Reference no: EM133161907

Question - Leon Inc. produces and sells three different models of stylish men's coats-Low, Moderate, and High. The company currently uses a traditional absorption costing system to allocate manufacturing overhead costs to product lines. This traditional costing system allocates manufacturing overhead cost on the basis of each product's direct labor costs in dollars. But the company's CEO, Leon, recently attended a conference on Activity Based Costing (ABC), and he's considering ABC implementation.

Leon collected the following product data for the year just ended:

	Low	Moderate	High
Units produced and sold	25,000	10,000	5,000
Direct labor hours used in production	5,000	3,500	2,000
Direct labor cost used in production	$90,000	$63,000	$36,000
Machine Hours used	7,500	6,000	8,500
Number of kilowatt hours used by factory during production	7,500	4,000	3,500
Number of production setups	4	5	7
Number of Employees	7	3	6

The company's CFO computed actual manufacturing overhead costs for the year just ended as:

Activity	Activity Costs
Machining	$140,000
Utilities	$270,000
Setups	$180,000
Supervision	$480,000
Total Manufacturing Overhead Cost	$1,070,000

The direct materials cost for the year just ended for units of Low was $12 per unit, for units of Moderate was $14 per unit, and for units of High was $21 per unit.

Required -

1. For the year just ended, (a) allocate manufacturing overhead costs to each product line and (b) compute a total manufacturing cost per unit for each product using the traditional absorption costing approach based on direct labor costs.

2. Assume that the cost driver used for the machining activity cost pool is the number of machine hours used, for the Utilities activity cost pool is the number of kilowatt hours used by the factory, for the Setups activity cost pool is the number of production setups, and for the Supervision activity cost pool is the number of employees. (a) Allocate manufacturing overhead costs for the year just ended to each product line and (b) compute a total manufacturing cost per unit for each product line using Activity Based Costing.

3. Which of the two methods from questions 1 and 2 is better for decision management? Thoroughly explain why that method is better for decision management.

4. Suppose Leon Inc. has been pricing its products for sale using a simplistic pricing rule of adding a 30% markup to its computed product cost. (a)Compute the unit selling prices for each individual product line on the basis of that product line's per unit product cost, as computed in each of questions 1 and 2, for the year just ended. (b)Discuss the differences in selling prices between products and across product costing methods.

5. In what ways might the use of traditional absorption costing and Leon Inc.'s current selling prices (as based on traditional absorption costing unit product costs) have hurt Leon Inc.'s profitability for the year just ended?

6. Which method for allocating manufacturing overhead costs to products, a traditional absorption costing (like in question 1) approach based on direct labor costs or an ABC approach (like in question 2), is better for decision control purposes? Thoroughly explain why.