Question

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.

Answer 1

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