Question

Petral Ltd. Manufactures 2 products, W and Z using the same factory and facilities. Details provided below:

Product Line	Vol of Production	Material (direct) cost per unit	Direct labour per unit	Machine time per unit	Labour cost per unit
W	600	$6	0.75hr	0.5hr	$4
Z	7100	$18	1.25hrs	1.75hrs	$10

Production overhead is comprised of the following costs:

Description of cost Amount

Factory overhead related to machine activity- $42,725

Set-up costs- $8,725

Cost of handling materials- $11,725

Administration costs for spare parts- $12,725

The firm uses a plant-wide overhead rate based on Machine hours of $5.97 per machine hour.

However, an investigation of the activities (in addition to machine hours) that drive costs at the product-line level revealed the following relationships:

Product line	# of set ups	# of times material was handled	# of spare parts
W	2	3	3
Z	9	13	5

Required:

1) Verify the firm's plant-wide rate of $5.97 per machine hour. Show all relevant calculations.

2) Compute all appropriate overhead rates using activity based costing. Round off all individual overhead rates to two decimal places. Show all relevant calculations.

3) Apply (1) and (2) to 2 product lines: that is, calculate the amount of overhead that should be allocated to Product-lines W and Z under the plant-wide rate and ABC rates. Show all relevant calculations.

4) Compare the overhead allocations to product lines W and Z. Clearly explain the differences in allocated costs with respect to each product line: your explanation should first provide a theoretical explanation for the differences, and second, explain these differences by referring back to the case facts provided. This part requires a narration that explains any figures calculated to highlight differences in allocated amounts: students cannot just provide calculations without providing a detailed explanation. Please ensure that the answer is written in full sentences and using paragraphs. An answer with key words only, which are not developed into a reasoned argument, is not acceptable for second-year assignments.

Answer 1

Answer 1

Plantwide rate = Total Overheads/ Total Machine Hours

Total Overheads= 42725+8725+11725+12725= 75,900

Total Machine Hours = 600*.5+ 7100*1.75= 12,725

Plantwide rate per machine hr = 75,900/12,725= 5.964 per machine hr.So it is verified

2. Overhead Rates using Activity based costing

Set up rate= Set up Cost/No of set ups = 8,725/11 = 793.18 per set up

Material Handling rate= cost of handling material/ no of times materail handled= 11,725/16=732.81 each time

Spare part handling= cost/ no of spare parts=12,725/8 =1590.6 per part

Machine rate= Machine overheads/machine hrs= 42,725/12,725= 3.36 per hr

3. Overhead Cost calculations for product W and Z using Activity based costing

Cost for each product line = cost Material Handling + admn cost for spares + overheads for machine activity

Overhead cost per unit cost= Total cost as per above/ volume of production

W=( 2*793.18+3*732.81+3*1590.6+600*.5*3.36)/600

= $13542.59/600= $15.97 per unit

Z = ( 9*793.18+13*732.81+5*1590.6+7100*1.75*3.36)/7100

= $66366.15/7100= $9.34 per unit

4.Comparing costs calculated in part 1 based on machine hrs and and under Activity based costing is different. In both these cases costs under ABC is more. It means that product line is under costed based on machine hrs . It is better to use ABC costing to have more effective costs as compared to traditional method of costing.