Question

Backyard Playground produces childrens swing-sets. 4,500 swing-sets were produced in a recent production run. The run required 1,500 machine hours, and also required four "set-ups" of equipment. Final inspection required 75 hours of inspection activity. Estimated overhead is estimated at $25 per machine hour, plus $3,500 per "set-up" and $20 per inspection hour. Direct materials and direct labor total $500 per swing-set. a) Apply activity-based costing and determine the amount assigned to a swing-set. b) For GAAP purposes, Backyard Playground applies traditional costing methods, and allocates overhead at $40 per machine hour. How much cost would be assigned to the 4,500 swing sets? What is the per unit cost of a swing-set under the traditional approach? What might explain the higher cost assignment, and how could this influence business decision making? Worksheet 8

Answer 1

Let us find the total cost assigned under Activity based costing for the production run and then we can find the overhead cost assigned to each swing set in next column by dividing total cost by no of units i.e. 4500.

Answer a.

Activity Based Costing
Particulars	Computation	Total	Per unit
Overhead cost	1500 x 25	37500	8.33
(Machine Hrs x Overhead rate/MHR)
Set up cost	3500 x 4	14000	3.11
(Cost per set up x No of set ups)
Inspection Cost	75 x 20	1500	0.33
Overhead Cost assigned to swing set		53000	11.78
Activity Based Costing
Particulars	Computation	Total	Per unit
Prime Cost	500 x 4500	2250000	500.00
(Cost per unit x No of units)
Overhead Cost assigned to swing set	11.78 x 4500	53000	11.78
(Cost per unit x No of units)
Total Cost		2303000	511.78

Answer b.

Traditional Costing
Particulars	Computation	Total	Per unit
Prime Cost	500 x 4500	2250000	500.00
(Cost per unit x No of units)
Overhead Cost assigned to swing set	40 x 1500	60000	13.33
(Rate per MHR x Machine Hrs)
Total Cost		2310000	513.33

Under Traditional costing the cost is higher due to overhead cost which is absorbed at a higher rate in this example. Traditional cost uses a single cost driver normally and is usually expressed as a function of one of these - Direct Labour/Direct Material/Prime Cost/Conversion cost/Labour Hours/Machine Hours, etc. Whereas ABC costing uses multiple cost driver relevant for each type of overhead cost.

Hence there is always a difference between overhead absorbed under Traditional approach and under Activity based costing.

Influence on business decision making: The costing ahs arrived more under Tradional method of costing. Hence this cost will form the basis of pricing of product and for the purpose of quotations for business contracts. The business would not be willing to sell below 513.33 under normal circumstances as this would lead to loss.

However if the business was following ABC costing only, then 511.78 would have been the minimum sale price under normal circumstances.