Product # of Setups # of Components # of Direct Labor Hours
Standard 3 30 650
Deluxe 7 50 150

Overhead costs 20000 50000

Assume a traditional costing system applies the $80,000 of overhead costs based on direct labor hours.

a. What is the total amount of overhead costs assigned to the standard model?
b. What is the total amount of overhead costs assigned to the deluxe model?

My Attempt at answering:
a. 80000/650= 123
b. 80000/150= 533

Assume an activity based costing system is used and that the number of setups and the number of components are identified as the activity-cost drivers for overhead?

c. What is the total amount of overhead costs assigned to the standard model?
d. What is the total amount of overhead costs assigned to the deluxe model?

My attempt at answering:
c. 80000/30+3= 2424
d. 80000/7+50= 1404

e. Explain the difference between the costs obtained from the traditional costing system and the ABC system. Which system provides a better estimate of costs? Why?

My attempt at answering:
Overhead is much higher under the ABC method vs. the traditional method. The ABC method however is more accurate for decisions. The reasons for the differences are that the traditional method used direct labor hours. ABC method provides a way to allocate costs even more accurately than the traditional method. ABC is more accurate because the overhead is not incurred like that of the direct labor. In the end, the more difficult the costing system I noticed there is more activities to deal with. Conclusion: ABC provides a more accurate estimate of costs.

I'm going to start by saying that you should always stop and think about the logic behind your answers. You can't necessarily know if they are correct, but there are certain things that should tell you when something just doesn't make any sense or is totally off.

All of the questions are asking for the "total amount of overhead costs" assigned to a model. For instance, you have 123 for (a) and 533 for (b). The total overhead costs are $80,000. You have only come up with $656 worth of costs to cover these two models. What happened to the rest of the $80,000?

There are two major boo-boo's in what you are doing. The first is that you're taking the total overhead costs and dividing invidually for each model. The $80,000 is the total overhead costs, for both models. i.e. it's covering all 800 hours of labor. By dividing 80,000 by 650, you're getting what that would be per hour for just one model. But the 80,000 isn't for just that model. It's for both models put together, all 800 hours. And you need to first get a cost per one hour.

(If you bought one bigger pizza for $10 which had 8 slices, and a smaller pizza for $7 which had 6 slices, and you wanted to know the average per slice, you cannot divide $17 total spent by 8 slices and then divide $17 by 6 slices. You spent $17 on both pizzes, all 14 slices.)

The other boo-boo is that your answers aren't total costs. By dividing, you only end up with a cost per hour. Not total costs. Total overhead costs are still $80,000 and that isn't going to change. You first get a cost per hour by dividing by the total hours. Once you have that, you multiply it back out by each model individual to get how much is applied to that model. They should total back to the $80,000.

Quote:

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Assume an activity based costing system is used and that the number of setups and the number of components are identified as the activity-cost drivers for overhead?

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I have never seen one of these add two drivers together like that, but I guess that's what you have to do. (30+3 for the one and 7+50 for the other.) I don't really see another choice. However, how you did it in the end is the same as how you did the labor, which has the same two boo-boo's.

My attempt at answering:

Quote:

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Overhead is much higher under the ABC method vs. the traditional method.

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This statement will never be true. The $80,000 is the total overhead and it hasn't changed by method used. So one can't be higher than the other. (In reality, the amount applied can change, but any over- or under-applied amount will be taken care of at the end of the period with adjusting entries. In the long run, whatever was spent on overhead is what was spent on overhead and you can't change that.)

Quote:

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The ABC method however is more accurate for decisions.

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Generally true, though not always better from a cost-benefit point of view. However, if you ask me, the ABC method presented here really isn't any different than traditional, because they lumped the setsups & components. In other words, it becomes ONE cost driver, just like the direct labor hours is. (I think it's a terribly flawed problem from that point of view.)

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The reasons for the differences are that the traditional method used direct labor hours. ABC method provides a way to allocate costs even more accurately than the traditional method. ABC is more accurate because the overhead is not incurred like that of the direct labor.

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There isn't anything inherently wrong with using direct labor, which is what you're making it sound like. There are situations in which using direct labor hours is perfectly reasonable. (I just looked at another problem using ABC and one of the 3 activities was still labor.)

Think instead about what the difference between the methods is. It isn't about whether direct labor hours happened to be used. You also might need to use an example from the book that is different than this problem, because this problem really doesn't display the advantages of ABC and as far as I'm concerned, kind of isn't. The idea of doing ABC isn't to change the activity used, and as far as I can see, that's all this problem has done. It's like changing from direct labor hours over to machine hours. That doesn't turn it into ABC. (Bad problem.)

Thank you so much for your help. I will take another crack at in a few hours before I go to class. I will post again. Can you come back and check my answers again if you don't mind. I trully appreciate all of the explanation.

80,000/800= 100
a. 100x650=65,000
b. 100x150= 15,000

80,000/90=889
(80,000/30+3+50+7)
c. 889x33= 29,337
d. 889x57=50673

e. I finally realized overhead does not change and is the same under both methods. However the ABC method is better to use to come up with a more accurate answer. The costs obtained using the ABC method focus more on the costs of the activities which allowed me to focus on the costs for the two specific products and how the overhead applied to each individually. The traditional method is focusing more on quantity of the units produced by considering the labor hours. You cannot use the traditional costing system to figure out what the costs are for the specifics like the example of standard and deluxe grooming stations.


Thanks for the help on this one!!

Quote:

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80,000/800= 100
a. 100x650=65,000
b. 100x150= 15,000

80,000/90=889
(80,000/30+3+50+7)
c. 889x33= 29,337
d. 889x57=50673

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Yup, that's the idea. I'm almost surprised you got that out of my jibberish. A & b are correct cause I can do that in my head -- I didn't check the math on c & d but you've got the idea.

Quote:

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e. I finally realized overhead does not change and is the same under both methods. However the ABC method is better to use to come up with a more accurate answer. The costs obtained using the ABC method focus more on the costs of the activities which allowed me to focus on the costs for the two specific products and how the overhead applied to each individually. The traditional method is focusing more on quantity of the units produced by considering the labor hours. You cannot use the traditional costing system to figure out what the costs are for the specifics like the example of standard and deluxe grooming stations.

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I still disagree with some details of this. Focusing on quantity of units is not necessarily a bad thing. It might be a very good thing and relevant. Not to mention that doing it by direct labor hours doesn't mean it's focusing on units anyway. It's focusing on labor. You're missing the real difference between the methods. The traditional only uses one cost driver and ends up applying all costs on that same driver. ABC can use a variety of different drivers and therefore is splitting up the overhead costs into different types of activities.

A good example is guitars. Let's say a place makes 100 guitars all much alike, and 10 custom built ones. While this is very labor-intensive, are all overhead costs about direct labor? No. That might be a fine way to do it if there aren't other things involved that throw that off. For instance, the salary of a quality control person is indirect labor and therefore overhead. They may only inspect random ones of the normal guitars, but they may inspect each and very one of the custom guitars carefully. So it might not make sense to base it on direct labor. You've got 10 times as many regular guitars as custom, and the custom ones might be taking 10 times as long to make. Or what about units. Divide all overhead by 110 guitars, and include that quality control person in there? It'd be all out of balance. So we can instead base that overhead cost on the number of inspections. We could base other costs on units. (Like things related to the space - work space & storage space.) Something could be based on direct labor too. So we could have 3-4 different types of costs.

It's not about that labor or units or whatever in and of themselves are good or bad things to use. It's about using one base for all the overhead, if overhead is too dependent on different activities.

As for being able to use traditional for the standard and deluxe - how do you know? You didn't answer "why." The information isn't really there for you to answer which is better or why. But they want an answer, so you have to make some assumptions.

I'm also wondering where the $20,000 and 50,000 came from to begin with. Where did that split come from? And is it important? And I just now realized that doesn't add up to $80,000. :p

Nice walkthrough tutorial, MG3! I'd toss a green coin into yer basket, but the forum says I haven't spent enough green coins elsewhere yet.

Well, thanks. I'll have to save this one for next time someone asks.

And really, I like gold coins much better anyway. LOL.

Limitations of Activity Based accounting

Quote:

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Originally Posted by neversatysfyd

80,000/800= 100
a. 100x650=65,000
b. 100x150= 15,000

80,000/90=889
(80,000/30+3+50+7)
c. 889x33= 29,337
d. 889x57=50673

e. I finally realized overhead does not change and is the same under both methods. However the ABC method is better to use to come up with a more accurate answer. The costs obtained using the ABC method focus more on the costs of the activities which allowed me to focus on the costs for the two specific products and how the overhead applied to each individually. The traditional method is focusing more on quantity of the units produced by considering the labor hours. You cannot use the traditional costing system to figure out what the costs are for the specifics like the example of standard and deluxe grooming stations.


Thanks for the help on this one !!!

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Parts a and b are correct, but c and d are not.

In ABC, you allocate overhead costs based on each different activity. You just can not mix them up. In your question, there are two specific activities: Number of setups and number of components. I have assumed that the overhead costs for setup are 30,000 and for components they are 50,000.

Cost per setup will be 30,000/10 or 3,000 per set up.

Standard gets 3 x 3,000 = 9,000
Delux gets 7 x 3,000 = 21,000

Cost per component will be 50,000/80 = 625 per component
Standard gets 30 x 625 = 18,750
Deluxe gets 50 x 625 = 31,250

The total overheads per ABC:
Standard 9,000 + 18,750 = 27,750
Deluxe 21,000 + 31,250 = 52,250

Compare these allocations with the traditional method:

Standard 27,750 vs 65,000
Deluxe 52,250 vs 15,000

Quote:

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Originally Posted by rehmanvohra

Parts a and b are correct, but c and d are not.

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Sorry, a & b were not correct. I know you want me to quote you a source, but that's going to be difficult.

Not only was this an improper way to pro-rate overhead costs (math issue), but the problem also asks for total overhead costs, and not the overhead rate, so the answer is also not complete. Yup, we all screw up, but I've already explained why this answer was incorrect, so I really got to wonder...

Quote:

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Originally Posted by morgaine300

Sorry, a & b were not correct. I know you want me to quote you a source, but that's going to be difficult.

Not only was this an improper way to pro-rate overhead costs (math issue), but the problem also asks for total overhead costs, and not the overhead rate, so the answer is also not complete. Yup, we all screw up, but I've already explained why this answer was incorrect, so I really gotta wonder....

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I think you agreed that a abd b are correct in your post of July 31, 2009.

As regards the other parts I would like you to refer to the following link


Activity Based Costing | AccountingCoach.com

I am sure you will find it interesting when you study the examples for two and four activities.

Yea... got this problem very incorrect. My teacher had great fun with his red pen... It's Ok. Thanks for the help though.

Quote:

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Originally Posted by rehmanvohra

I think you agreed that a abd b are correct in your post of July 31, 2009.

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My apologies -- I thought you were referring to the original post. This thing is old enough that I'd forgotten what was going on.

Quote:

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Originally Posted by morgaine300

My apologies -- I thought you were referring to the original post. This thing is old enough that I'd forgotten what was going on.

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No need to apologize. To err is human. Now that we are on a congenial path can we proceed as good friends from hereon? Please do look at the example on consignments and let me have your thoughts