Class Exercises – Activity Based Costing

Question 1:

Allen Inc. is a manufacturer of quality shoes. The company has always used a plant-wide allocation rate
for allocating manufacturing overhead to its products. The plant manager believes it is time to change to
a better method of cost allocation. The accounting department has established the following
relationships between production activities and manufacturing overhead costs:

Activities Cost Drivers Allocation Rate

Material handling Number of parts $ 8 per part
Assembly Labour hours 80 per hour
Inspection Time spent by item at inspection 12 per minute
station

The previous plant-wide allocation rate method was based on direct manufacturing labour hours, and if
that method is used, the allocation rate is $80 per labour hour.

Instructions:

a. Assume that a batch of 1,000 pairs of shoes requires 4,000 parts, 50 direct manufacturing labor
hours, and 60 minutes of inspection time. What are the indirect manufacturing costs per pair of
shoes to produce a batch of 1,000 pairs of shoes, assuming the previous plant-wide allocation
rate method is used?
b. What are the indirect manufacturing costs per pair of shoes to produce a batch of 1,000 pairs of
shoes, assuming the activity-based method of allocation was used?

Question 2:

The Silvernagel Company is attempting to institute an activity-based accounting system to cost products.
The Purchasing Department incurs costs of $473,500 per year and has five people working in it. Because
finding the best supplier takes the majority of the effort in the department, most of the costs are
allocated to this area.

Activity Allocation of Measure # of People Total Cost ($)

Finding best suppliers # of telephone calls 3 300,000
Issuing purchase order # of purchase orders 1 100,000
Reviewing receiving reports # of receiving reports 1 73,500

During the year, 150,000 telephone calls are made in the Purchasing Department, 10,000 purchase
orders are issued, and 7,000 shipments are received and reports filed. Many of the purchase orders are
received in the same shipment.

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A complex product manufactured by the company required the following activities in the Purchasing
Department over the year: 115 telephone calls, 36 purchase orders, and 29 receipts.

a. What amount of Purchasing Department cost should be assigned to the manufacturing of this
product?
b. If 200 units of product are manufactured during the year, what is the Purchasing Department
cost per unit?

Question 3:

Drextel Chemical Company has identified activity centers to which overhead costs are assigned. The cost
pools and cost drivers for these centers are as follows:

Activity Center Cost Pool ($) Cost Driver

Utilities 300,000 50,000 machine hours
Setup 100,000 700 setups
Materials handling 800,000 200,000 lbs. of material

The company’s products and related statistics follow:

Product A Product B
Machine hours 35,000 15,000
Direct Material 75,000 lbs. 125,000 lbs.
Direct labor hours 20,000 25,000
Number of setups 200 500
Number of units produced 10,000 5,000

Additional Data: One direct labor hour costs $10, and the 200,000 lbs. of material were purchased for
$360,000.

Required: Determine the unit cost for each product.

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