Harwell, Inc. uses a traditional volume-based costing system in which direct labor hours are the allocation base. Harwell produces two different products: Product A, which uses 40,000 direct labor hours, and Product B, which uses 60,000 direct labor hours. Harwell is considering switching to an ABC system by splitting its manufacturing overhead cost of $400,000 across three activities: Setup, Production, and Finishing. Under the traditional volume-based costing system, the predetermined overhead rate is $4.00/direct labor hour. Under the ABC system, the cost of each activity and proportion of the activity drivers used by each product are as follows: Total CostProportion used by Product AProportion used by Product BDesign (Engineering Hours)$50,00030%70%Production (Direct Labor

Question

Hours)$300,00040%60%Inspection (Batches)$50,00020%80%Required:a. Calculate the indirect manufacturing costs assigned to Product A under the traditional costing system.b. Calculate the indirect manufacturing costs assigned to Product B under the traditional costing system.c. Calculate the indirect manufacturing costs assigned to Product A under the ABC system.d. Calculate the indirect manufacturing costs assigned to Product B under the ABC system.e. Which product is under-costed and which is over-costed under the volume-based cost system compared to ABC?

What will be an ideal response?

Answer 1

a. $160,000 = $4.00 × 40,000
b. $240,000 = $4.00 × 60,000
c. $145,000 = ($50,000 × 30%) + ($300,000 × 40%) + ($50,000 × 20%)
d. $255,000 = ($50,000 × 70%) + ($300,000 × 60%) + ($50,000 × 80%)
e. Product B is under-costed and Product A is over-costed.

Predetermined overhead rate × Direct labor hours = Indirect costs assigned to each product under traditional system. Activity proportion × Cost = Activity cost. Sum of activity costs = Indirect costs assigned to each product under ABC. If the cost under the traditional system is higher than under ABC, it is overcosted. If lower, it is undercosted.