EcoFabrics has budgeted overhead costs of $1,096,200. It has allocated overhead on a plantwide basis to its two products (wool and cotton) using direct labor hours which are estimated to be 522,000 for the current year. The company has decided to experiment with activity-based costing and has created two activity cost pools and related activity cost drivers. These two cost pools are cutting (cost driver is machine hours) and design (cost driver is number of setups). Overhead allocated to the cutting cost pool is $417,600 and $678,600 is allocated to the design cost pool. Additional information related to these pools is as follows Wool Cotton Total
Machine hours 116,000 116,000 232,000
Number of setups 1,160 580 1,740
1. Calculate the overhead rate using activity-based costing.
2. Determine the amount of overhead allocated to the wool product line and the cotton product line using activity-based costing.
3. Calculate the overhead rate using traditional approach.

1. Cutting = $1.80 per machine hour and Design = $390 per set-up

2.Wool = $626,400 and Cotton = $435,000

3.$2.10 direct labor hours.

Explanation:

First determine the Cost Driver Rate for the Cost Pools :

Cost Driver Rate = Total Cost Pool Overhead / Total Cost Pool Activity

1. Cutting

Cost Driver Rate = Overhead / Total Machine hours

                            = $417,600 / 232,000

                            = $1.80 per machine hour

2. Design

Cost Driver Rate = Overhead / Total Number of Set-ups

                            = $678,600 / 1,740

                            = $390 per set-up

Allocate the Overhead to Products using the Cost Driver Rates

                                                       Wool                   Cotton

Overheads :

Cutting

Wool ($1.80 × 116,000)              $208,800

Cotton ($1.80 × 116,000)                                         $208,800

Design

Wool ($390 × 1,160)                    $417,600

Cotton ($390 × 580)                                               $226,200

Total                                           $626,400             $435,000

Traditional Approach :

Overhead rate = Total Budgeted Overheads / Total direct labor hours

                         =  $1,096,200 / 522,000

                         =  $ 2.10 direct labor hours.

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