Lavender Company uses activity-based costing. The company has two products: A and B. The annual production and sales of Product A is 1,500 units and of Product B is 3,000 units. There are three activity cost pools, with estimated total cost and expected activity as follows:
| Expected Activity | ||||
| Activity Cost Pool | Estimated Cost | Product A | Product B | Total |
| Activity 1 | $10,000 | 420 | 350 | 770 |
| Activity 2 | 12,000 | 120 | 420 | 540 |
| Activity 3 | 50,000 | 490 | 1,162 | 1,652 |
The cost per unit of Product B under activity-based costing is closest to which of the following?
Select one:
a. $35.38
b. $16.35
c. $24.10
d. $31.90
Activity-Based Costing (ABC) is a modern costing technique that allocates overhead costs to products or services based on their actual consumption of various activities within an organization. Lavender Company, a fictional entity, employs ABC to determine the cost per unit for its products A and B. In this analysis, we will focus on calculating the cost per unit for Product B under the activity-based costing system.
Lavender Company has identified three activity cost pools along with their estimated total costs and expected activities. These cost pools are as follows:
Activity 1: Estimated Cost – $10,000, Expected Activity – 770 (Product A: 420, Product B: 350)
Activity 2: Estimated Cost – $12,000, Expected Activity – 540 (Product A: 120, Product B: 420)
Activity 3: Estimated Cost – $50,000, Expected Activity – 1,652 (Product A: 490, Product B: 1,162)
Calculating Activity-Based Overhead Rate: To calculate the activity-based overhead rate for each activity, we divide the estimated cost by the expected activity for that activity pool.
Activity 1 Overhead Rate = $10,000 / 770 = $12.99 per activity unit
Activity 2 Overhead Rate = $12,000 / 540 = $22.22 per activity unit
Activity 3 Overhead Rate = $50,000 / 1,652 = $30.25 per activity unit
Next, we need to calculate the total overhead cost for Product B based on its consumption of each activity.
Activity 1 Cost for Product B = Activity 1 Overhead Rate * Expected Activity for Product B = $12.99 * 350 = $4,546.50
Activity 2 Cost for Product B = Activity 2 Overhead Rate * Expected Activity for Product B = $22.22 * 420 = $9,334.40
Activity 3 Cost for Product B = Activity 3 Overhead Rate * Expected Activity for Product B = $30.25 * 1,162 = $35,142.50
Total Overhead Cost for Product B = $4,546.50 + $9,334.40 + $35,142.50 = $49,023.40
Calculating Cost per Unit for Product B: The total overhead cost for Product B is $49,023.40, and the annual production and sales of Product B are 3,000 units. Therefore, the cost per unit for Product B under the activity-based costing system is:
Cost per Unit for Product B = Total Overhead Cost for Product B / Number of Units = $49,023.40 / 3,000 ≈ $16.34
After applying activity-based costing principles to Lavender Company’s cost structure, we calculated that the cost per unit for Product B is approximately $16.34. This calculation considers the consumption of various activities within the organization, providing a more accurate representation of the true costs associated with producing and selling Product B. This approach enhances cost allocation precision compared to traditional costing methods and supports better decision-making regarding pricing and resource allocation within the company.
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