ACTIVITY-BASED COSTING PROBLEM

Contrasting Traditional Costing & Activity-Based Costing

ACCT 2102 : Handout #7-2

The Markowitz Company produces three products: Alpha, Beta, and Zeba. The company uses a normal cost
system and overhead costs are currently charged to products using a plant-wide overhead rate based on machine
hours. Because of considerable differences in the support cost needs of each product, it is probably advisable
that the company switch to an activity-based costing system to charge overhead to products.

The company expects to produce 1,000 Alphas, 3,400 Betas, and 600 Zebas in fiscal year 2000. Each Alpha
requires 20 direct labor hours and 43 machine hours, Betas require 50 direct labor hours and 30 machine hours,
and Zebas require 80 direct labor hours and 25 machine hours. The total direct labor hours and total machine
hours the company expects to operate next year are 238,000 direct labor hours and 160,000 machine hours.

Budgeted (Estimated) Overhead Data For 1999:

Machine Engineering Inspect. & Total

Item Setups Changes Packing Overhead $’s

Overhead Dollars: $170,000 $320,000 $470,000 $960,000

Activity Levels: 34 setups 400 Eng. Chgs 5,000 units

Based on an analysis of the three overhead activities, it was estimated that the three products would require
these activities as follows in fiscal year 2000:

Overall
Activity Alphas Betas Zebas Totals
Machine Setups 5 setups 9 setups 20 setups 34 setups

Engineering Changes 140 changes 8 changes 252 changes 400 changes

Inspection & 1,000 units 3,400 units 600 units 5,000 units
Packing*

*All units of each product are individually inspected and packed.

The direct material and direct labor costs included in the three products are as follows:

Item Alphas Betas Zebas

Direct Material (per $680 $300 $730
unit)
Direct Labor (per unit) $900 $560 $850

Required:

1. Calculate the cost of each product using a plant-wide overhead rate based on machine hours.

2. Calculate the activity cost rates for (1) setups, (2) engineering changes and (3) inspection and packing.

3. Cost out the three products using an activity-based costing system.

 ACTIVITY-BASED COSTING PROBLEM
SOLUTION TO HANDOUT #7-2

1. The Cost of Each Product Using a Plant-Wide Rate Based On Machine Hours:

Step 1: Calculation of plant-wide overhead rate:

Total budgeted machine hours =

1,000 Alphas x 43 MH per unit + 3,400 Betas x 30 MH per unit + 600 Zebras x 25 MH/unit = 160,000
MH

Plant-wide Overhead Rate = Total Budgeted Overhead Dollars/Total Budgeted Machine Hours
= $960,000/ 160,000 machine hours = $6.00 per MH

Step 2: Calculation of each product’s cost using a plant-wide overhead rate:

Cost Item Alphas Betas Zebas

Direct Material $680 $300 $730
Direct Labor 900 560 850
Manufacturing Overhead 258* 180** 150***
Total Unit Cost $1,838 $1,040 $1,730

*43 MH @ $6 per MH = $258; **30 MH @ 6 per MH = $180; ***25 MH @ 6 per MH = $150

2. The Activity Cost Rates for (1) Setups, (2) Material Handling and (3) Packaging and Shipping:

(1) (2) (3)

Budgeted Estimated Activity
Activity Overhead Volume Cost
Dollars Level Rates*
Machine Setups $170,000 34 setups $5,000 per setup
Engineering Changes $320,000 400 changes $800 per change
Inspection & Packing $470,000 5,000 units $94 per unit

Note: column 3 = column 1 divided by column 2

3. Cost of The Three Products Using an Activity-Based Costing System:

1,000 3,400 600

Cost Item Alphas Betas Zebas
Direct Material 680,000 1,020,000 438,000
Direct Labor 900,000 1,904,000 510,000
Manufacturing Overhead:
- Machine Setups:
5 setups @ $5,000 per setup = $ 25,000 25,000
9 setups @ $5,000 per setup = $ 45,000 45,000
20 setups @ $5,000 per setup = $100,000 100,000
- Engineering Changes:
140 changes @ $800 per change = $112,000 112,000
8 changes @ $800 per change = $ 6,400 6,400
252 changes @ $800 per change = $201,600 201,600
- Inspecting & Packing:
1,000 units @ $94 per unit = $ 94,000 94,000
3,400 units @ $94 per unit = $319,600 319,600
600 units @ $94 per unit = $ 56,400 56,400
Total Manufacturing Cost For All Units $1,811,000 $3,295,000 $1,306,000
Total Units Produced 1,000 3,400 600
Total Cost Per Unit $1,811* $969.12** $2,176.66 *

* $1,811,000 / 1,000 units = $1,811 per unit; ** Same calculation for Betas and Zebas