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Activity-Based Costing and Product Cost Distortion Digital Storage Concept Inc. is considering a change to activity-based...

Activity-Based Costing and Product Cost Distortion

Digital Storage Concept Inc. is considering a change to activity-based product costing. The company produces two products, cell phones and tablet PCs, in a single production department. The production department is estimated to require 4,000 direct labor hours. The total indirect labor is budgeted to be $571,200.

Time records from indirect labor employees revealed that they spent 40% of their time setting up production runs and 60% of their time supporting actual production.

The following information about cell phones and tablet PCs was determined from the corporate records:

Number of
Setups
Direct Labor
Hours
Units
Cell phones 500 2,000 68,000
Tablet PCs 1,100 2,000 68,000
Total 1,600 4,000 136,000

If required, round your answers to the nearest cent.

a. Determine the indirect labor cost per unit allocated to cell phones and tablet PCs under a single plantwide factory overhead rate system using the direct labor hours as the allocation base.

Cell phones $ per unit
Tablet PCs $ per unit

b. Determine the budgeted activity costs and activity rates for the indirect labor under activity-based costing. Assume two activities—one for setup and the other for production support.

Budgeted Activity Cost Activity Rate
Setup $ $ per setup
Production support $ $ per direct labor hour

c. Determine the activity cost per unit for indirect labor allocated to each product under activity-based costing.

Cell phones $ per unit
Tablet PCs $ per unit

d. Why are the per-unit allocated costs in (a) different from the per-unit activity cost assigned to the products in (c)?

The per-unit indirect labor costs in (a) are distorted because setup activity  is consumed by the products in a different ratio from the direct labor. The activity-based  costing method results in the product with the larger  number of setups receiving a larger portion of the setup activity cost. The single rate system  allocates overhead only on the basis of direct labor hours. Since the direct labor hours are  equal for each product, the allocated indirect labor will also be  equal.

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Expert Solution

Digital Storage Concept

  1. Determination of the indirect labor cost per unit allocated to cell phones and tablet PCs under a single plantwide factory overhead rate system using the direct labor hours as the allocation base.

Total indirect labor cost = $571,200

Total direct labor hours = 4,000

Plantwide factory overhead rate per direct labor hour = $571,200/4,000 = $142.80

Direct labor hours

Direct labor hour rate

Total indirect labor cost

number of units

Cost per unit

cell phones

2,000

$142.80

$285,600

68,000

$4.20

tablet PCs

2,000

$142.80

$285,600

68,000

$4.20

  1. Determination of the budgeted activity costs and activity rates for the indirect labor under activity-based costing. Assume two activities—one for setup and the other for production support:

Budgeted activity cost

usage

activity rate

setup

$228,480

1,600 setups

142.8 per setup

production support

$342,720

4,000 direct labor hours

$85.68 per hour

Note: setup cost is 40% of indirect labor cost = 40% of 571,200 = $228,480

Production support cost is 60% = 60% of 571,200 = $342,720

  1. Determination of activity cost per unit for indirect labor allocated to each product under activity-based costing:

cell phones

$3.57 per unit

Tablet Pca

$4.83 per unit

Working –

cell phone

activity rate

activity usage

total activity cost

setup

$142.80 per setup

500 setups

$71,400

production support

$85.68

2,000

$171,360

Total indirect cost

$242,760

number of units

68,000

cost per unit

$3.57

Tablet PCs

activity rate

activity usage

total activity cost

setup

$142.80 per setup

1,100

$157,080

production support

$85.68

2,000

$171,360

Total indirect cost

$328,440

number of units

68,000

cost per unit

$4.83


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