Question

You’re in Hot Water Inc. manufactures Jacuzzi hot tubs. The company produces two models, the “Basic” and the “Superjet” which promises a jet power setting that “borders on cruel”. Since the introduction of the Superjet, the company’s profits have been faltering, despite increased sales. The company’s senior accountant believes that the costing system may be causing problems. The company uses direct-labour hours as the basis for applying overhead. Overhead is estimated to be $300,000.

The following cost data is known:

	Basic	Superjet
Direct Materials	$700	$1200
Direct Labour ($15 per hour)	60	90
Number of units produced	600 units	100 units

The CFO wishes to explore an activity-based costing system

Activity (Cost Driver)		Estimated MOH	Expected Activity
			Total	Basic	Superjet
Assembly (Labour Hours)		$60,000	3,000	2,400	600
Quality control (Inspection Hours)		75,000	800	600	200
Machining (Machine Hours)		25,000	40,000	30,000	10,000
Parts Admin (Number of Parts)		140,000	500	100	400
		$300,000

Required - Provide detailed solutions/ answers to the following:

1. Under the traditional costing method:
   1. Compute the predetermined overhead rate.
   2. Determine the unit cost of each product.
2. Under activity based costing:
   1. Compute the activity rates for each activity.
   2. Determine the expected unit cost of each product.
3. Compare and comment on your answers from parts a.) and b.) above.
4. If ABC produces more accurate cost data, why is it not more widely used?

Answer 1

i) Predetermined overhead rate = $300000 / 3000 = $100 per labor hour

ii) Labor hours per unit
Basic = $60 / 15 = 4
Superjet = $90 / 15 = 6

	Basic	Superjet
Direct Materials	$                700	$             1,200
Direct Labor	$                  60	$                   90
Overhead cost	$                400	$                 600
Unit cost	$            1,160	$             1,890

iii)

Activity	Cost	Cost Driver		Cost per Cost driver
Assembly	$          60,000	3000	Direct labor hours	$            20.00	per labor hour
Quality Control	$          75,000	800	Inspection hours	$            93.75	per inspection hour
Machining	$          25,000	40000	Machine hours	$              0.63	per machine hour
Parts Admin	$       140,000	500	Parts	$         280.00	per part
Total	$       300,000

iv)

	Basic	Superjet
Direct Material	$       420,000	$        120,000
Direct Labor	$          36,000	$             9,000
Overhead allocated
Assembly	$          48,000	$           12,000
Quality Control	$          56,250	$           18,750
Machining	$          18,750	$             6,250
Parts Admin	$          28,000	$        112,000
Total Overhead	$       151,000	$        149,000
Total Product Cost	$       607,000	$        278,000
Units Produced	600	100
Product Cost per unit	$      1,011.67	$       2,780.00

As per ABC Costing, product cost per unit for Superjet varies hugely as more overheads are allocated to Superjet compared to traditional costing. Whereas product cost per unit for Basic is lower in ABC

ABC is not used widely, because it is more time consuming, more complex to calculate, difficult to separate costs under different heads and identify their cost drivers