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Activity-Based Costing vs. Traditional Costing

Mission Bearings Corporation has a traditional costing system in which it applies manufacturing overhead to its products using a predetermined overhead rate based on direct labor-hours (DLHs). The company has two products, "Deluxe" and "Ultra", about which it has provided the following data:

"Deluxe" "Ultra"
Direct materials per unit $29.20 $47.40
Direct labor per unit $1.10 $23.10
Direct labor-hours per unit 0.10 2.10
Annual production 35,000 15,000

The company's estimated total manufacturing overhead for the year is $1,147,650 and the company's estimated total direct labor-hours for the year is 35,000.

The company is considering using activity-based costing to determine its unit product costs for external reports. Data for this proposed activity-based costing system appear below:

Activities and Activity Measures Estimated Overhead Cost
Assembling products (DLHs) $ 140,000
Preparing batches (batches) 241,150
Axial milling (MHs) 766,500
Total $1,147,650

Cost Drivers/Activity Level of Each
Measures
Deluxe Ultra Total
Assembling products 3,500 31,500 35,000
Preparing batches 560 1,295 1,855
Axial milling 1,540 1,015 2,555

a. Determine the manufacturing overhead cost per unit of each of the company's two products under the "traditional costing system".

b. Determine the manufacturing overhead cost per unit of each of the company's two products under "Activity-based costing system".

c. Explain the difference in the unit costs of each product using the different systems of overhead accounting. Be sure to provide appropriate quantitative analysis in your explanation.

Solution Preview

a. Determine the manufacturing overhead cost per unit of each of the company's two products under the "traditional costing system".

Under traditional costing, the overhead is allocated using the predetermined overhead rate. The predtermined overhead rate is calculated as Estimated Manufactuting Overhead/ Estimated base. In this case the total direct labor hours are the base as given and so we can use that for allocating the overhead.
Predetermined overhead rate = 1,147,650/35,000 = $32.79/DLH

We now allocate the overhead to the two products.
Deluxe has direct labor hours per unit of 0.10. The overhead cost per unit for deluxe is 32.79X0.10 = $3.279
Ultra has direct labor hours per unit of 2.10. The overhead cost for ultra is 32.79X2.10 = $68.86

b. Determine the manufacturing overhead cost per unit of each of the company's two ...

Solution Summary

The solution explains the calculations under activity based costing and traditional costing

$2.19