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

Exercise 38

Activity-Based Costing and Predetermined Overhead Rates

College Supply Company (CSC) makes three types of drinking glasses: short, medium, and tall. It presently applies overhead using a predetermined rate based on direct labor-hours. A group of company employees recommended that CSC switch to activity-based costing and identified the following activities, cost drivers, estimated costs, and estimated cost driver units for Year 5 for each activity center.

Activity	Recommended Cost Driver	Estimated Cost	Estimated Cost Driver Units
Setting up production	Number of production runs	$ 24,000	100 runs
Processing orders	Number of orders	40,000	200 orders
Handling materials	Pounds of materials	16,000	8,000 pounds
Using machines	Machine-hours	48,000	10,000 hours
Providing quality management.	Number of inspections	40,000	40 inspections
Packing and shipping	Units shipped	32,000	20,000 units
		$200,000

In addition, management estimated 2,000 direct labor-hours for year 5.

Assume that the following cost driver volumes occurred in February Year 5:

	Short	Medium	Tall
Number of units produced	1,000	500	400
Direct materials costs	$4,000	$2,500	$2,000
Direct labor-hours	100	120	110
Number of orders	8	8	4
Number of production runs	2	4	8
Pounds of material
Machine-hours	500	300	300
Number of inspections	2	2	2
Units shipped	1,000	500	300

Direct labor costs were $20 per hour.

Required

a.Compute a predetermined overhead rate for year 5 for each cost driver recommended by the employees. Also compute a predetermined rate using direct labor-hours as the allocation base.

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b.Compute the production costs for each product for February using direct labor-hours as the allocation base and the predetermined rate computed in requirement (a).

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c.Compute the production costs for each product for February using the cost drivers recommended by the employees and the predetermined rates computed in requirement (a). (Note: Do not assume that total overhead applied to products in February will be the same for activity-based costing as it was for the labor-hour-based allocation.)

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d.Management has seen your numbers and wants an explanation for the discrepancy between the product costs using direct labor-hours as the allocation base and the product costs using activity-based costing. Write a brief response to management.

Step 1 of 8

a.

Formula to calculate predetermined overhead rate for each activity.

Calculation of predetermined overhead rate for each cost driver is shown below