Question

Exercise 7-10 Eric Parker has been studying his department's profitability reports for the past six months. He has just completed a managerial accounting course and is beginning to question the company's approach to allocating overhead to products based on machine hours. The current department overhead budget of $1,140,000 is based on 40,000 machine hours. In an initial analysis of overhead costs, Eric has identified the following activity cost pools. Cost Pool Expected Cost Expected Activities Product assembly $ 600,000 40,000 Machine hours Machine setup and calibration 320,000 2,000 setups Product inspection 90,000 1,500 batches Raw materials storage 130,000 500,000 pounds $1,140,000 Eric Parker is taking the next step in his exploration of activity-based costing and wants to examine the overhead costs that would be allocated to two of the department's four products. He has gathered the following budget information about each product. Component 3F5 1,000 40 Component 176 10,000 Driver Usage Machine hours Setups Batches Pounds of raw materials 20 20 10 10,000 10,000 Eric Parker found that the budget included production of 500 units of Component 3F5 and 5,000 units of Component 176.

Answer 1

Solution a:

Tradition Overhead rate per machine hour = $1140000 / 40000 = $28.50 per machine hour

Overhead per unit of Component 3F5 = Overhead assigned / Units = ($28.50*1000) / 500 = $57 per unit

Overhead per unit of Component T76 = Overhead assigned / Units = ($28.50*10000) / 5000 = $57 per unit

Solution b:

Computation of Activity rates
Activity cost pool	Overhead costs	Estimated activity	Activity Rate
Product assembly	$6,00,000	40000	$15.00	Per MH
Machine setup and calibration	$3,20,000	2000	$160.00	per setup
Product inspection	$90,000	1500	$60.00	per batch
Raw Materials storage	$1,30,000	500000	$0.26	per pound

Computation of Overhead allocated and Overhead per unit
		Component 3F5		Component T76
Activity cost pool	Activity Rate	Estimated Activity	Overhead Allocated	Estimated Activity	Overhead Allocated
Product assembly	$15.00	1000	$15,000	10000	$1,50,000
Machine setup and calibration	$160.00	40	$6,400	20	$3,200
Product inspection	$60.00	20	$1,200	10	$600
Raw Materials storage	$0.26	10000	$2,600	10000	$2,600
Total Overhead allocated			$25,200		$1,56,400
No. of units			500		5000
Overhead per unit			50.40		31.28