Dakota Company manufactures only one product that is available in both a Deluxe model and a Regular model. The company has manufactured the Regular model for years and the Deluxe model was recently introduced. The company is concerned about the accuracy of its costing system because profits are declining since the Deluxe model was introduced.
Indirect production costs are assigned to the products using direct labor hours. For the current year, the company estimates $2,000,000 of indirect production costs and 40,000 direct labor hours. They expect to produce 5,000 units of the Deluxe model and 40,000 units of the Regular model. The Deluxe model requires 1.6 hours of direct labor time per unit and the Regular model requires 0.8 hours. Other costs are as follows:
Costs Deluxe Model Regular Model
Direct materials $150 $112
Direct labor $16 $8
Assume the company's indirect production costs can be traced to four activities with the following cost drivers:
Activity (Cost Driver) Costs
Purchase orders (number of purchase orders) $84,000
Rework orders (number of rework orders) $216,000
Product testing (number of tests) $450,000
Machining (number of machine hours) $1,250,000
Deluxe Regular
Cost Drivers Model Model
Number of purchase orders 400 600
Number of rework orders 200 600
Number of tests 4,000 6,000
Number of machine hours 20,000 30,000
Required:
A) Assume direct labor hours are the only cost-allocation base. What is the cost to manufacture one unit of each model?
B) Assume the activity-based costing method is used. What is the cost to manufacture one unit of each model?
C) Based on the results obtained from the activity-based costing method, what are the implications for pricing policy for the two models?