Elkhart Industries designs and manufactures custom dining room furniture. The company prices the furniture at 25% over estimated cost (excluding administrative and selling costs).
Devon Stryker, the owner of the company, has noted that its product mix is changing from large orders of tables that are relatively easy to produce because customers are claiming that the company’s prices are not competitive. The company has been receiving smaller orders for more complex furniture items, like hutches and arm chairs. Customers are more than willing to pay the prices for these more specialized pieces of furniture.
This situation was discussed in a weekly management meeting. The plant manager blamed the company’s current cost accounting system indicating that it doesn’t capture appropriate information to use to set product prices. He indicated he had been researching costing systems and felt that activity-based costing would provide more reliable data for setting prices.
The company contacted their local university and they were able to provide a couple of graduate students with undergraduate accounting majors to assist in accumulating information that could be used to implement activity-based costing. The students captured the following information related to production activities in 2021:
| Cost Pools | Annual Cost | Cost Driver | Annual Driver Value |
| Product design | $ 800,000 | Design hours | 16,000 |
| Material ordering and handling | 1,000,000 | Unique materials | 12,500 |
| Inspection | 350,000 | Inspections | 56,000 |
| Setup | 250,000 | Setups | 8,000 |
| Labor-related overhead | 800,000 | Direct labor Dollars | $1,000,000 |
| Depreciation of plant and equipment | 1,800,000 | Machine hours | 22,500 |
| $5.000,000 |
In the current system, overhead is applied based on direct labor cost.
The students also captured information about two different orders that were produced in 2021. The first was an order of 90 large dining room tables and the second was an order for one dining room hutch. The following table captures the direct material and direct labor cost along with the units of cost drivers that would have been incurred under activity-based costing:
| Dining Room Tables | |
| Direct materials per table | $ 250 |
| Direct labor per table | 150 |
| Cost Drivers for 90 tables | |
| Number of design hours | 10 |
| Number of unique materials | 5 |
| Number of inspections | 90 |
| Number of setups | 1 |
| Machine hours | 120 |
| Dining Room Hutch | |
| Direct materials | $ 750 |
| Direct labor | 200 |
| Cost Drivers for 1 hutch | |
| Number of design hours | 15 |
| Number of unique materials | 15 |
| Number of inspections | 3 |
| Number of setups | 1 |
| Machine hours | 5 |
Required:
- Compute the predetermined overhead rate for 2021 using traditional costing with direct labor cost as the allocation base. (15 points)
- Compute the total cost of manufacturing one dining room table and one dining room hutch using direct labor cost as the allocation base for manufacturing overhead. (15 points)
- Determine the price that would be charged using the 25% markup on manufacturing cost for one dining room table and one dining room hutch using direct labor cost as the allocation base for manufacturing overhead. (15 points)
- Determine the gross profit for one dining room table and one dining room hutch using the price calculated in requirement 3 and the total manufacturing cost calculated in requirement 2. (15 points)
- Compute the predetermined overhead rate per cost driver for each of the overhead cost pools using the proposed activity-based costing system. (30 points)
- Compute the total cost of manufacturing one dining room table and one dining room hutch using the proposed activity-based costing system. (30 points)
- Determine the price that would be charged using the 25% markup on manufacturing cost for one dining room table and one dining room hutch using the proposed activity-based costing system for applying manufacturing overhead. (20 points)
- Determine the gross profit for one dining room table and one dining room hutch using the price calculated in requirement 7 and the total manufacturing cost calculated in requirement 6. (15 points)
- Prepare a formal memo addressed to the owner of the company that includes a recommendation related to the adoption of activity-based costing. (50 points)
