Overhead

GM6143 Final Exam Summer 2010 Name Abigaíl Vázquez
T-bird ID# 1448879
Campus CCM

I. (24 Points) Medical Instruments produces over 100 different products, and has just changed its manufacturing costing system. The old system allocated indirect costs to product based on direct labor costs. The new system breaks up the indirect costs into the following two costpools: materials-handling overhead (which is applied on the basis of the number of parts of a product), and other production overhead (applied on the basis of budgeted throughput time). Total budgeted cost information for the company is as follows (total costs for producing all the company's products):
Total materials-handling overhead cost $ 9,000,000
Total other production overheadcost $ 12,000,000
Total direct labor cost $ 7,000,000
Total number of parts used 4,500,000 parts
Total throughput time incurred 240,000 hours
Detailed cost per unit information about two of the company's products, A and B, are as follows:
Product A Product B
Number of Parts128 260
Throughput time in hours 4.8 hrs 18.5 hrs
Direct labor cost $216 $183

1. (8 Points) What characteristics of a product will lead to it having a much higher cost under the new system relative to the old system?

If the product requires more throughput time, that’s mean a more complicated manufacturing process, would lead tohigher costs using the old system, because the old system integrates handling and production overhead cost in the same concept “indirect costs” and the cost per unit is based on direct labor costs.

Indirect costs= 12,000,000 + 9,000,000 = 21,000,000

Indirect Costs per hour: 21,000,000 / 240,000 = 87.5

Cost P(A)= 4.8(87.5)+216 = 636

Cost P(B)= 18.5(87.5)+183= 1,801.75

In the otherhand, the quantity of spares used for both products, A and B, are not directly related to the product, instead of that, they are related to labor used during the manufacturing process.

2. (8 Points) Compute the indirect manufacturing costs per unit for Product A under the new system.

Total materials-handling overhead cost: 9,000,000/4,500,000 = 2

Total other production overhead cost:12,000,000 / 240,000 = 5

Cost P(A) = 128(2)+48.5(5)+216= 496

3. (8 points) Describe the potential benefits of an ABC system to this firm (or any firm for that matter).

Activity Based Costing Advantages for this or any other firm:

•More accurate costing of products/services, customers, SKUs, distribution channels
•Better understanding overhead
•Easier to understand for everyone
•Utilizesunit cost rather than just total cost
•Integrates well with Six Sigma and other continuous improvement programs
•Makes visible waste and non-value added
•Supports performance management and scorecards
•Enables costing of processes, supply chains, and value streams
•Activity Based Costing mirrors way work is done
•Facilitates benchmarking

The cost allocation is more accurate in the newsystem, because both material and labor used are directly related to every product. With the accurate cost allocation, managers can take better decisions in order to improve savings, profits, budgeting, etc.

With the old system, it’s more time consuming and complex for production managers to detect why the product is too expensive, probably the one product A is using more spares than product B, butproduct B requires more labor and is more expensive according to the old system.

II. (30 points) Balco Inc. has two production departments, Clear and Cream, and two service departments, Electricity and Water. Electricity renders 20% of its services to Water, 20% to Clear, and 60% to Cream, while Water renders 40% of its services to Electricity, 30% to Clear, and 30% to Cream. Total costs...