Single Plantwide Rate and Activity-Based Costing

Whirlpool Corporation (WHR) 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	24		14		38		160
RefrigeratorMedium Volume	225		13		88		1,500
RefrigeratorHigh Volume	900		9		120		6,000

Prior to conducting the study, the factory overhead allocation was based on a single machine hour rate. The machine hour rate was $200 per hour. After conducting the activity-based costing study, assume that three activities were used to allocate the factory overhead. The new activity rate information is assumed to be as follows:

	Machining Activity	Setup Activity	Sales Order Processing Activity
Activity rate	$160	$240	$55

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 the

all costs50% of the factory overheadsentire factory overheads

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

direct material rateslabor ratesother two activity rates

. Thus, the

denominatornumerator

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

higherlower

per-unit cost than calculated under the single-rate method. In contrast, under activity-based costing the high-volume product has a

higherlower

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,

highlow

-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

highlow

-volume product. Thus, the low-volume products are produced and ordered in

largersmaller

batch sizes compared to the high-volume product. This implies that Whirlpool may wish to simplify its product line by eliminating some of the

highlow

-volume products or by attempting to reduce the overall cost of setup and sales order processing activities.