A company manufactures two products, P and R. P is the more complex of the two products, requiring more direct labor time and more machine time per unit than R.

Manufacturing overhead is currently assigned to the products on the basis of direct labor hours. The company has gathered some activity information and is interested in the differences between its present costing method and activity based costing. All overhead costs should be allocated to the products. The overhead cost pools and activity drivers are as follows;

ACTIVITY POOL                                   OVERHEAD COSTS           TOTAL DRIVER USAGE

Setup                                                  $256,000                    3,200 setups

Material Purchasing                         $110,000                    2,750 purchase orders

Machining/Fabricating                           $136,000                         27,200 machine hours

TOTAL OVERHEAD COSTS        $502,000

Other product information is as follows:

                                                            P                  R

Number of units produced        40,000       10,000

Direct labor hours              20,000        30,000

Setups                                          2,800          400

Purchase orders                      680         2,070

Machine hours                             19,200        8,000

 

1) Using the traditional method of allocating overhead based on direct labor hours, compute the total overhead costs of products P and R.

 

2) Using an activity based approach, compute the total overhead costs of products P and R. SHOW ALL OF YOUR CALCULATIONS.

 

3) Which method of allocation gives a better understanding of the costs of each product? Briefly explain your answer.