Question

Sand Castle Manufacturing produces concrete yard art. Recently, 2,500 concrete seahorses were produced in a production run. The run required 1,250 machine hours, and also required five "set-ups" of mixing equipment. Final inspection required 50 hours of inspection activity. Overhead is estimated at $30 per machine hour, plus $2,750 per "set-up," and $25 per inspection hour. Direct materials and direct labor total $75 per seahorse. (a) Apply activity-based costing and determine the amount assigned to a concrete seahorse. (b) For GAAP purposes, Sand Castle applies traditional costing methods, and allocates overhead at $50 per machine hour. How much cost would be assigned to the 2,500 seahorses? What is the per unit cost of a seahorse under the traditional approach? What might explain the higher cost assignment, and how could this influence business decision making?

Answer 1

Solution a:

Computation of cost assingned to Concrete Seahorse - Activity based costing
Particulars	Amount
Direct material & Direct labor (2500*$75)	$187,500.00
Overhead cost - Machining (1250*$30)	$37,500.00
Overhead cost - Setup (5*$2750)	$13,750.00
Overhead cost - Inspection (50*$25)	$1,250.00
Total amount assigned to concrete seahorse	$240,000.00

Solution b:

Computation of cost assingned to Concrete Seahorse - Traditional costing
Particulars	Amount
Direct material & Direct labor (2500*$75)	$187,500.00
Overhead cost (1250*$50)	$62,500.00
Total amount assigned to concrete seahorse	$250,000.00

Per unit cost of seahorse under traditional approach = $250,000 / 2500 = $100 per seahorse

As traditional approach is resulting in higher cost assignment, the reason for the same is that in traditional approch overhead is allocated using plantwide single overhead rate while in activity based costing overhead was assigned to activities indentified and applied to product on the basis of actual usage of activity. Thus activity based costing show the accruate cost of product rather than traditional approach. In this case traditional cost resulting in higher cost assignment that influence business decision like product pricing, accepting or rejecting the order. As cost is higher it will result in setup higher product price that may result in not able to sale desired quantity.