Question

Assume a company produces and sells only two products—14,000 units of Product A and 6,000 units of Product B. The selling prices are $65 per unit for Product A and $96 per unit for Product B. Product A’s direct materials and direct labor costs per unit are $30 and $12, respectively. Product B’s direct materials and direct labor costs per unit are $34 and $15, respectively. The company uses a plantwide overhead rate based on direct labor dollars. It is considering implementing an activity-based costing (ABC) system that allocates all of its manufacturing overhead to three cost pools. The following additional information is available for the company as a whole and for Products A and B:

Activity Cost Pool	Activity Measure	Estimated Overhead Cost			Expected Activity
Machining	Machine-hours	$	300,000		15,000	MH
Machine setups	Number of setups	$	150,000		200	Setups
Product design	Number of products	$	80,000		2	Products

Activity Measure	Product A	Product B
Machine-hours	9,000	6,000
Number of setups	50	150
Number of products	1	1

When comparing Product A’s total overhead costs using the traditional approach with its total overhead costs using the activity-based approach, which of the following statements is true?

Multiple Choice

• The traditional plantwide approach undercosts Product A by between $0 and $49,999 when compared to the activity-based approach.

• The traditional plantwide approach undercosts Product A by between $50,000 and $100,000 when compared to the activity-based approach.

• The traditional plantwide approach overcosts Product A by between $50,000 and $100,000 when compared to the activity-based approach.

• The traditional plantwide approach overcosts Product A by between $0 and $49,999 when compared to the activity-based approach.

Answer 1

product	Total production	direct labour per unit	total direct labour cost
A	14,000	$ 12	14,000 * 12=168,000
B	6,000	$ 15	6,000 * 15= 90,000
TOTAL= 258,000

in traditional approach overhead is allocated based on the direct labour dollars.

total overhead cost= machining cost + machine setup+ product design

=300,000+150,000+80,000=530,000

overhead allocation rate= total overhead / total direct labour dollars

=530,000/258,000 =2.05426

Total overhead cost of product A using tradtional approach = overhead allocation rate * total labour cost of product A

=168,000 * 2.05426 = 345,115.68

ACTIVITY BASED APPROACH

total overhead classified in to three, each will allocate in to products based on the cost driver.an allocation rate will find for all cost pools and it will allocate based on the activity used by the products

Cost pool	Cost	Activity	Allocation rate
Machining	300,000	15,000 MH	300,000/ 15000= 20 per MH
machine setup	150,000	200 setup	150,000/200= 750 per set up
Product design	80,000	2 products	80,000/2= 40,000 per product

Machining cost is allocate @ 20 per machine hour

total machine hours used by product A= 9,000

Machining cost allocated to Product A= 9,000 * 20 = 180,000

machine set up cost is 750 per set up

Total machine setup for Product A = 50

Machine set up cost allocated to product A= 750* 50= 37,500

product design cost is 40,000 per product

product design cost for product A =1 * 40,000= 40,000

TOTAL OVERHEAD COST OF PRODUCT A BY ACTIVITY BASED APPROACH= 180,000+37,500+40,000=257,500

Overhead cost Based on Traditional approach is 345,115.68. but in Activity based approach it is 257,500

345,115.68-257,500= 87,615.68

so option C is correct

The traditional plantwide approach overcosts Product A by between $50,000 and $100,000 when compared to the activity-based approach.