Question

Direct labor or machine hours may not be the appropriate cost driver for overhead

in all areas of manufacturing due to the complexities of many manufacturing

processes. Many companies use activity-based costing (ABC) which uses multiple drivers

(items that consume resources) rather than just one driver to apply overhead to their

activities. With ABC, a company can use a cost driver that has a direct cause/effect relationship

in its applied overhead costs.

Evian looked into ABC as a method of costing because of the variety of items it

produces and the many different activities in which it is involved. The activities listed

below are a sample of possible cost pools for Evian.

Assembling

Payroll

Billing

Plant supervision

Digging trenches

Purchasing materials

Machine maintenance

Selling

Machine setups

Testing

Molding

Welding

Packaging

Instructions for part 4

(a) For each of these cost pools, what would be the likely activity cost driver?

(b) Using the following information, determine the overhead rates and the actual cost assigned for each of the activity cost pools in a possible ABC system for Evian.

EVIAN CORPORATION

Expected

Use of                              Actual

Estimated           Cost Drivers                             Use of

Activity Cost Pools                        Cost Drivers      Overhead           per Activity                              Drivers

Irrigation installation                    Labor cost         $1,999,500               12,900                                     12,941

Machining (all machine use)       Machine hours 1,670,400         33,408,000                              33,409,000

Customer orders                            # of orders               30,636                    2,553                                       2,520

Shipping                                          none (direct)                    N/A traced directly

Design                                              Cost per design             820                       10                                           7

Selling                                              Number of calls       372,300              21,900                                     22,100

(d) (1) The results of ABC can provide a more accurate picture of costs. Discuss the value of Evian using this system to determine overhead costs.

(2) How might using ABC affect decision making at Evian?

Answer 1

(a)	For each of these cost pools. What would be the likely cost driver?
	Cost pool	cost driver
	Assembly	Product assembled
	Payroll	Number of employee on Payroll
	Billing	Number of bills sent out
	Plant supervison	supervisor hourss
	Digging trenches	Number of trenches dug
	Purchasing Materials	Number of purchases done
	Machine Maintenance	Machine hours
	Selling	Number of items sold
	Machine setup	Number of setups
	Testing	Number of test done
	Molding	Number of items molded
	Welding	Number of items welded
	Packaging	Number of items packaged
(b)	Using the following information, determine the overhead rates and actual cost assigned for each of activity pool

Activity cost pools	Cost drivers	Estimated overhead [A]	Expected use of cost drivers per activity [B]	Actual use of drivers[C]	Overhead rates [D=A/B]	Actual cost assigned
Irrigation installation	Labor cost	1999500	12900	12941	155	2005855
Machining	Machine hours	1670400	33408000	33409000	0.05	1670450
Customer orders	Number of orders	30636	2553	2520	12	30240
Shipping	None			Traced directly
Design	cost of per design	820	10	7	82	574
Selling	Number of sales calls	372300	21900	22100	17	375700

[c] The results of ABC can provide more accurate picture of costs. Discuss the value of Evain using this system to determine overhead costs.

Evain will benefit the following by implementing ABC Costing.

1. Costs are allocated more directly based on cost factors produced or used by each product.
2. It allows to have a great control over overhead costs. Overhead can be tracked directly to the activities.
3. This will helps in taking better management decisions. cost data helps to decide whether to buy or make a part of the component or product or eliminating the product.

[D].2 How might you use ABC affect decisson making at evian?

Activity based costing is major tool for managing decisson –making. ABC provides structured financial data that is different way from the accounting data provided in the general ledger. A clear relationship will be established between the related costs and activity demand by associating the cost for the activity. The association will helps the distributor of the product to determine where costs have been incurred and efforts to be applied to curb inflationary costs.