Premier
Products, Inc. manufactures tennis rackets. Premier Products has grown
extensively over the past two years. While the company has been very
profitable, President Mark Harrison is concerned with its ability to cost
products accurately. Some products appear to be very profitable while others,
which should be showing a profit, seem to be losing money. The production
manager is convinced that his production processes are as
efficient as any in the industry, and he is unable to explain the apparent high
cost of producing some of the products.
Harrison agreed
with his production manager and is convinced that the cost accounting system is
at fault. He has hired Tom Arnold, a management consultant, to analyze the
firm’s costing system. Arnold has documented the existing costing system. It is
a very simple system that uses a single allocation rate for all overhead costs.
The overhead rate for the year is determined by adding together the budgeted
variable and fixed overhead costs and dividing this sum by the number of
budgeted labor hours. The standard cost of a product is found by multiplying
the number of direct labor hours required to manufacture that product by the
overhead rate and adding this quantity to the direct labor and material costs.
Arnold is
convinced that the company’s costing system is partially to blame for some of
the firm’s problems. He has assembled data for four of Premier’s products. He
has put together the actual costs required for each of these products in Table
A. These costs will serve as the benchmark against which the results of
different allocation schemes can be evaluated.

Of course, in
real life we could never start out with accurate actual costs – accurate actual
costs would be the end result that we would attempt to determine. But we provide this information as a learning
aid to help you to clearly understand the key issues. Table A is as follows:

PRODUCT

A

B

C

D

Material

$15.00

$ 5.00

$10.00

$ 5.00

+ Labor

30.00

5.00

15.00

10.00

+Variable OH

15.00

7.50

5.00

7.50

= Unit var. cost

$60.00

$17.50

$30.00

$22.50

Fixed overhead

$10,000

$10,000

$12,500

$12,500

Units produced

1,000

1,000

1,000

1,000

Unit fixed cost

$10.00

$10.00

$12.50

$12.50

Total unit cost

$70.00

$27.50

$42.50

$35.00

The
manufacturing processes for these products are structured such that the same
labor and equipment can be used to produce products A and B but cannot be used
to manufacture products C and D. Similarly, the labor and equipment used to
manufacture products C and D cannot be used for A and B.
The company has
the capacity to produce:
(1) 1,000 units
of product A and 1,000 units of product B, or
(2) 2,000 units
of product A, or
(3) 2,000 units
of product B; or
(4) Any linear
combination of products A and B.
The same is true
for products C and D. The company has the capacity to produce:
(1) 1,000 units
of product C and 1,000 units of product D, or
(2) 2,000 units
of product C, or
(3) 2,000 units
of product D; or
(4) Any linear
combination of products C and D.

Product

Labor hrs per unit

Variable Ohd/unit

Number of units

Total labor hrs

Total varohd

A

6

$15.00

1,000

6,000

$15,000

B

1

7.50

1,000

1,000

7,500

C

3

5.00

1,000

3,000

5,000

D

2

7.50

1,000

2,000

7,500

Total

4,000

12,000

$35,000

The allocation
rate is:

Variable overhead

$35,000

Fixed overhead

45,000

Total overhead costs

$80,000

Labor hours

12,000

Allocation rate per hour

$6.67

Using this allocation rate, Arnold calculated the standard cost for the four
products.

PRODUCT

A

B

C

D

Material

$15.00

$ 5.00

$10.00

$ 5.00

+ Labor

30.00

5.00

15.00

10.00

+Allocated cost

40.00

6.67

20.00

13.33

Total unit cost

$85.00

$16.67

$45.00

$28.33

The selling prices for the four products are:

A

B

C

D

$98.00

$38.50

$59.50

$49.00

Premier is
considering a policy that would discontinue a product if its mark-on is under
25%. The mark-on is calculated by taking the selling price, subtracting the
product’s standard cost, and dividing by the standard cost. Harrison is
concerned that if the firm’s costing system does not provide accurate cost
estimates, products will be dropped that should be retained. Arnold calculated
that the mark-on for each product using the correct product costs in Table A is
40%.

TABLE B

PRODUCT

A

B

C

D

Selling price

$98.00

$38.50

$59.50

$49.00

Unit cost

$70.00

$27.50

$42.50

$35.00

Profit

$28.00

$11.00

$17.00

$14.00

Mark-on percentage

40% (28/70)

40% (11/27.50)

40% (17/42.50)

40% (14/35)

Arnold then
calculated the mark-on for the four products using the standard cost for each
product based on allocating the overhead costs using direct labor hours.

PRODUCT

A

B

C

D

Selling price

$98.00

$38.50

$59.50

$49.00

Unit cost

$85.00

$16.67

$45.00

$28.33

Profit

$13.00

$21.83

$14.50

$20.67

Mark-on percentage

15%

131%

32%

73%

Under the policy
of dropping products with mark-ons under 25%, product A would be dropped.
Arnold recalculates the allocation rate assuming product A is dropped and the
manufacturing capacity is shifted to produce an additional 1,000 units of
product B.

Product

Labor hrs per unit

Variable Ohd/unit

Number of units

Total labor hrs

Total varohd

B

1

7.50

2,000

2,000

$15,000

C

3

5.00

1,000

3,000

5,000

D

2

7.50

1,000

2,000

7,500

Total

4,000

7,000

$27,500

The new
allocation rate is:

Variable overhead

$27,500

Fixed overhead

45,000

Total overhead costs

$72,500

Labor hours

7,000

Allocation rate per hour

$10.36

Questions

4. What would
happen if the firm modified its costing system so that all variable costs were
traced to the product accurately, but fixed costs were allocated using the
existing system? Compute the cost for each product using this allocation
process. What would be the impact on profits? How accurate is this method of
allocating costs?
5. What would
happen if the firm modified its costing system so that it contained two cost
pools, one containing the overhead costs associated with Products A and B and
the other overhead costs associated with Products C and D, and then allocated
these overhead pools on the basis of direct labor hours? Compute the cost for
each product using this allocation process. What would be the impact on
profits? How accurate is this method of allocating costs?
Please
show answer in excel and detail description of all actions and calculationsPremier
Products, Inc. manufactures tennis rackets. Premier Products has grown
extensively over the past two years. While the company has been very
profitable, President Mark Harrison is concerned with its ability to cost
products accurately. Some products appear to be very profitable while others,
which should be showing a profit, seem to be losing money. The production
manager is convinced that his production processes are as
efficient as any in the industry, and he is unable to explain the apparent high
cost of producing some of the products. Harrison agreed
with his production manager and is convinced that the cost accounting system is
at fault. He has hired Tom Arnold, a management consultant, to analyze the
firm’s costing system. Arnold has documented the existing costing system. It is
a very simple system that uses a single allocation rate for all overhead costs.
The overhead rate for the year is determined by adding together the budgeted
variable and fixed overhead costs and dividing this sum by the number of
budgeted labor hours. The standard cost of a product is found by multiplying
the number of direct labor hours required to manufacture that product by the
overhead rate and adding this quantity to the direct labor and material costs. Arnold is
convinced that the company’s costing system is partially to blame for some of
the firm’s problems. He has assembled data for four of Premier’s products. He
has put together the actual costs required for each of these products in Table
A. These costs will serve as the benchmark against which the results of
different allocation schemes can be evaluated.
Of course, in
real life we could never start out with accurate actual costs – accurate actual
costs would be the end result that we would attempt to determine. But we provide this information as a learning
aid to help you to clearly understand the key issues. Table A is as follows:PRODUCTABCDMaterial$15.00$ 5.00$10.00$ 5.00+ Labor30.005.0015.0010.00+Variable OH15.007.505.007.50= Unit var. cost$60.00$17.50$30.00$22.50Fixed overhead$10,000$10,000$12,500$12,500Units produced1,0001,0001,0001,000Unit fixed cost$10.00$10.00$12.50$12.50Total unit cost$70.00$27.50$42.50$35.00The
manufacturing processes for these products are structured such that the same
labor and equipment can be used to produce products A and B but cannot be used
to manufacture products C and D. Similarly, the labor and equipment used to
manufacture products C and D cannot be used for A and B.The company has
the capacity to produce: (1) 1,000 units
of product A and 1,000 units of product B, or(2) 2,000 units
of product A, or(3) 2,000 units
of product B; or (4) Any linear
combination of products A and B. The same is true
for products C and D. The company has the capacity to produce: (1) 1,000 units
of product C and 1,000 units of product D, or(2) 2,000 units
of product C, or(3) 2,000 units
of product D; or (4) Any linear
combination of products C and D.
Product Labor hrs per unit Variable Ohd/unit Number of unitsTotal labor hrs Total varohdA6$15.001,0006,000$15,000B17.501,0001,0007,500C35.001,0003,0005,000D27.501,0002,000 7,500 Total 4,00012,000 $35,000The allocation
rate is:
Variable overhead $35,000 Fixed overhead 45,000 Total overhead costs $80,000 Labor hours 12,000 Allocation rate per hour $6.67
Using this allocation rate, Arnold calculated the standard cost for the four
products.
PRODUCTABCDMaterial$15.00$ 5.00$10.00$ 5.00+ Labor30.005.0015.0010.00+Allocated cost40.006.6720.0013.33Total unit cost$85.00$16.67$45.00$28.33
The selling prices for the four products are:
ABCD$98.00$38.50$59.50$49.00Premier is
considering a policy that would discontinue a product if its mark-on is under
25%. The mark-on is calculated by taking the selling price, subtracting the
product’s standard cost, and dividing by the standard cost. Harrison is
concerned that if the firm’s costing system does not provide accurate cost
estimates, products will be dropped that should be retained. Arnold calculated
that the mark-on for each product using the correct product costs in Table A is
40%.TABLE B
PRODUCTABCDSelling price$98.00$38.50$59.50$49.00Unit cost$70.00$27.50$42.50$35.00 Profit$28.00$11.00$17.00$14.00Mark-on percentage40% (28/70)40% (11/27.50)40% (17/42.50)40% (14/35)Arnold then
calculated the mark-on for the four products using the standard cost for each
product based on allocating the overhead costs using direct labor hours.
PRODUCTABCDSelling price$98.00$38.50$59.50$49.00Unit cost$85.00$16.67$45.00$28.33 Profit$13.00$21.83$14.50$20.67Mark-on percentage15%131% 32%73%Under the policy
of dropping products with mark-ons under 25%, product A would be dropped.
Arnold recalculates the allocation rate assuming product A is dropped and the
manufacturing capacity is shifted to produce an additional 1,000 units of
product B.
Product Labor hrs per unit Variable Ohd/unit Number of unitsTotal labor hrs Total varohdB17.502,0002,000$15,000C35.001,0003,0005,000D27.501,0002,000 7,500 Total 4,0007,000 $27,500The new
allocation rate is:
Variable overhead $27,500 Fixed overhead 45,000 Total overhead costs $72,500 Labor hours 7,000 Allocation rate per hour $10.36Questions4. What would
happen if the firm modified its costing system so that all variable costs were
traced to the product accurately, but fixed costs were allocated using the
existing system? Compute the cost for each product using this allocation
process. What would be the impact on profits? How accurate is this method of
allocating costs?5. What would
happen if the firm modified its costing system so that it contained two cost
pools, one containing the overhead costs associated with Products A and B and
the other overhead costs associated with Products C and D, and then allocated
these overhead pools on the basis of direct labor hours? Compute the cost for
each product using this allocation process. What would be the impact on
profits? How accurate is this method of allocating costs?Please
show answer in excel and detail description of all actions and calculations