REVIEW PROBLEM: ACTIVITY-BASED COSTING

Aerodec, Inc., manufactures and sells two types of wooden deck chairs: Deluxe and Tourist. Annual sales in units,
direct labor-hours (DLHs) per unit, and total direct labor-hours per year are provided below:

Costs for direct materials and direct labor for one unit of each product are given below:

Manufacturing overhead costs total $800,000 each year. The breakdown of these costs among the company's six
activity cost pools is given below. The activity measures are shown in parentheses.

Required:
1. Classify each of Aerodec's activities as either a unit-level, batch-level, product-level, or facility-level activity.
2. Assume that the company applies overhead cost to products on the basis of direct labor-hours.
a. Compute the predetermined overhead rate.
b. Determine the unit product cost of each product, using the predetermined overhead rate computed in
(2)(a) above.
3. Assume that the company uses activity-based costing to compute overhead rates.
a. Compute the activity rate for each of the six activities listed above.
b. Using the rates developed in (3)(a) above, determine the amount of overhead cost that would be
assigned to a unit of each product.
c. Determine the unit product cost of each product and compare this cost to the cost computed in (2)(b)
above.

Solution to Review Problem

1.

2. a.
 b.

3. a.

b.

c.
Under activity-based costing, the unit product cost of the Deluxe deck chair is much greater than the cost computed
in 2(b), and the unit product cost of the Tourist deck chair is much less. Using volume (direct labor-hours) in 2(b) to
apply overhead cost to products results in too little overhead cost being applied to the Deluxe deck chair (the low-
volume product) and too much overhead cost being applied to the Tourist deck chair (the high-volume product).

THE FOUNDATIONAL 15
Hickory Company manufactures two products—14,000 units of Product Y and 6,000 units of Product Z. The company
uses a plantwide overhead rate based on direct labor-hours. It is considering implementing an activity-based costing
(ABC) system that allocates all of its manufacturing overhead to four cost pools. The following additional information
is available for the company as a whole and for Products Y and Z:

1. What is the company's plantwide overhead rate?

2. Using the plantwide overhead rate, how much manufacturing overhead cost is allocated to Product Y? How
much is allocated to Product Z?
3. Page 142
What is the activity rate for the Machining activity cost pool?
4. What is the activity rate for the Machine Setups activity cost pool?
5. What is the activity rate for the Product Design activity cost pool?
6. What is the activity rate for the General Factory activity cost pool?
7. Which of the four activities is a batch-level activity? Why?
8. Which of the four activities is a product-level activity? Why?
9. Using the ABC system, how much total manufacturing overhead cost would be assigned to Product Y?
10. Using the ABC system, how much total manufacturing overhead cost would be assigned to Product Z?
11. Using the plantwide overhead rate, what percentage of the total overhead cost is allocated to Product Y?
What percentage is allocated to Product Z?
12. Using the ABC system, what percentage of the Machining cost is assigned to Product Y? What percentage
is assigned to Product Z? Are these percentages similar to those obtained in question 11? Why?
13. Using the ABC system, what percentage of Machine Setups cost is assigned to Product Y? What
percentage is assigned to Product Z? Are these percentages similar to those obtained in question 11? Why?
14. Using the ABC system, what percentage of the Product Design cost is assigned to Product Y? What
percentage is assigned to Product Z? Are these percentages similar to those obtained in question 11? Why?
15. Using the ABC system, what percentage of the General Factory cost is assigned to Product Y? What
percentage is assigned to Product Z? Are these percentages similar to those obtained in question 11? Why?
EXERCISE 3–10 Contrasting ABC and Conventional Product Costs [LO2, LO3, LO4]
Rocky Mountain Corporation makes two types of hiking boots—Xactive and Pathbreaker. Data concerning these two
product lines appear below:

The company has a conventional costing system in which manufacturing overhead is applied to units based on direct
labor-hours. Data concerning manufacturing overhead and direct labor-hours for the upcoming year appear below:

Required:

1. Compute the predetermined overhead rate based on direct labor-hours. Using this rate and other data from
the problem, determine the unit product cost of each product.
2. The company is considering replacing its conventional costing system with an activity-based costing system
that would assign its manufacturing overhead to the following four activity cost pools:

Determine the activity rate for each of the four activity cost pools.
3. Using the activity rates and other data from the problem, determine the unit product cost of each product.
4. Explain why the conventional and activity-based cost assignments differ.

PROBLEM 3–12A Contrasting ABC and Conventional Product Costs [LO2, LO3, LO4]
Precision Manufacturing Inc. (PMI) makes two types of industrial component parts—the EX300 and the TX500. It
annually produces 60,000 units of EX300 and 12,500 units of TX500. The company's conventional cost system
allocates manufacturing overhead to products using a plantwide overhead rate and direct labor dollars as the
allocation base. Additional information relating to the company's two product lines is shown below:

The company is considering implementing an activity-based costing system that distributes all of its manufacturing
overhead to four activities as shown below:

Page 148
Required:
1. Compute the plantwide overhead rate that would be used in the company's conventional cost system. Using
the plantwide rate, compute the unit product cost for each product.
2. Compute the activity rate for each activity cost pool. Using the activity rates, compute the unit product cost
for each product.
3. Why do the conventional and activity-based cost assignments differ from one another?

ROBLEM 3–17A Contrast Activity-Based Costing and Conventional Product Costs

Puget World, Inc., manufactures two models of television sets, the N 800 XL model and the N 500 model. Data
regarding the two products follow:

Additional information about the company follows:

a. Model N 800 XL requires $75 in direct materials per unit, and Model N 500 requires $25.
b. The direct labor wage rate is $18 per hour.
c. The company has always used direct labor-hours as the base for applying manufacturing overhead cost to
products.
d. Model N 800 XL is more complex to manufacture than Model N 500 and requires the use of special
equipment. Consequently, the company is considering the use of activity-based costing to assign
manufacturing overhead cost to products. Three activity cost pools have been identified as follows:

Required:
1. Assume that the company continues to use direct labor-hours as the base for applying overhead cost to
products.
a. Compute the predetermined overhead rate.
b. Compute the unit product cost of each model.
2. Assume that the company decides to use activity-based costing to assign manufacturing overhead cost to
products.
a. Compute the activity rate for each activity cost pool and determine the amount of overhead cost
that would be assigned to each model using the activity-based costing system.
b. Compute the unit product cost of each model.
3. Explain why manufacturing overhead cost shifts from Model N 500 to Model N 800 XL under activity-based
costing.