Question

HomeGardens Ltd is a manufacturer of garden fertiliser, and has two main products: VegieGrow and FlowerFood. At present, the company’s management accountant allocates overhead using a factory-wide application rate based on direct labour costs. However, consideration is now being given to implementing an activity-based costing (ABC) system. Two activity cost pools have been developed as follows:

Cost pool

1. Processing 2. Packaging

Activity undertaken

Acquisition and processing of raw materials processed

Products packaged ready for delivery to customers

Cost driver

Number of kilograms

Number of units packaged

The following annual cost and activity data is available for the company’s operations:

Direct labour costs Kilograms processed Units packaged

VegieGrow

$180,000 192,000 kg

90,000 units

FlowerFood

$420,000 320,000 kg 110,000 units

Total annual overhead cost is estimated at $960,000. Overhead cost allocated to the processing activity cost pool is $640,000, and $320,000 is allocated to the packaging activity cost pool.

Requirements:

a) Calculate the overhead rate using the traditional (factory-wide) approach and allocate the total overhead costs to the two products using this method. (1.5 Marks)

b) Calculate the overhead rates using the ABC approach and allocate the total overhead costs to the two products using this method. (2.5 Marks)

c) Explain how an organisation should select an appropriate “cost driver” for an activity cost pool. (1 Mark)

Answer 1

Solution a:

Total overhead cost = $960,000

Total direct labor cost = $180,000 + $420,000 = $600,000

Overhead rate using traditional appproch = Total overhead / Direct labor cost = $960,000 / $600,000 = $1.60 per dollar of direct labor cost.

Overhead cost assigned to Vagied grow = Direct labor cost * Overhead rate = $180,000 * $1.60 = $288,000

Overhead cost assigned to Flower Food = $420,000 * $1.60 = $672,000

Solution b:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	Vegie Grow		Flower Food
					Usage	Allocated Costs	Usage	Allocated Costs
Processing	$640,000.00	Nos of Kilograms	512000	$1.25	192000	$240,000.00	320000	$400,000.00
Packaging	$320,000.00	Nos of units packed	200000	$1.60	90000	$144,000.00	110000	$176,000.00
Total	$960,000.00					$384,000.00		$576,000.00

Solution c:

Cost drivers are characteristics of activities that cause a activity to incur costs. A cost object may be related to different activities, but in determining cost drivers, organization must choose those that linked with the cost object.