Question

ACTIVITY BASED COSTING

Surfs Up manufactures surfboards. The company produces two models: the small board and the big board. Data regarding the two boards are as follows:

                              Direct Labor               Annual                             Total Direct

     Product          Hours per Unit          Production                        Labor Hours

       Big                        1.5                        10,000 boards                         15,000

       Small                    1.0                        35,000 boards                         35,000

The big board requires $75 in direct materials per unit, whereas the small board requires $40. The company pays an average direct labor rate of $13 per hour. The company has historically used direct labor hours as the activity base for applying overhead to the boards. Manufacturing overhead is estimated to be $1,664,000 per year. The big board is more complex to manufacture than the small board because it requires more machine time.

Blake Moore, the company’s controller, is considering the use of activity-based costing to apply overhead because the surfboards require such different amounts of machining. Blake has identified the following four separate activity centers.      

                                                                                                Volume of Annual Activity

                                                                Traceable O/H                   Big                  Small

Activity Center          Cost Driver                Costs                         Board             Board

Machine Setup            Number of Setups       $100,000                   100                100

Special Design            Design Hours             $364,000                   900                100

Production                   Direct Labor Hours     $900,000                   15,000           35,000

Machining                   Machine Hours            $300,000                   9,000           1,000

Required:

a.    Calculate the predetermined overhead rate using the traditional overhead allocation with direct labor hours as the base.

b.    Determine the total cost to produce one unit of each product. (Use the overhead rate calculated above in Part A).

c.     Assume that Surfs Up has made the change to ABC, calculate the overhead rate for each activity center.

d.    Using the rates calculated in Part C, determine the amount of overhead assigned to each unit of product.

e.    Using the information from Part D, compute the cost to produce one unit of each product.

Answer 1

a. Predetermined Overhead rate using direct labor hours as the allocation base:

Total Manufacturing Overhead estimated = $1,664,000

Total Number of Labor hours = 15,000 + 35,000 = 50,000 hours.

Predetermined overhead rate = $1,664,000 50,000 = $33.28 per labor hour.

b. Total cost to produce one unit of each product, using the above calculated overhead rate:

Total Cost per unit of Big board is $144.42 and per unit of Small Board is $86.28 based on traditional allocation of overhead.

c. Overhead rate for each activity center:

d. Using the above rates in Part C, the amount of overhead assigned to each unit of product is as follows:

Overhead cost for Big Board is $91.76 per unit and for Small Board it is $21.33 per unit.

e. Cost to Produce one unit of each product based on ABC is as follows:

Total cost of Big Board is $186.26 and that of Small Board is $74.33