Revised Summer 2015

ACTIVITY BASED COSTING

Key Topics to Know

 Job Costing relied on a single plantwide overhead rate.
 Departments with very different processes may use departmental overhead rates
instead of a single plantwide rate to improve accuracy.
 Differences between activity-based costing and a traditional costing system (either
single rate or multiple rates)
 Understand the ABC methodology:
o How to compute activity rates for cost pools.
o How to assign costs to products.
o How to compute overhead cost per unit for each product.
o How to compute total unit cost for each product.
o How to apply overhead to production in work-in-process.
o Explain why product costs computed under activity based costing and
conventional costing methods differ.
 Flow of costs in an activity based costing system.

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Problems
Problem #1

Cabalo Company manufactures two products, Product C and Product D. The company
estimated it would incur $130,890 in manufacturing overhead costs during the current
period. Overhead currently is assigned to the products on the basis of direct labor
hours. Data concerning the current period’s operations appear below:
Product C Product D
Estimated volume 400 units 1,200 units
Direct labor hours per unit 0.70 hour 1.20 hours
Direct material cost per unit $10.70 $16.70
Direct labor cost per unit $11.20 $19.20

Management is considering using activity-based costing to apply manufacturing

overhead cost to products for external financial reports. The activity-based costing
system would have the following three activity cost pools:

Estimated
Activity Cost Pool Activity Measure Overhead Cost
Machine setups Number of setups $ 13,570
Purchase Orders Number of purchase orders 91,520
General Factory Direct labor hours 25,800

Activity Measure Product C Product D Total

Number of setups 100 130 230
Number of purchase orders 810 1,270 2,080
Number of direct labor hours 280 1,440 1,720

Required: a) Compute the predetermined overhead rate under the current

method and determine the unit product cost of each product.
b) Determine the activity rate (i.e. predetermined overhead rate) for
each cost pool
c) Compute the total amount of manufacturing overhead cost that
would be applied to each product using the activity-based costing
system. After these totals have been computed, determine the
amount of manufacturing overhead cost per unit of each product.
d) Compute the unit product cost of each product.
e) Compute the overhead applied to work-in-process using both
traditional costing and ABC for a job with the following actual
activity:

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Activity Measure Job
Number of setups 10
Number of purchase orders 40
Number of direct labor hours 60

Problem #2

Vassallo Corporation's activity-based costing system has three cost pools: Machining, Set
Up, and Other. The company's overhead costs, which consist of equipment depreciation
and indirect labor, are allocated to the cost pools in proportion to the activity cost pools'
consumption of resources.

Equipment depreciation $64,000

Indirect labor 4,000

Distribution of Resource Consumption by Cost Pool

Machining Set Up Other Total
Equipment depreciation $12,800 $19,200 $32,000 $64,000
Indirect labor 2,000 400 1,600 4,000
Total $14,800 $19,600 $33,600 $68,000

Costs in the Machining cost pool are assigned to products based on machine-hours
(MHs) and costs in the Setting Up cost pool are assigned to products based on the
number of batches. Costs in the Other cost pool are not assigned to products.

MHs Batches
Product R3 3,800 300
Product D6 16,200 700

Additional data concerning the company's products appears below:

Product R3 Product D6
Sales $168,700 $185,600
Direct materials 77,800 72,300
Direct labor 75,800 79,300

Required: a) Calculate activity rates for each activity cost pool using ABC.
b) Determine the amount of overhead cost that would be assigned to
each product using ABC.
c) Determine the product margins for each product using ABC.

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Problem #3

Wasden Corporation has an activity-based costing system with three activity cost pools-
Processing, Setting Up, and Other. Costs in the Processing cost pool are assigned to
products based on machine-hours (MHs) and costs in the Setting Up cost pool are
assigned to products based on the number of batches. Costs in the Other cost pool are
not assigned to products. Data concerning the two products and the company's costs
and activity-based costing system appear below:

Processing $12,200
Setting Up 25,100
Other 17,700

MHs Batches
Product C7 2,400 700
Product P8 17,600 300

Product C7 Product P8
Sales $135,700 $98,000
Direct materials 61,700 31,000
Direct labor 52,200 45,800

Required: a) Calculate activity rates for each activity cost pool using activity-
based costing.
b) Determine the amount of overhead cost that would be assigned to
each product using activity-based costing.
c) Determine the product margins for each product using activity-
based costing.

Problem #4

Maynard Manufacturing Company allocates overhead in the Machining Department on

the basis of machine hours, while in the Assembly Department overhead is allocated on
the basis of direct labor cost. The following budget data are provided:

Machining Assembly
Manufacturing overhead $500,000 $1,075,000
Direct labor 350,000 500,000

Machine hours 100,000 10,000

Direct labor hours 50,000 150,000
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The following information is provided for a job (Job No. 510) recently completed by the
company:

Machining Assembly
Manufacturing overhead $25,000 $37,500
Direct labor 10,000 12,500

Machine hours 5,000 1,000

Direct labor hours 2,000 3,000

Required: a) Compute the two departmental overhead rates.

b) Compute the cost of Job No. 510.
c) Assume that the company decides to use a single overhead rate
for the two departments, calculated by adding their overhead
costs and using direct labor hours as the allocation base. What
would the overhead rate be, and how much manufacturing
overhead cost would be assigned to Job No. 510?

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Multiple Choice Questions

The next 4 questions refer to the following information.
Bruton, Inc. produces two different products using two different activities:
Machining, which uses machine hours as an activity driver, and Inspection,
which uses number of batches as an activity driver. The cost of Machining is
$500,000, while the cost of Inspection is $30,000. Usage of the activity drivers
are as follows:

Product A Product B Total

Machine hours 1,000 3,000 4,000
Number of batches 45 15 60

Product A is assigned $125,000 in Machining cost, and $22,500 in Inspection

cost. Product B uses 75% of total machine hours and 25% of total batches.

1. What is the activity rate for Inspection?

a) $125 per batch
b) $500 per batch
c) $667 per batch
d) $2,000 per batch

2. What is the total Inspection cost assigned to Product A?

a) $7,500
b) $22,500
c) $125,000
d) $375,000

3. What is the total activity cost assigned to Product B?

a) $7,500
b) $147,500
c) $375,000
d) $382,500

4. What proportion of Machining activity is used by Product A?

a) 25%
b) 33%
c) 67%
d) 75%

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5. Which of the following is most likely to be true of the manufacturing overhead

costs assigned to a product with relatively low volume and high complexity?
a) An ABC system will assign more manufacturing overhead costs to the
product than a volume-based system.
b) A volume-based system will assign more manufacturing overhead costs to
the product than an ABC system.
c) An ABC system will assign the same manufacturing overhead costs to the
product as a volume-based system.
d) An ABC system will assign manufacturing overhead costs to the product,
while a volume-based system will not.

6. Buhl manufactures a product that uses $15 in direct materials and $5 in direct
labor per unit. Under the traditional costing system Buhl uses, manufacturing
overhead applied to each unit is $12. Buhl is considering switching to an ABC
system, under which the total activity cost would be $25. What is the total
manufacturing cost per unit for Buhl under the ABC system?
a) $20
b) $25
c) $32
d) $45

7. Millner Corporation has provided the following data from its activity-based
costing accounting system:
 


Pools Total Cost Total Activity

Designing product design
$1,372,448 7,798
products hours
Setting up
$33,300 740 batch set-ups
batches
Assembling
$126,160 6,640 assembly hours
products


The activity rate for the Designing Products activity cost pool is closest to:
a) $101 per hour
b) $1,372,448 per hour
c) $176 per hour
d) $57 per hour

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8. In activity-based costing, the activity rate for an activity cost pool is computed
by dividing the total overhead cost in the activity cost pool by:
a) the direct labor-hours required by the product.

b) the machine-hours required by the product.

c) the total activity for the activity cost pool.

d) the total direct labor-hours for the activity cost pool.

9. Nethery, Inc., manufactures and sells two products: Product U5 and Product
X2. The company has an activity-based costing system with the following
activity cost pools, activity measures, and expected activity:


Expected Activity
Estimated
Activity Cost Activity Product Product
Overhead Total
Pools Measures U5 X2
Cost
Labor-related DLHs $36,180 2,400 1,200 3,600
Product testing tests 65,760 400 600 1,000
General factory MHs 133,984 4,000 3,900 7,900
$235,924

The total overhead applied to Product U5 under activity-based costing is

closest to:
a) $141,555
b) $67,839
c) $157,272
d) $118,264

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10. Masiclat, Inc., manufactures and sells two products: Product K2 and Product
O8. Data concerning the expected production of each product and the
expected total direct labor-hours (DLHs) required to produce that output
appear below:


Expected Direct Labor- Total Direct

Production Hours Per Unit Labor-Hours
Product K2 500 9.0 4,500
Product O8 700 12.0 8,400
Total direct labor-hours 12,900

The direct labor rate is $21.10 per DLH. The direct materials cost per unit for
each product is given below:
 


Direct Materials Cost per Unit

Product K2 $201.30
Product O8 $298.90

The company is considering adopting an activity-based costing system with the

following activity cost pools, activity measures, and expected activity:


Expected Activity
Estimated

 Activity Activity Product Product
Overhead 
 Total
Cost Pools Measures K2 O8
Cost
Labor-
DLHs $426,861 4,500 8,400 12,900
related
Machine
setups 59,328 400 500 900
setups
General
MHs 442,085 4,300 4,200 8,500
factory
$928,274

The unit product cost of Product K2 under the company's traditional costing
method in which all overhead is allocated on the basis of direct labor-hours is
closest to:
a) $1,038.84
b) $689.01
c) $859.29
d) $984.48

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Solutions to Problems
Problem #1

a)
Product C Product D Total
Direct labor hours: 400 units 1,200 units
X .7 dlh/unit X 1.2 dlh/unit
280 dlh 1,440 dlh 1,720 dlh

Predetermined overhead rate: $130,890 / 1,720 dlh = $76.10/dlh

Unit Product Cost: Product C Product D

Direct Materials $10.70 $ 16.70
Direct Labor 11.20 19.20
Manufacturing Overhead * 53.27 ** 91.32
Total Unit Cost $ 75.17 $127.22

*.7 dlh/unit * $76.10 = $53.27

** 1.2 dlh/unit * $76.10 = $91.32

b)
Activity Cost Pool OH Cost Activity Activity Rate
Machine set-ups $ 13,570 230 setups $59 per setup
Purchase orders 91,520 2,080 orders $44 per order
General Factory 25,800 1,720 dlh $15 per dlh

c)
Product C Product D
Activities Activitiy Estimated Amount Estimated Amount
Rates Activity Activity
Machine set-ups $59 per setup 100 $5,900 130 $7,670
Purchase orders $44 per order 810 35,640 1,270 55,880
General Factory $15 per dlh 280 4,200 1,440 21,600
Total overhead cost $45,740 $85,150
Number of Units 400 1,200
Overhead cost per unit $114.35 $70.96

d)
Unit Product Cost: Product C Product D

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Direct Materials $10.70 $ 16.70
Direct Labor 11.20 19.20
Manufacturing Overhead 114.35 70.96
Total Unit Cost $136.25 $106.86

e)
Overhead Overhead
rate Activity applied
Traditional $76.10 60 dlh $4,566

ABC Machine set-ups $59.00 10 setups $590

Purchase orders $44.00 40 po’s $1,760
General Factory $15.00 60 dlh $900
Total $3,250

Problem #2

a)
Activity Cost Pool OH Cost Activity Activity Rate
Machining $14,800 20,000 MHs $.74 per MH
Setting Up 19,600 1,000 batches $19.60 per batch

b)
Product R3 Product D6
Activities Activity Estimated Amount Estimated Amount
Rates Activity Activity
Machining $.74 per MH 3,800 $2,812 16,200 $11,988
Setting Up $19.60 per batch 300 5,880 700 13,720
Total overhead cost $8,692 $25,700

c)
Product R3 Product D6
Sales $168,700 $185,600
Direct materials 77,800 72,300
Direct labor 75,800 79,300
Machining overhead 2,812 11,988
Setting Up overhead 5,880 13,720
Product margin $6,408 $8,292

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Problem #3

a)
Activity Cost Pool OH Cost Activity Activity Rate
Processing $12,200 20,000 MHs $.61 per MH
Setting Up 25,100 1,000 batches $25.10 per batch

b)
Product C7 Product P8
Activities Activity Estimated Amount Estimated Amount
Rates Activity Activity
Machining $.61 per MH 2,400 $1,464 17,600 $10,736
Setting Up $25.10 per batch 700 17,570 300 7,530
Total overhead cost $19,034 $18,266

c)
Product C7 Product P8
Sales $135,700 $98,000
Direct materials 61,700 31,000
Direct labor 52,200 45,800
Machining overhead 1,464 10,736
Setting Up overhead 17,570 7,530
Product margin $2,766 $2,934

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Problem #4

a)
Machining $500,000
$5.00 per MH
100,000 MH
Assembly $1,075,000
$2.15 per DL$
$500,000 DL$

b)
Machining Assembly Job 510
Direct materials $25,000 $37,500 $62,500
Direct labor 10,000 12,500 22,500
Overhead
Machining 25,000 25,000
Assembly 26,875 26,875
Total $136,875

c)
Plant-wide $1,575,000
$7.875 per DLH
200,000 DLH

Activity Rate Overhead

Plant-wide 5,000 DLH $7.875 per DLH $39,375

Departmental Machining $25,000

Assembly 26,875
$51,875

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Solutions to Multiple Choice Questions

1. B
2. B
3. D
4. A
5. A
6. D
7. C
8. C
9. D
10. A

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