Question

ACCT4210–Cost and Managerial Accounting

Problem 4: Activity-based costing

Rome, Inc., produces two products, Product A and Product B. If currently allocates overhead costs using direct-labor hours, but the controller has recommended an activity-based costing (ABC) system using the following data:

			Activity Level
Activity	Cost-Driver Base	Cost	Product A	Product B
Production setup	Number of setups	$ 90,000	11	19
Materials handling & requisition	Number of parts per unit	$ 15,000	6	18
Packaging & shipping	Number of units shipped	$ 45,000	30,000	60,000
Total overhead		$150,000

a. Compute the amount of overhead to be allocated to each product under ABC. (PLEASE SHOW YOUR WORK)

b.. Should the company follow the controller’s recommendation? Explain your answer.

PLEASE SHOW YOUR WORK

Answer 1

• All working forms part of the answer
• Workings for Requirement ‘a’

--Step 1: Calculation of Activity rate under ABC method---

			Activity Level
Activity	Cost-Driver Base	Cost	Product A	Product B	Total Activity Level	Activity rate per cost driver activity
		[A]	[B]	[C]	[D = B+C]	[E = A/D]
Production setup	Number of setups	$                  90,000.00	11	19	30	$          3,000.00	per Number of setups
Materials handling & requisition	Number of parts per unit	$                  15,000.00	6	18	24	$              625.00	per Number of parts per unit
Packaging & shipping	Number of units shipped	$                  45,000.00	30,000	60,000	90,000	$                   0.50	per Number of units shipped
Total overhead		$                150,000.00

---Step 2: Allocation of Overhead to PRODUCT A

Activity	Activity rate per cost driver activity		Activity Level for Product A	Overhead Allocated to Product A
	[A = calcuated above]		[B]	[C = A x B]
Production setup	$                                     3,000.00	per Number of setups	11	$         33,000.00
Materials handling & requisition	$                                         625.00	per Number of parts per unit	6	$           3,750.00
Packaging & shipping	$                                              0.50	per Number of units shipped	30,000	$         15,000.00
Total Overhead Allocated to Product A				$         51,750.00

---Step 3: Allocation of Overhead to PRODUCT B

Activity	Activity rate per cost driver activity		Activity Level for Product B	Overhead Allocated to Product B
	[A = calculated above]		[B]	[C = A x B]
Production setup	$                                     3,000.00	per Number of setups	19	$         57,000.00
Materials handling & requisition	$                                         625.00	per Number of parts per unit	18	$         11,250.00
Packaging & shipping	$                                              0.50	per Number of units shipped	60,000	$         30,000.00
Total Overhead Allocated to Product B				$         98,250.00

• Requirement ‘a’ [based on above workings]

	Product A	Product B
Overheads Allocated as per ABC method	$                                   51,750.00	$                  98,250.00

• Requirement ‘b’

YES, the company should follow the controller’s recommendation of following Activity Based Costing.

This is because:
>Allocating all the overheads just using direct labor hours (as being used currently) as the common base for all the overhead does not feel right because not all overheads are based on direct labor hours.

>Activity Based Costing method is more scientific and accurate and provides results that are actually meaningful for decision making.