Question

E17.1 Saddle Inc. has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has heard of activity-based costing and wants to see how the results would differ if this system were used. Two activity cost pools were developed: machining and machine setup. Presented below is information related to the company's operations.

Assign overhead using traditional costing and ABC.

		Standard		Custom
Direct labor costs		$50,000		$100,000
Machine hours		1,000		1,000
Setup hours		100		400

Total estimated overhead costs are $240,000. Overhead cost allocated to the machining activity cost pool is $140,000, and $100,000 is allocated to the machine setup activity cost pool.

Instructions

a. Compute the overhead rate using the traditional (plantwide) approach.

b. Compute the overhead rates using the activity-based costing approach.

c. Determine the difference in allocation between the two approaches.

Answer 1

a. overhead allocation using traditional system

	standard	custome
overhead cost	80,000 (240,000 x 5/15)	160,000 (240,000 x 10/15)

b. overhead allocation using activity-based costing

activity	cost	basis of allocation	standard	custom
machining activity	140,000	machine hour	70,000 (140,000 x1/2)	70,000 (140,000 x1/2)
machine setup	100,000	setup hour	20,000 (100,000 x 1/5)	80,000 (100,000 x 4/5)
total cost			90,000	150,000

c. difference between two approaches

Products	traditional system	activity-based cost
standard	80,000	90,000
custom	160,000	150,000