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Chapter 19: Q1DC_3 (page 1085)

Harris Systems specializes in servers for workgroup, e-commerce, and ERP applications. The company’s original job costing system has two direct cost categories: direct materials and direct labor. Overhead is allocated to jobs at the single rate of \(22 per direct labor hour.

A task force headed by Harris’s CFO recently designed an ABC system with four activities. The ABC system retains the current system’s two direct cost categories. Overhead costs are reflected in the four activities. Pertinent data follow:

___________________________________________________________________

Activity Allocation Base Predetermined Overhead

Allocation Rate____

Materials handling Number of parts \) 0.85

Machine setup Number of setups 500.00

Assembling Number of assembling hours 80.00

Shipping Number of shipments 1,500.00_______

Harris Systems has been awarded two new contracts, which will be produced as Job A and Job B. Budget data relating to the contracts follow:

____________________________________________________________

Job A Job B__

Number of parts 15,000 2,000

Number of setups 6 4

Number of assembling hours 1,500 200

Number of shipments 1 1

Total direct labor hours 8,000 600

Number of units produced 100 10

Direct materials cost \( 220,000 \) 30,000

Direct labor cost \( 160,000 \) 12,000__

Requirements

3. Which costing system more accurately assigns to jobs the costs of the resources consumed to produce them? Explain.

Short Answer

Expert verified

Activity-based costing more accurately allocate cost to a Job due to using the activity as the basis for allocating indirect cost.

Step by step solution

01

Step-by-Step-SolutionStep 1: Comparison of Budgeted cost under both the methods

Job A

Job B

Single Base Allocation Method

Total Budgeted Cost

$556,000

$393,200

Budgeted Cost per unit

$5,560

$39,320

Activity-Based Allocation Method

Total Budgeted Cost

$517,250

$63,200

Budgeted Cost per unit

$517.25

$6,320

02

Interpretation

Under the single base allocation method, the difference between the total budgeted costs for both the job has lower than in the activity-based allocation method. The reason for being is that the indirect cost has been computed based on the total labor hour in the first case.

The labor hour only is not the appropriate base for the allocation of direct cost. This is so because the overhead is incurred due to lots of manufacturing activities that are not directly related to production. The labor hour is the main activity for any production process but at the same time, all other indirect activities may not be involved in the production process as labor.

So if indirect cost is allocated or computed on the basis of labor hours it would cost more for the product or job that has very less amount of indirect activity.

In the given case, indirect activity is comparatively low for Job B. So when the indirect cost is allocated based on activity method it is apportioned fairly. But when labor hour is used for allocation then the Job having lower indirect activity is also allocated more cost due to labor hour activity.

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Most popular questions from this chapter

Question:Treat Dog Collars uses activity-based costing. Treat’s system has the following features:

___________________________________________________________________

Activity Allocation BasePredetermined

Overhead Allocation Rate

Purchasing Number of purchase orders \( 60.00 per purchase order

Assembling Number of parts 0.36 per part

Packaging Number of finished collars 0.19 per collar

___________________________________________________________________

Each collar has three parts, direct materials cost is \)5.00 per collar, and direct laborcost is \(4.00 per collar. Suppose Animal Hut has asked for a bid on 30,000 dog collars.Treat will issue a total of 175 purchase orders if Animal Hut accepts Treat’s bid.

Requirements

1. Compute the total estimated cost Treat will incur to purchase the needed materialsand then assemble and package 30,000 dog collars. Also compute the cost percollar.

2. For bidding, Treat adds a 40% markup to total cost. What total price will the companybid for the entire Animal Hut order?

3. Suppose that instead of an ABC system, Treat has a traditional product costingsystem that allocates indirect costs at the rate of \)9.50 per direct labor hour. Thedog collar order will require 9,000 direct labor hours. What total price will Treat bidusing this system’s total cost?

4. Use your answers to Requirements 2 and 3 to explain how ABC can help Treatmake a better decision about the bid price it will offer Animal Hut.

Koehler (see Exercise E19-15 and Exercise E19-16) makes handheld calculators in two models—basic and professional—and wants to further refine its costing system by allocating overhead using activity-based costing. The estimated \(721,000 of manufacturing overhead has been divided into three primary activities: Materials Handling, Machine Setup, and Insertion of Parts. The following data have been compiled:

Material Handling

Machine Setup

Insertion of Parts

Total

Overhead costs

\) 45,000

\( 136,000

\) 540,000

$ 721,000

Allocation base

Number of parts

Number of setups

Number of parts

Expected usage:

Basic Model

32 parts per calculator

24 setups per year

32 parts per calculator

Professional

Model

58 parts per calculator

44 setups per year

58 parts per calculator

Requirement 1

Koehler expects to produce 200,000 basic models and 200,000 professional models. Compute the predetermined overhead allocation rates using activity-based costing. How much overhead is allocated to the basic model? To the professional model?

Haworth Company is a management consulting firm. The company expects to incur \(167,500 of indirect costs this year. Indirect costs are allocated based on the following activities:

Activity

Estimated cost

Allocation Base

Estimated quantity of allocation base

Predetermined

Overhead allocation rate

Site visits

\) 45,000

Number of visits

900 visits

\( 50 per visit

Documentation Preparation

122,500

Number of pages

3,500 Pages

\) 35 per page

Total Indirect costs

\( 167,500

Haworth bills clients at 120% of the direct labor costs. The company has estimated direct labor costs at \)240 per hour. Last month, Haworth completed a consulting job for Client 76 and used the following resources:

Allocation Base Client 76

Direct labor hours 60

Visits 5

Pages 50

Determine the total cost of the consulting job and the operating income earned.

Refer to Exercises E19-20 and E19-21. Controller Michael Bender is surprised by the increase in cost of the deluxe model under ABC. Market research shows that for the deluxe rim to provide a reasonable profit, Eason will have to meet a target manufacturing cost of \(625.00 per rim. A value engineering study by Eason’s employees suggests that modifications to the finishing process could cut finishing cost from \)90.00 to \(60.00 per hour and reduce the finishing direct labor hours per deluxe rim from 5.50 hours to 5.0 hours. Direct materials would remain unchanged at \)48.00 per rim, as would direct labor at $52.00 per rim. The materials handling, machine setup, and insertion of parts activity costs also would remain the same.

Would implementing the value engineering recommendation enable Eason to achieve its target cost for the deluxe rim?

Question:Roxi, Inc. is using a costs-of-quality approach to evaluate design engineering efforts for a new skateboard. Roxi’s senior managers expect the engineering work to reduceappraisal, internal failure, and external failure activities. The predicted reductionsin activities over the two-year life of the skateboards follow. Also shown are thepredetermined overhead allocation rates for each activity.


Activity

Predicted Reduction in Activity Units

Predetermined Overhead Allocation Rate per unit

Inspection of incoming raw materials

395

\( 44

Inspection of finished goods

395

26

Number of defective units discovered in-house

1,500

54

Number of defective units discovered by customers

275

73

Lost profits due to dissatisfied customers

100

103

Requirements

1. Calculate the predicted quality cost savings from the design engineering work.

2. Roxi spent \)106,000 on design engineering for the new skateboard. What is the net benefit of this “preventive” quality activity?

3. What major difficulty would Roxi’s managers have in implementing this costs-of quality approach? What alternative approach could they use to measure quality improvement?
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