Sydney Dandons manufactures Motor Skate Boards in two distinct models, Easy and

ID: 2582770 • Letter: S

Question

Sydney Dandons manufactures Motor Skate Boards in two distinct models, Easy and Sharp. Sydney Dandons 2016 books reveal the following pieces of cost and activity information:

Number of Number of

Product Assembly activity Tuning activity Direct Labour Hours

Easy 31 301 6501

Sharp 71 501 1501

Indirect costs pertaining to ‘Assembly’ are $201,000 and ‘Tuning’ are $601,000.

Your manager, Joe, is interested in making a comparison between the Simple/Peanut Butter/Traditional costing system and the advanced Activity-Based costing (ABC) system. Joe asks you to work out ‘a’ and ‘b’ below under the Simple/Traditional costing system, applying all the $802,000 indirect/overhead costs using direct labour hours as the indirect cost allocation base.

Then, Joe asks you to work out ‘c’ and ‘d’ below under the advanced activity-based costing (ABC) system and using the number of ‘Assembly activity’ and the number of ‘Tuning activity’ as the cost drivers (i.e. cost allocation bases) for allocating the given overhead/indirect costs:

the amount of indirect/overhead costs assigned to the Easy model?

the amount of indirect/overhead costs assigned to the Sharp model?

the amount of indirect/overhead costs assigned to the Easy model?

the amount of indirect/overhead costs assigned to the Sharp model?

Round off all calculations to 2 decimal places.

Finally, Joe, asks you to:

e. Evaluate/interpret the difference you observe in the costs worked out under ‘a’ and ‘b’ (i.e. the Simple/Traditional costing system) and the costs worked out under ‘b’ and ‘c’ (i.e. under the ABC system), and conclude which of the two costing systems is a better reflection of the allocation of the indirect/overhead costs, and why?

Explanation / Answer

Allocation of overhead cost under traditional system:
Pre-determined overhead rate = overhead costs / Total direct labor hours
= $802,000 / (6,501+1,501)
= 802,000 / 8,002 = $100.2249 per direct labor hour.
Cost allocation to two products under traditional system:
Easy = Direct labor hours * rate per hour
= 6,501*$100.2249 = $651,562.4
Sharp = 1,501* $100.2249 = 150,437.6

Allocation of overhead cost based on ABC system:

Product

Easy

Sharp

Total

Assembly activity (31+71=102)

(201,000*31/102) = 61,088.24

(201,000*71/102) = 139,911.76

201,000

Tuning activity (301+501=802)

(601,000*301/802) = 225,562.34

(601,000*501/802) = 375,437.66

601,000

286,650.58

515,349.42

802,000

By comparing the above two allocations, we can clearly see that for product easy overhead cost is more than the other product. Thus, we can say that ABC is accurate method than the traditional method.
Under ABC system cost are allocated based on activity levels.