Question

Saddle Inc. has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has heard of activity-based costing and wants to see how the results would differ if this system were used. Two activity cost pools were developed: machining and machine setup. Presented below is information related to the company’s operations. Standard Custom Direct labor costs $ 51,000 $ 116,000 Machine hours 1,410 1,330 Setup hours 96 400 Total estimated overhead costs are $ 304,000. Overhead cost allocated to the machining activity cost pool is $ 195,000, and $ 109,000 is allocated to the machine setup activity cost pool.

Answer 1

Allocation of overhead based on plantwide overhead rate

Total Direct labor costs = 51,000 + 116,000

= $167,000

Plant wide overhead rate = Total estimated overhead costs/Direct labor costs

= 304,000/167,000

= $1.82 per Dollar direct labor cost

	Standard	Custom
Overhead	51,000 x 1.82 = $92,838	116,000 x 1.82 = $211,162

Allocation of overhead based on Activity based costing

Overhead cost allocated to the machining activity cost pool = $195,000

Overhead rate (machining activity cost pool) = Overhead cost allocated to the machining activity cost pool/Machine hours

= 195,000/2,740

= $71.17

Overhead cost allocated to the machine setup activity cost pool = $109,000

Overhead rate (setup activity cost pool) = Overhead cost allocated to the machine setup activity cost pool/Setup hours

= 109,000/496

= $219.76

	Standard	Custom
Machining activity cost	1410 x 71.17 = 100,350	1330 x 71.17 = 94,650
Machine setup activity cost	96 x 219.76 = 21,095	400 x 219.76 = 87,905
Total overheads	$121,445	$182,555

Exact answer may slightly differ due to rounding off.

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