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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
activity-based costing.
19 10, 11, 12 16 33, 34
*6. Apply activity-based
costing to service
industries.
18 9, 10 15 32 41A, 50B
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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
38A Assign overhead costs using traditional costing and ABC;
compare results.
Moderate 4050
39A Assign overhead costs using traditional costing and ABC;
compare results.
Moderate 3545
40A Assign overhead costs using traditional costing and ABC;
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
42A Assign overhead costs using traditional costing and ABC;
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
46B Assign overhead costs using traditional costing and ABC;
compare results.
Moderate 4050
47B Assign overhead costs using traditional costing and ABC;
compare results.
Moderate 30-40
48B Assign overhead costs using traditional costing and ABC;
compare results.
Moderate 4050
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ASSIGNMENT CHARACTERISTICS TABLE (Continued)
49B Assign overhead costs using traditional costing and ABC;
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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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
activity-based costing.
Q19 BE10, BE11,
BE12, D16, E33,
E34
*6. Apply activity-based costing
to service industries.
Q18 BE9, BE10, D15,
E32, P41A, P50B
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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.
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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).
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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.
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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.
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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
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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.
Cost Pool MOH Usage Rate
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
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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.
Cost Pool MOH Usage Rate
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
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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.
Cost Pool MOH Usage Rate
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
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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
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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.
Cost Pool MOH Usage Rate
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.
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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.
Cost Pool MOH Usage Rate
Cutting $400,000 200,000 $2 per machine hr.
Machine set-up $555,000 1,500 $370 per set-up
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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
Overhead assigned $570,000 $385,000
(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
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5-17
EXERCISE 5-20 (Continued)
$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.
Cost Pool MOH Usage Rate
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
Overhead assigned $237,000 $603,000
(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.
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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
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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.
Cost Pool MOH Usage Rate
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
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5-20
$3,250,000
EXERCISE 5-22 (Continued)
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)
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5-21
8. Faxing 9. Collating 10. Cutting and folding
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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
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(a) Est. Est.
Cost Pool MOH Usage Rate
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
Overhead assigned $30,700 $54,800
(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.
EXERCISE 5-26 (Continued)
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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.
Cost Pool MOH Usage Rate
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
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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.
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EXERCISE 5-29 (Continued)
(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
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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
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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
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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
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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
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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.
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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.
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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
Per unit overhead cost $104.00 $282.00
(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
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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.
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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
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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%.
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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
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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.
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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.
Cost Pool MOH Usage Rate Cost Drivers
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
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PROBLEM 5-40A (Continued)
(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
Overhead assigned $1,325 $1,862
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.
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PROBLEM 5-40A (Continued)
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.
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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
Total overhead assigned $357,663 $362,337
(c) Value-Added Non-Value-Added Typing and secretarial
Computing
Employee training Facility rental Travel
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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.
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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.
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SOLUTIONS TO PROBLEMSSET B
PROBLEM 5-43B
(a) Computation of unit coststraditional costing.
Deluxe Standard
Direct material $11.00 $42.00
Direct labour 18.00 18.00
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.
Cost Pool MOH Usage Rate Cost Drivers
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
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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
Overhead assigned $277,500 $702,500
Number of units produced 20,000 50,000
Overhead cost per unit $13.88 $14.05
(d) Total cost per unit Deluxe Standard
Direct material $11.00 $42.00
Direct labour 18.00 18.00
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.
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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
Per unit overhead cost $11.20 $14.70
(b) Per unit gross profit: Ice House Cool Chest
Selling price $35.00 $24.00
Less: unit cost
Direct material $9.50 $6.00
Direct labour 8.00 5.00
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.
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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
(b) Determine activity-based overhead rates:
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
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5-49
PROBLEM 5-45B (Continued)
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.
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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.
Cost Pool MOH Usage Rate Cost Drivers
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
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5-51
PROBLEM 5-46B (Continued)
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
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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.
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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
Direct material $200.00 $250.00
Direct labour 100.00 120.00
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.
Cost Pool MOH Usage Rate Cost Drivers
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
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5-54
PROBLEM 5-48B (Continued)
(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
Overhead assigned $1,275 $1,900
Unit costs under ABC method:
Standard
Steel Deluxe Steel
Direct material $ 200.00 $ 250.00
Direct labour 100.00 120.00
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.
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5-55
PROBLEM 5-48B (Continued)
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.
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5-56
PROBLEM 5-49B
(a) Determine activity-based overhead rates:
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
Direct labour 1.20 6.00
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.
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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
Total overhead assigned $229,000 $221,000
(c) Value-Added Non-Value-Added Typing and secretarial
Computing
Employee training Facility rental Travel
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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.
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5-59
PROBLEM 5-51B
(a) Determine activity-based overhead rates:
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
Total overhead assigned $84,604 $80,596
(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.
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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
= $22.50 per billable
hour
Total billable hours 120,000 Average charge out rate: 2 ($29.30 + $22.50) = $103.60
(b) Determine activity-based overhead rates:
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
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5-61
CASE 5-52 (Continued)
Assignment of activity cost pools to services:
Management Consulting: Total overhead
= $1,920,000
= $21.33 per billable
hour
Total billable hours 90,000 Executive Training: Total overhead
= $1,596,000
= $53.20 per billable
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.
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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