Utilities costs account for nearly $69.600 of Master File’s total manufacturing overhead costs. A large portion of this amount is incurred to heat the factory and supply power 10 the large machines used in manufacturing the metal cabinet line. Thus, using ABC; Master File identifies heating demands and machinery power demands as paraphrase activities.
As such, each of these pools is assigned a portion , of the $69.600 utilities costs. Management believes that the number of kilowatt hours (KWH) required for each activity is the most significant-driver of utilities costs.
Using KWH as an activity base. $24.360 is assigned to the /tcatilt!: cost pool. whereas $45.240 is assigned to the machinery cost pool, as computed helow , The costs assigned to each of these cost pools must now be allocated to the metal and wooden product lines.
Management believes that square feel of production space Outlined by each product line is the most appropriate activity base for allocating the heating cost pool, Of the company’s 40,000 square feet or production space, about (J is dedicated to the metal cabinet line, and 6,000 is dedicated to the wooden cabinet line. Thus. in it typical year. the metal cabinets are allocated $20,706 of heating pool COS, whereas wooden cabinets are allocated only $3.654, computed on the following page , The number of machine hours is determined to be the most significant driver of machinery power costs.
Thus machine hours will serve as the activity base for allocating the machinery cost pool to each product line. The company utilizes approximately 50,000 machine hours each year. Of these, about 45,000 pertain to machinery used to manufacture metal cabinets, and 5,000 pertain to machines used for making wooden cabinets.
Thus, in a typical year, the metal cabinets are allocated-approximately $40,716 of machinery pool costs, whereas wooden cabinets are allocated approximately $4,524, as shown below In summary, annual utilities costs average $24,360 for heating and $45,240 for powering machinery (for a total Of $69,6(0). At normal levels of production, ABC allocated approximately $20,706 of heating costs to the metal cabinet line and $3,654 of heating costs to the wooden cabinet line. In addition, it allocates $40,716 of machinery power costs to the metal cabinet line and $4,524 to the wooden cabinet line.
Determining’ Unit Costs Using ABC We ‘Miltown compute Master File’s overhead cost on a per-unit basis. At normal Levis or activity, the company produces and sells 42,000 metal file cabinets under 9.0()() wooden tile cabinets per year.
Thus the unit manufacturing overhead cost of each metal cabinet is if, compared to $5.31 for each wooden cabinet. These unit costs are computed below.1\vo observations should be made restrengthen figures. First, at normal levels of activity,
Master File’s ABC process allocates the entire $249,600 in annual overhead costs to each product line ($201,822 10 the metal cabinet line and $47.778 to the wooden cabinet line). Second, the amount of manufacturing overhead allocated to each product significantly different than what was allocated using a single activity base, as shown below,As indicated: manufacturing overhead applied to’ the metal file cabinets using ABC is $i.61 more than it was when single activity base of direct labor hours was used. However, the amount applied to the wooden cabinets using ABC is $7.49 less than it was previously.
As a consequence, Master File is likely to raise the selling price of its metal file cabinets and lower the selling price of its wooden file cabinets, as shown on the following ‘page.If Master File maintains Its current pricing policy, it will raise the price of. metal tile cabinets by $2.58 per unit and lower the price of its wooden file cabinets by $J J.98 per , unit. YQU, wiil recall that
Master File currently is selling its metal filing cabinets for about $3 less than competitive products. Therefore. the metal cabinet prices will remain competitive even if their sales price is raised by $2.58 per unit. However. the company’s wooden file cabinets have been priced at $JO.OO more than competitive products.
Thus. by lowering the unit selling price by $11.98, Master File’s wooden cabinets can now be , priced competitively without sacrificing product quality. Reallocating overhead costs to products based on ABC procedures has no cashflow effects unless managers change some of their decisions as a result of the new cost numbers. In the example lust provided, managers are considering changing the seiling prices of filing, cabinets. the managers hope these selling price changes will increase sales revenue and thus Increase cash Inflow. If managers can use the ABC information to manage more effectively and efficiently the activities that consurne resources. then cash outflows associated with those activities will decline. The important point is that ,adopting. ABC procedures will not change cash flows unless the procedure, manage meet decision making.