Escuha Company produces two type of calculators: scientific and business. Both p

Question

Escuha Company produces two type of calculators: scientific and business. Both products pass through two producing departments. The business calculator is by far the most popular. The following data have been gathered for these two products:

1) Compute the overhead cost per unit for each product using a plantwide, unit-based rate
using direct labor hours.

2) Compute the overhead cost per unit for each product using departmental rates. In
calculating departmental rates, use machine hours for Department 1 and direct labor hours
for Department 2. Repeat using direct labor hours for Department 1 and machine hours for
Department 2.

3) Compute the overhead cost per unit for each product using activity-based costing.

4) Comment on the ability of departmental rates to improve the accuracy of product costing.

Explanation / Answer

1) Budgeted overhead per labour hour = $1650000/1100000 = $1.5 per hour

Overhead cost per unit for each product

Scientific = ($1.5*100000)/75000 = 2 per unit

Business = ($1.5*1000000)/750000 = 2 per unit

2)

a. Use machine hours for department 1 and direct labor hour for dept2

Dept 1 = $850000/425000 = $2 per machine hour

Dept 2 = $800000/912500 = $0.8767 per labor hour

b. Use labor hours for department 1 and machine hour for dept2

Dept 1 = $850000/187500 = $4.5333 per labor hour

Dept 2 = $800000/125000 = $6.4 per machine hour

3)

Therefore overhead cost per unit for each product

Scientific = $5.9515 per unit

Business = $1.60485 per unit

4)

A second method, frequently referred to as the traditional two stage allocation approach, recognizes that there are service areas and producing areas in the plant. In the traditional two stage approach, service department costs are allocated to the producing departments in the first stage and then allocated (applied or traced) to the products produced along with other producing department overhead in the second stage using departmental overhead rates. A conceptual view of the idea is presented in Exhibit 6-1. Usually, only one overhead rate is developed for each producing department, although the basis for these rates may differ between departments. The various producing departments might use direct labor hours, equivalent units, material costs or machine hours, as an allocation basis. In the traditional approach, the activity measures, or allocation bases, are almost always related to production volume (like the four mentioned in the previous sentence). This traditional approach will provide accurate product costs if each producing department produces (or partially produces) a single product, or a few similar products, that consume all indirect resources within a department in the same proportion and in proportion to the allocation basis used. If Product X consumes 20 percent of one indirect resource within a department, it must consume 20 percent of all of the indirect resources within the department and the allocation basis must reflect this percentage. Otherwise a single departmental rate will not provide accurate product costs.

Activity cost driver total cost Scientific Business Set up cost No of production run $450000 $180000 $270000 Inspection cost inspection hours $350000 $140000 $210000 Power machine hours $400000 $36363.6364 $363636.3636 Maintenance cost Maintenance houra $450000 $90000 $360000 Total $1650000 $446363.6364 $1203636.3636 No of units 825000 75000 750000

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