Problem

ABC vs. Simpler system

First Company fishes the Firth River and prepares Fresh and Frozen fish products.

In order to determine the product costs, the following information is available.

The company currently uses direct labor hours (DLH) as its allocation base (cost driver) to allocate the $934,000 overhead from a single pool. Thus:

All Overhead                  Total Cost          Cost driver                     Fresh Fish          Frozen Fish

Total                             $934,000           40,000 DLH                   10,000 DLH       30,000 DLH

                                                                                                (25%)                (75%)

A study investigated the Total Overhead and determined the Total could be broken down into the following Activities and drivers.

                                                                                                Amount of driver consumed in

Activity                         Activity Cost       Cost driver                     Fresh Fish          Frozen Fish

Unloading Fish               $300,000           20,000 loads                   5,000 loads        15,000 loads

Utilities for filleting line    $24,000             60,000 gallons                14,400 gals        45,600 gals

Equipment maintenance    $330,000           4,000 machine hrs           2,680 mach hr     1,320 mach hr

Setups                           $280,000           1400 setups                    1,120 setups       280 setups

Total                             $934,000

To be clear, take Unloading fish. 76% of the loads (the cost driver) are associated with Frozen Fish.

REQUIRED.

1. Is the above information based on actual costs and volumes or anticipated costs and volumes? Explain your reasoning and what benefits can come from companies using the choice you suggest.

2. Remember that the company, at present, is using direct labor hours (DLH) to assign costs. It is now considering the use of just two of the above cost drivers to drive all the overhead costs to the two products. The two drivers considered are loads and gallons of water. 

If you compare the overhead costs allocated to the products using DLH to the overhead allocated using the two above noted drivers (loads and gallons), do the new drivers produce different product costs (remember that all the overhead will be allocated under both alternatives)? To answer this: (a) prove with calculations (b) also, please explain, with analysis of the production process data provided above, how and why using these two drivers will or will not produce significantly different costs for each of the products, compared to using DLH. 

1. If all four of the activities were used to allocate the overhead (ie a full ABC calculation), would the cost be significantly different from using the DLH allocation method? (a) prove with calculations (b) also, explain why or why not, with analysis of the production process data provided above.