Question

Devon Company uses activity-based costing to determine the costs of its two products: A and B. The total estimated cost of the purchasing function activity pool is $14,000. The cost driver for that pool equals number of purchase orders. A total of 400 purchase orders are expected to be issued for the budgeted production of Product A and 300 purchase orders are expected to be issued for the budgeted production of Product B. The activity rate for the purchasing cost pool is:

Answer 1

Answer:

The activity rate will be 20 per order.

For product A it will be $8,000 applied

for Product B it will be $6,000 applied

Explanation:

estimated cost / activity pool = rate

14,000 / 700 = 20

Applied cost:

activity x rate

Product A 400 x 20 = 8,000

Product B 300 x 20 = 6,000

Answer 2

Answer:

$20 per purchase order

Explanation:

Resources in a company are allocated to companies at the beginning of a budgeting period based on consumption estimates. Activity-based costing (ABC) is a method used to identify the activities undertaken by an organisation, assigning the cost of each activity to the goods or services produced or offered by a company based on actual consumption of the related goods or services. The ABC method may support decisions associated with pricing, outsourcing and measurement of process improvements. The method allocates overhead costs of an activity based on cost drivers to determine the activity rate. This rate is then used to allocate costs based on actual consumption.

The overhead cost for the purchasing function of Devon Company is: $14,000

The cost driver is given as the number of purchase orders: 300(A) and 400(B)

The activity rate for the purchasing pool is therefore: $14,000/700 = $20 per order

Application:

If the actual purchase orders were below the estimated amount : say the orders for A were 250 and the actual purchase orders for B were 95, then the total cost of the purchasing function for the period would be (250 * $20) +(95*$20 = $6900 which would be below the $14,000 budget. That would signal that management would need to reassess and lower the resources allocated to  the purchasing function during the next budgeting period.

If the actual orders were above the estimated amounts: say the orders for A were 450 and orders for B were 310 then the total cost incurred by the purchasing function would be (450 * $20) + (310 * $20) = $15200 which is above the budget. This would signal that there could be areas for process improvement to avoid redundancies arising from duplication of orders, loss of orders among other process inefficiencies.