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Chapter 9Activity-Based Costing Solutions to Review Questions

Common allocation bases are direct labor-hours, direct labor costs, and machine-hours. Somewhat less common is direct material costs.

False. Department allocation is a two-stage process, so the first-stage assignment of costs and the choice of cost drivers affects the allocation of costs to products. The total product costs are the same under either approach, but the individual product costs differ. This can affect the decisions managers make regarding individual products.

Most companies produce multiple products and simply adding them up does not account for differences in complexity of the use of resources. As an extreme example, suppose a company produced airplanes and staplers. Allocating overhead on the basis of units would assign the same overhead cost to a stapler and a plane.

The costs include the systems and the software, but the most important cost is managers time. Managers need to make many decisions about the activities and the cost drivers and managers need to make many of the first-stage allocations. The benefits come from having better information about the use of resources and better information for decisions.

1.Identify activities that consume resources.2.Identify the cost driver associated with each activity.3.Compute a cost rate per activity unit (e.g., rate per setup, rate per part, rate per machine-hour).4.Allocate costs to products by multiplying the activity rate times the volume of activity consumed by the product.

False. While the total cost allocated is the same, the reported costs for individual products will differ. Because managers make decisions at the product level, it is important that the reported costs reflect, to the extent possible, the use of resources by the products.

Activity-based costing will benefit most companies with high overhead costs and diverse products and processes. If there is little overhead or if there is a single product, the allocation process will not result in significantly different product costs. (Even if there are only a few, relatively homogeneous products, activity-based costing may be useful for cost management. See chapter 10 for a discussion.)

A personnel department provides its services by completing a set of activities using resources. In this way, implementing activity-based costing in an administrative function is the same as implementing it in a manufacturing firm. However, the products and activities may be much harder to define, making it less like a manufacturing environment.

Solutions to Critical Analysis and Discussion Questions

Direct labor is already measured, so no new data needs to be collected to use it as an allocation base. In addition, direct labor historically was the most important resource in manufacturing.

Activity-based costing does not change the process for direct costs, so the statement is false. For indirect cost, it is uncertain, because it depends on the cost drivers used and the diversity in the processes. For processes that are used in the same way for all products, the particular allocation process is not that important.

False. The services in a business school, as in any service business, require activities (preparing classrooms, organizing recruiting, etc.). The costs of the business school can be assigned to these activities and then allocated to services (e.g., degree programs) using appropriate cost drivers (e.g., number of students, number of classes, number of faculty, etc.).

False. Activity-based costing is most useful when the first-stage allocation is to activities, not departments. Further, an activity-based costing system also uses cost drivers that form a hierarchy of costs, as appropriate, whereas most department allocation costing systems use volume-based cost drivers.

There is no rule that the price charged for a product has to exceed its cost. There may be important marketing or strategic reasons why a company wants to be in a particular market. However, to ensure that this is a good decision, the firm should have the best information on cost that it can get. Managing a company by fooling yourself into thinking something costs less than it does is not smart.

Activity-based costing is like any other information system; it has its benefits and its costs. It is not appropriate in all situations and the benefits may not justify its costs in others.

False. The lesson learned from activity-based costing is that costs are a function not only of output volume, but also of other factors such as complexity. For example, a complex multiproduct operation will cost more than a simple single-product operation.

False. activity-based costing breaks down the costs into cost pools according to the activities that cause the costs. While several departments may have the same cost drivers, each department should individually determine which activities cause their costs.

There are two important characteristics you should look for. Are the first-stage cost pools activities? Second, do the cost drivers in the second stage form a cost hierarchy (e.g., volume related, batch related, etc.) or are they all volume-related costs?

Without information on the use of overhead resources by products, it is difficult for managers to make decisions that appropriately account for the use of these resources by the products. Although the specific allocation base to be used may not be clear, products that require more handling, perhaps because of toxicity, use more overhead resources. Allocating no overhead costs to a product is as likely to distort decision making as allocating costs based on an arbitrary allocation base.

Disagree. The cost of implementing activity-based costing for inventory valuation generally is not worth the small benefits that might be realized. It is most worthwhile when managers use product cost data to make decisions at the product level.

Answers will vary. The function selected will determine the activities, but some examples of activities are processing payments, processing job applications, checking backgrounds, processing bills, answering customer questions, and so on. Some examples of cost drivers are number of payments, number of applications, time spent, number of questions, and so on. Example cost objects might be departments or divisions, if the function provides support, or products or services, if the departments provide service to customer activities.

Answers will vary. Elements of the system that suggest it is an ABC system include cost pools that are activities, multiple cost pools, and multiple cost drivers. However, the two drivers are both volume-based, meaning there really is no cost hierarchy. The system will suffer from many of the problems of a traditional system, including the assignment of costs to products based on volume alone.

Solutions to Exercises (30 min.) Plantwide versus Department Allocation: Munoz Sporting Equipment.Baseball BatsTennis rackets

a.Sales revenue$2,700,000$1,800,000

Direct Labor500,000250,000

Direct Materials1,100,000550,000

Overhead1,000,000a500,000b

Profit$100,000$500,000

a $1,000,000 = $500,000 direct labor x 200%.b $500,000 = $250,000 direct labor x 200%.

b.Maria was wrong; Baseball bats were more profitable.Baseball BatsTennis rackets

Sales revenue$2,700,000$1,800,000

Direct Labor500,000250,000

Direct Materials1,100,000550,000

Overhead750,000a750,000b

Profit$350,000$250,000

a $750,000 = $500,000 direct labor x 150%.b $750,000 = $250,000 direct labor x 300%.

c.The plantwide allocation method allocates overhead at 200% of direct labor for both types of equipment. While this is the simplest method, it is usually not very accurate. It assumes that overhead in both departments has the same rate. When overhead costs are broken down into department cost pools, we see that Department B is allocated a smaller share of the overhead. Each department should try to assess what causes its overhead, and use that as its allocation base.(35 min.)Plantwide versus Department Allocation: Main Street Ice Cream Company.StrawberryVanillaChocolate

a.Direct Labor (per 1,000 gallons)$750$825$1,125

Raw Materials (per 1,000 gallons)800500600

Overhead 150a 165b 225c

Total cost (per 1,000 gallons)$1,700$1,490$1,950

a$150 = 50 labor-hours x $3 per hour.b$165 = 55 labor-hours x $3 per hour.c$225 = 75 labor-hours x $3 per hour.b.Department SV has an overhead allocation rate of $4.20 per machine-hour ($105,840 25,200 machine hours). Department C has an overhead allocation rate of $1.32 per labor-hour ($23,760 18,000 labor-hours).

c.StrawberryVanillaChocolate

Direct Labor (per 1,000 gallons)$750$825$1,125

Raw Materials (per 1,000 gallons)800500600

Overhead 210a 231b 99c

Total cost (per 1,000 gallons)$1,760$1,556$1,824

a$210 = 50 machine-hours x $4.20 per machine-hour.b$231 = 55 machine-hours x $4.20 per machine-hour.c$99 = 75 labor-hours x $1.32 per labor-hour.

d.Charlene was correct in her belief that she was being allocated some of Department SVs overhead. Plantwide allocation does not correctly allocate the overhead by department; it simply uses one allocation rate for all products in all departments. Under plantwide allocation, 1,000 gallons of chocolate cost $1,950. Once the overhead was reallocated into department cost pools, the cost of chocolate fell to $1,824. Although it requires more time and skill to collect and process the information, department allocation generally yields more accurate product cost information.

(30 min.) Unitwide versus Department Allocation: Drumm Corporation.

IllinoisOhio

Employees1,200300

Rate per employee $500 $500

Allocated cost$600,000$150,000

a.

b.

IllinoisOhio

Employees1,200300

Rate per employee $200 $200

Allocated cost$240,000$60,000

Transitions3050

Rate per transition$5,625$5,625

Allocated cost$$168,750$281,250

Total allocated cost$$408,750$341,250

(30 min.) Unit wide versus Department Allocation: Drumm Corporation.a. First, note that the total to be allocated is $750,000 (= $600,000 + $150,000 in the current system or $408,750 + $341,250 in the revised system). Then we just need to compute the variable cost to be allocated to Ohio; the difference between this and $750,000 will be allocated to Illinois.

Ohio

Employees300

Rate per employee $50

Allocated cost$15,000

Transitions50

Rate per transition$2,000

Allocated cost$$100,000

Total allocated cost$$115,000

The amount allocated to Illinois will be $635,000 ($750,000 $115,000).b. Kurt is correct that the incremental cost to Drumm from the activities of Ohio is measured by the $115,000. There is a danger that as Ohio grows relative to Illinois, the costs and activities of Personnel will be more highly influenced by the Ohio unit.

(30 min.) Activity-Based Costing: Joplin Industries.a. J25PJ40X

Direct material$1,500,000$2,400,000

Direct labor

Assembly$ 750,000$ 600,000

Packaging990,000360,000

Total direct labor$1,740,000$960,000

Direct costs$3,240,000$3,360,000

Overhead

Assembly building

Assembling (@ $30/mh)$ 180,000$ 900,000

Setting up machine (@$900/setup-hour)a27,000270,000

Handling material (@$3,000/run)24,000120,000

Packaging building

Inspecting and Packaging (@$5/direct labor-hour)300,000114,000

Shipping (@$1,320/shipment)132,000264,000

Total ABC O/H$ 663,000$1,668,000

Total ABC cost$3,903,000$5,028,000

Number of units100,00040,000

Unit cost$39.03$125.70

a 75% of the amounts in Exhibit 9.16. ($27,000 = .75 $36,000; $270,000 = .75 $360,000).

9-26. (continued)b.Kris could have made the reductions he planned, but the effect on the product costs would have been different. The $99,000 reduction in setup costs (25% of $396,000), would have been spread between the two products based on labor or machine-hours. ABC provides more detailed measures of costs than do plantwide or department allocation methods. In this case, ABC shows the costs of machining, setting up equipment, handling materials, inspecting, packaging products, and shipping. The plantwide and department allocation methods did not reveal any of these detailed cost drivers. With ABCs more detailed information, management has an opportunity to manage costs by managing cost drivers. For example, are there less costly ways to inspect and package products? Or perhaps spending additional resources to improve quality would more than pay for itself with reduced inspections.ABC also provides better measures of product costs than plantwide and department allocation methods, which leads to better decisions about product pricing and whether to keep or drop products.ABC requires more record keeping than plantwide or department allocation methods. ABC also requires more teamwork among accountants, production people, marketing, and management, which can be both costly and beneficial. In the end, management must decide whether the benefits of ABC, outlined above, are worth these costs.

(30 min.)Activity-Based Costing in a Nonmanufacturing Environment: Cathys Catering.a. & b.Activitiesa.Afternoon Picnicb.Formal Dinner

Advertising (parties)$ 80$ 80

Planning (parties)60100

Equipment rental (parties, guests)200a380b

Insurance (parties)160320

Server cost (parties)160c240d

Food (guests) 320e 480f

Total$980$1,600

a $200 = $40 + ($8 x 20 guests).b $380 = $60 + ($16 x 20 guests).c $160 = $40 x 4 servers.d $240 = $60 x 4 servers.e $320 = $16 x 20 guests.f $480 = $24 x 20 guests.c.If Cathy wants to cover her costs she should charge $49 per guest for the picnic ($980 20 guests), and $80.00 per guest for the formal dinner ($1,600 20 guests).

(35 min.)Activity-Based versus Traditional Costing: Rodent Corporation.a.RateWiredWirelessTotal

Direct labora$290,100$ 109,900$400,000

Direct materialsb$187,500$ 171,000$358,500

Overhead costs

Prod. runs$6,600c$ 132,000f$ 33,000$ 165,000

Quality tests9,900d59,400g89,100148,500

Ship. orders620e 31,000h 15,500 46,500

Total overhead$ 222,400$ 137,600$360,000

Total costs$700,000$418,500$1,118,500

Total unit cost$5.00i$8.37j

aData given in the first table of the exercise in the text.bData given in the first table of the exercise in the text.c$6,600 per run = $165,000 in production run costs 25 total runs.d$9,900 per test = $148,500 in quality costs 15 total tests.e$620 per order = $46,500 in shipping costs 75 processed orders.f$132,000 = $6,600 per production run x 20 runs for Wired.g$59,400 = $9,900 per quality test x 6 tests for Wired.h$31,000 = $620 per order shipped x 50 orders shipped for Wired.i$5.00 = $700,000 total costs for Wired 140,000 units produced.j$8.27 = $418,500 50,000 units produced.Reading from the table above, we can see that the total overhead assigned is $222,400 and $137,600 for Wired and Wireless, respectively. The total cost per unit is the total cost per product divided by the total units produced; $5.00 per Wired mouse and $8.37 per Wireless mouse.

9-28. (continued) b.RateWiredWirelessTotal

Direct labora$290,100$109,900$400,000

Direct materialsb187,500171,000358,500

Total overhead90%c 261,090d 98,910 360,000

Total costs$738,690$379,810$1,118,500

Total unit cost$5.28e$7.60

aData given in the first table in the exercise.bData given in the first table in the exercise.c90% = $360,000 total overhead $400,000 total direct labor.d$261,090 = $290,100 0.90e$5.28 = $738,690 140,000 units produced (rounded).

From the table above, total overhead allocated to Wired and Wireless is $261,090 and $98,910 respectively. The unit cost for Wired and Wireless is $5.28 and $7.60 respectively.

c.By allocating overhead on the basis of direct labor, Rodent has been understating the cost to manufacture Wireless mice thereby overstating the profits on the Wireless model.

(35 min.)Activity-Based versus Traditional Costing: Doaktown Products.a.RateM-008M-123Total

Direct materialsa$100,000$ 80,000$180,000

Direct laborb$100,000$ 40,000$140,000

Overhead costs

Machine-hours$ 15c$ 75,000f$ 45,000$ 120,000

Production runs3,500d35,000g35,00070,000

Inspections1,500e 30,000h 60,000 90,000

Total overhead$140,000$140,000$280,000

Total costs$340,000$260,000$600,000

Total unit cost$28.33i$130.00j

aData given in the first table of the exercise in the text.bData given in the first table of the exercise in the text.c$15 per machine-hour = $120,000 in production run costs 8,000 machine-hours.d$3,500 per run = $70,000 in quality costs 20 total runs.e$1,500 per inspection = $90,000 in shipping costs 60 inspections.f$75,000 = $15 per machine-hour x 5,000 machine-hours for M-008.g$35,000 = $3,500 per run x 10 runs for M-008.h$30,000 = $1,500 per inspection x 20 inspections for M-008.i$28.33 = $340,000 total costs for M-008 12,000 units produced (rounded).j$130 = $260,000 2,000 units produced.Reading from the table above, we can see that the total overhead assigned is $140,000 for both M-008 and M-123. The total cost per unit is the total cost per product divided by the total units produced; $28.33 per M-008 and $130 per M-123.

9-29. (continued) b.RateM-008M-123Total

Direct materialsa$100,000$80,000$180,000

Direct laborb100,00040,000140,000

Total overhead200%c 200,000d 80,000 280,000

Total costs$400,000$200,000$600,000

Total unit cost$33.33e$100.00

aData given in the first table in the exercise.bData given in the first table in the exercise.c200% = $280,000 total overhead $140,000 total direct labor.d$200,000 = $100,000 2.0.e$33.33 = $400,000 12,000 units produced (rounded).

From the table above, total overhead allocated to M-008 and M-123 is $200,000 and $80,000 respectively. The unit cost for M-008 and M-123 is $33.33 and $100.00 respectively.

c.By allocating overhead on the basis of direct labor, Doaktown Products has been understating the cost to manufacture M-123, thereby overstating the profits on M-123.

(30 min.)Activity-Based Costing in a Service Environment: We-Clean, Inc.Note: Answers may vary slightly due to rounding.

a.CommercialResidentialTotal

Revenuea$378,000$910,000$1,288,000

Direct Laborb210,000390,000600,000

Overheadc 43,400 80,600 124,000

Profit$124,600$439,400$ 564,000

a$378,000 = 14,000 hours x $27 per hour; $910,000 = 26,000 hours x $35 per hour.b$210,000 = 14,000 hours x $15 per hour; $390,000 = 26,000 hours x $15 per hour.c$43,400 = ($124,000 40,000 hours) x 14,000 hours; $80,600 = ($124,000 40,000 hours) x 26,000 hours.

b.RateCommercialResidentialTotal

Revenue$378,000$910,000$1,288,000

Direct Labor 210,000 390,000 600,000

Overhead

Traveling$250.00a$ 4,250b$ 11,750c$ 16,000

Equipment6.00d22,500e13,500f36,000

Supplies0.36g 46,800h 25,200i 72,000

Total Overhead$ 73,550$ 50,450$ 124,000

Profit$94,450$469,550$ 564,000

a $250 per client = $16,000 64 clients served.b $4,250 = 17 clients x $250 per client.c $11,750 = 47 clients x $250 per client.d $6.00 per hour = $36,000 6,000 equipment hours.e $22,500 = 3,750 equipment-hours x $6 per equipment-hour.f $13,500 = 2,250 equipment-hours x $6 per equipment-hour.g $0.36 per square yard = $72,000/200,000 square yards.h $46,800 = 130,000 square yards x $0.36 per square yard.i $25,200 = 70,000 square yards x $0.36 per square yard.

9-30. (continued)c.The recommendation to Ms. Lodge is that she should reconsider dropping residential services in favor of the commercial business. From the table in part b of the solution, we can show Ms. Lodge that commercial work has a profit margin of 25%, while the residential business has a profit margin of greater than 50%. We can explain the differences in profits under the two cost methods by showing Ms. Lodge that there is little correlation in costs between direct labor and the overhead costs.(35 min.)Activity-Based versus Traditional Costing: Isadores Implements, Inc.

a.Cost DriverRatePencilsPens

Setting up$1,440a$28,800d$ 43,200

Inspecting2,160b8,640e12,960

Packaging and Shipping0.36c16,200f 27,000

Total Overhead$53,640$83,160

a $1,440 per setup = $72,000 50 setups.b $2,160 per part = $21,600 10 parts.c $0.36 per unit shipped = $43,200 120,000 boxes shipped.d $28,800 = $1,440 x 20 setups.e $8,640 = $2,160 x 4 parts.f $16,200 = $0.36 x 45,000 boxes shipped.

b.PencilsPensTotal

Direct Labor Hours4,500a15,00019,500

Overhead$31,569b$105,231$136,800

a 4,500 hours = 0.1 hours per box of pencils x 45,000 boxes produced.b $31,569 = ($136,800 OH 19,500 hours) x 4,500 hours (rounded).

c.Not necessarily. Activity-based costing provides a more accurate allocation of overhead costs. However, the more accurate method is also more expensive. The ABC system should be adopted if the benefits from improved information exceed the additional costs required to obtain the information.(35 min.)Activity-Based versus Traditional CostingEthical Issues: Windy City Coaching.a.AccountRateTeen CounselingExecutive CoachingTotal

Revenue$66,000$135,000$201,000

Expenses:

Administrative support$4,000a24,000d16,00040,000

Transportation144b14,400e21,60036,000

Equipment.12.50c 11,250f 8,750 20,000

Profit$16,350$88,650$105,000

a $4,000 per client = $40,000 10 clients.b $144 per visit = $36,000 250 visits.c $12.50 per computer hour = $20,000 1,600 hours.d $24,000 = $4,000 per client x 6 clients.e $14,400 = $144 per hour x 100 visits.f $11,250 = $12.50 per computer hour x 900 hours.

b.AccountRateTeen CounselingExecutive CoachingTotal

Revenue$66,000$135,000$201,000

Expenses$143.2836a31,522b 64,478 96,000

Profit$34,478$ 70,522$105,000

a$201,000 revenue $300 per hour = 670 hours of labor. $143.2836 per labor hour = $96,000 of expenses 670 hours.b$31,522 = $143.28 per labor hour x 220 hours of labor.c.Under labor-based costing, teen counseling and executive coaching appear equally profitable (relative to revenues), so Wendy will not emphasize one or the other. However, using ABC, executive coaching appears to be much more profitable.d.ABC and traditional costing systems generally yield comparable product-line profits when overhead is a small portion of costs, or when cost drivers are highly correlated with the volume-related allocation base. In this case, labor-hours were distributed 32.8% to Teen Counseling and 67.2% to Executive Coaching. If Wendys three cost drivers were each also distributed 32.8% to Teen Counseling and 67.2% to Executive Coaching, the labor-hour allocation and ABC would have been identical.9-32. (continued)e. Activity-based costing assigns higher costs to teen counseling than the traditional method does, so using this would increase the chances of receiving the grant. If teen counseling uses more activities and these activities generate higher costs, there is nothing unethical about using and reporting ABC costs. Choosing to use ABC simply to increase the chances of receiving the grant, if there is no reason to believe these activities actually increase the costs, could be unethical. (30 min.)Activity-Based CostingCost Flows Through T-accounts: Delta Parts, Inc.

Materials Inventory

$300,000

Wages Payable

$150,000

Overhead Applied:Materials Handling

3,750 pounds x $18.00 per pound = $67,500 to WIP

Overhead Applied:Quality Inspections

750 inspections x $225 per inspection = $168,750 to WIP

Overhead Applied:Machine Setups

40 setups x $2,700 per setup = $108,000 to WIP

Overhead Applied:Running Machines

15,000 hours x $22.50 per hour = $337,500 to WIP

9-33. (continued)

Work in Process (WIP) InventoryFabrication Department

Direct Materials300,000

Direct Labor150,000

Material Handling OH67,500

Quality Inspect. OH168,750

Machine Setup OH108,000

Running Machines OH337,5001,131,750

Finished Goods Inventory

1,131,750

(30 min.) Activity-Based CostingCost Flows Through T-accounts: Carolina Fashions.

Materials Inventory

$200,000 to WIP

Wages Payable

$100,000 to WIP

Overhead Applied:Materials Handling

40,000 yards x $1 per yard = $40,000 to WIP

Overhead Applied:Quality Inspections

800 inspections x $100 per inspection = $80,000 to WIP

Overhead Applied:Machine Setups

100 setups x $800 per setup = $80,000 to WIP

Overhead Applied:Running Machines

20,000 hours x $10 per hour = $200,000 to WIP

9-34. (continued)

Work in Process (WIP) InventoryBuilding S

Direct Materials200,000

Direct Labor100,000

Material Handling40,000

Quality Inspect.80,000

Machine Setup80,000

Running Machines200,000700,000

Finished Goods Inventory

700,000

(20 min.)Activity-Based Costing for an Administrative Service: LastCall Enterprises.a.RateLaidBackStressedOutTotal

Allocated costsa$1,100$220,000b$55,000c$275,000

a $1,100 per employee = $275,000 Personnel cost 250 average employees.b $220,000 = $1,100 x 200 employees for LaidBack.c $55,000 = $1,100 per employee x 50 employees for StressedOut

b.RateLaidBackStressOutTotal

Employee maintenancea$6,000$60,000b$180,000c$240,000

Payrolld$14028,000e 7,000f 35,000

Total allocated costs$88,000$187,000$275,000

a $6,000 = $240,000 Employee maintenance costs 40 employees hired/leaving.b 60,000 = $6,000 10 employees hired/leaving.c 180,000 = $6,000 30 employees hired/leaving.d $140 = $35,000 Payroll costs 250 employees (average).e $28,000 = $140 200 employees (average).f $7,000 = $140 50 employees (average).

Allocating Personnel costs solely on number of employees understates the costs of employee turnover, which is much higher in StressedOut.

(20 min.)Activity-Based Costing for an Administrative Service: Johns Custom Computer Shop.a.RatePersonalBusinessTotal

Allocated costsa$84$50,400b$33,600c$84,000

a $84 per bill = $84,000 Accounts receivable cost 1,000 bills prepared.b $50,400 = $84 x 600 bills prepared for Personal.c $33,600 = $84 x 400 bills prepared for Business.

b.RatePersonalBusinessTotal

Billinga$48$28,800b$19,200c$48,000

Dispute resolutiond$50030,000e 6,000f 36,000

Total allocated costs$58,800$25,200$84,000

a $48 = $48,000 Billing costs 1,000 bills prepared.b 28,800 = $48 600 bills prepared.c 19,200 = $48 400 bills prepared.d $500 = $36,000 Dispute resolution costs 72 disputes.e $30,000 = $500 60 disputes.f $6,000 = $500 12 disputes.

Allocating Accounts Receivable costs solely on number of bills prepared understates the costs of billing disputes, which is much higher in Personal.

Solutions to Problems(40 min.)Comparative Income Statements and Management Analysis: EZ-Seat, Inc.a.EZ-Seat, Inc. Income Statement

AccountRateErgoStandardTotal

Sales revenue$2,925,000$2,760,000$5,685,000

Direct materials$ 550,000$ 500,000$1,050,000

Direct labor 400,000 200,000 600,000

Overhead costs:

Administration78%a312,000e156,000468,000

Production setup$7,200b360,000f720,0001,080,000

Quality control$1,800c360,000g360,000720,000

Distribution$192d 288,000h 1,152,000 1,440,000

Total overhead costs 1,320,000 2,388,0003,708,000

Operating profit$655,000$ (328,000)$327,000

a78% = $468,000 of Administrative costs $600,000 of direct labor costsb$7,200 = $1,080,000 of Production setup costs 150 production runsc$1,800 = $720,000 of Quality control costs 400 inspectionsd$192 = $1,440,000 of Distribution costs 7,500 units shippede$312,000 = 0.78 x $400,000 direct labor costsf$360,000 = $7,200 per setup x 50 production runsg$360,000 = $1,800 per inspection x 200 inspectionsh$288,000 = $192 per unit x 1,500 units shipped

b.Activity-based costing highlights the activities that cause costs, and provides insight into which costs could be reduced. For example, management may be able to operate with fewer but larger production runs, thereby reducing setup costs. Focusing on activities can identify non-value-adding activities that can be eliminated without reducing the products value.

9-37. (continued)c. EZ-Seat, Inc. Income Statement

AccountRateErgoStandardTotal

Sales revenue$2,925,000$2,760,000$5,685,000

Direct Materials550,000500,0001,050,000

Direct Labor400,000200,000600,000

Overhead Costs618%a2,472,000b1,236,0003,708,000

Operating Profit$ (497,000)$824,000$327,000

a 618% = $3,708,000 Overhead Costs $600,000 Direct Labor Costs.b $2,472,000 = 6.18 Overhead Rate x $400,000 Direct Labor Costs.

d.Dear Members of the Management Board:The purpose of this report is to explain the differences between the profits of our Ergo and Standard product lines using activity-based costing versus our traditional labor-based overhead allocation methods.The two costing methods differ in their results because of the way overhead costs are allocated between our products; direct costs do not differ under the two methods. Under the labor-based approach, all overhead costs are pooled together and allocated to our products on the basis of direct-labor costs. Under activity-based costing, cost drivers, such as inspections and set-ups, are identified and their costs are applied to the products in relation to usage.Traditional labor-based allocation is less accurate than activity-based allocations because many overhead costs are not well correlated with labor costs. For instance, our Ergo product receives 200% more overhead under our traditional approach than does our Standard product because it uses twice as much labor. However, after analyzing the factors driving the overhead and applying these costs to our products, we find that the Ergo line should receive only about 55% as much overhead as the Standard product.Our findings suggest that management might make sub-optimal decisions if it were to continue to use labor-based overhead allocations. Under our traditional method, the Ergo product line is not profitable (losses of $497,000), and management might wish to eliminate the Ergo model. Under the more accurate method of activity-based costing, the Ergo model is shown to contribute $655,000 towards profits. Management should not drop the Ergo line, instead we should pursue ways to reduce our costs, such as reducing the number of setups required.

(40 min.)Comparative Income Statements and Management Analysis: Bobs Baskets, Inc.a.Bobs Baskets, Inc.: Income Statement

AccountRateDeluxeStandardTotal

Sales revenue$216,000$240,000$456,000

Direct materials 20,000 20,000 40,000

Direct labor 48,000 72,000 120,000

Overhead costs:

Administration25%a12,000e18,00030,000

Setting up$2,000b40,000f20,00060,000

Performing quality control$375c22,500g7,50030,000

Distribution$0.12d 9,600h 14,400 24,000

Total overhead costs 84,100 59,900 144,000

Operating profit (loss)$63,900$ 88,100$152,000

a 25% = $30,000 administrative costs $120,000 direct labor costs.b $2,000 = $60,000 production setup costs 30 production runs.c $375 = $30,000 quality control costs 80 inspections.d $0.12 = $24,000 distribution costs 200,000 units shipped.e $12,000 = 0.25 x $48,000 direct labor costs.f $40,000 = $2,000 per run x 20 runs.g $22,500 = $375 per inspection x 60 inspections.h $9,600 = $0.12 per unit shipped x 80,000 units.

b.Activity-based costing highlights the activities that cause costs, and provides insight into which costs may be reduced. For instance, Bobs Baskets management has identified three cost driving activities; production setups, quality control inspections, and distribution. Setups cost $2,000 each and inspections cost $375 each. Therefore, between setups and inspections, the effort of making a one unit reduction in an activity should be directed at setups, as the savings would be greater than the same effort would produce if directed at inspections.

9-38. (continued)c.Bobs Baskets, Inc.Income Statement

AccountRateDeluxeStandardTotal

Sales revenue$216,000$240,000$456,000

Direct Materials20,00020,00040,000

Direct Labor48,00072,000120,000

Overhead Costs120%a 57,600b 86,400 144,000

Operating Profit (loss)$90,400$61,600$152,000

a 120% = $144,000 of Overhead Costs $120,000 Direct Labor Costs.b $57,600 = 120% Overhead rate x $48,000 Direct Labor Costs.

d.Dear Members of the Management Board:The purpose of this report is to explain the differences between the profits in our Deluxe and Standard product lines using activity-based costing versus our traditional labor-based overhead allocation method.The two costing methods differ in their results because of the way overhead costs are allocated between our products; direct costs, such as Materials and Labor do not differ under the two methods. Under the labor-based approach, all overhead costs are pooled together and allocated to our products on the basis of direct-labor costs. Under activity-based costing, cost drivers, such as inspections and set-ups, are identified and their costs are applied to the products in relation to usage.Traditional labor-based allocation is less accurate than activity-based allocations because many overhead costs are not well correlated with labor costs. For instance, our Deluxe basket receives two-thirds as much overhead under our labor-based allocation approach as does our Standard basket because it uses two-thirds as much labor. However, after analyzing the factors driving the overhead and applying these costs to our products, we find that the Deluxe line should receive $84,100, or about 40% more than the standard basket, in overhead.Our findings suggest that management might make sub-optimal decisions if it were to continue to use labor-based overhead allocations. Under our traditional method, the Standard Basket is less profitable than the Deluxe. Under the more accurate activity-based costing, the Standard basket line earns about 38% more than the Deluxe baskets in profits.

(15 min.) Ethics and Choice of Accounting Methods: Bobs Baskets, Inc.Yes, you should show the results to management. You have an ethical responsibility to communicate information fairly and objectively. Recall that the Institute of Management Accountants requires its members to Disclose fully all relevant information that could be reasonably expected to influence an intended users understanding of the reports, comments, and recommendations presented.(50 min.)Activity-Based Costing and Predetermined Overhead Allocation Rates: Kitchen Supply, Inc.a.Computing overhead allocation rates

ActivityCostDriverEst.CostsDriverUnitsRate

Processing ordersNo. of orders$54,000200=$270

Setting up productionNo. of runs216,000100=2,160

Handling materialsPounds360,000120,000=3.00

Using machinesMachine-hrs.288,00012,000=24

Performing quality controlNo. of insp.72,00045=1,600

PackingNo. of units144,000480,000=0.30

Total est. overhead$1,134,000

Predetermined rate for direct labor-hour=Estimated activity Estimated allocation base

=$1,134,000 7,500 hours

=$151.20 per hour

b. Production Costs using Direct Labor-Hours

AccountInstitutionalStandardSilverTotal

Direct materials$ 39,000$24,000$15,000$ 78,000

Direct labora6,7506,7509,00022,500

Indirect costsb 68,040 68,040 90,720 226,800

Total cost$113,790$98,790$114,720$327,300

a Number of labor-hours x $15 per hour.b Number of labor-hours x $151.20 per hour.

9-40. (continued)c. Production Costs using ABC

AccountInstitutionalStandardSilverTotal

Direct materials$39,000$24,000$15,000$78,000

Direct labor6,7506,7509,00022,500

Indirect costs

Processing orders3,2402,4301,6207,290

Setting up production6,4806,48012,96025,920

Handling materials45,00018,0009,00072,000

Using machines13,9203,3601,92019,200

Performing quality control4,8004,8004,80014,400

Packing18,0007,2002,70027,900

Total cost$137,190$73,020$57,000$267,210

d.Internal MemorandumThe discrepancy between our product costs using direct-labor hours as the allocation base versus activity-based costing is found in the way overhead costs are allocated. Our existing direct-labor cost method distorts our product costs because there is little correlation between our direct-labor costs and overhead. Activity-based overhead is more accurate. It allocates the individual components of our overhead to our products based upon the products use of that overhead component.With the more accurate product costs, we should begin to concentrate our efforts upon reducing the costs of our more expensive overhead operations. As seen in the activity-based costing report, a large share of our total overhead is comprised of materials handling and maintenance costscosts, which were not visible under the direct-labor approach. Reducing our materials handling and machine depreciation and maintenance costs should be a new priority.We recommend assessing the cost of using an activity-based system in our company. We will proceed with activity-based costing if we find the cost of the new system is less than the benefits of the more accurate information we will receive.

(50 min.)Activity-Based Costing and Predetermined Overhead Rates: College Supply Company.

a.ActivityRecommended BaseAllocation Rate

Setting up productionNo. of runs$360 per run ($36,000 100 runs)

Processing ordersNo. of orders$300 per order ($60,000 200 orders)

Handling materialsLbs. of material$3.00 per lb. ($24,000 8,000 lbs.)

Using machinesMachine-hours$7.20 per hour ($72,000 10,000 hrs.)

Performing quality managementNo. of inspections$1,500 per insp. ($60,000 40 insp.)

Packing & shippingUnits shipped$2.40 per unit ($48,000 20,000 units)

Direct labor hour rate$150 per hour ($300,000 2,000 hrs.)

b.ShortMediumTall

Direct materials$6,000$3,750$3,000

Direct labora3,0003,6003,300

Overheadb15,00018,00016,500

Total costs$24,000$25,350$22,800

a Number of hours x $30 per hour.b Number of hours x $150 per hour.

9-41 (continued)c.ShortMediumTall

Direct materials$6,000$3,750$3,000

Direct labor3,0003,6003,300

Setting up production720a1,4402,880

Processing orders2,400b2,4001,200

Handling materials1,200c2,400600

Using machines3,600d2,1602,160

Performing quality management3,000e3,0003,000

Shipping2,400f1,200720

Total cost$22,320$19,950$16,860

a $720 = $360 per run x 2 runs.b $2,400 = $300 per order x 8 orders.c $1,200 = $3.00 per lb. x 400 lbs.d $3,600 = $7.20 per hour x 500 hours.e $3,000 = $1,500 per inspection x 2 inspections.f $2,400 = $2.40 per unit x 1,000 units.

d.Internal MemorandumRe: Product Cost DiscrepancyThe discrepancy between our product costs using direct labor-hours as the allocation base versus activity-based costing is found in the way overhead costs are allocated. Our existing direct-labor cost method distorts our product costs because there is little correlation between our direct-labor costs per product and overhead. Activity-based overhead is more accurate. It allocates the individual components of our overhead to our products based upon the products use of that overhead component.With the more accurate product costs, we should begin to concentrate our efforts upon reducing the costs of our more expensive overhead operations. As seen in the activity-based costing report, a large share of our total overhead is comprised of order processing, quality management, equipment maintenance, and shipping costscosts that were not visible under the direct-labor approach. Reducing these overhead costs should be a top priority.We should use activity-based costing if we find the benefits from the new system exceed its costs.

(40 min.)Choosing an Activity-Based Costing System: Pickle Motorcycles, Inc.a.Pickle MotorcyclesIncome Statement

Route 66Main StreetAlley CatTotal

Sales revenue$7,600,000$11,200,000$9,500,000$28,300,000

Direct costs:

Direct material3,000,0004,800,0004,000,00011,800,000

Direct labor288,000480,0001,080,0001,848,000

Var. OHa939,6001,503,3602,255,040 4,698,000

Cont. margin$3,372,400$4,416,640$2,164,960$ 9,954,000

Fixed OH:

Plant admin. 1,760,000

Other2,800,000

Gross profit$ 5,394,000

a Rate = $93.96 (= $4,698,000 50,000 machine-hours) per machine-hour.

9-42. (continued)b.Pickle MotorcyclesIncome Statement

Route 66Main StreetBack AlleyTotal

Sales revenue$7,600,000$11,200,000$9,500,000$28,300,000

Direct costs:

Direct material3,000,0004,800,0004,000,00011,800,000

Direct labor288,000480,0001,080,0001,848,000

Var. OH:

Mach. setup102,960a159,120205,920468,000

Order proc.288,000b432,000432,0001,152,000

Warehousing418,500c418,500837,0001,674,000

Energy151,200d241,920362,880756,000

Shipping 43,200e 172,800 432,000 648,000

Cont. margin$3,308,140$4,495,660$ 2,150,200$ 9,954,000

Fixed OH:

Plant admin.1,760,000

Other2,800,000

Gross profit$ 5,394,000

a $4,680 (= $468,000 100 runs) per run x 22 runs = $102,960.b $720 (= $1,152,000 1,600 orders) per order x 400 orders = $288,000.c $2,092.50 (= $1,674,000 800 units) per unit x 200 units = $418,500.d $15.12 (= $756,000 50,000 machine-hours) per machine-hour x 10,000 machine-hours = $151,200.e $43.20 (= $648,000 15,000 units) per unit shipped x 1,000 units shipped = $43,200 c.The activity-based costing method provides a more detailed breakdown of the costs. This additional information should enable PMIs management to make better decisions. For example, if PMI wants to reduce costs then activity-based costing will list the activities on which management should focus its cost-reducing efforts. Also, the company will probably have more accurate product cost information for pricing and other decisions.d.Some costs may have no relationship to any volume or activity base. To artificially allocate these costs would distort the accounting information used for pricing, evaluation, etc. A preferable method of handling such costs might be to require a contribution margin from each product that must cover a portion of these costs.

(40 min.)Activity-Based Costing, Cost Flow Diagram, and Predetermined Overhead Rates: Huron Furniture.a.Burden rate = (Total overhead costs Budgeted total direct labor-hours)Budgeted total direct labor-hours = 3,200 + 1,800 + 5,000 = 10,000 hoursTotal overhead costs = $450,000 +$450,000 + $1,200,000 = $2,100,000Burden rate = $2,100,000 10,000 = $210 per DLHUnit costs:

OvalRoundSquare

Direct costs$ 80,000$ 80,000$ 80,000

Overhead (@ $210 per DLH)672,000378,0001,050,000

Total costs$752,000 $458,000$1,130,000

Number of units4,0002,0006,000

Unit cost$188$229$188.33

9-43. (continued)

b.

c. Utilities$450,000 60,000 MH=$7.50 per machine-hour.

Scheduling and setup$450,000 600 Setups=$750 per setup.

Material handling$1,200,000 1,600,000 lbs.=$0.75 per pound.

9-43. (continued)d.Unit Costs:

OvalRoundSquare

Direct Costs$ 80,000$ 80,000$ 80,000

Overhead:

Utilities225,000a75,000150,000

Scheduling and setup60,000b225,000165,000

Material handling 375,000c 225,000 600,000

Total costs$740,000$605,000$995,000

Number of units4,0002,0006,000

Unit cost$185.00$302.50$165.83

a $225,000 = $7.50 per machine-hour x 30,000 machine-hours.b $60,000 = $750 per setup x 80 setups.c $375,000 = $0.75 per pound x 500,000 pounds of material.

e.If management implemented an activity-based costing system it should be provided with a more thorough understanding of product costs. By breaking down costs into cost drivers, i.e., those activities that drive the costs, management should be able to see the relationship between product complexity, product volume, and product cost. This would be vital information for pricing decisions and profitability strategies. Management should also be able to streamline the production process by reducing those nonvalue-adding activities such as setups and travel time between activity centers or departments. (Management might consider running larger batches, or redesigning the plant layout.)

(40 min.)Activity-Based Costing, Cost Flow Diagram, and Predetermined Overhead Rates: Utica Manufacturing.a.Burden rate = (Total overhead costs Budgeted total machine-hours)Budgeted total machine-hours = 60,000 + 90,000 = 150,000 hoursTotal overhead costs = $170,000 +$1,500,000 + $700,000 + $480,000= $2,850,000Burden rate = $2,850,000 150,000 machine-hours = $19 per machine-hourUnit costs:

308510

Direct costs$216,000$216,000

Overhead (@ $19 per machine-hour)1,140,0001,710,000

Total costs$1,356,000 $1,926,000

Number of units30,00018,000

Unit cost$45.20$107.00

9-44. (continued)

b. Inspection$170,000 $68,000 material dollars=250% of material dollars.

Production$1,500,000 150,000 machine-hours=$10.00 per machine-hour

Machine setup$700,000 140 Setups=$5,000 per setup.

Shipping$480,000 48,000 units=$10.00 per unit.

c.Unit Costs:

308510

Direct Costs$216,000$216,000

Overhead:

Incoming inspection125,000a45,000

Production600,000b900,000

Machine setup250,000c450,000

Shipping 300,000d 180,000

Total costs$1,491,000$1,791,000

Number of units30,00018,000

Unit cost$49.70$99.50

a $125,000 = 250% of material dollars x $50,000.b $600,000 = $10.00 per machine-hour x 60,000 machine-hours.c $250,000 = $5,000 per setup x 50 setups.d $300,000 = $10.00 per unit x 30,000 units.

d.If management implemented an activity-based costing system it should be provided with a more thorough understanding of product costs. By breaking down costs into cost drivers, i.e., those activities that drive the costs, management should be able to see the relationship between product complexity, product volume, and product cost. This would be vital information for pricing decisions and profitability strategies. Management should also be able to streamline the production process by reducing those nonvalue-adding activities such as setups and travel time between activity centers or departments. (Management might consider running larger batches, or redesigning the plant layout.)

(40 min.)Activity-Based Costing and Predetermined Overhead Rates: Cain Components.a.Burden rate = (Total overhead costs Budgeted total machine-hours)Budgeted total machine-hours = 150,000 + 100,000 = 250,000 hoursTotal overhead costs = $600,000 +$5,500,000 + $900,000 + $1,000,000 = $8,000,000Burden rate = $8,000,000 250,000 machine-hours = $32 per machine-hourUnit costs:

StandardDeluxe

Direct costs$895,000$405,000

Overhead (@ $32 per machine-hour)4,800,0003,200,000

Total costs$5,695,000 $3,605,000

Number of units20,0005,000

Unit cost$284.75$721.00

9-45. (continued)

b. Receiving$600,000 $400,000 material dollars=150% of material dollars.

Production$5,500,000 250,000 machine-hours=$22.00 per machine-hour

Machine setup$900,000 200 Setups=$4,500 per setup.

Shipping$1,000,000 25,000 units=$40.00 per unit.

Unit Costs:

StandardDeluxe

Direct Costs$895,000$405,000

Overhead:

Receiving367,500a232,500

Manufacturing3,300,000b2,200,000

Machine setup337,500c562,500

Shipping 800,000d 200,000

Total costs$5,700,000$3,600,000

Number of units20,0005,000

Unit cost$285.00$720.00

a $367,500 = 150% of material dollars x $245,000.b $3,300,000 = $22.00 per machine-hour x 150,000 machine-hours.c $337,500 = $4,500 per setup x 75 setups.d $800,000 = $40.00 per unit x 20,000 units.

c.If these results are typical, it will probably not be worth adopting the ABC system. The difference in the reported product costs are not significant, meaning they would be unlikely to distort any decisions. It is important to note that this is true as long as these results (number of units, costs, and so on) remain in roughly these proportions. If there are large changes in the relative proportions, the two costs systems might no longer report similar results.

(40 min.)Activity-Based Costing and Predetermined Overhead Rates: Cain Components.a.

Receiving$600,000 $400,000 material dollars=150% of material dollars.

Manufacturing$3,300,000 250,000 machine-hours=$13.20 per machine-hour

Engineering$2,200,000 200 Setups=$11,000 per setup

Machine setup$900,000 200 Setups=$4,500 per setup.

Shipping$1,000,000 25,000 units=$40.00 per unit.

Unit Costs:

StandardDeluxe

Direct Costs$895,000$405,000

Overhead:

Receiving367,500a232,500

Manufacturing1,980,000b1,320,000

Engineering825,000c1,375,000

Machine setup337,500d562,500

Shipping 800,000e 200,000

Total costs$5,205,000$4,095,000

Number of units20,0005,000

Unit cost$260.25$819.00

a $367,500 = 150% of material dollars x $245,000.b $1,980,000 = $13.20 per machine-hour x 150,000 machine-hours.c $825,000 = $11,000 per setup x 75 setups.d $337,500 = $4,500 per setup x 75 setups.e $800,000 = $40.00 per unit x 20,000 units.

b.If these results are typical, it will probably be worth adopting the ABC system. The difference in the reported product costs is now significant, meaning they could be distort decisions.

(15 min.)Benefits of Activity-Based Costing: Cawker Products.Activity-based costing would help to clear his confusion by identifying the activities that drive overhead costs. In the old process, direct labor was used to move material. The costing system treats this cost as direct labor cost and so overhead is artificially low and direct labor cost is artificially high. An activity-based costing system would help by identifying the activities used in the plants. Even if direct labor was used to move the products, the cost could be accounted for as overhead (material handling) cost. The overhead rates would better reflect the comparison between the two plants. In addition, an investigation of the different material handling overhead rates would reveal the use of lower-cost labor used at the Russell plant. Managers at the Lucas plant could then evaluate whether they would also benefit by using different labor for this activity.

(40 min.)Choosing an Activity-Based Costing System: MTI.

a.Total overhead to allocate is $8,700,000 (= $2,400,000 + $1,800,000 + $2,400,000 + $1,200,000 + $900,000).The overhead rate is $348 per machine-hour (= $8,700,000 25,000 machine-hours).

MTIIncome Statement

M3100M4100M6100Total

Sales revenue$9,000,000$15,000,000$13,500,000$37,500,000

Direct costs:

Direct material.3,000,0004,500,0003,300,00010,800,000

Direct labor600,000900,0001,800,0003,300,000

Var. overhead2,088,000a3,132,0003,480,0008,700,000

Contribution margin$3,312,000$6,468,000$4,920,000$14,700,000

Plant admin.6,000,000

Gross profit$8,700,000

a $2,088,000 = $348 per machine-hour 6,000 machine-hours.

b.Cost driver rates:

ActivityCostActivity VolumeUnit Rate

Setting up machines$2,400,00050 runs=$48,000 per run

Processing sales orders $1,800,000800 orders=2,250 per order

Warehousing$2,400,000400 units=6,000 per unit

Operating machines$1,200,00025,000 machine-hrs=48 per machine-hr.

Shipping$900,00037,500 units shipped=24 per unit shipped

9-48. (continued)Income Statement

M3100M4100M6100Total

Sales revenue$9,000,000$15,000,000$13,500,000$37,500,000

Direct costs:

Direct material.3,000,0004,500,0003,300,00010,800,000

Direct labor600,000900,0001,800,0003,300,000

Var. overhead

Setting up machines480,000a960,000960,0002,400,000

Processing orders 405,000b900,000495,0001,800,000

Warehousing600,000c1,200,000600,0002,400,000

Operating machines288,000d432,000480,0001,200,000

Shipping 240,000e 420,000 240,000 900,000

Cont. margin$3,387,000$5,688,000$ 5,625,000$14,700,000

Plant admin.6,000,000

Gross profit$8,700,000

a $480,000 = $48,000 per run 10 runs.b $405,000 = $2,250 per order 180 orders.c $600,000 = $6,000 per unit 100 units.d $288,000 = $48 per machine-hour 6,000 machine-hours.e $240,000 = $24 per unit shipped 10,000 units shipped.

c.Although both methods yield similar product costs, the activity-based costing method provides a more detailed breakdown of the costs. This additional information should enable MTI management to make better decisions. For example, if MTI wants to reduce costs, then activity-based costing will list the activities on which management should focus its cost-reducing efforts. Further, activity-based costing should increase the accuracy of product costs, which would help decision making (e.g., pricing, make-or-buy decision).d.If plant administration costs were to be allocated to products, the costs should be allocated in some manner that bears a relationship to the benefits received by the products. In this case, we would want to know more about the contents of the plant administration costs. If the costs are mainly personnel costs, for example, such as the costs of a training program or of a plant cafeteria, we could allocate the costs based upon direct labor-hours.

Solutions to Integrative CasesDecision Making and Distorted Costs: ACE Industries.This problem is a simple illustration of the death spiral.a.ACETotal

Sales revenue$270,000$165,000$305,000$740,000

Material costs70,00065,000145,000280,000

Labor costs20,00012,00028,00060,000

Manufacturing overhead240,000

Operating profit$160,000

b.You will drop product E. The profit margin is 7%.The overhead rate, based on direct labor costs, is 400% (= $240,000 $60,000).Product line profits and profit margins are:ACE

Sales revenue$270,000$165,000$305,000

Material costs70,00065,000145,000

Labor costs20,00012,00028,000

Manufacturing overhead (@400%)80,00048,000112,000

Product line profit$100,000$40,000$20,000

Profit margin37%24%7%

9-49. (continued)c.ACTotal

Sales revenue$270,000$165,000$435,000

Material costs70,00065,000135,000

Labor costs20,00012,00032,000

Manufacturing overhead208,000

Operating profit$60,000

d.You will drop product C. The profit margin is 6%.The overhead rate, based on direct labor costs, is 650% (= $208,000 $32,000).Product line profits and profit margins are:AC

Sales revenue$270,000$165,000

Material costs70,00065,000

Labor costs20,00012,000

Manufacturing overhead (@650%)130,00078,000

Product line profit$50,000$10,000

Profit margin19%6%

9-49. (continued)e.ATotal

Sales revenue$270,000$270,000

Material costs70,00070,000

Labor costs20,00020,000

Manufacturing overhead190,000

Operating profit$(10,000)

f.The problem is that some part of the overhead is unavoidable, so that when products are dropped, the overhead does not decline proportionately. The reported profit margin, computed by using an overhead rate that includes both fixed and variable overhead costs is not useful for decision making.

(50 Min) Cost Allocation and Environmental ProcessesEthical Issues: California Circuits Company.

a.XL-DXL-C

Raw material$12.00$14.00

Direct labor Production$2.00$2.00

Direct labor Assembly 8.0010.00 8.0010.00

Overhead @ 120%a 12.00 12.00

Total$34.00$36.00

a Overhead rate = Total overhead Total direct labor cost= ($1,000,000 + $500,000) [(100,000 $10) + (25,000 $10)] = 120% of direct labor costs

b.XL-DXL-C

Raw material$12.00$14.00

Direct labor Production$2.00$2.00

Direct labor Assembly 8.0010.00 8.0010.00

Overhead Production @ $5 per MHa$8.00$8.00

Overhead - Assembly @ $10 per DLHb 4.00 12.00 4.00 12.00

Total$34.00$36.00

a Overhead rateProduction Department = Production overhead Total machine-hours= $1,000,000 [(100,000 1.6) + (25,000 1.6)] = $5 per machine-hourb Overhead RateAssembly Department = Assembly overhead Total direct labor-hrs= $500,000 [(100,000 0.4) + (25,000 0.4)] = $10 per direct labor-hour

c.Since both products use machine time and direct labor time in the same proportion (in fact, in equal amounts), it is irrelevant whether machine-hours or direct labor-hours are used to allocate overhead costs to the final products or whether it is done by manufacturing department or using a plantwide rate.

9-50. (continued)d.

XL-DXL-C

Raw material$12.00$14.00

Direct labor Production$2.00$2.00

Direct labor Assembly 8.0010.00 8.0010.00

Overhead Productiona

Supervision @ $8/direct labor-hour$0.80$0.80

Material handling @ 6% matl. cost0.720.84

Testing @ $0.40/ test hour1.201.20

Waste treatment @ $0.25/gallon2.500.00

Depreciation @ $2/mach. hr3.203.20

Shipping @ $0.05/pound 0.05 0.08

Total production overhead8.476.12

Overhead Assembly @ $10/DLHb 4.00 4.00

Total$34.47$34.12

a Production Department Overhead Calculations (Rate = Activity cost Driver volume):

ActivityActivity CostDriverDriver VolumeRate

Supervision$100,000Direct labor-hrs100,000 .1 + 25,000 .1 = 12,500 hours$8.00

Materials handling93,000Material cost100,000 $12 + 25,000 $14 = $1,550,0006%

Testing150,000Test hours100,000 3 + 25,000 3 = 375,000 hours$0.40

Wastewater treatment250,000Waste 100,000 10 + 25,000 0 = 1,000,000 gallons$0.25

Depreciation400,000Machine- hours100,000 1.6 + 25,000 1.6 = 200,000 machine-hours$2.00

Shipping7,000Weight100,000 1.0 + 25,000 1.6 = 140,000 pounds$0.05

b Overhead RateAssembly Department = Assembly overhead Total direct labor-hrs= $500,000 [(100,000 0.4) + (25,000 0.4)] = $10 per direct labor-hour

9-50. (continued)e. This question raises the issue of costs that are missing in the typical accounting records of the firm. In this case, the ABC system suggests that XL-C, the model that generates no wastewater, is actually less expensive. However, as the calculations show, the difference is relatively small.A question that is important to answer is what costs are associated with the wastewater that are not recorded by the firm. These environmental costs could be important and might affect the firm indirectly, perhaps through the health of its employees or because of problems with the community. It is difficult to argue with the controller that the decision should be made on the basis of costs. The relevant question is whether the cost system includes all the costs of production.(60 min.)Distortions Caused By Inappropriate Overhead Allocation Base: Chocolate Bars, Inc.a.Almond DreamKrispy KrackleCreamy Crunch

Product costs:

Labor-hours per case731

Total cases produced1,0001,0001,000

Material cost per case$8.00$2.00$9.00

Direct labor cost per case$42.00$18.00$6.00

Labor-hours per product7,0003,0001,000

Total overhead = $69,500Total labor-hours = 11,000Direct labor costs per hour = $6.00Allocation rate per labor-hour = $6.32 per labor-hour (rounded)Costs of products:Material cost per case$ 8.00$ 2.00$9.00

Direct labor cost per case42.0018.006.00

Allocated overhead per case44.2418.966.32

Product cost$94.24$38.96$21.32

Selling price$85.00$55.00$35.00

Gross profit margin(10.87)%29.16%39.09%

Drop product?YesNoNo

From the table above, we can see that the overhead allocation system used by CBI would lead them to drop Almond Dream and keep the remaining two bars, Krispy Krackle and Creamy Crunch.b.Almond Dream has a much higher proportion of direct labor-hours than Krispy Krackle or Creamy Crunch, so Almond Dream is allocated a greater share of the overhead costs.9-51. (continued)c.KrispyKrackleCreamyCrunch

Direct labor cost per hour$6.00$6.00

Direct labor-hours per case31

Total cases produced1,0002,000

Labor-hours per product3,0002,000

Total labor-hours: 5,000

Allocation rate per labor-hour=Total overhead Total labor-hours

=$69,500/5,000

=$13.90 per labor-hour

Allocated production costs:KrispyKrackleCreamyCrunch

Material cost per case$2.00$9.00

Direct labor cost per case18.006.00

Allocated overhead per case

($13.90 per labor-hour)41.7013.90

Product cost$61.70$28.90

Gross profit margins:

Selling price$55.00$35.00

Product costdirect labor allocation base(61.70)(28.90)

$ (6.70)$6.10

Profit margin percentage$(6.70) $55.00$6.10 $35.00

=(12.2)%=17.4%

The recommendation to management is to drop Krispy Krackle and increase production of Creamy Crunch.

9-51. (continued)

d.CreamyCrunch

Direct labor cost per hour$6.00

Direct labor hours per case1

Total cases produced3,000

Labor hours per product3,000

Total labor hours: 3,000

Allocation rate per labor hour=Total overhead/Total labor hours

=$69,500/3,000

=$23.17per labor hour

Allocated Production Costs:Creamy Crunch

Material cost per case$9.00

Direct labor cost per case6.00

Allocated overhead per case23.17

Product cost$38.17

Gross profit margins:

Selling price$35.00

Product costdirect labor allocation base(38.17)

$ (3.17)

Profit margin percentage$(3.17) $35.00

= (9.1)%

The recommendation to management is to drop Creamy Crunch and sell out!e.The policies and allocation method employed by CBI encourage poor decision making. The direct labor-hours are inappropriate as an allocation base and give misleading information. The allocation method and policy to drop products with gross profit margins less than 10 percent could lead to the systematic elimination of all products. CBI is a profitable firm, in total, and misallocation of overhead can lead management to make unprofitable decisions.

(90 min.)Multiple Allocation Bases: Chocolate Bars, Inc.a.AlmondDreamKrispyKrackleCreamy CrunchTotal

Total direct labor hoursa7,000(63.6%)3,000(27.3%)1,000(9.1%)11,000(100%)

Total machine hoursa2,000(13.3%)7,000(46.7%)6,000(40%)15,000(100%)

Factory space (sq. ft.)1,000(10%)4,000(40%)5,000 (50%)10,000(100%)

Total rent for factory space:$15,000 per month

Total machine operating costs:$30,000 per month

Total other overhead:$24,500 per month (= $69,500 $15,000 $30,000)

Total cases produced/month:3,000 cases

Product allocation base:Fraction:Labor (%)Machine hours (%)Factory space (%)

Almond Dream63.6%13.3%10%

Krispy Krackle27.346.740

Creamy Crunch9.140.050

Allocated Costs:TotalPer Case

Almond Dream (63.6% x $24,500) + (13.3% x $30,000) + (10% x $15,000)=$21,072$21.07

Krispy Krackle (27.3% x $24,500) + (46.7% x $30,000) + (40% x $15,000)=26,69926.70

Creamy Crunch (9.1% x $24,500) + (40% x $30,000) + (50% x $15,000)=21,73021.73

Allocated production costs:Almond DreamKrispy KrackleCreamyCrunch

Material cost$8.00$2.00$9.00

Direct labor42.0018.006.00

Allocated OH21.0726.7021.73

Production cost per case$71.07$46.70$36.73

Selling price$85.00$55.00$35.00

Product cost(71.07)(46.70)(36.73)

Profit (loss)$13.93$8.30$ (1.73)

Profit margin ratio16.4%15.1%(4.9)%

aTotals equal hours per case times 1,000 cases.

952.(continued)b.Based upon the table above and the gross profit margin rule, management would recommend dropping Creamy Crunch. Two characteristics of Creamy Crunch appear to make it appear relatively unprofitable: one, the selling price is comparatively low as compared to the other two products; two, Creamy Crunch uses 50% of the factory space and, thus, is allocated half of the rent costs.

c.Almond DreamKrispyKrackle

Direct labor hours per case73

Machine hours per case27

Factory space (sq. ft.)a 2,000(33.3%)4,000(66.7%)

Case of output per month 2,0001,000

Labor hours required14,000(82.4%)3,000(17.6%)

Machine hours required 4,000(36.4%)7,000(63.6%)

Total rent for factory space:$15,000 per month

Total machine operating costs:$30,000 per month

Total other overhead:$24,500 per month

Total labor hours/month:17,000

Total cases produced/month:3,000 cases

Total machine hours11,000 hours

Product allocation base:Fraction:Labor (%)Machine hours (%)Factory space (%)

Almond Dream82.4%36.4%33.3% (rounded)

Krispy Krackle17.663.666.7 (rounded)

aThis product mix leaves 4,000 square feet of space available.

9-52. (continued)Allocated Cost:TotalPer Case

Almond Dream (82.4% x $24,500) + (36.4% x $30,000) + (33.3% x $15,000)=$36,108$18.05

Krispy Krackle (17.6% x $24,500) + (63.6% x $30,000) + (66.7% x $15,000)= 33,392 33.39

Allocated production costs:AlmondDreamKrispyKrackle

Material cost$8.00$2.00

Direct labor42.0018.00

Allocated OH18.0533.39

Production cost per case$68.05$53.39

Selling price$85.00$55.00

Product cost(68.05)(53.39)

$16.95$1.61

Profit margin ratio:

Ratio = Gross Margin/Price19.9%2.9%

Based on the gross profit margins of Almond Dream and Krispy Krackle, management should drop Krispy Krackle and continue to produce Almond Dream. Almond Dream appears to be the most profitable product. In fact, its margin ratio is only 13.9%, computed as follows:Cases Produced = 3,000Overhead Allocation = $69,500 3,000 = $23.17

Allocated production costs:AlmondDream

Material cost$8.00

Direct labor42.00

Allocated OH23.17

Production cost per case$73.17

Selling price$85.00

Product cost(73.17)

$11.83

Profit margin ratio:

Ratio = Gross Margin/Price13.9%

9-52. (continued)If we compute the gross margin for the three products at maximum production, we find Almond Dream and Krispy Krackle to be equally profitable, computed as follows:

Almond DreamorKrispy KrackleorCreamy Crunch

Cases3,0003,0003,000

Costs

Materials$24,000$ 6,000$27,000

Labor126,00054,00018,000

Overhead+69,500+69,500+69,500

$219,500$129,500$114,500

Revenue$255,000$165,000$105,000

Total costs219,500129,500114,500

Gross margin$35,500$35,500$ (9,500)

Moral: Dont make too much of allocated cost numbers in decision making.

Chapter 09 - Activity-Based Costing

Chapter 09 - Activity-Based Costing

9-12 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

9-1 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.(90 min.)Activity-Based Costing The Grape Cola Caper.a.Percentage utilization of resource by activities:Activity

SetupsProductionRunsProductsMachineTime

Indirect labor (including fringe benefits) 50%40%10%0%

Information technology (IT)080200

Machinery depreciation000100

Machinery maintenance000100

Energy000100

Costs assigned to activiities:Activity

CostSetupsProductionRunsProductsMachineTime

Indirect labor $28,000$14,000$11,200$2,800$ 0

IT10,00008,0002,0000

Machinery depreciation8,0000008,000

Machinery maintenance4,0000004,000

Energy2,000 0 0 0 2,000

Total$52,000$14,000$19,200$4,800$14,000

Activity560 hours110 runs4 products10,000 hrs

Cost driver rates$25$174.55$1,200$1.40

9-57 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

9-53. (continued)b.

Unit Costs on Cola Bottling Line

DietRegularCherryGrapeTotal

Materials $ 25,000 $ 20,000 $ 4,680 $ 550 $ 50,230

Direct labor 10,000 8,000 1,800 200 20,000

Fringe benefits on direct labor 4,000 3,200 720 80 8,000

Setup costs 5,000a1,5006,0001,50014,000

Production run costs6,982b5,2365,2361,74619,200

Product costs1,200c1,2001,2001,2004,800

Machine costs 7,000d 5,600 1,260 140 14,000

Total costs $59,182 $44,736 $20,896 $ 5,416 $130,230

Volume50,00040,0009,0001,000

Cost per unit$1.18$1.12$2.32$5.42

a $5,000 = $25 per setup hour x 200 setup hours.b $6,928 = $174.55 per production run x 40 production runs.c $1,200 = $1,200 per product.d $7,000 = $1.40 per machine hour x 5,000 machine hours.

9-53. (continued)c.

Monthly Report on Cola Bottling Line

DietRegularCherryGrapeTotal

Sales revenue $75,000 $60,000 $13,950 $1,650 $150,600

Costs 59,182 44,736 20,896 5,416 130,230

Gross margin $15,818 $15,264 $(6,946) $(3,766) $20,370

d.Mr. Rockness:The activity-based costing analysis shows that Diet and Regular Cola are profitable, but the Cherry and Grape flavors are unprofitable. The primary cause of their high costs is the large demands they place on setup resources. We recommend an analysis of whether we can reduce the costs of Cherry and Grape by improving our ability to get the flavors right on these two products. If that is not possible, we recommend that you consider dropping these products, unless there are strategic reasons for offering these as part of the product portfolio.