Question

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.

Standard Custom
Direct labor costs $59,000 $112,000
Machine hours 1,380 1,110
Setup hours 101 370
Total estimated overhead costs are $309,000. Overhead cost allocated to the machining activity cost pool is $200,000 and $109,000 is allocated to the machine setup activity cost pool.
(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 between the two approaches.

Answer 1

Saddle Inc.

a) The overhead rate using the traditional (plantwide) approach is:

= $1.81 per direct labor cost.

b) The overhead rates using the activity-based costing approach:

Machining activity = $80.32

Machine setup activity = $231.42

c) The traditional approach overallocated total overhead by $515 than the activity-based approach.

Under the traditional approach, overhead allocated to the Custom product was $27,940 more than under the activity-based approach.

Similarly, under the activity-based approach, overhead allocated to the Standard product was $27,425 more than under the traditional approach.

The difference in the two being the overallocated overhead of $515 stated above.

Step-by-step explanation:

a) Data and Calculations:

Estimated overhead costs = $309,000

Overhead allocated:

Machining activity = $200,000

Machine setup activity = $109,000

Standard Custom Total

Direct labor costs $59,000 $112,000 $ 171,000

Machine hours 1,380 1,110 2,490

Setup hours 101 370 471

Overhead rate using plantwide approach:

Total overhead/Total direct labor costs

= $309,000/$171,000 = $1.81 per direct labor cost

Overhead rates, using activity-based costing:

Machining activity = $80.32 ($200,000/2,490)

Machine setup activity = $231.42 ($109,000/471)

Overhead Allocation

Standard Custom Total

Plantwide $106,790 $202,720 $309,510

($59,000 * $1.81) ($112,000 * $1.81)

Activity-based:

Machining $110,842 $89,155 $199,997

(1,380 * $80.32) (1,110 * $80.32)

Machine setup 23,373 85,625 108,998

(101 * $231.42) (370 * $231.42)

Total costs $134,215 $174,780 $308,995

Difference $27,425 $27,940 $515