Question

P17-3A Assign overhead costs using traditional costing and ABC; compare results.

Shaker Stairs Co. designs and builds factory-made premium wooden stairways for homes. Budgeted manufacturing overhead costs for the year 2017 are as follows.

Overhead Cost Pools	Amount
Purchasing	$ 75,000
Handling materials	82,000
Production (cutting, milling, finishing)	210,000
Setting up machines	105,000
Inspecting	90,000
Inventory control (raw materials and finished goods)	126,000
Utilities	180,000
Total budgeted overhead costs	$868,000

For the last 4 years, Shaker Stairs Co. has been charging overhead to products on the basis of machine hours. For the year 2017, 100,000 machine hours are budgeted.

Jeremy Nolan, owner-manager of Shaker Stairs Co., recently directed his accountant, Bill Seagren, to implement the activity-based costing system that he has repeatedly proposed. At Jeremy Nolan's request, Bill and the production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.

Activity Cost Pools	Cost Drivers	Expected Use of Cost Drivers
Purchasing	Number of orders	600
Handling materials	Number of moves	8,000
Production (cutting, milling, finishing)	Direct labor hours	100,000
Setting up machines	Number of setups	1,250
Inspecting	Number of inspections	6,000
Inventory control (raw materials and finished goods)	Number of components	168,000
Utilities	Square feet occupied	90,000

Steve Hannon, sales manager, has received an order for 250 stairways from Community Builders, Inc., a large housing development contractor. At Steve's request, Bill prepares cost estimates for producing components for 250 stairways so Steve can submit a contract price per stairway to Community Builders. He accumulates the following data for the production of 250 stairways.

Direct materials	$103,600
Direct labor	$112,000
Machine hours	14,500
Direct labor hours	5,000
Number of purchase orders	60
Number of material moves	800
Number of machine setups	100
Number of inspections	450
Number of components	16,000
Number of square feet occupied	8,000

Instructions

(a) Compute the predetermined overhead rate using traditional costing with machine hours as the basis.

(b) What is the manufacturing cost per stairway under traditional costing? (Round to the nearest cent.)

(c) What is the manufacturing cost per stairway under the proposed activity-based costing? (Round to the nearest cent. Prepare all of the necessary schedules.)

(d)

Which of the two costing systems is preferable in pricing decisions and why?

(b) Cost/stairway $1,365.84

(c) Cost/stairway $1,139.80

Answer 1

a.

Predetermined overhead rate under traditional method = Total estimated overhead cost / Total estimated machine hours

Predetermined overhead rate under traditional method = $868,000 / 100,000 = $8.68 per machine hour

b.

Manufacturing cost under traditional method:

Direct material	$103,600
Direct labor	112,000
Overhead applied (14,500*$8.68)	125,860
Total manufacturing cost	$341,460
Cost per stairway ($341,460/250)	$1,365.84

c.

Activity cost pool	Overhead cost	Basis of allocation	Activity rate	Overhead allocated
Purchasing	$75,000	600 number of orders	$75,000/600 = $125	$7,500 (60*$125)
Handling materials	82,000	8,000 number of moves	82,000/8,000 = $10.25	8,200 (800*$10.25)
Production	210,000	100,000 direct labor hours	210,000/100,000 = $2.1	10,500 (5,000*$2.1)
Setting up machines	105,000	1,250 number of setups	105,000/1,250 = $84	8,400 (100*$84)
Inspecting	90,000	6,000 number of inspection	90,000/6,000 = $15	6,750 (450*$15)
Inventory control	126,000	168,000 number of components	126,000/168,000 = $0.75	12,000 (16,000*$0.75)
Utilities	180,000	90,000 square feet occupied	180,000/90,000 = $2	16,000 (8,000*$2)
Total cost	$868,000			$69,350

Manufacturing cost under ABC based costing:

Direct material	$103,600
Direct labor	112,000
Overhead applied	69,350
Total manufacturing cost	$284,950
Cost per stairway ($284,950/250)	$1,139.8

d.

ABC based costing is preferable than traditional costing since results provided by ABC costing are more accurate as overhead cost is assigned based on cost drivers as in traditional costing overhead cost is assigned based on one allocation base.