Question:
Activity-Based Costing and Predetermined Overhead Allocation Rates
Kitchen Supply, Inc. (KSI), manufactures three types of flatware: institutional, standard, and silver. It applies all indirect costs according to a predetermined rate based on direct labor-hours. A consultant recently suggested that the company switch to an activity-based costing system and prepared the following cost estimates for year 2 for the recommended cost drivers.
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|
Recommended
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Estimated
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Estimated Cost
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|
Activity
|
Cost Driver
|
Cost
|
Driver Activity
|
|
Processing orders
|
Number of orders
|
$ 54,000
|
200 orders
|
|
Setting up production
|
Number of production runs
|
216,000
|
100 runs
|
|
Handling materials
|
Pounds of materials used
|
360,000
|
120,000 pounds
|
|
Machine depreciation
|
|
|
|
|
and maintenance
|
Machine-hours
|
288,000
|
12,000 hours
|
|
Performing quality control
|
Number of inspections
|
72,000
|
45 inspections
|
|
Packing
|
Number of units
|
144,000
|
480,000 units
|
|
Total estimated cost
|
|
$1,134,000
|
|
In addition, management estimated 7,500 direct labor-hours for Year 2.
Assume that the following cost driver volumes occurred in January Year 2:
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|
Institutional
|
Standard
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Silver
|
|
Number of units produced
|
60,000
|
24,000
|
9,000
|
|
Direct materials costs
|
$39,000 450
|
$24,000 450
|
$15,000
|
|
Direct labor-hours
|
|
|
600
|
|
Number of orders
|
12
|
9
|
6
|
|
Number of production runs
|
3 15,000 580
|
3 6,000 140
|
6 3,000
|
|
Pounds of material
|
|
|
80
|
|
Machine-hours
|
|
|
|
|
Number of inspections
|
3 60,000
|
3 24,000
|
3 9,000
|
|
Units shipped
|
|
|
|
Actual labor costs were $15 per hour.
Required
a. Compute a predetermined overhead rate for year 2 for each cost driver using the estimated costs and estimated cost driver units prepared by the consultant. Also compute a predetermined rate for year 2 using direct labor-hours as the allocation base.
b. Compute the production costs for each product for January using direct labor-hours as the allocation base and the predetermined rate computed in requirement (a).
c. Compute the production costs for each product for January using the cost drivers recommended by the consultant and the predetermined rates computed in requirement (a).
d. Management has seen your numbers and wants an explanation for the discrepancy between the product costs using direct labor-hours as the allocation base and the product costs using activity-based costing. Write a brief response to management.