Question

Saddle Inc. has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has 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.

Assign overhead using traditional costing and ABC.

Standard      Custom

Direct labor costs   $50,000       $100,000

Machine hours 1,000           1,000

Setup hours 100             400

Total estimated overhead costs are $240,000. Overhead cost allocated to the machining activity cost pool is $140,000, and $100,000 is allocated to the machine setup activity cost pool.

Instructions

1. Compute the overhead rate using the traditional (plantwide) approach.
2. Compute the overhead rates using the activity-based costing approach.
3. Determine the difference in allocation between the two approaches

Answer 1

1) Calculation of Overhead Rate using Traditional Approach :-

Calculation of Predetermined Overhead Rate :-

= (Total Estimated Overhead / Total Direct Labor Cost)*100

= ($240000/($50000+$100000))*100

= ($240000/$150000)*100

= 160%

2) Calculation of Overhead Rate using Activity Bases Costing :-

Machining Activity :-

= Overhead Cost Allocated to Machining Activity / Machine Hours

= $140000 / (1000+1000)

= $140000 / 2000

= $70 per Machine hour

Machine Setup Activity :-

= Overhead Cost Allocated to Machine Setup Activity / Setup Hours

= $100000 / (100+400)

= $100000 / 500

= $200 per setup hour

3) Overhead Allocation

As Per Traditional Approach :-

Standard :-

= Direct Labor Cost * Predetermined Rate

= $50000 * 160%

= $80000

Custom :-

= Direct Labor Cost * Predetermined Rate

= $100000 * 160%

= $160000

As Per Activity Based Costing Approach :-

Standard :-

= (Machine Hours * Rate) + (Setup Hours * Rate)

= (1000*$70) + (100*$200)

= $70000 + $20000

= $90000

Custom :-

= (Machine Hours * Rate) + (Setup Hours * Rate)

= (1000*$70) + (400*$200)

= $70000 + $80000

= $150000

Approach	Standard	Custom
Traditional Approach	$80000	$160000
Activity Based Costing Approach	$90000	$150000

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