Activity-based costing versus traditional overhead allocation methods. Woodruff
Industries manufactures and sells custom-made coffee tables. Its job costing system
was designed using an activity-based costing approach. Direct materials and direct
labor costs are accumulated separately, along with information concerning three
manufacturing overhead cost drivers (activities). Assume that the direct labor rate is
$15 per hour and that there were no beginning inventories. The following information
was available for 2004, based on an expected production level of 50,000 units
for the year:
Activity Budgeted Cost Driver Used Cost
(Cost Driver) Costs for 2004 as Allocation Base Allocation Rate
Materials handling $ 250,000 Number of parts used $ 0.20 per part
Cutting and lathe work 1,750,000 Number of parts used 1.40 per part
Assembly and inspection 4,000,000 Direct labor hours 20.00 per hour
The following production, costs, and activities occurred during the month of July:
Units Direct Number Direct
Produced Materials Costs of Parts Used Labor Hours
3,200 $107,200 70,400 13,120
Required:
a. Calculate the total manufacturing cost and the cost per unit of the coffee
tables produced during the month of July (using the activity-based costing
approach).
b. Assume instead that Woodruff Industries applies manufacturing overhead on
a direct labor hours basis (rather than using the activity-based costing system
described above). Calculate the total manufacturing cost and the cost per
unit of the coffee tables produced during the month of July. (Hint: You willneed to calculate the predetermined overhead application rate using the
total budgeted overhead costs for 2004.)
c. Compare the per unit cost figures calculated in parts (a) and (b) above.
Which approach do you think provides better information for manufacturing
managers? Explain your answer.
The total cost of producing 3,200 units in July:
Direct Material $107,200
Direct Labor 13,120 x 15 $196,800
Material handling 70,400 X 0.2 $14,080
Cutting/Lathe Work 70,400 X 1.40$98,560
Assembly/ Inspection 13,120 x 20$262,400
Total manufacturing cost $679,040
Per Unit $212.2
In Activity Based Costing, Overhead costs are allocated based on Cost Drivers. In this problem, the cost driver is the number of parts used, and direct labor hours for the company’s different departments. The allocation rates were also given in the question.
b.
The total manufacturing cost of producing the tables in July:
Direct Material $107,200
Direct Labor $196,800
Overhead 13,120 X 29.27 $384,022
Total Manufacturing cost $688,022
Per Unit $215
Total Budgeted Overhead = $6,000,000, and total budgeted labor hours = 205,000 DLH; therefore Predetermined Overhead Rate = $6,000,000 / 205,000
= $29.27
Since labor hours incurred to produce 3,200 units is 12,120, therefore multiplying that by the predetermined overhead rate would give us the total overhead rate.
c.
The ABC approach provides better information since overhead is allocated based on the cost drive that is responsible for the cost. This costing method provides a more accurate cost data for management.