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P4-2B Kinnard Electronics

Price: $2.50

Kinnard Electronics manufactures two home theater systems: the Elite which
sells for $1,400, and a new model, the Preferred, which sells for $1,100. The production
cost computed per unit under traditional costing for each model in 2014 was as

  Elite Preferred
Direct materials  600  320
Direct labor ($20 per hour)  100  80
Manufacturing overhead ($35  per DLH)  175  140
   875  540

In 2014, Kinnard manufactured 20,000 units of the Elite and 10,000 units of the Preferred.
The overhead rate of $35 per direct labor hour was determined by dividing total
expected manufacturing overhead of $4,900,000 by the total direct labor hours (140,000)
for the two models.

Under traditional costing, the gross profit on the models was Elite $525 ($1,400 -
$875), and Preferred $560 ($1,100 - $540). Because of this difference, management is
considering phasing out the Elite model and increasing the production of the Preferred

Before finalizing its decision, management asks Kinnard’s controller to prepare an
analysis using activity-based costing (ABC). The controller accumulates the following information
about overhead for the year ended December 31, 2014

Activity Cost Driver   Estimated Overhead Cost Driver Volume Overhead Rate
Purchase orders  Number of orders   775,000  25,000  31
Machine setups  Number of setups   580,000  20,000  29
Machine hours Machine hours   3,100,000  100,000  31
Quality control  Number of inspections   445,000  5,000  89

The cost drivers used for each product were:

Cost Driver Elite Preferred Total
Purchase orders  11,250 13,750 25,000
Machine setups  11,000 9,000 20,000
Machine hours  40,000 60,000 100,000
Inspections  2,750 2,250 5,000

(a) Assign the total 2014 manufacturing overhead costs to the two products using activity based
costing (ABC) and determine the overhead cost per unit.
(b) What was the cost per unit and gross profit of each model using ABC costing?
(c) Are management’s future plans for the two models sound? Explain.

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