EcoFabrics has budgeted overhead costs of $1,162,350. It has allocated overhead on a plantwide basis to its two products (wool and cotton) using direct labor hours which are estimated to be 553,500 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 $442,800 and $719,550 is allocated to the design cost pool. Additional information related to these pools is as follows.
Wool Cotton Total
Machine hours 123,000 123,000 246,000
Number of setups 1,230 615 1,845
1. Calculate the overhead rate using activity based costing. (Round answers to 2 decimal places, e.g. 12.25.)
2. Determine the amount of overhead allocated to the wool product line and the cotton product line using activity-based costing.
3. Calculate the overhead rate using traditional approach. (Round answer to 2 decimal places, e.g. 12.25.)
4. 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?

Answer:

EcoFabrics

1. Overhead Rates using activity-based costing:

Cutting = $1.80 per machine hour

Design = $390 per setup

2. Allocation of overhead:

                                  Wool                            Cotton

Cutting                  $221,400                     $221,400

Design                    479,700                       239,850

Total allocated      $701,100                      $461,250

3. Overhead rate using the traditional approach:

Predetermined overhead rate = $2.10

4. Allocation of overhead:

                               Wool            Cotton

Total allocated   $581,175        $581,175

Explanation:

a) Data and Calculations:

Budgeted overhead costs = $1,162,350

Estimated direct labor hours = 553,500

Activity Cost      Cost Drivers   Overhead Costs   Wool   Cotton     Total

Pools                  

Cutting               Machine hours     $442,800   123,000 123,000 246,000

Design                Number of setups  719,550        1,230         615      1,845

1. Overhead Rates using activity-based costing:

Cutting = $1.80 ($442,800/246,000) per machine hour

Design = $390 ($719,550/1,845) per setup

2. Allocation of overhead:

                               Wool                                     Cotton

Cutting                  $221,400 ($1.80 * 123,000)  $221,400 ($1.80 * 123,000)

Design                    479,700 ($390 * 1,230)        239,850 ($390 * 615)

Total allocated      $701,100                               $461,250

3. Overhead rate using the traditional approach:

Predetermined overhead rate = $2.10 ($1,162,350/553,500)

4. Allocation of overhead:

                               Wool                                     Cotton

Total allocated   $581,175 ($1,162,350 * 50%)   $581,175 ($1,162,350 * 50%)

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