Question

Ryan Foods produces gourmet gift baskets that it distributes online as well as from its small retail store. The following details about overhead costs are taken from its records.

Production Activity Indirect Labor Indirect Materials Other Overhead

Wrapping …………… \(300,000 \)200,000

Assembling ………… 400,000

Product design …….. 180,000

Quality inspection …. 100,000

Cooking ……………… 150,000 120,000

Additional information on the drivers for its production activities follows.

Wrapping ……………………………………………….... 100,000 units

Assembling ……………………………………………… 20,000 direct labor hours

Product design ………………………………………….. 3,000 design hours

Quality inspection ………………………………………. 20,000 direct labor hours

Cooking …………………………………………………… 1,000 batches

Required

1. Classify each activity as unit level, batch level, product level, or facility level.

2. Compute the activity overhead rates using ABC. Combine the assembling and quality inspection activities into a single cost pool.

3. Determine the overhead costs to assign to the following jobs using ABC.

Holiday Basket Executive Basket

Number of units ……………………… 8,000 units 1,000 units

Direct labor hours …………………… 2,000 DLH 500 DLH

Design hours …………………………. 40 design hours 40 design hours

Batches ………………………………... 80 batches 200 batches

4. What is the overhead cost per unit for the Holiday Basket? What is the overhead cost per unit for the Executive Basket?

5. If the company used a plantwide overhead rate based on direct labor hours, what is the overhead cost for each Holiday Basket unit? What would be the overhead cost for each Executive Basket unit if a single plantwide overhead rate were used?

6. Compare the costs per unit computed in requirements 4 and 5 for each job. Which cost assignment method provides the most accurate cost? Explain.

Short answer

Using ABC method,

Per unit overhead cost for Holiday basket:$14.25

Per unit overhead cost for Executive basket:$135.3

Using Plant-wide method,

Per unit overhead cost for Holiday basket:$18.13

Per unit overhead cost for Executive basket: $36.25

Step-by-step solution

Classification of activity

Activity Name	Activity Level	Reason
Wrapping	Unit Level	wrapping is done for each product and the cost may be affected by the number of units
Assembling	Unit Level	Assembling is done for each component and required direct labor hour
Product Design	Product Level	Product design is done for any particular class of product and not for each product separately
Quality Inspection	Unit Level	Inspection is done for each product and is related to the number of units.
Cooking	Batch Level	Cooking is done in the number of batches

Overhead rate under ABC

$\begin{array}{rcl}\mathbf{\text{Aseembling\&Qualityinspectionrate}}& \mathbf{=}& \frac{\mathbf{\text{Assemblingcost}}\mathbf{+}\mathbf{\text{Qualityinspectioncost}}}{\mathbf{\text{Numberofdirectlaborcosthour}}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{400}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{100}\mathbf{,}\mathbf{000}}{\mathbf{20}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{25}\end{array}$

$\begin{array}{rcl}\mathbf{\text{Wrappingrate}}& \mathbf{=}& \frac{\mathbf{\text{Wrappingcost}}}{\mathbf{\text{Numberofunits}}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{300}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{200}\mathbf{,}\mathbf{000}}{\mathbf{100}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{5}\end{array}$

$\begin{array}{rcl}\mathbf{\text{Productdesignrate}}& \mathbf{=}& \frac{\mathbf{\text{Productdesigncost}}}{\mathbf{\text{Numberofdesignhour}}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{180}\mathbf{,}\mathbf{000}}{\mathbf{3}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{60}\end{array}$

$\begin{array}{rcl}\mathbf{\text{Cookingrate}}& \mathbf{=}& \frac{\mathbf{\text{Cookingcost}}}{\mathbf{\text{Numberofbatches}}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{150}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{120}\mathbf{,}\mathbf{000}}{\mathbf{1000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{270}\end{array}$

Assign overhead cost

For Holiday Basket
Overhead Cost	Rate	X	Allocation base number	Amount
Assembling & Quality Inspection cost	$25	X	2000	$50,000
Wrapping cost	$5	X	8000	$40,000
Product design cost	$60	X	40	$2,400
Cooking cost	$270	X	80	$21,600
Total Overhead cost				$114,000

For Executive Basket
Overhead Cost	Rate	X	Allocation base number	Amount
Assembling & Quality Inspection cost	$25	X	500	$12,500
Wrapping cost	$5	X	1000	$5,000
Product design cost	$60	X	40	$2,400
Cooking cost	$270	X	200	$54,000
Total Overhead cost				$135,300

Overhead cost per unit

$\begin{array}{rcl}\mathbf{\text{OverheadcostperunitforHolidaybasket}}& \mathbf{=}& \frac{\mathbf{\text{Totaloverheadcost}}}{\mathbf{\text{Totalnumberofunits}}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{114}\mathbf{,}\mathbf{000}}{\mathbf{8}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{14}\mathbf{.}\mathbf{25}\end{array}$

$\begin{array}{rcl}\mathbf{\text{OverheadcostperunitforExecutivebasket}}& \mathbf{=}& \frac{\mathbf{\text{Totaloverheadcost}}}{\mathbf{\text{Totalnumberofunits}}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{135}\mathbf{,}\mathbf{300}}{\mathbf{1}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{135}\mathbf{.}\mathbf{3}\end{array}$

Overhead cost per unit plant wide overhead rate

$\begin{array}{rcl}\mathbf{\text{Perunitplantwideoverheadforholidaybasket}}& \mathbf{=}& \frac{\mathbf{\text{Totaloverhead\&indirectcost}}\mathbf{\times }\mathbf{\text{TotaldirectlaborhourJob}}}{\mathbf{\text{Totaldirectlaborhour}}\mathbf{\times }\mathbf{\text{TotalnumberofunitsforJob}}}\\ & \mathbf{=}& \frac{\left(\$500,000+\$400,000+\$180,000+\$100,000+\$270,000\right)\mathbf{\times }\mathbf{2}\mathbf{,}\mathbf{000}}{\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{8}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{18}\mathbf{.}\mathbf{125}\end{array}$

$\begin{array}{rcl}\mathbf{\text{PerunitplantwideoverheadforExecutivebasket}}& \mathbf{=}& \frac{\mathbf{\text{Totaloverhead\&Indirectcost}}\mathbf{\times }\mathbf{\text{TotaldirectlaborhourforJob}}}{\mathbf{\text{Totaldirectlaborhour}}\mathbf{\times }\mathbf{\text{TotalnumberofunitsforJob}}}\\ & \mathbf{=}& \frac{\left(\$500,000+\$400,000+\$180,000+\$100,000+\$270,000\right)\mathbf{\times }\mathbf{500}}{\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{1}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{36}\mathbf{.}\mathbf{25}\end{array}$

Comparison

Job Name	ABC allocation Method	Plant-wide allocation method
Holiday basket	$14.25	$18,125
Executive basket	$135.3	$36.25

From the above table, it can be seen that under ABC method the cost per unit is relatively justified than the plant wide method. This is so because the overheads under ABC method has been allocated based on actual activity rather than a single activity base.

So, it can be said ABC method more accurately assigns overhead cost.