Problem:
Tom's Manufacturing Company Ltd makes sophisticated custom parts on a job order basis. The company has two direct product cost categories: direct materials and direct labor. In the past, indirect manufacturing costs were allocated to products using a single indirect cost pool, allocated based on direct labor hours. The indirect cost rate was $ 230 per direct labor hour. The Manager (Mr. Bright) decided to switch from a manual system to software programs that release materials and signal machines when to begin working. Naturally thought was given to whether the existing costing would be suitable. After investigation, it was decided to adopt an activity based costing system. The manufacturing process has been organized into six activities, each with its own supervisor who is responsible for controlling costs. The following list indicates the activities, cost drivers and cost allocation rates.
|
Activity
|
Cost Driver
|
Cost per unit of cost driver
|
|
Materials handling
|
Number of parts
|
$0.80
|
|
Milling
|
Machine hours
|
40.00
|
|
Grinding
|
Number of parts
|
1.60
|
|
Assembly
|
Hours spent in assembly
|
10.00
|
|
Inspection
|
Number of units produced
|
50.00
|
|
Shipping
|
Number of orders shipped
|
3,000.00
|
The company's information system automatically collects the necessary data for these activities. The data for the first four jobs were as follows:
|
|
Job81
|
Job82
|
Job83
|
Job84
|
|
Direct materials cost
|
$19,400
|
$119,800
|
$9,700
|
$59,900
|
|
Direct labor cost
|
$1,500
|
$22,500
|
$750
|
$11,250
|
|
Number of direct labor hours
|
50
|
750
|
25
|
375
|
|
Number of parts
|
1,000
|
4,000
|
500
|
2,000
|
|
Number of machine hours
|
300
|
2,100
|
150
|
1,050
|
|
Number of job orders shipped
|
2
|
2
|
1
|
1
|
|
Number of units
|
20
|
400
|
10
|
200
|
|
Number of hours in assembly
|
4
|
60
|
2
|
30
|
Required:
(a) Under the conventional system previously used, calculate the manufacturing cost per unit for job orders 81, 82, 83 and 84.
(b) Under the new ABC system, calculate the manufacturing cost per unit for the four jobs.
(c) Compare the cost per unit for the four job orders calculated under both methods. Explain why the cost per unit under the conventional costing system is different from cost per unit under the ABC system.
(d) Explain why the choice of cost drivers is critical in an ABC system.
(e) Identify and explain to Mr Bright the possible advantages and disadvantages of adopting the ABC system.
Summary of Question:
This question is basically belongs to Accounting as well as it explains about preparing a job order for a manufacturing unit. The calculations have been provided in the solution in detail.