Comtek Sound, Inc.

, makes two products, a radio with a built-in CD player (called

manufacturers for installation in new vehicles. Recently, the company has been lo
bid. At the same time, Comtek Sound has been winning every bid it has submi
complaining that at the prices Comtek Sound is willing to bid, competitors are t
However, the prices competitors quote on thc CD players are below Comtek Soun
applies manufacturing overhead to products based on direct labor-hours. Producti
and the DVD player-the DVD player takes more overhead resources to make
system. With the enthusiastic cooperation of the company's accounting depart
assign

!!! You should fill in all yellow cells and put your answers instead of red questions.

The ABC team gathered basic information relating to the company's two p
selling 50,000 DVD units and 200,000 CD units. Both products require two direct
c

Number of units
DVD units: 50000
CD units 200000
Total direct labour-hours

Costs for direct materials and direct labor for one unit of each product are given be

DVD Units
Direct materials $90
Direct labor (at $10 per DLH) $20

The company's estimated manufacturing overhead costs for the current year to
for each product, the more complex DVD units require more machine time,
manufacture the DVD units in smaller batches;
The company has always used direct labo
 The company's estimated manufacturing overhead costs for the current year to
for each product, the more complex DVD units require more machine time,
manufacture the DVD units in smaller batches;
The company has always used direct labo
With these data in hand, the ABC team was prepared to begin the design of th
com

Direct Labor-Hours as a Base

Under the company's existing costing system, the predetermined overhead rate wo
20 (calculate) per direct labor-hour, computed as follows:

Predetermined overhead rate = 20

Using this rate, the ABC team computed the unit product costs as given below (fill i
activity based
DVD units
Direct materials 90
Direct labour 20
Manufacturing overhead (Number of
DLHs*Predetermined overhead rate) 40
Unit product cost 150

Com

The ABC team then analyzed Comtek Sound, Inc.'s operations and identified six m
the activities are presented in Exhibit X. That exhibit shows the amount of overhea
The machine setups activity cost pool, for example, was assigned $ 1 ,600.000 in o
be for DVD units and 1,000 will be for CD u
The ABC team then computed an activity rate for each activity. The activity rate
cost in the activity cost pool, $ 1 ,600,000, by the expected amount of activity, 4,0
system. Please c
 Once the activity rates were calculated, it was easy to compute the overhead cost t
to DVD units was determined by multiplying the activity rate of $400 per setup b
machine setup costs to be assigned to the DVD units. Note from the exhibit tha
assigned to each DVD unit and $XXX (your calculations) to each CD unit. The ABC
comparison, the exhibit also shows the unit product costs derive
costs to the products. The ABC team membe
In the past, the company has been charging $40.00 in overhead cost to a unit of e
only $XXX to each CD unit. Thus, unit costs have been badly distorted as
been suffering a ????on the DVD units without knowing it because the cost of
to ??????????? assign overhead costs to each product. Alth
on the CD units, it turns out that we were ????????????? for these units because o
the DVD units, but now we realize that our prices have been way too????? becaus
eve

Exhibit X E
Es
O

Activities and Activity Measures

Labor related (direct labor-hours)
Machine related (machine-hours)
Machine setups (setups)
Production orders (orders)
Parts administration (part types)
General factory (machine-hours)

Compu

(a)
Estimated
 Overhead
Activities Cost
Labor related (direct labor-hours)
Machine related (machine-hours)
Machine setups (setups)
Production orders (orders)
Parts administration (part types)
General factory (machine-hours)

Computation of the Overhead Cost per Un

DVD Units
Expected
Activities and activities rates Activity
Labor related (direct labor-hours) 100000
Machine related (machine-hours) 300000
Machine setups (setups) 3000
Production orders (orders) 800
Parts administration (part types) 400
General factory (machine-hours) 300000
Total overhead costs assigned (a)
Number of units produced (b)
Overhead cost per unit (a) -:- (b)

Comparison of Unit Product Cos

Activity-Based costing
Direct materials 90
Direct labour 20

Manufacturing overhead (Number of

DLHs*Predetermined overhead rate) 97.8
Unit product cost 207.8
with a built-in CD player (called a CD unit) and a radio with a built-in DVD player (called a DVD unit). Both
cently, the company has been losing bids to supply CD players because competitors have been bidding les
n winning every bid it has submitted for its DVD player, which management regards as a secondary produ
willing to bid, competitors are taking the company's high-volume CD business and leaving Comtek Sound
players are below Comtek Sound's manufacturing cost for these units-at least according to Comtek Soun
on direct labor-hours. Production managers suspected that the conventional costing system might be dis
e overhead resources to make than the CD player and yet their manufacturing overhead costs are i
e company's accounting department, a cross-functional team was formed to develop an activity-base
assign overhead costs to the two products.

f red questions.

ating to the company's two products. A summary of some of this information follows. For the current
th products require two direct labor-hours to complete. Therefore, the company plans to work 500
current year, computed as follows:

direct labour-hours (DLH) Total

2 100000
2 400000
500000

nit of each product are given below:

CD Units
$50
$20

ad costs for the current year total $10,000,000. The ABC team discovered that although the same amou
s require more machine time, more machine setups, and more testing than the CD units. Also, the tea
he DVD units in smaller batches; consequently, they require more production orders than the CD units.
pany has always used direct labor-hours as the base for assigning overhead costs to its products.
redetermined overhead rate would be

us dollars per one labour hour

oduct costs as given below (fill in the table):

CD units
50
20

40
110

Computing Activity Rates

s operations and identified six major activities to include in the new activity-based costing system. Cost an
bit shows the amount of overhead cost for each activity cost pool, along with the expected amount of acti
e, was assigned $ 1 ,600.000 in overhead cost. The company expects to complete 4,000 setups during the
units and 1,000 will be for CD units. Data for other activities are also shown in the exhibit.
each activity. The activity rate of $400 per machine setup, for example, was computed by dividing the to
expected amount of activity, 4,000 setups. This process was repeated for each of the other activities in th
system. Please calculate thee other activity rates.

Computing Product Costs

 to compute the overhead cost that would be allocated to each product. For example, the amount of mac
activity rate of $400 per setup by the 3,000 expected setups for DVD units during the year. This yielded a
units. Note from the exhibit that the use of an activity approach has resulted in $XXX (your calculations) i
tions) to each CD unit. The ABC team then used these amounts to determine unit product costs under ac
ows the unit product costs derived earlier when direct labor-hours were used as the base for assigning ove
products. The ABC team members summarized their findings as follows in the team's report:
0 in overhead cost to a unit of either product, whereas it should have been charging $XXXX in overhead c
sts have been badly distorted as a result of using direct labor-hours as the allocation base. The company m
knowing it because the cost of these units has been so vastly understated. Through activity-based costin
head costs to each product. Although in the past we thought our competitors were pricing below their co
????? for these units because our costs were ????????. Similarly, we always used to believe that our com
have been way too????? because the cost of our DVD units was being understated. It turns out that we, n
everything backwards.

Exibit X. Basic Data

Estimated
Overhead
Cost DVD Units

$
800000 100000
2100000 300000
1600000 3000
3150000 800
350000 400
2000000 300000
10000000

Computation of Activity Rates

(a) (b)
Estimated Total a/b
 Overhead Expected Activity
Cost Activity Rate
800000 500000 1.6
2100000 1000000 2.1
1600000 4000 400
3150000 1200 2625
350000 700 500
2000000 1000000 2

on of the Overhead Cost per Unit of Product

CD Units
Expected
Amount Activity Amount
160000 400000 640000
630000 700000 1470000
1200000 1000 400000
2100000 400 1050000
200000 300 150000
600000 700000 1400000
4890000 5110000
50000 200000
97.8 25.55

Comparison of Unit Product Costs

ctivity-Based costing Direct-Based costing
50 90 50
20 20 20

25.55 40 40
95.55 150 110
 d a DVD unit). Both of these products are sold to automobile
ave been bidding less than Comtek Sound has been willing to
a secondary product. The marketing manager has been
ving Comtek Sound with just the low-volume DVD business.
ng to Comtek Sound's conventional accounting system that
system might be distorting the relative costs of the CD player
verhead costs are identical under the conventional costing
op an activity-based costing system to more accurately

ws. For the current year, the company's budget provides for
plans to work 500,000 direct labor-hours (DLHs) during the

ugh the same amount of direct labor time is required

units. Also, the team found that it is necessary to
han the CD units.
s products.
ting system. Cost and other data relating to
cted amount of activity for the current year.
0 setups during the year, of which 3,000 will
hibit.
d by dividing the total estimated overhead
other activities in the activity-based costing
 the amount of machine setup cost allocated
year. This yielded a total of S I ,200,000 in
your calculations) in overhead cost being
duct costs under activity-based costing. For
se for assigning overhead
eport:
XXXX in overhead cost to each DVD unit and
ase. The company may even have
ctivity-based costing, we have been able
cing below their cost
elieve that our competitors were overpricing
turns out that we, not our competitors, had

Expected Activity
CD Units Total

400000 500000
700000 1000000
1000 4000
400 1200
300 700
700000 1000000