Question

Waymire Ltd. manufactures two products and currently allocates overhead based on direct labour hours. For the coming year, the company is considering changing to an activity based costing system by allocating overhead based on 3 activities. The estimated amount of overhead traceable to the 3 activities for the coming year are given below:

Activity	Cost driver	Cost	Product 1	Product 2
Purchase orders	# of orders	$840347	312	579
Maintenance	Machine hours	$456759	18555	19721
Inspection	# of inspections	$718649	1526	2200

Total estimated direct labour hours for the coming year are 33444 hours for Product 1 and 84234 hours for Product 2.

What is the difference between total overhead allocated to Product 2 using activity based costing versus traditional costing? Note: a negative number indicates less total overhead allocated using activity based costing.

Answer 1

Overhead Under Activity based costing

Activity	Cost Drivers	Cost	Product 1	Product 2	Total	Cost Per Driver {Note 1}	Cost for Product 1 {Note 2}	Cost for Product 2 {Note 3}
Purchase orders	# of orders	$840,347	312	579	891	$943.15	$294,262.92	$546,084.08
Maintenance	Machine hours	$456,759	18555	19721	38276	$11.93	$221,422.39	$235,336.61
Inspection	# of inspections	$718,649	1526	2200	3726	$192.87	$294,325.92	$424,323.08
Total Cost		$2,015,755					$810,011.23	$1,205,743.77

[Note 1 - Cost Per Driver = Cost / Total
Note 2 - Cost for Product 1 = Cost Per Driver x Product 1
Note 3 - Cost for Product 2 = Cost Per Driver x Product 2 ]

Overhead Under Traditional Costing (Based on Direct Labour Hours)

Total Overhead Cost = $2,015,755
Labour Hours of Product 1 = 33444 hours
Labour Hours of Product 2 = 84234 hours
Total Labour Hours = 117678 hours

Overhead Cost Per hour =  $2,015,755 / 117678 hours = $17.13 (Approx)

Overhead Cost of Products = No of Labour hours x Cost per Hour

Product	Labour Hour	Rate	Total Cost
Product 1	33444	$17.13	$572,876.07
Product 2	84234	$17.13	$1,442,878.93
Total =	117678		$2,015,755.00

Difference between total overhead allocated to Product 2 using activity based costing versus traditional costing =

Cost of Product 2 As per Activity Costing	$1,205,743.77
Cost of Product 2 As per Traditional Method	$2,015,755.00
Difference	-810011.23