Hansen Company uses activity-based costing. The factory overhead budget for the
ID: 341782 • Letter: H
Question
Hansen Company uses activity-based costing. The factory overhead budget for the coming period is $1,053,000, consisting of the following:
Cost Pool
Budgeted Amount
Supervision
$320,000
Machine usage
420,000
Machine setups
187,000
Design changes
126,000
Totals
$1,053,000
The potential allocation bases and their estimated amounts were as follows:
Allocation Base
Budgeted Amount
Number of design changes
35
Number of setups
110
Machine hours
6,000
Direct labor hours
10,000
a. What is the reason behind the difference in the costs of the job using Activities-based costing vs. the direct labor hour method of applying overhead?
Cost Pool
Budgeted Amount
Supervision
$320,000
Machine usage
420,000
Machine setups
187,000
Design changes
126,000
Totals
$1,053,000
Explanation / Answer
If Direct labor hour method of applying overhead is used, we will have a single overhead recovery rate ...
i.e 1053,000 / 10000 = 105.3 hours.
But Activity based costing method, makes the allocation more meaning full by allocating the overhead with multiple rates based on the activity demand. Such multiple overhead rate based on activity pools and drivers is as under
Difference
In customized production scenarios ( Job work) we see high amount of hetrogeneity in each job we under take. That means some jobs require more design changes, while less machine work. Some other jobs require more machine work than labor and supervison work. In the absence of activity based costing approach, over head application based on direct labor hour method provides wrong cost allocation leading wrong prices being quoted for jobs. This results in loss from accepted jobs, oppurtunity loss from unsuccessful bids.
Thus true cost allocation is not possible with direct labor hour method, if there is absence of homogeneity in jobs being performed.
Activity Amount Activity Over head rate Job design 126000 35 Designs 3600 Machine setup 187000 110 Setups 1700 Supervision 320000 10000 Lab Hours 32 Machine usage 420000 6000 Mac Hours 70Related Questions
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