SOLUTION BY CHARTERED ACCOUNTANT
E4-3 American Fabrics has budgeted overhead costs of $990,000. It has
allocated overhead
on a plantwide basis to its two products (wool and
cotton) using direct labor hours
which are estimated to be 450,000 for the
current year. The company has decided to experiment
with activity-based
costing and has created two activity cost pools and related
activity cost
drivers. These two cost pools are: cutting (cost driver is machine hours)
and
design (cost driver is number of setups). Overhead allocated to the
cutting cost pool is
$360,000 and $630,000 is allocated to the design cost
pool. Additional information related
to these pools is as follows.
Wool
Cotton Total
Machine hours 100,000 100,000 200,000
Number of setups 1,000
500 1,500
Instructions
(a) Determine the amount of overhead allocated to
the wool product line and the cotton
product line using activity-based
costing.
(b) What amount of overhead would be allocated to the wool and
cotton product lines
using the traditional approach, assuming direct labor
hours were incurred evenly
between the wool and cotton? How does this compare
with the amount allocated
using ABC in part (a)?
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