ABC Costing

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1

(a)

Estim timated an annual ov overhead costs  = Predetermined overhead rate Expected annual operating activity $1,000,000  = $10 per direct labor hour 100,000

(b)

90,000 90,000 direct direct labor labor hours hours X $10 = $900, $900,000 000 overhe overhead ad applied applied

(c)

If the the manu manufac facturi turing ng proce process ss is comp complex, lex, then then multip multiple le alloca allocatio tion n bases can result in more accurate product-cost computations. In such situations, managers need to consider a new overhead cost allocation method that uses multiple bases. That method is activitybased costing.

BRIEF EXERCISE 4-2 Under ABC, overhead costs are shifted from the high-volume products to the low-volume products. This shift results in more accurate costing for two reasons: 1. Low-vo Low-volum lume e produc products ts often often requ require ire more more spec special ial handl handling ing,, such such as more machine setups and inspections, than high-volume products. Thus, the low-volume product frequently is responsible for more overhead costs per unit than is a high-volume product. 2. Assign Assigning ing over overhea head d using using ABC will will usuall usually y increas increase e the cost cost per unit for low-volume products. Therefore, a traditional overhead allocation such as direct labor hours is usually a poor cost driver for assigning overhead costs to low-volume l ow-volume products. As a result, for Bowyer, one of the products (Product RX3) may have been low volume and therefore may have more overhead costs assigned to it under an ABC system.

BRIEF EXERCISE 4-3 An appropriate cost driver for each activity is: Activity

Cost Driver

Materials handling Machine setups Factory machine maintenance Factory supervision Quality control

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

BRIEF EXERCISE 4-4 (a) (a) (b) (c) (c) (d) (d) (e) (e) (f) (g) (g)

Numb Number er of part parts s or asse assemb mblie lies s Number of of se setup tups Numb Number er of emp employe loyees es Numb Number er of insp inspec ecti tion ons s Numb Number er of pu purc rcha hase se orde orders rs Machine hours Squa Square re foot footag age e occ occup upie ied d

BRIEF EXERCISE 4-5 Machine setups Machining Inspections

$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 Pool Designing Sizing and cutting Stitching and trimming Wrapping and packing

Estimated Expected Use of Overh erhead ead ÷ Cost Cost Drive Drivers rs per per Activ Activity ity = $ 450,000   4,000,000   1,440,000   336,000

12,000 designer designer hours 160,000 machine machine hours hours 80,000 labor hours 32,000 finished finished units

Activity-Based Overhead Rates $37.50 per designer hour $25.00 per machine hour $18.00 per labor hour $10.50 per finished unit

BRIEF EXERCISE 4-3 An appropriate cost driver for each activity is: Activity

Cost Driver

Materials handling Machine setups Factory machine maintenance Factory supervision Quality control

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

BRIEF EXERCISE 4-4 (a) (a) (b) (c) (c) (d) (d) (e) (e) (f) (g) (g)

Numb Number er of part parts s or asse assemb mblie lies s Number of of se setup tups Numb Number er of emp employe loyees es Numb Number er of insp inspec ecti tion ons s Numb Number er of pu purc rcha hase se orde orders rs Machine hours Squa Square re foot footag age e occ occup upie ied d

BRIEF EXERCISE 4-5 Machine setups Machining Inspections

$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 Pool Designing Sizing and cutting Stitching and trimming Wrapping and packing

Estimated Expected Use of Overh erhead ead ÷ Cost Cost Drive Drivers rs per per Activ Activity ity = $ 450,000   4,000,000   1,440,000   336,000

12,000 designer designer hours 160,000 machine machine hours hours 80,000 labor hours 32,000 finished finished units

Activity-Based Overhead Rates $37.50 per designer hour $25.00 per machine hour $18.00 per labor hour $10.50 per finished unit

BRIEF EXERCISE 4-7 Activity Cost Pool Ordering and receiving Etching Soldering

Estimated Expected Use of Overhead ÷ Cost Cost Driver Drivers s per per Activ Activity ity = $ 90,000   480,000   1,760,000

Cost Drivers 11,000 orders 50,000 machine hours 500,000 labor hours

X

  15,000 15,000 orders orders 60,000 machine machine hours 440,000 labor hours

Activity-Based Overhead Rates $6.00 per order $8.00 per machine hour $4.00 per labor hour

Overhead Total Overhead Rates = Applied $6 $ 66,000 $8   400,000 $4   2,000,000 $2,466,000

BRIEF EXERCISE 4-8 (a) (b) (c) (d) (e) (f) (g) (h)

Non-value-added Non-value-added Value-added Non-value-added Non-value-added Non-value-added Non-value-added Value-added

BRIEF EXERCISE 4-9 Value-added Activities

Hours

(1) Designing and drafting (3) On-site supervision (5) Consultation with client

3.0 2.0 1.5 6.5

Non-value-added Activities

Hours

(2) Staff meetings (4) Lunch (6) Entertaining a prospective client

1 1 2 4

BRIEF EXERCISE 4-10 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Batch- or unit-level Unit-level Unit-level Batch- or unit-level Facility-level Batch- or product-level Batch- or product-level Unit-level Facility-level Batch-level

BRIEF EXERCISE 4-11 (a) (b) (c) (d) (e) (f) (g) (h)

Facility-level Unit-level Product-level Unit-level Batch-level Batch-level Product-level Facility-level

BRIEF EXERCISE 4-12 (a) Product design

(b)

$50,000  = $5,000 per product change 10

Machining

$300,000  = $2 per machine hour 150,000

Material handling

$100,000  = $1,000 per set up 100

Product design—product-level Machining—unit-level Material handling—batch-level

SOLUTIONS TO DO IT! REVIEW EXERCISES

DO IT! 4-1 1. 2. 3. 4. 5.

True False False True True

DO IT! 4-2 (a) Computations of activity-based overhead rates per cost driver: Activity Cost   Pools Machine setup Machining Packing

Estimated Overhead $ 20,000 110,000 30,000 $160,000

Expected Use of Cost Activity-Based Drivers per Activity Overhead Rates 40 setups $500 per setup 5,000 machine hours 22 per machine hr. 500 orders 60 per order

(b) Assignment of each activity’s overhead cost to products using ABC: BC113

AD908

Expected

 

Activity Cost Pools

Machine setup Machining Packing Total assigned costs

Use of Cost Drivers per Activity-Based Cost   Product Overhead Rates  Assigned

Expected Use of Activity-Based Cost Drivers per Overhead Cost   Product   Rates  Assigned

25 1000

$500 $ 22

$12,500 22,000

15 4000

$500 $ 22

$

150

$ 60

9,000 $43,500

350

$ 60

21,000 $116,500

(c) Computation of overhead cost per unit: Total costs assigned Total units produced Overhead cost per unit

(a) (b) (a) ÷ (b)

BC113 $43,500 3,000 $14.50

AD908 $116,500 1,400 $83.21

7,500 88,000

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 a per unit basis, the overhead assigned to AD908 is close to six times that assigned to each BC113. DO IT! 4-3 1. 2. 3. 4. 5. 6.

NVA VA NVA NVA VA VA

DO IT! 4-4 (a) (b) (c) (d) (e) (f) (g) (h)

unit-level product-level facility-level batch-level unit-level batch-level facility-level unit-level

SOLUTIONS TO EXERCISES EXERCISE 4-1 (a)

Estimated overhead  = Predetermined overhead rate Direct labor costs $300,000  = 200% of direct labor cost $50,000 + $100,000

(b) Activity cost pools Machining Machine setup

Cost drivers Machine hours Set up hours

Estimated overhead $200,000 100,000

Activity-based overhead rates Machining: Machine setup: $200,000 $100,000  = $100 per machine hour  = $200 per setup hour 1,000 + 1,000 400 + 100 (c)

Traditional costing $50,000 X 200% $100,000 X 200%

Standard $100,000 $100,000

Activity-based costing Machining: 1,000 X $100 1,000 X $100 Machine setup: 100 X $200 400 X $200

Custom $200,000 $200,000

$100,000 $100,000

20,000 $120,000

80,000 $180,000

EXERCISE 4-2 (a)

Traditional costing system Sales Costs Operating income

(b)

Product 540X

Product 137Y

$200,000 55,000 $145,000

$160,000 50,000 $110,000

Product 249S $80,000 15,000 $65,000

Activity-based costing system Sales Costs Operating income

(c) Product 540X:

Product 540X

Product 137Y

$200,000 50,000 $150,000

$160,000 35,000 $125,000

Product 249S $80,000 35,000 $45,000

($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 are essentially the same; that is, they are based on a unit volume concept.

EXERCISE 4-3 (a)

Activity cost pools

Cost drivers

Cutting

Machine hours

Design

Number of setups

Activity-based overhead rates Cutting $300,000  = $1.50 per machine hour 200,000

Estimated overhead $300,000 600,000

Design $600,000 = $400 per setup 1,500 Wool

Activity-based costing Cutting 100,000 X $1.50 100,000 X $1.50 Design 1,000 X $400 500 X $400 Total cost allocated (b)

Cotton

$150,000 $150,000 400,000 200,000 $350,000

$550,000

Estimated overhead = $900,000  = $2 per direct labor hour Direct labors hours   450,000 Wool Traditional costing 225,000 X $2 225,000 X $2

Cotton

$450,000 $450,000

The wool product line is allocated $100,000 ($550,000 – $450,000) more overhead 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) = 40,000 Direct labor hours for truck wheels (10,000 X 3) = 30,000 Total direct labor hours 70,000 $700,000 (total estimated overhead) 70,000 (total direct labor hours)

 = $10 per direct labor hour.

 Overhead assigned Car wheels Truck wheels Total overhead (b) Activity Cost Pool

Estimated Overhead

Setting up machines Assembling Inspection

$180,000 280,000 240,000

(c) Activity Cost Pools Setting up machines Assembling Inspection Total cost assigned

= $400,000 = 300,000 $700,000

(40,000 X $10) (30,000 X $10)

Expected ABC Use of Overhead ÷ Cost Drivers =   Rate 1,000 70,000 1,200

Car Wheels Expected Use Activity-Based of Cost Driver Overhead per Product X Rates = 200 40,000 100

$180 $ 4 $200

$180 $ 4 $200

Cost Assigned $ 36,000 $160,000 $ 20,000 $216,000

EXERCISE 4-4 (Continued) (c)  Activity Cost Pools Setting up machines Assembling Inspection Total cost assigned (d)

Truck Wheels Expected use Activity-Based of Cost Driver Overhead per Product X Rates = 800 30,000 1,100

$180 $ 4 $200

Cost Assigned $144,000 $120,000 $220,000 $484,000

Assuming that the cost drivers are a reasonable representation of what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocation of resources and pricing decisions in the future.

EXERCISE 4-5 (a)

Expected use Activity Cost Pools Scheduling and travel Setup time

Estimated Overhead $90,000 $70,000

Supervision

÷ of Cost Drivers = ABC Overhead Rates 1,500 $ 60.00 700 $100.00

$40,000

$400,000*

$

.10

*$100,000 + $300,000 Commercial Activity Cost Pools Scheduling and travel Setup time Supervision

Expected use of Cost Drivers per Product 1,000 450 $100,000

X ABC Overhead Rates = $ 60.00 $100.00 $ .10

Total assigned costs

Cost Assigned $ 60,000 45,000 10,000 $115,000

Residential Activity Cost Pools Scheduling and travel Setup time

Expected use of Cost   Drivers per Product 500 250

Supervision Total assigned costs

$300,000

(b)

(c)

$

.10

Commercial $300,000

Revenues Direct material costs Direct labor costs Overhead costs Operating income (loss)

X ABC Overhead Rates = $ 60.00 $100.00

$ 30,000 100,000 115,000

245,000 $ 55,000

Cost Assigned $30,000 25,000 30,000 $85,000 Residential $480,000

$ 50,000 300,000 85,000

435,000 $ 45,000

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

EXERCISE 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:

Mobile safe Walk-in safe

Traditional Costing

Activity-Based Costing

$ 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 from your analysis of its operations and a discussion with the owner-manager, James Kieper. 1. 2. 3. 4.   5. 6.   7.   8.   9. 10.

Hiring and training personnel Purchasing supplies and materials Selling, promoting, and marketing Billing and collecting Designing Offset printing Copying Faxing Collating Cutting and folding

11. 12. 13.

Maintenance and repairs Delivery Accounting

EXERCISE 4-8 Budgeted Costs

Activity Cost Pool

Cost Driver

Engineering design Engineering prototypes

Engineering

Engineering hours

Depreciation, machinery Electricity, machinery

Machinery

Machine hours

Machine setup

Number of setups

Inspections Tests

Quality control

Number of tests or   inspections

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

Factory utilities

Square feet or Machine hours

Custodial wages

Maintenance

Machine setup, indirect labor Machine setup, indirect   materials

Number of machines or Machine hours

EXERCISE 4-9 The following cost drivers might be used to assign overhead: 1. 2. 3. 4. 5. 6. 7. 8.

Labor hours Labor hours Labor hours Gallons of chemicals Number of cartfuls or labor hours Number of cartfuls Gallons of juice Gallons of juice

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

Gallons of wine or months of aging Number of bottles Number of bottles Number of boxes Number of shipments Number of gallons processed Number of gallons processed

EXERCISE 4-10 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Number of engineering change orders; hours of designing Number of orders processed Number of parts in stock  Weight of material; number of boxes or cartons Employee turnover; number of employees hired Machine hours; direct labor hours Number of employees; number of parts; direct labor hours Number of employees Book or market value of assets Cost of goods manufactured, direct labor hours; number of employees Machine hours; number of machines Gallons of paint; number of appliances

EXERCISE 4-11 (a) The overhead rates are: Activity Cost Pools Materials handling Machine setups Quality inspections

Expected Use Estimated of Cost Drivers Activity-Based Overhead ÷ per Activity = Overhead Rates $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 Materials handling   ($35) 400 $14,000 600 Machine setups ($55) 200   11,000 300 Quality inspections   ($45) 200   9,000 400 Total costs assigned (a) $34,000

Cost

Cost Assigned

$21,000   16,500

$35,000   27,500

  18,000

  27,000

$55,500

$89,500

Units produced (b)

50

300

Overhead cost per Unit (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 that measure the activities performed on the product. The primary benefit of ABC is more accurate and meaningful product costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced. The improved cost data should also lead to better management decisions. More accurate product costing should contribute to setting selling prices which will help achieve desired profitability levels. In addition, it should be helpful in deciding whether to make or buy a product part or component, and sometimes even whether to eliminate a product.

EXERCISE 4-12 (a) (1) Traditional product costing system: $400,000 X .70 = $280,000 Selling costs assigned in March to the “high intensity” product line. (2) Activity-based costing system:

Activity Cost Pools Sales commissions Advertising—TV/Radio Advertising—Newspaper Catalogs Cost of catalog sales Credit and collection Total assigned cost for March

ActivityBased Cost Drivers Overhead Overhead Cost Used X Rates = Assigned $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 selling costs assigned to the “high intensity” product line. The difference of $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-calorie dessert line are $9,350 ($55,000 X .17).

2.

Activity-based costing system:

Activity Cost Pools Inspections of material received In-process inspections FDA certification Total assigned cost for June

ActivityBased Cost Drivers Overhead Overhead Cost Used X Rate = Assigned   6,000 10,000 420

$.60 $.33 $12.00

$ 3,600   3,300   5,040 $11,940

(b) As compared to ABC, the traditional costing system undercosts the quality-control overhead cost assigned to the low-calorie dessert product line by $2,590 ($11,940 – $9,350) in the month of June. That is a 21.7% understatement. (c) All three activities, as quality-control related activities, are non-valueadded activities.

EXERCISE 4-14 1. 2. 3. 4. 5. 6. 7. 8.

Value-added. It is assumed that any activity which directly enhances or improves the quality or quantity of the vines, grapes, or wine is a value-added activity. Non-value-added 9. Value-added Value-added 10. Value-added Value-added 11. Non-value-added Non-value-added 12. Non-value-added Value-added 13. Non-value-added Value-added 14. Non-value-added Value-added 15. Non-value-added

EXERCISE 4-15 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Value-added Non-value-added Non-value-added Non-value-added Non-value-added Value-added Value-added Non-value-added Non-value-added Non-value-added Non-value-added Value-added

EXERCISE 4-16 Value-Added Activities Writing contracts and letters Taking depositions Contemplating legal strategy Litigating a case in court Non-Value-Added Activities Attending staff meetings Doing research Traveling to/from court Eating lunch Entertaining a prospective client

Hours 1.0 1.0 1.0 2.5 5.5 Hours 0.5 1.0 1.0 1.0 2.0 5.5

Questionable Classifications Writing contracts is value-added; writing letters may be value-added if related to a specific case or it may be non-value-added if it is billing a client or collecting receivables. Research may be value-added if it is unique, related to a specific case, and is billable. Research may be non-value-added if it is something the attorney should already have known and is not billable to the client.

EXERCISE 4-17 Activity Cost Pools

Activity Level

Engineering Machinery Machine setup Quality control

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

Factory utilities Maintenance

EXERCISE 4-18 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Facility-level activity Product-level activity Batch-level activity Product-level activity Product-level activity Batch-level activity Facility-level activity Batch-level or unit-level activity Unit-level activity Unit-level activity

SOLUTIONS TO PROBLEMS PROBLEM 4-1A

(a) Computation of unit costs—traditional costing. Products Manufacturing Costs

Home Model

Commercial Model

$18.50   19.00 *  23.40* $60.90

$26.50   19.00 *  23.40* $68.90

Direct materials Direct labor Overhead Total unit cost *$15.60 X 1.5 = $23.40

(b) Estimated Overhead ÷

Activity Cost Pool Receiving Forming Assembling Testing Painting Packing and shipping

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

Expected Use of Cost Drivers

Activity-Based Overhead Rate

=

335,000 Pounds 35,000 Machine hours 217,000 Parts 25,500 Tests 5,258 Gallons 335,000 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 ActivityExpected Based Use of Overhead Cost Drivers X Rates = Assigned

Activity Cost Pool Receiving Forming Assembling Testing Painting Packing and shipping Total costs assigned (a) Units produced

215,000   27,000 165,000   15,500   3,680 215,000

(b)

Overhead cost per unit [(a) ÷ (b)]

$ .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  

Commercial Model ActivityExpected Based Use of Overhead Cost Drivers X Rates = Assigned 120,000   8,000   52,000   10,000   1,578 120,000

$ .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

54,000

  10,200

$19.10

$46.17

PROBLEM 4-1A (Continued) (d) ABC Manufacturing Costs Direct materials Direct labor Overhead Total cost per unit (e)

(f)

Home Model

Commercial Model

$18.50   19.00   19.10 $56.60

$26.50   19.00   46.17 $91.67

Activity

Value- vs. Non-Value-Added

Receiving Forming Assembling Testing Painting Packing and shipping

Non-value-added Value-added Value-added Non-value-added Value-added Value-added

(1) Activity-based costing shows the commercial model absorbs nearly 21 / 2  ($46.17 ÷ $19.10) times as much overhead per unit as the home model. (2) The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal at $23.40 but rather $19.10 for the home model and $46.17 for the commercial model. Under traditional costing, the margin of error on the commercial model was almost 100%, an understatement of $22.77 on an assignment of $23.40. These distorted overhead assignments have likely led to overpricing the home model and underpricing the commercial model.

PROBLEM 4-2A

(a) The allocation of total manufacturing overhead using activity-based costing is as follows: Royale Overhead Rate Purchase orders @ $30 Machine setups @ $50 Machine hours @ $40 Inspections @ $25 Total assigned costs (a)

Majestic

Drivers Used

Cost Assigned

Drivers Used

Cost Assigned

Total Overhead

15,000   5,000 75,000   9,000

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

25,000 13,000 45,000 19,000

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

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

Units produced (b)

 

25,000

 

10,000

Cost per unit (a) ÷ (b)

 

$157

 

$367.50

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

Majestic

Direct materials Direct labor Manufacturing overhead Total cost per unit

$ 700 120 157 $ 977

$     $

Sales price per unit Cost per unit Gross profit

$1,600 977 $ 623

$1,300.00   887.50 $ 412.50

420.00 100.00 367.50 887.50

(c) Management’s future plans for the two television models are not sound. Under ABC costing, the Royale model is $210.50 ($623.00 – $412.50) per unit more profitable than the Majestic model. If any product should be phased out, it is the Majestic. But, by applying ABC and activity-based management analysis, Overton may determine how to 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........................................................................... Direct labor................................................................................... Overhead (14,500 X $8.30)....................................................... Total cost of 280 stairs....................................................

$103,600 112,000 120,350 $335,950

Cost per stairway ($335,950 ÷ 280).......................................

$1,199.82

(c) Manufacturing cost per stairway under activity-based costing: Computation of Activity-Based Overhead Rates Activity Cost Pools Purchasing Handling materials Production Setting up machines Inspecting Inventory control Utilities

Estimated Expected Use of Cost Overhead ÷ Drivers per Activity = $ 57,000   82,000   210,000   85,000   90,000   126,000   180,000 $830,000

600 Orders 8,000 Moves 100,000 D/L Hours 1,250 Setups 6,000 Inspections 168,000 Components 90,000 Sq. ft.

Activity-Based Overhead Rate $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 Pools

Expected Use of Cost Drivers

Purchasing 60 Orders Handling materials 800 Moves Production 5,000 D/L Hours Setting up machines 100 Setups Inspecting 450 Inspections Inventory control 16,000 Components Utilities 8,000 Sq. ft. Total overhead assigned

Activity-Based X Overhead Rates = Cost Assigned $95 $10.25 $2.10 $68 $15 $.75 $2.00

$ 5,700   8,200   10,500   6,800   6,750   12,000   16,000 $65,950

PROBLEM 4-3A (Continued) Total manufacturing cost per stairway under ABC: Direct materials .................................................................................. Direct labor .......................................................................................... Overhead .............................................................................................. Total cost of 280 stairs ...........................................................

$ 103,600 112,000 65,950 $ 281,550

Total cost per stairway ($281,550 ÷ 280)....................................

$1,005.54

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

PROBLEM 4-4A

(a) Computation of unit costs—traditional costing Overhead cost per direct labor hour is $1,241,660 ÷ (150,000 + 27,000) = $7.015 Products Manufacturing Costs

CoolDay

Direct materials Direct labor Overhead

LiteMist

$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)

Estimated Expected Use Overhead ÷ of Cost Drivers =

Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect   equipment

(c)

Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect   equipment Total costs assigned (a) Liters produced

(b)

Overhead cost per liter [(a) ÷ (b)]

$      

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

  6,600 6,600,000   900,000   900,000

  240,800 $1,241,660

800

Activity-Based Overhead Rates $22.10 per cart $0.06 per month $0.30 per bottle $0.21 per bottle $301 per inspection

CoolDay Expected ActivityUse of Based Cost Overhead Cost Drivers X Rates = Assigned

LiteMist Expected ActivityUse of Based Cost Overhead Cost Drivers X Rates = Assigned

  6,000 3,000,000   600,000   600,000 350

$22.10   $0.06   $0.30   $0.21

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

600 3,600,000   300,000   300,000

$301

  105,350  $723,950

450

$22.10 $0.06 $0.30 $0.21

$ 13,260   216,000   90,000   63,000

$301

  135,450 $517,710

3,000,000

  300,000

 

  $1.726

$0.241

PROBLEM 4-4A (Continued) (d)

Products Manufacturing Costs Direct materials Direct labor Overhead

(e) To:

CoolDay

LiteMist

$0.400   0.250   0.241 $0.891

$1.200   0.500   1.726 $3.426

Mr. Greg Kagen

From:

Student

Subject:

Product costs using traditional approach versus ABC

The memorandum covers the following points: a.

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

b.

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

c.

In the case of the Polzin Corporation, the LiteMist product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When overhead costs were allocated using labor rates, too much overhead was allocated to the high volume CoolDay product. This reduced the apparent profitability of this product.

d.

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

PROBLEM 4-4A (Continued) CoolDay

LiteMist

Traditional approach

$1.001

$2.331

ABC

$0.891

$3.426

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

PROBLEM 4-5A

(a) Computation of assigned overhead under traditional costing (“direct labor dollars” appears in the first line of the schedule of overhead data): Predetermined overhead rate X direct labor dollars Overhead assigned to audit: Overhead assigned to tax:

.40 X $1,000,000 = $400,000 .40 X $800,000 = $320,000

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

Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel

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

Expected Use of Cost Drivers per Activity

Activity-Based Overhead Rates

=

$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 employee Direct

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

Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel Overhead costs assigned

Audit Expected ActivityUse of Based Cost Overhead Cost Driver X Rate = Assigned

Tax Expected ActivityUse of Based Cost Overhead Cost Driver X Rate = Assigned

$1,000,000 600   25,000 22   56,000

$800,000   1,900   35,000 18   25,300

$.12 $30.48 $3.40 $3,562.50 Direct

$120,000   18,288   85,000   78,375   56,000 $357,663

$.12 $30.48 $3.40 $3,562.50 Direct

$ 96,000   57,912   119,000   64,125   25,300 $362,337