Problem 23 - Accounting

Question

Cardio Care Inc. manufactures stationary bicycles and rowing machines. The products are produced in the Fabrication and Assembly production departments. In addition to production activities, several other activities are required to produce the two products. These activities and their associated activity rates are as follows: $$ \begin{array}{ll} \text { Activity } & \multicolumn{1}{c}{\text { Activity Rate }} \\ \hline \text { Fabrication } & \$ 24 \text { per machine hour (mh) } \\ \text { Assembly } & \$ 12 \text { per direct labor hour (dlh) } \\ \text { Setup } & \$ 40 \text { per setup } \\ \text { Inspecting } & \$ 22 \text { per inspection } \\ \text { Production scheduling } & \$ 14 \text { per production order } \\ \text { Purchasing } & \$ 6 \text { per purchase order } \end{array} $$ The activity-base usage quantities and units produced for each product were as follows: $$ \begin{array}{lrr} & \text { Stationary Bicycle } & \text { Rowing Machine } \\ \hline \text { Machine hours } & 1,950 & 975 \\ \text { Direct labor hours } & 436 & 162 \\ \text { Setups } & 48 & 15 \\ \text { Inspections } & 725 & 375 \\ \text { Production orders } & 68 & 20 \\ \text { Purchase orders } & 166 & 126 \\ \text { Units produced } & 1,000 & 1,000 \end{array} $$ Use the activity rate and usage information to compute the total activity costs and the activity costs per unit for each product.

Step-by-Step Solution

Answer

The activity costs per unit are $71.85 for stationary bicycles and $35.23 for rowing machines.

Step 1: Calculate Fabrication Costs

The cost for Fabrication is given by multiplying the machine hours by the activity rate for Fabrication. For stationary bicycles, this is \(1,950 \times 24 = 46,800\). For rowing machines, this is \(975 \times 24 = 23,400\).

Step 2: Calculate Assembly Costs

The cost for Assembly is obtained by multiplying the direct labor hours by the activity rate for Assembly. For stationary bicycles, this calculation is \(436 \times 12 = 5,232\). For rowing machines, it is \(162 \times 12 = 1,944\).

Step 3: Calculate Setup Costs

The Setup cost is computed by multiplying the number of setups by the activity rate. For stationary bicycles, the cost is \(48 \times 40 = 1,920\). For rowing machines, the cost is \(15 \times 40 = 600\).

Step 4: Calculate Inspecting Costs

The cost for Inspecting is found by multiplying the number of inspections by the activity rate for inspecting. For stationary bicycles, this is \(725 \times 22 = 15,950\). For rowing machines, this is \(375 \times 22 = 8,250\).

Step 5: Calculate Production Scheduling Costs

Production scheduling costs are determined by multiplying the number of production orders by the activity rate. The calculation for stationary bicycles is \(68 \times 14 = 952\), and for rowing machines, it is \(20 \times 14 = 280\).

Step 6: Calculate Purchasing Costs

Purchasing costs are found by multiplying the number of purchase orders by the activity rate. For stationary bicycles, the cost is \(166 \times 6 = 996\). For rowing machines, the cost is \(126 \times 6 = 756\).

Step 7: Compute Total Activity Cost for Each Product

Add up all the activity costs for each type of product. For stationary bicycles: \(46,800 + 5,232 + 1,920 + 15,950 + 952 + 996 = 71,850\). For rowing machines: \(23,400 + 1,944 + 600 + 8,250 + 280 + 756 = 35,230\).

Step 8: Calculate Activity Cost Per Unit for Each Product

Divide the total activity cost for each type by the number of units produced. For stationary bicycles, \(71,850 / 1,000 = 71.85\). For rowing machines, \(35,230 / 1,000 = 35.23\).

Key Concepts

Cost Allocation

Cost allocation is an essential component of Activity-Based Costing (ABC). This approach ensures that all costs are assigned to the specific products, services, or departments that actually incurred them. Often, businesses with multiple products or services can find it challenging to allocate indirect costs accurately. Activity-Based Costing provides a solution by using different 'cost drivers'. These are metrics that influence the amount of resources used by activities.

• For example, machine hours, direct labor hours, and the number of setups are some cost drivers used to allocate costs like fabrication and assembly costs to the products.
• The goal is to achieve precision, ensuring each product bears a fair share of the total costs.

By allocating costs accurately, businesses can make more informed pricing decisions, identify efficiencies or inefficiencies, and understand the profitability of each product.

Manufacturing Costs

Manufacturing costs refer to the total expenses incurred to produce a product, encompassing all activities in the production process. In ABC, these costs are categorized into different activities such as fabrication and assembly.

• Fabrication involves operations like cutting, welding, and painting, where machine hours are a common cost driver.
• Assembly includes putting parts together and testing, usually tracked by direct labor hours.
• Aside from direct costs like materials and labor, manufacturing costs also include overheads, such as setup and inspection costs.

Understanding these costs helps companies to set competitive prices and manage their operations efficiently.

Product Costing

Product costing is the process of determining the total cost associated with making a product. It is crucial for setting prices, valuation of inventories, and profit analysis. In the context of the given exercise, the costs are broken down into specific activities, a hallmark of Activity-Based Costing.
The calculation of product costs involves several steps:

• The total activity costs for each product are compiled by summing up all specific activity expenses involved like fabrication, assembly, setup, and inspecting.
• A breakdown provides visibility, allowing companies to spot areas that might need cost control or optimization.

This method provides a more accurate product cost than traditional costing methods, aligning costs directly with resource consumption.

Activity Cost Calculation

Activity cost calculation involves measuring the costs associated with each activity required for production. These are calculated by multiplying the activity usage with the respective activity rate.
For instance, in the exercise:

• Fabrication cost is found by multiplying machine hours by the fabrication activity rate.
• Assembly cost uses direct labor hours multiplied by the assembly rate.
• Setup costs are determined by the number of setups multiplied by the setup rate, and so forth.

This approach ensures that each activity's cost is traced directly to the product it supports, leading to precise costs per unit. Such granularity aids in strategic decision-making, ensuring that resource allocation aligns with corporate goals.