Question

Please answer part D primarily.

Smithson, Inc. produces two types of gas grills: a family model and a deluxe model. Smithson’s controller has decided to use a plantwide overhead rate based on direct labor costs. The president of the company recently heard of activity-based costing 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:

                                                                        Family Model      Deluxe Model

                        Direct labor costs                         $75,000                $150,000

                        Machine hours                                2,000                    2,000

                        Setup hours                                        200                         800

Total estimated overhead costs are $450,000. Overhead cost allocated to the machining activity cost pool is $270,000 and $180,000 is allocated to the machine setup activity cost pool.  

Instructions

(a)        Compute the overhead rate using the traditional (plantwide) approach.

(b)        Compute the overhead rates using the activity-based costing approach.

(c)        Determine the difference in allocation between the two approaches.  

(d)        Smithson, Inc. decided to implement the activity-based costing approach and was quite successful in its use.   However, the controller is wondering if instead of only two activity cost pools, they should expand to three activity cost pools based on the following:

                                                                        Family Model      Deluxe Model

                        Direct labor costs                         $75,000                $150,000

                        Machine hours                                 2,000                    2,000

                        Setup hours                                        200                         800

                        Packaging hours                                  50                           75

The estimated overhead of $450,000 is allocated as follows: machining activity cost pool $240,000, machine set up $170,000 and packaging $40,000.  

(1)        Determine the overhead rates using the activity-based costing approach with three cost pools.        

(2)        Determine the overhead allocation for the family model and the deluxe model using three activity cost pools. What is the difference in allocation between two activity cost pools and three activity cost pools? Is the difference in allocation worth using the third activity cost pool?

Answer 1

1.

Machining = $240,000 / 4,000 = $60 per machine hour

Machine set up = $170,000 / 1,000 = $170 per setup hours

Packaging = $40,000 / 125 = $320 per packaging hours

2.

Overhead allocated as per three activity cost pool:

	Family model	Deluxe model
Machining	$120,000 (2,000*$60)	$120,000 (2,000*$60)
Machine setup	34,000 (200*$170)	136,000 (800*$170)
Packaging	16,000 (50*$320)	24,000 (75*$320)
Total overhead allocated	$170,000	$280,000

	Family model	Deluxe model
Two activity cost pool:
Machining	$135,000 ($270,000/4,000*2,000)	$135,000 ($270,000/4,000*2,000)
Machine setup	36,000 (180,000/1,000*200)	144,000 (180,000/1,000*800)
Total overhead allocated	171,000	279,000
Three activity cost pool:
Total overhead allocated	170,000	280,000
Difference	$1,000	$(1,000)

Difference in allocation between the two activity cost pool and three activity cost pool is $0

As difference in both activity cost pool is $0. Adding an additional cost pool would give accurate results as to allocation of overhead cost.