Activity-Based Costing and Product Cost Distortion Digital Storage Concept Inc.
ID: 2550930 • Letter: A
Question
Activity-Based Costing and Product Cost Distortion
Digital Storage Concept 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 4,000 direct labor hours. The total indirect labor is budgeted to be $571,200.
Time records from indirect labor employees revealed that they spent 40% of their time setting up production runs and 60% of their time supporting actual production.
The following information about cell phones and tablet PCs was determined from the corporate records:
If required, round your answers to the nearest cent.
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.
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.
c. Determine the activity cost per unit for indirect labor allocated to each product under activity-based costing.
d. Why are the per-unit allocated costs in (a) different from the per-unit activity cost assigned to the products in (c)?
The per-unit indirect labor costs in (a) are distorted because setup activity is consumed by the products in a different ratio from the direct labor. The activity-based costing method results in the product with the larger number of setups receiving a larger portion of the setup activity cost. The single rate system allocates overhead only on the basis of direct labor hours. Since the direct labor hours are equal for each product, the allocated indirect labor will also be equal.
Number ofSetups Direct Labor
Hours Units Cell phones 500 2,000 68,000 Tablet PCs 1,100 2,000 68,000 Total 1,600 4,000 136,000
Explanation / Answer
Digital Storage Concept
Total indirect labor cost = $571,200
Total direct labor hours = 4,000
Plantwide factory overhead rate per direct labor hour = $571,200/4,000 = $142.80
Direct labor hours
Direct labor hour rate
Total indirect labor cost
number of units
Cost per unit
cell phones
2,000
$142.80
$285,600
68,000
$4.20
tablet PCs
2,000
$142.80
$285,600
68,000
$4.20
Budgeted activity cost
usage
activity rate
setup
$228,480
1,600 setups
142.8 per setup
production support
$342,720
4,000 direct labor hours
$85.68 per hour
Note: setup cost is 40% of indirect labor cost = 40% of 571,200 = $228,480
Production support cost is 60% = 60% of 571,200 = $342,720
cell phones
$3.57 per unit
Tablet Pca
$4.83 per unit
Working –
cell phone
activity rate
activity usage
total activity cost
setup
$142.80 per setup
500 setups
$71,400
production support
$85.68
2,000
$171,360
Total indirect cost
$242,760
number of units
68,000
cost per unit
$3.57
Tablet PCs
activity rate
activity usage
total activity cost
setup
$142.80 per setup
1,100
$157,080
production support
$85.68
2,000
$171,360
Total indirect cost
$328,440
number of units
68,000
cost per unit
$4.83
Direct labor hours
Direct labor hour rate
Total indirect labor cost
number of units
Cost per unit
cell phones
2,000
$142.80
$285,600
68,000
$4.20
tablet PCs
2,000
$142.80
$285,600
68,000
$4.20
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