Question

Problem 7-21 Crane is an electronics components manufacturer. Information about the company's two products follows: Units produced Direct labor hours required for production Units per batch Shipping weight per unit AM-2 FM-9 18,000 3,600 24,000 19,000 4,000 90 0.50 lbs. 4 lbs. The company incurs $1,412,655 in overhead per year and has traditionally applied overhead on the basis of direct labor hours. (i) How much overhead will be allocated to each product using the traditional direct labor hours allocation base? (Round per unit rates to 2 decimal places, e.g. 3.54 and final answers to o decimal places, e.g. 45,000.) AM-2 FM-9 Overhead allocated to each product $ (ii) What overhead cost per unit will be allocated to each product? (Round answers to 2 decimal places, e.g. 15.25.) AM-2 FM-9 Overhead cost per unit $

Answer 1

ANSWER TO FIRST PART OF PROBLEM 7.21

i) In the first question, the overheads are to be allocated on the basis of traditional direct labour hours.

The total direct labour hours for both the products are 24000 hours (AM-2) + 19000 hours (FM-9) = 43000 hours.

Now the total overhead costs of $1,412,655 for both the products would be allocated as follows:

TOTAL OVERHEAD COSTS * DIRECT LABOUR HOURS FOR A PRODUCT/TOTAL LABOUR HOURS

AM-2 : 1412655 * 24000/43000 = $788,458.60

FM-9 : 1412655 * 19000/43000 = $624,196.40

	AM-2	FM-9
Overhead allocated to each product	$788,459	$624,196

ii) The per unit overhead cost would be calculated by allocating total overhead costs of each product to each unit produced.

PER UNIT OVERHEAD COST = TOTAL OVERHEAD COST ALLOCATED IN (i) / NUMBER OF UNITS PRODUCED

The number of units produced are 18000 units of AM-2 and 3900 units of FM-9.

Therefore,

Per unit overhead cost of AM-2 = $788,459/18000 units = $43.8 per unit.

Per unit overhead cost of FM-9 = $624,196/3900 units = $160.05 per unit

	AM-2	FM-9
Overhead cost per unit	$43.8	$160.05

ANSWER TO SECOND PART OF PROBLEM 7.21

(i) Activity based costing method is specifically for allocating the overhead costs of the product i.e the indirect cost of production. The cost is allocated based on the specific cost drivers of different costs included in the overhead costs. As given in the question the overhead costs is distributed in three parts and they have specific cost drivers. Direct labour cost is to be allocated on the basis of direct labour hours, setup cost is to be allocated based on the number of batches of each product and packaging cost is to be allocated based on the total shipping weight of the products.

Pool	Total Costs	Cost driver	Ratio on the basis of cost driver	Cost allocation to AM-2	Cost allocation to FM-9
Assembly	$1,075,000	Direct labour hours	24000:19000	$600,000*	$475,000#
Setup costs	$122,375	Number of Setups	5:40 {Refer (a) below}	$13,597.22	$108,777,78
Packaging Costs	$215,280	Weight of shipping products	9000:14400 {Refer (b) below}	$82,800	$132,480
TOTAL	$1,412,655			$696,397 (rounded off)	$716,258 (rounded off)

^{*1,075,000 * 24000/43000 = $600,000}

^{#1,075,000 * 19000/43000 = $475,000}

a) The setup costs is allocated on the basis of the number of batches as the setup costs are incurred before the starting the production of a new batch of goods.

Therefore as given, for AM-2, if 4000 units are produced in a single batch, the total batches would be 18000 units/4000 units = 4.5 i.e 5 batches.

Similarly in case of FM-9, if 90 units are produced in a single batch, the total batches would be 3600 units/90 units = 40 batches.

Therefore the setup costs would be allocated between AM-2 and FM-9 in the ratio of 5:40.

b) The packaging costs are to be allocated on the basis of the shipping weight of the products, as given in the question. Therefore the total shipping weight of both the products would be = Shipping weight per unit x Total number of units produced.

Therefore, shipping weight of,

AM-2 = 0.5 lbs x 18000 units = 9,000 lbs

FM-9 = 4 lbs x 3600 units = 14,400 lbs

Therefore the packaging costs would be allocated between AM-2 and FM-9 in the ratio of 9000:14400.

(ii) The per unit overhead cost of each product would be as follows:

Per unit overhead cost of AM-2 = $696,397/18000 units = $38.69 per unit.

Per unit overhead cost of FM-9 = $716,258/3900 units = $183.66 per unit

	AM-2	FM-9
Overhead cost per unit	$38.69	$183.66