A company manufactures two products, P and R. P is the more complex of the two products, requiring more direct labor time and more machine time per unit than R.
Manufacturing overhead is currently assigned to the products on the basis of direct labor hours. The company has gathered some activity information and is interested in the differences between its present costing method and activity based costing. All overhead costs should be allocated to the products. The overhead cost pools and activity drivers are as follows;
ACTIVITY POOL OVERHEAD COSTS TOTAL DRIVER USAGE
Setup $256,000 3,200 setups
Material Purchasing $110,000 2,750 purchase orders
Machining/Fabricating $136,000 27,200 machine hours
TOTAL OVERHEAD COSTS $502,000
Other product information is as follows:
P R
Number of units produced 40,000 10,000
Direct labor hours 20,000 30,000
Setups 2,800 400
Purchase orders 680 2,070
Machine hours 19,200 8,000
1) Using the traditional method of allocating overhead based on direct labor hours, compute the total overhead costs of products P and R.
2) Using an activity based approach, compute the total overhead costs of products P and R. SHOW ALL OF YOUR CALCULATIONS.
3) Which method of allocation gives a better understanding of the costs of each product? Briefly explain your answer.