Single Plantwide Rate and Activity-Based Costing

Whirlpool Corporation conducted an activity-based costing study of its Evansville, Indiana, plant in order to identify its most profitable products. Assume that we select three representative refrigerators (out of 333): one low-, one medium-, and one high-volume refrigerator. Additionally, we assume the following activity-base information for each of the three refrigerators:

Three Representative Refrigerators	Number of Machine Hours		Number of Setups		Number of Sales Orders		Number of Units
RefrigeratorLow Volume	70		18		54		350
RefrigeratorMedium Volume	390		17		120		1,950
RefrigeratorHigh Volume	890		12		180		4,450

Prior to conducting the study, the factory overhead allocation was based on a single machine hour rate. The machine hour rate was $350 per hour. After conducting the activity-based costing study, assume that three activities were used to allocate the factory overhead. The new activity rateinformation is assumed to be as follows:

	Machining Activity		Setup Activity		Sales Order Processing Activity
Activity rate	$340		$530		$120

a. Complete the following table, using the single machine hour rate to determine the per-unit factory overhead for each refrigerator (Column A) and the three activity-based rates to determine the activity-based factory overhead per unit (Column B). Finally, compute the percent change in per-unit allocation from the single to activity-based rate methods (Column C).

If required, round all per unit answers to the nearest cent. Round percents to one decimal place. For column C, use the minus sign to indicate a negative or decrease.

	Column A	Column B	Column C
Product Volume Class	Single Rate Overhead Allocation Per Unit	ABC Overhead Allocation Per Unit	Percent Change in Allocation
Low	$	$	%
Medium	$	$	%
High	$	$	%

b. Why is the traditional overhead rate per machine hour greater under the single rate method than under the activity-based method?

The machine hour rate is greater under the single rate method than under the activity-based method because 100% of the factory overhead is entire factory overheads is allocated by machine hours under the single rate method. However, only a portion of the factory overhead is allocated under the machine rate method using activity-based costing. The remaining factory overhead is allocated using the other two activity rates . Thus, the numerator for numerator for determining the machine hour rate under activity-based costing must be less than the numerator under the single machine hour rate method.

c. Interpret Column C in your table from part (A).

Column C indicates that under activity-based costing the low-volume product has a higher per-unit cost than calculated under the single rate method. In contrast, under activity-based costing the high-volume product has a lower per-unit cost than calculated under the single rate method. This result will occur when there are activities that occur in proportions different from their volumes. In this case, lower volume products have setups and sales orders occurring in higher proportions of total setups and sales orders than their proportion of machine hours to total machine hours. The opposite is the case for the high volume product. Thus, the lower-volume products are produced and ordered in smaller batch sizes compared to the higher-volume product. This implies that Whirlpool may wish to simplify its product line by eliminating some of the low volume products or by attempting to reduce the overall cost of setup and sales order processing activities.