Problem -
Stevenson Furniture Ltd manufactures two models of recliner chairs. The company uses absorption product costing system, which means that both variable and fixed overhead are inclined in the cost. Cost estimates for the two models for the coming year are as follows:
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Velvet model
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Leather model
|
|
Direct materials
|
$240
|
$390
|
|
Direct labour (10 hours @ $21 per hour)
|
210
|
210
|
|
Manufacturing overhead
|
150
|
150
|
|
Total cost per set
|
$600
|
$750
|
Each chair requires 10 hours of direct labour. Each Velvet chair require two hours in Department 1 and eight hours in Department 2. Each set of the Leather chair requires eight hours in Department 1 and two hours in Department 2. The manufacturing overhead costs expected during the coming year in Departments 1 and 2 are as shown below.
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Department 1
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Department 2
|
|
Variable overhead
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$12 Direct labour hour
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$6 per direct labour hour
|
|
Fixed overhead
|
$225 000
|
$225 000
|
The expected operating activity for the coming year is 37 500 direct labours in each department.
Required:
1. Show how Stevenson Furniture derived its predetermined overhead rate.
2. What will be the price of each chair if the company prices its products at absorption manufacturing cost plus 15 per cent?
3. Suppose that Stevenson Furniture were to use department overhead rates. Calculate these rates for department 1 and 2 for the coming year.
4. Calculate the absorption cost of each chair using the department overhead rate calculated in requirement 3.
5. Suppose that management sticks with its policy of setting prices equal to absorption cost plus 15 percent. Calculate the new price for each chair using the process costs developed in the requirement 4.
6. Should Stevenson Furniture use plant-wide or department; overhead rates? Explain your answer.