Question

Hodges and Associates is a small firm that provides structural engineering services for its clients. The company performs structural engineering services for both residential and commercial buildings. Last year, total overhead costs of $330,000 were allocated based on direct labour costs. A total of $300,000 in direct labour costs were incurred in the following areas: $120,000 in the residential segment and $180,000 in the commercial segment. Direct materials used were negligible and are included in overhead costs. Sales revenue totalled $450,000 for residential services and $330,000 for commercial services.

The management of Hodges and Associates would like to use activity-based costing to allocate overhead rather than a plantwide rate based on direct labour costs. The following estimates are for the activities and related cost drivers identified as having the greatest impact on overhead costs.

Required:

a.

1. Using the plantwide allocation method, calculate the total cost for each product.

2. Using the plantwide approach, calculate the profit for each product. Also calculate profit as a percent of sales revenue for each product (round to the nearest tenth of a percent).

b.

1. Using activity-based costing, calculate the predetermined overhead rate for each activity. (Round results to the nearest cent.)

2. Using activity-based costing, calculate the amount of overhead assigned to each product.

3. Using activity-based costing, calculate the profit for each product. Also calculate profit as a percent of sales revenue for each product (round to the nearest tenth of a percent).

c. What caused the shift of overhead costs to the residential product using activity-based costing? How might management use this information to make improvements within the company?

Estimated Cost Driver Activity Residential Commercial Total Activity Cost Driver Estimated Overhead Costs $100,000 4,500 3,500 8,000 70,000 8,000 12,000 20,000 Scheduling and Direct labour data entry hours Computer Number of maintenance computer hours Processing permit Number of applications applications Total 160,000 400 400 800 $330,000

Answer 1

Manufacturing overhead absorption rate Total Overheads $330,000 Direct labor cost $300,000 110% % of Direct labor cost Direct labor cost Overhead % of Direct Labor cost Total Overheads allocated Residential $120,000 110% $132,000 Commercial $180,000 110% $198,000 A a) 1) Total cost Direct Labor Total Overhead allocated Total cost Residential $120,000 $132,000 $252,000 Commercial $180,000 $198,000 $378,000 2) Computation of profit (loss) Sales revenue Total cost Net profit (Loss) Profit (Loss) as % of Sales Residential $450,000 $252,000 $198,000 44.0% Commercial $330,000 $378,000 -$48,000 -14.5% b) 1) Calculation of Activity rates Activity Activity rate Scheduling and data entry Computer maintenance Processing Permits applications Total Overheads Total Overheads $100,000 $70,000 $160,000 $330,000 Total Activities 8,000 20,000 8001 $12.50 per direct labor hour $3.50 per computer hour $200.00 per application Allocation of Overheads - ABC method Activity Activity rate Scheduling and data entry Computer maintenance Processing Permits applications Total Overheads $12.50 $3.50 $200.000 Activities used Residential Commercial 4,500 3,500 8,000 12,000 400 400 Allocated Cost Residential Commercial $56,250 $43,750 $28,000 $42,000 $80,000 $80,000 $164,250 $165,750 2) Total cost Direct Labor Total Overhead allocated Total manufacturing cost per unit Residential $120,000 $164,250 $284,250 Commercial $180,000 $165,750 As per above working $345,750 3) Computation of profit (loss) Sales Total manufacturing cost per unit| Net profit (Loss) Profit (Loss) as % of Sales Residential $450,000 $284,250 $165,750 36.8% Commercial $330,000 $345,750 -$15,750 -4.8% c The shift of overheads to residential product using activity based costing has been caused due to higher consumption of activities Scheduling and data entry is higher for residential compared to commercial Processing permit application is equal consumption with commercial In case of direct labor cost the overheads was allocated at 40% ($120,000/$300,000) to residential product When activities are consumed in more than this proportion the overheads allocated to residential will increase The Activity based costing method is useful to management in below ways i) It helps in accurate product costing since the overheads allocation as per ABC method is reliable ii) It helps in product pricing since cost allocation is accurate and reliable iii) It helps in achieving the profitablity target iv) It helps in cost management through cost control and cost reduction v) It helps in elimination of non-value adding activities and thereby improve the process