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.
|
|
Recommended |
Estimated |
Estimated Cost |
|
Activity |
Cost Driver |
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 |
400 |
800 |
200 |
|
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.
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).
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.)
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.