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. Plantwide Overhead Rate= Total Overhead/ Total Labour Cost

$240000/150000=$1.60

b. Computation of Overhead Rate as per ABC
Activity	Overhead (a)	Activity(b)	Overhead Rate (a/b)
Machining	$140,000.00	2000	$70.00
Machine Setup Activity	$100,000.00	500	$200.00

C. The difference between allocation between 2 approach that in Plant Wide Overhead Approach, overhead allocated on the basis of single activity . However, as per ABC, activity rate calculate for each activity and accordingly overhead has been assinged activity wise.