Unit 2: June 2005, Question #2(b)

Telcom's Manufacturing Inc.

2b (i)   Calculation of total cost of L23 and L24 using the traditional costing system:

• Calculate the predetermined over rate (POHR) = Total Overhead Cost/Direct labor hours: $400,000/10,000 hours = $40/hr.                                        

Under the traditional costing system:

• L23 total costs equals $174,000
• L24 total costs equals $362,600.
  

2b (ii)   Computation of activity application rates for purchase order processing, machine processing and inspection:

The activity application rates for:

• Purchase order processing - $100 per purchase order
  
• Machine processing - $27.50 per machine hour
  
• Inspection - $140 per inspection
  

2b (iii)   Calculation of total cost of L23 and L24 using the activity based costing system:

Under the activity based costing system:

• L23 total costs equals $242,750
• L24 total costs equals $293,850.
  

2b (iv)  In order to determine why Telcom is experiencing significant decline in profits, it is useful, but not necessary to assimilate all the results of parts 1 and 2:
Table showing the cost per unit under each costing method:

Reasons why Tecom may be experiencing a significant decline in profits:
           It can be seen that under the traditional costing method the cost of producing a unit of L23 is understated by $68.75 ($242.75-$174), when compared to the cost of production under the activity based costing method. As a result of this the current price of the L23 will be set much lower than it should be resulting in significantly declined profits as Telcom’s prices are based heavily on cost.

         Conversely under the traditional costing method the cost of producing a unit of L24 is overstated by $49.11 ($259-$209.89), when compared to the cost of production under the activity based costing method. As a result of this, the current price of the L24 will be set higher than it should be and this can chase potential customers away and thus drive its sales down. This scenario will also result in a declined profits for Telcom.

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