Question

Salatic Co has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has heard of activity-based costing system and wants to see how the results would differ if this system were used. Two activity cost pools were developed: machining and machine setup. Presented below is information related to the company's operations: Standard Custom Total Direct labor costs $340,000 $204,000 $544,000 Machine hours 17,000 25,500 42,500 Setup hours 850 680 1,530 Total estimated overhead costs $380,800 Overhead cost allocated to machining cost pool $272,000 Overhead cost allocated to setup cost pool $108,800

Requirement: 1 Compute overhead costs allocated to each product using traditional (plantwide) approach

2 Compute overhead costs allocated to each product using ABC approach

3 Determine the difference and comment on the results.

Answer 1

Basic Data

Particulars	Standard	Custom	Total
Direct Labour	340000	204000	544000
Machine Hours	17000	25500	42500
Setup Hrs	850	680	1530
Total Overhead Cost			380800

I. Overhead Cost Allocation under Traditional Approach

Overhead Recovery Rate

Particulars	Amount
A. Overhead cost	380800
B. Total Machine Hours	42500
C. Plantwide overhead recovery Rate (A/B)	$8.96/Machine Hour

Overhead Cost Allocation Table

Particulars	Standard	Custom	Total
A. Direct Labour	340000	204000	544000
Add: Overhead
B. Overhead Recovery Rate	8.96	8.96
C.Machine Hours	17000	25500
D.Overhead cost per product (B*C)	152320	228480	380800
Total Cost (A+D)	492320	432480	924800

2.ABC APPROACH

CALCULATION OF ABC RECOVERY RATE

Particulars	Details
a. Machine Cost	272000
ABC cost Driver	Machine Hours
b. Total Machine Hours	42500
c. ABC Rate on Machine Cost (a/b)	6.4
a. Machine Set up cost	108800
ABC cost driver	Setup Hrs
b. Total Set up Hrs	1530
c. ABC Rate on Machine Set up Cost (a/b)	71.1111

COST ALLOCATION IN ABC APPROACH

Particulars	Standard	Custom	Total
A. Direct Labout	340000	204000	544000
Add: Overhead
Machine cost
a.Machine Hrs	17000	25500
b. ABC Rate	6.4	6.4
B. Machine Cost (a*b)	108800	163200	272000
Machine Setup Cost
c.Setup Hrs	850	680
d. ABC Rate	71.1111	71.1111
C. Machine Setupcost (c*d)	60444.435	48355.5	108800
D. Total Overhead Cost (B+C)	169244	211556	380800
Total Cost	509244.435	415555.5	924800

3.REASON FOR DIFFERENCE

PARTICULARS	STADARD	CUSTOM
a. Overhead cost as per traditional approach	152320	228480
b. Overhead cost under ABC approach	169244	211556
c. Difference (a-b)	(16924)	16924

A fundamental difference between traditional costing and ABC costing is that ABC methods expand the number of indirect cost pools (ABC recovery rate) that can be allocated to specific products. The traditional method takes one pool of a company's total overhead costs to allocate universally to all products.