Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 26

Activity-Based Costing versus Traditional Costing

Doaktown Products manufactures fishing equipment for recreational uses. The Miramichi plant produces the company's two versions of a special reel used for river fishing. The two models are the M-008, a basic reel, and the M-123, a new and improved version. Cost accountants at company headquarters have prepared costs for the two reels for the most recent period. The plant manager is concerned. The cost report does not coincide with her intuition about the relative costs of the two models. She has asked you to review the cost accounting and help her prepare a response to headquarters.

Manufacturing overhead is currently assigned to products based on their direct labor costs. For the most recent month, manufacturing overhead was $280,000. During that time, the company produced 12,000 units of the M-008 and 2,000 units of the M-123. The direct costs of production were as follows:

	M-008	M-123	Total
Direct materials	$100,000	$80,000	$180,000
Direct labor	100,000	40,000	140,000

Management determined that overhead costs are caused by three cost drivers. These drivers and their costs for last year were as follows:

			Activity Level
Cost Driver	Costs		M-008	M-123	Total
Number of machine-hours	$120,000		5,000	3,000	8,000
Number of production runs	70,000		10	10	20
Number of inspections	90,000		20	40	60
Total  overhead		$280,000

Required

a.How much overhead will be assigned to each product if these three cost drivers are used to allocate overhead? What is the total cost per unit produced for each product?

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b.How much of the overhead will be assigned to each product if direct labor cost is used to allocate overhead? What is the total cost per unit produced for each product?

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c.Draft a memo for the plant manager explaining why the two systems result in different costs along with your recommendation for which costing system to use.

Step 1 of 22

Activity-based Costing:

Activity-based Costing which is more popularly known as ABC method is an accounting method in which the firms identify the various activities and then assigns indirect costs incurred to carry out those activities.