E4-1 Assign overhead using traditional costing and ABC Saddle Inc. has two types
ID: 2547486 • Letter: E
Question
E4-1 Assign overhead using traditional costing and ABC Saddle Inc. has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has heard of activity-based costing and wants to see how the results would differ if this system was used. Two activity cost pools were developed: machining and machine setup. Presented below is information related to the company's operations. Standard Custom Direct labor costs $50,000 $100,000 Machine hours 1,000 1,000 Setup hours 100 400 Total estimated overhead costs are $240,000. Overhead cost allocated to the machining activity cost pool is $140,000 and $100,000 is allocated to the machine setup activity cost pool. Instructions
(a) Compute the overhead rate using the traditional (plantwide) approach.
(b) Compute the overhead rates using the activity-based costing approach.
(c) Determine the difference in allocation between the two approaches. NOTE: Enter a number in cells requesting a value; enter either a number or a formula in cells with a "?" . (a) Estimated overhead = Predetermined overhead rate Direct Labor Costs = of direct labor cost (b) Activity cost pools Cost drivers Estimated overhead Machining Machine hours $140,000 Machine setup Setup hours 100,000 Activity-based overhead rates Machining: = per machine hour Machine setup: = per setup hour (c) Traditional costing Standard Custom $50,000 x POH rate $100,000 x POH rate Total OH allocation Activity-based costing Standard Custom Machining: 1,000 MH x OH rate 1,000 MH x OH rate Machine setup: 100 Setup Hr x OH rate 400 Setup Hr x OH rate Total OH allocation
Explanation / Answer
Solution:
Part 1) Calculation of Predetermined Overhead Rates
Predetermined Overhead Rate
- Predetermined Overhead Rate is the rate which is used to apply manufacturing overhead to products or job orders.
- Normally, it is calculated at the beginning of the period.
- It is calculated by dividing the estimated factory overhead cost by an allocation base (or suitable basis).
- Allocation bases may be direct labor hours, direct labor costs, machine hours etc..
Predetermined Overhead Rate = Estimated Manufacturing Overhead Cost / Estimated Allocation Base
Plant-wide overhead rate means predetermined overhead rate of plant as a whole.
Plant side Overhead Rate = Estimated MF Overhead $240,000 / Direct Labor Costs ($50,000 + 100,000)
= $240,000 / $150,000
= 160% of Direct labor cost or $1.6 per direct labor dollar
Part 2 --- Overhead rates using the ABC approach
Activity Based Costing System
- ABC is a costing method which identifies the activities in the organization and assigns the cost of each activity with resources to all the products or services according to the actual consumption of activity by the product or service.
- This system determines all the activities related to product or production process.
- This system calculates the cost of those activities which are related to product or production process and thereafter determine the cost of the product.
- In ABC costing the overhead costs are distributed to the product on the basis of benefit received from indirect activity.
- It helps to distribution of overheads on the basis of activities.
The Activity based overhead rate = Estimated Overheads related to the activity / Total Cost Driver per activity or Expected Total Activity)
First of all we will calculate Activity Rate per activity
Activity Cost Pool
Expected Overhead Costs (A)
Total Expected Activity (B)
Overhead Rate per Unit of Activity (C = A/B)
Machining
$140,000
2000
Machine Hours
$70.00
per MH
Machine Setup
$100,000
500
Setup hours
$200.00
per setup hour
Part 3 -- The difference in allocation between the two approaches.
Standard Handbag
Custom Handbag
Traditional Costing Approach
Direct labor Costs (A)
$50,000
$100,000
Plant wide (Traditional) Overhead Rate per direct labor cost (B)
$1.60
$1.60
Applied Manufacturing Overhead (A*B)
$80,000
$160,000
ABC Costing Approach (Refer Note 1)
$90,000
$150,000
Difference in Allocation
($10,000)
$10,000
Note 1 –
Standard
Custom
Activity Cost Pool
Expected Overhead Costs (A)
Total Expected Activity (B)
Overhead Rate per Unit of Activity (C = A/B)
Activity Driver USAGE (H)
Overhead Assigned (C*H)
Activity Driver USAGE (E)
Overhead Assigned (C*E)
Machining
$140,000
2000
Machine Hours
$70.00
per MH
1000
$70,000
1000
$70,000
Machine Setup
$100,000
500
Setup hours
$200.00
per setup hour
100
$20,000
400
$80,000
$90,000
$150,000
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Activity Cost Pool
Expected Overhead Costs (A)
Total Expected Activity (B)
Overhead Rate per Unit of Activity (C = A/B)
Machining
$140,000
2000
Machine Hours
$70.00
per MH
Machine Setup
$100,000
500
Setup hours
$200.00
per setup hour
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