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    Activity-based costing vs traditional overhead allocation

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    Activity-based costing versus tradtional overhead allocation methods:

    Woodruff Industries manufactures and sells custom-made coffee tables. Its job costing system was designed using an activity-based costing approach. Direct materials and direct labor costs are accumulated separately, along with information concerning three manufacturing overheadcost drivers (activities). Assume that the direct labor rate is $15 per hour and that there were no beginning inventories. The following information was available for 2004, based on an expected production level of 50, 000 units for the year:
    Activity Cost Drivers Budgeted costs Cost driver used Cost allocation rate
    Materials handling $ 250,000 Number of parts used $0.20 per part
    Cutting/Lathe work 1,750,000 Number of parts used $1.40 per part
    Assembly/inspection 4,000,000 Direct labor hours $20.00 per hour

    The following production, costs, and activities occured during the month oof July:
    Units produced Direct materials costs Number of parts used Direct labor hours
    3,200 $107,200 70,400 13, 120

    A) Calculate the total manufacturing cost and the cost per unit of the coffee tables produced during the month of July (using the activity-based costing approach).

    B) Assume instead that Woodruff Industries applies manufacturing overhead on a direct labor hours basis (rather than using activity-based costing system). Calculate the total manufacturing cost and cost per unit of coffee tables produced during the month on July. (??need to calculate the predetermined overhead application rate using budgeted overhead costs for 2004.)

    C) Compare the unit cost figures calculated in questions A nd B. Which approach do you think provides better information for manufacturing managers? Please Explain.

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    Solution Preview

    a. In Activity Based Costing ( ABC) the overhead costs are allocated based on the cost drivers. In this case the cost drivers are - Nu,ber of Parts Used and Direct Labor Hours. We are also given the rate at which the overhead is to be allocated.
    The total cost of producing 3,200 units in July is
    Direct Material 107,200
    Direct Labor 13,120 x 15 ...

    Solution Summary

    The solution compares the product cost using traditional costing and activity based costing