Question 26.IP.1: Hammer Company plans to use activity-based costing to determ...
Hammer Company plans to use activity-based costing to determine its product costs. It presently uses a single plantwide factory overhead rate for allocating factory overhead to products, based on direct labor hours. The total factory overhead cost is as follows:
| Department | Factory Overhead |
| Production Support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $1,225,000 |
| Production (factory overhead only) . . . . . . . . . . . . . . . . . . . . | 175,000 |
| Total cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | \underline{\underline{\$ \ 1,400,000}} |
The company determined that it performed four major activities in the Production Support Department. These activities, along with their budgeted activity costs, are as follows:
| Production Support Activities | Budgeted Activity Cost |
| Setup. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $ 428,750 |
| Production control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | 245,000 |
| Quality control. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | 183,750 |
| Materials management . . . . . . . . . . . . . . . . . . . . . . . . . . . | 367,500 |
| Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | \underline{\underline{\$ \ 1,225,000}} |
Hammer Company estimated the following activity-base usage and units produced
for each of its three products:
| Products | Number of Units | Direct Labor Hrs. | Setups | Production Orders | Inspections | Material Requisitions |
| TV . . . . . . . . . . . . . . . . . . . . . . | 10,000 | 25,000 | 80 | 80 | 35 | 320 |
| Computer . . . . . . . . . . . . . . . | 2,000 | 10,000 | 40 | 40 | 40 | 400 |
| Cell phone . . . . . . . . . . . . . . | 50,000 | 140,000 | 5 | 5 | 0 | 30 |
| Total cost . . . . . . . . . . . . . | \underline{\underline{62,000}} | \underline{\underline{175,000}} | \underline{\underline{125}} | \underline{\underline{125}} | \underline{\underline{75}} | \underline{\underline{750}} |
Instructions
1. Determine the factory overhead cost per unit for the TV, computer, and cell phone under the single plantwide factory overhead rate method. Use direct labor hours as the activity base.
2. Determine the factory overhead cost per unit for the TV, computer, and cell phone under activity-based costing. Round to whole cents.
3. Which method provides more accurate product costing? Why
1. Single Plantwide Factory Overhead Rate = \frac{\$ 1,400,000}{175,000 direct labor hours}
= $8 per direct labor hour
Factory overhead cost per unit:
| TV | Computer | Cell Phone | |
| Number of direct labor hours. . . . . . . . . . . . . . . . . . . . . . . . . . . | 25,000 | 10,000 | 140,000 |
| Single plantwide factory overhead rate . . . . . . . . . . . . . . . . . | × $8/dlh | × $8/dlh | × $8/dlh |
| Total factory overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $200,000 | $80,000 | $1,120,000 |
| Number of units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | ÷ 10,000 | ÷ 2,000 | ÷ 50,000 |
| Factory overhead cost per unit . . . . . . . . . . . . . . . . . . . . . . . . . | \underline{\underline{\$ \ 20.00}} | \underline{\underline{\$ \ 40.00}} | \underline{\underline{\$ \ 22.40}} |
2. Under activity-based costing, an activity rate must be determined for each activity pool:
| Activity | Budgeted Activity Cost | ÷ | Total Activity- Base Usage | = | Activity Rate |
| Setup . . . . . . . . . . . . . . . . . . . . . | $428,750 | ÷ | 125 setups | = | $3,430 per setup |
| Production control. . . . . . . . . | $245,000 | ÷ | 125 production orders | = | $1,960 per production order |
| Quality control. . . . . . . . . . . . . | $183,750 | ÷ | 75 inspections | = | $2,450 per inspection |
| Materials management . . . . | $367,500 | ÷ | 750 requisitions | = | $490 per requisition |
| Production . . . . . . . . . . . . . . . . | $175,000 | ÷ | 175,000 direct labor hours | = | $1 per direct labor hour |
These activity rates can be used to determine the activity-based factory overhead cost per unit as follows:
| TV | |||||
| Activity | Activity-Base Usage | × | Activity Rate | = | Activity Cost |
| Setup . . . . . . . . . . . . . . . . . . . . . | 80 setups | × | $3,430 | = | $274,400 |
| Production control. . . . . . . . . | 80 production orders | × | $1,960 | = | 156,800 |
| Quality control. . . . . . . . . . . . . | 35 inspections | × | $2,450 | = | 85,750 |
| Materials management . . . . | 320 requisitions | × | $490 | = | 156,800 |
| Production . . . . . . . . . . . . . . . . | 25,000 direct labor hrs. | × | $1 | = | 25,000 |
| Total factory overhead . . . . . . . | $698,750 | ||||
| Unit volume . . . . . . . . . . . . . . . . . | ÷ 10,000 |
||||
| Factory overhead cost per unit. . . . . . . . . . . . . . . |
\underline{\underline{\$ \ 69.88}} | ||||
| Computer | |||||
| Activity | Activity-Base Usage | × | Activity Rate | = | Activity Cost |
| Setup . . . . . . . . . . . . . . . . . . . . . | 40 setups | × | $3,430 | = | $137,200 |
| Production control. . . . . . . . . | 40 production orders | × | $1,960 | = | 78,400 |
| Quality control. . . . . . . . . . . . . | 40 inspections | × | $2,450 | = | 98,000 |
| Materials management . . . . | 4000 requisitions | × | $490 | = | 196,000 |
| Production . . . . . . . . . . . . . . . . | 10,000 direct labor hrs. | × | $1 | = | 10,000 |
| Total factory overhead . . . . . . . | $519,600 | ||||
| Unit volume . . . . . . . . . . . . . . . . . | ÷ 2,000 | ||||
| Factory overhead cost per unit. . . . . . . . . . . . . . . |
\underline{\underline{\$ \ 259.80}} | ||||
| Cell phone | |||||
| Activity | Activity-Base Usage | × | Activity Rate | = | Activity Cost |
| Setup . . . . . . . . . . . . . . . . . . . . . | 5 setups | × | $3,430 | = | $ 17,150 |
| Production control. . . . . . . . . | 5 production orders | × | $1,960 | = | 9,800 |
| Quality control. . . . . . . . . . . . . | 0 inspections | × | $2,450 | = | 0 |
| Materials management . . . . | 30 requisitions | × | $490 | = | 14,700 |
| Production . . . . . . . . . . . . . . . . | 140,000 direct labor hrs. | × | $1 | = | 140,000 |
| Total factory overhead . . . . . . . | $181,650 | ||||
| Unit volume . . . . . . . . . . . . . . . . . | ÷ 50,000 | ||||
| Factory overhead cost per unit. . . . . . . . . . . . . . . |
\underline{\underline{\$ \ 3.63}} | ||||
3. Activity-based costing is more accurate, compared to the single plantwide factory overhead rate method. Activity-based costing properly shows that the cell phone is actually less expensive to make, while the other two products are more expensive to make. The reason is that the single plantwide factory overhead rate method fails to account for activity costs correctly. The setup, production control, quality-control, and materials management activities are all performed on products in amounts that are proportionately different than their volumes. For example, the computer requires many of these activities relative to its actual unit volume. The computer requires 40 setups over a volume of 2,000 units (average production run size = 50 units), while the cell phone has only 5 setups over 50,000 units (average production run size = 10,000 units). Thus, the computer requires greater support costs relative to the cell phone.
The cell phone requires minimum activity support because it is scheduled in large batches and requires no inspections (has high quality) and few requisitions. The other two products exhibit the opposite characteristics.