Chapter 4, Problem 15P

1

To determine

Predetermined overhead rate

The allocation rate which is calculated to allocate overhead or indirect cost to various cost objects is called predetermined overhead rate.

Unit product cost

It is the total cost incurred to produce a single unit and it is obtained by the division of total cost incurred and total number of units manufactured.

To calculate: The predetermined overhead rate by using direct labor hours (DLHs) and unit product cost.

Answer to Problem 15P

Predetermined overhead rate is $50 per DLH.

Unit product cost of flexible model is $240and unit product cost of regular model is $145.

Explanation of Solution

Predetermined overhead rate based on DLHs will be calculated as:

  $\text{Predetermined overhead rate = }\frac{\text{Expexted overhead costs}}{\text{Total}\text{direct}\text{labor}\text{hours}}$

Here, total expected overhead cost is $6,00,000 and total direct labor hours will be calculated by using the following formula:

  $\begin{array}{l}\text{Total direct labor hours }\left(\text{DLHs}\right)\text{ = (Units produced of flexible model × DLH per unit) }\\ \text{ + }\left(\text{Units produced of regular model × DLH per unit}\right)\\ \text{Total direct labor hours }\left(\text{DLHs}\right)\text{= }\left(\text{1,000 × 2}\right)\text{ + (10,000 × 1)}\\ \text{Total direct labor hours }\left(\text{DLHs}\right)\text{= 2,000 + 10,000}\\ \text{Total direct labor hours }\left(\text{DLHs}\right)\text{ = 12,000}\text{. }\end{array}$

So, predetermined overhead rate will be:

  $\begin{array}{l}\text{Predetermined overhead rate = }\frac{\$600,000}{12,000}\\ \text{Predetermined overhead rate}=\$50\text{ per DLH}\end{array}$

Now, unit product cost will be calculated as follows:

Particulars	Flexible model(in $)	Regular model(in $)
Direct material cost (per unit)	110	80
Direct labor cost (per unit)	30	15
Overhead cost (per unit) (Calculated below)	100	50
Total product cost (per unit)	240	145

Overhead cost per unit will be calculated as:

  $\text{Overhead cost (per}\text{unit) = Given DLH \&*\#x00A0;Predetermind overhead rate}$

For flexible model overhead cost (per unit) will be:

  $\begin{array}{l}\text{Overhead cost (per}\text{unit) = 2 \&*\#x00A0;50}\\ \text{Overhead cost (per}\text{unit)}=\$100\end{array}$

For regular model overhead cost (per unit) will be:

  $\begin{array}{l}\text{Overhead cost (per}\text{unit) = 1 \&*\#x00A0;50}\\ \text{Overhead cost (per}\text{unit)}=\$50\end{array}$

2

To determine

Activity based costing:

ABC is a system that identifies every task performed by the organization as an activity and then cost of every activity is assigned to all the products. Allocation of cost is done by creating a relationship among activity, costs and products.

Activity cost pool:

An activity cost pool represents the aggregate cost incurred by a company while performing one manufacturing process or task.

An activity rate for each activity cost pool.

Answer to Problem 15P

Activity rate:

For purchase orders is $50 per order,

For rework requests is $50 per request,

For product testing is $100 per test and

For machine related activities is $90 per MH.

Explanation of Solution

Activity rates are calculated with the help of following formula:

  $\text{Activity rate = }\frac{\text{Estimated overhead cost }}{\text{Expected}\text{}\text{activity}}$

So, activity rates will be calculated as follows:

Activity cost pool	Activity measure	Expected value of overheads (X)(in $)	Total expected activity (Y)	Activity rate (X/Y)(in $)
Purchase orders	Orders	20,000	400	50 per order
Rework requests	Requests	10,000	200	50 per request
Product testing	Tests	210,000	2,100	100 per test
Machine related	Machine hours (MHs)	360,000	4,000	90 per MH

Activity rate of purchase orders is $50 per order, for rework requests is $50 per request, product testing is $100 per test and machine related activities is $90 per MH.

3

To determine

Overhead cost allocation:

Overhead costs are the indirect costs (not directly related to products) which are incurred to support the general operations within an organization. Total overhead cost incurred is allocated to all the products using the correct measure.

Unit product cost

Unit product cost represents the total cost incurred for producing a single unit. Calculation for this cost is done by dividing total amount of cost by total number of units produced.

Total overhead cost that will be allocated to each product and cost of one unit.

Answer to Problem 15P

Overhead cost allocated to flexible model is $233,000 and to rigid model is $367,000.

Unit product cost of flexible model is $373 and unit product cost of rigid model is $131.7.

Explanation of Solution

Under the ABC system, overhead costs are allocated to each product according to the consumption of each activity by every product. So firstly, consumption ratio for each activity will be calculated.

Calculation of ratio:

Particulars	Flexible model	Rigid model	RatioFlexible: Rigid
Purchase orders	100	300	1:3
Rework requests	60	140	6:14 or 3:7
Product testing	900	1,200	9:12 or 3:4
Machine related	1,500	2,500	15:25 or 3:5

Now, overhead costs will be allocated as follows:

Activity cost pool	Overhead expense(in $)	Ratio	Flexible model(in $)	Rigid model (in $)
Purchase orders (orders)	20,000	1:3	5,000	15,000
Rework requests (requests)	10,000	3:7	3,000	7,000
Product testing (tests)	210,000	3:4	90,000	120,000
Machine related (machine hours)	360,000	3:5	135,000	225,000
Total overhead cost			233,000	367,000

So, total overhead cost allocated to flexible model is $233,000 and to rigid model is $367,000.

Calculation for unit product cost will be done as follows:

Particulars	Flexible model ($)	Rigid model ($)
Total direct material cost	$110* 1000 = 110,000	$80 *10,000= 800,000
Total direct labor cost	$30 *1000 = 30,000	$15* 10,000 = 150,000
Total overhead cost	233,000	367,000
Total product cost	373,000	1,317,000
Number of units	1,000	10,000
Unit product cost	373.00	131.70

4

To determine

Traditional method

In this method, a single measure or base is used to distribute the total overhead cost to all the products.

ABC method

In ABC method, different measures or bases are used in the allocation process.

To explain: Why profit differs or decline when different methods are used.

Explanation of Solution

Amount of profits differ in both the methods and generally, it is less when ABC system is used. This different occurs because cost allocation method in both the methods is different.

Conventional method uses a single or uniform measure to allocate the overhead cost to products and ABC method uses different measures to allocate the overhead costs. Different activity measures are applied for different cost pools. Because of different methods, overhead cost allocated to products differ in both the methods which leads to different profits.