A company uses activity based costing. Annual overheads are: machining $90,000 (driver: 30,000 machine hours) and set-ups $48,000 (driver: 120 set-ups). Product Z has annual output of 2,000 units, uses 1,000 machine hours and needs 20 set-ups. What is the overhead cost per unit of Z?

Correct answer: C) $5.50

Explanation

Cost driver rates: machining 90,000 / 30,000 = $3 per machine hour; set-ups 48,000 / 120 = $400 per set-up. Overheads for Z = (1,000 x 3) + (20 x 400) = 3,000 + 8,000 = $11,000. Per unit = 11,000 / 2,000 = $5.50. A traditional machine hour rate of 138,000 / 30,000 = $4.60 would give only 0.5 x 4.60 = $2.30, which understates the cost of this small-batch product.