Afirm produces and sells two products, plus and max. the following information is available relating to setup costs (a part of factory overhead): plus max units produced 200 16,000batch size (units) 10 400number of setups 20 40direct labor hours per unit 5 5total direct labor hours 1,000 80,000cost per setup $1,080 total setup cost $64,800 using number of setups as the activity base, the amount of setup cost allocated to each unit of product for plus and max, respectively is:

Setup cost per unit of PLUS= $108

Setup cost per unit of MAX= $2.7

Explanation:

Number of setups is used as the activity base for the allocation of setup cost. First of all, we need to calculate setup cost per setup and then multiply cost per setup to the number of setups required by each product to get the setup cost for each unit of product PLUS and MAX, see as follows:

Setup cost per setup = $64800÷ (20+40)

Setup cost per setup = $1080 per setup

Each batch of 10 unit of product PLUS requires 20 setups to complete so the allocated setup cost to each unit of product PLUS would be as follows;

Setup cost of batch of 10 units of product PLUS = $1080× 20

Setup cost of batch of 10 units of product PLUS = $21600

Setup cost per unit of PLUS= $21600÷ 200

Setup cost per unit of PLUS= $108

Similarly,

Each batch of 400 unit of product MAX requires 40 setups to complete so the setup cost of batch of 400 units of product MAX would be as follows;

Setup cost of batch of 400 units of product MAX = $1080× 40

Setup cost of batch of 400 units of product MAX =  $43200

Setup cost per unit of MAX= $43200÷ 16000

Setup cost per unit of MAX= $2.7

Setup cost per unit of product: Plus-$108, Max-$2.7

Explanation:

This question falls under the activity-based costing method.

Traditional absorption costing uses volume-related bases to charge overheads to cost units. It assumes that resources used during production of products are consumed in proportion to the amount of direct labour hours, machine hours used. This is a major problem in a modern manufacturing setting where non-production activities account for a large amount of the production costs. Examples of such activities include setting up of machines, production scheduling, procurement of material e.t.c

To ensure that the overheads of these activities are accurately charged to the products, it is important that  products which benefit more from a particular activity should end up with higher cost. This is what activity-based costing(ABC) seeks to achieve.

Activity based costing allocates overheads to cost units using cost drivers. Overheads are first collected together, this is called a cost pool and then charged to the cost units using a cost driver rate. The steps below should be adopted when dealing with activity-based costing:

Step 1: identify the activities e.g procurement, setup, delivery

The activity is setup in this question

Step 2: Ascertain the cost pool. Collect and separate all the costs related to each activity

The cost pool is $64,800

Step 3: Identify the appropriate cost driver  suitable for each activity. For example, number of set ups is a suitable cost driver for setup activity cost.

cost driver:  20 +40 = 60

Step 4: calculate the cost per driver. Divide the activity overhead by the number of cost drivers

given as $1080

Step 5: charge overhead to product. This is done by multiplying the cost driver rate by the amount of cost driver consumed .

Plus; (1080*20)/200= 108

Max: (1080*40)/16000=2.7

We divided by 200 and 16000 for Plus and Max respectively to determine cost per unit

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