What is the difference in the cost of Widget B, per product, using a traditional

Question

What is the difference in the cost of Widget B, per product, using a traditional labor allocation vs. activity based costing method, assuming the three main cost activities are:

> Direct Labor

> Machine Hours

> # of Purchase Orders

Assume the following bases & General Ledger

Data:

Direct labor hours = 1000

Machine hours = 250

Purchase orders = 100

Widget A Widget B Total

Direct labor hours = 400 600 1000

Machine hours = 100 150 250

Purchase orders = 50 50 100

General Ledger

Payroll taxes $1,700

Machine maintenance $750

Purchasing Dept. labor $3,500

Fringe benefits $1,500

Purchasing Dept. Supplies $300

Equipment depreciation $1000

Electricity $1500 Unemployment insurance $1,300

A. The traditional method UNDER counts the cost by $475 per unit

B. The traditional method OVER counts the cost by $475 per unit

C. The traditional method UNDER counts the cost by $380 per unit

D. The traditional method OVER counts the cost by $380 per unit

Explanation / Answer

Traditional System Payroll taxes $1,700 Machine maintenance $750 Purchasing Dept. Labor $3,500 Fringe benefits $1,500 Purchasing Dept. Supplies $300 Equipment depreciation $1,000 Electricity $1,500 Unemployment insurance $1,300 Total Overheads (a) $11,550 Labor Hours (b) 1000 Overhead Rate/Labor hour (c = a/b) $11.55 Allocation of Overheads under Traditional System Widget A - 600 labor hours * $11.55 $6,930.00 Widget B - 400 labor hours * $11.55 $4,620.00 Activity Based Costing Basis Direct Labor Machine Hours # of Purchase Orders Payroll taxes Direct Labor $1,700 Machine maintenance Machine Hours $750 Purchasing Dept. Labor # of Purchase Orders $3,500 Fringe benefits Direct Labor $1,500 Purchasing Dept. Supplies # of Purchase Orders $300 Equipment depreciation Machine Hours $1,000 Electricity Machine Hours $1,500 Unemployment insurance Direct Labor $1,300 Total (a) $4,500 $3,250 $3,800 Bases (b) 1000 250 100 Overhead Rate (c = a/b) $4.50 $13.00 $38.00 Allocation of Overheads using ABC Method Widget A Direct Labor - 400 * $4.50 $1,800.00 Machine Hours - 100 * $13 $1,300.00 # of Purchase Orders - 50 * $38 $1,900.00 Total $5,000.00 Widget B Direct Labor - 600 * $4.50 $2,700.00 Machine Hours - 150 * $13 $1,950.00 # of Purchase Orders - 50 * $38 $1,900.00 Total $6,550.00 For Widget A, Traditional Method under counts cost by $380 ($4620 - $5000) For Widget B, Traditional Method over counts cost by $380 ($6930 - $6550)

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