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Ideal Manufacturing Company of Sycamore, Illinois, has supported a research and development (R&D)...

Question:

Ideal Manufacturing Company of Sycamore, Illinois, has supported a research and development (R&D) department that has for many years been the sole contributor to the company's new farm machinery products. The R&D activity is an overhead cost center that provides services only to in-house manufacturing departments (four different product lines), all of which produce agricultural/farm/ranch related machinery products.

The department has never sold its services outside, but because of its long history of success, larger manufacturers of agricultural products have approached the Ideal to hire its R&D department for special projects. Because the costs of operating the R&D department have been spiraling uncontrollably, Ideal s management is considering entertaining these outside approaches to absorb the increasing costs. But, (1) management doesn't have any cost basis for charging R&D services to outsiders, and (2) it needs to gain control of R&D costs. Management decides to implement an activity-based costing system in order to determine the charges for both outsiders and the in-house users of the department s services.

R&D activities fall into four pools with the following annual costs.

Market analysis $1,050,000
Product design 2,350,000
Product development 3,600,000
Prototype testing 1,400,000

Activity analysis determines that the appropriate cost drivers and their usage for the four activities are:

Activities Cost Drivers Total Estimated Cost Driver Activity
Market analysis Hours of analysis 15,000 hours
Product design Number of designs 2,500 designs
Product development Number of products 90 products
Prototype testing Number of tests 500 tests

Instructions:

a) Compute the activity-based overhead rate (pool rate) for each activity cost pool.

b) How much cost would be charged to an in-house manufacturing department that consumed 1,800 hours of market analysis time, was provided 280 designs relating to 10 products, and requested 92 engineering tests?

c) How much cost would serve as a basis for pricing and R&D bid with an outside company on a contract that would consume 800 hours of analysis time, require 178 designs relating to 3 products, and resulting in 70 engineering tests?

d) What is the benefit to the Ideal Manufacturing of applying activity-based costing to its R&D activity for both in-house and outside charging purposes?

Research and Development (R&D) Expenses:

The Research and Development (R&D) expenses are incurred in a large amount which could not be allocated easily to the related product or process as the benefits related to the Research and Development (R&D) expenses could not be ascertained so easily.

Answer and Explanation: 1

Requirement a, b, and c:

(a) Computation for overhead rate
Activities Cost Drivers Total Estimated Cost Driver Activity (a) Activity Cost (b) Cost per activity (c = b/a)
Market analysis Hours of analysis 15,000 $1,050,000 $70
Product design Number of designs 2,500 $2,350,000 $940
Product development Number of products 90 $3,600,000 $40,000
Prototype testing Number of tests 500 $1,400,000 $2,800
(b) Computation for total overhead cost
Activities Rate (a) Number of Activities (b) Cost (a x b)
Market analysis $70 1,800 $126,000
Product design $940 280 $263,200
Product development $40,000 10 $400,000
Prototype testing $2,800 92 $257,600
Total Cost $1,046,800
(c) Computation for total overhead cost
Activities Rate (a) Number of Activities (b) Cost (a x b)
Market analysis $70 800 $56,000
Product design $940 178 $167,320
Product development $40,000 3 $120,000
Prototype testing $2,800 70 $196,000
Total Cost $539,320

d) Followings are the benefits to the Ideal Manufacturing of applying activity-based costing to its R&D activity for both in-house and outside charging purposes: -

(i) The R&D cost related to the in-house production is identified and better cost allocation could be done after using activity-based costing.

(ii) The cost related to R&D service provided to outsiders could be determined and the same could be charged accordingly.


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Cost Allocation: Definition, Terms & Examples

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Chapter 4 / Lesson 1
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Learn the cost allocation definition and its process. Understand how costs are allocated using examples.


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