Perioto Inc. currently charges manufacturing overhead costs to products using machine hours. However, company management believes that the use of ABC would provide more realistic cost estimates and, in turn, give the company an edge in pricing over its competitors. Perioto’s accountant and production manager have provided the following budgeted information for 2011, given a budgeted capacity of 1,000,000 machine hours:
Type of Manufacturing Cost Cost Amount
Electric power …………………………………… $500,000
Work cells ………………………………………..3,000,000
Material handling …………………………………1,000,000
Quality control inspections ……………………….1,000,000
Machine setups ……………………………………. 350,000
Total budgeted overhead costs ……………….. $5,850,000
Type of Manufacturing Cost Activity Drivers
Electric power …………………………………200,000 kilowatt hours
Work cells ……………………………………..300,000 square feet
Material handling ………………………………200,000 material moves
Quality control inspections ……………………. 50,000 inspections
Machine setups ……………………………….. 25,000 setups
A national construction company approached Pete Lang, the VP of marketing, about a bid for 2,500 doors. Lang asked the cost accountant to prepare a cost estimate for producing the 2,500 doors; he received the following data:
Direct material cost ……………………… $50,000
Direct labor cost …………………………$150,000
Machine hours ……………………………… 5,000
Direct labor hours ………………………….. 2,500
Electric power—kilowatt hours ……………. 500
Work cells—square feet ……………………. 1,000
Number of material handling moves ……….. . 20
Number of quality control inspections ……….. 15
Number of setups …………………………… 6
Source: Adapted from Nabil Hassa, Herbert E. Brown, and Paul M. Saunders, ?oManagement Accounting Case Study: Beaver Window Inc.,?? Management Accounting Campus Report (Fall 1990).
Copyright Institute of Management Accountants, Montvale, NJ.
a. What is the predetermined overhead rate if the traditional measure of machine hours is used?
b. What is the manufacturing cost per door as presently accounted for?
c. What is the manufacturing cost per door under the proposed ABC method?
d. If the two cost systems will result in different cost estimates, which cost accounting system is preferable as a pricing base and why?
e. If activity-based management were implemented prior to an ABC system, which of the manufacturing overhead costs might be reduced or eliminated? Why?