Comparison of two costing systems, original activity-based costs, implementing change The Redwood City plant of Crimson Components Company makes two types of rotators for automobile engines: R361 and R572. The old cost accounting system at the plant traced support costs to four cost pools:
Cost Pool Support Costs Cost Driver
S1 $1,176,000 Direct Labor Cost
S2 $1,120,000 Machine Hours
P1 $480,000 –
P2 $780,000 –
Totals $3,556,000
Pool S1 included service activity costs related to setups, production scheduling, plant administration, janitorial services, materials handling, and shipping. Pool S2 included activity costs related to machine maintenance and repair, rent, insurance, power, and utilities. Pools P1 and P2 included supervisors’ wages, idle time, and indirect materials for the two production departments, casting and machining, respectively.
The old accounting system allocated support costs in pools S1 and S2 to the two production departments using direct labor cost and machine hours, respectively, as the cost drivers. Then the accumulated support costs in pools P1 and P2 were applied to the products on the basis of direct labor hours. A separate rate was determined for each of the two production departments. The direct labor wage rate is $15 per hour in casting and $18 per hour in machining.
DIRECT LABOR HOURS (DLH)
Department R361 R572 Total Direct Labor Costs
Casting (P1) 60,000 20,000 80,000 $1,200,000
Machining (P2) 72,000 48,000 120,000 $2,160,000
Totals 132,000 68,000 200,000 $3,360,000
MACHINE HOURS (MH)
Department R361 R572 Total
Casting (P1) 30,000 10,000 40,000
Machining (P2) 72,000 48,000 120,000
Totals 102,000 58,000 160,000
Item R361 R572
Sales price per unit $19 $20
Sales and production units 500,000 400,000
Number of orders 1,000 1,000
Number of setups 2,000 4,000
Materials cost per unit $8 $10
Now the plant has implemented an activity-based costing system. The following table presents the amounts from the old cost pools that are traced to each of the new activity cost pools:
OLD COST POOLS:
Activity cost drivers S1 S2 P1 P2 Total
P1-DLH $120,000 $0 $120,000 $0 $240,000
P2-DLH $240,000 $0 0 $120,000 $360,000
Setup hours $816,000 $80,000 $240,000 $540,000 $1,676,000
P1-MH 0 $260,000 $120,000 $0 $380,000
P2-MH 0 $780,000 0 $120,000 $900,000
Total $1,176,000 $1,120,000 $480,000 $780,000 $3,556,000
Setups for R572 are 50% more complex than those for R361; that is, each R572 setup takes 1.5 times as long as one R361 setup.
Required:
(a) Determine the product costs per unit using the old system. Show all intermediate steps for allocations, including departmental cost driver rates and a breakdown of product costs into each of their components.
(b) Determine the product costs per unit using the new system.
(c) Explain the intuitive reason that the product costs differ under the two accounting systems.
(d) What should Crimson Components do to improve the profitability of its Redwood City plant? Include marketing and product-related changes among your recommendations.
(e) Describe how experienced production and sales managers are likely to react to the new product costs.
