Question

The following budgeted information is available for Zeta Company:

Activity	Budgeted Cost	Activity Driver		Consumption of Drivers for Zeta’s Product Lines
			Total Activity Driver	Product A	Product B
Processing & Testing
Developing test programs	$400,000	Engineering hours	10,000	2,500	7,500
Making probe cards	58,750	Development hours	4,000	400	3,600
Testing products	300,000	Test hours	20,000	2,000	18,000
Setups	40,000	Number of batches	100	55	45
Engineering design	80,000	Number of change orders	60	9	51
Handling lots	90,000	Number of moves	200	110	90
Subtotal, Processing & Testing	$968,750
Procurement
Purchasing materials	450,000	Number of purchase orders	2,500	500	2,000
Unloading materials	60,000	Number of deliveries	3,000	600	2,400
Inspecting materials	75,000	Inspection hours	5,000	3,500	1,500
Moving materials	30,000	Distance moved (feet)	3,000	2,100	900
Paying suppliers	66,250	Number of invoices	1,250	250	1,000
Subtotal, Procurement	681,250
Total	$1,650,000

1. Assume the company currently uses departmental rates for allocating overhead. Calculate the pre-determined overhead rate for the Processing & Testing Department (based on Engineering hours) and the Procurement Department (based on Number of purchase orders). Round to three (3) places after the decimal.

2.   Identify which activity cost pools can be combined.

3. After combining cost pools as appropriate, calculate the pre-determined overhead rates for each activity cost pool.

4. Calculate the cost of Product line A using the departmental rates calculated in #1.

5. Calculate the cost of Product line A using the ABC rates calculated in #3.

6. Is ABC better for Zeta Company? Why or why not?

Answer 1

1.

Pre-determined overhead rate for the Processing & Testing Department

= Total fixed overhead / Total engineering hours

= 968750 / 10000

= 96.875 per engg hour

Pre-determined overhead rate for Procurement Department

= Total fixed overhead / Number of purchase orders

= 681250 / 2500

= 272.50 per purchase order

2.

Following cost pools can be combined:

Setups	These two have cost drivers of Product A & B in the ratio of 9:11	COST POOL 1
Handling lots

Making probe cards	These two have cost drivers of Product A & B in the ratio of 1:9	COST POOL 2
Testing products

Purchasing materials	These three have cost drivers of Product A & B in the ratio of 1:4	COST POOL 3
Unloading materials
Paying suppliers

Inspecting materials	These two have cost drivers of Product A & B in the ratio of 7:3	COST POOL 4
Moving materials

3.

Cost Pools	Total Cost	Ratio	Total Driver	Cost Driver Rate
COST POOL 1	$1,30,000.00	9:11	300	$433.333
COST POOL 2	$3,58,750.00	1:9	24000	$14.948
COST POOL 3	$5,76,250.00	1:4	6750	$85.370
COST POOL 4	$1,05,000.00	7:3	8000	$13.125
Developing test programs	$4,00,000.00	1:3	10000	$40.000
Engineering design	$80,000.00	3:17	60	$1,333.333

4. Cost of Product line A using the ABC rates

Cost Pools	Cost Driver Rate	Cost Drivers	Total Cost
COST POOL 1	$433.333	165	$71,500.000
COST POOL 2	$14.948	2400	$35,875.000
COST POOL 3	$85.370	1350	$1,15,250.000
COST POOL 4	$13.125	4600	$60,375.000
Developing test programs	$40.000	2500	$1,00,000.000
Engineering design	$1,333.333	9	$12,000.000
		Total	$395,000

5.

Overhead Cost of A using traditional Approach = (98.875 * 2500) + (272.50 * 500) = $383,438

Overhead Cost of A using ABC Approach = $395,000

Since there is a difference in both approaches, it is better to use ABC approach. The main reason being ABC approach is said to be more accurate in allocation of overhead costs among products.