.Bright Window Company designs and builds custom windows for luxury homes. Most of the windows are custom made but occasionally the company does mass production on order. Its budgeted manufacturing overhead costs for the year 2011 are as follows:
Overhead Cost Pools Amount
Purchasing $ 180,000
Production (cutting, milling, finishing) 400,000
Setting up machines 135,000
Inspecting 160,000
Utilities 300,000
Total budget overhead costs $1,175,000
For the last three years, the company has been charging overhead to products on the basis of machine hours. For the year 2011, 100,000 machine hours are budgeted.
Susan Craft, owner-manager of Bright Window, recently directed her accountant to implement the activity-based costing system she has repeatedly proposed. At Susan's request, the accountant and production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.
Overhead Cost Pools Activity Cost Drivers Total Drivers
Purchasing Number of orders 500
Production (cutting, milling, finishing) Direct labor hours 80,000
Setting up machines Number of setups 1,000
Inspecting Number of inspections 5,000
Utilities Square feet occupied 75,000
During this month, the company received an order for 50 window sets from a housing development contractor. The accountant prepares cost estimates for producing components for 50 window sets so Susan can submit a contract price per window set to the contractor. The following data for the production of 50 window sets is accumulated:
Direct materials $120,000
Direct labor $135,000
Machine hours 12,000
Direct labor hours 10,000
Number of purchase orders 50
Number of machine setups 80
Number of inspections 380
Number of square feet occupied 7,000
Instructions
(a) Compute the predetermined overhead rate using traditional costing with machine hours as the basis.
(b) Compute the manufacturing cost per window set under traditional costing.
(c) Compute the manufacturing cost per window set under the proposed activity-based costing.
Solution:
Part a) Predetermined overhead rate using traditional costing with machine hours as the basis.
| Overhead rate = | Total budgeted overhead cost |
| Total Machine hours |
Total budgeted overhead cost = $11,75,000
Budgeted Machine hours = 100,000 hours
Overhead rate = $11,75,000/ 100,000
= $11.75/hour.
b) Manufacturing cost per window set under traditional costing
Since cost of 50 units is given , we will first compute total manufacturing cost for 50 window set, then we will divide it with 50 , to get cost per window. We will use machine hours to compute overhead cost share as we are coumpting under traditional costing.
Manufacturing cost= Direct costs + Share of Overhead cost
| Particulars | Cost ($) |
| Direct Materials (Given) | 1,20,000 |
| Direct Labour (Given) | 1,35,000 |
| Overhead Cost (12000 hrs * 11.75/hour) | 141000 |
| Total cost for 50 Windows sets | 3,96,000 |
| Cost Per Window Set= | Total cost for 50 Windows sets |
| 50 windows sets |
= $396,000/ 50 sets
= $7,920 /window set.
c) Manufacturing cost per window set under Activity based costing
Activity based costing is a costing technique where cost are assigned to output or services according to actual consumption by each activity. In Activity based costing costs are assigned after identifying suitable cost drivers related to each activity. For example; No of setups is a cost driver, which will be used to allocate Set Up activity cost.
Steps:
1. We will compute Activity based overhead rate . Activity based overrate is ascertained by Dividing a particular activity overhead cost by total driver pool assigned to that activity.
2. Computation of overhead cost based on the Activity-Based overhead rate computed in step 1.
3. Calculation of manufacturing/ cost per window set.
Step 1 Computation of Activity-Based Overhead rate
| Overhead Cost Pools | Amount ($) (A) | Activity cost driver | Total Drivers (B) | Activity-Based Overhead rate (A/B) ($) |
| Purchasing | 180,000 | Number of orders | 500 | $360/ order |
| Production (cutting, milling, finishing) | 400,000 | Direct labor hours | 80000 | $5/hour |
| Setting up machines | 135,000 | Number of setups | 1000 | $135/setup |
| Inspecting | 160,000 | Number of inspections | 5000 | $32/ inspection |
| Utilities | 300,000 | Square feet occupied | 75000 | $4/ sq feet |
Step 2 Computation of overhead cost based on the Activity-Based overhead rate computed in step 1
| Overhead Cost Pools | Activity cost driver | Driver for 50 sets | Activity-Based Overhead rate | Overhead cost ($) |
| Purchasing | Number of orders | 50 | $360/ order | 18,000 |
| Production (cutting, milling, finishing) | Direct labor hours | 10,000 | $5/hour | 50,000 |
| Setting up machines | Number of setups | 80 | $135/setup | 10,800 |
| Inspecting | Number of inspections | 380 | $32/ inspection | 12,160 |
| Utilities | Square feet occupied | 7,000 | $4/ sq feet | 28,000 |
| Total | 118,960 |
Step 3 Calculation of manufacturing/ cost per window set.
| Particulars | Cost ($) |
| Direct Materials (Given) | 120,000 |
| Direct Labour (Given) | 135,000 |
| Overhead Cost (Step 2) | 118,960 |
| Total cost for 50 Windows sets | 373,960 |
| Cost Per Window Set= | Total cost for 50 Windows sets |
| 50 windows sets |
= $373,960 / 50 sets
Cost Per Window set = $ 7,479.2/ set
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