Broadening Your Perspective

Broadening Your Perspective
Ideal Manufacturing Company is an Illinois-based company which produces a farm and agricultural related machinery products. Research department is the only department in the company that has been contributing a new products for several years. The research department facilitates only in-house manufacturing departments and assist them in producing farm and agriculture related machine products. The Ideal Company has never sold his research department’s services outside Because of the increasing cost of this department, company is now considering to offer its services outside to absorb the increasing cost. In order to gain the control of its research department management has decided to implement an activity based costing (Kimmel, Weygandt, & Kieso, 2011, "Broadening Your Perspective"). a) Overhead Rates for Activity Cost Pools
There are four different cost pools based on the activities of the research department, which includes Product Development, Prototype Testing, Market Analysis and Product Design with the total annual costs of $3,600,000, $1,400,000, $1,050,000,and and $2,350,000, respectively (Kimmel, Weygandt, & Kieso, 2011, "Broadening Your Perspective").
The management should look into the overhead rates based on activity for each pool, which would help the management to take a decision and control the cost. The rates and calculations for each activity cost pool are shown below.

Activities | Annual Cost(a) | Estimated Use of Cost Drivers(b) | Activity-Based Overhead Rate (a)/(b) | Market Analysis | 1,050,000 | 15,000 Hours | $70 per Hour | Product Design | 2,350,000 | 2500 Design | $940 per Design | Product Development | 3,600,000 | 90 Products | $40,000 per Product | Prototype Testing | 1,400,000 | 500 Tests | $2800 per Test |

b) In House Manufacturing Department Cost
The total cost and the costs for each activity cost pool are calculated and shown below in the table, which would incur due to the manufacturing department consumption in house. Activity Cost Pools | Use of Cost Drivers(a) | Activity- Based Overhead Rates(b) | Cost for Each Activity Cost Pool (a)*(b) | Market Analysis | 1800 | $70 per Hour | $126,000 | Product Design | 280 | $940 per Design | $263,200 | Product Development | 10 | $40,000 per Product | $400,000 | Prototype Testing | 92 | $2800 per Test | $257,600 | Total Cost | | | $1,046,800 |

It can be observed from the above table that an in house manufacturing department would be charged the total cost of $1,046,800 as a result of consumption of 1,800 hours of market analysis, 280 designs relating to the 10 products and 92 engineering test (Kimmel, Weygandt, & Kieso, 2011, "Broadening Your Perspective"). c) Cost for Outside Company Contract
The total cost and the costs for each activity cost pool are calculated and shown below in the table, which would serve as a basis for a bid for an outside company on a contract. Activity Cost Pools | Use of Cost Drivers(a) | Activity- Based Overhead Rates(b) | Cost for Each Activity Cost Pool (a)*(b) | Market Analysis | 800 | $70 per Hour | $56,000 | Product Design | 178 | $940 per Design | $167,320 | Product Development | 3 | $40,000 per Product | $120,000 | Prototype Testing | 70 | $2800 per Test | $196,000 | Total Cost | | | $539,320 |

It can be observed from the above table that the total cost of $539,320 could be utilized for an outside company contract as a basis of a bid that would consume 800 hours of market analysis, 280178 designs relating to the 3 products and 70 engineering test (Kimmel, Weygandt, & Kieso, 2011, "Broadening Your Perspective"). d) Benefits of Applying Activity-Based Costing
Applying activity-based costing will enable the Ideal Manufacturing to monitor the cost of each activity pool for both in house and outside contracts, and will help the company in pricing decisions. It will increase the overall understanding of overhead cost and cost drivers and will make non-value adding and costly activities prominent, allowing Ideal’s management to eliminate or reduce them.

References
Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2011). Accounting Tools for Business Decision Making (4th ed.). Retrieved from The University of Phoenix eBook Collection database.