Ontario, Inc. manufactures two products, Standard and Enhanced, and applies overhead on the basis of direct-labor hours. Anticipated overhead and direct-labor time for the upcoming accounting period is $800,000 and 25,000 hours, respectively. Information about the company’s products follows.
Estimated production volume
3,000 units 4,000 units
$25 per unit $40 per unit
Direct labor per unit
3 hours at $12 per hour 4 hours at $12 per hour
Ontario’s overhead of $800,000 can be identified with three major activities: order processing ($150,000), machine processing ($560,000), and product inspection ($90,000). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively.
Data relevant to these activities follow:
Orders Processed Machine Hours Worked Inspection Hours
300 18,000 2,000
200 22,000 8,000
500 40,000 10,000
Top management is very concerned about declining profitability despite a healthy increase in sales volume. The decrease in income is especially puzzling because the company recently undertook a massive plant renovation during which new, highly automated machinery was installed—machinery that was expected to produce significant operating efficiencies.
Using a Microsoft Excel format for calculations, complete the following:
- Assuming use of direct-labor hours to apply overhead to production, calculate the unit manufacturing costs of the standard and enhanced products if the expected manufacturing volume is attained.
- Assuming the use of activity-based costing, calculate the unit manufacturing cost of the standard and enhanced products if the expected manufacturing volume is attained.
- Ontario’s selling price is based heavily on cost:
- Calculate which product is over cost and which is under cost by using direct-labor hours as an application base.
- Explain if it is possible that this over costing and under costing is responsible for the profit issues the company is facing.
- Illustrate how the solution will change if the following data changes:
- The overhead associated with order processing is $300,000 and the overhead associated with product inspection is $270,000.