Direct labor or machine hours may not be the appropriate costdriver for overhead
in all areas of manufacturing due to the complexities of manymanufacturing
processes. Many companies use activity-based costing (ABC) whichuses multiple drivers
(items that consume resources) rather than just one driver toapply overhead to their
activities. With ABC, a company can use a cost driver that has adirect cause/effect relationship
in its applied overhead costs.
Evian looked into ABC as a method of costing because of thevariety of items it
produces and the many different activities in which it isinvolved. The activities listed
below are a sample of possible cost pools for Evian.
Assembling
Payroll
Billing
Plant supervision
Digging trenches
Purchasing materials
Machine maintenance
Selling
Machine setups
Testing
Molding
Welding
Packaging
Instructions for part 4
(a) For each of these cost pools, what would be thelikely activity cost driver?
(b) Using the following information, determine theoverhead rates and the actual cost assigned for each of theactivity cost pools in a possible ABC system forEvian.
EVIAN CORPORATION
Expected
Use of Actual
Estimated CostDrivers Use of
Activity CostPools Cost Drivers Overhead per Activity Drivers
Irrigationinstallation Labor cost $1,999,500 12,900 12,941
Machining (all machine use) Machine hours 1,670,400 33,408,000 33,409,000
Customer orders # of orders 30,636 2,553 2,520
Shipping none(direct) N/A traced directly
Design Cost per design 820 10 7
Selling Number of calls 372,300 21,900 22,100
(d) (1) The results of ABC can provide a more accuratepicture of costs. Discuss the value of Evian using this system todetermine overhead costs.
(2) How might using ABC affect decision making atEvian?
Direct labor or machine hours may not be the appropriate costdriver for overhead
in all areas of manufacturing due to the complexities of manymanufacturing
processes. Many companies use activity-based costing (ABC) whichuses multiple drivers
(items that consume resources) rather than just one driver toapply overhead to their
activities. With ABC, a company can use a cost driver that has adirect cause/effect relationship
in its applied overhead costs.
Evian looked into ABC as a method of costing because of thevariety of items it
produces and the many different activities in which it isinvolved. The activities listed
below are a sample of possible cost pools for Evian.
Assembling
Payroll
Billing
Plant supervision
Digging trenches
Purchasing materials
Machine maintenance
Selling
Machine setups
Testing
Molding
Welding
Packaging
Instructions for part 4
(a) For each of these cost pools, what would be thelikely activity cost driver?
(b) Using the following information, determine theoverhead rates and the actual cost assigned for each of theactivity cost pools in a possible ABC system forEvian.
EVIAN CORPORATION
Expected
Use of Actual
Estimated CostDrivers Use of
Activity CostPools Cost Drivers Overhead per Activity Drivers
Irrigationinstallation Labor cost $1,999,500 12,900 12,941
Machining (all machine use) Machine hours 1,670,400 33,408,000 33,409,000
Customer orders # of orders 30,636 2,553 2,520
Shipping none(direct) N/A traced directly
Design Cost per design 820 10 7
Selling Number of calls 372,300 21,900 22,100
(d) (1) The results of ABC can provide a more accuratepicture of costs. Discuss the value of Evian using this system todetermine overhead costs.
(2) How might using ABC affect decision making atEvian?
Related questions
Section IV: Alternative Costing Method
Hampshire has always produced stick umbrellas. However, it isconsidering expanding its production to include collapsibleumbrellas. This consideration has been spurred by Tours Today, atouring company that is interested in providing its customers withcollapsible umbrellas imprinted with its logo. The management atHampshire is currently working out a deal with the touring companyto produce 3,000 collapsible umbrellas and believes it can sellthose umbrellas for $14.00 each. Here are the costs that can bedirectly traced to this special order:
Direct Materials: $9,300
Direct Labor Hours: 600
Hourly Rate of Direct labor: $8.00
In the traditional costing approach, overhead is applied at therate of $24.60 per labor hour. This expansion in production willadd additional overhead costs. The total overhead costs (assumingproduction of the stick and collapsible umbrellas) to include thecost pools and cost drivers are provided in Table 2.
An alternative costing method that might benefit Hampshire isthe implementation of activity-based costing (ABC).Hampshire would like to implement an ABC approach to analyze theproduction of this special order of collapsible umbrellas. Thecontroller has assembled the following information:
Stick | Collapsible | |
Units Sold | 60,000 | 3,000 |
Selling Price | $12.50 | $14.00 |
Direct Material Cost per Unit | $3 | $3.10 |
Direct Labor Cost per Hour | $7.50 | $8.00 |
Variable Manufacturing Overhead | $0.40 | $0.40 |
Variable Selling Costs | $1.10 | $1.10 |
Labor Hours per Unit | 0.2 | 0.2 |
Sales Orders | 120 | 1 |
Purchase Orders | 50 | 3 |
Production Runs | 45 | 6 |
Material Moves | 86 | 10 |
Machine Setups | 130 | 6 |
Machine Hours | 525 | 32 |
Inspections | 200 | 10 |
Shipments | 60 | 3 |
Table 1: Direct Cost Information and Activities
Activity | Activity Cost | Activity Cost Driver |
Order Processing | $35,000 | Number of Sales Orders |
Purchasing | $36,000 | Number of Purchase Orders |
Material Handing | $28,000 | Material Moves |
Machine Setup | $14,000 | Machine Setups |
Production | $99,000 | Production Runs |
Assembly | $80,000 | Machine Hours |
Inspecting | $11,000 | Number of Inspections |
Shipping | $7,500 | Number of Shipments |
Table 2: Activity Cost Pools and Cost Drivers
Another alternative to traditional costing and ABC istime-driven activity-based costing (TDABC). You will need todetermine which of these three methods would be the best approachfor the Hampshire Company. The following article may assist you inyour analysis: Time-Driven Activity-Based Costing. Additionally,you may want to use the Shapiro Library to conduct further researchon the three methods. You will need to defend your position whenanswering the prompts for the written portion of this section.
Using the information provided above, complete the following inthe Hampshire Company Spreadsheet in order to assist you inresponding to all components of Section IV:
1.Calculate the allocation rates foreach cost driver using ABC.
2.Use the traditional costing approachto calculate the total cost and the unit cost of the stick andcollapsible umbrellas.
3.Use ABC to compute the total costsand the unit cost for the stick and collapsible umbrellas.
4.Compute the difference between theproduct cost per stick and collapsible umbrellas using the unitcost that you computed with the traditional approach and the onethat you computed using ABC.
