suggests the Standard product appears more profitable than it truly is, and the Enhanced appears less profitable. Such misrepresentation could influence managerial decisions on pricing, product mix, and resource allocation, potentially exacerbating profitability issues. Over-costing of Standard might lead to price reductions or unprofitable sales, while under-costing of Enhanced might cause underpricing and overlooked profitability potential.

Impact of Changes in Overhead Allocation

If overheads tied to order processing increase to $300,000 and inspection to $270,000, the rates and costs will adjust significantly:

New activity rates:

  • Order processing: $300,000 / 500 orders = $600 per order
  • Inspection: $270,000 / 10,000 hours = $27 per inspection hour

Recalculating overheads for products:

  • Standard:
    • Order: 300 × $600 = $180,000
    • Machine: unchanged at $252,000
    • Inspection: 2,000 × $27 = $54,000
    • Total: $180,000 + $252,000 + $54,000 = $486,000
  • Enhanced:
    • Order: 200 × $600 = $120,000
    • Machine: $308,000 (unchanged)
    • Inspection: 8,000 × $27 = $216,000
    • Total: $120,000 + $308,000 + $216,000 = $644,000

Per-unit costs then escalate significantly, exacerbating potential over- and under-costing issues, and illustrating how overhead reallocations critically affect cost management and profitability analysis.

In conclusion, adopting activity-based costing provides a nuanced understanding of product costs, revealing distortions inherent in traditional allocation methods. Accurate costing is essential for strategic decision-making, particularly when overheads constitute a substantial portion of total costs. Changes in overhead allocation rates further emphasize the importance of precise cost attribution, influencing pricing, profitability assessments, and resource distribution decisions capable of improving financial outcomes and internal management effectiveness.

References

  • Drury, C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning.
  • Kaplan, R. S., & Anderson, S. R. (2004). Time-driven activity-based costing. Harvard business review, 82(11), 131-138.
  • Horngren, C. T., Datar, S. M., & Rajan, M. V. (2020). Cost Accounting: A Managerial Emphasis (16th ed.). Pearson.
  • Innes, J., & Mitchell, F. (1995). Activity-based costing in the UK’s largest companies. Management Accounting Research, 6(2), 137-153.
  • Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting (16th ed.). McGraw-Hill Education.
  • Cooper, R., & Kaplan, R. S. (1988). Measure costs right: make the right decisions. Harvard business review, 66(5), 96-103.
  • Arnaboldi, M., Lapsley, I., & Steccolini, I. (2015). Nonprofit accounting a critical review. Nonprofit and Voluntary Sector Quarterly, 44(3), 429–456.
  • Blocker, C., & Cook, J. (2016). Activity-based Costing and Decision-Making Effectiveness. Journal of Accounting & Organisational Change, 12(2), 245–272.
  • Shank, J. K., & Govindarajan, V. (1993). Strategic Cost Analysis. The Free Press.
  • Turney, P. B. B. (1991). Activity-based costing: a review with case studies. Management Accounting Research, 2(4), 339-359.

Related Assignments