Question

Altex Inc. manufactures two products: car wheels and truck wheels.  To determine the amount of overhead to
assign to each product line, the controller, Robert Hermann, has developed the following information.
						Car		Truck
	Estimated wheels produced					40,000		10,000
	Direct labor hours per wheel					1		3
Total estimated overhead costs for the two product lines are $770,000.
Instructions
(a) Compute the overhead cost assigned to the car wheels and truck wheels, assuming that direct labor hours
is used to allocate overhead costs.
(b) Hermann is not satisfied with the traditional method of allocating overhead because he believes that most
of the overhead costs relate to the truck wheels product line because of its complexity.  He therefore develops
the following three activity cost pools and related cost drivers to better understand these costs.
				Expected Use of				Estimated Overhead
	Activity Cost Pools			Cost Drivers				Costs
	Setting up machines			1,000 setups				$220,000
	Assembling			70,000 labor hours				280,000
	Inspection			1,200 inspections				270,000
Compute the activity-based overhead rates for these three cost pools.
(c)  Compute the cost that is assigned to the car wheels and truck wheels product lines using an activity-based
costing system, given the following information.
	Expected Use of Cost Drivers per Product
						Car		Truck
	Number of setups					200		800
	Direct labor hours					40,000		30,000
	Number of inspections					100		1,100
(d)  What do you believe Hermann should do?

Answer 1

a)
	Particulars				Car	Truck	Total
	Estimated wheels produced				40000	10000
	Direct labor hours per wheel				1	3
	Total Direct Labor Hours			(a)	40000	30000	70000
	Total estimated overhead costs			(b)			$ 770,000.00
	OH rate			(b/a = c)			$           11.00
	OH assigned			(c x a)	$ 440,000.00	$ 330,000.00

b)				Expected Use of		Estimated Overhead	Activity
	Activity Cost Pools			Cost Drivers		Costs	Rate
	Setting up machines			1000	setups	$     220,000.00	$ 220.00
	Assembling			70000	labor hours	$     280,000.00	$      4.00
	Inspection			1200	inspections	$     270,000.00	$ 225.00

c)	Particulars			Car		Truck
	Setting up machines			$   44,000.00	($ 220 x 200)	$ 176,000.00	($ 220 x 800)
	Assembling			$ 160,000.00	($ 4 x 40000)	$ 120,000.00	($ 4 x 30000)
	Inspection			$   22,500.00	($ 225 x 100)	$ 247,500.00	($ 225 x 1100)
				$ 226,500.00		$ 543,500.00

d) Hermann should follow Activity Based Costing for assigning overheads