Q1DC_3 - Horngren'S Financial And Managerial Accounting

Question

Harris Systems specializes in servers for workgroup, e-commerce, and ERP applications. The company’s original job costing system has two direct cost categories: direct materials and direct labor. Overhead is allocated to jobs at the single rate of \(22 per direct labor hour.

A task force headed by Harris’s CFO recently designed an ABC system with four activities. The ABC system retains the current system’s two direct cost categories. Overhead costs are reflected in the four activities. Pertinent data follow:

___________________________________________________________________

Activity                                Allocation Base                   Predetermined Overhead

                                                                                                   Allocation Rate____

Materials handling             Number of parts                                    \) 0.85

Machine setup                    Number of setups                                500.00

Assembling                         Number of assembling hours              80.00

Shipping                              Number of shipments                      1,500.00_______

 

Harris Systems has been awarded two new contracts, which will be produced as Job A and Job B. Budget data relating to the contracts follow:

____________________________________________________________

                                                                     Job A                             Job B__

Number of parts                                        15,000                            2,000

Number of setups                                              6                                   4

Number of assembling hours                    1,500                               200

Number of shipments                                        1                                  1

Total direct labor hours                              8,000                              600

Number of units produced                            100                                10

Direct materials cost                           \( 220,000                       \) 30,000

Direct labor cost                                  \( 160,000                       \) 12,000__

 

Requirements

3. Which costing system more accurately assigns to jobs the costs of the resources consumed to produce them? Explain.

Step-by-Step Solution

Answer

Activity-based costing more accurately allocate cost to a Job due to using the activity as the basis for allocating indirect cost.

Step-by-Step-Solution Step 1: Comparison of Budgeted cost under both the methods

	Job A	Job B
Single Base Allocation Method
Total Budgeted Cost	$556,000	$393,200
Budgeted Cost per unit	$5,560	$39,320
Activity-Based Allocation Method
Total Budgeted Cost	$517,250	$63,200
Budgeted Cost per unit	$517.25	$6,320

Step 2: Interpretation

Under the single base allocation method, the difference between the total budgeted costs for both the job has lower than in the activity-based allocation method. The reason for being is that the indirect cost has been computed based on the total labor hour in the first case. 

The labor hour only is not the appropriate base for the allocation of direct cost. This is so because the overhead is incurred due to lots of manufacturing activities that are not directly related to production. The labor hour is the main activity for any production process but at the same time, all other indirect activities may not be involved in the production process as labor.  

So if indirect cost is allocated or computed on the basis of labor hours it would cost more for the product or job that has very less amount of indirect activity.

In the given case, indirect activity is comparatively low for Job B. So when the indirect cost is allocated based on activity method it is apportioned fairly. But when labor hour is used for allocation then the Job having lower indirect activity is also allocated more cost due to labor hour activity.