Several years after reengineering its production process, King Corporation hired a new controller, Christine Erickson. She developed an ABC system very similar to the one used by King's chief rival. Part of the reason Erickson developed the ABC system was because King's profits had been declining, even though the company had shifted its product mix toward the product that had appeared most profitable under the old system. Before „ adopting the new ABC system, the company had used a plantwide overhead rate, based on direct labor hours developed years ago. For the upcoming year, King's budgeted ABC manufacturing overhead allocation rates are as follows: Activity Allocation Base Activity Cost allocation rate
Materials handling Number of parts $4.00 per part
Machine setup Number of setups $375.00 per setup
Insertion of parts Number of parts $28.00 per part
Finishing Finishing direct labor hours $54.00 per hour

The number of parts is now a feasible allocation base because King recently purchased bar-coding technology. King produces two wheel models: Standard and Deluxe Budgeted data for the upcoming year are as follows:

Standard Delux
Parts per wheel 8 10
Setups per 1,000 wheels 20 20
Finishing direct labor hours per wheel 2 3.5
Total direct labor hours per wheel 2.6 3.4

The company's managers expect to produce 1,000 units of each model during the year.

Required:
a. Compute the total budgeted manufacturing overhead cost for the upcoming year.
b. Compute the manufacturing overhead cost per wheel of each model using ABC.
c. Compute the company's traditional plantwide overhead rate. Use this rate to determine the manufacturing overhead cost per wheel under the traditional system.

King Corporation

a. Computation of total budgeted manufacturing overhead cost:

 Activities                                   Standard      Deluxe      Total

Materials handling (number of parts):

Standard = 8 x $4 x 1,000         $32,000

Deluxe = 10 x $4 x 1,000                               $40,000      $72,000

Machine setup (number of parts):

                = 20 x $375                $7,500        $7,500       $15,000

Insertion of parts (number of parts):

Standard = 8 x $28 x 1,000  $224,000

Deluxe = 10 x $28 x 1,000                         $280,000   $504,000

Finishing (direct labor hours):

Standard = 2 x $54 x 1,000  $108,000

Deluxe = 3.5 x $54 x 1,000                      $189,000     $297,000

Total                                      $371,500    $516,500     $888,000

b. Computation of the manufacturing overhead cost per wheel of each model using ABC:

Standards = $371,500/1,000 = $371.50

Deluxe =     $516,500/1,000 = $516.50

c. Computation of the company's traditional plantwide overhead rate to determine manufacturing overhead cost per wheel:

Overhead rate = $888,000/6,000 = $148

Manufacturing overhead cost per wheel:

Standard = $148 x 2.6 = $384.80

Deluxe = $148 x 3.4   = $503.20

Explanation:

a) Calculations:

Total overhead cost = $888,000

Allocation based on total direct labor hours per wheel

Plantwide overhead rate:

Total labor hours:

Standard  2.6 x 1,000 = 2,600 hours

Deluxe  3.4 x 1,000 = 3,400 hours

Total labor hours = 6,000 (2,600 + 3,400)

= $888,000/6,000 = $148 per direct hour

b) According to wikipedia.com, "Activity-based costing is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. This model assigns more indirect costs into direct costs compared to conventional costing."

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