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 B’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 overcosts Product B by between $50,000 and $100,000 when compared to the activity-based approach.

• The traditional plantwide approach undercosts Product B by between $50,00 and $100,000 when compared to the activity-based approach.

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

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

Answer 1

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

Option B is correct

Workings:
Traditional plantwide:
Direct labor costs:
Product A	168000	=14000*12
Product B	90000	=6000*15
Direct labor costs	258000
Estimated Overhead Cost	530000	=300000+150000+80000
/ Direct labor costs	258000
Plantwide overhead rate	205.43%
Overhead allocated:
Product B	184887	=90000*205.43%
Activity-based approach:
Activity rates:
Machining	20	=300000/15000
Machine setups	750	=150000/200
Product design	40000	=80000/2
Overhead allocated:
Product B
Machining	120000	=6000*20
Machine setups	112500	=150*750
Product design	40000
Overhead allocated product B	272500
Traditional plantwide approach undercosts	87613	=272500-184887