Question

Number 4 Smithson, Inc. produces two types of gas grills: a family model and a deluxe model. Smithsons controller has decided to use a plantwide overhead rate based on direct labor costs. The president of the company recently heard of activity-based costing and wants to see how the results would differ if this system were used. Two activity cost pools were developed machining and machine setup. Presented below is information related to the company's operations: Direct labor costs Machine hours Setup hours Family Model $75,000 2,000 200 Deluxe Model $150,000 2,000 800 Total estimated overhead costs are $450,000. Overhead cost allocated to the machining activity cost pool is $270,000 and $180,000 is allocated to the machine setup activity cost pool Instructions (a) Compute the overhead rate using the traditional (plantwide) approach. (b) Compute the overhead rates using the activity-based costing approach (c) Determine the difference in allocation between the two approaches. (d) Smithson, Inc. decided to implement the activity-based costing approach and was quite successful in its use. However, the controller is wondering if instead of only two activity cost pools, they should expand to three activity cost pools based on the following: Family Model Deluxe Model Direct labor costs $75,000 $150,000 Machine hours 2.000 2.000 Setup hours 200 800 Packaging hours 50 75 The estimated overhead of $450.000 is allocated as follows: machining activity cost pool $240,000, machine set up $170,000 and packaging $40,000 (1) Determine the overhead rates using the activity-based costing approach with three cost pools. Determine the overhead allocation for the family model and the deluxe model using three activity cost pools. What is the difference in allocation between two activity cost pools and three activity cost pools? Is the difference in allocation worth using the third activity cost pool? (2)

Answer 1

(a)

Particulars	Family Model	Deluxe Model
Direct labor costs	$              75,000	$           1,50,000
Overheads using direct labor costs	$          1,50,000	$           3,00,000
	(450000/225000*75000)	450000/225000*150000)

(b)

Overhead rates using two cost pools
Activity	Activity costs	Total no of Acitivities	Cost per activity
Machining	$          2,70,000	4,000	$              67.50
Machine set up	$          1,80,000	1,000	$            180.00
Total	$          4,50,000	$                 5,000
Allocation of overheads
Family Model
Particulars	No of Acitivities	Cost per activity	Total Overhead
Machining	2,000	$                 67.50	$        1,35,000
Machine set up	200	$              180.00	$            36,000
			$        1,71,000
Deluxe model
Particulars	No of Activities	Cost per activity	Total Overhead
Machining	2,000	$                 67.50	$        1,35,000
Machine set up	800	$              180.00	$        1,44,000
			$        2,79,000

(c) DIfference in allocation

Particulars	Using traditinal mode	Activity based costing model	Difference
Family Model	$          1,50,000	$           1,71,000	$         (21,000)
Deluxe Model	$          3,00,000	$           2,79,000	$            21,000

(d)

(1)

Overhead rates using three cost pools
Activity	Activity costs	Total no of Acitivities	Cost per activity
Machining	$          2,40,000	4,000	$              60.00
Machine set up	$          1,70,000	1,000	$            170.00
Packing hours	$              40,000	125	$            320.00
Total	$          4,50,000	$                 5,125
Allocation of overheads
Family Model
Particulars	No of Acitivities	Cost per activity	Total Overhead
Machining	2,000	$                 60.00	$        1,20,000
Machine set up	200	$              170.00	$            34,000
Packing hours	50	$              320.00	$            16,000
Total			$        1,70,000
Deluxe model
Particulars	No of Activities	Cost per activity	Total Overhead
Machining	2,000	$                 60.00	$        1,20,000
Machine set up	800	$              170.00	$        1,36,000
Packing hours	75	$              320.00	$            24,000
Total			$        2,80,000

(2)

Particulars	Two activity cost pools	Three activity cost pools	Difference
Family Model	$          1,71,000	$           1,70,000	$              1,000
Deluxe Model	$          2,79,000	$           2,80,000	$            (1,000)
Total	$          4,50,000	$           4,50,000	$                     -

As per above, there is no material difference is allocation when the third cost pool used. Hence it is not worth using the 3rd cost pool.