Chapter 5 Solutions

Atkinson, Solutions Manual t/a Management Accounting, 6E
Chapter 5
Activity-Based Cost Systems
QUESTIONS 5-1 Traditional volume-based cost allocation systems that use only drivers that vary directly with the volume of products producedsuch as direct labor dollars, direct labor hours, or machine hoursare likely to systematically distort product costs because they break the link between the cause for the costs and the basis for assignment of the costs to the individual products. Costs may vary not only with respect to volume of production, but also, for example, with batch-related activities (e.g., changeovers, setups, and inspection of the first item of production run and the number of products (e.g., scheduling materials receipts and improving products . !lso, cost distortions tend to be greater with greater differences between relative proportions of indirect resources used by cost ob"ects because traditional cost assignments based on volume-related measures do not accurately reflect these differences. #olume-based traditional product costing systems that use only drivers that vary directly with the volume of products producedsuch as direct labor dollars, direct labor hours, or machine hoursare most likely to distort product costs under the following two conditions$ (% &ndirect and support expenses are high, especially when they exceed the cost of the allocation base itself (such as direct labor cost ' and (( )roduct diversity is high$ the plant produces both high-volume and low-volume products, standard and custom products, and complex and simple products. The combination of these two conditions will magnify the distortions that arise because volume-based product costing systems do not accurately reflect differences in non-volumerelated resource usage across products or other cost ob"ects. !ctivity-based costing systems provide more accurate costs when these two conditions hold by creating more accurate links between the causes of indirect and support costs and the bases for assignment of the costs to cost ob"ects. *or example, costs may vary not only with respect to volume of production, but
5-2
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also activities such as changeovers, setups, and inspection of the first item of production run, which are not done in proportion to the number of units produced. .oreover, some costs vary with the number of different products (e.g., scheduling materials receipts and improving products . 5-3 /es, traditional costing systems are more likely to overcost high-volume products because all indirect and support costs are assigned to products in proportion to the number of production units (through volume-based cost drivers , and the low-volume products are likely to re0uire higher indirect and support costs per unit. The high-volume products essentially cross-subsidi1e the low-volume products in the sense that indirect and support costs are assigned uniformly in proportion to volume. Companies producing a varied and complex mix of products re0uire many more resources to support their highly varied mix, and therefore have higher costs. 2xamples of the greater resources re0uired include a much larger production support staff to schedule machine and production runs' perform changeovers and setups between production runs' inspect items at the beginning of each production run' move materials' ship and expedite orders' develop new and improve existing products' negotiate with vendors' schedule materials receipts' order, receive, and inspect incoming materials and parts' and update and maintain the much larger computer-based information system. ! significant change in resource costs triggers an update of the capacity cost rates. ! significant and permanent change in operations, such as the efficiency with which an activity is performed, triggers an update of the unit time estimate. &f new activities become part of operations, the time to perform the activity will be estimated and then multiplied by the appropriate capacity cost rate to determine the cost of the activity. The two sets of parameters that must be estimated in time-driven activitybased costing are % the capacity cost rate for each type of indirect resource' that is, the unit cost of supplying capacity for each department or process, based on practical capacity, and ( the consumption of capacity, which is an estimate of how much of a resource3s capacity (such as time or space is used by the activities performed to produce the various products, services, or customers. To compute a capacity cost rate, first identify all costs incurred to supply that resource (such as a machine, an indirect production employee, the computer system, factory space, a warehouse, or a truck . Then, identify the capacity supplied by that resource. The capacity would be the hours of work provided
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5-4
5-5
5-6
Chapter 5: Activity-Base Cost Systems
5-7
by the machine or production employee, or the space provided by the warehouse or truck. *or most resources (people, e0uipment, and machines , capacity is measured by the time supplied. The resource3s capacity cost rate is calculated by dividing its cost by the capacity it supplies, usually expressed as a cost per hour or cost per minute. *or warehouses, production space, and trucks, the capacity cost rate would be measured by cost per s0uare foot (or s0uare meter of usable space. *or computer memory, the resource capacity cost rate would be the cost per megabyte or gigabyte. .anagers use the information on activity costs to identify opportunities for operational improvements and reductions in operations costs, decisions about product mix and pricing, and targeted customer segments. !n example of an operational change is re0uiring minimum order si1es to eliminate short, unprofitable production runs. !nother example is changing the facility layout to reduce moves of work in progress. )roduct designs can be changed in order to manufacture products with fewer parts or common parts to reduce material handling support costs. *inally, as discussed in more detail in Chapter 5, if activity-based cost analysis shows that full-pallet shipments are less costly per unit than partial-pallet shipments, customers can be encouraged to receive fullpallet shipments. 6f course, customers who insist on very small order si1es or partial-pallet shipments can be charged a price high enough to cover the extra costs associated with such activities. The capacity cost driver rate should reflect the underlying efficiency of the processfor example, the cost of resources to handle each production order and this efficiency is measured better by using the capacity of the resources supplied (practical capacity as the denominator when calculating capacity cost driver rates. The numerator in a capacity cost driver rate calculation represents the costs of supplying resource capacity to do work. The denominator should match the numerator by representing the 0uantity of work the resources can perform. 7nassigned costs represent the cost of unused capacity and should be used as feedback to managers on their supply and demand decisions. &mmediate financial improvement may not follow even after process improvements reduce the demand for indirect and support resources. This is because the support costs are often committed. The organi1ation must actively manage the unused capacity by increasing the volume of business or reducing the supply of unused resources.
5-8
5-9
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5-10 :ervice organi1ations are often ideally suited for activity-based costing because virtually all of the costs for a service company are indirect and appear to be fixed. The large component of apparently fixed costs in service companies arises because, unlike manufacturing companies, service companies have virtually no material coststhe prime source of short-term variable costs. :ervice companies must supply virtually all of their resources in advance to provide the capacity to perform work for customers during each period. *luctuations during the period of demand by individual products and customers for the activities performed by these resources do not influence short-term spending to supply the resources. 5-11 !s mentioned in ;-%9, virtually all the costs for a service company are indirect and appear to be fixed. :ervice companies have few or no direct materials and many of their personnel provide indirect, not direct, support to products and customers. Conse0uently, service companies do not have direct, traceable costs to serve as convenient allocation bases. 7nlike physical products, services cannot be inventoried for future sales. :ervice companies must supply virtually all their resources in advance to provide the capacity to perform work for customers during each period, and demand often fluctuates. *or some service industries, the increase in spending resulting from an incremental transaction or customer is essentially 1ero. Therefore, service companies making decisions about products and customers based on short-term variable costs might provide a full range of all products and services to customers at prices near 1ero, leading to little recovery of the costs of all the committed resources supplied in order to deliver services to customers. &t can be difficult to identify and measure the outputs for a service organi1ation. The variation in demand for organi1ational resources is much more customer-driven in service organi1ations than in manufacturing organi1ations. ! service company can determine and control the efficiency of its internal activities, but customers determine the 0uantity of demands for these operating activities. *or example, customers may vary greatly in the number of transactions and the balances in their checking accounts. :ervice companies must focus on customer costs and customer profitability' measuring revenues and costs at the customer level provides service companies with far more relevant and useful information than at the product level. *inally, a customer may have multiple relationships with a service company. Therefore, the cost system should provide information that supports determining profitability of the entire relationship with the customer.
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Customer costs and customer profitability are discussed in more detail in Chapter 5. 5-12 &ndividuals may feel vulnerable facing uncertainty about what the activitybased cost analysis may show, or they may feel threatened by the suggestion that their work could be improved. *or example, the analysis might reveal that products or customers thought to be very profitable are actually unprofitable, or that some processes are inefficient. &ndividuals may be concerned that they will then be "udged as poor managers, even though they were making decisions that others would agree were good decisions based on the cost system in place. 5-13 Time-driven activity-based costing has a number of advantages over traditional activity-based costing. The advantages include (% &t is easy and fast to build an accurate model even for large enterprises' (( &t exploits the detailed transactions data that are available from 2<) systems' (, &t drives costs to transactions and orders with time e0uations that use specific characteristics of particular orders, processes, suppliers, and customers' (8 &t provides visibility to capacity utili1ation and the cost of unused capacity' (; &t enables managers to forecast future resource demands, allowing them to budget for resource capacity on the basis of predicted order 0uantities and complexity' and (5 &t is easy to update the model as resource costs and process efficiencies change. EXERCISES 5-14 )otter Corporation should switch to activity-based costing because its current system appears to be distorting product costs, resulting in prices of specialty products that are too low (hence increasing their market share and prices of simple products that are too high (thus, lowering their market share . This, in turn, leads to lower overall profitability as )otter pushes products that, in reality, produce low profit margins or even lose money. 5-15 (a The time-driven !=C model will now incorporate a capacity cost rate for computer resources, computed as >%-,999 divided by the practical capacity computer hours per month. 7sage of computer resources can be measured in computer time per product or production run. (b =efore the machinery energy costs were discovered, the machinery rate was computed as >%;,899 divided by ,9- practical capacity hours, which e0uals >;9 per hour. The energy costs of >8,999 per month will be added to
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the >%;,899 monthly machinery costs, for a new machinery resource cost of >%4,899 per month, leading to a higher rate per hour. The new rate is >%4,899?,9- @ >5(.44, which can be rounded to >5, per hour for convenience. (c &f the company introduces a new flavor, the new flavor3s consumption of direct and indirect resources will need to be estimated and then multiplied by the appropriate cost or cost rate. *or example, start with the 0uantity of direct materials and labor hours per gallon produced, and multiply these amounts by the related cost per unit of direct materials and wage rate, respectively. Aext, estimate the 0uantity of indirect labor (for changeovers, scheduling and product maintenance and machine time (for production runs and setups . These will then be multiplied by the associated capacity cost rates of each indirect resource and added to the direct materials and direct labor costs in order to compute the total cost of producing the new flavor. 5-16 (a ! %9B increase in indirect labor costs will increase the indirect labor capacity cost rate by %9B (from >,; to >,-.;9 and therefore will increase the indirect labor costs assigned to products by %9B. The revised income statement that is similar to 2xhibit ;-; will show indirect labor costs that are %9B higher than in 2xhibit ;-;, with correspondingly lower product gross profits, as shown below. (:mall differences may result if the calculations are performed in a spreadsheet package.
#anilla Chocolate :trawberry >,9,99 9 > (8,999 >,,459 >5,999 >8,-99 >C(9 >-,C;9 >8,45C >5,C99 >,,;-, %%.48B >C,999 >,,;-% >;,999 >,,5%4 %;.9-B >%,9;9 >,,--4 >%,559 >(,,,;4 +-8.-(B .ocha!lmond >(,-99 >;(9 >C99 >8,98, >%,589 >(8,%9, +%85.;8B Total >59,C59 >%(,989 >%C,;99 >%5,8-9 >%;,999 >((59 +9.8,B
:ales Direct materials Direct labor (including fringes &ndirect labor usage .achine usage Eross profit (loss Eross profit (loss as percent of sales
(b Fith the reduction in unit time for scheduling a production from four hours per run to three hours per run, we first compute the revised indirect labor hours per month and then multiply by the new indirect labor capacity cost rate of >,-.;9 per hour.
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The revised indirect labor hours per month are calculated as follows$ #anilla :chedule production runs, purchasing, etc. (hours per run Changeovers (hours per batch Aumber of employees per changeover &ndirect labor hours per changeover &ndirect labor time per run (batch Aumber of production runs &ndirect labor per run )roduct-sustaining (hrs per month &ndirect labor hours per month &ndirect rate per hour &ndirect labor cost , (.9 , 5 4 G %( %94 %%C G >,-.;9 >8,;98.;9 Chocolate , %.9 , , 5 G %( C( 4 -% G >,-.;9 >,,%%-.;9 :trawberry , (.; , C.; %9.; G-8 4 .ocha!lmond , 8.9 , %( %; G5 49 4
4, 44 G >,-.;9 G >,-.;9 >,,;-9.;9 >,,-%%.;9
The new income statement shows lower indirect labor costs than in part (a because of the reduced scheduling time per run. (:mall differences may result if the calculations are performed in a spreadsheet package.
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:ales Direct materials Direct labor (including fringes &ndirect labor usage .achine usage Eross profit (loss Eross profit (loss as percent of sales
#anilla Chocolate :trawberry >,9,99 9 > (8,999 >,,459 >5,999 >8,-99 >C(9 >-,C;9 >8,;9; >5,C99 >8,98; %,.8-B >C,999 >,,%%4 >;,999 >8,9-% %C.99B >%,9;9 >,,;-% >%,559 >(,,9;% +CC.9;B
.ocha!lmond >(,-99 >;(9 >C99 >,,-%( >%,589 >(,,-C( +%,-.(4B
Total >59,C59 >%(,989 >%C,;99 >%;,9%C >%;,999 >%,(9, %.4-B
Combining direct labor and indirect labor costs, the summary income statement showing unused capacity costs is as follows$ Totals with 7nused !ssigned Capacity Costs Costs >59,C59 >%(,989 >,(,;%C >5>%;,999 899 >%,(9, >(85Totals with Capacity Costs >59,C59 >%(,989 >,(,;-; >%;,899 >C,;
:ales Direct materials Direct labor and indirect labora .achine usage Eross profit (loss Eross profit (loss as percent of sales %.4-B %.(%B a Habor capacity cost @ >8,5;; G C employees @ >,(,;-;. 2mployees perform direct labor and indirect labor tasks. 5-17 (a Iours$ )umps %,;99 ;,999 (99 Iours$ #alves %,-99 5,999 899 <ate >(9 >,9 >-9 Cost$ )umps > ,9,999 >%;9,999 > %5,999 >%45,999 Cost$ #alves > ,5,999 >%-9,999 > ,(,999 >(8-,999
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(b
The cost of unused capacity, which will be expensed on the income statement, is calculated as follows$ Iours$ 7nused Capacity <ate ,99 >(9 (99 >,9 ;9 >-9 Cost$ 7nused Capacity > 5,999 > 5,999 > 8,999 >%5,999 >-49,999 >%(9,999 49,999 %45,999 (8-,999
Total revenues Total direct labor cost Total direct materials cost 6I applied to pumps 6I applied to valves Cost of unused practical capacity :EJ! expenses Aet income 5-18 (a
>5;8,999 %5,999 %99,999 >%(9,999
Ken3s previous average fixed cost per meal was >,,,99 599 @ >;.;9. Fith the drop in demand, the average fixed cost is now >,,,99 ;;9 @ >5. &f demand decreases further and Ken continues to use the same method to determine his costs of serving a meal, the average fixed cost will continue to increase, and Ken will want to raise his prices even more. Iowever, the rising prices may contribute to further declines in demand, leading Ken into a downward (or death spiral. Ken should use the practical capacity 0uantity of meals per day to determine cost per meal in order to avoid the fluctuations described in part (a and to understand the cost rate at the point where the resources used e0ual the practical capacity usage. &f resource usage is less than practical capacity, Ken should monitor the cost of unused capacity. Ie may be able to reduce the capacity costs or to find other profitable uses for the capacity. &n this problem, one may assume the practical capacity is 599 meals per day.
(b
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PROB E!S 5-19 (a (b Capacity cost rate @ >;99,999?%9,999 hours @ >;9 per hour. The activity-based cost associated with Division %3s customers is (9.; G %,999 L %.9 G 8,999 G >;9 per hour @ 8,;99 hours G >;9 per hour @ >((;,999. The activity-based cost associated with Division (3s customers is (9.; G (99 L 9.% G 899 G >;9 per hour @ %89 hours G >;9 per hour @ >C,999. The change will result in (9.; G %,999 L %.9 G (,999 L 9.% G (,999 @ (,C99 hours used, a reduction from the 8,;99 hours in part (a . The new activity-based cost associated with Division %3s customers is (,C99 hours G >;9 per hour @ >%,;,999. The lower cost assigned to Division % will not reduce Meta3s costs unless Meta also reduces the >;99,999 total resource cost. This can be accomplished in the following way' with the change in the mix of more electronic and fewer manual transactions, %,-99 fewer hours of accounts receivable time is re0uired. :ince the capacity of each employee is about %,55C hours per year (%9,999 N 5 , Meta can operate with one fewer employee, saving the full cost of one employee, probably at least >59,999 per year. The practical capacity per month for each packaging and shipping employee is (- O %.(; hours per day G (9 days per month @ %,; hours per month. The capacity cost rate @ >8,9;9?%,; hours @ >,9 per hour. 6rder C9;, which consists of 89 items, re0uires packaging preparation time of 9.(; hours plus 89 G 9.% hours to bubble wrap and pack the 89 items in the carton, for a total of 8.(; hours The cost assigned to 6rder C9; is therefore 8.(; G >,9 per hour @>%(C.;9.
(c
(d
5-20 (a
(b
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5-21 (a
Fith the stated change, .adison Dairy will re0uire - full-time production employees and , machines, as shown below. Habor Aumber of production runs Iandle production run (hours?run &ndirect labor$ handle runs :etup time per run (hours Aumber of employees per changeover &ndirect labor hours per run &ndirect labor$ total setup hours &ndirect labor$ maintain products Total indirect labor hours #olume (gallons Direct labor hours per gallon Total direct labor hours Total labor hours )roductive hours per employee per month Aumber of employees needed Aumber of fulltime employees :traw- .ocha#anilla Chocolate berry !lmond %(.; 45.0 (.9 ( 8.9 72.0 8.0 125.0 %;,;99 9.9(; 387.5 512.5 %5 (.; 40.0 %.9 ( (.9 32.0 8.0 80.0 %,,999 9.9(; 325.0 405.0 8 (.; 10.0 (.9 ( 8.9 16.0 8.0 34.0 %,5 99 9.9(; 40.0 74.0 , (.; 7.5 ,.( ( 5.8 19.2 8.0 34.7 %,(99 9.9(; 30.0 782.5 64.7 1,056.2 %,,.9 C.4 8.0
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Total
102.5
139.2 32.0 273.7 ,%,,99
.achines )roduction volume .achine hours per %999 gallons Total machine run time (hours Aumber of production runs :etup time per run (hours .achine setup time (hours Total machine hours )roductive hours per month Aumber of machines needed (rounded up (b
#anilla %;,;99 %% 170.5 %(.9 36.0 206.5
:traw- .ochaChocolate =erry !lmond %,,999 %% 143.0 %5 %.9 16.0 159.0 %,599 %% 17.6 8 (.9 8.0 25.6 %,(99 %% 13.2 , ,.( 9.6 22.8
Total
344.3
69.6 413.9 %;8.9
3.0
)ro forma monthly product line income statement (total dollar amounts are rounded $ #anilla > (.49 %;,;99 >88,4;9 4,,9 9 %,,;5 , 8,,C; %9,,(; >C,,-C %5.8B :trawChocolate berry > (.49 > ,.89 %,,999 %,599 > ,C,C99 > ;,889 C,-99 %%,,C; (,-99 C,4;9 > C,CC; (9.5B
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:elling price :ales volume <evenues Direct materials Direct labor (including fringes &ndirect labor .achinery Eross profit Eross profit
.ocha!lmond > 8.99 %,(99 > 8,-99 C-9 %,9;9 %,(%; %,%89 > 5%; %(.-B
Total > (.4C ,%,,99 > 4(,-49 %-,-89 (C,,-4,;-9 (9,54; >%5,,-C %C.5B
459 %,899 %,%49 %,(-9 >5%9 %%.(B
(B of sales (c The cost of the - production employees is - G >8,5;; @ >,C,(89 and the unused labor capacity cost is therefore >,C,(89 O >(C,,-- O >4,;-9 @ >(C(. The cost of the , machines is , G >C,C99 @ >(,,%99 and the unused machine capacity cost is >(,,%99 O >(9,54; @ >(,89;. !fter incorporating the unused capacity cost, the pro forma monthly gross profit is >%5,,-C O >(C( O >(,89; @ >%,,C%9 and gross profit as a percent of sales is >%,,C%9?>4(,-49 @ %8.-B.
5-22 !ctivity-based costing provides a means to accurately trace costs to operational processes, and these costs can be used as one of the operations management measures in the process perspective of a =alanced :corecard. !ctivity-based costing can also provide a means to measure customer profitability or percent of profitable customers, which many companies include in the customer or financial perspective of their =alanced :corecards (this application will be discussed in Chapter 5 . 5-23 The choice really depends on what short-term problems the company faces. &f it is experiencing large, rising, and difficulty-to-control indirect and support costs, as well as a proliferation of products and customers, then an activitybased costing system will supply valuable information to management decisions on process improvements, product mix, pricing, and managing customer relationships. This is because activity-based costing re0uires understanding processes and their underlying activities, as well as what drives support costs. The development of the activity-based costing model, as well as the model itself, will help the organi1ation identify costly and inefficient processes. !dditional potential benefits include identifying costly customers or understanding how costly complex products are. The company can improve inefficient processes, encourage costly customers to interact at a lower cost to the company, revise product pricing, and find new revenue-generating uses of freed-up capacity or attempt to reduce capacity costs. &f, however, the biggest issue the company faces is moving to a new strategy, particularly one focused on customers and a new value proposition, then implementing the =alanced :corecard will be highly beneficial in communicating the new strategy and providing a systematic mechanism for monitoring and improving the new strategy. The =alanced :corecard process can greatly facilitate and speed the ma"or change that is desired, lead to team building and commitment to the new strategy among the executive team,
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translate the strategy to operational terms, and lead to communication of the strategy throughout the organi1ation. 6f course, both approaches are highly compatible with each other. 5-24 (a 2ach server is available for ((( days G ((8 hours per day @ ;(- hours per month. The average cost per hour is therefore >,,545?;(- hours @ >C per hour. Aon-peak-hour usage accounts for ((9 servers G (%5 hours per day @ ,(9 hours per day. )eak-hour usage accounts for (-9 servers G (- hours per day @ 589 hours per day. .oreover, the 59-server excess capacity during non-peak hours exists because of the peak-hour need. Therefore the cost of the excess capacity of 59 G %5 hours @ 459 hours should be charged to peak-hour users. Thus, the peak-usage hourly rate is >C G (589 L 459 ?589 @ >%%,(99?589 @ >%C.;9 per hour. !s discussed in part (a , the peak-usage hours should bear the cost of the excess capacity that exists during non-peak usage. The non-peak hourly rate is then the average cost of >C per hour. Cost !ssigned Driver CostP Quantity >8;9,999 >59,999 >49,999 >599,999 !ctivity Cost Driver <atePP >;5.(; per -,999 customer order >%;9.99 per 899 customer complaint >(99.99 per 8;9 credit check
(b
5-25 (a !ctivity Iandle customer orders )rocess customer complaints )erform customer credit checks )ercent C;B %9B %;B %99B
P >599,999 times the given percentage. PP !ssigned Cost divided by Cost Driver Quantity.
(b
Capacity cost rate @ >599,999?%9,999 @ >59 per hour. 7nit Time !ctivity (Iours !ctivity Cost Driver <ate Iandle customer orders 9.C; >8; )er customer order )rocess customer complaints )erform customer credit checks
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,.;9 ,.99
>(%9 )er customer complaint >%-9 )er credit check
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(c !ctivity Iandle customer orders )rocess customer complaints )erform customer credit checks Total
7nit Time (Iours 9.C; ,.;9 ,.99
Quantity of !ctivities -,999 899 8;9
Total Cost Iours !ssigned 5,999 >,59,999 %,899 %,,;9 -,C;9 >-8,999 >-%,999 >;(;,999
)ractical capacity used @ -,C;9 %9,999 @ -C.;B 7nused capacity @ %9,999 O -,C;9 hours @ %,(;9 hours. 7nassigned cost @ >599,999 O >;(;,999 @ >C;,999. .anagers can try to reduce the unused capacity and its associated expense. !lternatively, managers can try to generate new uses for the unused capacity by introducing new products or expanding into new markets. The cost system provides information to assist managers in deciding whether these new uses of capacity can be handled with the current capacity or re0uire additional resources and spending. (d !ctivity Iandle customer orders )rocess customer complaints )erform customer credit checks Total )ractical capacity used @ 4,%99 %9,999 @ 4%.9B 7nused capacity @ %9,999 O 4,%99 hours @ 499 hours. 7nassigned cost @ >599,999 O >;85,999 @ >;8,999. (e The costs driver rates in (a and (b likely differ because not all the practical capacity of the resources supplied during the period was used for productive work, as illustrated in parts (c and (d . The !=C system
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7nit Time (Iours 9.C; ,.;9 ,.99
Quantity of Total !ctivities Iours -,;99 5,,C; ,;9 ;99 %,((; %,;99 4,%99
Cost !ssigned >,-(,;99 >C,,;99 >49,999 >;85,999
in part (a overestimated the costs of performing activities by apportioning all customer service costs to the three activities and therefore assigned not only the costs of resource capacity used, but also the cost of unused resources. Determining the unit times to complete each activity in con"unction with the time-driven !=C system in part (b provides clearer information about the resources needed for each activity and about the unused capacity. 5-26 (a The resource units would depend on the organizations facilities and resources. If the
organization is self-contained with operating rooms, recovery rooms, and radiology and pharmacy facilities, then these resource units would be part of Riverdales activity-based cost system. Other likely resource units include personnel performing scheduling, admissions, and record-keeping computers used in the clinic. medical personnel, such as nurses and surgeons the cost of e!uipment "such as rehabilitation e!uipment and e#amination tables$
(b
Capacity cost rates must be developed for each resource. Then, for each patient, track their routing through the clinic to identify which resources the
patient uses, and how much time is spent with each resource. %inally, sum up the costs of all the resources used by the patient as he or she gets processed, treated, and, eventually, released by the hospital. &his will yield the total cost associated with the complete cycle of care for this patient episode.
5-27 (7nofficial C.! !nswer, adapted (a %. .anufacturing support costs include all indirect production costs (all production costs except direct material and direct labor . These costs cannot be practically or economically traced to end products and, therefore, must be assigned by some allocation methods. Typical manufacturing support costs include$ R &ndirect labor, e.g., lift-truck driver3s wages, maintenance and inspection labor, engineering labor, scheduling, purchasing and supervisors. 6ther indirect factory costs, e.g., building maintenance, machine and tool maintenance, property taxes, property insurance, pension costs, depreciation on plant and e0uipment, rent expense, and utility expense.
(.
Companies develop manufacturing support cost driver rates to facilitate the costing of products as they are completed and
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shipped, rather than waiting until actual costs are accumulated at the end of a fiscal period. (b The cost driver rate increase should not have a negative impact on .oss .anufacturing because the increase in indirect costs was offset by a decrease in direct labor costs.
(c
<ather than using a universal plantwide rate, .oss .anufacturing could implement separate cost pools for different activities. 2xamples are as follows$ R !ccumulate separate costs into departmental accounts (or other relevant pools , with one account for each production and service department. 2ach department would allocate its support costs to products on the basis that best reflects the use of these services. &ndividual machines (or other more relevant allocation bases could be treated as separate cost centers with the machine costs collected and charged to the products using the machine(s .
(d
!n activity-based costing system might benefit .oss .anufacturing because it
R measures the cost of unused resource capacity and provides more accurate resource consumption and cost information as input to decisions that increase company profitability R costs products according to the activities involved in the production process.
5-28 (a
! call-related activity cost driver would better identify the linkage to call center support costs. The number of calls (a transaction driver per product can be used because of its simplicity. The number of minutes of calls (a duration driver provides better linkage to call center support costs, but it is more time-consuming to measure. Previous system: !llocated support costs$ ;B of sales Activity-based costs: >.C9 per minute )roduct S >(9,999 >8,499 )roduct / >;,999 >(%,999
(b
+%;;+
(c
7nder the previous system, product managers can only reduce the assigned call center costs by reducing sales. 7nder the new system, product managers can work with other functional areas to find ways to reduce the number of calls or to reduce the length of calls. *or example, product /3s manager can work with package designers or the marketing group to develop clearer instructions for consumers. The instructions might include a company web address that provides answers to fre0uently asked 0uestions (based on calls to the call center . )roduct /3s manager is likely to resist implementation of the activitybased cost system if the manager understands the relative usage of call center resources devoted to product /. Call center staff may resist implementation of activity-based costing because it will involve tracking of staff activity. The staff may resent tracking the number of calls or minutes of calls, and may resent the additional monitoring because it may lead to pressure to reduce the minutes per call. The call center staff may also fear that the desire for cost or efficiency improvements will lead to staff reduction or to outsourcing the entire call center. The company will need to consider the broader management issues related to "ob loss if the call center activities are outsourced. !s an input to that decision, however, the company can benchmark its costs per minute to other call centers, or compare it to the cost of outsourcing. The company may also pursue an intermediate course of communicating the current costs per minute and benchmarked or competitive costs, and allowing the call center staff to improve efficiency and lower costs per minute. .anufacturing support cost driver rate $11,500, 000 = 100, 000 + 300, 000 = $28.75 per direct labor hour.
(d
(e
5-29 (a
+%;5+
Costs )er 7nit Direct materials cost Direct labor cost ( >(%,999,999%99,999 , >(8,;99,999,99,999 .anufacturing support cost >(-.C; (%99,999;9,999 >(-.C; (,99,999%99,999 7nit cost (b
)roduct S(% >%(9.99 (9.99 ;C.;9 >%4C.;9
)roduct /,C >%89.99 8;.99 -5.(; >(C%.(;
Cost Cost Capacity Driver Driver !ctivity costs Quantity <ate Iandling >,,999,999 59,999 ;9 Aumber of parts Design changes :etups Total (,899,999 ,,,99,999 (,-99,999 >%%,;99,999 (9,999 ,,999 %8,999 %(9
Costs !llocated to )roducts S(% ;9 89,999 %(9 %(,999 /,C ;9 (9,999 %(9 -,999
%,%99 %,%99 (,999 %,%99 %,999 (99 (99 -,999 >C,(89,999 /,C >%89.99 8;.99 (99 5,999 >8,(59,999
Costs )er 7nit Direct materials cost Direct labor cost .anufacturing support cost >C,(89,999 ;9,999 >8,(59,999 %99,999 7nit cost (c
S(% >%(9.99 (9.99 %88.-9
8(.59 >(-8.-9 >((C.59
!ctivity-based costing produces more accurate estimates of "ob costs because it takes into account the cost drivers that give rise to support costs.
+%;C+
(d
Cost-based )rices Traditional costing %.(; G unit costs in part (a !ctivity-based costing %.(; G unit costs in part (b
)roduct S(% >(85.->,;5.99
)roduct /,C >,,4.95 >(-8.;9
&f 2ndo plans to continue to use cost-based pricing, it should use activity-based costs as the basis for its markups. Aote S(%3s current price is not even covering its manufacturing costs as determined using activity-based costing. Conversely, /,C may be overpriced. 2ndo should consider raising S(%3s price and could consider lowering /,C3s price if competitors are selling the same product for a lower price. (e The company sells half as many S(%3s as /,C3s, but S(% has twice as many design changes and ;9B more parts. These facts suggest that the company can explore ways to reduce the number of design changes and the number of parts. .anagement accountants would be involved in developing and communicating the cost of design changes and parts proliferation' design engineers would be directly involved in studying different designs and trying to reduce the number of parts. &n addition, sales staff who communicate with customers could make greater efforts to understand customer needs and convey this information to the design engineers. Total manufacturing support costs @ >%,999,999 Total direct labor hours @ T;,999 ( L 89,999 %U @ ;9,999 .anufacturing support cost rate @ >(9 per direct labor hour. Direct material Direct labor .anufacturing support 7nit cost Deluxe >8; >(9 >89 >%9; <egular >,9 >%9 >(9 >59
5-30 (a
(b
+%;-+
(c
!ctivity )urchase orders Quality control )roduction setups .achine maintenance
<ate )er 7nit of Cost Driver >%-9,999 = >,99 599 >(;9,999 = >%(; (,999
>((9,999 = >%,%99 (99 >,;9,999 = >%9 ,;,999
!ctivity )urchase orders
Quality control )roduction setups %99 >%,%99 @ %%9,999 %99 >%,%99 @ %%9,999 .achine maintenance (9,999 >%9 @ (99,999 %;,999 >%9 @ %;9,999 Total manufacturing support costs >84;,999 >;9;,999 Aumber of units ;,999 89,999 7nit manufacturing support costs >44 >%(.5(; Direct material Direct labor .anufacturing support 7nit cost Deluxe >8;.999 >(9.999 >44.999 >%58.999 <egular >,9.999 >%9.999 >%(.5(; >;(.5(;
Capacity costs !ssigned to )roducts Deluxe <egular (99 >,99 @ >59,999 899 >,99 @ >%(9,999 %,999 >%(; @ %(;,999 %,999 >%(; @ %(;,999
+%;4+
(d !ctivity )urchase orders Quality control )roduction setups .achine maintenance Deluxe (99 = 9.98 ;,999 %,999 = 9.( ;,999 <egular 899 = 9.9% 89,999 %,999 = 9.9(; 89,999
<atio of Deluxe$<egular 8$% -$% -$% %9.5C$%
%99 = 9.9( ;,999

(9,999 =8 ;,999
%99 = 9.99(; 89,999

%;,999 = 9.,C; 89,999
7nit costs are distorted by the old system because it assigns manufacturing support cost to products using direct labor hours as a base. !lthough the deluxe model re0uires twice as much labor time as the regular model, it was not allocated ade0uate support cost. !naly1ing the company3s capacity costs reveals that the deluxe model is very expensive to manufacture as compared to the regular model because (i the deluxe model re0uires 8 times as many purchase orders as the regular model, (ii the deluxe model re0uires - times as many inspections and setups as the regular model, and (iii the deluxe model re0uires over %9 times as many machine hours as the regular model. (e Ao, the deluxe model is not as profitable as the company thinks. 7nder !=C, the following profitability analysis for each product line can be prepared$ :elling price per unit 7nit cost Eross margin per unit (f Deluxe >%89.999 >%58.999 (>(8.999 <egular >-9.999 >;(.5(; >(C.,C;
The regular model is more profitable than the deluxe model. Therefore, marketing staff can (i push the regular model (increase commissions on the regular model, and?or decrease commission on the deluxe model , and?or (ii raise the price of the deluxe model.
+%59+
Design engineers can try to re-engineer the deluxe product to decrease its high demand for activity resources. 5-31 (7nofficial C.! !nswer, adapted (a !t least four general advantages associated with activity-based costing include the following$ R )rovides management with a thorough understanding of complex product costs and product profitability for improved resource management and pricing decisions. )rovides estimates of unused capacity costs. Iighlights the interrelationships (cause and effect of activities and identifies opportunities to reduce costs, e.g., designing products with fewer parts to reduce the cost of the manufacturing process. )rovides more appropriate means of charging support costs to products. 7sing standard costs, the total contribution expected this year from the T# board is >%,4;9,999, calculated as follows$ )er 7nit >%;9 -9 (% 5 ; >%(9 >,9 Totals for 5;,999 7nits >4,C;9,999 ;,(99,999 ;(9,999 %,,5;,999 ,49,999 ,(;,999 >C,-99,999 >%,4;9,999
R R
R (b %.
<evenue Direct material .aterial support (%9B of material Direct labor (>%8 %.; hours #ariable support (>8 %.; hours P 6ther mfg. support (>%9 9.; machine hour Total cost 7nit contribution Total contribution (5;,999 ,9
P
#ariable support rate$ >%,%(9,999 (-9,999 hours @ >8 per hour.
+%5%+
(.
7sing standard costs, the total contribution expected this year from the )C =oard is >(,,59,999, calculated as follows$ <evenue Direct material .aterial support (%9B of material Direct labor (>%8 8 hours #ariable support (>8 8 hours P 6ther mfg. support (>%9 %.; machine hours Total cost 7nit contribution Total contribution (89,999 >;4
P
)er 7nit >,99 %89 %8 ;5 %5 %; >(8% >;4
Totals for 89,999 7nits >%(,999,999 ;,599,999 ;59,999 (,(89,999 589,999 599,999 >4,589,999 >(,,59,999
#ariable support rate$ >%,%(9,999 (-9,999 hours @ >8 per hour.
(c
:hown below are the calculations of the cost drivers which apply to both (c % and (c (. )rocurement$ )roduction scheduling$ )ackaging and shipping$ .achine setups$ Ia1ardous waste disposal$ Quality control$ Eeneral supplies$
>899,999 = >.%9 per part 8,999,999

>((9,999 = >(.99 per board %%9,999
>889,999 = >8.99 per board %%9,999

>885,999 = >%.59 per setup (C-,C;9
>8-,999 = >,.99 per pound %5,999
>;59,999 = >,.;9 per inspection %59,999 >55,999 = >.59 per board %%9,999
+%5(+
.achine insertion$ .anual insertion$ Fave soldering$ %.
>%,(99,999 = >.89 per machine insertion ,,999,999 >8,999,999 = >8.99 per manual insertion %,999,999
>%,(,999 = >%.(9 per board %%9,999
7sing activity-based costing, the total contribution expected this year from the T# =oard is >(,;;C,%99 calculated as follows$ )er 7nit >%;9.99 -9.99 (.;9 (.99 8.99 ,.(9 .95 ,.;9 .59 4.59 8.99 %.(9 >%%9.55 >,4.,8 Totals for 5;,999 7nits >4,C;9,999 ;,(99,999 %5(,;99 %,9,999 (59,999 (9-,999 ,,499 ((C,;99 ,4,999 5(8,999 (59,999 C-,999 >C,%4(,499 >(,;;C,%99
<evenue Direct material .aterial support$ )rocurement (>.%9 (; )roduction scheduling )ackaging and shipping #ariable support$ .achine setups (>%.59 ( Faste disposal (>, .9( Quality control Eeneral supplies 6ther manufacturing support$ .achine insertion (>9.89 (8 .anual insertion Fave soldering Total cost 7nit contribution Total contribution (5;,999 >,4.,8
+%5,+
(.
7sing activity-based costing, the total contribution expected this year from the )C =oard is >%,;48,999 calculated as follows$ )er Totals for 89,999 7nit 7nits >,99.99 >%(,999,999 %89.99 ;.;9 (.99 8.99 8.-9 %.9; C.99 9.59 %8.99 -9.99 %.(9 >(59.%; >,4.-; >%,;48,999 ;,599,999 ((9,999 -9,999 %59,999 %4(,999 8(,999 (-9,999 (8,999 ;59,999 ,,(99,999 8-,999 >%9,895,999
<evenue Direct material .aterial support$ )rocurement (>.%9 ;; )roduction scheduling )ackaging and shipping #ariable support$ .achine setups (>%.59 , Faste disposal (>, .,; Quality control (>,.;9 ( Eeneral supplies 6ther manufacturing support$ .achine insertion (>9.89 ,; .anual insertion (>8 (9 Fave soldering Total cost 7nit contribution Total contribution (89,999 >,4.-; (d
The analysis using standard costs shows that the unit contribution of the )C =oard is almost double that of the T# =oard. 6n this basis, !laire3s management is likely to accept the suggestion of the production manager and concentrate promotional efforts on expanding the market for the )C =oards. Iowever, the analysis using activity-based costs does not support this decision. This analysis shows that the total dollar contribution from the T# =oard exceeds that of the )C =oard by almost
+%58+
>%,999,999. !s a percentage of selling price, the contribution from the T# =oard is double that of the )C =oard, e.g., (5B versus %,B. CASES 5-32 This 0uestion is designed to get students to think about the factors creating the demand for activity-based cost systems. (a ! traditional cost system, which assigns direct materials and direct labor to products, and allocates factory support based on direct labor, cannot signal the cost of component and product variety. .arketing research may identify that consumers like to choose from a variety of options (especially when the alternatives are available without any cost associated with choosing' e.g., you can have any color of this or any variety of that . &n this situation, product engineers can design lots of varieties and options. The cost system assigns cost only on the direct labor and materials content of these options. Thus making one million units of one steering column appears to cost the same as making %99,999 of 8 different steering columns, %9,999 each of ,9 other steering columns, and %,999 each of ,99 other columns. =ut making ,,8 steering columns in batch si1es ranging from, for example, %99 to %9,999, and designing and supporting ,,8 different steering columns is much more expensive than "ust producing ; or at most 89 different columns. ! traditional cost system would report that production costs of labor and materials for the %,999,999 steering columns is the same whether they are produced in ; varieties, 89 varieties, or ,,8 varieties. Thus model and component proliferation is virtually impossible to stop when companies cost products using traditional cost systems. &n order to understand the cost of variety, the new cost system should identify the cost of introducing new varieties, colors, and options. The cost system will show the cost of setting up or changing over to make the new variety, color and option, a cost that will be independent of the number of units produced after the setup. !lso the new cost system will show the cost of designing and supporting each new variety, color, and option (technically, in !=C terms, called the Vproduct-sustainingW costs that will be independent of the number of units produced. Fith the more accurate understanding of the costs of resources that perform batch and product-sustaining activities, the product engineers and marketing managers can "ointly make better decisions on whether the
(b
+%5;+
higher cost of introducing another customi1ed option will be compensated with higher sales volumes and?or higher margins. !s a specific example, one of Eeneral .otors3 competitors examined the cost of how many wire harnesses it used in a given car model. Currently it was producing %( different wire harnesses, a number that seemed optimal using its traditional cost system. The !=C system which incorporated the economics of batch production and productsustaining expensesrevealed that the optimal number of harnesses was ; or 5. !nd when the cost of stocking and servicing all the dealerships was incorporated into the analysis, the optimal number dropped to (. &n effect, the apparent savings in direct materials and labor from having customi1ed wire harnesses for individual combinations of car options was far lower than the much higher support costs triggered by high engineering, production support, and service resources associated with having to produce, stock, and service %( different wire harnesses for a single car model. 5-33 This situation is drawn from VCott Corporation$ )rivate Habel in the %449s.W Iarvard =usiness :chool Case #9-594-031. This is a truly challenging exercise since it re0uires students to think about the design of activity-based cost systems, not "ust the analysis of existing or proposed systems. =ut, if a good discussion can be generated in the class, it could motivate the work that will be done in the rest of the course. :tudents may feel that activity-based cost systems are only necessary for large organi1ations, like Eeneral .otors, Chrysler, )rocter J Eamble, Coca Cola, Iewlett )ackard, or Xohn Deere. This discussion shows how even small, entrepreneurial ventures can benefit from knowing the cost of products, services, and customers. Cott executives could use a variety of different activity-based cost systems. *irst, and perhaps most obvious, would be an analysis of production costs. Cott, as any small company, would start with producing a limited set of high volume, popular cola beverages such as regular cola and diet cola. :o initially, they would have long runs, few setups, and little product variety. Traditional cost systems work fine in this environment. =ut if retailers want to use Cott as their only private label beverage provider, they will ask Cott to provide a fuller line of beverages, say caffeine-free and diet-caffeine free. !lso, they may want a variety of packaging$ %( o1 cans, and % and ( liter plastic bottles. !nd they may start to re0uest beverages beyond the cola category, such as sparkling
+%55+
water, mineral water, new-age beverages, ginger ale, flavored soft drinks, etc. 2ach new retailer that Cott signs up as a customer may also want its own slight variation in beverage formulation (ingredients and labeling. !s Cott begins to respond to the demand for higher variety, it will be performing many more activities$ scheduling production runs, buying more different ingredients and packaging materials from more suppliers, setting up for each production run, changing over packaging lines, more 0uality control activities (re0uired for each production run and each uni0ue formulation , and more product support activities to maintain information re0uired for each individual :K7. Cott will need an !=C system to understand the cost of these activities that are driven by increased variety and be sure that these costs are covered by the volume of business and prices received from retailers. 6therwise, its cost structure will increase and it will either lose money on the incremental orders or, as it attempts to raise prices, will lose much of its price advantage over the national brands. Cott will want to understand its costs by individual :K7, to be sure that the increased costs associated with offering and delivering customi1ed, low-volume :K7s do not become spread on to the basic high volume beverages (say, regular and diet cola . :econd, Cott is customi1ing its product and service offering to individual retailers. *or each retailer, Cott can offer uni0ue product formulations, customi1ed to the retailer3s specifications, design of a retailer-specific label for the beverages, and marketing, promotional, and consulting assistance to help the retailer launch and sustain a private-label cola line. Thus Cott can incur substantial customer-specific expenses with each new retailer. &t will need to measure all these front-end, customer-specific expenses and link them to the revenues received, less product and customer-specific beverage costs Tas described in the previous paragraphU to determine customer profitability. !n !=C model of individual customer profitability will enable Cott to predict in advance the volume and mix of business re0uired to payback heavy front-end investments in product design, package design, and consulting assistance. 2x post, Cott will use the !=C customer profitability model to assess whether the actual volume and mix of business, at actual prices and !=C-calculated product costs, are generating sufficient margin to repay the front-end and perhaps on-going customer-specific support expenses. Cott executives can use such a model to guide their negotiations with each retailer. Third, one of Cott3s principal marketing devices with a retailer is to convince the retailer3s executives, (% that Cott beverages are profitable for the retailer to sell, and (( that Cott beverages may be even more profitable for the retailer than national-branded beverages. This will re0uire Cott to work with the
+%5C+
retailer to develop a retailer profitability model for the cola beverage category (one of the highest gross volume categories in a retail grocery store . *rom the retailer3s perspective, profit would be measured by the gross margin (net selling price less the price paid to Cott minus retailer expenses to receive the beverage containers in a warehouse, store and then ship them to retail outlets, receive the shipments at the retail store, and then shelve and promote them at the store. This re0uires an !=C model to be built for the retailer3s operating expenses, including the cost of inventory and shelf-space occupancy. This is especially important since the national brands (Coke and )epsi charge the retailer much higher prices and the retailer marks these items up less than it might do for a private label beverage. =ut since the national brands are delivered directly to individual stores and shelved by the national brands3 personnel, the retailer does not use its warehouse, distribution, or in-store resources (other than shelf space for these brands. Thus a fair comparison re0uires the !=C model to cost out the extra activities related to the Cottsupplied beverages but not re0uired for Coke and )epsi. =ut think about the power of the outcome from such a study. Fouldn3t you, as a supplier, like to be able to demonstrate to your customer that you are not "ust the lowest cost supplier but the most profitable supplier in a categoryY :tudents may also suggest other, non-cost, aspects of the Coke vs. Cott decision. =ut thinking about these three !=C models$ factory costs reflecting the cost of variety and customi1ation, customer cost and profitability reflecting the cost of uni0ue marketing, design, and promotional assistance, and, finally, customer3s profitability structures should give students ample opportunity to reflect on the strategic use of accurate product, distribution, and customer cost information. 5-34 This case on Eotham City is adapted from V&ndianapolis$ !ctivity-=ased Costing of City :ervices (! and (= ,W Iarvard =usiness :chool Case #9-196115? and -117. The material below reports on the &ndianapolis experience. (a There are at least two reasons for estimating !=C costs of current operations before contemplating a privati1ation decision. *irst, it may turn out that the municipal workers are doing the work at a lower cost than private sector alternatives. Fhile this may seem fanciful, the &ndianapolis experience revealed 0uite a few tasks where the work could be done by municipal workers at lower cost than by paying the lowestbidding private contractor. 6f course, for this comparison to be on a level playing field, the cost estimate for the municipal workers must include not only their direct labor cost but also the cost of e0uipment,
+%5-+
supervision, and all resources performing support activities (since any private company must bid to cover the costs of these resources as well . The !=C approach provides a reasonable estimate of all direct and indirect costs associated with performing a given activity (such as filling potholes, picking up trash, sweeping streets, treating water and sewage, repaving roads, and operating an airport . The .ayor of &ndianapolis, after seeing the !=C cost estimates for internal provision of these services, announced he was more interested in competition (between the public and private sector for the lowest cost supply of services than in privati1ation. The second reason for the !=C approach is that should a company in the private sector win the business, the city must then identify all the resources that are no longer needed when the work is done by the private contractor. !gain, the city resources that should be reduced include not only the front-line municipal workers, but also all their e0uipment, supervisors, and support resources behind the front-line worker. 6therwise, the city will pay twice for the service, first for the contractor doing the work, and then for the people and other support resources who now have less or no work to perform. That is why a cross-functional, comprehensive total cost view is needed to provide transparency about all the resources in place to support a front-line worker. (b They should identify all the resource units used such as trucks, machines, computers, and facilities. Then they need to identify all the costs incurred to supply the resources and the capacity supplied by each resource. ! capacity cost rate (the cost of the indirect resource divided by the capacity supplied by the resource can then be developed for each resource type. 2stimates then need to be obtained for the amount of each resource3s capacity used by different activities performed to provide services to the community. The answer to this 0uestion provides a third reason for building !=C models before considering privati1ing municipal services. =efore building an !=C cost model, workers would have no idea about the cost of performing the work. 6nce they see the cost of labor, e0uipment, supervision, and other support services, they can make suggestions to lower the cost of performing the work. !s a specific example, in &ndianapolis, the workers saw that there was one supervisor for every two workers, clearly an excessive amount. They also developed
+%54+
(c
procedures so that a pothole could be filled with a three-person crew rather than a five- or six-person crew, to share e0uipment with other activities, to use their e0uipment more efficiently, and to perform other work (such as cleaning streets while waiting for e0uipment or materials to be delivered to the site. The sum total of all these improvement suggestions enabled the municipal workers to submit a much lower bid than any private contractor, thereby retaining the business. This message reinforces the point that sharing cost information with frontline workers enables them to make suggestions for how to accomplish the same outcomes with fewer resources, resulting in substantial productivity improvements. 6nly good cost information can identify the opportunities for the largest improvements in resource expenses. 5-35 (a :tage %$ !llocation of :% and :( costs to production departments Department )% Department )( Directly traceable >8-9,999 >C-9,999 costs :% :( Total support DHI Cost driver rate %,%C5,999 G ,,5 @ 8(9,999 %,%C5,999 G ,,5 @ C;5,999 %,%(9,999 G
89 %59 %(9 (%5
@ %,%(9,999 G %59 @ -89,999 >(,,C5,999 %(9,999 >%4.-9 per DHI
%(9
(-9,999 >%,%-9,999 -9, 999 >%8.C; per DHI
)% )(
:tage ($ !llocation of )% and )( costs to products )roduct <,5% )roduct <;C( >%8.C; 59,999 = >--;,999 >%8.C; (9,999 = (4;,999
>%4.-9 C(,999 = %,8(;,599 >(,,%9,599
>%4.-9 8-,999 = 4;9,899 >%,(8;,899
+%C9+
)roduct costing Direct materials Direct labor$ )% Direct labor$ )( :upport Total cost Total units 7nit cost :ales price Eross margin Eross margin B (b )roduct <,5% >- ;99,999 = >8,999,999 )roduct <;C( >%9 899,999 = 8,999,999
>%; 59,999 = 499,999 >%- C(,999 = %,(45,999
>%; (9,999 = ,99,999 >%- 8-,999 = -58,999
>(,,%9,599
>-,;95,599
;99,999 >%C.9%,(
>%,(8;,899
>5,894,899
899,999 >%5.9(,;
%4.9999
>%.4-5%9.8599B
(9.9999
>,.4C5; %4.--B
Het ! denote the number of hours re0uired for each <,5% setup. Then the number of hours re0uired for each <;C( setup @ %.;!" <,5% Aumber of setups :etup hours (,999 (,999! ((;B Aumber of transactions !ctivity Cost Traceable Drivers Costs Total )%-DHI >(89,999 -9,999 )(-DHI :etup hours )%-.I )(-.I ,59,999 %(9,999 %,5C5,999 -,999! <,5% 59,999 C(,999 (,999! ,9,999 C(,999 Capacity <;C( Cost Driver <ate (9,999 >,?)% DHI 8-,999 >,?)( DHI 5,999! <;C( 8,999 5,999! @ 8,999 %.;! (C;B
>(94.; ? setup hour !
,-9,999 89,999 499,999 %(9,999
%9,999 >4.;9?)% .I 8-,999 >C.;9?)( .I
+%C%+
Total :upport Costs Capacity Cost Drivers )%-DHI )(-DHI :etup hours )%-.I )(-.I )roduct <,5% >, 59,999 @ >%-9,999 >, C(,999 @ (%5,999 )roduct <;C(
>, (9,999 = >59,999 >, 8-,999 = %88,999
(94.; (94.; (999 ! = 8%4,999 5,999 ! @ %,(;C,999 ! ! >4.; ,9,999 = (-;,999 >4.; %9,999 = 4;,999
>C.; C(,999 = ;89,999

>%,589,999
>C.; 8-,999 = ,59,999

>%,4%5,999
!lternatively, Capacity Cost Drivers )%-DHI Total :upport Costs )roduct <,5% )roduct <;C(
59 (9 >(89,999 = >%-9,999 >(89,999 = >59,999 -9 -9 C( 8 >,59,999 = >(%5,999 >,59,999 = %88,999 )(-DHI %(9 %(9 (,999 ! 5,999! :etup %,5C5,999 = 8%4,999 %,5C5,999 = %,(;C,999 hours -,999 ! -,999 !
)%-.I )(-.I
,9 >,-9,999 = (-;,999 89 C( >499,999 = ;89,999 %(9 >%,589,999
%9 >,-9,999 = 4;,999 89 8 >499,999 = ,59,999 %(9 >%,4%5,999
+%C(+
)roduct costing Direct materials Direct labor$ )% Direct labor$ )( :upport costs Total cost Total units 7nit cost :ales price Eross margin Eross margin B (c )roduct <,5% >8,999,999 499,999 %,(45,999 >%,589,999 >C,-,5,999 ;99,999 >%;.5C( %4.999 >,.,(%C.;(9B )roduct <;C( >8,999,999 ,99,999 -58,999 >%,4%5,999 >C,9-9,999 899,999 >%C.C99 (9.999 >(.,99 %%.;99B
The old cost accounting system ignored the fact that a large part of support costs is driven by setup hours. 7nder the old cost accounting system, <;C( was un ercoste because it had disproportionally more setup hours compared to direct labor hours. The ratio of setup hours per unit of <,5% to the setup hours per unit of <;C( e0uals$
(,999 ! 5,999 ! = = 8.%; ;99,999 899,999

6ld Cost !ccounting :ystem <,5% <;C( >%4.9999 >(9.9999 %C.9%,( >%.4-5%9.85B %5.9(,; >,.4C5; %4.--B !=C :ystem <,5% >%4.9999 %;.5C(9 >,.,(-9 %C.;(B <;C( >(9.9999 %C.C999 >(.,999 %%.;9B
:ales price 7nit cost Eross margin Eross margin B
+%C,+
(d
#ecommen ations $or marketing: %. <,5% is more profitable than <;C(. Therefore, push <,5% by increasing the commission on <,5% or decreasing the commission on <;C(. (. <aise the price of <;C(.
#ecommen ations $or pro uction: %. ! large part of support costs is driven by setup hours. Therefore, reengineer the products to decrease setup hours. (. 6ffer discounts to customers for larger batch si1es to reduce the number of setups. (This recommendation may also involve marketing staff.
(e
The experienced production manager is likely to have an intuitive understanding of the higher production complexity for <;C( and will likely agree with the activity-based cost analysis. Iowever, the sales manager will likely want to keep sales high and has already built up relations with <;C( customers. Therefore, the sales manager will likely oppose increasing the price of <;C( since it will reduce its sales.
5-36 :ippican Corporation (! (I=: Case 9-106-058 eac!i"# P$a" This is an introductory case, and yet it introduces a powerful new approach for building an !=C model. Considerable theory is illustrated in how we build the :ippican time-driven !=C (TD!=C model. !lso, the (= case introduces an important link, previously recogni1ed but not exploited, in how to embed an !=C model into the budgeting process, replacing line-item budgeting with an integrated, analytic approach. The case discussion provides insight and confidence about the feasibility of building a TD!=C model, especially in the face of resistance from finance people who claim that !=C is too complex to implement.
+%C8+
Q$
Fhat is the competitive situation faced by :ippicanY .ature products Declining profits &nability to explain pricing decisions in market place + high margins and little price competition in one line' continued price pressure in another
Q$
Fhy was Knight studying :ippican3s overhead costsY The following two characteristics serve as indicators that a traditional costing approach to overhead costs is likely providing inaccurate costs$ %. %he &illie Sutton rule$ Hook for areas with large expenses in indirect and support resources, especially where such expenses have been growing over time. 6perations where almost all expenses are direct labor and direct materials, which can already be directly traced to individual products by traditional costing systems, may have less need for !=C systems. &n effect, if organi1ational activities are all at the unit level (virtually no batch or product-sustaining activities , then !=C systems and traditional cost systems will likely give very similar economic signals.
%
(. 'igh (iversity rule$ Hook for a situation in which large variety exists in products, customers, or processes. *or example, consider a facility that produces mature and newly introduced products, standard and custom products, high-volume and lowvolume products. *or marketing and selling expenses, companies may have a mixture of customers who order highvolume, standard products with few special demands as well as customers who order in small volumes, special products, and re0uire large 0uantities of pre-sales and post-sales technical support.
Fillie :utton was a successful bank robber in the 7nited :tates during the %4;9s. Fillie, who was eventually captured at his home not far from a local police station, was asked during his initial interrogation, VFhy do you rob banksYW Fillie replied, with the wisdom that had made him successful for many years, VThat3s where the money isZW Fhen developing !=C systems, we should follow Fillie3s sage advice (but not his particular application of the insight to focus on high cost areas where improvements in visibility and action could produce ma"or benefits to the organi1ation. !pplying an !=C analysis to a set of resource expenses that are below %B of total spending will not lead to high payoffs to the organi1ation.
%
+%C;+
6bservation$ )roducts such as pumps and valves may be commodities' but how they are produced (small lots, custom designs and delivered (direct, expedited is not a commodity. These special services create a basis for differentiation. =ut Vdifferentiation is a successful strategy only when the delta value created by differentiation exceeds the cost to differentiate.W % &eve"ues '(rom !i#!er )rices, !i#!er sa$es vo$umes* + % ,osts Q$ :hould :ippican abandon its overhead cost allocation system and make managerial decision based on contribution margin' in effect use marginal costs rather than average costsY (a :ippican3s executives should not abandon overhead assignment to products. The contribution margin is revenues minus variable costs. !nalysis based on unit contribution margins can be useful for short-term decisions, such as whether to accept a one-time order when operating with excess capacity. &n this case, management is concerned about recurring sales. 6verhead cost is si1able (>5;8,599, which exceeds either direct labor or direct material costs .anagement will benefit by understanding the impact of variety in the use of overhead resources by individual products. The contribution margin approach, by definition, does not reveal the different demands that individual products make on overhead resources (for machine time, engineering design, setups, receiving, shipping, etc. . Companies that cut prices based on contribution margin to get new business should be cautious about (i competitive reactions, (ii having to lower prices to existing customers, and (iii filling up capacity with business that does not pay for capacity costs. &f a company cuts prices when near capacity, demand could increase beyond existing capacity. Conse0uently, the company may end up having to supply more capacity for support resources to handle the work, without being paid for supplying these capacity resources. 7sing TD!=C, only two parameters are needed for each department or process$ %. Calculate capacity cost rates for each department or process
+%C5+
(. Time re0uired by products, orders, services, and customers on the organi1ation3s capacity resources. Q$ Het3s start building the time-driven !=C model. Fhat are the various capacity cost ratesY (b Capacity Cost <ates
Cost? .onth )roduction and :etup Habor .achine 2xpenses <eceiving and )roduction Control 2ngineering )ackaging and :hipping >,,499 >;,899 >,,499 >4,C;9 >,,499 Days 7sed )aid Irs Aonprod. )rod. )rod. ,ost )er .onth )er Day Iours Irs?Day Irs?.o Per -r (9 (9 (9 (9 (9 C.; C.; C.; C.; %.; %.9 %.; %.9 5.9 %(.9 5.; 5.9 5.; %(9 (89 %,9 %(9 %,9 .32.50 .22.50 .30.00 .81.25 .30.00
Iours 7sed #alvesP C,;99 (,-;9 ,,C;9 %99 %99 (; 59 %,9,, *low )umps ControllersP %(,;99 8,999 5,(;9 5,(;9 599 599 %(; (89 %,C;9 %,599 %,(99 (,C99 (,C99 (-% 599 C99 Total Iours (8,999 %9,C99 %%,(99 ,,899 %8,599 ,,899 8,% 499 ,,8-,
)roduction #olume DH ()roduction and !ssembly .achine <uns .achine :etups Total .achine :etup Habor <eceiving and )roduction Control 2ngineers )ackaging and :hipping
P*or valves, DH hours @ C,;99 valves G 9.,- DH hours per valve @ (,-;9 .achine run hours @ C,;99 valves G 9.; machine hours per valve @ ,,C;9 .achine setup hours and labor setup hours (from case @ %99 (@ ; G (9 <eceiving and production hours @ %.(; G (9 production runs @ (; 2ngineering hours (from case $ 59 )ackaging and shipping hours @ (89 shipments G ;9?59 L (C,;99 valves G -?59 @ %,9,,
+%CC+
+%C-+
*or flow controllers$ DH hours @ 8,999 G 9.89 @%,599 .achine run hours@ 8,999 G 9.,9 @%,(99 .achine setups (from case @ @ (,C99 (@ ((; G %( Habor setup hours (from case @ @ (,C99 (@ ((; G %( <eceiving and production hours @ ((; G %.(; @ (-% 2ngineering (from case $ 599 )ackaging and shipping hours @ ((99G ;9?59 L (8,999 G -?59 @ C99 The figures for pumps are computed similarly. )ractical and 7sed Capacity <esources DH ()roduction and !ssembly .achines (<uns and :etup :etup Habor <eceiving and )roduction Control 2ngineers )ackaging and :hipping P<ounded <es. Quant. 49 5( ,9 8 (Iours !vail? <es. 7nit %(9 (89 %(9 %,9 %(9 %,9 Iours !vail. Iours 7sed !vail O B Cap. 7sed Irs 7sed %99 (-9 (99 -4P 59 %;CP 44B 4-B 48B -,B 48B 45B
%9,-99 %9,C99 %8,--9 %8,599 ,,599 ,,899 ;(9 459 ,,589 8,% 499 ,,8-,
+%C4+
Het3s assign the costs of these various resources?departments to the flow controller line$ ota$ ime ,ost &ate ,ost Assi#"ed /"it ,ost '4,000* .achine run time$ %,(99 >((.;9 > (C,999 > 5.C; :et-ups (labor (,C99 ,(.;9 -C,C;9 (%.48 :et-ups (machines (,C99 ((.;9 59,C;9 %;.%4 <eceive?)rod Ctrl ((;G(C;?59 (-%.(; ,9.99 -,8,(.%% )ackage J :hip T(99G;9L8,999G-U?59 C99 ,9.99 (%,999 ;.(; 2ngineering 599 -%.(; 8-,C;9 %(.%4 ota$ 0ver!ead >(;,,5->5,.8( Direct Habor ;(,999 %,.99 Direct .aterials --,999 ((.99 >,4,,5-> 4-.8( <evenues Eross .argin >,-9,999 >(%,,5-4;.99 (> ,.8(
Iand out sheet of )JH of :ippican. Do you believe the revised )JHY
+%-9+
(c (:mall discrepancies in totals are due to calculations performed in a spreadsheet package.

#alves C,;99 >;4(,;99 %(9,999 4(,5(; ,C4,-C; #alves$ per unit costs )umps %(,;99 >-C;,999 (;9,999 (9,,%(; 8(%,-C; )umps$ per unit costs *low Contr. 8,999 >,-9,99 9 --,999 ;(,999 (89,999 *Cs$ per unit costs Total 7nused CapacityP !ctual )ercent of :ales
7nits :ales .aterials 2xpenses DH 2xpenses Contribution .argin .anufacturing 6verhead .achine 2xpenses :etup Habor .achine :etupPP <eceiving and )roduction Control 2ngineering )ackaging and :hipping Total .anufacturing 6verhead Total costs Eross .argin Eross .argin?:ales B :elling and !dministrative 2xps. 6perating )rofit <eturn on :ales
>C4.99 %5.99 %(.,; ;9.5;
>C9.99 (9.99 %5.(; ,,.C;
>4;.99 ((.99 %,.99 59.99
>%,-8C,;99 >8;-,999 >,8C,C;9 >%,98%,C;9
>%,-8C,;99 >8;-,999 >,;%,999 >%,9,-,;99
%99B
>,,(;9 ->,,(;9
;5B
-8,,C; ,,(;9 (,(;9 C;9 8,-C; ,%,999 %(5,;99 ,,4,%(; (;,,,C; 8(.-B
%%.(; 9.8, 9.,9 9.%9 9.5; 8.%, %5.-C 8;.(( ,,.C-
%89,5(; %4,;99 %,,;99 ,,C;9 %4,;99 ;(,;99 (84,,C; C9(,;99 %C(,;99 %4.CB
%%.(; %.;5 %.99.,9 %.;5 8.(9 %4.4; ;5.(9 %,.-9
(C,999 -C,C;9 59,C;9 -,8,8-,C;9 (%,999 (;,,5-,4,,5--%,,5--,.5B
5.C; (%.48 %;.%4 (.%% %(.%4 ;.(; 5,.8( 4-.8( -,.8(
>(;(,999 >%%9,;99 >C5,;99 >%(,4,>C,,%(; >%98,;99 >5(4,;5, >%,8,;,,%, >8%(,%-((.,B
>5,,99 >5,;99 >9 >(,55, >8,-C; >8,C99 >(;,9,>(-,(-->(-,(--
>(;-,,99 >%%C,999 >C5,;99 >%;,599 >C-,999 >%94,(99 >5;8,599 >%,85,,599 >,-,,499 (9.-B >,;9,999 >,,,499 %.-,B
,;B
(%B %4B (B
P :ee the following table. PP.achine :etup unused capacity is included with .achine 2xpenses unused capacity.
+%-%+
Chapter ): Activity-Base Cost Systems
7sing the capacity rates and unused capacity hours computed in part (b , the cost of unused capacity is as follows. <esources DH ()roduction and !ssembly .achines (<uns and :etup :etup Habor <eceiving and )roduction Control 2ngineers )ackaging and :hipping P<ounded !vailable O 7sed Irs %99.99 (-9.99 (99.99 --.C; 59.99 %;5.5CP Cost?Ir >,(.;9 >((.;9 >,(.;9 >,9.99 >-%.(; >,9.99 Cost of 7nused Capacity >,,(;9 >5,,99 >5,;99 >(,55, >8,-C; >8,C99
The following table summari1es the difference in reported product costs and profitability with the traditional cost system that :ippican used previously, and the time-driven activity-based costing (TD!=C . The difference lies in the assigned manufacturing overhead costs. The traditional method assigns manufacturing overhead at %-;B of direct labor cost, which results in pumps receiving the greatest overhead per unit, flow controllers the next highest overhead per unit, and valves the least. =ased on the more accurate TD!=C assignment of machine and support expenses, management can see that valves are even more profitable than they thought' pumps, while not earning the targeted ,;B gross margin, are still strong profit contributors, and flow controllers + previously thought to be the most profitable product line + actually lose money because of the high costs of setups, engineering, and shipping. .ost of the engineering work was for the customi1ed flow controllers re0uested by customers.
+ %-( +
Atkinson, Solution Manual t/a Management Accounting, )E
Traditional Cost !nalysis :elling price Direct labor cost Direct material cost .anufacturing overhead at %-;B of DH cost :tandard unit costs Eross margin Eross margin (B Time-Driven !=C !nalysis :elling price Direct labor cost Direct material cost TD!=C overhead :tandard unit costs Eross margin Eross margin (B (d
#alves >C4.99 >%(.,; %5.99 ((.-; >;%.(9 >(C.-9 ,;B #alves >C4.99 >%(.,; %5.99 %5.-C >8;.(( >,,.C8,B
)umps *low Controllers >C9.99 >4;.99 >%5.(; (9.99 ,9.95 >55.,% >,.54 ;B >%,.99 ((.99 (8.9; >;4.9; >,;.4; ,-B
)umps *low Controllers >C9.99 >4;.99 >%5.(; (9.99 %4.4; >;5.(9 >%,.-9 (9B >%,.99 ((.99 5,.8( >4-.8( (>,.8( -,.5B
/es, the approach can be extended to service companies and much larger companies than :ippican. The Towerton case in this chapter provides such an example. Time-driven activity-based costing reduced some of the barriers associated with developing and updating the common approach to activity-based costing, which assigns many resource expenses to activities based on interviews and surveys. Aevertheless, barriers and difficulties associated with managing any ma"or change remain. *or example, individuals may feel vulnerable facing uncertainty about what the time-driven activity-based cost analysis may show. The analysis might reveal that products or customers thought to be very profitable are actually unprofitable, some processes are
+ %-, +
inefficient, or there is substantial unused capacity. &ndividuals may be concerned that they will then be "udged as poor managers, even though they were making decisions that others would agree were good decisions based on the cost system that was in place. (e The company should reconsider its product strategy and focus on its core productsvalves and pumps. :ippican might attempt to increase market share in valves by offering discounts for large orders of valves. *urthermore, :ippican could reduce discounting for pumps, especially for small orders. *inally, :ippican should aggressively raise prices for flow controllers or accept orders to produce flow controllers only when the pricing and order si1e indicate that they can be sold at a profit' :ippican could establish a minimum order si1e. :ippican can also focus on improving processes. *or example, the company could reduce setup times or schedule production of components for multiple product orders to share components across multiple batches. These improvements, in con"unction with the focus on larger orders, should lead to many fewer production runs and shipments, allowing for the possibility of reducing capacity and related costs. This discussion can be carried forward in the same context to include topics such as the =alanced :corecard and activity-based budgeting by using the :ippican = case that follows (case ;-,C and the accompanying )ower)oint presentation slides. 5-37 :ippican Corporation (= (I=: Case 9-106-060 (:ee also the teaching plan for case ;-,5$ :ippican Corporation (! (I=: Case 9-106-058 and the )ower)oint presentation available to instructors. &n :ippican (! , the company experiences declining profits and struggles to understand why it is encountering severe price competition on one product line. The controller collects data that will enable development of a timedriven, activity-based cost model to explain better the different demands of each product line on :ippican[s indirect and support resources. !pplying the newly estimated capacity cost rates for the resources to the production statistics of the three product lines produces a radically different perspective on product line profitability. The (! and (= cases together illustrate motivation and design of a time-driven, activity-based system, the action
+ %-8 +
steps that emerge from a more accurate cost analysis, and a powerful connection between strategic planning and operational budgeting. The following figure diagrams the connections among the =alanced :corecard and strategic planning, activity-based costing, and activity-based operational budgeting.
A new integrated approach links strategic planning with operational budgeting.
S !" Prod$ct a(d C$stomer Pro-ita%i#ity # $orces Model
Activity-Based Costing
Develop Strategy and Strategy Map
BSC
" O%&ectives " !eas$res " Tar'ets " Reve($e )ro*th + !i, " Prod$ctivity a(d Process Improveme(ts
Select Strategic (nitiatives
Develop Sales $orecasts
Propose Production & Sales Plans
ActivityBased Budgeting
Strate'ic I(itiative E,pe(se B$d'et
I(itiative !a(a'eme(t
Resource Plan
" " " Peop#e Capita# S$pport
Budget and Pro $or%a P&'
Process !a(a'eme(t
eac!i"# P$a" This case illustrates that fixed (capacity costs are typically not one big piece of e0uipment. .ost capacity costs come from having many machines and many people. These can be ad"usted up or down based on forecasts of future capacity needs. :ippican currently has 5( machines, %(9 production workers, (- packaging and shipping workers, 8 receiving and production control workers, and - engineers. &t is hard to argue that these are all VfixedW and not avoidable over some not very long time period. Fhile one can have VfixedW costs with one machine and one indirect worker, 5( machines and %59 employees do not represent a VfixedW cost. =ut how do these resource levels and associated costs change as production levels changeY The company uses activity-based budgeting to translate the detailed sales and production plans into specific demands for labor and machine resources. Direct labor increases slightly, but setup labor demand drops dramatically because of fewer production runs and reductions in setup time. :mall
+ %-; +
reductions also occur in indirect labor and engineering time. !ctivity-based budgeting is a powerful tool for creating bottoms-up operational budgets. Iowever, it does re0uire much finer granularity in the sales forecasts and production plan to estimate the demands for organi1ational resources, particularly those performing support functions. (a The planned hours used can be computed based on the data provided in 2xhibit ;-%( and case ;-,5 (:ippican (! $
1a$ves )roduction units Pum)s 2$o3 ,o"tro$$ers (,;99 ota$ (8,;99
Total DH hours %,999 %9,-99 Total machine run hours C;9 %%,C;9 .achine setup hours 8-9 -,( Total machine hours %,(,9 %(,;-( Habor setup hours 8-9 -,( <eceiving and 5(.; %5, production controla 2ngineering hours 59 (89 899 C99 )ackaging and shippingb %,,5C %,5;8%C ,,88( a <eceiving and )roduction Control Time 20uation$ #alves$ %.(; G 89 production runs @ ;9 hours' )umps$ %.(; G 89 @ ;9 hours *low Controllers$ %.(; G ;9 production runs @ 5(.; hours
b
%9,999 %(,999 %ime in 'ours ,,-99 5,999 ;,999 5,999 %59 %4( ;,%59 5,%4( %59 %4( ;9 ;9
)ackaging and :hipping Time 20uation$ #alves$ T89 G ;9 L %9,999 G -U?59 @ -(,999?59 @ %,,5C hours )umps$ TC9 G ;9 L %(,999 G -U?59 @ 44,;99?59 @ %,5;- hours *low Controllers$ T%99 G ;9 L (,;99 G -U?59 @ (;,999?59 @8%C hours
The units of each resource type needed to meet pro"ected demand follow (see the :ippican (! solutions for hours available per resource unit .
<esources Aeeded Direct labor :etup labor .achines <eceiving and production control )ackaging and shipping 2ngineers Iours Irs. !vail. per \*T2s Aeeded <esource 7nit Aeeded %9,-99 %(9 49.99 -,( %(9 5.4, %(,;-( (89 ;(.8, %5, ,,88( C99 + %-5 + %,9 %,9 %(9 %.(; (5.8;.-, !ctual 49 C ;, ( (C 5
(b
&f :ippican can reduce its supply of resources to the estimated needs, :ippican estimated spending and profit next period are as presented in the following statement. &f :ippican cannot reduce its supply of resources to the minimum needed for pro"ected demand, or if :ippican wants to preserve some protective capacity, then spending in V7nused CapacityW will increase.
#alves %9,999 > C;9,999 ,-B > %(,,;99 %59,999 855,;99 5(B %%(,;99 ,,599 ;,(99 %,;99 8,-C; 8%,999 %5-,5C; > 8;(,%C; > (4C,-(; 89B *low )umps Controllers %(,999 (,;99 > 459,999 > (C;,999 8-B %8B > %4;,999 > ,(,;99 (89,999 ;(;,999 ;;B %,;,999 8,,(9 5,(89 %,;99 %4,;99 84,C;9 (%5,,%9 > 5;%,,%9 > ,9-,549 ,(B ;;,999 %-C,;9 9 5-B %5,-C; %9,-99 %;,599 %,-C; ,(,;99 %(,;99 49,%;9 > %CC,5;9 > 4C,,;9 ,;B Charged %,4-;,999 > ,;%,999 8;;,999 %,%C4,999 ;4B (58,,C; %-,C(9 (C,989 8,-C; ;5,-C; %9,,(;9 8C;,%,; %,(-%,%,; > C9,,-5; ,;B 9B ,,%9; (59 (,4(; %,5(; (,9;9 4,45; > 4,45; >(4,45; 7nused Capacity !ctual >%,4-;,999 > ,;%,999 8;;,999 %,%C4,999 ;4B (5C,8-9 (C,,99 C,-99 ;-,;99 %9;,,99 > 8-;,%99 >%,(4%,%99 > 54,,499 ,;B ,;9,999 > ,8,,499 %C.,B
:ippican (= )ro *orma :ales (units :ales revenue :ales percentage DH expenses .aterial expenses Contribution margin .achine runtime expense .achine set-up expense :etup labor <eceiving and production control 2ngineering )ackage J ship .anufacturing overhead Total costs Eross margin Eross margin B :J! 6perating profit <eturn on sales
(c
&f :ippican can reduce the supply of support labor and machines to budgeted levels, the company will earn a ,;B gross margin percent (of sales and a %C.,B return on sales, a considerable improvement from the (%B gross margin percent and (B return on sales of recent experience. !ll products now have pro"ected gross margins around the targeted ,;B level. Total gross margin increases by almost -%B and operating profit
+ %-C +
increases more than ten-fold. The huge profit increase assumes only a modest increase in unit sales and average selling prices. !lthough total units sold increase by only (B, the company is selling more valves and fewer flow controllers. The changes in price and volume are pro"ected to increase sales revenue by C.8B. The ma"or impact on profit is due to ad"usting the types of orders accepted, and reducing the supply of resources no longer needed to handle the small unprofitable orders. ! comparison of product line profitability before and after the changes follows.
+ %-- +
)roduction )rice Direct labor Direct materials Contribution margin Cont. margin B .anufacturing overhead .achine expenses :etup labor .achine setup cost <eceiving and production control 2ngineering )ackage J ship Total manufacturing overhead Total costs Eross margin E. B
:ippican (! )roduct Hine )rofitability #alves )umps *low Controllers C,;99 %(,;99 8,999 > C4.99 > C9.99 > 4;.99 %(.,; %5.(; %,.99 %5.99 (9.99 ((.99 > ;9.5; > ,,.C; > 59.99 58B %%.(; 9.8, 9.,9 9.%9 9.5; 8.%, 8-B %%.(; %.;5 %.99.,9 %.;5 8.(9 5,B 5.C; (%.48 %;.%4 (.%% %(.%4 ;.(; > 5,.8( 4-.8( > (,.8( -8B
:ippican (= )roduct Hine )rofitability #alves )umps *low Controllers %9,999 %(,999 (,;99 > C;.99 > -9.99 > %%9.99 %(.,; %5.(; %,.99 %5.99 (9.99 ((.99 > 85.5; > 8,.C; > C;.99 5(B %%.(; 9.;( 9.,5 9.%; 9.84 8.%9 > %5.-C 8;.(( > (4.C89B ;;B %%.(; 9.;( 9.,5 9.%, %.5, 8.%; > %-.9, ;8.(> (;.C( ,(B 5-B 5.C; 5.(8 8.,( 9.C; %,.99 ;.99 > ,5.95 C%.95 > ,-.48 ,;B
> %5.-C > %4.4; 8;.(( ;5.(9 > ,,.C- > %,.-9 8,B (9B
+ %-4 +
5-38 (a
)ractical capacity for the personnel resources is calculated as follows$ )aid Iours per Day Aonpro- )roductive ductive Iours per Iours per Day Day %.; 5.; %.; %.; %.; 5.; 5.; 5.; Days 7sed per .onth (9 (9 (9 (9 )ractical Capacity Iours per .onth %,9 %,9 %,9 %,9
=rokers !ccount .anagers *inancial )lanners )rincipals Customer service representatives
%.9
C.9
(9
%89
Capacity cost rates are calculated as follows$ Cost )er )erson )er .onth =rokers !ccount .anagers *inancial )lanners )rincipals Customer service representatives > 5,C-C > -,4;8 > -,-(> %(,4,( > 8,%4( )ractical Capacity Iours )er .onth %,9 %,9 %,9 %,9 %89
Capacity Cost <ate > ;(.(% > 5-.-> 5C.4% > 44.8> (4.48
+ %49 +
(b
! summary table of time utili1ation appears below, and supporting computations appear in the subse0uent table. Time .utual 7tili1ation :tock *und a (Iours Trading Trading =rokers (C,((5 (,C98 !ccount .anagers *inancial )lanners )rincipals (,58, (5( Customer service representatives 8,9-5 %,99C a Computations are shown below. !ccount .anagement (,9-9 8%(,%;8 %,9 *inancial )lanning
(9C
%(4
.inutes of activity per month are calculated as follows and then divided by 59 to arrive at the time utili1ation in hours in the table above$
.inutes of !ctivity )er .onth 4ro5ers Aew accounts (minutes for new accounts opened 2xisting accounts (minutes for transactions .eetings with existing accounts (minutes for meetings Total minutes Accou"t 6a"a#ers Aew accounts (minutes for new .utual *und Trading (;;G 59 @ %;,,99 (5,,(; G ; @ %,%,5(; C5;G (9 @ %;,,99 %5(,((; %C; G (89 @ 8(,999 !ccount .anagement *inancial )lanning
:tock Trading ;4;G 59 @ ,;,C99 ,9;,(-- G ; @ %,;(5,889 ,;C9 G (9 @ C%,899 %,5,,,;89
+ %4% +
accounts opened 2xisting accounts (minutes for transactions .eetings with existing accounts (minutes for meetings Total minutes 2i"a"cia$ P$a""ers Aew accounts (minutes for new accounts opened 2xisting accounts (minutes for transactions .eetings with existing accounts (minutes for meetings Total minutes Pri"ci)a$s Aew !ccounts (minutes for new accounts opened 2xisting !ccounts (minutes for transactions or accounts Total minutes ,ustomer 7ervice Aew accounts (minutes for new accounts opened 2xisting accounts (minutes for calls Total minutes
;,899 G %9 @ ;8,999 8-9 G 59 @ (-,-99 %(8,-99
%,9 G 599 @ C-,999
;54 G 49 @ ;%,(%9 %(4,(%9
;4; G %9 @ ;,4;9 ,9;,(-- G 9.; @ %;(,588 %;-,;48 ;4; G %( @ C,%89 8C,599 G ; @ (,-,999 (8;,%89
(;; G %9 @ (,;;9 (5,,(; G 9.; @ %,,%5, %;,C%, (;; G %( @ ,,959 %%,8C; G ; @ ;C,,C; 59,8,;
%C; G (9 @ ,,;99 ;,899 G 8 @ (%,599 (;,%99 %C; G %- @ ,,%;9 %,,(9 G C @ 4,(89 %(,,49
%,9 G 59 @ C,-99
C,-99 %,9 G %- @ (,,89 ;89 G %9 @ ;,899 C,C89
+ %4( +
(c
! summary table of .&): usage during peak and non-peak hours appears below, and sample computations appear in the subse0uent table.
.&): 7sage )eak Aonpeak :tock Trading 85;,4%, .utual *und Trading ,9,(99 !ccount .anagement 45,C-, C(,(%( *inancial )lanning %%,-(, %%,-59 !vailable )roductive Time 55-,-99 ,,8,899
TotalP 598,C%(-4,8%;
44,,;- %9;,4-5
PThe small discrepancies in the totals are due to rounding in the previous columns. .&): usage during peak and non-peak hours is calculated by multiplying .&): per transaction by the number of transactions during peak and non-peak hours, respectively. The computations for stock trading appear below. The other computations are similar.
Transactions )rocessed by :ervers Aumber of Transactions$ :tock Trading )eak 6rder placements, trades and order clearing and settlement activities !ccount balance in0uiries Quotation re0uests =alance transfers !ccount statement preparation Total Aon)eak
.&): )er Transaction
.&): for :tock Trading )eak Aon)eak
%.8 9.% 9.% 9.C 9.4
,9;,(-;(,54; ,,(,899 9 9 549,,-,
9 (,,C,9 %CC,%99 C;,999 (4,C;9 ,9;,;-9
8(C,89, ;,(C9 ,,,(89 9 9 85;,4%,
9 (,,C, %C,C%9 ;(,;99 (5,CC; 44,,;-
Aote$ The cost of .&): usage is provided in this case but the calculation can be assigned as an additional exercise, assuming the servers can process ;9 .&): per hour. The calculation for peak and non-peak usage is as follows$
+ %4, +
2ach server is available for ((( days G ((8 hours per day @ ;(- hours per month. The average cost per hour is therefore >,,%5-?;(- hours @ >5 per hour. Aon-peak-hour usage accounts for (%4 servers G (%5 hours per day @ ,98 hours per day. )eak-hour usage accounts for (C5 servers G (hours per day @ 59- hours per day. .oreover, the ;C-server excess capacity during non-peak hours exists because of the peak-hour need. Therefore the cost of the excess capacity of ;C G %5 hours @ 4%( hours should be charged to peak-hour users. Thus, the peak-usage hourly rate is >5 G (59- L 4%( ?59- @ >%; per hour. The non-peak cost per .&): is >5?;9 @ >9.%( and the peak cost per .&): is >%;?;9 @ >9.,9, as stated in the case. (d !n income statement showing rounded costs and profits in thousands for each of Towerton3s four product lines, as well as the cost of unused capacity, appears below, with sample calculations following. The small discrepancies in the totals and margins are due to rounding.
:tock Trading >(,5-C %,8(% .utual *und Trading > %,94% %8% %8, 9 8( 5 ,((4 > (%,4 -%;8B %85 %, 8 ; %5> (%( --B !ccount .anage -ment > 49 *inancial )lanning >%;5
(999s :ales Costs$ =rokers !ccount .anagers *inancial )lanners )rincipals Customer service reps. Computer server expenses Total Costs .argin .argin B :, E J ! 6perating &ncome 6perating .argin
Total 7sed >8,9(8 %,;5, %8, %85 ,88 %5, (%5 (,;C8 >%,8;9 ,5B
7nused Capacity
Total :upplied >8,9(8 %,;5% %5% %CC ,-%C5 (8% (,C98 >%,,(9 ,,B %,,99 >(9 9.;B
(( %,9 88 %8 (; %(4 > (%(4 -,B
(5, %(( %;( %,4;> C((CB
(5 ,9 (( (%4 > -C( -9B
+ %48 +
:tock trading sales @ >-.-9 G ,9;,(-- @ >(,5-5,;,8. .utual fund trading sales @ >8%.8; G (5,,(; @ >%,94%,%C%. !ccount management sales @ %.;B G >59,999 G %,(99?%( @ >49,999. *inancial planning sales @ (%,9 G >%,(99 L (T49?59U G >%(; @ >%;5,%--. The personnel costs are computed by multiplying the capacity cost rates in part (a by the hours of time utili1ation in part (b . The computer server expenses are calculated by multiplying the peakusage .&): by >9.,9 and the non-peak-usage .&): by >9.%(. *or example, the computation for stock trading is (85;,4%, G >9.,9 L (44,,;- G>9.%( @ >%;%,54C (rounded . The costs in the Vtotal suppliedW column are computed as follows$ Cost )er <esource .onth =rokers !ccount .anagers *inancial )lanners )rincipals Customer service representatives Computer server expenses Total > 5,C-C > -,4;8 > -,-(>%(,4,( > 8,%4( > ,,%5Aumber of <esources (,9 %(9 ,9 8( C5
Total Cost >%,;5%,9%9 > %5%,%C( > %C5,;59 > ,-C,459 > %C5,958 > (89,C5>(,C9,,;,8
The core stock trading and mutual fund trading product lines are profitable, with mutual fund trading highly profitable. &n contrast, the new product lines, investment account management and financial planning, are unprofitable' investment account management is highly unprofitable, with a return on sales of +%;8B. The large differences in profits across the product lines are due in part to the high cost of personnel (account managers and principals for account management, and financial planners for financial planning in proportion to product
+ %4; +
line sales for the unprofitable product lines. &n addition, computer server expenses are 8%.4B of sales for account management. This percentage is far greater than for any of the remaining product lines. (:ee the table below. Costs as a )ercent of 6wn )roduct Hine :ales :tock Trading =rokers !ccount .anagers *inancial )lanners )rincipals Customer service representatives Computer server expenses Total (e ;(.4B 9.9B 9.9B 4.-B 8.5B ;.5B C(.4B .utual *und Trading %(.4B 9.9B 9.9B (.8B (.-B (.9B (9.%B !ccount .anagement 9.9B %;4.(B 9.9B 85.(B 5.4B 8%.4B (;8.(B *inancial )lanning 9.9B 9.9B 4,.5B -.,B (.;B ,.(B %9C.5B
Towerton3s management team could specify a minimum accounting balance for investment account management and reprice its financial planning services. .anagement could also consider raising prices on stock trading and placing a greater emphasis on mutual fund trading, which is its most profitable product line.
+ %45 +

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

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

Chapter 5: Activity-Base Cost Systems

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

Chapter 5: Activity-Base Cost Systems

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

Chapter 5: Activity-Base Cost Systems

4, 44 G >,-.;9 G >,-.;9 >,,;-9.;9 >,,-%%.;9

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

.ocha!lmond >(,-99 >;(9 >C99 >,,-%( >%,589 >(,,-C( +%,-.(4B

Total >59,C59 >%(,989 >%C,;99 >%;,9%C >%;,999 >%,(9, %.4-B

Chapter 5: Activity-Base Cost Systems

>5;8,999 %5,999 %99,999 >%(9,999

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

Chapter 5: Activity-Base Cost Systems

139.2 32.0 273.7 ,%,,99

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

#anilla %;,;99 %% 170.5 %(.9 36.0 206.5

69.6 413.9 %;8.9

459 %,899 %,%49 %,(-9 >5%9 %%.(B

Chapter 5: Activity-Base Cost Systems

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

>(%9 )er customer complaint >%-9 )er credit check

Chapter 5: Activity-Base Cost Systems

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

7nit Time (Iours 9.C; ,.;9 ,.99

Quantity of !ctivities -,999 899 8;9

7nit Time (Iours 9.C; ,.;9 ,.99

Cost !ssigned >,-(,;99 >C,,;99 >49,999 >;85,999

Chapter 5: Activity-Base Cost Systems

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

!n activity-based costing system might benefit .oss .anufacturing because it

Chapter 5: Activity-Base Cost Systems

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

)roduct S(% >%(9.99 (9.99 ;C.;9 >%4C.;9

)roduct /,C >%89.99 8;.99 -5.(; >(C%.(;

S(% >%(9.99 (9.99 %88.-9

8(.59 >(-8.-9 >((C.59

Chapter 5: Activity-Base Cost Systems

)roduct S(% >(85.->,;5.99

)roduct /,C >,,4.95 >(-8.;9

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

!ctivity )urchase orders Quality control )roduction setups .achine maintenance

>((9,999 = >%,%99 (99 >,;9,999 = >%9 ,;,999

!ctivity )urchase orders

Chapter 5: Activity-Base Cost Systems

<atio of Deluxe$<egular 8$% -$% -$% %9.5C$%

%99 = 9.9( ;,999

%99 = 9.99(; 89,999

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

#ariable support rate$ >%,%(9,999 (-9,999 hours @ >8 per hour.

Chapter 5: Activity-Base Cost Systems

)er 7nit >,99 %89 %8 ;5 %5 %; >(8% >;4

#ariable support rate$ >%,%(9,999 (-9,999 hours @ >8 per hour.

>899,999 = >.%9 per part 8,999,999

>889,999 = >8.99 per board %%9,999

>8-,999 = >,.99 per pound %5,999

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

.achine insertion$ .anual insertion$ Fave soldering$ %.

>%,(,999 = >%.(9 per board %%9,999

Chapter 5: Activity-Base Cost Systems

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

Chapter 5: Activity-Base Cost Systems