Question

$ Additional ABC Problems 1. Activity-Based versus Traditional Costing Maglie Company manufactures two video game consoles: handheld and home. The handheld consoles are smaller and less expensive than the home consoles. Management believes that the accounting system is not accurately allocating costs to products and has asked you to investigate if there is a cost allocation problem. You find that manufacturing overhead costs are currently assigned to products based on their direct labor costs. For your investigation, you have data from last year. Manufacturing overhead was $1,440,000 based on production of 28,000 handheld consoles and 10,000 home consoles. Direct labor and direct materials costs were as follows: Direct labor Direct materials Handheld $1,160,400 750,000 Home $439,600 684,000 Total $1,600,000 1,434,000 Management has determined that overhead costs are caused by three activities and have identified their cost drivers. These activities/cost drivers and their costs for last year are as follows: 40 Activities/Cost Driver Setup costs (# of production runs) Quality tests (# of tests performed) Shipping orders (# of orders) Total overhead Activity Level Activity Cost Handheld Home Total S 660,000 10 50 594,000 12 18 30 186,000 100 50 150 $1,440,000 Required a. How much overhead will be assigned to each product if direct labor cost is used to allocate overhead? What is the per-unit cost for each product? b. How much overhead will be assigned to each product if the three activity cost drivers are used to allocate overhead? What is the per-unit cost for each product? c. Comment on the results of the activity-based costing in requirement (b).

Answer 1

a) Total manufacturing overhead cost Total direct labor cost Plantwide overhead rate per direct labor cost $1,440,000 $1,600,000 $0.9 ($1440000 / $1600000] Direct labor dollars Plantwide overhead rate per direct labor cost Overhad costs allocated to each product Add: Direct materials Add: Direct labor cost Total manufacturing costs recorded Number of units produced Unit product cost Handheld Home $1,160,400 $439,600 --> (a) $0.9 $0.9 --> (b) $1,044,360 $395,640 --> (a) (b) $750,000 $684,000 $1,160,400 $439,600 $2,954,760 $1,519,240 --> (p) 28,000 10,000 --> (9) $105.53 $151.92 --> (p)/(q) b) Activity Cost Pool Setups Quality test Shipping orders Cost Driver prod. runs # of tests # of orders Activity Cost $660,000 $594,000 $186,000 Volume Activity Rate $13,200 [$660000 / 50] 30 $19,800 ($594000 / 30] 150 $1,240 ($186000 / 150]

Usage Activity Activity Activity Activity costs assigned to Handheld: Rate Cost Setups $13,200 40 $528,000 ($13200 x 40] Quality test $19,800 12 $237,600 ($19800 x 12] Shipping orders $1,240 100 $124,000 ($1240 x 100] Activity costs assigned to Handheld: $889,600 Add: Direct materials $750,000 Add: Direct labor cost $1,160,400 Total manufacturing costs recorded $2,800,000 --> (p) Number of units produced 28,000 --> (9) Unit product cost $100.00 --> (p)/(q) Activity Activity Activity Activity costs assigned to Home: Rate Usage Cost Setups $13,200 10 $132,000 ($13200 x 10] Quality test $19,800 18 $356,400 ($19800 x 18] Shipping orders $1,240 50 $62,000 ($1240 x 50] Activity costs assigned to Home: $550,400 Add: Direct materials $684,000 Add: Direct labor cost $439,600 Total manufacturing costs recorded $1,674,000 --> (p) Number of units produced 10,000 --> (9) Unit product cost $167.40 --> (p)/ (9)

Maglie Company should adopt activity-based-cost overhead allocation method to allocate overhead costs between the products because this method allocates overhead costs rationally based on actual usage of cost drivers. If plant-wide overhead rate based on usage of direct labor cost is used to allocate overhead between the products, there will be over-pricing for $Handheld and under-pricing for Home due to inappropriate cost allocation between the products.