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Traditional vs. ABCLO2

Traditional vs. ABCLO2, 3, 4
The following cost information is available for Senkowski, Ltd.:
Activity Allocation Base Volume of Activity Overhead Cost
Purchasing Purchase orders 30,000 $150,000
Receiving Shipments received 15,000 60,000
Machine setups Setups 2,500 200,000
Quality control Inspections 18,000 90,000
Direct materials are $15 per unit for luxury handbags and $11 per unit for deluxe handbags. There were 12,500 direct labor hours, each of which was charged to inventory at $18 per hour.
• A. Management is trying to decide between using the traditional allocation method based on direct labor hours and using activity-based costing. Calculate the overhead rates for each method.
• B. One particular batch of 40 luxury handbags had the following specifications:
Direct labor hours 8
Purchase orders 4
Shipments received 3
Setups 2
Inspections 12
• Calculate the overhead to be allocated to the bags under the traditional and activity-based costing techniques.
• C. Which costing method do you think is better for the company? Why?

Decision Focus: ABCLO1, 2, 3, 4
Worth Hawes Manufacturing has just completed a major change in its quality control (QC) process. Previously, QC inspectors had reviewed products at the end of each major process and the company’s 10 QC inspectors were charged as direct labor to the operation or job. In an effort to improve efficiency and quality, Worth Hawes purchased a computer video QC system for $250,000. The system consists of a minicomputer, 15 video cameras, other peripheral hardware, and software.
The new system uses cameras stationed by QC engineers at key points in the production process. Each time an operation changes or a new operation begins, the cameras are moved and a QC engineer loads a new master picture into the computer. The camera takes pictures of the unit in process, and the computer compares them with the picture of a “good” unit. Any differences are sent to a QC engineer, who removes the bad units and immediately discusses the flaws with the production supervisors. The new system has replaced the 10 QC inspectors with two QC engineers.
The operating costs of the new QC system, including the salaries of the QC engineers, have been included as overhead in calculating the company’s plantwide factory overhead rate, which is based on direct labor dollars.
In short, the company’s president is confused. The vice president of production has been commenting on how efficient the new system is, yet the president has observed that there has been a significant increase in the factory overhead rate. The computation of the rate before and after implementation of the new QC system is as follows:
Before After
Budgeted overhead $1,900,000 $2,100,000
Budgeted direct labor $1,000,000 $ 700,000
Budgeted overhead rate 190% 300%
“Three hundred percent,” lamented the president. “How can we compete with such a high factory overhead rate?”
• A. Discuss the development of factory overhead rates. Why do we need factory overhead rates, and how are they computed? Discuss the accuracy of the computation of a factory overhead rate.
• B. Explain why the increase in the overhead rate should not have a negative impact on Worth Hawes Manufacturing.
• C. Explain, in the greatest detail possible, how the company could change its overhead accounting system to eliminate confusion over product costs.
• D. Discuss how an activity-based costing system might benefit Worth Hawes Manufacturing.



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