Question

Decorative Doors, Inc., produces two types of doors, interior and exterior. The company's simple costing system has two direct-cost categories (materials and labor) and one indirect-cost pool. The simple costing system allocates indirect costs on the basis of machine-hours. Recently, the owners of Decorative Doors have been concemed about a decline in the market share for their interior doors, usually their biggest seller. Information related to Decorative Doors production for the most recent year follows: Interior 2200 $ 125 Exterior 1800 $200 $ 15 150 225 Units sold Selling price Direct material cost per unit Direct mandfacturing labor cost per hour Direct manufacturing labor-hours per un Production Tunis Material moves Machines Machine-hours Number of inspections 155 400 5.500 250 The owners have heard of other companies in the industry that are now using an activity-based costing system and are curious how an ABC system would affect their product costing decisions. After analyzing the indirect-cost pool for Decorative Doors, the owners identify six activities as generating indirect costs: production scheduling, material handling, machine setup, assembly. inspection, and marketing. Decorative Doors collected the following data related to the indirect- cost activities: Activity Activity Cost Activity Cost Driver Production scheduling Se Production runs Material handling Material moves Machine setup 525.000 Machine setups Assembly 550.000 Machine-hours Inspection $ 8.000 Number of inspections Marketing costs were determined to be 3% of the sales revenue for each type of door. Required 1. Calculate the cost of an interior door and an exterior door under the existing simple costing system. 2. Calculate the cost of an interior door and an exterior door under an activity-based costing system. 3. Compare the costs of the doors in requirements 1 and 2. Why do the simple and activity-based costing systems differ in the cost of an interior door and an exterior door? 4. How might Decorative Doors, Inc., use the new cost information from its activity-based costing system to address the declining market share for interior doors?

Answer 1

1. Calculate the cost of an interior door and an exterior door under the existing simple costing system. Production Scheduling Material Handling Machine Setup Assembly Inspection Marketing 3%*(3200*125)) Marketing 3%*(1800*200) Total Indirect cost (A) Total Machine Hours (B) Indirect Cost Rate Per Machine Hour (A/B) 95000 45000 25000 60000 8000 12000 10800 255800 10000 (5500+4500) 25.58 Per Machine Hour Interior Exterior Direct materials (30*3200),(45*1800) Direct manufacturing labor (3200*1.50*16) Indirect cost allocated to each job Total costs (A) Number of Units Produced B) Total cost per unit (A/B) 96000 76800 140690 313490 3200 97.97 81000 64800 (1800*2.25*16) 115110 260910 1800 144.95

61 2. Calculate the cost of an interior door and an exterior door under an activity-based costing system. Activity Budgeted Cost Driver Volume Cost Driver (B) Product scheduling Materials handling Machine setup Assembly Inspection Marketing Production runs Material Moves Machine setups Machine Hours Inspections Percentage of revenues Budgeted Overhead Cost (A) 95000 45000 25000 60000 8000 125 240 200 10000 400 Activity Rate (A/B) 760 per production run 188 Per material move 125 per setup 6 per machine hour 20 per inspection 0.03 per dollar of sales Activity Exterior (C) Overhead Rate (A) 760 188 125 Product scheduling Materials handling Machine setup Assembly Inspection Marketing Total Overheads (A) Number of Units Produced (B) Overhead Cost Per Unit (A/B) Expected Activity Interior (B) 40 72 45 5500 250 400000 85 168 155 4500 150 360000 Assigned Overheads Interior Exterior (A*B) (A*C) 30400 64600 13500 31500 5625 19375 33000 27000 5000 3000 12000 10800 99525 156275 3200 1800 31.10 86.82 20 0.03

Interior Exterior Direct materials (30*3200),(45*1800) Direct manufacturing labor (3200*1.50*16) Indirect cost allocated to each job Total costs (A) Number of Units Produced (B) Total cost per unit (A/B) 96000 76800 99525 272325 3200 85.10 81000 64800 (1800*2.25*16) 156275 302075 1800 167.82 3. Compare the costs of the doors in requirements 1 and 2. Why do the simple and activity-based costing systems differ in the cost of an interior door and an Interior Exterior Simple Costing System Activity Based Costing Difference 97.97 85.10 12.86 144.95 167.82 -22.87 99 100 101 102 Under Simple costing system, overheads are allocated on the basis of single overhead rate whereas in Activity Based Costing Overheads are allocated on the basis of activity consumed by each activity.

104 4. How might Decorative Doors, Inc., use the new cost information from its activity-based costing system to address the declining markets 105 106 Simple Costing 107 108 109 Interior Exterior 200 110 Selling Price Per Unit Less Manufacturing Cost Per Unit Profit 125 97.97 27.03 111 144.95 55.05 112 113 ABC Costing 114 Interior Exterior 115 116 125 Selling Price Per Unit Less Manufacturing Cost Per Unit Profit 85.10 39.90 200 167.82 32.18 118 119 120 121 Decorative Doors, Inc., should consider decreasing the price of its interior doors to be more competitive in case of simple costing and should consider Increasing the price of exterior doors in case of ABC Costing.