Question

Saddle Inc. has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has heard of activity-based costing and wants to see how the results would differ if this system were used. Two activity cost pools were developed: machining and machine setup. Presented below is information related to the company’s operations.

		Standard		Custom
Direct labor costs		$50,000		$100,000
Machine hours		1,200		1,500
Setup hours		90		390

Total estimated overhead costs are $285,000. Overhead cost allocated to the machining activity cost pool is $189,000, and $96,000 is allocated to the machine setup activity cost pool

Determine the difference in allocation between the two approaches.

Traditional costing
Standard		$enter a dollar amount
Custom		$enter a dollar amount
Activity-based costing
Standard		$enter a dollar amount
Custom		$enter a dollar amount

Answer 1

Solution:

Traditional Costing:

Predetermined Overhead rate = Estimated Overhead / Total direct labor costs = $285000 / ($50000 + $100000) = $285000 / $150000 = 190%

Overhead allocated to Standard = $50000 *190% = $95,000

Overhead allocated to Custom = $100000 *190% = $190,000

Activity based costing:

Activity Cost Pool	Overhead Cost	Expected Activity		Activity Rate
Machining	$1,89,000	2700	Machine Hours	$70.00	per Mchine hour
Machine Setup	$96,000	480	Setup hours	$200.00	per setup hour

Overhead allocated to Standard
Activity Cost Pool	Activity Rate	Activity Usage	Overhead Allocated
Machining	$70.00	1200	84000
Machine Setup	$200.00	90	18000
Overhead allocated to Standard			102000

Overhead allocated to Custom
Activity Cost Pool	Activity Rate	Activity Usage	Overhead Allocated
Machining	$70.00	1500	105000
Machine Setup	$200.00	390	78000
Overhead allocated to Custom			183000