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Laguna Mission
Actual Costs Model Model
Construction Period Feb-June 2008 May-Oct 2008
Direct Materials $106,450 $127,604
Direct Labor $36,276 $41,410
Direct Labor-Hours 900 1,010

2008 Budget Support Costs $8,000,000

2008 Budget DL Hrs 160,000

2008 Actual Support Costs $6,888,000

2008 Actual DL Hrs 164,000

1.) Budgeted Indirect Budgeted indirect costs $8,000,000

a.) Cost Rate = Budgeted direct labor hours 160,000 $50.00

Actual Indirect Actual indirect costs $6,888,000

b.) Cost Rate = Actual direct labor hours 164,000 $42.00

These rates differ because both the numerator and the denominator in the two calculations
are different—one based on budgeted numbers and the other based on actual numbers.

2a.) Budgeted Rate * DLH Laguna Mission

Normal Costing Model Model
Direct Costs
Direct Materials $106,450 $127,604
Direct Labor 36,276 41,410
142,726 169,014
Indirect costs
Assembly support 45,000 50,500
($50 x 900; $50 x 1,010)
TOTAL COSTS $187,726 $219,514

2b.) Actual Costing Actual Rate * DLH

Direct Costs
Direct Materials $106,450 $127,604
Direct Labor 36,276 41,410
142,726 169,014
Indirect costs
Assembly support 37,800 42,420
($42 x 900; $42 x 1,010)
TOTAL COSTS $180,526 $211,434
 Normal costing enables Anderson to report a job cost as soon as the job is completed,
assuming that both the direct materials and direct labor costs are known at the time of use.
Once the 900 direct labor-hours are known for the Laguna Model (June 2007), Anderson
can compute the $187,726 cost figure using normal costing. Anderson can use this
information to manage the costs of the Laguna Model job as well as to bid on similar jobs
later in the year. In contrast, Anderson has to wait until the December 2007 year-end to
3.) compute the $180,526 cost of the Laguna Model using actual costing.
Per DL Hr

Per DL Hr
4-19 Page 126

Budgeted manufacturing overhead costs $4,000,000

Budgeted machine-hours 200,000
Actual manufacturing overhead costs $3,860,000
Actual machine-hours 195,000

1.) Budgeted manufacturing overhead rate = Budgeted manufacturing overhead

Budgeted machine hours

$4,000,000
200,000 $20.00

2.) Manufacturing overhead allocated = Actual Machine hours x Budgeted mfg OH rate
195,000
$20.00
$3,900,000

3.) Manufacturing overhead allocated $3,900,000

Actual manufacturing overhead costs $3,860,000
Over(Under) allocated mfg overhead $40,000

Since manufacturing overhead allocated is greater than the actual manufacturing overhead costs,
Waheed overallocated manufacturing overhead
5-19 Page 165

1.) Usage of Cost Drivers by Customer Contract

Variable
Manufacturing Holden Leland
Department Cost Driver Overhead in 2009 United Motors Motors Vehicle
CAD-design
Design hours $ 39,000 110 200 80
Engineering
Engineering hours $ 29,600 70 60 240

Production Machine hours $ 240,000 120 2,800 1,080

Total $308,600

Percentage of machine overhead

Variable manufacturing hours used by eachto
allocated customer
each 3% 70% 27%
customer with machine-hours as allocation base $9,258 $216,020 $83,322

2.) Variable Usage of Cost Drivers by Customer Contract

Manufacturing Holden Leland
Department Cost Driver Overhead in 2007 United Motors Motors Vehicle
CAD-design
Design hours $ 39,000 110 200 80
Engineering
Engineering hours 29,600 70 60 240

Production Machine hours 240,000 120 2,800 1,080

Design-related overhead,
Production-related allocated
overhead, on CAD-design
allocated hours
on engineering $11,000 $20,000 $8,000
hours $5,600 $4,800 $19,200
Engineering-related overhead, allocated on machine hours $7,200 $168,000 $64,800
Total $23,800 $192,800 $92,000

Holden Leland
3.) United Motors Motors Vehicle
Department rates (Requirement 2) $23,800 $192,800 $92,000
Machine Hour Rate (Requirement 1) $9,258 $216,020 $83,322
Difference $14,542 $(23,220) $8,678
Ratio 2.57 0.89 1.10

The variable manufacturing overhead allocated to United Motors increases by 157% under the department rates,
the overhead allocated to Holden decreases by about 11% and the overhead allocated to Leland increases by abou
10%.

The three contracts differ sizably in the way they use the resources of the three departments.
The percentage of total driver units in each department used by the companies is:

Percentage of CAD-design hours used by each customer 28% 51% 21%

 Percentage of engineering hours used by each customer 19% 16% 65%
Percentage of machine hours used by each customer 3% 70% 27%

The United Motors contract uses only 3% of total machines hours in 2004, yet uses 28% of CAD design-hours
and 19% of engineering hours. The result is that the plantwide rate, based on machine hours, will greatly
underestimate the cost of resources used on the United Motors contract. This explains the 157% increase in
indirect costs assigned to the United Motors contract when department rates are used.
In contrast, the Holden Motors contract uses less of design (51%) and engineering (16%) than of machine-hours
(70%). Hence, the use of department rates will report lower indirect costs for Holden Motors than does a
plantwide rate.

Holden Motors was probably complaining under the use of the simple system because its contract was being
overcosted relative to its consumption of MOH resources. United, on the other hand was having its contract
undercosted and underpriced by the simple system. Assuming that AP is an efficient and competitive supplier, if
the new department-based rates are used to price contracts, United will be unhappy. AP should explain to United
how the calculation was done, and point out United’s high use of design and engineering resources relative to
production machine hours. Discuss ways of reducing the consumption of those resources, if possible, and show
willingness to partner with them to do so. If the price rise is going to be steep, perhaps offer to phase in the new
prices.

4.)
Other than for pricing, AP can also use the information from the department-based system to examine and
streamline its own operations so that there is maximum value-added from all indirect resources. It might set
targets over time to reduce both the consumption of each indirect resource and the unit costs of the resources. The
department-based system gives AP more opportunities for targeted cost management.

5.) ÷

It would not be worthwhile to further refine the cost system into an ABC system if there wasn’t much variation
among contracts in the consumption of activities within a department. If, for example, most activities within the
design department were, in fact, driven by CAD-design hours, then the more refined system would be more costly
and no more accurate than the department-based cost system. Even if there was sufficient variation, considering
the relative sizes of the 3 department cost pools, it may only be cost-effective to further analyze the engineering
cost pool, which consumes 78% ($240,000$308,600) of the manufacturing overhead.
Customer Contract

Total

390

370

4,000

100%
$308,600

Customer Contract

Total Rate

390 $100

370 $80

4,000 $60

$39,000
29,600
240,000
$308,600

$308,600
$308,600
$-

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