Chapter 9, Problem 51P

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.

In addition, management estimated 7,500 direct labor-hours for year 2.

Assume that the following cost driver volumes occurred in January, year 2:

Actual labor costs were $15 per hour.

Required

1. 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.
2. 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).
3. 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). (Note: Do not assume that total overhead applied to products in January will be the same for activity-based costing as it was for the labor-hour-based allocation.)
4. 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.