Ideal Manufacturing Company of Sycamore, Illinois, has supported a research and development (R&D) department that has for many years been the sole contributor to the company’s new farm machinery products. The R&D activity is an overhead cost center that provides services only to in-house manufacturing departments (four different product lines), all of which produce agricultural/farm/ranch related machinery products. The department has never sold its services outside, but because of its long history of success, larger manufacturers of agricultural products have approached Ideal to hire its R&D department for special projects. Because the costs of operating the R&D department have been spiraling uncontrollably, Ideal’s management is considering entertaining these outside approaches to absorb the increasing costs. But, (1) management doesn’t have any cost basis for charging R&D services to outsiders, and (2) it needs to gain control of its R&D costs. Management decides to implement an activity-based costing system in order to determine the charges for both outsiders and the inhouse users of the department’s services. R&D activities fall into four pools with the following annual costs.
Activity Cost Driver Annual Costs Total estimated drivers
Market Analysis Hours of analysis $1,050,000 15,000
Product Design Number of designs 2,350,000 2,500
Product Development Number of products 3,600,000 90
Prototype Testing Number of tests 1,400,000 500
Compute the activity-based overhead rate for each activity cost pool. (b) How much cost would be charged to an in-house manufacturing department that consumed 1,800 hours of market analysis time, was provided 280 designs relating to 10 products, and requested 92 engineering tests? (c) How much cost would serve as the basis for pricing an R&D bid with an outside company on a contract that would consume 800 hours of analysis time, require 178 designs relating to 3 products, and result in 70 engineering tests? (d) What is the benefit to Ideal Manufacturing of applying activity-based costing to its R&D activity for both in-house and outside charging purposes?