Question

Smithson, Inc. produces two types of gas grills: a family model and a deluxe model. Smithson’s controller has decided to use a plantwide overhead rate based on direct labor costs. The president of the company recently 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:

                                                                        Family Model      Deluxe Model

                        Direct labor costs                         $75,000                $150,000

                        Machine hours                                    2,000                   2,000

                        Setup hours                                         200                         800

Total estimated overhead costs are $450,000. Overhead cost allocated to the machining activity cost pool is $270,000 and $180,000 is allocated to the machine setup activity cost pool.

(a)        Compute the overhead rate using the traditional (plantwide) approach.

(b)        Compute the overhead rates using the activity-based costing approach.

(c)        Determine the difference in allocation between the two approaches.

(d)       Smithson, Inc. decided to implement the activity-based costing approach and was quite successful in its use.   However, the controller is wondering if instead of only two activity cost pools, they should expand to three activity cost pools based on the following:

                                                                        Family Model      Deluxe Model

                        Direct labor costs                         $75,000                $150,000

                        Machine hours                                    2,000                   2,000

                        Setup hours                                         200                         800

                        Packaging hours                                   50                           75

The estimated overhead of $450,000 is allocated as follows: machining activity cost pool $240,000, machine set up $170,000 and packaging $40,000.

(1)        Determine the overhead rates using the activity-based costing approach with three cost pools.              

(2)        Determine the overhead allocation for the family model and the deluxe model using three activity cost pools. What is the difference in allocation between two activity cost pools and three activity cost pools? Is the difference in allocation worth using the third activity cost pool?

Answer 1

a. Computation of Overhead Recovery Rate ( Traditional Approach)
Estimated Over head Cost		$450,000.00
Direct Labour Cost ($75000+$150000)		$225,000.00
Recovery Rate /Labour Cost		$2.00
				b. Compute Overhead Rate (ABC Approach)
				Detail	Amount	Total Activities	Activity Rate
Machining Activity Overhead Cost	$270,000.00	4000 Machine Hour	$67.5/Machine Hour
Machine Setup Activity Overhead Cost	$180,000.00	1000 Setup Hours	$180/Setup Hour
Total Overhead Cost	$450,000.00
c) Determine the difference in allocation between Two Approach
	Family Model	Deluxe Model	Total
Overhead Allocation( Traditional)	$150,000	$300,000	$450,000
($75000*$2) ( $150000*$2)
Overhead Allocated (1)	$150,000	$300,000	$450,000
Overhead Allocation( ABC)
Machining Activity (a)	$135,000	$135,000	$270,000
(2000 Machine Hour *$67.50)
Machine Setup Activity (b)	$36,000	$144,000	$180,000
(200 Setup Hour *$180) (800 SetupHour*$180)
Overhead Allocated( 2=a+b)	$171,000	$279,000	$450,000
Difference (1-2)	-$21,000	$21,000	$0