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    Activity Based vs Traditional Costing

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    Activity-based costing versus traditional overhead allocation methods.. Summerset Industries manufacturers and sells custom-made windows. 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 overhead cost drivers (activities). Assume that the direct labor rate is $18 per hour and that there were no beginning inventories. The following information was available for 2007, based on an expected production level of 50,000 units for the year, which will require 200,000 direct labor hours:

    Activity Budgeted Cost Driver Used Cost
    (Cost Driver) Costs for 2007 as Allocation Base Allocation Rate

    Materials handling $225,000 Number of parts used $0.18 per part
    Cutting and lathe work $1,875,000 Number of parts used $1,50 per part
    Assembly and inspection $4,400,000 Direct labor hours $22.00 per hour

    The following production, costs, and activities occurred during the month of February:

    Units Direct Number Direct
    Produced Materials Costs of Parts Used Labor Hours

    3,400 $126,240 74,800 14,320

    a) Calculate the total manufacturing cost and the cost per unit of the windows produced during the month of February (using) the activity-based costing approach).

    b) Assume instead that Summerset Industries applies manufacturing overhead on a direct labor hours basis (rather than using the activity-based costing system described above). Calculate the total manufacturing cost and the cost per unit of the windows produced during the month of February. (Hint: You will need to calculate the predetermined overhead application rate using the total budgeted overhead costs for 2007.)

    c) Compare the per unit cost figures calculated in parts (a) and (b). Which approach do you think provides better information for manufacturing managers? Explain your answer.

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    Solution Summary

    The solution explains the calculation using Activity Based Costing and Traditional Costing