Saddle Inc has two types of handbags standard and custom The

Saddle Inc. has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has heard of activity-based costing and wants to see how the results would differ if this system were used. Two activity cost pools were developed: machining and machine setup. Presented below is information related to the company’s operations.

Total estimated overhead costs are $304,000. Overhead cost allocated to the machining activity cost pool is $197,000, and $107,000 is allocated to the machine setup activity cost pool.

Determine the difference in allocation between the two approaches. (Round answers to 0 decimal places, e.g. 1,225.)

Traditional Costing

Standard          $

Custom             $

Activity-based costing

Standard          $

Custom             $

Standard Custom Direct labor costs Machine hours Setup hours $58,000$97,000 1,220 400 1,190 109

Solution

(a) Overhead rate using the traditional (plant wide) approach

Overhead rate = Total estimated overhead costs / Direct labor costs

= $304,000 / [ $58,000 + 97,000 ]

= $304,000 / 155,000

= 196% of direct labor cost

(b)Overhead rates using the activity-based costing approach

Activity-based overhead rates

Machining Activity

= Overhead cost allocated to the machining activity cost pool / Total Machine Hours

= $197,000 / [ 1190 Machine hours + 1220 Machine Hours ]

= $197,000 / 2410 Machine Hours

= $82 per machine hours

Machine setup

= Overhead cost allocated to the machining activity cost pool / Total Set up hours

= $107,000 / [ 109 set up hours + 400 set up hours ]

= $107,000 / 509 Set up hours

= $210 per set up hours

(c) Difference in allocation between the two approaches

Traditional costing

Standard

Custom

$58,000 x 196%

$113,680

-

$97,000 x 196%

-

$190,120

TOTAL

$113,680

$190,120

Activity-based costing

Standard

Custom

Machining:

1190 Machine hours x $82

97,580

1220 Machine hours x $82

100040

Machine setup:

109 Set up hours x $210

22,890

400 Set up hours x $210

84,000

TOTAL

120,470

184,040

Traditional costing	Standard	Custom
$58,000 x 196%	$113,680	-
$97,000 x 196%	-	$190,120
TOTAL	$113,680	$190,120
Activity-based costing	Standard	Custom
Machining:
1190 Machine hours x $82	97,580
1220 Machine hours x $82		100040
Machine setup:
109 Set up hours x $210	22,890
400 Set up hours x $210		84,000
TOTAL	120,470	184,040