Problem:
ABC versus traditional costing. Eyepod corporation produces two types of compact discs: standard and high grade. The standard CDs are used primarily in computer drives and are designed for data storage rather than accurate sound reproduction. The company only recently began producing the higher quality, high grade model to enter the lucrative music recording market. Since the new product was introduced, profits have seen only a modest increase. Management expected a significant profit increase related to rapidly growing sales of the high grade discs. Management believes the accounting system may not be accurately allocating costs to products.
Investigating the cost allocation problem manufacturing overhead is currently assigned to products based on the direct labor costs in the products. Last year’s manufacturing overhead was $880,000, based on the production of 320,000 standard CDs and 120,000 high grade CDs. Selling prices last year averaged $3.60 per standard disc and $5.80 per high disc. Direct labor and direct material costs for last year are:
Standard High-Grade Total
Direct Labor $160,000 $80,000 $240,000
Direct Materials 125,000 114,000 239,000
The cost drivers.
Case Assigned standard High Grade Total
Number of Production $300,000 20 10 30
Quality tests performed 360,000 12 18 30
Shipping orders processed 220,000 100 50 150
Total Overhead $880,000
A) How much of the overhead will be assigned to each product if the three cost drivers are used to allocate overhead? What would be the cost per unit produced for each product?
B) How much of the overhead would have been assigned to each product if direct labor cost had been used to allocate overhead? What would have been the total cost per unit produced for each product?
C) How might the results explain why profits did not increase as much as management expected?