Question: Colonels uses a traditional cost system and estimates next years overhead will be $480,000, with the estimated cost driver of 240,000 direct labor hours. It manufactures three products and estimates these costs:
Small Medium Large
Units 32,000 12,000 4,000
Direct Material cost $5 $8 $9
Direct Labor Hrs / Unit 4 Hrs 6 Hrs 10 Hrs
If the labor rate is $25 per hour, what is the per-unit cost of each product?
Answer:
Step 1: Identify Absorption Basis
Here, absorption basis is Labor hours.
Step 2: Find the Overhead Absorbed Rate by dividing total Overhead by total absorption basis.
The formula is as under:
Overhead Absorbed=Total Overhead / Total Absorption Basis... Equation 1
By putting values in Equation 1:
Overhead absorption Rate OAR =$480,000 / 240,000 Machine Hrs = $2 per Labor hour
Step 3: Now calculate overhead per unit for product Small, Medium and Large by simply multiplying OAR with Direct Labor hours consumed per unit
Overhead per unit for Product X= OAR * Direct Labor hours consumed per Product X....................Equation 2
Now simply put the values in Equation 2 of direct labor used by each product and calculate Overhead per unit.
For Product Small:
Overhead per unit for Product Small= $2 * 4 direct labor hours= $8 per unit
For Product Medium:
Overhead per unit for Product Medium= $2 * 6 direct labor hours= $12 per unit
For Product Large:
Overhead per unit for Product Large= $2 * 10 direct labor hours= $20 per unit
Step 4: Add the per unit prime cost to Overhead cost per unit calculated in the Step 3 to calculate the total unit cost of the product. Prime cost is the sum of all direct costs. In this question, Prime cost includes Direct labor cost and Direct material cost.
Now first of all find prime cost of each product by using following formula:
Prime cost per unit for Product X= (Direct material cost per unit of Product X) + (Direct labor cost per unit of Product X)............Equation 3
Thereafter add prime cost to overhead unit cost calculated in step 3.
For Product Small:
Prime cost per unit for Small= ($5 per unit) + ($25 per direct labor hour * 4 number of direct labor hours)=$5 per unit + $100 per unit= $125 per unit
Total Unit cost of product Small= Overhead cost per unit for Small + Prime cost per unit for Small =$125 per unit + $8 per unit=$133 per unit
For Product Medium:
Prime cost per unit for Medium= ($8 per unit) + ($25 per direct labor hour * 6 number of direct labor hours)=$5 per unit + $150 per unit= $155 per unit
Total Unit cost of product Medium= Overhead cost per unit for Medium + Prime cost per unit for medium =$155 per unit + $12 per unit=$167 per unit
For Product Large:
Prime cost per unit for Large= ($9 per unit) + ($25 per direct labor hour * 10 number of direct labor hours)=$9 per unit + $250 per unit= $259 per unit
Total Unit cost of product Large= Overhead cost per unit for Large + Prime cost per unit for Large =$259 per unit + $20 per unit=$279 per unit