Question

The Garden of Eden Company produces three products: Adam, Eve and Serpent. The company uses a normal cost system and overhead costs are currently charged to products using a plant-wide overhead rate based on machine hours. Because of considerable differences in the support cost needs of each product, it is probably advisable that the company switch to an activity-based costing system to charge overhead to products.

The company expects to produce 1,000 Adams, 3,400 Eves, and 600 Serpents in fiscal year 2019. Each Adam requires 20 direct labor hours and 43 machine hours, Eves require 50 direct labor hours and 30 machine hours, and Serpents require 80 direct labor hours and 25 machine hours. The total direct labor hours and total machine hours the company expects to operate next year are 238,000 direct labor hours and 160,000 machine hours.

Budgeted (Estimated) Overhead Data For 2019:

	Machine	Engineering	Inspect. &	Total
Item	Setups	Changes	Packing	Overhead $’s
Overhead Dollars:	$170,000	$320,000	$470,000	$960,000
Activity Levels:	34 setups	400 Changes	5,000 units

Based on an analysis of the three overhead activities, it was estimated that the three products would require these activities as follows in fiscal year 2019:

				Overall
Activity	Adam	Eve	Serpent	Totals
Machine Setups	5 setups	9 setups	20 setups	34 setups
Engineering Changes	140 changes	8 changes	252 changes	400 changes
Inspection & Packing*	1,000 units	3,400 units	600 units	5,000 units

*All units of each product are individually inspected and packed.

The direct material and direct labor costs included in the three products are as follows:

Item	Adam	Eve	Serpent
Direct Material (per unit)	$680	$300	$730
Direct Labor (per unit)	$900	$560	$850

Required:

a. Calculate the cost of each product using a plant-wide overhead rate based on machine hours.

b. Calculate the activity cost rates for (1) setups, (2) engineering changes and (3) inspection and packing.

c. Cost out the three products using an activity-based costing system.

d. Explain whether the normal costing system (in question 1) or the activity-based system (in question 2) is a better choice for the Garden of Eden.

Answer 1

a. Cost of Each Product using Plant-wide OH Rate

Plant-Wide OH Rate = Total Overheads / Total Machine Hours = $960000 / 160000 = $6 per Machine Hour

b. Computation of Activity Cost rates

Machine Setups = Total Setup OH / Total Setups = $170000 / 34 = $5000 per Setup

Engineering Changes = Total Engineering changes OH / Total Engineering Changes = $320000 / 400 = $800 per Change

Inspection and Packing = Total I&P OH / Total I&P = $470000 / 5000 = $94 per Unit

c. Cost of Three products

d. ABC system is obviously a better in case of multiple products produced by the company as it helps in tracing of OH costsand will accurate product cost and will eventually helps in better decision making and cost management