Question

Activity-Based Costing and Product Cost Distortion

Handbrain Inc. is considering a change to activity-based product costing. The company produces two products, cell phones and tablet PCs, in a single production department. The production department is estimated to require 4,000 direct labor hours. The total indirect labor is budgeted to be $462,400.

Time records from indirect labor employees revealed that they spent 40% of their time setting up production runs and 60% of their time supporting actual production.

The following information about cell phones and tablet PCs was determined from the corporate records:

Number of
SetupsDirect Labor
HoursUnits

Cell phones500 2,000 68,000

Tablet PCs1,100 2,000 68,000

Total1,600 4,000 136,000

If required, round your answers to the nearest cent.

a. Determine the indirect labor cost per unit allocated to cell phones and tablet PCs under a single plantwide factory overhead rate system using the direct labor hours as the allocation base.

Cell phones$ per unit

Tablet PCs$ per unit

b. Determine the budgeted activity costs and activity rates for the indirect labor under activity-based costing. Assume two activities—one for setup and the other for production support.

Budgeted Activity CostActivity Rate

Setup$$per setup

Production support$$per direct labor hour

c. Determine the activity cost per unit for indirect labor allocated to each product under activity-based costing.

Cell phones$ per unit

Tablet PCs$ per unit

d. Why are the per-unit allocated costs in (a) different from the per-unit activity cost assigned to the products in (c)?

The per-unit indirect labor costs in (a) are distorted because setup activity  is consumed by the products in a different ratio from the direct labor. The activity-based  costing method results in the product with the larger  number of setups receiving a larger portion of the setup activity cost. The single-rate system  allocates overhead only on the basis of direct labor hours. Since the direct labor hours are  equal for each product, the allocated indirect labor will also be  equal.

Answer 1

Answer a.

Predetermined overhead rate = Estimated indirect labor cost / Estimated direct labor hours
Predetermined overhead rate = $595,200 / 4,000
Predetermined overhead rate = $148.80 per direct labor hour

Cell Phones:

Indirect labor cost = Predetermined overhead rate * Number of direct labor-hours
Indirect labor cost = $148.80 * 2,000
Indirect labor cost = $297,600

Indirect labor cost per unit = Indirect labor cost / Number of units produced
Indirect labor cost per unit = $297,600 / 96,000
Indirect labor cost per unit = $3.10

Tablet PCs:

Indirect labor cost = Predetermined overhead rate * Number of direct labor-hours
Indirect labor cost = $148.80 * 2,000
Indirect labor cost = $297,600

Indirect labor cost per unit = Indirect labor cost / Number of units produced
Indirect labor cost per unit = $297,600 / 96,000
Indirect labor cost per unit = $3.10

Answer b.

Setup:

Budgeted activity cost = 40% * Estimated indirect labor cost
Budgeted activity cost = 40% * $595,200
Budgeted activity cost = $238,080

Activity rate = Budgeted activity cost / Number of setups
Activity rate = $238,080 / 1,600
Activity rate = $148.80 per setup

Production support:

Budgeted activity cost = 60% * Estimated indirect labor cost
Budgeted activity cost = 60% * $595,200
Budgeted activity cost = $357,120

Activity rate = Budgeted activity cost / Number of direct labor hours
Activity rate = $357,120 / 4,000
Activity rate = $89.28 per direct labor hour

Answer c.

Cell Phones:

Indirect labor cost = $148.80 Number of setups + $89.28 Number of direct labor-hours
Indirect labor cost = $148.80 500 + $89.28 2,000
Indirect labor cost = $252,960

Indirect labor cost per unit = Indirect labor cost / Number of units produced
Indirect labor cost per unit = $252,960 / 96,000
Indirect labor cost per unit = $2.635 or $2.64

Tablet PCs:

Indirect labor cost = $148.80 Number of setups + $89.28 Number of direct labor-hours
Indirect labor cost = $148.80 1,100 + $89.28 2,000
Indirect labor cost = $342,240

Indirect labor cost per unit = Indirect labor cost / Number of units produced
Indirect labor cost per unit = $342,240 / 96,000
Indirect labor cost per unit = $3.565 or $3.57