Chapter 4, Problem 13E

Handbrain Inc. is considering a change to activity-based product costing. The company produces two products, cell phones and tablet PCs, in a single production department. The production department is estimated to require 2,000 direct labor hours. The total indirect labor is budgeted to be $200,000.

Time records from indirect labor employees revealed that they spent 30% of their time setting up production runs and 70% of their time supporting actual production.

The following information about cell phones and tablet PCs was determined from the corporate records:

1. a. Determine the indirect labor cost per unit allocated to cell phones and tablet PCs under a single plantwide factory overhead rate system using the direct labor hours as the allocation base.
2. b. Determine the budgeted activity costs and activity rates for the indirect labor under activity-based costing. Assume two activities—one for setup and the other for production support.
3. c. Determine the activity cost per unit for indirect labor allocated to each product under activity-based costing.
4. d. Why are the per-unit allocated costs in (a) different from the per-unit activity cost assigned to the products in (c)?

To determine

Compute the indirect labor cost per unit allocated to cell phones and tablet under a single plant wide factory overhead rate system.

Explanation of Solution

Single plant-wide factory overhead rate: The rate at which the factory or manufacturing overheads are allocated to products is referred to as single plant-wide factory overhead rate.

Formula to compute single plant-wide overhead rate:

$\begin{array}{l}\text{Single plant-wide }\\ \text{overhead rate}\end{array}\}\text{ = }\frac{\text{Total budgeted factory overhead}}{\text{Total budgeted plant-wide allocation base}}$

Activity-based costing (ABC) method: The costing method which allocates overheads to the products based on factory overhead rate for each activity or cost object, according to the cost pooled for the cost drivers (allocation base).

Formula to compute activity-based overhead rate:

$\begin{array}{l}\text{Activity-based}\\ \text{overhead rate}\end{array}\}\text{ = }\frac{\text{Budgeted activity cost}}{\text{Total activity-base usage}}$

Compute the indirect labor cost per unit allocated to cell phones and tablet under a single plant wide factory overhead rate system.

Types of Products	Indirect labor cost (A) (2)	Number of units (B)	Indirect labor cost  per unit $\left(\frac{\text{A}}{\text{B}}\right)$
Cell phones	$100,000	80,000	$1.25
Tablets	$100,000	80,000	$1.25

Table (1)

Working note (1):

Compute the single plant-wide overhead rate using direct labor hour (DLH) as the allocation base.

$\begin{array}{c}\begin{array}{l}\text{Single plant-wide }\\ \text{overhead rate}\end{array}\}\text{ = }\frac{\text{Total budgeted factory overhead}}{\text{Total budgeted plant-wide allocation base}}\\ \text{= }\frac{\text{\$200,000}}{\text{2,000 DLH}}\\ \text{= \$100 per DLH}\end{array}$

Working note (2):

Compute the total indirect labor cost for each product.

Types of Products	Indirect labor hours	×	Single Plant-Wide Overhead Rate (1)	=	indirect labor cost
Cell phones	1,000	×	$100 per DLH	=	$100,000
Tablets	1,000	×	$100 per DLH	=	$100,000

Table (2)

To determine

Compute the activity-based overhead rate for each of the given activities.

Explanation of Solution

Compute the activity-based overhead rates for each activity.

Computation of Activity-Based Overhead Rates
Activity	Activity Cost (C)	Total Activity-Base Usage (D)	Activity-Based Overhead Rates $\left(\frac{\text{C}}{\text{D}}\right)$
Setup	$60,000 (3)	4,000 setups	$15 per setup
Production support	140,000 (4)	2,000 DLH	$70 per DLH

Table (3)

Working note (3):

Compute the activity cost for setup activity.

$\begin{array}{c}\text{Activity cost for setup = }\left\{\begin{array}{l}\text{Indirect labor budgeted×}\\ \text{Percentage of setup cost}\end{array}\right\}\\ \text{=\$200,000×}\frac{\text{30}}{100}\\ \text{=\$60,000}\end{array}$

Working note (3):

Compute the activity cost for production support activity.

$\begin{array}{c}\begin{array}{l}\text{Activity cost for }\\ \text{production support}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Indirect labor budgeted×}\\ \text{Percentage of production support cost}\end{array}\right\}\\ \text{=\$200,000×}\frac{\text{70}}{100}\\ \text{=\$140,000}\end{array}$

To determine

Compute the activity-cost per unit of the each product.

Explanation of Solution

Compute the activity cost allocated per unit of cell phone.

Activity	Activity-Based Overhead Rates	×	Actual Use of Activity-Base (Cost Driver)	=	Activity Cost Allocated
Setup	$15 per setup	×	1,200 setups	=	$18,000
Production support	$70 per DLH	×	1,000 DLH	=	70,000
Total activity costs allocated to cell phones (E)					$88,000
Number of units of cell phone (F)					80,000 units
Activity-based overhead cost per unit of cell phone $\left(\frac{\text{E}}{\text{F}}\right)$					$1.10

Table (4)

Note: Refer to Table (2) for the value and computation of activity allocation rates.

Compute the activity cost allocated per unit of tablet.

Activity	Activity-Based Overhead Rates	×	Actual Use of Activity-Base (Cost Driver)	=	Activity Cost Allocated
Setup	$15 per setup	×	2,800 setups	=	$42,000
Production support	$70 per DLH	×	1,000 DLH	=	70,000
Total activity costs allocated to tablets (G)					$112,00
Number of units of tablet (H)					80,000 units
Activity-based overhead cost per unit of tablet $\left(\frac{\text{G}}{\text{H}}\right)$					$1.40

Table (5)

Note: Refer to Table (2) for the value and computation of activity allocation rates.

To determine

Discuss the reason why the per unit allocated costs in single plant-wide overhead rate approach is different from the per unit allocated costs in the activity based costing.

Explanation of Solution

The product cost under single plant-wide overhead rate approach and ABC approach are different. The product cost is distorted in single plant-wide overhead rate approach because the time spent for setup production for cell phones and tablets is not in the same ratio as the direct labor hours used in support production for cell phones and tablets.