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	$	22,400		80	runs
Processing orders	Number of orders		48,000		200	orders
Handling materials	Pounds of materials		14,000		7,000	pounds
Using machines	Machine-hours		60,000		10,000	hours
Providing quality management	Number of inspections		48,000		40	inspections
Packing and shipping	Units shipped		38,000		19,000	units
		$	230,400

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		1,100			500			400
Direct materials costs	$	3,000		$	2,500		$	2,000
Direct labor-hours		90			110			110
Number of orders		8			7			5
Number of production runs		1			4			8
Pounds of material		400			900			200
Machine-hours		500			200			300
Number of inspections		3			1			2
Units shipped		1,100			500			300

Direct labor costs were $20 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
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 (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

Solution a: Determination of activity rate for each activity

Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate
Setting up production	22,400	Nos of production runs	80	$280.00
Processing orders	48,000	Nos of orders	200	$240.00
Handling materials	14,000	Pound of materials	7,000	$2.00
Using machines	60,000	Machine hours	10,000	$6.00
Providing Quality management	48,000	Nos of inspections	40	$1,200.00
Packing and Shipping	38,000	Units shipped	19,000	$2.00
Total	230,400

Predetermined overhead rate using direct labor hours = Estimated overhead / Estimated direct labor hours

= $230,400 / 2000 = $115.20 per direct labor hour

Solution b: Computation of Production Cost - Using Predetermined overhead rate
For February

Particulars	Short	Medium	Tall
Direct materials costs	$3,000	$2,500	$2,000
Direct labor cost	$1,800	$2,200	$2,200
Manufacturing overhead	$10,368	$12,672	$12,672
Production Cost	$15,168	$17,372	$16,872

Solution c: Allocation of Overhead to Products

					Short		Medium		Tall
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	Usage	Allocated Costs	Usage	Allocated Costs	Usage	Allocated Costs
Setting up production	22,400	Nos of production runs	80	$280.00	1	$280.00	4	$1,120	8	$2,240
Processing orders	48,000	Nos of orders	200	$240.00	8	$1,920	7	$1,680	5	$1,200
Handling materials	14,000	Pound of materials	7,000	$2.00	400	$800	900	$1,800	200	$400
Using machines	60,000	Machine hours	10,000	$6.00	500	$3,000	200	$1,200	300	$1,800
Providing Quality management	48,000	Nos of inspections	40	$1,200.00	3	$3,600	1	$1,200	2	$2,400
Packing and Shipping	38,000	Units shipped	19,000	$2.00	1,100	$2,200	500	$1,000	300	$600
Total	230,400					$11,800		$8,000		$8,640

Computation of Production Cost - Activity Based Costing
For February

Particulars	Short	Medium	Tall
Direct materials costs	$3,000	$2,500	$2,000
Direct labor cost	$1,800	$2,200	$2,200
Manufacturing overhead	$11,800	$8,000	$8,640
Production Cost	$16,600	$12,700	$12,840