Question

Appleby Manufacturing uses an activity-based costing system. The company produces Model F and Model G. Information relating to the two products is as follows:

	Model F	Model G
Units produced	24,000	30,000
Machine hours	7,500	8,500
Direct labor hours	8,000	12,000
Material handling (number of moves)	4,000	6,000
Setups	5,000	7,000
Purchase orders	30	40
Inspections	10,000	14,000
Product line variations	8	12

The following overhead costs are reported for the following activities of the production process:

Material handling	$ 40,000
Labor-related overhead	120,000
Setups	60,000
Product design	100,000
Batch inspections	120,000
Central purchasing	70,000

Appleby Manufacturing has used activity-based costing to assign costs to Models F and G as given in the table below:

Activity	Cost Pool	Driver	Pool Rate	Model F Activity	Model F Cost	Model G Activity	Model G Cost	Total
Material handling	$40,000	10,000	$4	4,000	$16,000	6,000	$24,000	$40,000
Labor related overhead	$120,000	20,000	$6	8,000	$48,000	12,000	$72,000	$120,000
Setups	$60,000	12,000	$5	5,000	$25,000	7,000	$35,000	$60,000
Product design	$100,000	20	$5,000	8	$40,000	12	$60,000	$100,000
Batch inspections	$120,000	24,000	$5	10,000	$50,000	14,000	$70,000	$120,000
Central purchasing	$70,000	70	$1,000	30	$30,000	40	$40,000	$70,000
Total					$209,000		$301,000	$510,000

Appleby Manufacturing wants to implement an approximately relevant ABC system by using the two most expensive activities for cost assignment.

Under this new approach using consumption ratios for labor related and batch inspections, what set of equations would be used to create equally accurate reduced ABC allocation rates (where a = labor hours and b = batch inspections)? (round to 5 decimal places)

a.0.50 = 0.4a + 0.6b
0.50 = 0.6a + 0.4b

b.0.41 = 0.4a + 0.41667b
0.59 = 0.6a + 0.58333b

c.0.44 = 0.8a + 0.75b
0.56 = 0.12a + 0.85b

d.0.40 = 0.8a + 0.75b
0.60 = 0.12a + 0.85b

Answer 1

(b) 0.41 = 0.4a + 0.41667b ; 0.59 = 0.6a + 0.58333b

Explanation:

Let us compute the ratio between the Model F and Model G

Labor Hours (a):

Labor Hours for Model F = 8,000 hours

Labor Hours for Model G = 12,000 hours

Total Hours = 20,000 hours

Ratio of Labor Hours for Models F & G (i.e. F : G) = 4 : 6

Batch Inspection (b):

Batch Inspection for Model F = 10,000

Batch Inspection for Model G = 14,000

Total Batch Inspections = 24,000

Ratio of Batch Inspections for Models F & G (i.e. F : G) = 41.667 : 58.333

Total Cost: (Only batch Inspection and Labor related Overheads)

Total Cost for Model F = $48,000 + $50,000 i.e. $98,000

Total Cost of Model G = $72,000 + $70,000 i.e. $142,000

Ratio of Costs for Models F & G (i.e. F : G) = 0.41 : 0.59

Combining all the computed ratios, the equation formed are as follows

Model F : 0.41 = 0.4a + 0.41667b

Model G : 0.59 = 0.6a + 0.58333b

Therefore, Option (b) is the correct answer

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