Question

1. How much expense related to “handling production run activity” was allocated to Blue pens on the traditional income statement (Exhibit 1) versus the amount allocated on your ABC income statements? Explain what causes the difference

Exhibit 1: Traditional Income Statement
							Blue	Black	Red	Purple	Total
Sales	$        75,000	$        60,000	$        13,950	$        1,650	$        150,600
Material Costs	25,000	20,000	4,680	550	50,230
Direct Labor	10,000	8,000	1,800	200	20,000
Overhead @ 300%	30,000	24,000	5,400	600	60,000
Total Operating Income	$        10,000	$          8,000	$          2,070	$           300	$          20,370
Return on Sales	13.6%	13.3%	14.8%	18.2%	13.5%

ABC Income Statement
	Blue	Black	Red	Purple	Total
Sales	$75,000	$60,000	$13,950	$1,650	$150,600
Material Costs	$25,000	$20,000	$4,680	$550	$50,230
Direct Labor	$10,000	$8,000	$1,800	$200	$20,000
Production Run	$7,333	$7,333	$5,573	$1,760	$22,000
Setup	$4,259	$1,065	$4,855	$1,022	$11,200
Parts Admin	$1,200	$1,200	$1,200	$1,200	$4,800
Support	$7,000	$5,600	$1,260	$140	$14,000
Direct Labor Fringe	$4,000	$3,200	$720	$80	$8,000
Total Operating Costs	$58,792	$46,398	$20,088	$4,952	$130,230
Total Operating Income	$16,208	$13,602	-$6,138	-$3,302	$20,370
Return on Sales	21.6%	22.7%	-44.0%	-200.1%	13.5%

Answer 1

Answer is given below

The difference in allocation is mainly due to predetermined overhead rate Vs Activity cost driver rate Explanation: Traditional Costing system Under traditional costing system overhead rate is computed on direct labor cost basis and allocation is done based on direct labor cost for each product. Hence it is not possible to identify handling production run activity cost in the traditional costing system because a blanket predetermined overhead rate has been used to allocate overheads Predetermined overhead rate Total overheads Total direct labour cost ABC Costing system In ABC Costing cost is allocated based on activities consumed. An Activity cost pool is identified along with cost driver. Allocation is based on activities consumed multiplied by activity cost driver rate Activity cost rate Handling production run activity Total Production run