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Chapter 4: Accumulating and Assigning Costs to Products

Chapter 4 Accumulating and Assigning Costs to Products

QUESTIONS 4-1

The two cost management systems that have been traditionally used to cost products and services are job order costing and process costing. Many companies still use these two systems. However, since the mid-1980s, many companies have been adopting activity-based costing for products, customers, and services.

4-2

Manufacturing organizations face greater challenges in product costing, especially the assignment of overhead costs, than retail or service organizations do. The basic idea behind all manufacturing costing systems is to determine the costs that products accumulate as they consume organization resources during manufacturing, as described above in 4-1. In retail organizations, goods are purchased rather than manufactured; the cost of the goods purchased is entered into an account that accumulates the cost of merchandise inventory in the store. Stores incur various overhead costs such as labor, depreciation on the store, lighting, and heating. The primary focus in retail operations is the profitability of product lines or departments. Therefore, retail organizations, like manufacturing operations, face the issue of how to allocate various overhead costs to determine, for example, the cost of purchasing and selling products, or department costs. Service organizations that undertake major projects, such as in a consultancy, focus on determining the cost of a project. In such situations, the major direct cost, employee pay, is often a large proportion of the project’s cost. The organization will also assign various overhead costs to determine project profitability

4.3 4-4

A cost object is anything for which a cost is computed. Four examples of cost objects are activities, products, product lines, and departments. The defining characteristic of a consumable (flexible) resource is that its cost depends on the amount of resource that is used. Examples of consumable resources are wood in a furniture factory, fabric in a clothing factory, and iron – 65 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

ore in a steel mill. The cost of a consumable resource is often called a variable cost because the total cost depends on how much of the resource is consumed. The contrasting defining characteristic of a capacity-related resource is that its cost depends on the amount of resource capacity that is acquired and not on how much of the capacity is used. As the size of a proposed factory or warehouse increases, the associated capacity-related cost will increase. Examples of capacity-related costs are depreciation on production equipment (the capacity-related resource) and salaries paid to employees (the capacity-related resource) in a consultancy. The cost of a capacity-related resource is often called a fixed cost because the cost of the resource is independent of how much of the resource is used. 4-5

Direct and indirect costs are specified in relation to distinct cost objects. A direct cost is a cost that is uniquely and unequivocally attributable to a single cost object. If the cost fails the test of being direct it is classified as indirect with respect to the designated cost object. For example, if the cost object is a unit of product, then direct material (e.g., wood, steel) and direct labor are direct costs, and manufacturing overhead costs (e.g., factory rent, supervisors’ salaries) are indirect costs. However, if a department within a plant is the chosen cost object, then the department manager’s salary is a direct cost for the department (assuming the manager only manages that department) and the cost of heat for the plant is an indirect cost.

4-6

The attributes of direct cost are:  The resource involved is a consumable resource;  The total cost of resource is proportional to the amount of the resource consumed;  It is consumed by the production process.

4-7

Once the cost driver is chosen, the expected indirect factory costs are divided by the number of cost driver units to compute a rate called the predetermined indirect cost rate, or predetermined overhead rate, or cost driver rate. When a single predetermined cost driver rate is used for the entire factory it is called a single cost driver rate.

4-8

In practice, predetermined indirect cost rates are commonly called predetermined overhead rates or cost driver rates.

4-9

Costs need to be estimated for individual jobs in order to bid for them and to price them competitively. Costs may differ across individual jobs because jobs may differ in their materials content, the hours of labor required to manufacture them, and in the demand they place on capacity-related – 66 –

Chapter 4: Accumulating and Assigning Costs to Products

resources. Estimated costs are also useful for comparison with actual costs for management control purposes. 4-10 Indirect cost rates (also called predetermined indirect cost rates, predetermined overhead rates, or cost driver rates) are determined by dividing expected indirect factory costs by the number of cost driver units. 4-11 Overhead cost for a job is estimated by multiplying the cost driver rate(s) by the number of units of the cost driver(s) associated with the job. 4-12 Indirect cost pools collect overhead costs into separate groups, for each of which a separate cost driver rate is associated. 4-13 Most organizations use multiple indirect cost pools in order to improve costing. Cost distortions arise when an indirect cost pool includes costs with different cost drivers and where different products use the capacities underlying the indirect costs differentially. (The increase in measurement costs for a more detailed cost system, however, must be traded off against the benefit of increased accuracy in estimating product costs.) 4-14 Determination of cost driver rates based on planned or actual short-term usage will result in rates that are too high in periods of low demand and that are too low in periods of high demand. Thus, product costs are distorted in such a costing system. If management uses cost-plus pricing, a death spiral can result, as follows. If expected demand goes down, the cost driver rate will increase, causing the cost-plus price to increase. Increasing prices cause demand to fall, which leads to further price increases as the cost driver rate increases the cost-plus price. 4-15 Unlike direct material costs and direct labor costs, overhead costs cannot be traced easily to each job. When actual costs are recorded for a job during the course of a fiscal period, the total overhead costs for the period and consequently, the actual cost driver rate is not yet determined. Therefore, costs are applied to jobs using predetermined rates. 4-16 Yes. A separate cost driver rate should be determined for each cost pool when multiple cost drivers (where “cost driver” refers to a cause of costs, as discussed in Chapter 3) are involved, or else job cost estimates may be distorted. The increase in measurement costs for a more detailed cost system, however, must be traded off against the benefit of increased accuracy in estimating product costs. Though not covered in the textbook, students may note that if the different cost drivers vary together in the same proportion (for example, if machine hours and direct labors hours are used in the same – 67 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

proportions as the total number of units increases), then any one of them will be sufficient. 4-17 The three options for dealing with the difference between actual and applied capacity (overhead) costs are: (1) Charge the difference to cost of goods sold; (2) Prorate the difference to work in process, finished goods, and cost of goods sold; (3) Decompose the difference into two parts: the difference between actual and budgeted indirect costs, and the difference between budgeted and applied indirect costs. 4-18 Computing the cost driver rate by using the planned level of the cost driver will result in rates that are too high in periods of low demand and that are too low in periods of high demand. If management uses cost-plus pricing, a death spiral can result, as follows. If expected demand goes down, the cost driver rate will increase, causing the cost-plus price to increase. Increasing prices cause demand to fall, which leads to further price increases as the cost driver rate increases the cost-plus price. This cycle can continue until there is no further demand, hence the term “death spiral.” 4-19 Estimating practical capacity begins with an estimate of theoretical capacity. Suppose a machine is nominally available for 100 hours each week. That is, theoretical capacity is 100 hours each week. A common rule of thumb is to allow about 20% of theoretical capacity or, in this case, 20 hours for activities such as maintenance, setup, and repair. In the case of labor hired for the year, theoretical capacity is 2,080 hours (52 weeks, 40 hours per week). However, workers on average have 3 weeks off and, with breaks, work about 35 hours per week. Therefore, practical capacity is 1,715 hours (49 weeks, 35 hours per week). In this case practical capacity is about 82% (1,715/2,080) of theoretical capacity. Alternatively, for both machines and labor, detailed records of nonproductive time may provide a more accurate level of practical capacity. 4-20 Job order costing is an approach to costing that estimates costs for specific customer orders because the orders vary from customer to customer. The purpose of the job order costing system is to accumulate the cost of the job because costs will vary across jobs. Each job will have a cost that is computed by summing the direct and indirect costs of each department or activity that was used to complete the job. Two situations in which job order costing might be used are  providing a meal from a restaurant menu;  treating a patient in a hospital.

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Chapter 4: Accumulating and Assigning Costs to Products

4-21 Continuous processing plants are characterized by the fact that production flows continuously, semi-continuously, or in large batches from one process stage to the next. At each successive process stage, further progress is made toward converting the raw materials into finished products. Therefore, the product costing system must accumulate conversion costs assigned to individual products for successive process stages. Product costs must also reflect the input materials in each process stage. The total cost of all products is determined by adding up all material and conversion costs used to produce the products and then dividing by the number of products produced to get a cost per unit. More specifically, the steps are: 1. Identify the physical flow of units 2. Compute the equivalent units for materials and conversion costs 3. Identify the costs of materials and conversion costs 4. Compute the cost per equivalent unit. 4-22 Multistage process costing systems have the same objective as job order costing systems. Both types of systems assign material, labor, and manufacturing overhead costs to products to determine product costs. The two types of systems differ, however, on some dimensions. In a job order environment, production requirements vary across different jobs, so production occurs job by job and costs are measured for individual jobs. In a multistage process environment, production requirements are homogeneous across products or jobs, so production occurs continuously, semicontinuously, or in large batches, and costs are measured for individual process stages. 4-23 Production departments are those directly responsible for transforming raw materials into finished products or for providing services for customers. Service departments do not directly produce goods or services for customers, but instead provide services to the departments or activities that produce goods or services. In a manufacturing setting, production engineering and machine maintenance are service departments for the production departments. EXERCISES 4-24 (a) Famous Flange’s previous cost driver rate was $4,000,000  100,000 = $40 per machine hour. With the drop in demand, the cost driver rate is now $4,000,000  80,000 = $50 per machine hour. The company will consequently raise its prices because the products will have higher reported costs. If demand decreases further and the company continues to use the same method to – 69 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

determine its cost driver rate, the rate will continue to increase, and the company will want to raise its prices even more. However, the rising prices may contribute to further declines in demand, leading the company into a downward spiral. (b)Famous Flange should use the practical capacity quantity of machine hours to determine the cost driver rate in order to avoid the fluctuations described in part (a) and to understand the cost driver rates at the point where the cost of the resources provided (the numerator) is matched with the practical capacity usage provided (the denominator). If resource usage is less than practical capacity, the company should monitor the cost of unused capacity. Famous Flange may be able to reduce the capacity costs or to find other profitable uses for the capacity. 4-25 Theoretical Capacity:  Theoretical capacity of each machine per week: 6 hours per shift X 3 shifts per day X 6 days per week = 108 hours  Theoretical capacity of the company per week: 108 hours X 120 machines = 12,960 hours Practical Capacity:  Practical capacity of each machine per week: [6 – 1.5] hours per shift X 3 shifts per day X 6 days per week = 81 hours  Practical capacity of the company per week: 81 hours X 120 machines = 9,720 hours i.e. 75% of theoretical capacity 4-26 Theoretical capacity: 52 weeks X 38 hours per week = 1,976 hours Practical capacity: (52 – 6) weeks X 38 hours per week = 1,824 hours i.e. about 92.3% of theoretical capacity.

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Chapter 4: Accumulating and Assigning Costs to Products

4-27 (a)

Direct material Part A327 Part B149 Total direct material cost Direct labor Assembly Inspection Total direct labor cost

Quantity 1,000 units 1,000 units

Price $60 120

Amount $60,000 120,000 $180,000

Hours 6,000 1,000 7,000

Rate $10 12

Amount $60,000 12,000 $72,000

Overhead costs 7,000 Direct labor hours  $5 per hour

Amount $35,000

Total cost (b)

$287,000

Number of units produced

1,000

Selling price per monitor

$350

Cost per monitor

287

Gross margin per monitor 4.28 Direct Materials: Engine Oil (15 X $4) Lubricant (3 X $5)

$ 63

60 15

75 Direct Labor (6 labor hours X $20) Overheads (6 labor hours X $ 25) 4-29 (a)

(b)

4-30 (a)

120 150 345

Support cost driver rate: = $ 7,500,000 $ (25,000 X 12) = 2.5 X Direct labor cost Consulting engagement cost: Labor cost $100,000 Support cost 2.5  labor cost $250,000 Total cost $350,000 Cost driver rate for the machine department: $350,000/14,000 machine hrs = $25/machine hr – 71 –

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Cost driver rate for the finishing department: $280,000/$350,000 = 80% of DL cost (b) Machining Department $8,000 250 1,250a $9,500

Direct materials cost Direct labor cost Manufacturing overhead Total costs of Job 101 a b

Finishing Department $1,400 800 640b $2,840

Total $9,400 1,050 1,890 $12,340

$1,250 = $25 × 50 $640 = 80% of 800

4-31 (a) Plantwide cost driver rate: $ 100,000 . 8,000 direct labor hours = $ 12.5 per direct labor hour (b) Departmental cost driver rates: Cutting Department: $ 40,000 . 4,000 machine hours = $ 10 per machine hour Assembly Department: $ 60,000 . 6,000 direct labor hours = $ 10 per direct labor hour (c) The company may favor the method in (b) if support activity costs in the cutting department have a cause-and-effect relationship with machine hours, while those in the assembly department have a cause-and-effect relationship with direct labor hours. The company may use the method in (a) because it is simpler than the method in (b), which is potentially more accurate. – 72 –

Chapter 4: Accumulating and Assigning Costs to Products

4-32 (a)

(b)

Month January February March April May June July August September October November December Total Hours

Actual Machine Hours 1,350 1,400 1,500 1,450 1,450 1,400 1,400 1,400 1,500 1,600 1,600 1,600 17,650

Monthly Overhead Costs $51.85 $50.00 $46.67 $48.28 $48.28 $50.00 $50.00 $50.00 $46.67 $43.75 $43.75 $43.75

The cost driver rate should be determined as the ratio of the estimated cost accumulated in the cost pool to the practical capacity of the cost driver (the basis for assigning overhead). For Morrison’s machinerelated overhead costs, the computation is: $70,000  12 months  $46.67 per machine hour 1,500 machine hours  12 months If the cost driver rate is based instead on actual or budgeted activity quantities that fluctuate over time, then overhead costs assigned to products will be understated in periods of high demand and overstated in periods of low demand, as shown in part (a). If Morrison’s overhead costs are caused by multiple variables (cost drivers, as defined in Chapter 3), the company may develop a more accurate cost system by using multiple cost driver rates.

4-33 Ingredient A: $0.40 × 10,000 Ingredient B: $0.60 × 20,000 Conversion costs: $0.55 × 30,000 Total costs Number of gallons of blended vegetable juice Cost per gallon of blended vegetable juice 4-34 Direct materials Direct labor Overhead costs

$232,000 120,000 60,000 – 73 –

$4,000 12,000

$16,000 $16,500 $32,500 27,000 $1.204

Atkinson, Solutions Manual t/a Management Accounting, 6E

Disposal costs of waste product Total costs Number of pounds of Goody Cost per pound of Goody

20,000 $432,000 200,000 $2.16

4-35 Materials Conversion Completed and transferred out 6000  100% gallons Ending work-in-process gallons 4000  25%; 4000  10% Equivalent units of production 4-36 (a)

Allocation of machine setup costs: 300  $30,000 Assembly Dept.: $40,000  300  100 Finishing Dept.: $40,000 

(b)

100  $10,000 300  100

Allocation of inspection costs: Assembly Dept.: $15,000  Finishing Dept.: $15,000 

200  $4,285.71 200  500

500  $10,714.29 200  500

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6000 1000 7000

6000 400 6400

Chapter 4: Accumulating and Assigning Costs to Products

Service Departments S1 S2

4-37 Overhead costs

$65,000

Allocation of S1 costs

(65,000)

Allocation of S2 costs

—

Total allocated overhead costs

$0

4-38 (a)

$55,000

Production Departments P1 P2 $160,000 $240,000

15,000

20,000

30,000

(70,000)

33,600

36,400

$0

$213,600 $306,400

P1 S1: $300,000 

P2

30  $150,000 30  30

25 S2: $300,000   $100,000 25  50

$300,000 

30  $150,000 30  30

$300,000 

50  $200,000 25  50

$250,000 (b)

S1 Directly identified costs Allocation of S1 costs

S2

P1

P2

$300,000

$300,000

($300,000)

120,000

$90,000

$90,000

(420,000)

140,000

280,000

$0

$230,000

$370,000

Allocation of S2 costs Totals (c)

$350,000

$0

S1  $300,000  0.25S2 S2  $300,000  0.4S1

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Therefore, S1  $300,000  0.25$300,000  0.4S1  $375,000  01 . S1 0.9S1  $375,000 $375,000 S1   $416,667 0.9 S2  $300,000  0.4  $416,667  $466,667 Allocation of S1 and S2 costs to P1 and P2 P1 S1: $416,667  30% S2: $466,667  25%

$125,000

P2 $416,667  30%

$125,000

$116,667

$466,667  50%

$233,333

$241,667

$358,333

The summary below incorporates the allocation of 0.25 × S2 = $116,667 to S1 and 0.4 × S1= $166,667 to S2. S1 $300,000

S2 $300,000

Allocation of S1 costs (416,667)

166,667

$125,000

$125,000

116,667

(466,667)

116,667

233,333

$0

$0

$241,667

$358,333

Directly identified costs

Allocation of S2 costs Total

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P1

P2

Chapter 4: Accumulating and Assigning Costs to Products

PROBLEMS 4-39 (a)

Plantwide cost driver rate = $15,000,000/100,000 machine hours = $150 per machine hour Applied overhead = $150  90,000 = $13,500,000

(b)

Actual overhead − applied overhead = $14,200,000 − $13,500,000 = $700,000 Overhead is underapplied, so an adjustment will be made to increase the previously recorded cost of goods sold by $700,000.

(c)

Work in process, finished goods, and cost of goods sold will be increased by $700,000 times 20%, 45%, and 35%, respectively. These increases are $140,000, $315,000, and $245,000, respectively.

(d)

Actual overhead − estimated overhead = $14,200,000 − $15,000,000 = −$800,000 Estimated overhead − applied overhead = $15,000,000 − $13,500,000 = $1,500,000

(e)

The approach in part (d) develops information that helps identify the reasons for the difference between actual and applied costs, and is therefore relevant for internal decision making purposes. The difference between actual and estimated overhead cost is –$800,000. The lower actual cost creates a favorable effect on income, relative to the budgeted cost. The difference between estimated and applied overhead cost results from idle capacity. Recall that the machine hour practical capacity was 100,000 while the actual machine hours used totaled 90,000. This means that idle capacity was 10,000 (100,000 – 90,000) machine hours with an associated idle capacity cost of $1,500,000 (10,000 × $150). Management will likely seek explanations for why actual overhead differed from estimated overhead, and why applied overhead differed from estimated overhead. In response to these explanations, management might revise the overhead budget or explore new product opportunities to use the idle capacity. – 77 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

4-40 (a) Cost driver rate: Salaries of mechanics Fringe benefits General and administrative Depreciation Total conversion costs Billable hours Conversion cost per billable hour Mark-up Cost driver rate

$225,000 $ 65,000 $ 16,000 54,000 $360,000  6,000 $60.00  1.30 $78.00 per DL hr

(b) Job 123: Job 123 Materials Conversion cost plus mark-up: 0.8 DL hours  $78 Total price

$52.50 62.40 $114.9 0

4-41 Job 101 $25,500

Beginning Work in Process Department 1 Direct materials Direct labora Manufacturing overheadb Department 2 Direct materials Direct labora Manufacturing overheadb Department 3 Direct materials

Driver 500 DL hrs $40,000 DM

Driver $40,000 6,000 60,000

Driver 200 DL hrs 1200 mh

Job 102 $32,400

400 DL hrs $26,000 DM

Driver $26,000 4,800 39,000

Driver $3,000 3,600 9,600

Driver – 78 –

300 DL hrs $58,000 DM

$58,000 3,600 87,000

Driver

250 DL hrs

$5,000 4,500

350 DL hrs

1500 mh

12,000

2700 mh

Driver $0

Job 103 $0

$14,000 6,300 21,600

Driver $0

$0

Chapter 4: Accumulating and Assigning Costs to Products

Direct labora Manufacturing overheadb

1500 DL hrs

22,500

1800 DL hrs

27,000

2500 DL hrs

37,500

$22,500 DL

45,000

$27,000 DL

54,000

$37,500 DL

75,000

Total Costs a

Direct labor rates: Department 1: $12 per DL hr Department 2: $18 per DL hr Department 3: $15 per DL hr

b

Cost driver rates: Department 1: 150% of DM cost Department 2: $8 per machine hr Department 3: 200% of DL cost

$215,200

(a)

Total cost of completed Job 101  $215,200

(b)

Total cost of completed Job 102  $204,700

(c)

Work-in-process for Job 103 at June 30  $303,000

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$204,700

$303,000

Atkinson, Solutions Manual t/a Management Accounting, 6E

4-42 (a)

Allocating costs in proportion to the number of actual passengers can be justified by the argument that the service center costs should be spread equally over all passengers because each passenger uses approximately the same amount of service center resources. Week 1 2 3 4 5 * **

(b)

1,500 2 ,400

Boston $4,800 4,500* 5,118 5,200** 5,100

Cambridge $2,400 2,700 2,482 2,600 2,100

 7,200  $4,500

1,700 2 ,550

 7,800  $5,200

Another alternative is to allocate $3 = $7,200/2,400 per passenger. Using this approach to allocate service center costs is justified by the argument that the service center costs are caused primarily by the capacity that is made available rather than the actual usage of the committed resources. Week 1 2 3 4 5

Boston $4,800* 4,500 4,950 5,100 5,100

Cambridge Unallocated $2,400 – 2,700 – 2,400 $250 2,550 150 2,100 –

* 1,600 passengers  $3 per passenger

Another alternative is to allocate normal costs 2:1 (1,600:800) based on long run demand and additional help costs in the proportion of additional demand. This method best reflects the factors that cause the costs to be incurred.

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Chapter 4: Accumulating and Assigning Costs to Products

Week 1 2 3 4 5

Boston $4,800 4,800 5,200* 5,200** 4,800

Cambridge $2,400 2,400 2,400 2,600 2,400

* 5,200 = 4,800 + (7,600 – 7,200) ** 5,200 

7,800  (1,700  1,600) (1,700  1,600)  (850  800)

$120,000  $160,000 (8,000  12,000) direct labor hours $280,000  20,000 direct labor hours Plantwide cost driver rate  $14 per direct labor hour 

4-43 (a)

Job Cost Sheet: Job #714 Direct materials Milling Assembly Total direct material cost

$800 50

Direct labor Milling Assembly Total direct labor cost

$100 600

$850

700

Manufacturing Overhead 50 Direct labor hours  $14 per hour Total cost

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700 $2,250

Atkinson, Solutions Manual t/a Management Accounting, 6E

(b)

$120,000 12,000 machine hours  $10 per machine hour

Cost driver rate  Milling 

$160,000 12,000 direct labor hours  $13.33 per direct labor hour

Cost driver rate  Assembly 

Job Cost Sheet: Job #714 Direct materials Milling Assembly Total direct material cost

$800 50

Direct labor Milling Assembly Total direct labor cost

$100 600

$850.00

700.00

Overhead $180.00 Milling: 18 machine hours  $10 per hour Assembly: 40 direct labor hours  $13.33 per hour 533.20 Total overhead cost Total cost

713.20 $2,263.20

(c) Part (a) $2,250.00 562.50 $2,812.50

Manufacturing cost 25% markup Bid price (d)

Part (b) $2,263.20 565.80 $2,829.00

The company may favor the method in (b) if overhead costs in the milling department have a cause-and-effect relationship with machine hours, while those in the assembly department have a cause-and-effect relationship with direct labor hours. In this case, the computed total manufacturing cost in part (a) is of similar magnitude to the cost in part (b), and therefore the bid prices are also of similar magnitude. Given this result, one might be inclined to use the simpler method in part (a) rather than the more accurate but more complex method in part (b). However, comparisons across different products may produce greater differences in computed costs and bid prices. – 82 –

Chapter 4: Accumulating and Assigning Costs to Products

4-44 (a) Support cost

Cutting

Grinding

Drilling

$700,000

$2,400,000

$2,750,000 $5,850,000

100,000

125,000

Direct labor hours 75,000

Total

300,000

Plantwide cost driver rate: $ 5,850,000 . = $ 19.50 per direct labor hour 300,000 direct labor hours Support cost applied to Job ST101: $19.50 × (2,400 + 3,000 + 5,000) = $202,800. (b)

Cost driver rate: Cutting $700,000 = $0.70 per machine hour 1,000,000 Cost driver rate: Grinding $2,400,000 = $24 per labor hour 1,00,000 Cost driver rate: Drilling $2,750,000 = $22 per labor hour 1,25,000 Support cost applied to Job ST101: Dept Cutting Grinding Drilling

Rate $0.70 $24.00 $22.00

Units of Driver Used 24,000 MH 3,000 DLH 5,000 DLH

Support Cost $16,800 $ 72,000 $ 110,000 $198,800

(c) The company may favor departmental support cost driver rates if support activity costs in the cutting department have a cause-and-effect relationship with machine hours, while those in the grinding and drilling departments have a cause-and-effect relationship with direct labor hours. – 83 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

The company may use a plant-wide cost driver rate because it is simpler than using multiple departmental rates, though the departmental rate method is potentially more accurate. 4-45 (a) Cost driver rate for machining: $750,000 . = $30 per machine hour 25,000 machine hours Cost driver rate for finishing: $450,000 = 75% of direct labor cost $600,000

(b) Direct material cost Direct labor cost Manufacturing support Total costs of Job 134

Machining Department $15,000 1,000 3,000a $19,000

Finishing Department $5,000 1,600 1,200b $7,800

Total $20,000 2,600 4,200 $26,800

a $3,000 = $30 X 100 b $1200  $1,600 X 75% (c)

Gonzalez Company probably believes that its manufacturing support costs are driven by different factors. Specifically, support activity costs in the machining department have a cause-and-effect relationship with machine hours, while those in the finishing department have a cause-and-effect relationship with direct labor costs.

4-46 (a)

Total conversion costs Total number of process hours – 84 –

Mixing and Reaction Pulverizing Blending Chambers and Packing $437,500 $1,575,000 $528,000 8,750 35,000 8,800

Chapter 4: Accumulating and Assigning Costs to Products

Conversion cost per process hour

$50

$45

$60

(b) Costs Materials: Raw materials Packing materials

C206 $1,525 $215

8 hrs x $60 Total conversion costs Total cost

$1,525 $300

$1,740

$1,825

500 900

500 900

Conversion costs: Mixing and blending: 10 hrs x $50 Reaction chamber: 20 hrs x $45 Pulverizing and packing: 4 hrs x $60,

C208

240 480 $1,640 $1,880 $3,380 $3,705

4-47 (a) Materials Conversion Completed and transferred out units 8000  100% 4000  40%; 4000  25% Ending WIP units EUs of production

8,000 1,600 9,600

8,000 1,000 9,000

(b) Costs, beginning of October Added during October To be accounted for EUs of production Cost per equivalent unit

Materials Conversion Total $1,050 $3,240 $4,290 8,200 22,620 30,820 $9,250 $25,860 $35,110 9,600 9,000 $0.96 $2.87 $3.83

(c) Costs, beginning of October – 85 –

Materials Conversion $1,050 $3,240

Atkinson, Solutions Manual t/a Management Accounting, 6E

Corresponding equivalent units Cost per equivalent unit

1,400 $0.75

1,200 $2.70

Costs added during October Corresponding equivalent units* Cost per equivalent unit

$8,200 8,200 $1.00

$22,620 7,800 $2.90

*Equivalent units: Completed during October from beginning WIP Equivalent units in ending WIP Started and completed during October: (12,000 – 2,000 – 4,000)  100% Total EU s in October

Materials

Conversion

2000  30% = 600 4000  40% = 1600

2000  40% = 800 4000  25% = 1000

6000 8200

6000 7800

The costs per equivalent increased in October (materials increased from $0.75 to $1 and conversion cost increased from $2.70 to $2.90). The weighted average method produces weighted average equivalent unit costs of $0.96 and $2.87 for materials and conversion cost, respectively.

– 86 –

Chapter 4: Accumulating and Assigning Costs to Products

4-48 (a)

Service Departments Production Departments Personnel Maintenance Machining Assembly Directly identified costs $100,000 $200,000 $400,000 Allocation of Personnel Dept. costs (100,000) — 11,111a Allocation of Maintenance Dept. costs — (200,000) 176,471c $0 $0 $587,582 a

b

(b)

$100,000  $100,000 

5

c

45 40 45

d

$200,000  $200,000 

$300,000 88,889b 23,529d $412,418

7,500 8,500 1,000 8,500

$587,582 Cost driver rate: Machining 10,000 machine hours  $58.7582 per machine hour 

$412,418 Cost driver rate: Assembly 10,000 direct labor hours  $41.2418 per direct labor hour 

Direct materials and labor costs:

$ 450.00

Overhead costs from Machining Department ($58.7582  3 machine hours)

176.27

Overhead costs from Assembly Department ($41.2418  5 direct labor hours)

206.21

Total unit cost

$ 832.48

Markup (30%)

249.74

Bid price

$1,082.22

– 87 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

(c)

Service Departments Production Departments Personnel Maintenance Machining Assembly

a

b

c

Directly identified costs $100,000

$200,000

Allocation of Maintenance Dept. costs

30,000a

(200,000)

150,000b

20,000c

Allocation of Personnel Dept. costs

(130,000)

—

14,444d

115,556e

$0

$0

$564,444 $435,556

$200,000  $200,000  $200,000 

1,500 10,000 7 ,500 10,000

d

e

$130,000  $130,000 

$400,000 $300,000

5 45 40 45

1,000 10,000

$564, 444 10, 000 machine hours Cost driver rate: Machining  $56. 4444  per machine hour 

(d)

$435, 556 10, 000 direct labor hours Cost driver rate: Assembly  $43.5556 per direct labor hour 

Direct materials and labor costs: Overhead costs from Machining Department ($56.4444  3 machine hours)

169.33

Overhead costs from Assembly Department ($43.5556  5 direct labor hours)

217.78

Total unit cost

$837.11

Markup (30%)

251.13

Bid price 4-49 (a)

$450.00

$1,088.24 Service Departments – 88 –

Production Departments

Chapter 4: Accumulating and Assigning Costs to Products

Maintenance Grounds

b

Assembly

Directly identified costs

$18,000

$14,000

$45,000

$25,000

Allocation of Maintenance Dept. costs

(18,000)

—

12,000a

6,000b

Allocation of Grounds Dept. costs

a

Fabricating

$18,000 

$18,000 

12,000

c

18,000 6,000

d

18,000

(b)

—

(14,000)

6,000c

8,000d

$0

$0

$63,000

$39,000

$14,000 

$14,000 

15,000 35,000 20,000 35,000

Service Departments Production Departments Maintenance Grounds Fabricating Assembly Directly identified costs Allocation of Maintenance Dept. costs Allocation of Grounds Dept. costs

a

b

c

$18,000  $18,000  $18,000 

1,500

$18,000

$14,000

(18,000)

1,385a

11,077b

5,538c

—

(15,385)

6,594d

8,791e

$0

$0

$62,671

d

19,500 12 ,000 19 ,500

e

$15,385  $15,385 

6,000 19,500

– 89 –

15,000 35,000 20,000 35,000

$45,000

$25,000

$39,329

Atkinson, Solutions Manual t/a Management Accounting, 6E

(c) Directly identified costs

Service Departments Maintenance Grounds

Production Departments Fabricating Assembly

$18,000.0000 $14,000.0000

$45,000.0000 $25,000.0000

Allocation of Maintenance Dept. costs ($19,221.9959) ($19,221.9959) Allocation of Grounds Dept. costs ($15,478.6151)

1,478.6151a

1,221.9959d (15,478.6151) $0 $0

11,828.9206b

5,914.4603c

6,109.9796e 8,146.6395f $62,938.9002 $39,061.0998

Note: These calculations were done by spreadsheet and rounded. a b c

1,500 19,500 12,000 $19,221.9959  19,500 6,000 $19,221.9959  19,500

$19,221.9959 

d e f

3,000 38,000 15,000 $15,478.6151  38,000 20,000 $15,478.6151  38,000 $15,478.6151 

3,000 G 38,000 1,500 G  $14,000  M 19,500 M  $18,000 

Therefore, M  $18,000 

3,000  1,500  M  $14,000  38,000  19,500 

0.993927126 M = $19,105.26316 M = $19,221.995927 G  $14,000 

1,500  $19,221.995927 19,500

G = $15,478.61507 4-50 (a) Service Dept. Cost Allocation: Direct Method Service Departments Maintenance Power – 90 –

Production Departments Casting Assembly

Chapter 4: Accumulating and Assigning Costs to Products

Directly identified costs

$750,000

$450,000

$150,000

$110,000

Allocation of Maint. Dept. Costsa

(750,000)

—

500,000a 0a0a

250,000

Allocation of Power Dept. Costsb

—

(450,000)

250,000

200,000

$0

$0

$900,000

$560,000

a



80,000 40,000      500,000; 750,000     250,000  80,000  40,000   80,000  40,000 

750,000   b



200,000 160,000      250,000; 450,000     200,0  200,000  160,000   200,000  160,000 

450,000  

$900,000 80,000 machine hours  $11.25 per machine hour

Cost driver rate: Casting 

$560,000 60,000 direct labor hours  $9.33 per direct labor hour

Cost driver rate: Assembly 

– 91 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

Direct labor and material costs

$32.000

Overhead costs: $11.250

Casting (1  $11.25) Assembly (0.5  $9.33)

4.665

Unit cost

$47.915

Number of units per month

(b)

15.915 1,000.000

Total manufacturing costs per month

$47,915.000

Mark up (25%)

$11,978.750

Bid price (per month)

$59,893.750

Service Dept. Cost Allocation: Sequential Method Service Departments Maintenance Power

Production Departments Casting Assembly

Directly identified costs

$750,000

$450,000

$150,000

$110,000

Allocation of Maint. Dept. costs

(750,000) $300,000

300,000

150,000

Allocation of Power Dept. costs

— (750,000)

416,667

333,333

$866,667

$593,333

$0

$0

$866, 667 80, 000 Cost driver rate: Casting  $10.833 per machine hour 

$593, 333 60, 000 Cost driver rate: Assembly  $9.889 per labor hour 

– 92 –

Chapter 4: Accumulating and Assigning Costs to Products

Direct labor and material costs

$32.000

Overhead costs: Casting (1  $10.833)

$10.833

Assembly (0.5  $9.889)

4.944

Unit cost

$47.777

Number of units per month

(c)

15.777 1,000.000

Total manufacturing costs per month

$47,777.000

Mark up (25%)

$11,944.250

Bid price (per month)

$59,721.250

M  $750,000  01 .P P  $450,000  0.4 M Therefore, M = $750,000 + 0.1  (450,000 + 0.4 M) M = $795,000 + 0.04 M

0.96 M = $795,000 $795,000  $828,125 0.96 P  450,000  0.4  $828,125  $781,250 M

Casting Directly identified costs

Assembly $150,000

$110,000

Allocation of Maint. Dept. costs $828,125  40% = $331,250 $828,125  20% = $165,625 Allocation of Power Dept. costs

$781,250 50% = $390,625 $781,250  40% = $312,500 $871,875

– 93 –

$588,125

Atkinson, Solutions Manual t/a Management Accounting, 6E

$871, 875 80, 000 Cost driver rate: Casting  $10.8984 per machine hour 

$588,125 60, 000 Cost driver rate: Assembly  $9.8021 per labor hour 

Direct labor and material costs

$32.0000

Overhead costs: Casting (1  $10.8984)

$10.8984

Assembly (0.5  $9.8021)

4.9011

Unit cost

15.7995 $47.7995

Number of units per month

1,000.0000

Total manufacturing costs per month

$47,799.5000

Mark up (25%)

$11,949.8750

Bid price (per month)

$59,749.3750

CASES 4-51 (a)

The plantwide cost driver rate is $122,000/(2,400 + 1,440 + 720 +320) = $25.00 per direct labor hour Unit gross margins: Selling Price

A $ 15.00

B $18.00

C $20.00

D $ 22.00

Materials Cost Labor Cost Overheada Total Cost

4.00 7.20 6.00 $ 17.20

5.00 5.40 4.50 $14.90

6.00 3.60 3.00 $12.60

7.00 2.40 2.00 $ 11.40

Gross Margin $ (2.20) a $25 per direct labor hour

$ 3.10

$ 7.40

$ 10.60

– 94 –

Chapter 4: Accumulating and Assigning Costs to Products

Total gross margins: Selling Price Materials Cost Labor Cost Overhead Total Cost Gross Margin (b)

A

B

C

D

Total

$ 150,000

$ 144,000

$120,000

$88,000

$502,000

40,000 72,000 60,000 172,000

40,000 43,200 36,000 119,200

36,000 21,600 18,000 75,600

28,000 9,600 8,000 45,600

144,000 146,400 122,000 412,400

$ (22,000)

$ 24,800

$ 44,400

$42,400

$ 89,600

After dropping product A, the plantwide cost driver rate is $122,000/ (1,440 + 720 +320) = $49.1935 per direct labor hour Unit gross margins: Selling Price

B $18.00

C $20.00

D $ 22.00

Materials Cost Labor Cost Overheada Total Cost

5.00 5.40 $ 8.85 $19.25

6.00 3.60 $ 5.90 $15.50

7.00 2.40 $ 3.94 $ 13.34

Gross Margin $ (1.25) $ 4.50 a $49.1935 per direct labor hour

$ 8.66

Total gross margins: Selling Price Materials Cost Labor Cost Overhead Total Cost Gross Margin

B

C

D

Total

$ 144,000

$120,000

$88,000

$352,000

40,000 43,200 70,839 154,039

36,000 21,600 35,419 93,019

28,000 9,600 15,742 53,342

104,000 74,400 122,000 300,400

$ (10,039)

$ 26,981

$34,658

$ 51,600

– 95 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

(c)

After further dropping product B, the plantwide cost driver rate is $122,000/(720 +320) = $117.3077 per direct labor hour Unit gross margins: Selling Price

C $20.00

D $ 22.00

Materials Cost Labor Cost Overheada Total Cost

6.00 3.60 $14.08 $23.68

7.00 2.40 $ 9.38 $ 18.78

Gross Margin $ (3.68) $ 3.22 a $117.3077 per direct labor hour Total gross margins: Selling Price Materials Cost Labor Cost Overhead

C

D

Total

$120,000

$88,000

$208,000

36,000 21,600

28,000 9,600 37,53 8 75,13 8

64,000 31,200

84,462 Total Cost 142,062 Gross Margin

$ (22,062)

122,000 217,200

$ 12,862 $ (9,200)

Now product C appears unprofitable. After further dropping product C, the plantwide cost driver rate is $122,000/320 = $381.25 per direct labor hour

– 96 –

Chapter 4: Accumulating and Assigning Costs to Products

Unit gross margin for product D, the only remaining product: D Selling Price $ 22.00 Materials Cost Labor Cost Overheada Total Cost

7.00 2.40 $ 30.50 $ 39.90

Gross Margin $(17.90) a $381.25 per direct labor hour Total gross margin for D and for the company: D

(d)

Selling Price

$88,000

Materials Cost Labor Cost Overhead Total Cost

28,000 9,600 122,000 159,600

Gross Margin

$(71,600)

Youngsborough has encountered a type of death spiral by using planned levels of direct labor hours in the denominator for the cost driver rates. In Youngsborough’s situation, the capacity-related overhead costs are fixed. Dropping unprofitable product A made the cost driver rate increase, in turn making product B look unprofitable. This cycle continued until Youngsborough had no products that appeared profitable. This situation would likely have been avoided if Youngsborough had used practical capacity direct labor hours in the denominator for the cost driver rate. The cost driver rate would then have remained unchanged when the company dropped product A, so the remaining products would appear as profitable as they were before. Of course, the company would then have underapplied overhead (idle capacity costs), and should explore opportunities to use the idle capacity productively, such as increasing sales of the remaining products or developing new profitable products. Chapter 5 addresses activity-based – 97 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

cost systems, which can more accurately assign overhead costs when there is large variation in overhead resources that products require. 4-52 (a)

Let salaries be denoted as follows: M = manager, S =senior mechanic, and J = junior mechanic. The estimated total conversion (labor and overhead) costs are: Personnel costs (1M + 4S + 4J) + Capacity-related (fixed) costs = $75,000 + (4 × $65,000) + (4 × $45,000) + $96,800 = $611,800. Estimated total number of hours on customer jobs  8  1,750  95%  13,300 hours Therefore, the cost driver rate 

$611,800  $46 per hour 13,300 hours

Furthermore, 51.06   1  

x    46 100 

so x = 11.

– 98 –

Chapter 4: Accumulating and Assigning Costs to Products

(b)

Class A Repairs

Estimated total conversion 611800 ,  60%  $367,080 costs Estimated total hours on customer jobs

13,300 

1  6,650 2

Conversion cost per customer 367,080  $55.20 per hour 6,650 job hour Price per hour (c)

Class B Repairs

611,800  40%  $244,720

13,300 

1  6,650 2

244,720  $36.80 per hour 6,650

$55.2  111 .  $61.27 per hour $36.8  111 .  $40.85 per hour

Job 101: 4.5 A  1.5B Job 102: 2B (Note: A  Class A repair hours, B  Class B repair hours) Under the present accounting system, costs charged to: Job 101: 6  51. 06  $306. 36 Job 102: 2  51. 06  $102.12 Under the proposed accounting system, costs charged to: Job 101: 4.5  61. 27  1.5  40.85  $337. 00 (if all the calculations are performed in Excel; with the rates shown, the total is $336.99). Job 102: 2  40.85  $81. 70 Therefore, under the present accounting system: Job 101 is undercosted and underpriced. Job 102 is overcosted and overpriced.

– 99 –

Atkinson, Solutions Manual t/a Management Accounting, 6E

(d)

Depending on competition for repairs, the proportion of Class B repairs may increase and the proportion of Class A repairs may decrease because of the price change.

(e)

The current costing system is simple to administer and results in pricing at a uniform labor rate (that includes coverage of overhead costs). The proposed costing system more accurately reflects resource usage, but is more complex to administer and to communicate to customers in pricing.

– 100 –