Comparing Traditional Costing and Activity Based Costing

1. You’re in Hot Water Inc. manufactures Jacuzzi hot tubs. The company produces two models, the
“Basic” and the “Superjet” which promises a jet power setting that “borders on cruel”. Since the
introduction of the Superjet, the company’s profits have been faltering, despite increased sales. The
company’s senior accountant believes that the costing system may be causing problems. The
company uses direct-labour hours as the basis for applying overhead. Overhead is estimated to be
$300,000.

The following cost data is known:

Basic Superjet
Direct Materials $700 $1200
Direct Labour ($15 per hour) 60 90
Number of units produced 600 units 100 units

The CFO wishes to explore an activity-based costing system

Activity (Cost Driver) Estimated MOH Expected Activity

Total Basic Superjet
Assembly (Labour Hours) $60,000 3,000 2,400 600
Quality control (Inspection Hours) 75,000 800 600 200
Machining (Machine Hours) 25,000 40,000 30,000 10,000
Parts Admin (Number of Parts) 140,000 500 100 400
$300,000

Required:
a.) Under the traditional costing method:
i. Compute the predetermined overhead rate.
ii. Determine the unit cost of each product.
b.) Under activity based costing:
i. Compute the activity rates for each activity.
ii. Determine the expected unit cost of each product.
c.) Compare and comment on your answers from parts a.) and b.) above.
d.) If ABC produces more accurate cost data, why is it not more widely used?
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