Accounting ACCT 2620 Lecture 3: Chapter Three Product Costing
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Bushman Case
The Bushman Company is a publicly traded corporation that produces different types of digital control systems. My name is Alan Smith and I have worked for this company for the last ten years in the controllerâs office. I was both an accounting and finance major in university. The company currently produces 300 products and does not anticipate any new products coming out over the next three years. I have previously mentioned to my superiors that it is not appropriate for our firm to use a traditional accounting system (where overhead costs are allocated across products at a rate of 400% of direct labor costs) when different products require different amounts of indirect overhead resources. For example, under the traditional system all costs associated with testing of products for quality assurance purposes are part of overhead costs and therefore allocated across products based on direct labor costs. Yet, some of our products require as much as 5 hours of testing whereas some products require less than 1 minute of testing with no connection to direct labor costs. Given that traditional costing systems result in significant cost distortions when determining products costs and given that the firm now has revenues of over $700,000,000 a year, Bushman has decided to adopt activity based costing over the next year or two.
Bushmanâs management has hired Deloitte Consulting to help us implement activity based costing. I will be acting as the liaison between our firm and Deloitte. As part of the initial implementation phase, I have asked Deloitte to derive the costs and product margins associated with two of our products, delta and vega, so that these costs and product margins could be compared with the costs and product margins under our current traditional accounting system. I picked these products since Bushman management believe they have very different demands on indirect overhead resources. Further, delta is sold in large quantities whereas vega is sold in small quantities and traditional accounting systems can cause large cost distortions in different directions for products sold in large and small quantities.
Current information from our existing system on a per unit basis is shown in Exhibit 1.
Exhibit 1
| delta | vega | |
| Direct material | $10 | $10 |
| Direct labor hours | 1 | 1 |
| Direct labor wage rate per hour | $20 | $20 |
| Sales price per unit | $160 | $170 |
My staff has identified for Deloitte five activity cost pools. Information on those cost pools and the related activity measures are provided in Exhibit 2.
Exhibit 2
| Activity cost pool | Total costs | Activity measure | Activity level |
| Equipment setups | $20,000,000 | number of setups | 50,000 |
| Purchase orders | $15,000,000 | number of purchase orders | 300,000 |
| Machining | $90,000,000 | number of machine hours | 2,000,000 |
| Testing | $13,300,000 | number of testing hours | 700,000 |
| Packaging | $24,000,000 | number of containers | 2,000,000 |
Although fixed costs are lumped in with variable costs across the five different cost pools, I am aware that machining related costs consists almost exclusively of depreciation costs. Hence, with respect to all questions asked in this case, machining costs will be treated as entirely fixed with respect to machine hours. Each machine is used in the production of multiple product lines. The resale value of machines is only affected by the passage of time and not by how much they are used in a given year.
In all questions asked in this case, the firm will assume that costs associated with equipment setups, purchase orders, testing, and packaging are variable with respect to their respective activity measures. Currently, we believe our assumptions on cost behavior patterns are quite reasonable.
All products are produced in batches, where the size of a batch differs across products. For example, if we produce 80 units of a product in batch sizes of 40, then the product will be produced in two batches. An equipment setup must be performed before producing each batch of a product. Hence, in the example above, two equipment setups would be performed. Units of product are packaged in containers and sent to distributors.
Production volumes are set equal to sales volumes since the company only produces products that they have orders for. Consequently, the firm never has a beginning or ending work in process inventory, and it does not have a beginning or ending finished goods inventory.
Further information on our two products is provided in Exhibit 3
Exhibit 3
| delta | vega | |
| annual sales and production in units | 800,000 | 12,000 |
| number of units per batch | 200 | 150 |
| number of purchase orders | 400 | 100 |
| number of machine hours per unit | 0.2 | 3 |
| total number of testing hours | 7,000 | 21,000 |
| total number of containers | 5,000 | 2,000 |
REQUIRED:
1. (20 Points) Prepare an income statement for delta and an income statement for vega using the traditional accounting system where overhead is applied at a rate of 400% of direct labor costs. (For simplicity, there are no SG&A expenses for the firm.) The income statements should be prepared on a total basis and then show the average net operating income per unit using the following template for guidance:
delta vega
Sales $$$ $$$
Direct materials $$$ $$$
Direct labor $$$ $$$
Manufacturing overhead $$$ $$$
Total Costs $$$ $$$
Net operating income $$$ $$$
Average net operating income
per unit $$$ $$$
2. (20 Points) Calculate the five activity rates under activity based costing.
3. (35 Points) Prepare an income statement for delta and an income statement for vega using activity based costing. (For simplicity, there are no SG&A expenses for the firm.) The income statements should be prepared on a total basis and then show the average net operating income per unit using the following template for guidance:
delta vega
Sales $$$ $$$
Direct materials $$$ $$$
Direct labor $$$ $$$
Equipment Setups $$$ $$$
Purchase orders $$$ $$$
Machining $$$ $$$
Testing $$$ $$$
Packaging $$$ $$$
Total Costs $$$ $$$
Net operating income $$$ $$$
Average net operating income
per unit $$$ $$$
4. (10 Points) Assume next year that the activity rates remain the same as you calculated in question (2). Assume that the demand for delta is expected to increase significantly. Consequently, the firm expects to produce more batches of delta next year than this year and the firm plans to produce in batch sizes of 500 rather than 200. Calculate what the equipment setup cost per unit of delta will be next year if it can be calculated. If it cannot be calculated, then explain in words why the equipment setup cost per unit of delta cannot be determined in the absence of more information. Excluding your quantitative analysis if any, your explanation should not be more than 1/3 page double spaced with a 12 font size. Your grade will be lowered for poor writing (e.g., grammar).
5. (15 Points) Question 5 is independent of question 4. Next year, because of an expected increase in product demand, machine hours are expected to increase from 2,000,000 to 2,500,000. The company will not need any new machinery since the current machinery is highly underutilized. Also, the number of purchase orders will increase from 300,000 to 360,000. Assume that these new levels of operations are within the firmâs relevant range. Calculate what the activity rate for the cost pool of machining would be next year if it can be calculated. Also, calculate what the activity rate for the cost pool of purchase order would be next year if it can be calculated. If one or both rates cannot be calculated, then explain in words why the calculations cannot be determined in the absence of more information. Excluding any quantitative analysis, your explanation should not be more than 1/3 page double spaced with 12 font. Your grade will be lowered for poor writing (e.g., grammar).
All questions have to do with cost accounting systems,more in particular, job order costing.
Complete each of the following statements/Answer the followingquestions
1. A custom-furniture designer would probably use which methodof cost accounting? 1. ____
2. The cost of finished products on hand that have not been soldis called 2. ____
3-5. Work in process consists of these costs that have enteredthe manufacturing process on unfinished products:
3. ____
4. ____
5. ____
6. The accounting system that accumulates the product costsoriginating with inventory and ending with the cost of goods soldis the 6. ____
7. The system best suited to industries that manufacture customgoods to fill special orders is referred to as a 7. ____
8. The system that accumulates costs for each of the departmentswithin the factory is a 8. ____
9. The Receiving Department document that shows the quantityreceived and its condition is the 9. ____
10. Materials are released from the storeroom to the factory inresponse to a 10. ____
11. The amount of time spent by an employee in the factory isusually recorded on 11. ____
12. Indirect materials and indirect labor are examples of thismanufacturing cost 12. ____
13. The costing method that accumulates and allocates factoryoverhead costs to products using many overhead rates is 13.____
14. If estimated total factory overhead costs are $75,000 anddirect labor hours are 15,000, the predetermined factory overheadrate is 14. ____
15. The process of assigning factory overhead costs to a costobject is termed 15. ____
16. In highly-automated factory settings, a widely used activitybase for predetermining a factory overhead rate is 16. ____
17. The subsidiary ledger that contains cost data for the unitsmanufactured, units sold, and units on hand is 17. ____
18. The direct labor and overhead costs of a service businessare accumulated in a 18. ____
19. If the actual factory overhead costs exceed the amount offactory overhead applied, the factory overhead account balance willbe a (debit or credit) 19. ____
20. The factory overhead in Question 19 is said to be 20.____
21. The source of the data for debiting Work in Process fordirect materials is a 21. ____
22. The accounting document that is used to accumulate the costsfor each clientâs job in a service business is a 22. ____
23. The controlling account for the cost ledger is 23. ____
24. The measure used to allocate overhead that reflects itsconsumption is called 24. ____
Indicate the titles of the accounts to be debited andcredited in recording the summarized operations presented below byinserting the letter or letters of the account titles listed in theappropriate columns.
ACCOUNTS
A. Accounts Payable E. FactoryOverhead I. Selling and AdministrativeExpenses
B. Accounts Receivable F.Finished Goods J. Wages Payable
C. Cash G. MaterialsK. Work in Process
D. Cost of Goods Sold H.Sales
TRANSACTIONS | Debit | Credit | ||
0. Cash paid on account...................................................................................... | A | 0. ____ | C | 0. ____ |
1-2. Materials requisitioned for use on specific jobsand for general factory use....................................................................................................................... |
|
| ||
3-4. Factory labor incurred on specific jobs and forgeneral factory use ....... | 3. ____ | 4. ____ | ||
5-6. Applied factory overhead to jobs................................................................... | 5. ____ | 6. ____ | ||
7-8. Paid salary of vice-president of finance....................................................... | 7. ____ | 8. ____ | ||
9-10. Cashpaid for overhead costs incurred......................................................... | 9. ____ | 10. ____ | ||
11-12. Transferred smallbalance of under-applied overhead ............................ | 11. ____ | 12. ____ | ||
13-14. Jobs completed................................................................................................. | 13. ____ | 14. ____ |
