Section IV: Alternative Costing Method
Hampshire has always produced stick umbrellas. However, it is considering expanding its production to include collapsible umbrellas. This consideration has been spurred by Tours Today, a touring company that is interested in providing its customers with collapsible umbrellas imprinted with its logo. The management at Hampshire is currently working out a deal with the touring company to produce 3,000 collapsible umbrellas and believes it can sell those umbrellas for $14.00 each. Here are the costs that can be directly traced to this special order:
Direct Materials: $9,300
Direct Labor Hours: 600
Hourly Rate of Direct labor: $8.00
In the traditional costing approach, overhead is applied at the rate of $24.60 per labor hour. This expansion in production will add additional overhead costs. The total overhead costs (assuming production of the stick and collapsible umbrellas) to include the cost pools and cost drivers are provided in Table 2.
An alternative costing method that might benefit Hampshire is the implementation of activity-based costing (ABC). Hampshire would like to implement an ABC approach to analyze the production of this special order of collapsible umbrellas. The controller has assembled the following information:
|
Stick
|
Collapsible
|
|
Units Sold
|
60,000
|
3,000
|
|
Selling Price
|
$12.50
|
$14.00
|
|
Direct Material Cost per Unit
|
$3
|
$3.10
|
|
Direct Labor Cost per Hour
|
$7.50
|
$8.00
|
|
Variable Manufacturing Overhead
|
$0.40
|
$0.40
|
|
Variable Selling Costs
|
$1.10
|
$1.10
|
|
Labor Hours per Unit
|
0.2
|
0.2
|
|
Sales Orders
|
120
|
1
|
|
Purchase Orders
|
50
|
3
|
|
Production Runs
|
45
|
6
|
|
Material Moves
|
86
|
10
|
|
Machine Setups
|
130
|
6
|
|
Machine Hours
|
525
|
32
|
|
Inspections
|
200
|
10
|
|
Shipments
|
60
|
3
|
Table 1: Direct Cost Information and Activities
|
Activity
|
Activity Cost
|
Activity Cost Driver
|
|
Order Processing
|
$35,000
|
Number of Sales Orders
|
|
Purchasing
|
$36,000
|
Number of Purchase Orders
|
|
Material Handing
|
$28,000
|
Material Moves
|
|
Machine Setup
|
$14,000
|
Machine Setups
|
|
Production
|
$99,000
|
Production Runs
|
|
Assembly
|
$80,000
|
Machine Hours
|
|
Inspecting
|
$11,000
|
Number of Inspections
|
|
Shipping
|
$7,500
|
Number of Shipments
|
Table 2: Activity Cost Pools and Cost Drivers
Another alternative to traditional costing and ABC is time-driven activity-based costing (TDABC). You will need to determine which of these three methods would be the best approach for the Hampshire Company. The following article may assist you in your analysis: Time-Driven Activity-Based Costing. Additionally, you may want to use the Shapiro Library to conduct further research on the three methods. You will need to defend your position when answering the prompts for the written portion of this section.
Using the information provided above, complete the following in the Hampshire Company Spreadsheet in order to assist you in responding to all components of Section IV:
1. Calculate the allocation rates for each cost driver using ABC.
2. Use the traditional costing approach to calculate the total cost and the unit cost of the stick and collapsible umbrellas.
3. Use ABC to compute the total costs and the unit cost for the stick and collapsible umbrellas.
4. Compute the difference between the product cost per stick and collapsible umbrellas using the unit cost that you computed with the traditional approach and the one that you computed using ABC.