Problem

Routers Inc. manufactures and sells two types of high-speed, secure wireless routers: a home router and a commercial router. Routers Inc. purchases components (printed circuit boards, antennas, power supplies, plastic cases), assembles complete units and tests and boxes them in its plant. The following table summarizes operations for the last fiscal year. Home Commercial Number of units produced 12,000 5,000 Direct labor minutes per unit 9 21 Direct material cost per unit $6.50 $23.00 In other words, management budgeted and produced 12,000 home routers last year and budgeted and produced 5,000 commercial routers. Each direct labor minute cost the firm $0.40, and manufacturing overhead last year amounted to $426,000. Routers Inc. employs a traditional absorption costing system to allocate manufacturing overhead to products using direct labor minutes as the allocation base.

Required:

a. What was the manufacturing overhead rate Routers Inc. calculated last year assuming that actual and budgeted overheads and volumes were identical? (In other words, budgeted volume and actual volumes were the same, and budgeted and actual manufacturing overheads were the same.)

b. Compute the total unit manufacturing costs of the home and commercial routers for last year.

c. Some senior managers at Routers Inc. questioned using direct labor minutes to allocate the $426,000 of manufacturing overhead arguing (i) it is too coarse and (ii) a more nuanced (sophisticated) approach was required. An extensive study of the manufacturing overheads revealed that the annual manufacturing overhead of $426,000 consists of two components: batch-related costs of $308,000 and product-line related costs of $118,000. Each time a batch is produced, components must be ordered in advance, inspected and stocked when received, and moved to the assembly department before production commences. Then, the assembly line must be prepared for the batch, and a few routers produced and tested to insure the assembly process is performing properly. During the year, 40 batches of home routers were assembled (each with 300 home routers per batch) and 100 batches of commercial routers were assembled (each with 50 commercial routers per batch). The product-line related costs of $118,000 consist of engineering and technician expenses devoted to revising the technical specifications of the components used in the two product lines to comply with the various government agencies regulating wireless devices. Each product line consumes half of the product-line related costs of $118,000. Given the data revealed in the cost study (discussed earlier), compute the manufacturing overhead that should be assigned to the home router and the commercial router.

d. The people conducting the manufacturing overhead cost study argue that using the new manufacturing overhead allocations will increase the accuracy of the cost of producing home routers and commercial routers, and hence should be adopted. You are hired as a consultant to the chief financial officer (CFO). Write a brief memo recommending how the CFO should proceed. Should the CFO stay with the existing absorption costing system, switch to the new system, or gather additional information (and what information should be gathered)?