Thursday, 10 April 2014

Kingsport Containers, Ltd, of the Bahamas experiences wide variation in demand for the 200-liter steel drums it fabricates. The leakproof, rustproof steel drums have a variety of uses from storing liquids and bulk materials to serving as makeshift musical instruments. The drums are made to order and



Exercise 2-18 Varying Predetermined Overhead Rates [LO3, LO5]
Kingsport Containers, Ltd, of the Bahamas experiences wide variation in demand for the 200-liter steel drums it fabricates. The leakproof, rustproof steel drums have a variety of uses from storing liquids and bulk materials to serving as makeshift musical instruments. The drums are made to order and are painted according to the customer's specifications—often in bright patterns and designs. The company is well known for the artwork that appears on its drums. Unit product costs are computed on a quarterly basis by dividing each quarter's manufacturing costs (materials, labor, and overhead) by the quarter's production in units. The company's estimated costs, by quarter, for the coming year follow:
 

Quarter

First
Second
Third
Fourth
  Direct materials
$240,000   
$120,000   
$60,000   
$177,000   
  Direct labor
96,000   
48,000   
24,000   
70,800   
  Manufacturing overhead
246,000   
203,000   
193,000   
173,900   
  Total manufacturing costs
$582,000   
$371,000   
$277,000   
$421,700   
  Number of units to be produced
80,000   
40,000   
20,000   
59,000   
  Estimated unit product cost
$7.28   
$9.28   
$13.85   
$7.15   

 
Management finds the variation in unit costs confusing and difficult to work with. It has been suggested that the problem lies with manufacturing overhead because it is the largest element of cost. Accordingly, you have been asked to find a more appropriate way of assigning manufacturing overhead cost to units of product. After some analysis, you have determined that the company's overhead costs are mostly fixed and therefore show little sensitivity to changes in the level of production.
 
Requirement 1:
What would be the predetermined manufacturing overhead rate on the basis of total units of product? (Round your answer to 2 decimal places. Omit the "$" sign in your response.)

  Predetermined overhead rate
$  
per unit
 
Requirement 2:
Recompute the company's unit product costs in accordance with your computation in Requirement 1 above. (Round the "Unit product cost" to 2 decimal places. Omit the "$" sign in your response.)


Quarter

First
Second
Third
Fourth
  Direct materials
$  
$  
$  
$  
  Direct labor




  Manufacturing overhead




  Total cost
$  
$  
$  
$  
  Number of units to be produced




  Estimated unit product cost
$  
$  
$  
$  



Explanation:
1: 
As suggested, the costing problem does indeed lie with manufacturing overhead cost. Because manufacturing overhead is mostly fixed, the cost per unit increases as the level of production decreases. This apparent problem can be "solved" by using a predetermined overhead rate, which should be based on expected activity for the entire year. Some students will use units of product in computing the predetermined overhead rate, as follows:
 
Predetermined
=
Estimated total manufacturing overhead cost
overhead rates
Estimated total amount of the allocation base


  =
$815,900
  

199,000 units
 

  =
$4.10 per unit.