Decision: Traditional vs. ABC

Gramercy, Inc. manufacturers sailboats and has two major categories of overhead: materials handling and quality inspection. The costs expected for these categories for the coming year are as follows:

Materials handling (based on 500 material moves) $100,000

Quality inspection (based on 200 inspections) $300,000

The plant currently applies overhead based on direct labor hours. The estimated amount of direct labor hours is 50,000. Polly Richardson, the plan manager, has been asked to submit a bid and has assembled the following data on the proposed job:

Direct materials  $3,700

Direct labor (1,000 hours) $17,000

Overhead  ?

Number of material moves 10

Number of inspections 5

Polly has been told that many similar companies use an activity-based approach to assign overhead to jobs. Before submitting a bid, Polly wants to assess the effects of this alternative approach.

Use the traditional overhead application to calculate the total cost of the potential job.

Use activity-based costing with the new cost drivers to calculate the total cost of the job.

Discuss the difference in the costs calculated under the two overhead allocation methods and what impact the change to activity-based costing might have on the pricing decision.