Question

Back Porch Company manufactures lawn chairs using an activity based costing system to allocate all manufacturing conversion costs. The following information is provided for the month of June: − Activity Estimated Indirect Activity Costs Allocation Base Estimated Quantity of Allocation Base Materials handling $12,000 Number of parts 12,000 parts Assembling $16,800 Number of parts 12,000 parts Packaging $4,500 Number of lawn chairs 1,500 lawn chairs Each lawn chair consists of 8 parts; the total direct materials cost per pillow is $10.00. If the cost to purchase the same lawn chair from a supplier is $35.00, what should Back Porch do to maximize profits?

Answer 1

After calculating the costs based on activity-based costing, the total production cost per lawn chair for Back Porch Company is $29. Since this is less than the $35 purchase cost, the company should manufacture the lawn chairs in-house to maximize profits.

Step-by-step explanation:

To decide whether Back Porch Company should manufacture the lawn chairs or purchase them, we need to evaluate the total cost of production using activity-based costing (ABC) and compare it to the purchase cost per chair.

The company uses three activities with different allocation bases. Here's how the costs break down:

• Materials handling: Allocates $12,000 based on 12,000 parts. Since each chair consists of 8 parts, the cost per part is $12,000 / 12,000 = $1. Thus, for each chair, it is 8 x $1 = $8.
• Assembling: Allocates $16,800 based on 12,000 parts, which is also $1 per part and $8 per chair for this activity.
• Packaging: Allocates $4,500 based on 1,500 chairs, which is $4,500 / 1,500 = $3 per chair.

The total conversion cost per chair is $8 (material handling) + $8 (assembling) + $3 (packaging) = $19.

Adding the direct materials cost of $10 per chair, the total production cost per chair is $19 (conversion) + $10 (materials) = $29.

Given the choice to manufacture a chair at $29 or purchase it at $35, Back Porch should opt to manufacture the chair as it minimizes costs and maximizes profits.