4. It is risky to draw any definite conclusions based on the above analysis.
The activity-based costing system used in this company is not com-
pletely suitable for making decisions. Product costs probably include
costs of idle capacity and organization-sustaining costs. They also ex-
clude nonmanufacturing costs that may be caused by the products.
Nevertheless, the above analysis is suggestive.
Unit costs appear to be distorted as a result of using direct labor-hours
as the base for assigning overhead cost to products. Although the de-
luxe model requires twice as much labor time as the regular model, it
still is not being assigned enough overhead cost, as shown in the analy-
sis in part 3(a).
When the company’s overhead costs are analyzed on an activities basis,
it appears that the deluxe model is more expensive to manufacture than
the company realizes. Note that the deluxe model accounts for a major-
ity of the machine-hours worked, even though it accounts for only 20%
of the company’s direct labor-hours. Also, it requires just as many
scrap/rework orders as the regular model, and scrap/rework orders are
very costly to the company.
When activity-based costing is used and the company’s transactions are
analyzed by product, the overhead cost jumps for the deluxe model
from $36.00 per unit to $79.80 per unit. This suggests that less than
half the overhead cost is being assigned to the deluxe model that ought
to be assigned, and unit costs for the deluxe model are badly under-
stated. If these costs are being used as a basis for pricing, then the sell-
ing price for the deluxe model may be too low. This may be the reason
Problem 8-23 (45 minutes)
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