ABC Costing

Copyright 2010 John Wiley & Sons, Inc. Weygandt, Managerial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 4-7

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 4-1

(a) Estimated annual overhead costsExpected annual operating activity

= Predetermined overhead rate

$1,000,000100,000

= $10 per direct labor hour

(b) 90,000 direct labor hours X $10 = $900,000 overhead applied

(c) If the manufacturing process is complex, then multiple allocationbases can result in more accurate product-cost computations. Insuch situations, managers need to consider a new overhead costallocation method that uses multiple bases. That method is activity-based costing.

BRIEF EXERCISE 4-2

Under ABC, overhead costs are shifted from the high-volume products tothe low-volume products. This shift results in more accurate costing fortwo reasons:

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

2. Assigning overhead using ABC will usually increase the cost perunit for low-volume products. Therefore, a traditional overheadallocation such as direct labor hours is usually a poor cost driverfor assigning overhead costs to low-volume products.

As a result, for Bowyer, one of the products (Product RX3) may have beenlow volume and therefore may have more overhead costs assigned to itunder an ABC system.

nidaStamp

4-8 Copyright 2010 John Wiley & Sons, Inc. Weygandt, Managerial Accounting, 5/e, Solutions Manual (For Instructor Use Only)

BRIEF EXERCISE 4-3

An appropriate cost driver for each activity is:

Activity Cost DriverMaterials handlingMachine setupsFactory machine maintenanceFactory supervisionQuality control

Number of requisitionsNumber of setupsMachine hours usedDirect labor hoursNumber of inspections

BRIEF EXERCISE 4-4

(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 4-5

Machine setupsMachiningInspections

$180,000 2,500 = $72 per setup$325,000 25,000 = $13 per machine hour$ 87,500 1,750 = $50 per inspection

BRIEF EXERCISE 4-6

Activity Cost PoolEstimatedOverhead

Expected Use ofCost Drivers per Activity =

Activity-BasedOverhead Rates

DesigningSizing and cuttingStitching and trimmingWrapping and packing

$ 450,000 4,000,000 1,440,000 336,000

12,000 designer hours160,000 machine hours 80,000 labor hours 32,000 finished units

$37.50 per designer hour$25.00 per machine hour$18.00 per labor hour$10.50 per finished unit


BRIEF EXERCISE 4-7




Ordering and receivingEtchingSoldering

$ 90,000 480,000 1,760,000

15,000 orders 60,000 machine hours440,000 labor hours

$6.00 per order$8.00 per machine hour$4.00 per labor hour

Cost Drivers XOverhead

Rates =Total Overhead

Applied11,000 orders50,000 machine hours500,000 labor hours

$6$8$4

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

BRIEF EXERCISE 4-8

(a)(b)(c)(d)(e)(f)(g)(h)

Non-value-addedNon-value-addedValue-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedValue-added

BRIEF EXERCISE 4-9

Value-added Activities Hours(1)(3)(5)

Designing and draftingOn-site supervisionConsultation with client

3.02.01.56.5

Non-value-added Activities Hours(2)(4)(6)

Staff meetingsLunchEntertaining a prospective client

1 1 2 4


BRIEF EXERCISE 4-10

(a) Batch- or unit-level(b) Unit-level(c) Unit-level(d) Batch- or unit-level(e) Facility-level(f) Batch- or product-level(g) Batch- or product-level(h) Unit-level(i) Facility-level(j) Batch-level

BRIEF EXERCISE 4-11

(a) Facility-level(b) Unit-level(c) Product-level(d) Unit-level(e) Batch-level(f) Batch-level(g) Product-level(h) Facility-level

BRIEF EXERCISE 4-12

(a) Product design $50,00010

= $5,000 per product change

Machining $300,000150,000

= $2 per machine hour

Material handling $100,000100

= $1,000 per set up

(b) Product designproduct-levelMachiningunit-levelMaterial handlingbatch-level


SOLUTIONS TO DO IT! REVIEW EXERCISES

DO IT! 4-1

1. True2. False3. False4. True5. True

DO IT! 4-2

(a) Computations of activity-based overhead rates per cost driver:Activity Cost

Pools EstimatedOverhead

Expected Use of Cost Drivers per Activity

Activity-Based Overhead Rates

Machine setup $ 20,000 40 setups $500 per setupMachining 110,000 5,000 machine hours 22 per machine hr.Packing 30,000 500 orders 60 per order

$160,000(b) Assignment of each activitys overhead cost to products using ABC:

BC113 AD908

Activity Cost Pools

ExpectedUse of CostDrivers per Product


Cost Assigned

Expected Use ofCost Drivers per

Product

Activity-BasedOverhead

Rates Cost

Assigned Machine setup 25 $500 $12,500 15 $500 $ 7,500Machining 1000 $ 22 22,000 4000 $ 22 88,000Packing 150 $ 60 9,000 350 $ 60 21,000Total assigned costs $43,500 $116,500

(c) Computation of overhead cost per unit:BC113 AD908

Total costs assigned (a) $43,500 $116,500Total units produced (b) 3,000 1,400Overhead cost per unit (a) (b) $14.50 $83.21


DO IT! 4-2 (Continued)(d) These computations show that the total overhead assigned to Product

AD908 is more than two and a half times that assigned to BC113. On aper unit basis, the overhead assigned to AD908 is close to six timesthat assigned to each BC113.

DO IT! 4-3

1. NVA2. VA3. NVA4. NVA5. VA6. VA

DO IT! 4-4

(a) unit-level(b) product-level(c) facility-level(d) batch-level(e) unit-level(f) batch-level(g) facility-level(h) unit-level


SOLUTIONS TO EXERCISES

EXERCISE 4-1

(a) Estimated overheadDirect labor costs

= Predetermined overhead rate

$300,000$50,000 + $100,000

= 200% of direct labor cost

(b) Activity cost pools Cost drivers Estimated overheadMachining Machine hours $200,000Machine setup Set up hours 100,000

Activity-based overhead ratesMachining: Machine setup:

$200,000 $100,0001,000 + 1,000

= $100 per machine hour400 + 100

= $200 per setup hour

(c) Traditional costing Standard Custom $50,000 X 200% $100,000$100,000 X 200% $200,000

$100,000 $200,000

Activity-based costingMachining:1,000 X $100 $100,0001,000 X $100 $100,000

Machine setup:100 X $200 20,000400 X $200 80,000

$120,000 $180,000


EXERCISE 4-2

(a) Traditional costing systemProduct 540X Product 137Y Product 249S

Sales $200,000 $160,000 $80,000Costs 55,000 50,000 15,000Operating income $145,000 $110,000 $65,000

(b) Activity-based costing systemProduct 540X Product 137Y Product 249S

Sales $200,000 $160,000 $80,000Costs 50,000 35,000 35,000Operating income $150,000 $125,000 $45,000

(c) Product 540X: ($150,000 $145,000) $145,000 = 3.45%Product 137Y ($125,000 $110,000) $110,000 = 13.64%Product 249S ($45,000 $65,000) $65,000 = (30.77%)

(d) These costs are similar probably because the cost drivers areessentially the same; that is, they are based on a unit volumeconcept.


EXERCISE 4-3

(a) Activity cost pools Cost drivers Estimated overheadCutting Machine hours $300,000Design Number of setups 600,000

Activity-based overhead ratesCutting Design$300,000 $600,000200,000 = $1.50 per machine hour 1,500 = $400 per setup

Wool CottonActivity-based costing

Cutting100,000 X $1.50 $150,000100,000 X $1.50 $150,000

Design1,000 X $400 400,000

500 X $400 200,000Total cost allocated $550,000 $350,000

(b) Estimated overhead $900,000Direct labors hours = 450,000 = $2 per direct labor hour

Wool CottonTraditional costing

225,000 X $2 $450,000225,000 X $2 $450,000

The wool product line is allocated $100,000 ($550,000 $450,000) moreoverhead cost when an activity-based costing system is used. As a result,the cotton product line is allocated $100,000 ($450,000 $350,000) less.


EXERCISE 4-4

(a) Direct labor hours for car wheels (40,000 X 1) = 40,000Direct labor hours for truck wheels (10,000 X 3) = 30,000Total direct labor hours 70,000

$700,000 (total estimated overhead)70,000 (total direct labor hours) = $10 per direct labor hour.

Overhead assignedCar wheels (40,000 X $10) = $400,000Truck wheels (30,000 X $10) = 300,000Total overhead $700,000

(b) Activity Cost Pool

EstimatedOverhead

ExpectedUse of

Cost Drivers =

ABCOverhead Rate

Setting up machines $180,000 1,000 $180Assembling 280,000 70,000 $ 4Inspection 240,000 1,200 $200

(c) Car Wheels

Activity Cost Pools

Expected Useof Cost Driver

per Product X


Rates =Cost

Assigned

Setting up machines 200 $180 $ 36,000Assembling 40,000 $ 4 $160,000Inspection 100 $200 $ 20,000 Total cost assigned $216,000


EXERCISE 4-4 (Continued)(c) Truck Wheels

Activity Cost Pools

Expected useof Cost Driver per Product X


Rates =Cost

Assigned

Setting up machines 800 $180 $144,000Assembling 30,000 $ 4 $120,000Inspection 1,100 $200 $220,000 Total cost assigned $484,000

(d) Assuming that the cost drivers are a reasonable representation ofwhat is occurring in the two product lines, it seems appropriate toswitch to activity-based costing. By using this system, more accuratecost information is developed which should lead to better allocationof resources and pricing decisions in the future.


EXERCISE 4-5

(a)Activity Cost Pools Estimated Overhead

Expected useof Cost Drivers = ABC Overhead Rates

Scheduling and travel $90,000 1,500 $ 60.00Setup time $70,000 700 $100.00Supervision $40,000 $400,000* $ .10

*$100,000 + $300,000

Commercial

Activity Cost PoolsExpected use of Cost

Drivers per Product X ABC Overhead Rates = Cost AssignedScheduling and travel 1,000 $ 60.00 $ 60,000Setup time 450 $100.00 45,000Supervision $100,000 $ .10 10,000

Total assigned costs $115,000

Residential

Activity Cost PoolsExpected use of Cost Drivers per Product X ABC Overhead Rates = Cost Assigned

Scheduling and travel 500 $ 60.00 $30,000Setup time 250 $100.00 25,000Supervision $300,000 $ .10 30,000

Total assigned costs $85,000

(b) Commercial ResidentialRevenues $300,000 $480,000Direct material costs $ 30,000 $ 50,000Direct labor costs 100,000 300,000Overhead costs 115,000 245,000 85,000 435,000Operating income (loss) $ 55,000 $ 45,000

(c) Assuming that the cost drivers are a reasonable representation ofwhat is occurring in the two product lines, it seems appropriate toswitch to activity-based costing. By using this system, more accuratecost information is developed which should lead to better allocationsof resources and more informative pricing decisions in the future.


EXERCISE 4-6

(a) Traditional costing:$235,000 2,500 (800 + 1,700) hours

= $94 per direct labor hour

(1) One mobile safe:800 hours X $94 = $75,200$75,200 200 = $376 each

(2) One walk-in safe:1,700 hours X $94 = $159,800$159,800 50 = $3,196 each

(b) Activity-based costing:(1) Material handling costs

$150,000 500 (300 + 200) moves = $300 per move(a) One mobile safe:

300 moves X $300 = $90,000$90,000 200 = $450 each

(b) One walk-in safe:200 moves X $300 = $60,000$60,000 50 = $1,200 each

(2) Purchasing activity costs$85,000 800 (450 + 350) orders = $106.25 per order

(a) One mobile safe:450 orders X $106.25 = $47,812.50$47,812.50 200 = $239.0625 each

(b) One walk-in safe:350 orders X $106.25 = $37,187.50$37,187.50 50 = $743.75 each


EXERCISE 4-6 (Continued)(c) The total amount of overhead allocated to each unit of the two products

under the two allocation approaches is:

TraditionalCosting

Activity-BasedCosting

Mobile safeWalk-in safe

$ 376$3,196

**$689.0625** $ 1,943.75**

**$450 + $239.0625**$1,200 + $743.75

EXERCISE 4-7

The following activities might be identified at Quik Prints Company fromyour analysis of its operations and a discussion with the owner-manager,James Kieper.

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 8. Faxing 9. Collating10. Cutting and folding


EXERCISE 4-8

Budgeted Costs Activity Cost Pool Cost Driver

Engineering designEngineering prototypes Engineering Engineering hours

Depreciation, machineryElectricity, machinery Machinery Machine hours

Machine setup, indirect laborMachine setup, indirect materials

Machine setup Number of setups

InspectionsTests Quality control

Number of tests or inspections

Depreciation, plantInsurance, plantProperty taxesOil, heatingElectricity, plant lighting

Factory utilities Square feet orMachine hours

Custodial wages Maintenance Number of machines orMachine hours

EXERCISE 4-9

The following cost drivers might be used to assign overhead:

1.2.3.4.5.

6.7.8.

Labor hoursLabor hoursLabor hoursGallons of chemicalsNumber of cartfuls or labor hoursNumber of cartfulsGallons of juiceGallons of juice

9.10.11.12.13.14.15.

Gallons of wine or months of agingNumber of bottlesNumber of bottlesNumber of boxesNumber of shipmentsNumber of gallons processedNumber of gallons processed


EXERCISE 4-10

1. Number of engineering change orders; hours of designing 2. Number of orders processed 3. Number of parts in stock 4. Weight of material; number of boxes or cartons 5. Employee turnover; number of employees hired 6. Machine hours; direct labor hours 7. Number of employees; number of parts; direct labor hours 8. Number of employees 9. Book or market value of assets10. Cost of goods manufactured, direct labor hours; number

of employees11. Machine hours; number of machines12. Gallons of paint; number of appliances

EXERCISE 4-11

(a) The overhead rates are:

Activity Cost PoolsEstimatedOverhead

Expected Useof Cost Drivers

per Activity =Activity-Based

Overhead RatesMaterials handlingMachine setupsQuality inspections

$35,000 27,500 27,000

1,000 500 600

$35 55 45

(b) The assignment of the overhead costs to products is as follows:Instruments Gauges

Cost Driver Number Cost Number CostCost

AssignedMaterials handling ($35)Machine setups ($55)Quality inspections ($45)

Total costsassigned (a)Units produced (b)

400200

200

$14,000 11,000

9,000

$34,000 50

600300

400

$21,000 16,500

18,000

$55,500 300

$35,000 27,500

27,000

$89,500

Overhead cost perUnit (a) (b) $680 $185


EXERCISE 4-11 (Continued)(c) MEMO

To: President, Sorce 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 thatmeasure the activities performed on the product.

The primary benefit of ABC is more accurate and meaningful productcosting. This improved cost data can lead to reduced costs as managersbecome more aware of the underlying causes of cost incurrence. Thus,control over costs is enhanced.

The improved cost data should also lead to better managementdecisions. More accurate product costing should contribute to settingselling prices which will help achieve desired profitability levels. Inaddition, it should be helpful in deciding whether to make or buy aproduct part or component, and sometimes even whether to eliminatea product.


EXERCISE 4-12

(a) (1) Traditional product costing system:$400,000 X .70 = $280,000 Selling costs assigned in March to thehigh intensity product line.

(2) Activity-based costing system:

Activity Cost PoolsCost Drivers

Used X

Activity-Based

OverheadRates =

Overhead CostAssigned

Sales commissionsAdvertisingTV/RadioAdvertisingNewspaperCatalogsCost of catalog salesCredit and collection

Total assigned cost for March

$930,000 250 2,000 60,000 9,000$930,000

$.05$300$10$2.50$1.00$.03

$ 46,500 75,000 20,000 150,000 9,000 27,900$328,400

(b) As compared to ABC, traditional costing grossly undercosts the sellingcosts assigned to the high intensity product line. The differenceof $48,400 ($328,400 $280,000) in the month of March is a 14.7%understatement.

(c) All six activities, as selling activities, are non-value-added activities.


EXERCISE 4-13

(a) 1. Traditional product costing system:Quality-control overhead costs assigned in June to the low-caloriedessert line are $9,350 ($55,000 X .17).

2. Activity-based costing system:

Activity Cost PoolsCost Drivers

Used X

Activity-Based

OverheadRate =

Overhead CostAssigned

Inspections of material receivedIn-process inspectionsFDA certification

Total assigned cost for June

6,00010,000 420

$.60$.33$12.00

$ 3,600 3,300 5,040$11,940

(b) As compared to ABC, the traditional costing system undercosts thequality-control overhead cost assigned to the low-calorie dessertproduct line by $2,590 ($11,940 $9,350) in the month of June. That isa 21.7% understatement.

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

EXERCISE 4-14

1. Value-added. It is assumed that any activity which directly enhances orimproves the quality or quantity of the vines, grapes, or wine is avalue-added activity.

2.3.4.5.6.7.8.

Non-value-addedValue-addedValue-addedNon-value-addedValue-addedValue-addedValue-added

9.10.11.12.13.14.15.

Value-addedValue-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedNon-value-added


EXERCISE 4-15

1. 2. 3. 4. 5. 6. 7. 8. 9.10.11.12.

Value-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedValue-addedValue-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedValue-added

EXERCISE 4-16

Value-Added Activities HoursWriting contracts and lettersTaking depositionsContemplating legal strategyLitigating a case in court

1.01.01.02.55.5

Non-Value-Added Activities HoursAttending staff meetingsDoing researchTraveling to/from courtEating lunchEntertaining a prospective client

0.51.01.01.02.05.5

Questionable ClassificationsWriting contracts is value-added; writing letters may be value-added ifrelated to a specific case or it may be non-value-added if it is billing a clientor collecting receivables. Research may be value-added if it is unique, relatedto a specific case, and is billable. Research may be non-value-added if it issomething the attorney should already have known and is not billable tothe client.


EXERCISE 4-17

Activity Cost Pools Activity LevelEngineeringMachineryMachine setupQuality control

Factory utilitiesMaintenance

Product-levelUnit-levelBatch-levelDepends on frequency. Could be unit, batch, or product-levelFacility-levelFacility-level

EXERCISE 4-18

1. Facility-level activity 2. Product-level activity 3. Batch-level activity 4. Product-level activity 5. Product-level activity 6. Batch-level activity 7. Facility-level activity 8. Batch-level or unit-level activity 9. Unit-level activity10. Unit-level activity


SOLUTIONS TO PROBLEMS

PROBLEM 4-1A

(a) Computation of unit coststraditional costing.

ProductsManufacturing Costs Home Model Commercial ModelDirect materialsDirect laborOverhead

Total unit cost

$18.50 19.00

* 23.40*$60.90

$26.50 19.00

* 23.40*$68.90

*$15.60 X 1.5 = $23.40

(b)


ExpectedUse of Cost Drivers =

Activity-BasedOverhead Rate

ReceivingFormingAssemblingTestingPaintingPacking and shipping

$ 70,350 150,500 390,600 51,000 52,580 787,250$1,502,280

335,000 Pounds 35,000 Machine hours217,000 Parts 25,500 Tests 5,258 Gallons335,000 Pounds

$ .21 per pound$ 4.30 per machine hour$ 1.80 per part$ 2.00 per test$10.00 per gallon$ 2.35 per pound

(c)Home Model Commercial Model

Activity Cost Pool

ExpectedUse ofDrivers X

Activity-Based

OverheadRates =

CostAssigned

ExpectedUse ofDrivers X

Activity-Based

OverheadRates =

CostAssigned

ReceivingFormingAssemblingTestingPaintingPacking and shipping

Total costs assigned

Units produced

(a)(b)

215,000 27,000165,000 15,500 3,680215,000

$ .21$ 4.30$ 1.80$ 2.00$10.00$ 2.35

$ 45,150 116,100 297,000 31,000 36,800 505,250$1,031,300 54,000

120,000 8,000 52,000 10,000 1,578120,000

$ .21$ 4.30$ 1.80$ 2.00$10.00$ 2.35

$ 25,200 34,400 93,600 20,000 15,780 282,000$470,980 10,200

Overhead cost per unit [(a) (b)] $19.10 $46.17


PROBLEM 4-1A (Continued)(d)

ABC Manufacturing Costs Home Model Commercial ModelDirect materialsDirect laborOverhead

Total cost per unit

$18.50 19.00 19.10$56.60

$26.50 19.00 46.17$91.67

(e) Activity Value- vs. Non-Value-AddedReceivingFormingAssemblingTestingPaintingPacking and shipping

Non-value-addedValue-addedValue-addedNon-value-addedValue-addedValue-added

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

(2) The comparison of ABC and traditional costing shows that theproper amount of overhead assigned to the two products is notequal at $23.40 but rather $19.10 for the home model and $46.17for the commercial model. Under traditional costing, the margin oferror on the commercial model was almost 100%, an understatementof $22.77 on an assignment of $23.40. These distorted overheadassignments have likely led to overpricing the home model andunderpricing the commercial model.


PROBLEM 4-2A

(a) The allocation of total manufacturing overhead using activity-basedcosting is as follows:

Royale Majestic

Overhead RateDriversUsed

CostAssigned

DriversUsed

CostAssigned

TotalOverhead

Purchase orders @ $30Machine setups @ $50Machine hours @ $40Inspections @ $25

Total assigned costs (a)Units produced (b)Cost per unit (a) (b)

15,000 5,00075,000 9,000

$ 450,000 250,000 3,000,000 225,000$3,925,000 25,000

$157

25,00013,00045,00019,000

$ 750,000 650,000 1,800,000 475,000$3,675,000 10,000

$367.50

$1,200,000 900,000 4,800,000 700,000$7,600,000

(b) The cost per unit and gross profit of each model under ABC costingwere:

Royale MajesticDirect materialsDirect laborManufacturing overhead

Total cost per unit

Sales price per unitCost per unitGross profit

$ 700 120 157$ 977

$1,600 977$ 623

$ 420.00 100.00 367.50$ 887.50

$1,300.00 887.50$ 412.50

(c) Managements future plans for the two television models are notsound. Under ABC costing, the Royale model is $210.50 ($623.00 $412.50) per unit more profitable than the Majestic model. If anyproduct should be phased out, it is the Majestic. But, by applying ABCand activity-based management analysis, Overton may determine howto reduce the costs of producing the Majestic model.


PROBLEM 4-3A

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

(b) Manufacturing cost per stairway under traditional costing:Direct materials........................................................................... $103,600Direct labor................................................................................... 112,000Overhead (14,500 X $8.30)....................................................... 120,350

Total cost of 280 stairs .................................................... $335,950Cost per stairway ($335,950 280)....................................... $1,199.82

(c) Manufacturing cost per stairway under activity-based costing:Computation of Activity-Based Overhead Rates


Expected Use of CostDrivers per Activity =

Activity-BasedOverhead Rate

PurchasingHandling materialsProductionSetting up machinesInspectingInventory controlUtilities

$ 57,000 82,000 210,000 85,000 90,000 126,000 180,000$830,000

600 Orders 8,000 Moves100,000 D/L Hours 1,250 Setups 6,000 Inspections168,000 Components 90,000 Sq. ft.

$95 per order$10.25 per move$2.10 per D/L hour$68 per setup$15 per inspection$.75 per component$2.00 per sq. ft.

Assignment of Overhead to Order of 280 Stairs

Activity Cost PoolsExpected Use of

Cost Drivers XActivity-Based

Overhead Rates = Cost AssignedPurchasingHandling materialsProductionSetting up machinesInspectingInventory controlUtilities

60 Orders 800 Moves 5,000 D/L Hours 100 Setups 450 Inspections16,000 Components 8,000 Sq. ft.

$95$10.25$2.10$68$15$.75

$2.00

$ 5,700 8,200 10,500 6,800 6,750 12,000 16,000

Total overhead assigned $65,950


PROBLEM 4-3A (Continued)Total manufacturing cost per stairway under ABC:

Direct materials .................................................................................. $ 103,600Direct labor .......................................................................................... 112,000Overhead .............................................................................................. 65,950

Total cost of 280 stairs ........................................................... $ 281,550Total cost per stairway ($281,550 280).................................... $1,005.54

(d) The difference between the traditional cost and the activity-based costper unit, $1,199.82 versus $1,005.54, is not great in amount but $194.28($1,199.82 $1,005.54) is 19.3% of the more correct ABC cost perunit. Activity-based costing is the preferable costing system for settingprices because the real costs are more accurately reflected. The greateraccuracy is a result of multiple, more relevant activity cost driversunder ABC than the single cost driver used with the traditional volume-based system.


PROBLEM 4-4A

(a) Computation of unit coststraditional costingOverhead cost per direct labor hour is $1,241,660 (150,000 + 27,000) =$7.015

ProductsManufacturing Costs CoolDay LiteMistDirect materialsDirect laborOverhead

$0.400 0.250 0.351*$1.001

$1.200 0.500 0.631**$2.331

*$7.015 X .05 **$7.015 X .09

(b)Activity Cost Pools

EstimatedOverhead

Expected Useof Cost Drivers =


Grape processingAgingBottling and corkingLabeling and boxingMaintain and inspect equipment

$ 145,860 396,000 270,000 189,000

240,800$1,241,660

6,6006,600,000 900,000 900,000

800

$22.10 per cart$0.06 per month$0.30 per bottle$0.21 per bottle

$301 per inspection

(c) CoolDay LiteMist

Activity Cost Pools

ExpectedUse ofCost

Drivers X

Activity-Based

OverheadRates =

CostAssigned

ExpectedUse ofCost

Drivers X

Activity-Based

OverheadRates =

CostAssigned

Grape processingAgingBottling and corkingLabeling and boxingMaintain and inspect equipmentTotal costs assigned (a)Liters produced (b)Overhead cost per liter [(a) (b)]

6,0003,000,000 600,000 600,000

350

$22.10 $0.06 $0.30 $0.21

$301

$132,600 180,000 180,000 126,000

105,350 $723,950

3,000,000

$0.241

6003,600,000 300,000 300,000

450

$22.10$0.06$0.30$0.21

$301

$ 13,260 216,000 90,000 63,000

135,450$517,710

300,000

$1.726


PROBLEM 4-4A (Continued)(d) Products

Manufacturing Costs CoolDay LiteMistDirect materialsDirect laborOverhead

$0.400 0.250 0.241$0.891

$1.200 0.500 1.726$3.426

(e) To: Mr. Greg KagenFrom: 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 useof cost drivers. Thus, ABC results in overhead allocation thatmore closely approximates each products generation of overheadcosts.

b. Traditional approaches that allocate costs as a function of volumetend to be biased toward allocating too much overhead to highvolume, simple products, and too little to low volume, complexproducts. This is because the actual incurrence of overhead costsis rarely correlated with labor costs.

c. In the case of the Polzin Corporation, the LiteMist product requiredthe company to begin using more complex methods and equipment.Overhead costs increased substantially. When overhead costs wereallocated using labor rates, too much overhead was allocated tothe high volume CoolDay product. This reduced the apparent profit-ability of this product.

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


PROBLEM 4-4A (Continued)CoolDay LiteMist

Traditional approachABC

$1.001$0.891

$2.331$3.426

Therefore, the relative profitability of the two products should bedetermined using ABC costing.


PROBLEM 4-5A

(a) Computation of assigned overhead under traditional costing (directlabor dollars appears in the first line of the schedule of overhead data):

Predetermined overhead rate X direct labor dollars

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

(b) (1) Computation of activity-based overhead rates:




Employee trainingTyping and secretarialComputingFacility rentalTravel

$216,000 76,200 204,000 142,500 81,300$720,000

$1,800,000 Direct labor dollars 2,500 Reports/forms 60,000 Minutes 40 Employees Direct

$.12 per DL dollar$30.48 per report/form$3.40 per minute$3,562.50 per employeeDirect

(2) Assignment of overhead to audit and tax services:

Audit Tax

Activity Cost Pools

ExpectedUse ofCost

Driver X

Activity-Based

OverheadRate =

CostAssigned

ExpectedUse ofCost

Driver X

Activity-Based

OverheadRate =

CostAssigned


$1,000,000 600 25,000 22 56,000

$.12$30.48$3.40

$3,562.50Direct

$120,000 18,288 85,000 78,375 56,000

$800,000 1,900 35,000 18 25,300

$.12$30.48$3.40

$3,562.50Direct

$ 96,000 57,912 119,000 64,125 25,300

Overhead costsassigned $357,663 $362,337


PROBLEM 4-5A (Continued)(c) Activity Value-Added vs. Non-Value-Added


Non-value-addedValue-addedValue-addedNon-value-addedNon-value-added

(d) Overhead is assigned to the two service lines as follows:Audit Tax

Traditional costingABC

Difference

$400,000 357,663$ 42,337

$320,000 362,337$ 42,337

The $42,337 difference for audits is 10.6% lower under ABC costing,while the $42,337 difference for tax is 13.2% higher under ABC costing.Clearly, ABC costing should be used to determine the relative profit-ability of each service.

ABC Costing

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