Meditech, Inc. manufactures two types of medical devices, Medform and Procel, and applies over- head on the basis of direct-labor hours. Anticipated overhead and direct-labor time for the upcoming accounting period are $710,000 and 20,000 hours, respectively. Information about the company’s prod- ucts follows.

Medform:

Estimated production volume, 2,500 units Direct-material cost, $30 per unit

Direct labor per unit, 3 hours at $15 per hour

Procel:

Estimated production volume, 3,125 units Direct-material cost, $45 per unit

Direct labor per unit, 4 hours at $15 per hour

Meditech’s overhead of $710,000 can be identified with three major activities: order processing ($120,000), machine processing ($500,000), and product inspection ($90,000). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively. Data relevant to these activities follow.

 

Orders Processed

 

Machine Hours Worked

 

Inspection Hours

 

Medform ....................................................          350                         23,000                           4,000

Procel ........................................................          250                         27,000                         11,000

                                                                                                                                                  

Total ......................................................          600                         50,000                         15,000

                                                                                                                                                  

 

Management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in income is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery was installed—machinery that was expected to produce significant operating efficiencies.

Required:

1.      Assuming use of direct-labor hours to apply overhead to production, compute the unit manufactur- ing costs of the Medform and Procel products if the expected manufacturing volume is attained.

2.      Assuming use of activity-based costing, compute the unit manufacturing costs of the Medform and Procel products if the expected manufacturing volume is attained.

 

 

 

 

3.      Meditech’s selling prices are based heavily on cost.

a.      By using direct-labor hours as an application base, which product is overcosted and which product is undercosted? Calculate the amount of the cost distortion for each product.

b.      Is it possible that overcosting and undercosting (i.e., cost distortion) and the subsequent deter- mination of selling prices are contributing to the company’s profit woes? Explain.

4.      Build a spreadsheet: Construct an Excel spreadsheet to solve requirements 1, 2, and 3(a) above. Show how the solution will change if the following data change: the overhead associated with order processing is $125,000 and the overhead associated with product inspection is $95,000.