Question

Craft Pro Machining produces machine tools for the construction industry. The following details about overhead costs were taken from its company records.

Production Activity Indirect Labor Indirect Materials Other Overhead

Grinding ……………… \(320,000

Polishing …………….. \)135,000

Product modification . 600,000

Providing power ……. $255,000

System calibration …. 500,000

Additional information on the drivers for its production activities follows.

Grinding……………………………………………………… 13,000 machine hours

Polishing …………………………………………………….. 13,000 machine hours

Product modification …………………………………….... 1,500 engineering hours

Providing power ……………………………………………. 17,000 direct labor hours

System calibration …………………………………………. 400 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 grinding and polishing activities into a single cost pool.

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

Job 3175 Job 4286

Number of units…………………………………… 200 units 2,500 units

Machine hours ……………………………………. 550 MH 5,500 MH

Engineering hours ……………………………….. 26 eng. hours 32 eng. hours

Batches …………………………………………….. 30 batches 90 batches

Direct labor hours ………………………………… 500 DLH 4,375 DLH

4. What is the overhead cost per unit for Job 3175? What is the overhead cost per unit for Job 4286?

5. If the company uses a plantwide overhead rate based on direct labor hours, what is the overhead cost for each unit of Job 3175? Of Job 4286?

6. Compare the overhead costs per unit computed in requirements 4 and 5 for each job. Which method more accurately assigns overhead costs?

Short answer

Using ABC method,

Per unit overhead cost for Job 3175 = $373.25

Per unit overhead cost for Job 4286 = $153.37

Using Plant-wide method,

Per unit overhead cost for Job 3175 = $266.18

Per unit overhead cost for Job 4286 = $186.32

Step-by-step solution

Meaning of Activity-based Costing

Activity-based costing is a technique or method of costing that assigns accurate overhead costs after the identification of the activities of the organization.

Explanation of requirement 1

Activity Name	Activity Level	Reason
Grinding	Unit Level	Grinding is done for each product, and the number of units may affect the cost.
Polishing	Unit Level	Polishing is done for each product, and the number of units may affect the cost.
Product Modification	Product Level	Product modification is done for any particular product class and not for each product.
Providing Power	Facility Level	Power is provided to the whole facility and is affected only after a certain production level or capacity.
System Calibration	Batch Level	System calibration is done at the batch level.

Calculation of requirement 2

$\begin{array}{rcl}\mathbf{Grinding}\mathbf{}\mathbf{\&}\mathbf{}\mathbf{Polising}\mathbf{}\mathbf{rate}\mathbf{}& \mathbf{=}& \mathbf{}\frac{\mathbf{Grinding}\mathbf{}\mathbf{cost}\mathbf{+}\mathbf{Polishing}\mathbf{}\mathbf{cost}}{\mathbf{Number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{machine}\mathbf{}\mathbf{hour}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{320}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{135}\mathbf{,}\mathbf{000}}{\mathbf{13}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{35}\end{array}$

$\begin{array}{rcl}\mathbf{Product}\mathbf{}\mathbf{modification}\mathbf{}\mathbf{rate}& \mathbf{=}& \frac{\mathbf{Product}\mathbf{}\mathbf{modification}\mathbf{}\mathbf{cost}}{\mathbf{Number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{engineering}\mathbf{}\mathbf{hour}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{600}\mathbf{,}\mathbf{000}}{\mathbf{1}\mathbf{,}\mathbf{500}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{400}\end{array}$

$\begin{array}{rcl}\mathbf{Power}\mathbf{}\mathbf{providing}\mathbf{}\mathbf{rate}& \mathbf{=}& \frac{\mathbf{Providing}\mathbf{}\mathbf{power}\mathbf{}\mathbf{cost}}{\mathbf{Number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{direct}\mathbf{}\mathbf{labor}\mathbf{}\mathbf{hour}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{255}\mathbf{,}\mathbf{000}}{\mathbf{17}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{15}\end{array}$

$\begin{array}{rcl}\mathbf{System}\mathbf{}\mathbf{calibration}\mathbf{}\mathbf{rate}& \mathbf{=}& \frac{\mathbf{System}\mathbf{}\mathbf{calibration}\mathbf{}\mathbf{cost}}{\mathbf{Number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{batches}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{500}\mathbf{,}\mathbf{000}}{\mathbf{400}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{250}\end{array}$

Calculation of requirement 3

For Job 3175
Overhead Cost	Rate	X	Allocation base number	Amount
Grinding & Polishing cost	$35	X	550	$19,250
Product modification cost	$400	X	26	$10,400
Providing power cost	$15	X	500	$7,500
System calibration cost	$1,250	X	30	$37,500
Total Overhead cost				$74,650

For Job 4286
Overhead Cost	Rate	X	Allocation base number	Amount
Grinding & Polishing cost	$35	X	5,500	$192,500
Product modification cost	$400	X	32	$12,800
Providing power cost	$15	X	4,375	$65,625
System calibration cost	$1,250	X	90	$112,500
Total Overhead cost				$383,425

Calculation of requirement 4

$\begin{array}{rcl}\mathbf{Overhead}\mathbf{}\mathbf{cost}\mathbf{}\mathbf{per}\mathbf{}\mathbf{unit}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}\mathbf{}\mathbf{3175}& \mathbf{=}& \frac{\mathbf{Total}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{cost}}{\mathbf{Total}\mathbf{}\mathbf{number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{units}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{74}\mathbf{,}\mathbf{650}}{\mathbf{200}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{373}\mathbf{.}\mathbf{25}\end{array}$

$\begin{array}{rcl}\mathbf{Overhead}\mathbf{}\mathbf{cost}\mathbf{}\mathbf{per}\mathbf{}\mathbf{unit}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}\mathbf{}\mathbf{4286}& \mathbf{=}& \frac{\mathbf{Total}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{cost}}{\mathbf{Total}\mathbf{}\mathbf{number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{units}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{383}\mathbf{,}\mathbf{425}}{\mathbf{2}\mathbf{,}\mathbf{500}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{153}\mathbf{.}\mathbf{37}\end{array}$

Calculation of requirement 5

$\begin{array}{rcl}\mathbf{Per}\mathbf{}\mathbf{unit}\mathbf{}\mathbf{plantwide}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}\mathbf{}\mathbf{3175}& \mathbf{=}& \frac{\mathbf{Total}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{\&}\mathbf{}\mathbf{Indirect}\mathbf{}\mathbf{cost}\mathbf{}\mathbf{\times }\mathbf{Total}\mathbf{}\mathbf{direct}\mathbf{}\mathbf{labor}\mathbf{}\mathbf{hour}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}}{\mathbf{Total}\mathbf{}\mathbf{direct}\mathbf{}\mathbf{labor}\mathbf{}\mathbf{hour}\mathbf{\times }\mathbf{Total}\mathbf{}\mathbf{number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{units}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}}\\ & \mathbf{=}& \frac{\left(\$320,000+\$135,000+\$600,000+\$255,000+\$500,000\right)\mathbf{\times }\mathbf{500}}{\mathbf{17}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{200}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{266}\mathbf{.}\mathbf{18}\end{array}$

$\begin{array}{rcl}\mathbf{Per}\mathbf{}\mathbf{unit}\mathbf{}\mathbf{plantwide}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}\mathbf{}\mathbf{4286}& \mathbf{=}& \frac{\mathbf{Total}\mathbf{}\mathbf{overhead}\mathbf{}\mathbf{\&}\mathbf{}\mathbf{Indirect}\mathbf{}\mathbf{cost}\mathbf{\times }\mathbf{Total}\mathbf{}\mathbf{direct}\mathbf{}\mathbf{labor}\mathbf{}\mathbf{hour}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}}{\mathbf{Total}\mathbf{}\mathbf{direct}\mathbf{}\mathbf{labor}\mathbf{}\mathbf{hour}\mathbf{\times }\mathbf{Total}\mathbf{}\mathbf{number}\mathbf{}\mathbf{of}\mathbf{}\mathbf{units}\mathbf{}\mathbf{for}\mathbf{}\mathbf{job}}\\ & \mathbf{=}& \frac{\left(\$320,000+\$135,000+\$600,000+\$255,000+\$500,000\right)\mathbf{\times }\mathbf{4}\mathbf{,}\mathbf{375}}{\mathbf{17}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{2}\mathbf{,}\mathbf{500}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{186}\mathbf{.}\mathbf{32}\end{array}$

Explanation of requirement 6

Job Name	ABC allocation Method	Plant-wide allocation method
Job 3175	$373,25	$266.18
Job 4286	$153.37	$186.32

The above table shows that the cost per unit is relatively justified under the ABC method than the plant-wide method. It is so because the overheads under the ABC method have been allocated based on actual activity rather than a single activity base.

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