Question1.

Traditional overhead cost per product can be calculated by the product of direct labor
and the overhead rate (200%).

CALCULATION OVERHEAD COSTS USING TRADITIONAL COSTING

Products
Manufacturing Widgets Gadgets Smidgets Smadgets
Costs
Direct Labor 100,000 300,000 400,000 200,000
Rate 200% 200% 200% 200%
Total Costs $200,000 $600,000 $800,000 $400,000

Question2. Using the traditional costing method, compute the total costs per product.

CALCULATION PRODUCT COSTS USING TRADITIONAL COSTING

Products
Manufacturing Widgets Gadgets Smidgets Smadgets
Costs
Direct Material 100,000 200,000 150,000 250,000
Direct Labor 100,000 300,000 400,000 200,000
Overhead 200,000 600,000 800,000 400,000
Total Costs $400,000 $1,100,000 $1,350,000 $850,000

Question3. Under ABC:

A. Calculate the activity-based overhead rates per activity cost driver.

Activity-based costing can be determined, first by calculating the activity-based overhead rates.
Activity-based overhead rates are derived from the estimated overhead costs per activity by the
total units for each cost driver.

ACTITVITY-BASED OVERHEAD RTES

Overhead Estimated / Expected Cost = Activity-based

Cost Driver Overhead Drivers / Activity Overhead Rates
Depreciation $300,000 3,000 machine hours $100/machine hours
Set-up $700,000 1,000 setup hours $700/setup hours
Rent $1,000,000 100,000 ft2 $10/ft2

B. For each product, compute the overhead costs per activity cost driver.

The total overhead costs per product can be calculated by multiplying the activity-based
overhead rates by each product’s expected use of the overhead costs drivers.
 TOTAL OVERHEAD COSTS PER PRODUCT USING ABC

Products
Overhead Cost Driver Widgets Gadgets Smidgets Smagets
Depreciation 50,000 90,000 40,000 120,000
Set-up 140,000 210,000 70,000 280,000
Rent 200,000 300,000 100,000 400,000
Total Overhead Costs $390,000 $600,000 $210,000 $800,000

C. Using the overhead costs from b., calculate the total costs per product.
The total cost per product can be determined by adding the direct costs to the total overhead
costs which is derived in part b.
TOTAL COST PER PRODCUTION USING ABC
Products
Manufacturing Costs Widgets Gadgets Smidgets Smagets
Direct labor 100,000 300,000 400,000 200,000
Direct Material 100,000 200,000 150,000 250,000
Overhead $390,000 $600,000 $210,000 $800,000
Total Costs $590,000 $1,100,000 $760,000 $1,250,000

Question4.
 Widgets, Smidgets and Smadgets were incorrectly priced using the traditional costing method
Widgets and Smadgets were underpriced by $190,000 and $400,000 respectively. Smidgets
was overpriced by $590,000. Only Gadgets was accurately priced on both the traditional
costing and ABC method.
 Firstly, inaccurate budgeting can reduce production capacity. Departments without enough
funding cannot manufacture enough products to meet customer demands. Secondly, incorrect
budgeting may increase the difficulty of management because it is inequitable for different
departments. The result is that management has more difficulty assessing overhead costs that
will reduce a departments overall costs. Finally, incorrect budgeting may reduce investment
opportunities, because it is more difficult for managers to use resources more efficiently.
Question5. The most reasonable approach is for the CFO to suggest adopting the ABC model.
ABC model is more accurate in allocating budget to each production lines and it permits
management to evaluate efficiency and investigate cost reducing alternatives.

Question6. The traditional costing method does not evaluate varying overhead between
products. Traditional costing considers one overhead rate according to historical expenses for
whole manufacturing process. A single overhead rate cannot take difference in per unit overhead
expenses into account; therefore there is excessive budgeting for products with smaller per unit
overhead expenses. Activity based costing provides overhead rated according to specific
overhead cost pools, thus it allocate the rates to the unit requirements of these cost pools per
product. The final result is total expenses that more accurately show differences in per unit
overhead expenses.

Question7.Activity-based costing provides more accurate budget separation for management.

But, ABC is more expensive to use, and it requires management to derive individual overhead
for each product. Therefore, before implementing ABC costing, management need to consider
whether traditional costing makes more sense. Two circumstances where traditional costing is
equally effective are:
 Companies where direct labor costs have proven an effective cost driver of overhead
expenses.
 In companies where overhead costs are extremely low