Gramercy Inc manufactures sailboats and has two major categories of overhead: ma

Question

Gramercy Inc manufactures sailboats and has two major categories of overhead: materials handling and quality inspection. The costs expected for these categories for the coming year are as follows

Materials handling (based on 500 material moves) $100,000

Quality inspection (based on 200 inspections) $300,000

The plant currently applies overhead based on direct labor hours. The estimated amount of direct labor hours is 50,000. Polly Richardson, the plant manager, has been asked to submit a bid and has assembled the following data on the proposed job:

Direct Materials: $3,700

Direct Labor (1,000 hours) : $17,000

Overhead: ?

Number of Material Moves: 10

Number of Inspections: 5

Polly has been told that many similar companies use an activity-based approach to assign overhead to jobs. Before submitting a bid, Polly wants to assess the effects of this alternative approach.

A. Use the traditional overhead application to calculate the total cost of the potential job.

B. Use activity-based costing with the new cost drivers to calculate the total cost of the job.

C. Discuss the differences in the costs calculated under the two overhead allocation methods and what impact the change to activity-based costing may have on the pricing decision.

D. In addition to completing the problem, address the following questions: What is the difference between variable and absorption costing? What is the difference between traditional and activity-based costing? Finally, what are the pros and cons of an activity based costing system?

Explanation / Answer

1) under tradational method=Direct material+Direct labour+Overhead

=$3,700+$17,000+$150,000/50,000*1000=$23,700

2)Under ABC=$3,700+$17,000+$100,000/500*10+$300,000/200*5=$30,200

3) Cost as per ABC is $30,200 but as per tradation method it is $23,700

it is more cost as per ABC by $6,500

so if the organization accepts the this project then would get loss of $6,500

4)As per tradational specific activities per cost not considered but in ABC the cost will be allocated by the cost per actvity so the ABC is the most reliable method for allocate the overhead costs

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