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Question

This problem continues the Piedmont Computer Company situation from Chapter 17. Recall that Piedmont Computer Company allocated manufacturing overhead costs to jobs based on a predetermined overhead allocation rate, computed as 25% of direct labor costs. Piedmont Computer Company is now considering using an ABC system. Information about ABC costs for 2020 follows:

Activity Allocation Base Predetermined

Overhead Allocation Rate

Assembly Number of parts \( 0.25

Programming Number of direct labor hours 3.50

Testing Number of tests 125.00

Records for two jobs appear here:

Job Total Direct Total Number Total Direct Total Number

Materials Costs of Parts Labor Hours of Tests

Job 721 \) 23,400 2,500 780 8

Job 722 2,500 300 60 2

Requirements

1. Compute the total cost for each job using activity-based costing. The cost of direct labor is $25 per hour.

2. Is the job cost greater or less than that computed in Chapter 17 for each job? Why?

3. If Piedmont Computer Company wants to earn an operating income equal to 45% of the total cost, what sales price should it charge each of these two customers?

Step-by-Step Solution

Verified

Answer

1. Cost for Job 721 = $47,255

Cost for Job 722 = $4,535

2. Under ABC, cost for job 721 is lower and for job 722 is higher than under single allocation base method.

3. Sales price for job 721 = $68,520

Sales price for job 722 = $6,576

1Step 1: Computation of total cost for each Job

Computation of cost for Job 721

$\begin{array}{rcl} D i r e c t l a b o r c o s t & = & T o t a l d i r e c t l a b o r h o u r \times D i r e c t l a b o r c o s t p e r h o u r \\ = & 780 \times $ 25 \\ = & $ 19, 500 \end{array}$

$\begin{array}{rcl} A s s e m b l y c o s t & = & N o . o f p a r t s \times P r e d e t e r m i n d e a l l o c a t i o n r a t e \\ = & 2, 500 \times $ 0.25 \\ = & $ 625 \end{array}$

$\begin{array}{rcl} P r o g r a m m i n g c o s t & = & N o . o f D L h o u r s \times P r e d e t e r m i n e d a l l o c a t i o n r a t e \\ = & 780 \times $ 3.5 \\ = & $ 2, 730 \end{array}$

$\begin{array}{rcl} T e s t i n g c o s t & = & N o . o f t e s t s \times P r e d e t e r m i n e d a l l o c a t i o n r a t e \\ = & 8 \times $ 125 \\ = & $ 1, 000 \end{array}$

$\begin{array}{rcl} T o t a l c o s t f o r J o b 721 & = & D i r e c t M a t e r i a l C o s t + D i r e c t l a b o r c o s t + (A s s e m b l y c o s t + P r o g r a m m i n g c o s t + T e s t i n g c o s t) \\ = & $ 23, 400 + $ 19, 500 + ($ 625 + $ 2, 730 + $ 1, 000) \\ = & $ 47.255 \end{array}$

Computation of cost for Job 722

$\begin{array}{rcl} D i r e c t l a b o r c o s t & = & T o t a l d i r e c t l a b o r h o u r \times D i r e c t l a b o r c o s t p e r h o u r \\ = & 60 \times $ 25 \\ = & $ 1, 500 \end{array}$

$\begin{array}{rcl} A s s e m b l y c o s t & = & N o . o f p a r t s \times P r e d e t e r m i n e d a l l o c a t i o n r a t e \\ = & 300 \times $ 0.25 \\ = & $ 75 \end{array}$

$\begin{array}{rcl} P r o g r a m m i n g c o s t & = & N o . o f D L h o u r \times P r e d e t e r m i n e d a l l o c a t i o n r a t e \\ = & 60 \times $ 3.5 \\ = & $ 210 \end{array}$

$\begin{array}{rcl} T e s t i n g c o s t & = & N o . o f t e s t s \times P r e d e t e r m i n e d a l l o c a t i o n r a t e \\ = & 2 \times $ 125 \\ = & $ 250 \end{array}$

$\begin{array}{rcl} T o t a l c o s t f o r J o b 722 & = & D i r e c t M a t e r i a l C o s t + D i r e c t l a b o r c o s t + (A s s e m b l y c o s t + P r o g r a m m i n g c o s t + T e s t i n g c o s t) \\ = & $ 2, 500 + $ 1, 500 + ($ 75 + $ 210 + $ 250) \\ = & $ 4, 535 \end{array}$

2Step 2: Comparison of costs under two methods

Cost computed under single allocation base method

For job 721 = $47,775

For job 722 = $4,375

Cost computed under ABC system

For job 721 = $47,255

For job 722 = $4,535

Result -

1. Cost for job 721 is less under the ABC allocation method. This is so because the cost has been allocated based on a different activity for manufacturing overhead. But in contrast, under chapter 17, the cost has been allocated as per the single allocation base which I s not justified in this case.

2. Cost for job 722 is greater under the ABC allocation method. This is so because in this method the cost has been allocated based on the actual activity level for different overheads costs. In contrast in chapter 17, a single allocation base was used which was not justified.

3Step 3: Computation of sales price for each job

Computation of sales price for job 721

$\begin{array}{rcl} S a l e s p r i c e & = & C o s t \times \frac{100 + T a r g e t n e t i n c o m e}{100} \\ = & $ 47, 255 \times \frac{100 + 45}{100} \\ = & $ 68, 520 \end{array}$

Computation of sales price for job 722

$\begin{array}{rcl} S a l e s p r i c e & = & C o s t \times \frac{100 + Target net income}{100} \\ = & $ 4, 535 \times \frac{100 + 45}{100} \\ = & $ 6, 576 \end{array}$

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