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 $58,000 $97,000
Machine hours 1,190 1,220
Setup hours 109 400

Total estimated overhead costs are $304,000. Overhead cost allocated to the machining activity cost pool is $197,000, and $107,000 is allocated to the machine setup activity cost pool.

Compute the overhead rate using the traditional (plantwide) approach. (Round answer to 2 decimal places, e.g. 12.25.)

Predetermined overhead rate
% of direct labor cost

Compute the overhead rates using the activity-based costing approach. (Round answers to 2 decimal places, e.g. 12.25.)

Machining
$
per machine hour
Machine setup
$
per setup hour

Determine the difference in allocation between the two approaches. (Round answers to 0 decimal places, e.g. 1,225.)

Traditional costing
Standard
$
Custom
$

Activity-based costing
Standard
$
Custom
$

Answer 1

• All working forms part of the answer
• Predetermined Overhead rate

A	Total estimated Overhead	$       3,04,000.00
B	Total Direct Labor cost [58000 + 97000]	155000
C= A/B	Predetermined Overhead rate	$                     1.96
D = (A/B) x 100	% of direct labor cost	196.13%

• Overhead rates using Activity based Costing

Cost Pool	Overhead cost	Cost driver	Total cost drivers	Activity rates [Answer]
Machine Activity	$       1,97,000.00	machine hours	1190 + 1220 = 2410 machine hours	197000/2410 = $ 81.74 per machine hours
Machine Setup	$       1,07,000.00	setup hours	109 + 400 = 509 setup hours	107000/509 = $ 210.22 per setup hours

• Working

---traditional method

		Standard	Custom
A	Predetermined Overhead rate	$1.96 per $ labor cost	$1.96 per $ labor cost
B	Direct labor cost	$           58,000.00	$                     97,000.00
C=A x B	Total overhead allocated	$       1,13,680.00	$                 1,90,120.00

---Activity based costing method

		Standard	Custom
A	Predetermined Overhead rate	$1.96 per $labor cost	$1.96 per $labor cost
B	Direct labor cost	$           58,000.00	$                     97,000.00
C=A x B	Total overhead allocated	$       1,13,680.00	$                 1,90,120.00
		Standard	Custom
A	Machine Activity cost pool rate	$81.74 per machine hours	$81.74 per machine hours
B	Total machine hours	1190	1220
C=A x B	Overhead allocated	$           97,270.60	$                     99,722.80
D	Machine Setup activity rate	$ 210.22 per setup hours	$ 210.22 per setup hours
E	no. of setup hours	109	400
F=D x E	Overhead allocated	$           22,913.98	$                     84,088.00
G = C + F	Total Overhead allocated	$       1,20,184.58	$                 1,83,810.80

• Final Answer [based on above working]

Overheads allocated	Traditional	Activity based Costing
Standard	$       1,13,680.00	$                 1,90,120.00
Custom	$       1,20,184.58	$                 1,83,810.80