Royce’s Commemoratives makes and sells two types of decorative plates. One plate displays a hand-painted image of Princess Kate; the other plate displays a machine-pressed image of Marilyn Monroe. The Kate plates require 25,000 hours of direct labor to make; the Monroe plates require only 5,000 hours of direct labor. Overhead costs are composed of (1) $105,000 machine-related activity costs, including indirect labor, utilities, and depreciation, and (2) $75,000 labor-related activity costs, including overtime pay, fringe benefits, and payroll taxes.
a. Assuming that Royce’s uses direct labor hours as the allocation base, determine the amount of the total $180,000 overhead cost that would be allocated to each type of plate.
b. Explain why using direct labor hours may distort the allocation of overhead cost to the two products.
c. Explain how activity-based costing could improve the accuracy of the overhead cost allocation.