E44 Altex Inc manufactures two products car wheels and truck

E4-4 Altex Inc. manufactures two products: car wheels and truck wheels. To determine the amount of overhead to assign to each product line, the controller, Robert Hermann, has developed the following information Car Truck 10,000 Estimated wheels produced Direct labor hours per wheel 40,000 Total estimated overhead costs for the two product lines are $770,000. Instructions (a) Compute the overhead cost assigned to the car wheels and truck wheels, assuming that direct labor hours is used to allocate overhead costs. (b) Hermann is not satisfied with the traditional method of allocating overhead because he believes that most of the overhead costs relate to the truck wheels product line because of its complexity. He therefore develops the following three activity cost pools and related cost drivers to better understand these costs. Estimated Overhead Expected Use of Cost Drivers Activity Cost Pools Setting up machines Assembling Inspection Costs $220,000 280,000 1,000 setups 70,000 labor hours 1,200 inspections 270,000 Compute the activity-based overhead rates for these three cost pools. using an activity-based costing system, given the following information. (c) Compute the cost that is assigned to the car wheels and truck wheels product lines Expected Use of Cost Drivers per Product Car Number of setups Direct labor hours Number of inspections 200 40,000 100 Truck 800 30,000 1,100 (d) What do you believe Hermann should do?

Solution

(a) Direct labor hours for Car wheels 40,000 Direct labor hours for truck wheels 30,000 Total direct labor hours 70,000 total estimated overhead 770,000 Total direct labor hours 70,000 OH rate /DLH 11 Overhead assigned Car wheels Truck wheels Direct labor hours 40,000 30,000 Overhead rate /Direct labor hour 11 11 Total OH assigned 440000 330000 (b) Activity Cost Pool Estimated Estimated ABC OH OH use of CD rate Setting up machines 220,000 1,000 220 Assembling 280,000 70,000 4 Inspection 270,000 1,200 225 ( c) Car wheels Estimated ABC OH Cost assigned use of CD rate Activity cost pool Setting up machines 200 220 44000 Assembling 40,000 4 160000 Inspection 100 225 22500 total cost assigned 226500 Truck wheels Estimated ABC OH Cost assigned use of CD rate Activity cost pool Setting up machines 800 220 176000 Assembling 30,000 4 120000 Inspection 1,100 225 247500 total cost assigned 543500 (d) Hermann should use ABC method since it is based on actual activities and therefore is more realistic.