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# Activity Based Costing

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A company produces two types of leather purses: standard and handcrafted Both purses use equipment for cutting and stitching. The equipment also has the capability of creating standard designs. The standard purses use only these standard designs. They are all of the same size to accommodate the design features of the equipment. The handcrafted purses can be cut to any size and because the designs are created manually. Many of the manually produced designs are in response to specific requests of retailers. The equipment must be specially configured to accommodate the production of a batch of purses that will receive a handcrafted design. The company assigns overhead using direct labor dollars. The sales manager is convinced that the purses are not being costed correctly.

To illustrate his point, the sales manager decided to focus on the expected annual setup and machine related costs, which are as follows:

Setup equipment \$18,000
Depreciation \$20,000*
Operating Costs \$22,000

? Computed on a straight-line basis, book value at the beginning of the year was \$100,000. The machine has the capability of supplying 100,000 machine hours over it's remaining life.

The sales manager also collected the expected annual prime costs for each purse, the machine hours, and the expected production (which is the normal output for the company).
The details are:
Standard Purse Handcrafted Purse
Direct labor \$12,000 \$36,000
Direct Materials \$12,000 \$12,000
Units 3000 3000
Machine hours 18,000 2,000
Number of setups 40 40
Setup time 400 hours 200 hours

#1. The controller has suggested that overhead costs be assigned to each product using a plantwide rate based on direct labor dollars. Machine costs and setup costs are overhead costs. Assume that these are the only overhead costs. For each type of purse, calculate the overhead per unit that would be assigned using a direct labor dollars overhead rate.

#2. Calculate the overhead cost per unit per purse using two overhead rates: one for the setup activity and one for the machining activity. In choosing a driver to assign the setup costs, use number of setups for one and use number of setup hours for another.

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Standard Purse Handcrafted Purse
Direct labor \$12,000 \$36,000
Direct Materials \$12,000 \$12,000
Units 3000 3000
Machine hours 18,000 2,000
Number of setups 40 40
Setup time 400 hours 200 hours

Setup equipment \$18,000
Depreciation \$20,000*
Operating Costs \$22,000

Computed on a straight-line basis, book value at the beginning of the year was \$100,000. The machine has the capability of supplying 100,000 machine hours over it's remaining life.

book value at the beginning of the year= \$100,000
No of machine hrs remaining= 100,000
Therefore Cost per hr= \$1 =\$100,000/100,000
Total no of hrs= 20,000 =18,000+2,000
Therefore ...

#### Solution Summary

The solution shows steps to assign overhead costs using Activity Based Costing.

\$2.49