ch 05 solutions

Solutions Manual 2012 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

5-1

CHAPTER 5

Activity-Based Costing

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Questions

Brief

Exercises

Do It!

Review

Exercises

A & B

Problems

*1. Recognize the difference

between traditional costing

and activity-based costing

(ABC) and understand the

nature of ABC.

1, 2, 3, 4, 5 1, 2 13 17, 18, 19,

20, 21, 22,

26, 28, 29

35A, 36A, 38A,

39A, 40A, 41A,

42A, 43B, 45B,

46B, 47B, 48B,

49B, 50B

*2. Identify the steps in the

development of an activity-

based costing system and

compare unit costs.

6, 7, 9, 10,

11, 12

3, 4, 5, 6,

7, 12

14 17, 19, 20,

21, 22, 23,

24, 25, 26,

27, 28, 29

35A, 36A, 37A,

38A, 39A, 40A,

41A, 42A, 43B,

44B, 45B, 46B,

47B, 48B, 49B,

50B

3. Understand the bene-

fits and limitations of

activity-based costing.

13, 14, 15,

16

27 51B

*4. Differentiate between

value-added and non-

value-added activities.

8, 17 8, 9 15 28, 29, 30,

31, 32

35A, 41A, 43B,

50B

*5. Understand the value of

using activity levels in


19 10, 11, 12 16 33, 34

*6. Apply activity-based

costing to service

industries.

18 9, 10 15 32 41A, 50B


5-2

ASSIGNMENT CHARACTERISTICS TABLE Problem

Number

Description

Difficulty

Level

Time

Allotted (min.)

35A Assign overhead using traditional costing and ABC;

calculate unit costs; classify activities as value-added or

non-value-added.

Moderate 3545

36A Assign overhead costs using traditional costing and ABC;

compare results.

Moderate 3545

37A Assign overhead to products using ABC and evaluate the

decision.

Moderate 2535


compare results.

Moderate 4050


compare results.

Moderate 3545


compare results.

Moderate 3545

41A Assign overhead costs to services using traditional

costing and ABC; calculate overhead rates and unit costs;

compare results.

Moderate 3545


compare results.

Moderate 3545

43B Assign overhead using traditional costing and ABC;

calculate unit costs; classify activities as value-added or

nonvalue-added.

Moderate 4050

44B Assign overhead to products using ABC and evaluate the

decision.

Moderate 3545

45B Assign overhead costs using traditional costing and ABC;

compare results.

Moderate 3545


compare results.

Moderate 4050


compare results.

Moderate 30-40


compare results.

Moderate 4050


5-3

ASSIGNMENT CHARACTERISTICS TABLE (Continued)


compare results.

Moderate 4050

50B Assign overhead costs to services using traditional

costing and ABC; calculate overhead rates and unit costs;

compare results.

Moderate 3545

51B Assign overhead costs using ABC. Moderate 2535

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5-4

Correlation Chart between Blooms Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems

Study Objective Knowledge Comprehensio

n

Application Analysis Synthesis Evaluation

*1. Recognize the difference

between traditional costing

and activity-based costing

(ABC) and understand the

nature of ABC.

Q1, Q2, Q3, Q4,

Q5, D13

BE2 BE1, E17, E19, E20, E21,

E22, E26, P36A, P38A,

P39A, P42A, P45B,

P46B, P47B, P49B

E18, P35A, P40A,

P41A, P43B,

P48B, P50B

*

2. Identify the steps in the

development of an activity-

based costing system and

compare unit costs.

Q6, Q7, Q9,

Q10, Q11, Q12,

BE3, BE4, E23,

E25

BE5, BE6, BE7, D14,

E17, E19, E20, E21, E22,

E26, E27, P36A, P37A,

P38A, P39A, P42A,

P44B, P45B, P46B,

P47B, P49B, P51B

BE12, E24, E28,

E29, P35A, P40A,

P41A, P43B,

P48B, P50B

*

3. Understand the benefits and

limitations of activity-based

costing.

Q13, Q14, Q15,

Q16

E27, P51B

*4. Differentiate between value-

added and non-value-added

activities.

Q17 Q8 BE8, BE9, D15,

E28, E29, E30,

E31, E32, P41A,

P43B, P50B

*

5. Understand the value of

using activity levels in


Q19 BE10, BE11,

BE12, D16, E33,

E34

*6. Apply activity-based costing

to service industries.

Q18 BE9, BE10, D15,

E32, P41A, P50B

Managerial Accounting: Tools for Business Decision-Making, Third Canadian Edition Weygandt, Kimmel, Kieso, Aly


5-5

ANSWERS TO QUESTIONS

1. Direct labour is a valid basis for allocating overhead when: (a) direct labour constitutes a

significant part of total product cost, and (b) there is a high correlation between direct labour and

changes in the amount of overhead costs.

2. The amount of direct labour in many industries has greatly decreased, due to advances in

computerized systems, technological innovation, global competition and automation.

Total overhead costs resulting from depreciation on expensive equipment and machinery,

utilities, repairs, and maintenance have significantly increased. Many companies now use

machine hours as the basis on which to allocate overhead in an automated manufacturing

environment.

3. In many automated manufacturing environments, machine hours is a more relevant basis on

which to allocate overhead.

4. Under a traditional volume-based costing system where overhead cost is allocated on the basis

of units of output, the high-volume product will undoubtedly absorb more overhead than the low-

volume product.

5. (a) The principal differences are: Activity-Based Costing Traditional Costing (1)

(2)

(3)

Primary focus

Bases of allocation

Total product costs

Activities performed in making

products

Multiple cost drivers

Sum of costs of activities

consumed in making

product

Units of production

Single unit-level base

Direct materials plus direct

labour plus manufacturing

overhead (b) There are two assumptions that must be met in using ABC:

(1) All overhead costs related to the activity must be driven by the cost driver used to

assign costs to products.

(2) All overhead costs related to the activity should respond proportionally to changes in

the activity level of the cost driver.

6. Activity-based overhead rates are computed using the following formula: Estimated Overhead per Activity

Expected Use of Cost Drivers per Activity

7. The four steps involved in developing an ABC system are:

(1) Identify and classify the major activities involved in the manufacture of specific products, and

allocate manufacturing overhead costs to appropriate cost pools.



5-6

Questions Chapter 5 (Continued)

(2) Identify the cost driver that has a strong correlation to the costs accumulated in the cost

pool.

(3) Compute the overhead rate for each cost driver.

(4) Assign manufacturing overhead costs for each cost pool to products, using the overhead

rates (cost per driver).

8. A value-added/non-value-added activity flowchart is based on a systematic analysis of all the

activities (resource-consuming actions and transactions) performed to manufacture a product or

render a service. The flowchart documents each activity and the time involved in each activity.

The flow chart also documents managements proposed reengineering of the manufacturing process.

9. An activity cost pool is the overhead cost attributed to a distinct type of activity.

10. A cost driver is any factor or activity that has a direct cause-effect relationship with the resources

consumed.

11. A cost driver is accurate and appropriate if it measures the actual consumption of the activity in

manufacturing a product or rendering a service and the data relating to the cost driver is available

and easily obtained.

12. The formula for assigning activity cost pools to products is: Activity-based overhead rate Expected use of cost drivers per activity

13. The primary benefit of ABC is more accurate product costing. This results from using more cost

pools and enhanced control over overhead costs, and leads to better management decisions.

14. The limitations of ABC are: (a) increased costs that accompany multiple-activity cost pools and

cost drivers and (b) the necessity still to allocate some costs arbitrarily. Also, depending on how

the ABC system is designed, it may not conform to IFRS, which means the company may have to

use a traditional costing system for external reporting and ABC for internal decision making,

greatly increasing the administrative and accounting costs.

15. ABC is the superior costing system when: (1) product lines differ greatly in volume and

manufacturing complexity; (2) product lines are numerous, diverse, and require differing degrees

of support services; (3) overhead costs constitute a significant portion of total costs; (4) the

manufacturing process or the number of products has changed significantly; and (5) data from

the existing system is being ignored.

16. Basic ABC has been enhanced by identifying activities as value-added and non-value-added.

17. Identifying non-value-added activities highlights for managers the activities that should be

reduced or eliminated because they add no value to the product or service from the customers perspective(s).



5-7

Questions Chapter 5 (Continued)

18. The overall objective of ABC in service firms is no different than for manufacturing companies;

that is, improved costing of services rendered (by job, service, contract, or customer). The

general approach to costing is the sameanalyze operations, identify activities, assign overhead costs to activity cost pools, and identify and use cost drivers to assign the cost pools to the

services.

19. Greater accuracy in cost allocation is achieved by recognizing the four levels of activity. Some

activities are affected (driven) by changes in the number of units produced, while other activities

are affected only by changes in the number of batches or the number of products, and some,

facility-level activities, are unaffected by changes in either units, batches, or products produced.



5-8

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1

(a) Estimated annual overhead costs = Predetermined overhead rate

Expected annual operating activity

$500,000

= $10 per machine hour 50,000

(b) 40,000 machine hours $10 = $400,000 overhead applied (c) If the manufacturing process is complex, then multiple allocation

bases can result in more accurate product-cost computations. In such situations, managers need to consider a new overhead cost allocation method that uses multiple bases considering resource consumption. That method is activity-based costing.

BRIEF EXERCISE 5-2 Under ABC, overhead costs are shifted from the high-volume products to the low-volume products. This shift results in more accurate costing for two reasons:

1. Low-volume products often require more special handling, such as more machine setups and inspections, than high-volume products. Thus, the low-volume product frequently is responsible for more overhead costs per unit than is a high-volume product.

2. Assigning overhead using ABC will usually increase the cost per unit for low-volume products. Therefore, a traditional overhead allocation such as direct labour hours is usually a poor cost driver for assigning overhead costs to low-volume products.

As a result, for Sassafras, one of the products (Product RX3) may have been low volume and therefore may have more overhead costs assigned to it under an ABC system.



5-9

BRIEF EXERCISE 5-3 An appropriate cost driver for each activity is:

Activity Cost Driver Materials handling Machine setups Factory machine maintenance Factory supervision Quality control

Number of requisitions Number of setups Machine hours used Direct labour hours Number of inspections

BRIEF EXERCISE 5-4 (a) Number of parts or assemblies (b) Number of setups (c) Number of employees (d) Number of inspections (e) Number of purchase orders (f) Machine hours (g) Square footage occupied

BRIEF EXERCISE 5-5

Activity-based overhead rate = $960,000 960* = $1,000 per set-up.

*(180 + 240 + 540 = 960)

Assigned overhead: Overhead ABC rate Usage Assigned Product Red $1,000 180 $180,000 Product Black $1,000 240 $240,000 Product Yellow $1,000 540 $540,000 960 $960,000



5-10

BRIEF EXERCISE 5-6

Est. Est.

Cost Pool MOH Usage Rate

Designing $450,000 12,000 $37.50 per designer hr.

Sizing and cutting $4,000,000 160,000 $25.00 per machine hr.

Stitching and trimming $1,440,000 80,000 $18.00 per labour hr.

Wrapping and packing $336,000 32,000 $10.50 per unit

BRIEF EXERCISE 5-7

First determine the overhead rates.

Estimated Expected use of Cost = Activity-based Overhead Drivers per Activity Overhead Rates

Est. Est.


Ordering & receiving $90,000 15,000 $6.00 per order

Etching $480,000 60,000 $8.00 per machine hr.

Soldering $1,760,000 440,000 $4.00 per labour hr. Then use the rates to determine total overhead applied.

Cost Drivers

Overhead Rates

=

Total Overhead Applied

11,000 orders 50,000 machine hours 500,000 labour hours

$6 $8 $4

$ 66,000 400,000 2,000,000 $2,466,000

BRIEF EXERCISE 5-8

(a) Non-value-added (e) Non-value-added

(b) Non-value-added (f) Non-value-added

(c) Value-added (g) Non-value-added

(d) Non-value-added (h) Value-added



5-11

BRIEF EXERCISE 5-9 Value-added Activities Non-value-added Activities (a) (c) (e)

Designing and drafting On-site supervision Consultation with client

(b) (d) (f)

Staff meetings Lunch Entertaining prospective client

BRIEF EXERCISE 5-10 (a) Batch- or unit-level (f) Batch- or product-level (b) Unit-level (g) Batch- or product-level (c) Unit-level (h) Unit-level (d) Batch- or unit-level (i) Facility-level (e) Facility-level (j) Batch-level BRIEF EXERCISE 5-11 (a) Facility-level (e) Batch-level (b) Unit-level (f) Batch-level (c) Product-level (g) Product-level (d) Unit-level (h) Facility-level BRIEF EXERCISE 5-12

(a) Est. Est.


Setting up machines $300,000 1,500 $200 per set-up

Assembling $1,500,000 50,000 $30 per labour hr.

Inspection $300,000 60 $5,000 per inspection (b) Setting up machinesbatch level Assemblingunit level Inspectionproduct level



5-12

SOLUTIONS TO DO IT! REVIEW

DO IT! REVIEW 5-13 (a) True. (b) False. Activity-based costing is an approach for allocating overhead to

products or services. (c) False. Direct labour is an appropriate basis for allocating costs to

products if it represents the best cost driver for that cost. (d) True. (e) True. DO IT! REVIEW 5-14

(a) Est. Est.


Machine set-up $20,000 40 $500 per set-up

Machining $110,000 5,000 $22 per machine hr.

Packing $30,000 500 $60 per order

(b) Usage

Cost Pool Rate BC113 AD908

Machine set-up $500 per set-up 25 15

Machining $22 per machine hr. 1,000 4,000

Packing $60 per order 150 350

Assignment of overhead: BC113 AD908

Machine set-up ($500 25; 15) $12,500 $7,500

Machining ($22 1,000; 4,000) $22,000 $88,000

Packing ($60 150; 350) $ 9,000 $21,000

Overhead assigned $43,500 $116,500



5-13

DO IT! REVIEW 5-14 (Continued)

(c) Overhead cost per unit: BC113 AD908

Total overhead assigned $43,500 $116,500

Number of units produced 3,000 1,400

$14.50 $83.21

(d) The data shows that while the total overhead assigned to the lower-

volume product is three times the total amount assigned to the higher-volume product, the per unit cost ends up being almost six times more.

DO IT! REVIEW 5-15

(a) Non-value-added

(b) Value-added

(c) Non-value-added

(d) Non-value-added

(e) Value-added

(f) Value-added DO IT! REVIEW 5-16

(a) unit-level (e) unit-level

(b) product-level (f) batch-level

(c) facility-level (g) facility-level

(d) batch-level (h) unit-level



5-14

SOLUTIONS TO EXERCISES EXERCISE 5-17

(a) Estimated overhead = Predetermined overhead rate

Direct labour costs

$277,500 = 185% of direct labour cost

$50,000 + $100,000

(b) Est. Est.


Machining $177,000 1,500 $118.00 per machine hr.

Machine set-up $100,500 500 $201.00 per set-up

(c) Traditional costing Standard Custom

$ 50,000 185% $92,500

$100,000 185% $185,000

$92,500 $185,000

Activity-based costing

Machining:

500 $118 $59,000

1,000 $118 $118,000

Machine setup:

100 $201 20,100

400 $201 80,400

$79,100 $198,400

The difference between the two systems illustrates that under a traditional system more overhead is often allocated to the high-volume standard product, when, in fact, the custom product consumes more resources.



5-15

EXERCISE 5-18 (a) Traditional costing system

Product 440X Product 137Y Product 249S

Sales $200,000 $160,000 $80,000

Costs 50,000 60,000 20,000

Operating income $150,000 $100,000 $60,000

(b) Activity-based costing system

Product 440X Product 137Y Product 249S

Sales $200,000 $160,000 $80,000

Costs 40,000 45,000 45,000

Operating income $160,000 $115,000 $35,000

(c) Product 440X: ($160,000 $150,000) $150,000 = 6.67% Product 137Y ($115,000 $100,000) $100,000 = 15.00% Product 249S ($35,000 $60,000) $60,000 = (41.67%) (d) The costs for 440X under both methods could be similar because

the cost drivers under both methods might be the same; for example, they both may be based on units of production, or volume.

EXERCISE 5-19

(a) Est. Est.


Cutting $400,000 200,000 $2 per machine hr.

Machine set-up $555,000 1,500 $370 per set-up



5-16

EXERCISE 5-19 (Continued)

Usage

Cost Pool Rate Wool Cotton

Cutting $2 per machine hr. 100,000 100,000

Machine set-up $370 per set-up 1,000 500

Assignment of overhead: Wool Cotton

Cutting ($2 100,000; 100,000) $200,000 $200,000

Machine set-up ($370 1,000; 500) $370,000 $185,000


(b) Estimated overhead =

$955,000 = $2 per direct labour hour

Direct labour hours 477,500

Wool Cotton Traditional costing

238,750 $2 $477,500

238,750 $2 $477,500

The wool product line is allocated $92,500 ($570,000 $477,500) more overhead cost when an activity-based costing system is used. As a result, the cotton product line is allocated $92,500 ($477,500 $385,000) less. This happens because wool takes twice as many set-up as cotton, which is not reflected in the cost assigned when using labour hours. EXERCISE 5-20

(a) Direct labour hrs for car wheels (40,000 2) = 80,000

Direct labour hrs for truck wheels (10,000 6) = 60,000

Total direct labour hours 140,000



5-17


$840,000 ( total estimated overhead) = $6 per direct labour hour

140,000 (total direct labour hours)

Overhead assigned

Car wheels (80,000 $6) = $480,000

Truck wheels (60,000 $6) = 360,000

Total overhead $840,000

(b) Est. Est.


Setting up machines $260,000

500 $520 per set-up

Assembling $280,000 35,000 $8 per labour hrs

Inspection $300,000 600 $500 per inspection

$840,000

(c) Usage

Cost Pool Rate Car Truck

Setting up machines $520 per set-up 100 400

Assembling $8 per labour hrs 20,000 15,000

Inspection $500 per inspection 50 550

Assignment of overhead: Car Truck

Setting up machines ($520 100; 400) $52,000 $208,000

Assembling ($8 20,000; 15,000) $160,000 $120,000

Inspection ($500 50; 550) $25,000 $275,000


(d) Because of the uneven usage of two of the activities (set-ups [100 vs.

400] and inspection [50 vs. 550]) between the two products, using the three different cost pools will provide a more accurate assignment of overhead costs. YuYu should use activity-based costing.



5-18

EXERCISE 5-21 (a) Estimated Overhead Expected use of Cost = Activity-based

Drivers per Activity Overhead Rates

Scheduling & travel: $84, 000 1,680 = $50 per travel hour

Set-up time: $77,000 700 = $110 per set-up

Supervision: $56,000 $400,000 = 14% of direct labour cost

Commercial Residential

Activity-based overhead applied: Scheduling & traveltravel hours ($50 1,000) $50,000 ($50 680) $34,000 Set-up timenumber of set-ups ($110 450) 49,500 ($110 250) 27,500 Supervisiondirect labour costs (14% $100,000) 14,000 (14% $300,000) 42,000 Total overhead costs applied $113,500 $103,500

(b) Commercial Residential

Revenues

$300,000

$480,000

Direct material costs $30,000 $70,000

Direct labour costs 100,000 300,000

Overhead costs applied 113,500 243,500 103,500 473,500

Operating income (loss) $56,500 $6,500



5-19

EXERCISE 5-21 (Continued) (c) Assuming that the cost drivers are a reasonable representation of

what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocations of resources and more informative pricing decisions in the future.

EXERCISE 5-22

(a) Total overhead costs:

Setting up of machines $ 400,000

Machining 1,500,000

Inspecting 450,000

Material handling 750,000

Purchasing orders 150,000

$3,250,000 Assuming that direct labour hours are used as the activity base with the traditional costing method, the overhead rate would be: $3,250,000 400,000 direct labour hours = $8.125 per hour Assignment of overhead: Standard: 150,000 $8.125 = $1,218,750

Deluxe: 250,000 $8.125 = $2,031,250

(b) Est. Est.


Setting up machines $400,000 500 $800 per set-up

Machining $1,500,000 100,000 $15 per machine hrs

Inspections $450,000 1,500 $300 per inspection

Material handling $750,000 15,000 $50 per unit

Purchasing orders $150,000 500 $300 per order



5-20

$3,250,000


Usage

Cost Pool Rate Standard Deluxe

Setting up machines $800 per set-up 300 200

Machining $15 per machine hr 48,000 52,000

Inspections $300 per inspection 800 700

Material handling $50 per unit 5,000 10,000

Purchasing orders $300 per order 300 200

Assignment of overhead: Standard Deluxe

Setting up machines $240,000 $160,000

Machining $720,000 $780,000

Inspections $240,000 $210,000

Material handling $250,000 $500,000

Purchasing orders $90,000 $60,000

Overhead assigned $1,540,000 $1,710,000 EXERCISE 5-23 The following activities might be identified at Quik Prints Company from your analysis of its operations and a discussion with the owner-manager, Damon Whitebone. 1. Hiring and training personnel 11. Maintenance and repairs 2. Purchasing supplies and materials 12. Delivery 3. Selling, promoting, and marketing 13. Accounting 4. Billing and collecting 5. Designing 6. Offset printing 7. Copying EXERCISE 5-23 (Continued)



5-21

8. Faxing 9. Collating 10. Cutting and folding



5-22

EXERCISE 5-24

Budgeted Costs Activity Cost Pool Cost Driver Engineering design Engineering prototypes

Engineering

Engineering hours

Depreciation, machinery Electricity, machinery

Machinery

Machine hours

Machine setup, indirect labour Machine setup, indirect materials

Machine setup

Number of setups

Inspections Tests

Quality control

Number of tests or inspections

Depreciation, plant Insurance, plant Property taxes Oil, heating Electricity, plant lighting

Factory utilities

Square feet or Machine hours

Custodial wages

Maintenance Number of

machines or Machine hours

EXERCISE 5-25 The following cost drivers might be used to assign overhead: 1. 2. 3. 4. 5. 6. 7. 8.

Labour hours Labour hours Labour hours Litres of chemicals Number of cartfuls or labour hrs Number of cartfuls Litres of juice Litres of juice

9. 10. 11. 12. 13. 14. 15.

Litres of wine or months of aging Number of bottles Number of bottles Number of boxes Number of shipments Number of litres processed Number of litres processed

EXERCISE 5-26



5-23

(a) Est. Est.


Materials handling $33,000 1,000 $33 per requisiton

Machine set-ups $27,900 450 $62 per set-up

Inspections $24,600 600 $41 per inspection

$85,500

(b) Usage

Cost Pool Rate Instruments Gauges

Materials handling $33 per requisition 400 600

Machine set-ups $62 per set-up 150 300

Inspections $41 per inspection 200 400

Assignment of overhead: Instruments Gauges

Materials handling $13,200 $19,800

Machine set-ups $9,300 $18,600

Inspections $8,200 $16,400


(c) MEMO

To: President, Fontillas Instrument, Inc. From: Student Re: Benefits of activity-based costing (ABC)

ABC focuses on the activities performed in producing a product. Overhead costs are assigned to products based on cost drivers that measure the activities performed on the product.

The primary benefit of ABC is more accurate and meaningful product

costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced.




5-24

The improved cost data should also lead to better management

decisions. More accurate product costing should contribute to setting selling prices which will help achieve desired profitability levels. In addition, it should be helpful in deciding whether to make or buy a product part or component, and sometimes even whether to eliminate a product.

EXERCISE 5-27

Est. Est.


Materials handling $200,000 100,000 $2 per part

Purchase orders $210,000 35 $6,000 per order

Set-up hours $300,000 150 $2,000 per set-up hr

Machining $480,000 3,000 $160 per machine hr

$1,190,000

(a) 75,000 parts $2 = $150,000 material handling cost allocated to PC-21 (b) $210,000 35 orders = $6,000 per order (c) 50 hours $2,000 = $100,000 set-up costs allocated to WX-34

(d) Assignment of overhead: PC-21

Rate Usage Allocation

Materials handling $2 per part 75,000 $150,000

Purchase orders $6,000 per order 15 $90,000

Set-up hours $2,000 per set-up hr 100 $200,000

Machining $160 per machine hr 2,000 $320,000

Overhead assigned $760,000



5-25

EXERCISE 5-28 (a) (1) Traditional product costing system: $400,000 .80 = $320,000 Selling costs assigned in March to the

high intensity product line.

(2) Activity-based costing system:

Activity cost pool:

Number of Cost Driver

Used

Overhead

Rate

High Intensity

Attire

Sales commissions $950,000 $0.06 $57,000

AdvertisingTV/Radio 250 min. $300 75,000

AdvertisingNewspaper 2,000 in. $10 20,000

Catalogues 6,000 $2.50 15,000

Cost of catalogue sales 9,000 $1.00 9,000

Credits and collection $950,000 $0.04 38,000

$214,000

(b) As compared to ABC, traditional costing greatly over-costs the selling costs assigned to the high intensity product line. The difference of $106,000 ($320,000 $214,000) in the month of March is an almost 50% overstatement.

(c) All six activities, as selling activities, are non-value-added activities. EXERCISE 5-29 (a) (1) Traditional product costing system: $55,000 .17 = $9,350 overhead assigned to low-cal dessert line.



5-26


(2) Activity-based costing system:

Activity cost pool:

Number of Cost Driver

Used

Over- head Rate

Over-head

applied

Inspections of:

Materials received 6,000 kg. $0.60 $3,600

In Process 10,000 servings $0.33 3,300

CFIA Certification 420 orders $12.00 5,040

$11,940

(b) As compared to ABC, the traditional costing system undercosts the quality-control overhead cost assigned to the low-calorie dessert product line by $2,590 ($11,940 $9,350) in the month of June. That is a 27.7% understatement.

(c) All three activities, as quality-control related activities, are non-value-added activities.

EXERCISE 5-30

It is assumed that any activity which directly enhances or improves the quality or quantity of the vines, grapes, or wine is a value-added activity.

1.

2.

3.

4.

5.

6.

7.

8.

Value-added

Non-value-added

Value-added

Value-added

Non-value-added

Value-added

Value-added

Value-added

9.

10.

11.

12.

13.

14.

15.

Value-added

Value-added

Non-value-added

Non-value-added

Non-value-added

Non-value-added

Non-value-added



5-27

EXERCISE 5-31

1. Value-added 5. Non-value added 9. Non-value added

2. Non-value added 6. Value-added 10. Non-value added

3. Non-value added 7. Value-added 11. Non-value added

4. Non-value added 8. Non-value added 12. Value-added

EXERCISE 5-32

Value-Added Activities

Hours

Non-Value-Added Activities

Hours

Writing contracts and letters 1.0 Staff meetings 0.5

Taking depositions 1.0 Doing research 1.0

Contemplating legal strategy 1.0 Traveling 1.0

Litigating a case in court 2.5 Eating lunch 1.0

Entertaining 2.0

Total hours 5.5 5.5

Questionable Classifications Writing contracts is value-added; writing letters may be value-added if related to a specific case or it may be non-value-added if it is billing a client or collecting receivables. Research may be value-added if it is unique, related to a specific case, and is billable. Research may be non-value-added if it is something the attorney should already have known and is not billable to the client. EXERCISE 5-33 Activity Cost Pools Activity Level Engineering Machinery Machine setup Quality control Factory utilities Maintenance

Product-level Unit-level Batch-level Depends on frequency. Could be unit, batch, or product-level Facility-level Facility-level



5-28

EXERCISE 5-34 1. Facility-level activity 2. Product-level activity 3. Batch-level activity 4. Product-level activity 5. Product-level activity 6. Batch-level or unit-level activity 7. Facility-level activity 8. Batch-level or unit-level activity 9. Unit-level activity 10. Unit-level activity



5-29

SOLUTIONS TO PROBLEMSSET A

PROBLEM 5-35A

(a) Computation of unit coststraditional costing. Products

Manufacturing Costs Home

Model Commercial

Model Direct materials

Direct labour Overhead Total unit cost

$18.50 19.00

* 23.40* $60.90

$26.50 19.00

* 23.40* $68.90

*$15.60 1.5 = $23.40

(b) Est. Est.

Cost Pool MOH Usage Rate Cost Drivers

Receiving $70,350 335,000 $0.21 per kilogram

Forming $150,500 35,000 $4.30 per machine hr

Assembly $390,600 217,000 $1.80 per part

Testing $51,000 25,500 $2.00 per test

Painting $52,580 5,258 $10.00 per litre

Packing & shipping $787,250 335,000 $2.35 per kilogram

$1,502,280

(c) Usage

Cost Pool Rate Home Commercial

Receiving $0.21 per kilogram 215,000 120,000

Forming $4.30 per machine hr 27,000 8,000

Assembly $1.80 per part 165,000 52,000

Testing $2.00 per test 15,500 10,000

Painting $10.00 per litre 3,680 1,578

Packing & shipping $2.35 per kilogram 215,000 120,000



5-30

PROBLEM 5-35A (Continued) Activity-based overhead applied Home Commercial Receivingkilograms

$0.21 215,000; $0.21 120,000 $45,150 $25,200 Formingmachine hours $4.30 27,000; $4.30 8,000 116,100 34,400 Assembly# of parts $1.80 165,000; $1.80 52,000 297,000 93,600 Testing# of tests $2 15,500; $2 10,000 31,000 20,000 Painting# litres $10 3,680; $10 1,578 36,800 15,780 Packing and shippingkilograms $2.35 215,000; $2.35 120,000 505,250 282,000

Total overhead applied $1,031,300 $470,980

Total units produced 54,000 10,200

Per unit overhead cost $19.10 $46.17

(d) Computation of unit costsactivity-based costing. Manufacturing costs Home Commercial

Direct material $18.50 $26.50 Direct labour 19.00 19.00 Overhead cost 19.10 46.17

Per unit cost $56.60 $91.67

(e) Value Added Non-Value-Added Forming

Assembling Painting

Packing & shipping

Receiving Testing



5-31

PROBLEM 5-35A (Continued)

(f) (1) Activity-based costing shows the commercial model absorbs nearly 21/2 ($46.17 $19.10) times as much overhead per unit as the home model.

(2) The comparison of ABC and traditional costing shows that the

proper amount of overhead assigned to the two products is not equal as under the traditional costing. Under traditional costing, the margin of error on the commercial model was almost 100%, an understatement of $22.77 on an assignment of $23.40. These distorted overhead assignments have likely led to overpricing the home model and under-pricing the commercial model.



5-32

PROBLEM 5-36A

(a) Computation of indirect manufacturing costsusing the plant-wide allocation rate of $800 per labour hour: 50 labour hours $800 overhead rate = $40,000 for 1,000 pairs The rate would be $40 per pair ($40,000 1,000).

(b) Activity-based overhead applied Material handling# of parts $8.00 4,000 parts $32,000 Assemblylabour hours $80.00 50 hours 4,000 Inspectionminutes $12.00 60 minutes 720

Total overhead applied $36,720 Number of pairs per batch 1,000

Overhead applied per pair $36.72

(c) The traditional product-costing system over-costs the shoes by $3.28 ($40.00 $36.72). This may have caused the shoes to be overpriced.



5-33

PROBLEM 5-37A

(a) The total manufacturing cost per unit using activity-based costing is

as follows:

Activity-based overhead applied

Royale

Majestic

Purchasingpurchase orders $30 11,250; 13,750 $337,500 $412,500 Machine set-ups# of set-ups $30 10,000; 10,000 300,000 300,000 Machiningmachine hours $31 40,000; 60,000 1,240,000 1,860,000 Inspections# of inspections $90 2,250; 2,750 202,500 247,500

Total overhead applied $2,080,000 $2,820,000 Number of units manufactured 20,000 10,000


(b) Computation of unit costs Royale Majestic

Direct material $600.00 $320.00 Direct labour 100.00 80.00 Overhead cost 104.00 282.00

Per unit cost $804.00 $682.00

Gross Profit: Royale Majestic

Selling price $1,400.00 $1,100.00 Less: per unit cost 804.00 682.00

Gross profit $ 596.00 $ 418.00

(c) Managements future plans for the two television models are not sound. Under ABC costing, the Royale model is $178.00 ($596.00



5-34

PROBLEM 5-37A (continued)

$418.00) per unit more profitable than the Majestic model. If any product should be phased out, it is the Majestic.



5-35

PROBLEM 5-38A

(a) The normal selling price per mountain bike using the single-rate

method for assigning overhead on a plant-wide basis is as follows: Overhead rate = $300,000 10,000 direct labour hours = $30 per direct labour hour Single rate method: Direct material $160.00 Direct labour 180.00 Applied overhead ($30 7.5 hours per unit) 225.00

Full cost per unit 565.00 Plus: mark-up at 20% 113.00

Normal price per mountain bike $678.00

The unit price offered of $575 is lower than the normal price. Therefore the company should refuse the offer even if sales would increase 30%.

(b) Determine activity-based overhead rates:

Machining: $75,000 25,000 = $3.00 per machine hour

Reworking: $45,000 600 = $75 per unit

Inspection: $25,000 500 = $50 per hour

Scrap: $35,000 140 = $250 per unit

General: $120,000 12,000 = $10 per direct labour hour



5-36

PROBLEM 5-38A (Continued) Activity-based costing method: Direct material $160.00 Direct labour 180.00 Machining ($3 6 hrs) 18.00 Rework labour ($75 0.25 units) 18.75 Inspection ($50 0.1 hour) 5.00 Scrap costs ($250 0.05 units) 12.50 General overhead ($10 7.5 DLH) 75.00

Full cost per unit 469.25 Plus: mark-up at 20% 93.85

Normal price per mountain bike $563.10

Using an activity-based costing approach, Kiddy should accept the offered price of $575, which has a slightly higher mark-up than the target mark-up of 20%.



5-37

PROBLEM 5-39A

(a) Predetermined overhead rate using machine hours: $830,000 100,000 hours = $8.30 per machine hour

(b) Manufacturing cost per stair under traditional costing: Direct materials ............................................................... $103,600 Direct labour ................................................................... 112,000 Overhead (14,500 $8.30) .............................................. 120,350 Total cost of 280 stairs ........................................... $335,950 Cost per stair ($335,950 280) ....................................... $1,199.82

(c) Manufacturing cost per stair under activity-based costing:

Determine activity-based overhead rates:

Purchasing: $57,000 600 = $95 per order

Handling materials: $82,000 8,000 = $10.25 per move

Production: $210,000 100,000 = $2.10 per direct labour hour

Setting-up: $85,000 1,250 = $68 per set-up

Inspecting: $90,000 6,000 = $15 per inspection

Inventory control: $126,000 168,000 = $0.75 per component

Utilities: $180,000 9,000 = $20.00 per square foot

Assign overhead to the order

Purchasing ($95 60 orders) $5,700 Handling materials ($10.25 800 moves) 8,200 Production ($2.10 5,000 direct labour hrs) 10,500 Setting-up ($68 100 set-ups) 6,800 Inspecting ($15 450 inspections) 6,750 Inventory control ($0.75 16,000 components) 12,000 Utilities ($20.00 800 square feet) 16,000

Total overhead applied to this order $65,950



5-38

PROBLEM 5-39A (Continued) Total manufacturing cost per stair under ABC: Direct materials ...................................................................... $ 103,600 Direct labour ........................................................................... 112,000 Overhead ................................................................................ 65,950 Total cost of 280 stairs................................................... $ 281,550 Total cost per stair ($281,550 280) ..................................... $1,005.54

(d) Activity-based costing is the preferred costing system for setting prices because the costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity cost drivers under ABC than the single cost driver used with the traditional volume-based system.



5-39

PROBLEM 5-40A

(a) Predetermined overhead rate under the traditional method: $1,930,000 90,000 = $21.44 per machine hour

Soft Steel

Hard Steel

Direct material $ 300.00 $ 200.00

Direct labour 120.00 60.00

Manufacturing overhead

($21.44 50; 50 machine hrs.) 1,072.00 1,072.00

Total manufacturing cost per unit $1,492.00 $1,332.00

(b) Determine overhead rates for each activity:

Est. Est.


Material handling $280,000 40,000 $7.00 per move

Purchase orders $100,000 1,200 $83.33 per order

Product testing $420,000 3,500 $120.00 per test

Machine set-up $320,000 5,000 $64.00 per set-up

Machining $810,000 90,000 $9.00 per machine hr

$1,930,000

Determine activity usage for each product:

Usage

Cost Pool Rate Soft Steel

Hard Steel

Material handling $7.00 per move 4 6

Purchase orders $83.33 per order 2 3

Product testing $120.00 per test 3 4

Machine set-up $64.00 per set-up 5 10

Machining $9.00 per machine hr 50 50



5-40


(c) Assignment of overhead:

Rate Soft

Steel Hard Steel

Material handling $7.00 per move $28 $42

Purchase orders $83.33 per order 167 250

Product testing $120.00 per test 360 480

Machine set-up $64.00 per set-up 320 640

Machining $9.00 per machine hr 450 450


Soft Steel

Hard Steel

Direct material $300 $200

Direct labour 120 60

Manufacturing overhead 1,325 1,862

Total manufacturing cost per unit using ABC $1,745 $2,122

Total manufacturing cost per unit (traditional) $1,492 $1,332

(d) To: Mr. Tyler Silva, President, International Steel Company From: Student Subject: Product costs using traditional approach versus ABC

The memorandum covers the following points:

a. ABC allocates overhead costs as a function of each products use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each products generation of overhead costs.



5-41


b. Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labour costs.

c. In the case of the International Steel Company, the hard steel product would require the company to begin using more complex methods and equipment. Overhead costs would increase substantially. When overhead costs are allocated using labour rates, too much overhead will be allocated to the high volume soft steel product. This would cause the soft steel product to appear to be less profitable than it is because it is subsidizing the overhead of the hard steel.

d. The total cost of the two products under the two approaches was as follows:

Soft Steel

Hard Steel

Traditional approach

ABC

$1,492

$1,745

$1,332

$2,122 Therefore, the relative profitability of the two products should be

determined using ABC costing.



5-42

PROBLEM 5-41A

(a) Overhead assigned to audit: .40 $1,000,000 = $400,000 Overhead assigned to tax: .40 $800,000 = $320,000

(b) (1) Determine activity-based overhead rates:

Employee training: $216,000 $1,800,000 = $0.12 per DL dollar

Secretarial: $76,200 2,500 = $30.48 per report/form

Computing: $204,000 60,000 = $3.40 per minute

Facility rental: $142,500 40 = $3,562.50 per employee

Travel: No rate; expenses are traced directly

(2) Assign overhead: Audit Tax

Training ($0.12 $1,000,000 DL$) $120,000 ($0.12 $800,000 DL$) $96,000 Secretarial ($30.48 600 reports) 18,288 ($30.48 1,900 reports) 57,912 Computing ($3.40 25,000 min.) 85,000 ($3.40 35,000 min.) 119,000 Rent ($3,562.50 22 employees) 78,375 ($3,562.50 18 employees) 64,125 Travel (Direct) 56,000 25,300


(c) Value-Added Non-Value-Added Typing and secretarial

Computing

Employee training Facility rental Travel



5-43

PROBLEM 5-41A (Continued) (d) Overhead is assigned to the two service lines as follows: Audit Tax Traditional costing

ABC

$400,000 357,663

$320,000 362,337

Traditional costing using direct labour dollars as the overhead base

assigned $80,000 more to Audit than to Tax. But under ABC, using six different overhead categories, it shows the two departments are more closely matched in total costs, differing by only $4,674. It would appear that under the traditional method Audit would be subsidizing some of Taxs overhead cost.



5-44

PROBLEM 5-42A

(a) Determine activity-based overhead rates:

Machine set-up: $25,000 50 = $500 per set-up

Order processing: $60,000 800 = $75 per order

Warehouse costs: $90,000 400 = $225 per inventory unit

Shipping: $35,000 7,500 = $4.667 per unit

GOGO LTD. Income Statement for the year ended December 31, 2012 Standard Deluxe Super Total

Sales $475,000 $380,000 $560,000 $1,415,000

Direct costs:

Direct material 200,000 150,000 240,000 590,000

Direct labour 54,000 14,000 24,000 92,000

Variable Overhead:

Machine set-up1 11,000 5,500 8,500 25,000

Order processing1 22,500 15,000 22,500 60,000

Warehouse costs1 45,000 22,500 22,500 90,000

Shipping1 23,333 2,333 9,334 35,000

Contribution margin $119,167 $170,667 $233,166 523,000

Fixed overhead: Plant administration 88,000

Other fixed 182,000

Net operating profit $253,000 1 Amount = Overhead rate activity usage (b) Activity-based costing (ABC) provides a more detailed breakdown of

costs and better matches each cost with the activity that incurred the cost. This additional information should enable GoGo to make better decisions. For example, if GoGo wants to reduce costs, with ABC it can identify the most costly activities and/or which costs are most amenable to reduction. Also the company will have more accurate cost information for product pricing.



5-45

SOLUTIONS TO PROBLEMSSET B

PROBLEM 5-43B

(a) Computation of unit coststraditional costing.

Deluxe Standard

Direct material $11.00 $42.00


Manufacturing overhead ($7 per DL hr) 14.00 14.00

Total manufacturing cost per unit $43.00 $74.00

(b) Overhead rates for each cost pool:

Est. Est.


Purchasing $130,000 500 $260.00 per order

Receiving $30,000 20,000 1.50 per kilogram

Assembling $370,000 74,000 5.00 per part

Testing $115,000 23,000 5.00 per test

Finishing $140,000 70,000 2.00 per unit

Packing & shipping $195,000 78,000 2.50 per kilogram

$980,000

Usage of the cost driver for each product:

Usage

Cost Pool Rate Deluxe Standard

Purchasing $260.00 per order 150 350

Receiving 1.50 per kilogram 4,000 16,000

Assembling 5.00 per part 20,000 54,000

Testing 5.00 per test 10,000 13,000

Finishing 2.00 per unit 20,000 50,000



5-46

PROBLEM 5-43B (Continued)

c) Assignment of overhead:

Cost Pool Rate Deluxe Standard

Purchasing $260.00 per order $39,000 $91,000

Receiving $1.50 per kilogram 6,000 24,000

Assembling $5.00 per part 100,000 270,000

Testing $5.00 per test 50,000 65,000

Finishing $2.00 per unit 40,000 100,000

Packing & shipping $2.50 per kilogram 42,500 152,500


Number of units produced 20,000 50,000

Overhead cost per unit $13.88 $14.05

(d) Total cost per unit Deluxe Standard



Manufacturing overhead 13.88 14.05

$42.88 $74.05

(e) Value Added Non-Value-Added Assembling

Finishing Packing and shipping

Purchasing Receiving Testing

(f) (1) There is little difference between the amount of overhead allocated to the products under the two different methods. This would indicate that direct labour hours (used with the traditional method) are a fairly accurate cost driver for overhead costs.

(2) Because there is little change between the overhead assigned under the two methods, the total unit costs are also very close. For these two products it would be appropriate for the company to save time and money by using the simpler, traditional costing method.



5-47

PROBLEM 5-44B

(a) The allocation of total manufacturing overhead using activity-based

costing is as follows:

Ice

House

Cool Chest

Purchasing ($40 2,500; 1,975 orders) $100,000 $79,000 Set-ups ($250 480; 300 set-ups) 120,000 75,000 Extruding ($4 60,000; 20,000 hrs.) 240,000 80,000 Testing ($20 5,000; 3,000 tests) 100,000 60,000

Total overhead costs $560,000 $294,000 Units produced 50,000 20,000


(b) Per unit gross profit: Ice House Cool Chest

Selling price $35.00 $24.00

Less: unit cost



Overhead 11.20 28.70 14.70 25.70

Gross profit per unit $6.30 $(1.70)

(c) Activity-based costing reveals a very different situation than traditional costing. Management must be stunned to learn that the Cool Chest is unprofitable, losing $1.70 per unit while its other product, Ice House, earns gross profit of $6.30 per unit. Obviously, management must revise its marketing and selling efforts as well as its pricing, and maybe its production, of the Cool Chest.



5-48

PROBLEM 5-45B

(a) Determine overhead rate based on machine hours:

$1,500,000 300,000 = $5.00 per machine hour

Determine applied overhead per unit:

3,000 machine hrs $5 per hour = $2.50 per unit

6,000 units produced

Bid price per unit of Job #287 (using single overhead rate)

Direct materials $1.350

Direct labour 1.850

Applied overhead 2.500

Full manufacturing cost per unit $5.700

Mark-up (25% $5.70) 1.425

Bid price per unit $7.125


Purchasing & receiving: $300,000 3,000 = $100 per receipt

Machining: $900,000 300,000 = $3.00 per machine hour

Materials handling: $160,000 400,000 = $0.40 per move

Shipping: $140,000 280,000 = $0.50 per kilometre

Determine per unit overhead cost:

Purchasing & receiving ($100 3 receipts) $300 Machine operating costs ($3.00 3,000 machine hrs) 9,000 Materials handling ($0.40 300 moves) 120 Shipping ($0.50 2,300 kilometers) 1,150

Total overhead costs $10,570 Units produced 6,000

Per unit overhead cost $ 1.762



5-49


Bid price per unit of Job #287 (using activity-based costing)

Direct materials $1.350

Direct labour 1.850

Applied overhead 1.762

Full manufacturing cost per unit $4.962

Mark-up (25% $4.962) 1.240

Bid price per unit $6.202

Using an activity-based approach, Mars Companys bid price of $6.202 per unit is lower than Arrow Companys bid price of $6.75 per unit. Thus, Mars is more likely to receive the contract.



5-50

PROBLEM 5-46B

(a) Predetermined overhead rate using material cost: $510,000 $500,000 = 102% of material cost.

(b) Manufacturing cost per armoire under traditional costing:

Direct materials $5,200.00

Direct labour 3,500.00

Applied overhead ($5,200 1.02) 5,304.00

Full manufacturing cost $14,004.00

Number of armoires produced 10

Manufacturing cost per armoire $1,400.40

(c) Manufacturing cost per armoire under activity-based costing: Determine activity-based overhead rates:

Est. Est.


Purchasing $40,000 500 $80.00 per order

Handling materials $45,000 5,000 $9.00 per move

Production $130,000 65,000 $2.00 per labour hr

Setting up machines $50,000 1,000 $50.00 per set-up

Inspecting $60,000 4,000 $15.00 per inspection

Inventory control $80,000 40,000 $2.00 per component

Utilities $105,000 5,000 $21.00 per m2



5-51


Assign overhead: Armoires

Rate Usage Overhead

Purchasing $80.00 per order 3 $240

Handling materials $9.00 per move 32 288

Production $2.00 per labour hr 200 400

Setting up machines $50.00 per set-up 4 200

Inspecting $15.00 per inspection 20 300

Inventory control $2.00 per component 640 1,280

Utilities $21.00 per m2 32 672

$3,380

(d) The difference between the traditional cost and the activity-based cost per unit of $192.40 ($1,400.40 vs. $1,208.00) is significant13.7% ($192.04 $1,400.40). The traditional costing did not take into account the different amount of activities required to convert the material into an armoire. ABC recognizes the savings from fewer orders, fewer material moves, fewer setups, fewer labour hours, and fewer inspections when producing 10 identical units. The greater accuracy of ABC over traditional costing, which used only one cost driver (material costs), results from the identification of multiple activities and their relevant cost drivers.

Management can make much better pricing decisions using the ABC costing method.

Per unit manufacturing cost:

Direct materials $5,200

Direct labour 3,500

Overhead 3,380

Total cost 12,080

Spread over 10 armoires 10

Manufacturing cost per armoire $1,208.00



5-52

PROBLEM 5-47B

(a) Quality control costs assigned to the Varnish line under the

traditional system:

30% $100,000 direct labour cost = $30,000 quality control costs (b) Quality control costs assigned to the Varnish line under activity-

based costing:

Incoming material inspection:

$25 50 types of material $1,250

In-process inspection:

$0.30 30,000 units 9,000

Product certification:

$150 80 orders 12,000

Total quality control cost applied to this line $22,250

(c) With respect to the quality control costs, the traditional product-

costing system over-costs the Varnish paint product line by $7,750 ($30,000 $22,250). If the traditional method is used, it could lead to over-pricing the Varnish line, and losing sales to competitors who are using the more accurate way to allocate overhead costs. It could also lead to other bad pricing decisions, based on under-costing the products the Varnish paint is subsidizing.



5-53

PROBLEM 5-48B

(a) Predetermined overhead rate under the traditional method: $2,500,000 100,000 = $25.00 per machine hour

Standard

Steel Deluxe Steel



Manufacturing overhead

($25.00 50; 50 machine hrs.) 1,250.00 1,250.00

Total manufacturing cost per unit $1,550.00 $1,620.00

(b) Determine overhead rates for each activity:

Est. Est.


Material handling $250,000 50,000 $5.00 per move

Purchase orders 200,000 4,000 50.00 per order

Product testing 450,000 9,000 50.00 per test

Machine set-up 600,000 6,000 100.00 per set-up

Machining 1,000,000 100,000 10.00 per machine hr

$2,500,000

Determine activity usage for each product:

Usage

Cost Pool Rate Standard

Steel Deluxe Steel

Material handling $5.00 per move 5 10

Purchase orders 50.00 per order 2 3

Product testing 50.00 per test 3 4

Machine set-up 100.00 per set-up 5 10

Machining 10.00 per machine hr 50 50



5-54


(c)Assign Overhead

Rate Standard

Steel Deluxe Steel

Material handling $5.00 per move $25 $50

Purchase orders 50.00 per order 100 150

Product testing 50.00 per test 150 200

Machine set-up 100.00 per set-up 500 1,000

Machining 10.00 per machine hr 500 500


Unit costs under ABC method:

Standard

Steel Deluxe Steel

Direct material $ 200.00 $ 250.00


Manufacturing overhead 1,275.00 1,900.00

Total manufacturing cost per unit with ABC $1,575.00 $2,270.00

Total cost per unit with traditional method $1,550.00 $1,620.00

(d) To: Mr. Tyler Silva, President International Steel Company From: Student Subject: Product costs using traditional approach versus ABC

The memorandum covers the following points:

a. ABC allocates overhead costs as a function of each products use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each products generation of overhead costs.



5-55


b. Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labour costs.

c. In the case of the International Steel Company, the deluxe steel product would require the company to begin using more complex methods and equipment. Overhead costs would increase substantially. When overhead costs are allocated using labour rates, too much overhead will be allocated to the high volume standard steel product. This would cause the standard steel product to appear to be less profitable than it is because it is subsidizing the overhead of the deluxe steel.

d. The total cost of the two products under the two approaches was as follows:

Standard Steel

Deluxe Steel

Traditional approach

ABC

$1,550

$1,575

$1,620

$2,270 Therefore, the relative profitability of the two products should be

determined using ABC costing.



5-56

PROBLEM 5-49B


Engineering: $80,000 4,000 = $20 per engineering hour

Set-ups: $45,000 250 = $180 per set-up

Machining: $120,000 20,000 = $6 per machine hour

Inspection: $60,000 1,500 = $40 per inspection

Processing: $35,000 7,000 = $5 per direct labour hour

Net Profit per unit

BrakeDisk

Gear

Sales $35.00 $43.00

Less: Per unit manufacturing cost

Direct materials 10.00 7.50


Overhead:

Engineering ($20 0.05; 0.15 hrs.) 1.00 3.00

Set-ups ($180 25/5,000; 9/3,000 0.90 0.54

Machining ($6 2.5; 1.0 hrs) 15.00 6.00

Inspection ($40 250/5,000; 125/3,000) 2.00 1.67

Processing ($5 0.1; 0.5 DL hrs.) 0.50 2.50

Total manufacturing cost 30.60 27.21

Net profit per unit $4.40 $15.79

Net profit margin percentage 12.57% 36.72%

(b) The gear requires more direct labour hours than the brake disk (0.5 vs.

0.1). By using the direct labour hours to assign overhead, the gear absorbs more overhead costs than the brake disk. However, by using the activity-based costing method, the costs assigned to the gear more accurately reflect the actual consumption of resources used by the activities to produce the gear.



5-57

PROBLEM 5-50B

(a) Overhead assigned to Corporate: 28.125% $900,000 = $253,125 Overhead assigned to Individual: 28.125% $700,000 = $196,875

(b) (1) Determine activity-based overhead rates:

Employee training: $120,000 $1,600,000 = $0.075 per DL dollar

Secretarial: $60,000 2,000 = $30.00 per report/form

Computing: $100,000 40,000 = $2.50 per minute

Facility rental: $100,000 25 = $4,000.00 per employee

Travel: No rate; expenses are traced directly

(2) Assign overhead:

Corporate

Individual Training ($0.075 $900,000 DL$) $67,500 ($0.075 $700,000 DL$) $52,500 Secretarial ($30.00 500 reports 15,000 ($30.00 1,500 reports) 45,000 Computing ($2.50 17,000 min.) 42,500 ($2.50 23,000 min.) 57,500 Rent ($4,000.00 14 employees) 56,000 ($4,000.00 11 employees) 44,000 Travel (Direct) 48,000 22,000


(c) Value-Added Non-Value-Added Typing and secretarial

Computing

Employee training Facility rental Travel



5-58

PROBLEM 5-50B (Continued) (d) Overhead is assigned to the two service lines as follows: Corporate Individual Total Traditional costing $253,125 $196,875 $450,000 ABC $229,000 $221,000 $450,000 Traditional costing using direct labour dollars as the overhead base

assigned $56,250 more to Corporate than to Individual. But under ABC, using six different overhead categories, it shows the two departments are more closely matched in total costs, differing by only $8,000. It would appear that under the traditional method Corporate would be subsidizing $24,125 of Individuals overhead cost.



5-59

PROBLEM 5-51B


Material requisitions: $54,000 108 = $500 per requisition

Product inspections: $8,200 54 = $151.85 per inspection

Orders shipped: $103,000 296 = $347.97 per order

Assign overhead: Thun-

derbolt Earth-

quake

Material requisitions: $500 46 requisitions $23,000 $500 62 requisitions $31,000 Product inspections $151.85 23 inspections 3,493 $151.85 31 inspections 4,708 Orders shipped $347.97 167 orders 58,111 $347.97 129 orders 44,888


(b) Three conditions that should be present in PDI are:

The consumption ratios of unit-based and non-unit-based activities

must differ. Non-unit-based costs should be a significant portion of total overhead

costs. Measurement costs of the identified cost pools must be relatively low.



5-60

SOLUTIONS TO CASES

CASE 5-52

(a) Computation of the average hourly charge-out rate: Total overhead

= $3,516,000

= $29.30 per billable

hour

Total billable hours 120,000 Direct labour cost

= $2,700,000


hour

Total billable hours 120,000 Average charge out rate: 2 ($29.30 + $22.50) = $103.60


Planning and review: $900,000 120,000 = $7.50 per billable hour

Research: $150,000 400 = $375 per journal

General administration: $1,800,000 600 = $3,000 per client

Building & equipment: $360,000 2,400 = $150 per sq. meter

Clerical: $306,000 34 = $9,000 per staff member

Assign overhead: MGMT Consult

EXEC Train

Planning & review ($7.50 90,000 hrs) $675,000 ($7.50 30,000 hrs) $225,000 Research ($375 280 journals) 105,000 ($375 120 journals) 45,000 General admin ($3,000 240 clients) 720,000 ($3,000 360 clients) 1,080,000 Build & equip ($150 1,600 sq. metres) 240,000 ($150 800 sq. metres) 120,000 Clerical ($9,000 20 staff) 180,000 ($9,000 14 staff) 126,000

Total overhead assigned $1,920,000 $1,596,000



5-61

CASE 5-52 (Continued)

Assignment of activity cost pools to services:

Management Consulting: Total overhead

= $1,920,000


hour

Total billable hours 90,000 Executive Training: Total overhead

= $1,596,000


hour

Total billable hours 30,000

Charge-out rate:

Management Consulting:

Direct Labour Cost $20.00 ($1,800,000 90,000 hrs)

Overhead 21.33 (as above)

$41.33 2 = $82.66 per hour

Executive Training:

Direct Labour Cost $30.00 ($900,000 30,000 hrs)

Overhead 53.20 (as above)

$83.20 2 = $166.40 per hour

(c) Three ways that ABC leads to more accurate product costs:

i) ABC increases the number of cost pools used to accumulate overhead costs. Rather than accumulating all overhead costs in a single company-wide pool, or accumulating them in departmental pools, costs are accumulated by activity. As a result, many pools are created with cost-driving activities that are better related to the incurrence of cost.

ii) ABC changes the base used to assign overhead costs to products. Rather than assigning costs on a basis of direct labour or some other measure of volume, costs are assigned on a basis of cost-driving activities that can be traced to the product or job involved.



5-62

CASE 5-52 (Continued)

iii) ABC changes a managers perception that many of the overhead costs are indirect. It becomes obvious with ABC that many overhead costs can be identified with specific activities, and thereby are recognized as being traceable to individual products.

(d) i. ABC costing can be expensive to use because of the increased cost of identifying multiple activities and applying numerous cost drivers. ii. Certain overhead costs still need to be allocated using some arbitrary volume-based cost driver, such as labour or machine hours.

(e) The cost driver used would have a bearing on the overhead calculation. Thus, underestimating or overestimating these would impact on the billing charges that would be passed on to the c

ch 05 solutions

Documents

costing abc

b assign overhead costs

traditional costing

b problems

b solutions manual

costing system

unit costs

overhead rates