1 Midterm Review Class #1.1- COGM; Income Statement, Cost Behaviour On January 30, 2013, the manufacturing facility of Trucks R Us was severely damaged by a fire. As a result, the company s direct materials, work-in-process, and finished goods inventories were destroyed. The company did have access to certain incomplete accounting records, which revealed the following: Beginning inventories at January 1, 2013: Direct Materials $ 32,000 Work in Process $ 68,000 Finished Goods $ 30,000 Key ratios for the month of January 2013 are as follows: Manufacturing Overhead = Prime costs = Gross margin = 40% of conversion costs 70% of total manufacturing costs for the period 20% of sales Ending Work in Process (WIP) is always 10% of the total manufacturing costs for the period. All costs are incurred uniformly in the manufacturing process. Actual operations data for the month of January 2013: Sales $ 900,000 Direct material purchases $ 320,000 Direct labour incurred $ 360,000 Required 1: Prepare a statement of cost of goods manufactured (COGM). Notes: Conversion costs = DL + OH Prime costs = DM + DL Manufacturing costs (see COGM statement) = DM + DL +OH There is no Raw Materials Inventory it is just DM inventory. Therefore there is no indirect consumption of Raw materials.
2 Trucks R Us Statement of Cost of Goods Manufactured For the period January 1 to 30, 2012 Direct Materials: DM Beginning inventory (Jan. 1) $ 32,000 Add: Purchases 320,000 Direct Materials available $ 352,000 Less: DM Ending inventory (Jan. 30) Total Direct Materials used Direct Labour 360,000 Overhead Total manufacturing costs for the period Add: Beginning Work-in-Process Inventory (Jan. 1) 68,000 Total costs to account for Less: Work-in-Process Inventory (Jan. 30) Cost of Goods Manufactured  Given: MOH = 40% of conversion costs. Conversion costs = DL + Factory OH. (1 mark for the formula or being able to proceed to the next step) MOH = 40% x (DL + Factory OH) Given DL = $360,000 MOH = (0.40) ($360,000 + Factory OH) (1 mark) MOH = $144, Factory OH MOH 0.40 MOH = $144, MOH = $144,000 MOH = $144,000 / 0.60 MOH = $240,000(1 mark) (So, 3 marks for getting the $240,000) Given: Prime costs = 70% of mfg. costs added for the period Jan Prime costs = DM + DL. Therefore DM + DL = 70% x manufacturing costs added for the period Manufacturing costs = DM + DL + OH. Therefore DM + DL = 70% x (DM + DL + OH) (1 mark for the formula or being able to get to this point) DM + DL = 0.70DM DL OH DM 0.70DM + DL 0.70DL = 0.70 OH 0.30DM DL = 0.70OH
3 Now we know that OH = $240,000 [calculated in  above] We were given that DL = $360, DM x 360,000= 0.70 x $240, DM + $108,000 = $168, DM = $168,000 - $108, DM = $60,000 DM = $60,000 / 0.30 DM = $200,000(2 marks for the correct number or a correct process to get to this point) (So, 3 marks for getting the $200,000)  Therefore DM Ending inventory must be $152,000 (2 marks for the correct number or a correct process to get to this point) as DM available DM Ending = DM used $352,000 DM ending = $200,000 $352,000 $200,000 = DM Ending  Therefore total manufacturing costs must be $800,000 as Given: Ending Work-in-Process Inventory is always 10% of the monthly manufacturing costs: 0.10 x $800,000 = $80,000. Trucks R Us Statement of Cost of Goods Manufactured For the period January 1 to 30, 2012 Direct Materials: DM Beginning inventory (Jan. 1) $ 32,000 ½ mark* Add: Purchases 320,000 ½ mark* Direct Materials available $ 352,000 Less: DM Ending inventory (Jan. 30)  152,000 2 marks Total Direct Materials used  $ 200,000 3 marks Direct Labour 360,000 ½ mark* Overhead  240,000 3 marks Total manufacturing costs for the period  $ 800,000 2 marks Add: Beginning Work-in-Process Inventory 68,000 ½ mark* (Jan. 1) Total costs to account for $ 868,000 Less: Work-in-Process Inventory (Jan. 30) 80,000 2 marks  Cost of Goods Manufactured $ 788,000 * These numbers are all given in the problem. The ½ mark is for putting it in the COGM statement.
4 Required 2: Calculate the total cost of inventory lost, identifying each category where possible (i.e. Direct Materials, Work in process and Finished Goods) at January 31, DM above WIP above FG = Sales COGS = GM 900,000 COGS = 20% of Sales (or 0.2 * 900,000) = 180, , ,000 = COGS COGS = 720,000
5 Midterm Review Class #1.2- Plantwide versus Departmental Overhead Rates; Underapplied or Overapplied Overhead Don t tell me we ve lost another bid! exclaimed Sandy Kovallas, president of Lenko Products Inc. I m afraid so replied Doug Martin, the operations vice-president. One of our competitors underbid us by about $10,000 on the Hasting job. I just can t figure it out, said Kovallas, It seems we re either too high to get the job or too low to make any money on half the jobs we bid. What s happened? Lenko Products manufactures specialized goods to customers specifications and operates a joborder costing system. Manufacturing overhead cost is applied to jobs on the basis of direct labour cost. The following estimates were made at the beginning of the year: Cutting Machining Assembly Total Direct labour $300,000 $200,000 $400,000 $900,000 Manufacturing overhead $540,000 $800,000 $100,000 $1,440,000 Jobs require varying amounts of work in the three departments. The Hastings job, for example, would have required manufacturing costs in the three departments as follows: Cutting Machining Assembly Total Direct materials $12,000 $900 $5,600 $18,500 Direct labour $6,500 $1,700 $13,000 $21,200 Manufacturing overhead???? The company uses a plantwide overhead rate to apply manufacturing overhead cost to jobs. Required 1: Assuming the use of a plantwide overhead rate: a. Compute the rate for the current year. Predetermined = Estimated total manufacturing overhead cost Overhead rate Estimated total amount of the allocation base = $1,440,000 $900,000 direct labour cost = 160% Direct labour cost b. Determine the amount of manufacturing overhead cost that would have been applied to the Hastings job. $21, % = $33,920.
6 Required 2: Suppose that instead of using a plantwide overhead rate, the company had used a separate predetermined overhead rate in each department. Under these conditions a. Compute the rate for each department for the current year. Cutting Department Machining Department Assembly Department Estimated manufacturing overhead cost (a)... $540,000 $800,000 $100,000 Estimated direct labour cost (b)... $300,000 $200,000 $400,000 Predetermined overhead rate (a) (b) % 400% 25% b. Determine the amount of manufacturing overhead cost that would have been applied to the Hastings job. Cutting Department: $6, %... $11,700 Machining Department: $1, %... 6,800 Assembly Department: $13,000 25%... 3,250 Total applied overhead... $21,750 Required 3: Explain the difference between the manufacturing overhead that would have been applied to the Hastings job using the plantwide rate in question 1(b) above and using the departmental rates in question 2(b). The bulk of the labour cost on the Hastings job is in the Assembly Department, which incurs very little overhead cost. The department has an overhead rate of only 25% of direct labour cost as compared to much higher rates in the other two departments. Therefore, as shown above, use of departmental overhead rates results in a relatively small amount of overhead cost charged to the job. However, use of a plantwide overhead rate in effect redistributes overhead costs proportionately between the three departments (at 160% of direct labour cost) and results in a large amount of overhead cost being charged to the Hastings job, as shown in Part 1. This may explain why the company bid too high and lost the job. Too much overhead cost was assigned to the job for the
7 kind of work being done on the job in the plant. If a plantwide overhead rate is being used, the company will tend to charge too little overhead cost to jobs that require a large amount of labour in the Cutting or Machining Departments. The reason is that the plantwide overhead rate (160%) is much lower than the rates if these departments were considered separately. Required 4: Assume that it is customary in the industry to bid jobs at 150% of total manufacturing cost (direct materials, direct labour, and applied overhead). What was the company s bid price on theh Hastings job? What would the bid price have been if departmental overhead rates had been used to apply overhead cost? The company s bid price was: Direct materials... $ 18,500 Direct labour... 21,200 Manufacturing overhead applied (above)... 33,920 Total manufacturing cost... 73,620 Bidding rate Total bid price... $110,430 If departmental overhead rates had been used, the bid price would have been: Direct materials... $ 18,500 Direct labour... 21,200 Manufacturing overhead applied (above)... 21,750 Total manufacturing cost... 61,450 Bidding rate Total bid price... $ 92,175 Note that if departmental overhead rates had been used, Lenko Products would have been the low bidder on the Hastings job since the competitor underbid Lenko by only $10,000. Required 5: At the end of the year, the company assembled the following actual cost data relating to all jobs worked on during the year: Cutting Machining Assembly Total Direct materials $780,000 $90,000 $410,000 $1,260,000 Direct labour $320,000 $210,000 $340,000 $870,000 Manufacturing overhead $560,000 $830,000 $92,000 $1,482,000
8 Compute the underapplied or overapplied overhead for the year a. Assuming that a plantwide overhead rate is used, Actual overhead cost... $1,482,000 Applied overhead cost ($870, %)... 1,392,000 Underapplied overhead cost... $ 90,000 b. Assuming that departmental overhead rates are used Department Cutting Machining Assembly Total Plant Actual overhead cost... $560,000 $830,000 $92,000 $1,482,000 Applied overhead cost: $320, % ,000 $210, % ,000 $340,000 25%... 85,000 1,501,000 Underapplied (overapplied) overhead cost... $(16,000) $(10,000) $ 7,000 $ (19,000)
9 Midterm Review Class #1.3- Activity-Based Costing as an Alternative to Traditional Product Costing For many years, Dover Company manufactured a single product called a mono-circuit. Then, three years ago, the company automated a portion of its plant and at the same time introduced a second product called a bi-circuit that has become increasingly popular. The bi-circuit product is a more complex product than the mono-circuit, requiring two hours of direct labour time per unit to manufacture, and extensive machining in the automated portion of the plant. In addition, it requires numerous inspections to ensure that high quality is maintained. The mono-circuit requires only one hour of direct labour time per unit, only a small amount of machining, and few quality control checks. Manufacturing overhead costs are assigned to the products on the basis of direct labour hours. Despite the growing popularity of the company s new bi-circuit, profits have declined steadily. Management is beginning to believe that the company s costing system may be faulty. Unit costs for materials and labour for the two products follow: Mono-Circuit Bi-Circuit Direct materials $40 $80 Direct labour ($18 per hour) $18 $36 Management estimates that the company will incur $3,000,000 in manufacturing overhead costs during the current year and that 40,000 units of the mono-circuit and 10,000 units of the bicircuit will be produced and sold. Required 1: Compute the predetermined overhead rate assuming that the company continues to apply manufacturing overhead cost to products on the basis of direct labour hours. Using this rate and other data from the problem, determine the unit product cost of each product. The company expects to work 60,000 direct labour-hours during the year, computed as follows: Mono-circuit: 40,000 units 1 DLH per unit... 40,000 Bi-circuit: 10,000 units 2 DLH per unit... 20,000 Total direct labour-hours... 60,000 Using direct labour-hours as the base, the predetermined manufacturing overhead rate would be: = $3,000,000 60,000 = $50 per direct labour hour
10 The unit product cost of each product would be: Mono-circuit Bi-circuit Direct materials (given)... $ 40 $ 80 Direct labour (given) Manufacturing overhead: $50 per DLH 1 DLH and 2 DLHs Total unit product cost... $108 $216 Required 2: Management is considering using activity-based costing to apply manufacturing overhead cost to products for external financial reports. Some preliminary work has been done and the data that have been collected are displayed below: Activity Cost Pool (and Activity Measure) Estimated Overhead Costs Activity Measure Mono-Circuit Bi-Circuit Maintaining parts inventory (number of part types) $360, Processing purchase orders (number of orders) $540,000 2,000 1,000 Quality control (number of tests) $600,000 2,000 6,000 Machine-related (machine-hours) $1,500,000 20,000 30,000 Determine the predetermined overhead rate (i.e. activity rate) for each of the four activity costs pools. The predetermined overhead rates would be computed as follows: (a) Estimated Overhead Costs (b) Expected Activity (a) (b) Predetermined Overhead Rate Activity Center Maintaining parts inventory... $360, part types $400 per part type Processing purchase orders... $540,000 3,000 orders $180 per order Quality control... $600,000 8,000 tests $75 per test Machine-related... $1,500,000 50,000 MHs $30 per MH
11 Required 3: Using the predetermined manufacturing overhead rates that you computed in part (2) above, do the following: a. Determine the total amount of manufacturing overhead cost that would be applied to each product using the activity-based costing system. After these totals have been computed, determine the amount of manufacturing overhead cost per unit of each product. b. Compute the unit product cost of each product.
12 Review Class #1.3(continued) 3. a. The overhead applied to each product can be determined as follows: Mono-Circuit (a) Predetermined Overhead Rate (a) (b) Overhead Applied (b) Activity Cost Pool Activity Maintaining parts inventory... $400 per part type 300 part types $ 120,000 Processing purchase orders... $180 per order 2,000 orders 360,000 Quality control... $75 per test 2,000 tests 150,000 Machine-related... $30 per MH 20,000 MHs 600,000 Total manufacturing overhead cost (a)... $1,230,000 Number of units produced (b)... 40,000 Overhead cost per unit (a) (b)... $30.75 Bi-Circuit (a) Predetermined Overhead Rate (a) (b) Overhead Applied (b) Activity Cost Pool Activity Maintaining parts inventory... $400 per part type 600 part types $ 240,000 Processing purchase orders... $180 per order 1,000 orders 180,000 Quality control... $75 per test 6,000 tests 450,000 Machine-related... $30 per MH 30,000 MHs 900,000 Total manufacturing overhead cost (a)... $1,770,000 Number of units produced (b)... 10,000 Overhead cost per unit (a) (b)... $177.00
13 Review class #1.3 (continued) b. Using activity-based costing, the unit product cost of each product would be: Mono-circuit Bi-circuit Direct materials... $40.00 $ Direct labour Manufacturing overhead (above) Total unit product cost... $88.75 $ Required 4: Look at the data you have computed in parts (1) through (3) above. In terms of manufacturing overhead cost, what factors make the bi-circuit more costly to produce than the mono-circuit? Is the bi-circuit as profitable as the company thinks it is? Explain. Although the bi-circuit accounts for only 20% of the company s total production, it is responsible for two-thirds of the part types carried in inventory and 60% of the machine-hours. It is also responsible for one-third of the purchase orders and three-fourths of the quality control tests. These factors have been concealed as a result of using direct labour-hours as the base for assigning overhead cost to products. Since the bi-circuit is responsible for a majority of the activity in the company, under activity-based costing it is assigned most of the overhead cost. Managers should be cautious about drawing firm conclusions about the profitability of products from the above activity-based cost analysis. The ABC system used in this company is not completely suitable for making decisions. Product costs probably include costs of idle capacity and organization-sustaining costs. They also exclude non-manufacturing costs that may be caused by the products. Nevertheless, the above analysis is suggestive. The bi-circuit may not be as profitable as management believes, and this may be the reason for the company s declining profits. Note that from part (1), the unit product cost of the bi-circuit is $216. In part (3), however, the activity-based costing system sets the unit product cost of the bi-circuit at $293. This is a difference of $77 per unit. If the unit product cost of $216 is being used to set the selling price for the bi-circuit, the selling price may not be high enough to cover the company s costs.