Question

Exercise C: Activity-Based Costing

Erte, Inc. has the following predicted indirect costs and cost drivers for 2017 for the given activity cost pools:

	Manufacture Department	Finishing Department	Cost Driver
Maintenance	$30,000	$15,000	Machine hours
Materials handling	$40,000	$25,000	Material moves
Machine setups	$80,000	$5,000	Machine setups
Inspections	$0	$20,000	Inspection hours
Total	150,000	$65,000

The following activity predictions were also made for the year:

	Manufacture Department	Finishing Department
Machine hours	15,000	8,000
Materials moves	5,000	3,500
Machine setups	900	150
Inspection hours	0	3,000

It is assumed that the cost per unit of activity for a given activity does not vary between departments. The company’s president is trying to evaluate the company’s product mix strategy regarding two of its four product models, K200 and V400. The company has been using a company-wide overhead rate based on machine hours but is considering switching to either department rates or activity-based rates. The production manager has provided the following data for the production of a batch of 150 units for each of these models:

	K200	V400
Direct materials cost	$15,000	$22,000
Direct labor cost	$7,000	$6,000
Machine hours (Manufacture)	700	900
Machine hours (Finishing)	400	300
Materials moves	60	80
Machine setups	9	12
Inspection hours	60	80

  

Required:

1. Determine the cost of one unit each of K200 and V400, assuming a company-wide overhead rate is used based on total machine hours.
2. Determine the cost of one unit each of K200 and V400, assuming department overhead rates are used. Overhead is assigned based on machine hours in both departments.
3. Determine the cost of one unit each of K200 and V400, assuming activity-based overhead rates are used for maintenance handling, machine setup, and inspection activities.

Answer 1

Requirement a:

Overhead rate based on total machine hours

Overhead rate = Total Overhead cost / Total machine hours

Overhead rate = ($150,000 + $65,000) / (15,000 + 8,000) = $9.35 per machine hour

Manufacturing overhead

K200 = (700 machine hours + 400 machine hours) * $9.35 per machine hour = $10,285

V400 = (900 machine hours + 300 machine hours) * $9.35 per machine hour = $11,220

Product Costs per Unit

Particulars	K200	V400
Direct Materials	$15,000	$22,000
Direct labor	$7,000	$6,000
Manufacturing overhead	$10,285	$11,220
Total Cost per batch	$32,285	$39,220
Number of units per batch	150	150
Cost per unit	$215.23	$261.47

Requirement b:

Departmental Overhead rate:

Departmental overhead rate = Departmental overhead cost / Departmental machine hours

Manufacture Department's overhead rate = $150,000 / 15,000 machine hours = $10.00 per machine hour

Finishing department's overhead rate = $65,000 / 8,000 machine hours = $8.13 per machine hour

Manufacturing overhead

K200 = (700 machine hours * $10.00 per machine hour) + (400 machine hours * $8.13 per machine hour) = $10,252

V400 = (900 machine hours * $10.00 per machine hour) + (300 machine hours * $8.13 per machine hour) = $11,439

Product Costs per Unit

Particulars	K200	V400
Direct Materials	$15,000	$22,000
Direct labor	$7,000	$6,000
Manufacturing overhead	$10,252	$11,439
Total Cost per batch	$32,252	$39,439
Number of units per batch	150	150
Cost per unit	$215.01	$262.93

Requirement c:

Activity-based overhead rates:

Activity	Computation	Activity Rate
Maintenance	($30,000 + $15,000) / (15,000 + 8,000)	$1.96 per machine hour
Materials handling	($40,000 + $25,000) / (5,000 + 3,500)	$7.65 per material move
Machine setup	($80,000 + $5,000) / (900 + 150)	$80.95 per machine setup
Inspection activities	($0 + $20,000) / (0 + 3,000)	$6.67 per inspection

Manufacturing overhead

K200

Activity	Computation	Overhead Cost
Maintenance	(700 + 400) * $1.96 per machine hour	$2,156
Materials handling	60 * $7.65 per material move	$459
Machine setup	9 * $80.95 per machine setup	$729
Inspection activities	60 * $6.67 per inspection	$400

V400

Activity	Computation	Overhead Cost
Maintenance	(900 + 300) * $1.96 per machine hour	$2,352
Materials handling	80 * $7.65 per material move	$612
Machine setup	12 * $80.95 per machine setup	$971
Inspection activities	80 * $6.67 per inspection	$534

Product Costs per Unit

Particulars	K200	V400
Direct Materials	$15,000	$22,000
Direct labor	$7,000	$6,000
Manufacturing overhead:
Maintenance activity	$2,156	$2,352
Materials handling activity	$459	$612
Machine setup activity	$729	$971
Inspection activity	$400	$534
Total Cost per batch	$25,744	$32,469
Number of units per batch	150	150
Cost per unit	$171.63	$216.46

All the best...