Morelli Case
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INTRODUCTION OF THE CASE
Over the years, Morelli Electric Motor Corporation (MEMC) used job costing system with manufacturing overhead applied on the basis of direct labour hours. But, the conventional costing system is inappropriate to a business where product diversity has increased and cost structures have become more overhead intensive. Under these circumstances, the cost of high-volume, relatively simple products produced in large batches are likely to be overstated, and the cost of low-volume, speciality products produced in small batches are likely to be understated.
Indeed, this seemed to have happened to MEMC where their outdated costing systems imply their distorted product costs. In such circumstance, activity-based costing (ABC) system can be used to overcome problems that occur due to conventional costing systems. Furthermore, product cost computation via ABC system will be more accurate compared to current system as it identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each.
Regarding this case, raw material, direct labour, manufacturing overhead and non-manufacturing costs were analysed so that management could obtain useful information for managing activities right across the business.
CASE BACKGROUND
Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models assigned as standard, deluxe and heavy duty. Thus, the product costs and annual sales data are as a given below to evaluate Morelli company product costing system.
Standard model
Deluxe model
Heavy-duty model
Annual sales (units)
20 000
1 000
10 000
Product costs :
Raw material
Direct labour
(0.5 hr @ $20)
(1 hr @ $20)
(1hr @ $20)
Manufacturing overhead*
$ 170
$ 170
Total product cost
$ 105
$ 215
$ 232
* Calculation of predetermined overhead rate:
Manufacturing overhead budget:
Depreciation, machinery $ 1 480 000
Maintenance, machinery 120 000
Depreciation, taxes and
Insurance for factory 300 000
Engineering 350 000
Purchasing, receiving and shipping 250 000
Inspection and repair of defects 375 000
Material handling 400 000
Miscellaneous manufacturing
Overhead costs 295 000
Total $ 3 570 000
Direct labour budget:
Standard model 10 000 hrs
Deluxe model 1 000 hrs
Heavy duty model 10 000 hrs
Total 21 000 hrs
Predetermined overhead rate = Budgeted overhead
Budgeted direct labour hours
= $ 3 570 000
21 000 hours
= $ 170 per hour
The percentages are the proportion of each activity driver consumed by each product line.
Activity
Activity driver
Standard model
Deluxe
model
Heavy-duty model
Depreciation, machinery
Maintenance, machinery
Machine time
Engineering
Inspection and repair of defects
Engineering hours
Purchasing, receiving and shipping
Material handling
Number of material orders
Depreciation, taxes and insurance for factory
Miscellaneous manufacturing overhead
Factory space usage
QUESTIONS AND SOLUTIONS
QUESTION 1
Calculate the budgeted prices for the three models, based on the conventional product costing system.
Solution:
Budgeted price for the three models:
Standard Model
Deluxe Model
Heavy-duty Model
Product