Activity-Based Costing

The president of H&Y Company has been concerned about the profitability of the company product lines.

First, she wants you to examine the current situation using traditional approach of allocating overhead.

Second, she wants you to apply Activity-Based costing to develop a new product cost for each product

line. Third, she wants your opinion about the best approach to use to determine the products' unit cost.

1. The expected level of sales is 200 of each product.

Product A selling price: $11,000

Product B selling price: $20,000

2. Direct Material cost per unit Product A $6,700

Direct Material cost per unit Product B $12,600

3. Direct Labor cost per unit Product A $380

Direct Labor cost per unit Product B $2,000

4. Factory Overhead Activities:

a. Every product is inspected.

b. Product A moving parts oiled:

5 parts per product

Product B moving parts oiled: 3 parts per product

c. Material is delivered to each of the product lines on a daily basis.

Product A 5 times per week

Product B 5 times per week

d. Product A redesign: 5 hours per week

Product B redesign: 20 hours per week

e. Product A supplier purchase orders: 5 times per week

Product B supplier purchase orders: 2 times per month

f. Facility administration is based on direct labor costs.

Total Estimated Activity Cost

Activity Cost Driver Estimated Cost

Inspection # units $190,000

Lubricating oil # oil applications $80,000

Material handling # deliveries $100,000

Product design # redesign hours $456,000

Purchase orders # purchase orders $90,000

Facility Administration direct labor cost ($) $36,000

Total factory overhead $952,000

For this challenge, both Product A and Product B have a planned level of production of 200 units each.

You will need to use the per unit data on the first page and the planned number of units in production

to calculate the total planned levels of activity.

When calculating the activity rate (#2) you will need to round to 3 decimal places for product design,

material handling, and purchases orders. You need to round faculty administration rate to 5 decimal places.

Then when you use these rates for #3 round to a whole number.

Planned Activity Level

Cost Driver Product A Product B Total

# products inspected

# oil applications

# deliveries

# redesign hours

# purchase orders

direct labor cost ($)

1. Calculate the factory overhead using traditionally allocated predetermined overhead rate of

200% of direct labor cost.

Direct Labor Cost per Unit Overhead Allocation per unit Total Overhead Allocation (@ 200 products)

Product A

Product B

Total

2. Calculate the planned activity rate for each cost pool using the Activity-Based Costing Method

Activity Estimated Cost Total Planned Activity Level Planned Activity Rate

Inspection

Lubricating oil

Material handling

Product design

Purchase orders

Facility Administration

3. Calculate the factory overhead allocated to the product lines using ABC method:

Activity Product A Product B Total

Inspection

Lubricating oil

Material handling

Product design

Purchase orders

Facility Administration

Total

4. Complete the following table:

Factory Overhead Comparison Traditional ABC Difference

Product A

Product B

Total

5. Calculate the unit cost using traditional method and ABC method of allocating overhead.

Traditional Method Product A Product B

Direct Materials per product

Direct Labor per product

Factory Overhead

Total cost per product

Gross profit per product

ABC Method Product A Product B

Direct Materials per product

Direct Labor per product

Factory Overhead

Total cost per product

Gross profit per product

6. Under which method is the most overhead charged to production this year?

7. How will this affect net income?

8. Which method would you prefer to use? Why?