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

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?

Explanation / Answer

(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.

[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.

(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

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