Market Analysis

Ans a)

The activity-based overhead rates for each activity cost pool are as calculated below:

Market Analysis

Cost Driver – Hours of Analysis

Estimated Drivers = 15,000 hours

Annual Market Analysis Cost = $1,050,000

Hence overhead rate per hour = $1,050,000/15,000 = $70 per hour

Product Design

Cost Driver – Number of designs

Estimated Drivers = 2,500 designs

Annual Product Design Cost = $2,350,000

Hence overhead rate per design = $2,350,000/2,500 = $940 per design

Product Development

Cost Driver – Number of products

Estimated Drivers = 90 products

Annual Product Development Cost = $3,600,000

Hence overhead rate per product = $3,600,000/90 = $40,000 per product

Prototype Testing

Cost Driver – Number of tests

Estimated Drivers = 500 tests

Annual Prototype Testing Cost = $1,400,000

Hence overhead rate per test = $1,400,000/500 = $2,800 per test

Ans b)

To calculate the total cost to be charged to the in-house manufacturing department we first obtain the costs incurred under the different activity cost pools. The costs incurred under the different activity cost pools is obtained by multiplying the number of drivers of the activity consumed and the activity-based overhead rate for the cost pool as shown below:

Market Analysis

Overhead rate per hour = $70 per hour

No of hours of market analysis = 1,800 hours

Hence total overhead cost = $70 * 1,800 = $126,000

Product Design

Overhead rate per design = $940 per design

No of product designs provided = 280 designs

Hence total overhead cost = $940 * 280 = $263,200

Product Development

Overhead rate per product = $40,000 per product

No of products developed = 10 products

Hence total overhead cost = $40,000 * 10 = $400,000

Prototype Testing

Overhead rate per test = $2,800 per test

No of engineering tests conducted = 92 tests

Hence total overhead cost = $2,800 * 92 = $257,600

Thus total cost to be charged to in-house manufacturing department

= $126,000 + $263,200 + $400,000 + $257,600

=$1,046,800

Ans c)

To calculate the price to be charged to the outside company for the R&D bid we first obtain the costs incurred under the different activity cost pools. The costs incurred under the different activity cost pools is obtained by multiplying the number of drivers of the activity consumed and the activity-based overhead rate for the cost pool as shown below:

Market Analysis

Overhead rate per hour = $70 per hour

No of hours of market analysis = 800 hours

Hence total overhead cost = $70 * 800 = $56,000

Product Design

Overhead rate per design = $940 per design

No of product designs provided = 178 designs

Hence total overhead cost = $940 * 178 = $167,320

Product Development

Overhead rate per product = $40,000 per product

No of products developed = 3 products

Hence total overhead cost = $40,000 * 3 = $120,000

Prototype Testing

Overhead rate per test = $2,800 per test

No of engineering tests conducted = 70 tests

Hence total overhead cost = $2,800 * 70 = $196,000

Thus the price to be charged to the outside company for the R&D bid

= Total Overhead costs to be incurred for the four activity cost pools

= $56,000 + $167,320 + $120,000 + $196,000

=$539,320

Ans d)

The activity-based costing method helps a company to accurately determine the product cost as it focuses on the cause and effect relation between costs and activities consumed with respect to production of a good. At the same time as the overhead costs incurred for different activity cost pools are measured on the basis of activity-based overhead rates and the drivers of cost consumed, a company can easily monitor and control the different overhead costs.

In the given case it is evident that Ideal Manufacturing Company has the highest activity-based overhead rate in the case of product development. On the other hand the company has the lowest activity-based overhead rate in the case of market analysis. Thus if the company had to improve the operating margins it would first look at the activity cost pool of product development and look for reducing overhead expenses in that category. It would also help the company to assess to decide on whether to perform certain activities in-house or save on over-head costs by outsourcing them.

Again when the company has to charge outside companies for R&D activities the activity based costing approach will help the management in accurately estimating the price of providing the R&D services. ABC method of costing will also help the company in identifying the cost pools to target for cost efficiencies so that it remains competitive while placing bids on contracts floated by outside companies.