EXERCISE 8-21 (CONTINUED)

3. It is especially important to note that, even under activity-based costing,

70% of the company’s overhead costs continue to be applied to prod-

ucts on the basis of direct labor-hours:

Machine setups (number of setups) .... $ 360,000 20%

Special processing (machine-hours) .... 180,000 10

General factory (direct labor-hours) .... 1,260,000 70

Total overhead cost... $1,800,000 100%

Thus, the shift in overhead cost from the high-volume product (Model

X99) to the low-volume product (Model X200) occurred as a result of

reassigning only 30% of the company’s overhead costs.

Problem 8-26 (continued)

The increase in unit product cost for Model X200 can be explained as

follows: First, where possible, overhead costs have been traced to the

products rather than being lumped together and spread uniformly over

production. Therefore, the special processing costs, which are traceable

to Model X200, have all been assigned to Model X200 and none as-

signed to Model X99 under the activity-based costing approach. It is

common in industry to have some products that require special handling

or special processing of some type. This is especially true in modern fac-

tories that produce a variety of products. Activity-based costing provides

a vehicle for assigning these costs to the appropriate products.

Second, the costs associated with the batch-level activity (machine set-

ups) have also been assigned to the specific products to which they re-

late. These costs have been assigned according to the number of setups

completed for each product. However, since a batch-level activity is in-

volved, another factor affecting unit costs comes into play. That factor is

batch size. Some products are produced in large batches and some are

produced in small batches. The smaller the batch, the higher the per

unit cost of the batch activity. In the case at hand, the data can be ana-

lyzed as follows:

Model X200:

Cost to complete one setup [see 2(a)] ... $2,400 (a)

Number of units processed per setup

(5,000 units per setup ÷ 50 setups = 100 units) ... 100 units (b)

Setup cost per unit (a) ÷ (b) ... $24

Model X99:

Cost to complete one setup (above)... $2,400 (a)

(30,000 units per setup ÷ 100 setups = 300 units) ... 300 units (b)

Setup cost per unit (a) ÷ (b) ... $8

Thus, the cost per unit for setups is three times as great for Model

X200, the low-volume product, as it is for Model X99, the high-volume

product. Such differences in cost are obscured when direct labor-hours

(or any other volume measure) is used as a basis for applying overhead

cost to products.

In sum, overhead cost has shifted from the high-volume product to the

low-volume product as a result of more appropriately assigning some

costs to the products on the basis of the activities involved, rather than

on the basis of direct labor-hours.

Problem 8-27 (45 minutes)