Question

Nicholas Company produces two products: Product A and Product B. The company is budgeted to produce 4,000 units of each product during the year. The total factory overhead for the year is budgeted at $100,000. Each unit requires 0.5 direct labor hour to produce 1. Determine (a) the total number of budgeted direct labor hours budgeted for the year, (b) the single plant-wide factory overhead rate, and (c) the factory overhead rate per unit for each product using the single plantwide factory overhead rate. hrs) Assume Nicholas Company instead uses activity-based costing for overhead allocation for Products A and B. Budgeted production is 4,000 units each. Total budgeted factory overhead is $100,000, divided into four activities: fabrication, $30,000; set-up, $20,000; assembly, $40,000; and inspection, $10,000. The activity-based usage quantities for each product by each activity is as follows: Product B Total Fabrication (DL 2,200 3,800 6,00 0 Set-ups (#) 2,000 3,000 5,000 Assembly (DL hrs) 1,800 3,200 5,00 0 Inspections () 1,200 800 2,000 1. Determine (a) the activity rate for each activity and (b) the activity-based factory overhead per unit for each product. Evaluate the results of the two methods (single plantwide rate vs. ABC). Which method is more precise? In the real world, what could be a negative result from applying the single plantwide rate to decision making? Ignoring direct materials and direct labor costs, what if you were to set the selling price of both products using the single plantwide rate at $2 above the factory overhead cost. What would you expect to see in terms of sales volume of each product?

Answer 1

Nicholas Company
Traditional Overhead method
Product	A	B	Total
Budgeted production units	4,000	4,000	8,000
DL Hours Required Each unit	0.50	0.5
Total DL Hours budgeted =	2,000.00	2,000.00	4,000.00	Ans a
Total Factory Overhead Budgeted			$           100,000
Single Plantwide factory OH rate per DL Hour=			$               25.00	Ans b.
Factory OH using Planwide rate/DL Hur=0.5*25=	$                12.50	$              12.50		Ans c.

Activity Costing vased OH rate	a	b
Activity Pool	Total Activity cost Budgeted	Total Activity Qty	Activity Rate =a/b
Fabrication (DL Hours)	$              30,000	6,000	$                 5.00
Set Up (#)	$              20,000	5,000	$                 4.00
Assembly (DL Hrs)	$              40,000	5,000	$                 8.00
Inspections (#)	$              10,000	2,000	$                 5.00

	a.	b		c
		Product A	Product A
Finding Activity Based OH per unit of Product	Activity Rate	Activity Qty	OH Amount allocated=a*b	Activity Qty	OH Amount=a*c
Activity Pool
Fabrication (DL Hours)	$                       5	2200	$             11,000	3800	$           19,000
Set Up (#)	$                       4	2000	$               8,000	3000	$           12,000
Assembly (DL Hrs)	$                       8	1800	$             14,400	3200	$           25,600
Inspections (#)	$                       5	1200	$               6,000	800	$              4,000
Total OH Assigned By ABC			$             39,400		$           60,600
No of Units Produced			4000		4000
OH Assigned by ABC per unit of Production =			$                 9.85		$             15.15

Comparison of OH per unit	Product A	Product B
Plantwide Rate	$                12.50	$              12.50
ABC Methos	$                  9.85	$              15.15

ABC method of OH allocation is more precise as it is assigned based on the actual consumtion of activities that consume the overhead
costs instead of Direct labor hour basis which has no direct realtion with overheads.
In real world , if we apply Overhead on the basis of single plantwide rate , there will be high chance of distorted production cost
due to unrealistic application of overhead based on arbitrary base. So products consuming less activities realted to overhead may
get high allocation of overhead due to high incidence of allocation base and vice vers. So cost of production and the setting of selling
price based on cost of production will be unrealistic.

Selling Price by the given method would be	Product A	Product B
Plantwide Rate	$                12.50	$              12.50
Salling Price	$                14.50	$              14.50
In this case, Product A will be overpriced and Product B will be underpriced as compared
to their origfinal cost considering ABC costing method.
So the demand of Product A will be less and demand of Product B will be very high.