Holly Manufacturing Company produces two cello models. One is a standard acoustic cello that sells for $600 and is constructed

from medium-grade materials. The other model is a custom-made amplified cello with pearl inlays and a body constructed from special woods.

The custom cello sells for $900. Both cellos require 10 hours of direct labor to produce, but the custom cello is manufactured by more

experienced workers who are paid at a higher rate.

Most of Holly’s sales come from the standard cello, but sales of the custom model have been growing. Following is the company’s sales,

production, and cost information for last year:

Cello                                     Standard              Custom

Sales and production volume in units      900         100

Unit Selling Price                             $600.00 $900.00

Unit costs:

Direct materials                             $150.00 $375.00

Direct labor                                       $180.00 $240.00

Manufacturing overhead*              $135.00 $135.00

Total unit costs                          $465.00 $750.00

Unit Gross Profit                             $135.00 $150.00

Direct Labor Hours                          10.00     10.00

Direct Labor Rate Per Hour          $18.00   $24.00

*Manufacturing overhead costs:

Building depreciation   $ 40,000

Maintenance   $15,000.00

Purchasing        $20,000.00

Inspection         $12,000.00

Indirect materials           $15,000.00

Supervision      $30,000.00

Supplies             $3,000.00

Total manufacturing overhead costs   $135,000.00

These manufacturing overhead costs are fixed in nature: they do not vary with the volume of manufacturing activity.

They are company wide manufacturing costs that will not be eliminated if one line of product is eliminated.

The company allocates overhead costs using the traditional method. Its activity base is direct labor hours. The predetermined overhead rate,

based on 10,000 direct labor hours, is $13.50 per direct labor hour ($135,000 ÷ 10,000 direct labor hours).

Johann Brahms, president of Holly, is concerned that the traditional cost-allocation system the company is using may not be generating accurate

information and that the selling price of the custom cello may not be covering its true cost.