(b) Activity-based costing (8 marks) K-Tel manufactures knife sharpeners. Tradit

Question

(b) Activity-based costing (8 marks)
K-Tel manufactures knife sharpeners. Traditionally, a plant-wide rate of $200 per direct labour hour has been used to allocate overhead to its products. The accountant believes it is time to find a better method of cost allocation and has established the following relationships between activities and overhead:

Activity Cost Driver Allocation Rate
Material handling Number of parts $2 per part
Assembly Labour hours $20 per hour
Inspection Inspection time $3 per minute

(i) What is the overhead cost per unit from a batch of 1,000 sharpeners using the traditional method? The batch requires 2,000 parts, 20 direct labour hours and 30 minutes of inspection time (2 marks) (Show all workings).
(ii) What is the overhead cost per unit from a batch of 1,000 sharpeners using the ABC method? (3 marks) (Show all workings)
(iii) Many companies that have previously applied overhead costs to final products using Direct Labour hours as the cost driver have changed to other cost drivers, such as machine hours. Why? (3 marks)

Explanation / Answer

Overhead cost using traditional method Overhead = 20*200 $4,000.00 Overhead cost using ABC method $ Material handling charges = 2000*2 4000 Direct labor =20*20 400 Inspection time = 3*30 90 Total overhead alloctae dusing ABC costing 4490 The companies are changing their cost drivers because it is not appropiate to allocate all the cost on the basis of single driver. So as per the recent trend followed by company is that to divide the cost on the basis of activity used for incurring that cost. So Activity based costing gives more perfect allocation of cost to output compared to other methods.

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