Question

Please do it by type not pics.

Smithson, Inc. produces two types of gas grills: a family model and a deluxe model. Smithson’s controller has decided to use a plant-wide 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

Answer:
(a)	Computation of the overhead rate using the traditional (plantwide) approach
	Total overhed cost	$               450,000.00
	Direct labour costs	$               225,000.00
	Overhead cost per direct labour hours	$                            2.00	($450,000/$225,000)
(b)	Computation of the overhead rate using activity based costing approach
	Overhead	Total cost	Number of activity	Cost per activity
	Machining activity	$               270,000.00	4000	$                67.50	($270000/4000)
	Machining setup activity	$               180,000.00	1000	$              180.00	($180000/1000)
		$               450,000.00
( c)	Cost allocation based on traditional approach
		Family model	Deluxe Model
	Direct labours cost	$                  75,000.00	$               150,000.00
Add:	Overhead cost	$               150,000.00	$               300,000.00
		($75000*$2)	($150000*$2)
	Total cost	$               225,000.00	$               450,000.00	$      675,000.00
	Cost allocation based on ABC approach
		Family model	Deluxe Model
	Direct labours cost	$                  75,000.00	$               150,000.00
Add:	Machining activity cost	$               135,000.00	$               135,000.00
		($67.50*2,000)	($67.50*2,000)
Add:	Machining setup activity cost	$                  36,000.00	$               144,000.00
		($180*200)	($180*800)
	Total cost	$               246,000.00	$               429,000.00	$      675,000.00
	Total cost allocated to Family model is lower by $21,000 ($246,000-$225,000) under traditional approach and cost of deluxe model is higher by $21,000 (450,000-429,000) under traditional costing approach.
(d)
1	Computation of the overhead rate using activity based costing approach
	Overhead	Total cost	Number of activity	Cost per activity
	Machining activity	$               240,000.00	4000	$                60.00	($270000/4000)
	Machining setup activity	$               170,000.00	1000	$              170.00	($180000/1000)
	Packaging	$                  40,000.00	125	$              320.00	($40000/125)
		$               450,000.00
2	Cost allocation based on ABC approach
		Family model	Deluxe Model
	Direct labours cost	$                  75,000.00	$               150,000.00
Add:	Machining activity cost	$               120,000.00	$               120,000.00
		($60*2,000)	($60*2,000)
Add:	Machining setup activity cost	$                  34,000.00	$               136,000.00
		($170*200)	($170*800)
Add:	Packaging cost	$                  16,000.00	$                  24,000.00
		($320*50)	($320*75)
	Total cost	$               245,000.00	$               430,000.00
	Total cost allocated to Family model is higher by $20,000 ($245,000-$225,000) under traditional approach and cost of deluxe model is higher by $20,000 (450,000-430,000) under traditional costing approach.There is a difference of $1,000 in allocation of total cost using third activity.