Question

Adirondack Corporation is estimating activity costs associated with producing two different sized e-reader tablets. The indirect labor can be traced to three separate activity pools. The budgeted activity cost and activity base information, along with the estimated activity-base information, is provided below.
ActivityCost Activity Base

Purchasing $250,000 Number of purchase orders

Materials handling $500,000 Number of moves

Production   1,350,000     Machine hours

TOTAL $2,100,000

Number of Purchase Orders; Number of Moves; Machine Hours; Number of Units

7” tablet 3,000 1,500   2,500   2,500

10" tablet 5,000      600   7,500   3,500

TOTALS   8,000 2,100   10,000   6,000

Required: Determine the Activity rate for each activity cost pool. All work must be shown for credit.

Please label your answer as the activity rate for: Purchasing; Materials handling; & Production.

Using the information from the activity based costing problem:

If traditional costing had been used and number of machine hours were the allocation base, what would the single allocation rate be? Would applying a single allocation rate be a wise decision to apply costs in this scenario? Why or why not

If traditional costing had been used and number of machine hours were the allocation base, what would the single allocation rate be? Would applying a single allocation rate be a wise decision to apply costs in this scenario? Why or why not?

Answer 1

• All working forms part of the answer
• Requirement 1: Calculation of activity rates for the cost pool.

			No. of activity cost drivers
Activity	Overhead cost	Activity Base	7" Tablet	10" tablet	Total no. of activity cost driver	Activity Rate per cost driver
	[A]		[B]	[C]	[D = B + C]	[E = A / D] = Answer column
Purchasing	$                      250,000.00	No. of purchase orders	3000	5000	8000	$               31.25	per purchase order
Material Handling	$                      500,000.00	no. of moves	1500	600	2100	$            238.10	per move
Production	$                   1,350,000.00	No. of machine hours	2500	7500	10000	$            135.00	per machine hour
TOTAL	$                   2,100,000.00

----Final Activity Rates for each cost pool activity, based on above working:

Activity	Overhead cost	Activity Rate per cost driver
Purchasing	$                      250,000.00	$               31.25	per purchase order
Material Handling	$                      500,000.00	$            238.10	per move
Production	$                   1,350,000.00	$            135.00	per machine hour

• Comparison of Traditional Method and Activity Based Costing Method-----
• Step 1: Calculation of Overheads allocated and per unit overhead cost of 7” Tablet using Activity rates calculated above:

Working #1: Allocation of Overhead to 7" Tablets
Activity	Activity Rate per cost driver		Activity Base	No. of cost driver	Overhead allocated
	[A]			[B]	[C = A x B]
Purchasing	$                                 31.25	per purchase order	No. of purchase orders	3000	$           93,750.00
Material Handling	$                               238.10	per move	no. of moves	1500	$        357,150.00
Production	$                               135.00	per machine hour	No. of machine hours	2500	$        337,500.00
TOTAL Overheads allocated					$        788,400.00
Total Units					2,500
Overhead cost per unit					$                 315.36

• Step 2: Calculation of Overheads allocated and per unit overhead cost of 10” Tablet using Activity rates calculated above:

Working #2: Allocation of Overhead to 10" Tablets
Activity	Activity Rate per cost driver		Activity Base	No. of cost driver	Overhead allocated
	[A]			[B]	[C = A x B]
Purchasing	$                                 31.25	per purchase order	No. of purchase orders	5000	$        156,250.00
Material Handling	$                               238.10	per move	no. of moves	600	$        142,860.00
Production	$                               135.00	per machine hour	No. of machine hours	7500	$     1,012,500.00
TOTAL Overheads allocated					$     1,311,610.00
Total Units					3,500
Overhead cost per unit					$                 374.75

• Step 3: Now that Overhead cost ‘per unit’ has been calculated using Activity Based costing method, the Overhead cost ‘per unit’ using Traditional Method is to be computed by using total machine hours for predetermined Overhead rate.

A	Total Overheads	$                   2,100,000.00
B	Total Machine hours	10,000
C = A/B	Overhead predetermined rate per machine hours	$                               210.00
	7" Tablet:
D	No. of machine hours	2,500
E = C x D	Overheads allocated	$                      525,000.00
F	Units	2,500
G = E/F	Overhead cost per unit	$                               210.00
	10" Tablet:
H	No. of machine hours	7,500
I = C x H	Overheads allocated	$                   1,575,000.00
J	Units	3,500
K = I / J	Overhead cost per unit	$                               450.00

• Step 4: Final Summarised Comparison between the results of two methods:

	Overhead cost per unit
	7" Tablet	10" tablet
Traditional Method	$                               210.00	$                                             450.00
Activity based costing method	$                               315.36	$                                             374.75
Difference	$                               105.36	$                                               75.25

• Final Judgement and Answer for 2^nd part of Requirement.

>If Traditional Method would have been used, the single predetermined Overhead rate would have been $ 210 per machine hours (as calculated in Step 3).

>Using this rate of $ 210 per machine hours would not be a wise decision to apply cost in this scenario because both tablet product consumes different amount of other ‘activities’ and cost of those activities should be in accordance with the amount of activities consumed (and not on the basis of machine hours only).

>If Traditional Method would have been used (See step 4):

---Overhead cost per unit of 7” tablet would have been $ 105.36 LESS THAN the overhead cost per unit as per ABC method.
--- Overhead cost per unit of 10” tablet would have been $ 75.25 MORE THAN the overhead cost per unit as per ABC method.

Hence, Traditional Method is NOT ADVISED.