Zeus Industries manufactures two types of electrical power units, custom and standard, which involve four factory overhead activities—production setup, procurement, quality control, and materials management. An activity analysis of the overhead revealed the following estimated activity costs and activity bases for these activities:
Activity Activity Cost Activity Base
Production setup $ 44,000 Number of setups
Procurement 13,500 Number of purchase orders (PO)
Quality control 97,500 Number of inspections
Materials management 84,000 Number of components
Total$239,000p
The activity-base usage quantities for each product are as follows:
Setups
Purchase
Orders Inspections Components Unit Volume
Custom 290 760 1,200 500 2,000
Standard 110 140 300 200 2,000
Total 400 900 1,500 700 4,000
a. Determine an activity rate for each activity.
b. Assign activity costs to each product, and determine the unit activity cost, using the activity rates from part (a).
c. Assume that each product required one direct labor hour per unit. Determine the per unit cost if factory overhead is allocated on the basis of direct labor hours.
d. Explain why the answers in parts (b) and (c) are different.
Answer:
Production Quality
Materials
a. Setup Procurement Control
Activity cost…… $44,000 $13,500 $97,500
÷ Activity base… 400 900 1,500
Activity rate…… $110/setup $15/PO $65/inspection
Management
$84,000
700
$120/component
b. Custom Standard
Number of setups…………………… 290 110
× Rate per setup……………………… $110 $110
Number of purchase orders………
760
$ 31,900
140
$12,100
× Rate per purchase order………… $15 $15
11,400 2,100
Number of inspections…………… 1,200 300
× Rate per inspection………………… $65 $65
78,000 19,500
Number of components…………… 500 200
× Rate per component……………… $120 $120
60,000 24,000
Total product cost…………………… $181,300 $57,700
÷ Unit volume………………………… 2,000 2,000
Unit cost……………………………… $ 90.65 $ 28.85
c. The factory overhead allocated to each product on the basis of direct labor hours
would be 50%, since each product has the same 2,000 direct labor hours. The
factory overhead per direct labor hour for each product is computed as follows:
$239,000
4,000 per direct labor hour
= $59.75 per hour
Since each product requires one direct labor hour, the factory overhead cost per
unit is also $59.75 for each product.
d. The factory overhead allocated to the custom power unit is much higher under the
activity-based approach, compared to the direct labor method. The reason is that
the setup, procurement, and quality control activities are not related to the number
of direct labor hours but are instead related to the number of setups, purchase
orders, and inspections. In addition, the custom product has a more complex design
(more components) than does the standard product. As a result, the custom product
will consume more materials management activities than will the standard product.
