Question

Multiple versus Single Overhead Rates, Activity Drivers

Deoro Company has identified the following overhead activities, costs, and activity drivers for the coming year:

Deoro produces two models of dishwashers with the following expected prime costs and activity demands:

The company’s normal activity is 8,000 direct labor hours.

Required:

1. Determine the unit cost for each model using direct labor hours to apply overhead.

---

2. Determine the unit cost for each model using the four activity drivers.

---

3. Which method produces the more accurate cost assignment? Why?

Answer 1

1. Calculation of unit cost for each model using direct labor hours to assign overhead:

Particulars	Model A		Model B
Direct materials	$600,000		$800,000
Direct labor	$480,000		$480,000
Overhead (as per working note-1 & 2)	$1,560,000		$520,000
Total manufacturing costs	$2,640,000		$1,800,000
Units of production	÷16,000		÷8,000
Unit cost	$165		$225

Therefore, Unit cost for model A is $165 and for model B is $225 by using direct labor hours to assign overhead.

Working Note-1: Calculation of overhead rate based on direct labor hours

Given,

Activity	Expected Cost
Setting up equipment	$480,000
Ordering costs	$360,000
Machine costs	$840,000
Receiving costs	$400,000
Total expected overhead cost	$2,080,000

Direct labor hours for model A	6,000 direct labor hours
Direct labor hours for model B	2,000 direct labor hours
Total expected direct labor hours	8,000 direct labor hours

= $260 per direct labor hour

Therefore, overhead rate is $260 per direct labor hour.

Working Note-2: Calculation of applied overhead to model A and B

Applied Overhead:

	Model A	Model B
	$1,560,000
		$520,000

Therefore,

Applied overhead for model A is $1,560,000 and for model B is $520,000.

2. Activity Rate Calculations:

Setting up equipment rate: = $800 per setup

Ordering cost rate: = $20 per order

Machine cost rate: = $20 per machine hour

Receiving cost rate: = $40 per receiving hour

Therefore, setting up equipment rate is $800 per setup, Ordering cost rate is $20 per order, machine cost rate is $20 per machine hour and receiving rate is $40 per receiving hour.

Calculation of unit cost:

Particulars	Model A		Model B
Direct materials	$600,000		$800,000
Direct labor	$480,000		$480,000
Overhead costs:
Setting up equipment:
	$320,000
			$160,000
Ordering cost:
	$120,000
			$240,000
Machine cost:
	$480,000
			$360,000
Receiving cost:
	$120,000
			$280,000
Total manufacturing costs	$2,120,000		$2,320,000
Units of production	÷16,000		÷8,000
Unit cost	$132.50		$290

Unit cost of Model A is $132.50 per unit and Model B is $290 per unit.

3. Unit-based cost allocation is not appropriate in this company. Since, this organizations providing multiple, diversified products and having non-unit overhead costs. At this juncture one has to identify the need of ABC (Activity-Based Costing) system with multiple rates using unit and non-unit drivers which provide accurate cost assignments. In ABC system overhead cost assigned to products based on the resource consumed by the respective products. Hence, ABC system resulting accurate product costs.