Question

College Supply Company (CSC) makes three types of drinking glasses: short, medium, and tall. It presently applies overhead using a predetermined rate based on direct labor-hours. A group of company employees recommended that CSC switch to activity-based costing and identified the following activities, cost drivers, estimated costs, and estimated cost driver units for Year 5 for each activity center.

Activity	Recommended Cost Driver	Estimated Cost			Estimated Cost Driver Units
Setting up production	Number of production runs	$	25,600		80	runs
Processing orders	Number of orders		43,200		180	orders
Handling materials	Pounds of materials		18,000		9,000	pounds
Using machines	Machine-hours		63,000		9,000	hours
Providing quality management	Number of inspections		56,000		40	inspections
Packing and shipping	Units shipped		40,000		20,000	units
		$	245,800

In addition, management estimated 2,000 direct labor-hours for year 5.

Assume that the following cost driver volumes occurred in February, year 5.

	Short			Medium			Tall
Number of units produced		1,000			500			400
Direct materials costs	$	4,000		$	2,500		$	2,500
Direct labor-hours		110			110			120
Number of orders		9			7			3
Number of production runs		2			4			9
Pounds of material		400			900			300
Machine-hours		400			300			200
Number of inspections		2			2			2
Units shipped		1,000			500			300

Direct labor costs were $18 per hour.

Required:

a. Compute a predetermined overhead rate for year 5 for each cost driver recommended by the employees. Also compute a predetermined rate using direct labor-hours as the allocation base.
b. Compute the production costs for each product for February using direct labor-hours as the allocation base and the predetermined rate computed in requirement a.
c. Compute the production costs for each product for February using the cost drivers recommended by the employees and the predetermined rates computed in requirement a. (Note: Do not assume that total overhead applied to products in February will be the same for activity-based costing as it was for the labor-hour-based allocation.)

Answer 1

Requirement a:

Predetermined overhead rate using ABC system

Activity	Cost Pool	/	Cost Driver	=	Activity Rate
Setting up production	$25,600	/	80 runs	=	$320 per run
Processing orders	$43,200	/	180 orders	=	$240 per order
Handling materials	$18,000	/	9,000 pounds	=	$2 per pounds
Using machines	$63,000	/	9,000 machine hours	=	$7 per machine hour
Providing quality management	$56,000	/	40 inspections	=	$1,400 per inspection
Packaging and shipping	$40,000	/	20,000 units	=	$2 per units shipped

Predetermined overhead rate using traditional system

Predetermined overhead rate = Total overhead cost / Direct labor hours

Predetermined overhead rate = $245,800 / 2,000 = $122.90 per direct labor hour

Requirement b:

Production cost using traditional costing system

Particulars	Short	Medium	Tall
Direct Material cost	$4,000	$2,500	$2,500
Direct labor Cost (110 * $18) (110 * $18) (120 * $18)	$1,980	$1,980	$2,160
Overhead costs (110 * $122.90) (110 * $122.90) (120 * $122.90)	$13,519	$13,519	$14,748
Total Product Costs	$19,499	$17,999	$19,408
Number of units	1,000	500	400
Unit Product cost	$19.50	$36.00	$48.52

Requirement c:

Production cost using ABC system

Allocation of overheads

Short

Activity	Cost Driver	x	Activity rate	=	Overhead cost
Setting up	2	x	$320	=	$640
Processing orders	9	x	$240	=	$2,160
Handling Materials	400	x	$2	=	$800
Using Machines	400	x	$7	=	$2,800
Quality Management	2	x	$1,400	=	$2,800
Packing and shipping	1,000	x	$2	=	$2,000
Total Overhead costs				=	$11,200

Medium

Activity	Cost Driver	x	Activity rate	=	Overhead cost
Setting up	4	x	$320	=	$1,280
Processing orders	7	x	$240	=	$1,680
Handling Materials	900	x	$2	=	$1,800
Using Machines	300	x	$7	=	$2,100
Quality Management	2	x	$1,400	=	$2,800
Packing and shipping	500	x	$2	=	$1,000
Total Overhead costs				=	$10,660

Tall

Activity	Cost Driver	x	Activity rate	=	Overhead cost
Setting up	9	x	$320	=	$2,880
Processing orders	3	x	$240	=	$720
Handling Materials	300	x	$2	=	$600
Using Machines	200	x	$7	=	$1,400
Quality Management	2	x	$1,400	=	$2,800
Packing and shipping	300	x	$2	=	$600
Total Overhead costs				=	$9,000

Production cost using ABC system

Particulars	Short	Medium	Tall
Direct Material cost	$4,000	$2,500	$2,500
Direct labor Cost (110 * $18) (110 * $18) (120 * $18)	$1,980	$1,980	$2,160
Overhead costs	$11,200	$10,660	$9,000
Total Product Costs	$17,180	$15,140	$13,660
Number of units	1,000	500	400
Unit Product cost	$17.18	$30.28	$34.15

All the best...