Question

Rusted from the Rain, Inc. is a producer of specialized anti-rust automotive equipment. Currently, overhead costs are allocated at a rate of $50 per machine hour produced and the company used 2,000 machine hours last year. Rusted’s CEO, William Talent, has heard about ABC, and would like to see if it makes any difference in the costs allocated to jobs at the company.

The accounting staff has provided the following information about manufacturing overhead:

                                                            Amount                      Cost Driver

Setups                                                 $30,000                       Number of setups

Equipment                                           20,000                        Number of machine hours

Inspection                                           50,000                        Number of inspections

The company estimates that it will perform 150 setups and 1,000 inspections each year and will use 2,000 machine hours. Job CRT will require 18 setups, 85 machine hours, and 60 inspections.

Required:

1. Calculate the activity rates to be used under ABC costing.
2. Using ABC, what amount of manufacturing overhead will be allocated to Job CRT?
3. What amount would be allocated to job CRT using their current, traditional system? (1 mark)
4. Explain why and how the two overhead allocation methods yield such different answers.

Answer 1

Activity Rates

Activity	Total Overhead	Cost Driver	Total Number	Cost per Cost Driver
a	b	c	d	e = b/d
Setups	$           30,000	Setups	150	$              200	Per Setup
Equipment	$           20,000	Machine hours	2000	$                10	Per Machine hour
Inspection	$           50,000	Inspections	1000	$                50	Per Inspection
	$        1,00,000

ABC

Overhead Allocated
Setups	$             3,600
Equipment	$                 850
Inspection	$             3,000
Total Overhead	$             7,450

Traditional System
Overhead allocated = 85 x $50 = $4250

There is huge difference in both the systems, as in activity based costing, overhead is allocated based on usage of that particular activity for the job, which might be in different proportions for different jobs. But in Traditional system overhead is based only on one activity.