Thornton Company produces commercial gardening equipment. Since production is highly automated, the company allocates its overhead costs to product lines using activity-based costing. The costs and cost drivers associated with the four overhead activity cost pools follow:Production of 800 sets of cutting shears, one of the company's 20 products, took 200 labor hours and 6 setups and consumed 15 percent of the product-sustaining activities. Required:A. Had the company used labor hours as a companywide allocation base, how much overhead would it have allocated to the cutting shears? B. How much overhead is allocated to the cutting shears using activity-based costing? C. Compute the overhead cost per unit for cutting shears first using activity-based costing and then using direct labor hours for allocation if 800 units are produced. If direct product costs are $240 and the product is priced at 30 percent above cost (rounded to two decimal points), for what price would the product sell under each allocation system? D. Assuming that activity-based costing provides a more accurate estimate of cost, indicate whether the cutting shears would be over- or underpriced if direct labor hours are used as an allocation base. Explain how over-or undercosting can affect Vaulker's profitability. E. Comment on the validity of using the allocated facility-level cost in the pricing decision. Should other costs be considered in a cost- plus pricing decision? If so, which ones? What costs would you include if you were trying to decide whether to accept a special order?

Explanation:

               Unit LevelBatch LevelProduct Level    Facility LevelTotal

Cost$ 180,000$ 40,000$ 20,000 $ 240,000$   480,000

Cost driver  1,500 labor hrs.40 setupsPercentage of use12,000 units  

a)Allocation Rate per labor hour = Total overhead/ Total labor hours

=$480,000/1500 labor hours

= $320 per labor hour

Overhead to be allocated on the basis of labor hours = 200 hours *$320/ hour = $64,000

b)LevelUnitBatchProduct   FacilityTotal Allocated Cost

       Cost (a)$ 180,000$ 40,000   $ 20,000$ 240,000  

       Driver (b)  1500          40            % of Use12000  

       Rate (a / b=c)$120 per hr$1000/Setup% of Use$20/Unit  

       Weight (d)200 Hrs   6 Setups0.15           800 Units  

       Allocation (c x d)$24,000$6,000$3,000$ 16,000$ 49,000

c)OH cost per unit using DL Hrs = $64,000 / 800 units = $80.00

       OH cost per unit under ABC = $49,000/ 800 Units = $61.25

       Particulars                 ABCLabor Hrs

     Allocated overhead    $61.2580

        Direct cost                 $240$240

        Total cost per unit(a)$301.25$320.00

        Desired profit (30%*a)$90.38$96.00

        Sales price                 $391.63$416.00

d)Cutting shears would be undercosted So it is overpriced. Overpricing can turn into a loss of business. As sales volume declines, cost per unit will increase, thereby causing further distortions in price. Profitability will suffer.

e)For long-term pricing decisions all costs should be included in a cost plus pricing decision. Accordingly, facility-level costs should be considered. Also, upstream and downstream costs should be included in the decision. However, if you are making a short-term special order decision, only the relevant ( differential) costs should be considered. Under these circumstances, facility-level costs should be ignored.