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

Exercise 22

Plantwide versus Department Allocation

Main Street Ice Cream Company uses a plantwide allocation method to allocate overhead based on direct labor-hours at a rate of $3 per labor-hour. Strawberry and vanilla flavors are produced in Department SV Chocolate is produced in Department C. Sven manages Department SV and Charlene manages Department C. The product costs (per thousand gallons) follow:

	Strawberry	Vanilla	Chocolate
Direct labor (per 1,000 gallons)	$750	$825	$1,125
Raw materials (per 1,000 gallons).	800	500	600

Required

a. If the number of hours of labor per 1,000 gallons is 50 for strawberry, 55 for vanilla, and 75 for chocolate, compute the total cost of 1,000 gallons of each flavor using plantwide allocation.

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b. Charlene's department uses older, outdated machines. She believes that her department is being allocated some of the overhead of Department SV which recently bought state-of-the-art machines. After she requested that overhead costs be broken down by department, the following information was discovered:

	Department SV	Department C
Overhead	$105,840	$23,760
Machine-hours	25,200	36,000
Labor-hours	25,200	18,000

Using machine-hours as the department allocation base for Department SV and labor-hours as the department allocation base for Department C, compute the allocation rate for each.

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c.Compute the cost of 1,000 gallons of each flavor of ice cream using the department allocation rates computed in requirement (b) if the number of machine-hours for 1,000 gallons of each of the three flavors of ice cream are as follows: strawberry, 50; vanilla, 55; and chocolate, 150. Direct labor hours by product remain the same as in requirement a.

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d.Was Charlene correct in her belief? What happened to the cost of chocolate when the department allocation was used? Which costing method provides more accurate product costs?

Step 1 of 14

Activity based costing system:

Activity based costing system is technique to identify the overhead cost in a better way than in a traditional costing system. In a traditional costing system overheads are identified using overhead absorption rate based on direct material direct labor, machine hours etc. Which not allocate the overheads in relative manner to products?

Activity based costing system allocate the overhead cost based on activities used in producing the products which ultimately allocates the overheads more accurately than traditional costing system.

So activity based costing system is related to a method of allocation of overheads.