Question

Harris Systems specializes in servers for workgroup, e-commerce, and ERP applications. The company’s original job costing system has two direct cost categories: direct materials and direct labor. Overhead is allocated to jobs at the single rate of \(22 per direct labor hour.

A task force headed by Harris’s CFO recently designed an ABC system with four activities. The ABC system retains the current system’s two direct cost categories. Overhead costs are reflected in the four activities. Pertinent data follow:

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Activity Allocation Base Predetermined Overhead

Allocation Rate____

Materials handling Number of parts \) 0.85

Machine setup Number of setups 500.00

Assembling Number of assembling hours 80.00

Shipping Number of shipments 1,500.00_______

Harris Systems has been awarded two new contracts, which will be produced as Job A and Job B. Budget data relating to the contracts follow:

____________________________________________________________

Job A Job B__

Number of parts 15,000 2,000

Number of setups 6 4

Number of assembling hours 1,500 200

Number of shipments 1 1

Total direct labor hours 8,000 600

Number of units produced 100 10

Direct materials cost \( 220,000 \) 30,000

Direct labor cost \( 160,000 \) 12,000__

Requirements

3. Which costing system more accurately assigns to jobs the costs of the resources consumed to produce them? Explain.

Short answer

Activity-based costing more accurately allocate cost to a Job due to using the activity as the basis for allocating indirect cost.

Step-by-step solution

Step-by-Step-SolutionStep 1: Comparison of Budgeted cost under both the methods

	Job A	Job B
Single Base Allocation Method
Total Budgeted Cost	$556,000	$393,200
Budgeted Cost per unit	$5,560	$39,320
Activity-Based Allocation Method
Total Budgeted Cost	$517,250	$63,200
Budgeted Cost per unit	$517.25	$6,320

Interpretation

Under the single base allocation method, the difference between the total budgeted costs for both the job has lower than in the activity-based allocation method. The reason for being is that the indirect cost has been computed based on the total labor hour in the first case.

The labor hour only is not the appropriate base for the allocation of direct cost. This is so because the overhead is incurred due to lots of manufacturing activities that are not directly related to production. The labor hour is the main activity for any production process but at the same time, all other indirect activities may not be involved in the production process as labor.

So if indirect cost is allocated or computed on the basis of labor hours it would cost more for the product or job that has very less amount of indirect activity.

In the given case, indirect activity is comparatively low for Job B. So when the indirect cost is allocated based on activity method it is apportioned fairly. But when labor hour is used for allocation then the Job having lower indirect activity is also allocated more cost due to labor hour activity.