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

Exercise 28

Activity-Based versus Traditional Costing

Isadore's Implements, Inc., manufactures pens and mechanical pencils often used for gifts. Overhead costs are currently allocated using direct labor-hours, but the controller has recommended an activity-based costing system using the following data:

			Cost Driver Volume
Activity	Cost Driver	Cost	Pencils	Pens
Setting up	Number of setups	$ 80,000	20	30
Inspecting	Number of parts Number	24,000	4	6
Packing and shipping	of boxes shipped	48,000	45,000	75,000
Total overhead		$152,000

Required

a.Compute the amount of overhead to be allocated to each product under activity-based costing.

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b.Compute the amount of overhead to be allocated to each product using labor-hours as the allocation base. Assume that the number of labor-hours required to assemble each box is 0.1 for pencils and 0.2 for pens and that 45,000 boxes of pencils and 75,000 boxes of pens were produced during the period.

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c.Should the company follow the controller's recommendations?

Step 1 of 7

a.

A two stage product costing method that assigns costs first two activities and then to products based on each product’s use of activities is called Activity Based Costing (ABC). ABC concept determines product costs based on activities consumed by the products.

On using ABC operation performance and quality of products would increase. ABC could provide useful information to managers to improve operational performance. However, there may not be any financial improvement but accurate product costs on logically proven method.

Compute the amount of overhead to be allocated to each product under Activity Based Costing:

Overheads are allocated to each product under ABC is as follows.