Sunteți pe pagina 1din 74

CHAPTER 5: ACTIVITY-BASED COSTING AND MANAGEMENT

QUESTIONS

5-1 Product costs are likely distorted when a firm uses a volume-based rate if the
plant has more than one activity in its operations and not all activities consume
overhead in the same proportion. The more diverse the product mixes of the
plant are in volume, sizes, manufacturing processes, or product complexities,
the greater the cost distortions are likely to be in using a volume-based rate.

5-2 Undercosting a product may appear to have increased the reported profit the
product earned (assuming the firm did not lower its selling price because of the
reported lower product cost). However, the increased profit is, at best, a twist in
truth. Costs of the product not charged to the product itself are borne by other
products of the firm.

Worse, undercosting a product may result in managers erroneously believing the


product to be more profitable than other products and shifting the limited
resource the firm has into manufacturing, promotion, and sales of the product
when, in fact, other products are more profitable to the firm. Severe cost
distortions may lead firms not to drop unprofitable products because the cost
data show these products are profitable.

5-3 Overcosting does not increase revenues. A firm can increase the selling price of
a product, thereby increasing the total revenue from the product only if the
market allows. Increases in the selling price of a product without experiencing
noticeable decrease in the sales quantity of the product is likely an indication
that the product was not priced properly, which might be a result of undercosting
of the product.

Furthermore, overcosting a product is likely accompanied by undercosting of the


firms other products and, as a result, underpricing of one or more of the firms
other products.

When a firm sets a high selling price that is a result of overcosting, competitors
also are likely to enter the market and take away the firms market share. A firm
also may drop or de-emphasize an erroneously overcosted product when it
erroneously believes the product is either unprofitable or having a low-margin.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-1 The McGraw-Hill Companies, Inc., 2008


5-4 Activity-based costing recognizes that resources are spent on activities and the
cost of a product or service is the sum of the costs of activities performed in
manufacturing the product or providing the service.

An activity-based costing system traces costs to the activity that consumes


resources. Costs are determined based on the activities performed for cost
objects and their underlying cost drivers that consume resources. Product or
service costs determined using activity-based costing reflect costs of resources
consumed for activities performed in manufacturing products or providing
services. In contrast, a volume-based costing system uses cost allocations to
channel indirect costs to products or services. As a result, the cost of a product
or service often bears little or no relationship to activities performed in the
manufacturing of the product or service.

5-5 Based on the activities of most manufacturing firms, the general levels of cost
hierarchy of an activity-based costing system are:
Unit-level cost;
Batch-level cost;
Product-level cost; and
Facility-level cost.

5-6 In an activity-based costing system, the second-stage procedure in tracing costs


to products or services is a process by which the costs of activities or activity
pools are assigned to cost objects using one or more appropriate activity
consumption cost drivers.

5-7 All firms should use an ABC system when the benefits of such a system exceed
the costs of implementing it. It is especially beneficial to firms with product
diversity and/or process complexity.

5-8 Unit-level activities are activities performed on individual units of product or


service. The frequency of a unit-level activity varies in proportion with the units
of product manufactured or service provided.

Examples of unit-level activities are using direct materials, using direct labor
hours, inserting a component, inspecting each unit, and consuming power to run
machines.

5-9 Batch-level activities are activities performed for a group of units of products or
services rather than for each individual unit of product or service. The frequency
of batch-level activity is determined by both the size of the group and the total
number of units to be manufactured or provided.

Examples of batch-level activities are setting up machines, processing and


placing of purchase orders, scheduling production runs, inspecting products by
batch, and handling materials.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-2 The McGraw-Hill Companies, Inc., 2008


5-10 Product-level activities are activities undertaken to support individual products or
services rather than for each individual unit of product or service or a group of
individual units of products or services.

Examples of product-level activities include product design, parts administration,


and product modification.

5-11 Facility-level activities are activities performed for the entire organization or
division to meet the required operating procedure or support the operation of the
organization or division.

Examples of facility-level activities include providing security for the facility,


maintaining general equipment and facility, plant management, plant
depreciation, and property taxes and insurance premium for facilities.

5-12 A product-costing system that uses a single volume-based cost driver is likely to
overcost high-volume products because high-volume products do not consume
support resources in proportion to their production volumes. As a result, a
product-costing system that uses a single volume-based cost driver often
overcosts high-volume products or services and undercosts low-volume products
or services.

The cross-subsidizations of low-volume products by high-volume products is


likely to lead the firm not to price its products properly. This may also decrease
the profits of the firm and reduce managements confidence in the product cost
predictions. Poor pricing can lead a firm to promote less profitable products
while not spending sufficient resources on more profitable items.

5-13 Activity-based management is the use of an activity-based costing system to


improve operations, increase customer value, and enhance profitability.

5.14 Examples of high-value-added activities include insertion of parts, assembling of


components, machining to meet specification, reducing response time, and
reduction of defective characteristics.

5.15 Examples of low-value-added activities include moving parts between


workstations, transporting finished units to warehouse, waiting for materials or
parts to arrive, inspecting, repairing, and storing.

5.16 Service organizations such as banks, hospitals, transportation companies, law


firms, and trading companies can use activity-based costing and management in
all phases of their operations as manufacturing firms do. For example, a bank can
use ABC to calculate the cost to process a check, a hospital can use ABC to
determine costs per patient day for different kinds of patients and the cost to
admit a patient, etc.

5.17

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-3 The McGraw-Hill Companies, Inc., 2008


Opportunities afforded by customer profitability analysis are:
Providing better services to highly profitable customers;
Identifying and securing highly profitable customers from competitors;
Setting prices based on the cost to serve;
Negotiating with customers to set mutually beneficial levels of services;
Transforming unprofitable customers into profitable ones through targeted
negotiations on price, quantity, product mix, order processing, delivery terms,
and payment arrangements;
Identifying and conceding permanent loss customers to competitors.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-4 The McGraw-Hill Companies, Inc., 2008


BRIEF EXERCISES

5-18 Total Cost per Batch = $50 + (.1 x 5,000)


= $550
Cost to produce 100,000 cans = (50 x (100,000/5,000)) + (.1 x 100,000)
= $11,000

5-19 ((30,000 x 0.2) / 60) x $10= $1,000

5-20 Cost for 50 Heads = (60 / 20) x 5 + (50 x $0.1) = $20


Cost for 60 Heads = (60 / 20) x 5 + (60 x $0.1) = $21
Difference = $21 $20 = $1

5-21 (($15 x .5) + $5) x 5 cars x 5 days = $312.50 per week

5-22 Cost per computer = $1,000,000 / 5,000 = $200 per computer


$200 = (2 x (cost of one technician hour)) + (5 x $10)
Cost for technician time = $200 - $50 = $150
$150 = 2 x (cost of one technician hour)
technician hourly rate = $75 per technician hour

5-23
Materials Cost = $3,000,000 / 100,000 = $30 per camera
Labor Cost = $500,000 / (100,000 x .5)
= $10 per camera
Inspection Cost = $1,000,000 / (100,000 x .2)
= $50 per camera
Packaging Cost = $500,000 / 100,000
= $5 per camera

5-24
Direct Labor = $8 x 5 = $40
Copying = $0.05 x 1,000 = $50
Total Job Cost = $50 + $40 = $90

5-25
Data Entry = $2,000,000 / 100,000 = $20 per hour
Data Analysis = $3,000,000 / 30,000 = $100 per hour

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-5 The McGraw-Hill Companies, Inc., 2008


5-26
Volume Based Rate = 2 x $10 = $20 overhead per mattress
Activity Based Rate:
Materials Handling = 30 x $.10
= $3 materials handling cost per mattress
Setup Cost = $5 x 2
= $10 per mattress
Total ABC = $3 + $10
= $13 per mattress
Overstatement = $20 $13 = $7 per mattress

5-27
$150 x .2 = $30 million
500,000 x 20 = 10 million

$30/10 = $3 per part

Total inspection cost:


$3 x 20 = $60 for 20 parts

$3 x 50 = $150 for 50 parts

5-28
6 x 10,000 x $.50 = $30,000

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-6 The McGraw-Hill Companies, Inc., 2008


EXERCISES

5-29 Activity Levels (5 min)

1. Cost Hierarchy
a. Unit-level f. Product-level
b. Unit-level g. Facility-level
c. Facility-level h. Facility-level
d. Unit-level i. Batch-level
e. Unit-level j. Batch-level (one bag per customer).

2. Cost Driver

a. Number of hamburgers
b. Number of hours
c. Square feet
d. Number of hamburgers; Size of hamburgers
e. Number of hamburgers
f. Number of times the advertising is run
g. Number of hours store is open
h. Square feet
i. Number of coupons redeemed; Number of multiple orders; Number
of hamburgers
j. Number of customers

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-7 The McGraw-Hill Companies, Inc., 2008


5-30 Activity Levels and Cost Drivers (5 min)
1. Activity Levels
a. Unit-level f. Facility-level
b. Batch-level g. Product-level
c. Batch-level h. Product-level
d. Batch-level; Product-level i. Unit-level; Batch-level
e. Product-level j. Batch-level.

2. Cost Drivers
a. Machine hours
b. Number of setups or setup hours
c. Number of production orders
d. Number of material receipts; Number of purchase orders
e. Number of products
f. Number of machine hours
g. Number of engineering change notices; number of modifications;
Number of products
h. Number of parts; Number of products; Number of purchase orders
i. Number of inspection hours; Number of units; Number of batches
j. Number of loads; Number of material moves; Material weights

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-8 The McGraw-Hill Companies, Inc., 2008


5-31 Activity Levels and Cost Drivers (5 min)

1. Activity Levels
a. Product-level f. Batch-level
b. Product-level g. Unit-level
c. Product-level h. Facility-level
d. Product-level i. Product-level
e. Batch-level j. Facility-level

2. Cost Drivers
a. Number of products
b. Number of products
c. Number of products
d. Number of products
e. Number of batches or setups
f. Number of batches
g. Number of units
h. Purchase costs; Replacement costs; Book values
i. Number of purchase orders; Number of products; Number of suppliers
j. Square feet

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-9 The McGraw-Hill Companies, Inc., 2008


5-32 Activity Levels and Cost Drivers - Service Company (15 min)

1. Output unit-level costs:


a. Salaries and wages of lab technicians $1,200,000
b. Equipment-related costs $ 300,000

These costs are likely to vary with the number of test-hours, which are
functions of the output units (test).

Batch-level costs:
c. setup costs $240,000
Setup costs are incurred each time a batch of tests is setup for either
ST or PRT, regardless of the number of hours of the tests.

Product-level costs:
d. Costs of test designs $360,000
These costs are incurred in designing ST and PRT tests, regardless of
the number of test-hours or number of batches tested.

2. As shown in the calculation below, the current costing system of


charging $70 per test-hour for overhead undercosts the soil test (ST)
and overcosts the pesticide residues test (PRT). One reason is that ST
uses more setup costs and test design costs than PRT does, while ST
has lower test hours than PRT. On average, ST tests take longer to
setup (0.85 versus 0.575 setup hour per test hour) and it is more
difficult to design the test (0.58 versus 0.21 setup hours per test hour)

Setup Hours Test Design Hours


Test-Hours Total Per Test-Hour Total Per Test-Hour
ST 10,000 8,500 0.850 5,800 0.58
PRT 20,000 11,500 0.575 4,200 0.21

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-10 The McGraw-Hill Companies, Inc., 2008


5-32 (continued)
3.
ST PRT
Total Per Hour Total Per Hour TOTAL
Test hours 10,000 20,000 30,000
Salaries and Wages $540,000 $54.00 $660,000 $33.00 $1,200,000
Equipment-related
costs*
ST 100,000 $10.00
PRT 200,000 $10.00
Setup costs#
ST 102,000 $10.20
PRT 138,000 $6.90
Test design costs&
ST 208,800 $20.88
PRT ________ ______ 151,200 7.56
TOTAL $950,800 $95.08 $1,149,200 $57.46

*Equipment-related
costs $300,000
Test hours 10,000 20,000 30,000
Per test hour $10
Total 100,000 200,000
#
Setup costs: $240,000
Setup hours 8,500 11,500 20,000
Per hour $12.00
Total 102,000 138,000
&
Test design costs: $360,000
Test design hours 5,800 4,200 10,000
Per hour $36.00
Total 208,800 151,200

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-11 The McGraw-Hill Companies, Inc., 2008


5-32 (continued-2)
4.
ST PRT
Total Per Hour Total Per Hour TOTAL
Test hours 2,500 5,000 7,500
Salaries and Wages $135,000 $54.00 $165,000 $33.00 $300,000
Equipment-related costs*
ST 100,000 $40.00
PRT 200,000 $40.00
Setup costs #

ST 255,000 $102.00
PRT $345,000 $69.00
Test design costs&

ST 522,000 $208.80
PRT _________ _______ 378,000 $75.60
TOTAL $1,012,000 $404.80 $1,088,000 $217.60

*Equipment-related costs: $300,000


Test hours 2,500 5,000 7,500
Per test hour $40
Total 100,000 200,000
#
Setup costs: $240,000 $360,000 $600,000
Setup hours 8,500 11,500 20,000
Per hour $30.00
Total 255,000 345,000
&
Test design costs: $360,000 $540,000 $900,000
Test design hours 5,800 4,200 10,000
Per hour $90.00
Total 522,000 378,000

The cost per test-hour increased from $95.08 to $404.80 for ST and from
$57.46 to $217.60 for PRT. Platte Valley needs to reexamine the
appropriateness for using test-hours as the basis for costing. The bulk of the
cost is for setup and test-design and the direct cost related to test-hour is
only a fraction of the setup and test-design costs. A costing system based on
the direct test-hour is likely to distort the true cost of testing.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-12 The McGraw-Hill Companies, Inc., 2008


5-33 Volume-Based Costing vs. ABC (20 minutes)

1. The volume-based cost system developed for inventory valuation is


likely to distort product cost information because the cost system:
a. is designed to value inventory in the aggregate and not related to
product cost information.
b. uses a common departmental or volume-based measure of
activity, such as direct labor hours or dollars (now a small portion
of overall production costs) to distribute manufacturing overhead
to products.
c. de-emphasizes long-term product analysis (when fixed costs
become variable costs).
d. causes managers, who are aware of distortions in the volume-
based system, to make intuitive, imprecise adjustments to the
volume-based cost information without understanding the
complete impact.

2. Outlined below are the purpose and several characteristics of the


three noted cost systems.

a. Inventory Valuation
Meets external reporting requirements for aggregate balance sheet
valuation and income determination.
Provides monthly and quarterly reporting.

b. Operational Control
Evaluates operations to quickly detect problems to allow for
implementation of corrective action.
Compares costs against budget for monitoring variances.

c. Activity-based costing
Differentiates costs between high-value added and low-value-added
activities.
Costs products according to activities involved in the production
process.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-13 The McGraw-Hill Companies, Inc., 2008


5-33 (continued)

3. The benefits that management can expect from activity-based costing


include these:
a. Leads to a more competitive position by evaluating cost drivers,
i.e., costs associated with the complexity of the transaction rather
than the production volume.
b. Streamlines production processes by reducing low-value-added
activities, e.g., reduced set-up times, optional plant layout, and
improved quality.
c. Provides management with a more thorough understanding of
product costs and product profitability for strategies and pricing
decisions.

4. The steps that a company, using a volume-based cost system, would


take to implement activity-based costing include:
a. evaluation of the existing system to assess how well the system
supports the objective of an activity-based cost system.
b. identification of the activities for which cost information is needed
with differentiation between high-value added and low-value-
added activities.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-14 The McGraw-Hill Companies, Inc., 2008


5-34 Activity-Based Costing Hakara Company (10 min)

Cost Pools Activity Costs Cost Drivers Overhead Rate


Machine setup $360,000 3,000 setup hours $120
Materials handling 100,000 25,000 pounds 4
Electric power 40,000 40,000 kilowatt hours 1

A B .
Direct materials $40,000 $50,000
Direct labor 24,000 40,000
Factory overhead:
Machine setup $120 x 200 = 24,000 $120 x 240 = 28,800
Materials handling $4 x 1,000= 4,000 $4 x 3,000 = 12,000
Electric power $1 x 2,000 = 2,000 $1 x 4,000 = 4,000
Total product costs $94,000 $134,800
Production units 4,000 20,000
COST PER UNIT $23.50 $6.74

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-15 The McGraw-Hill Companies, Inc., 2008


5-35 Customer Profitability Analysis: Hotels (15 min)

1. The information gathering program are a logical fit for the luxury type
hotels described here. These firms compete on their ability to attract high-
paying customers to their luxury hotels. These additional services can give
the hotel a competitive edge.

2. There is a good application for activity-based costing here. The program


should be analyzed by activity (the different types of premium services
offered), and then the cost drivers of these activities should then be
identified, and traced to the cost object, which in this case is the individual
customer. It is likely that the hotel rates are sufficiently high, that the cost of
the extra services is covered by the room charges, but those managing the
program should be able to know how effective it is in general, and for each
customer. This type of information will help them revise the program if
necessary, and to better target their most profitable customers.

3. Some will argue there is not ethical issue with the information gathering.
Others might argue that the guest should be informed that the information is
being obtained and used throughout the hotel chains system. For
example, Marriott has guests fill out a form to participate, so the program is
entirely optional. Other ethical issues arise, for example, if the hotel chain
chooses to sell the information to third parties, such as magazine
publishers, retail stores, or other businesses.

This exercise is based on information obtained from the article by Avery


Johnson, Hotels Take Know Your Customer to New Level, The Wall
Street Journal, February 6, 2006, p D1.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-16 The McGraw-Hill Companies, Inc., 2008


5-36 Applications of ABC Costing in Government (20 min)

1,2. A variety of examples are possible here. For additional examples:


Gary Cokins, Activity-Based Cost Management in Government,
Management Concepts, Inc., 2001. Also, see case studies of
governmental agencies in Cost & Effect, by Robert S. Kaplan and Robin
Cooper, Harvard Business School Press, 1998, pp 245-250. Kaplan and
Cooper explain application at the U.S. Veterans Affairs Department, the U.S.
Immigration and Naturalization Service, the U.S. Internal Revenue Service,
and the City of Indianapolis.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-17 The McGraw-Hill Companies, Inc., 2008


5-37 Activity-Based Costing in the Fashion Apparel Industry (20 min)

The ABC-costing solution follows:

The results suggest that the trouser line is more profitable than previously
thought (using volume-based costing). This is likely due to the common
situation in which the high-volume products are overcosted using volume-
based costing.

Source of data used in the example: Andrew Hughes, ABC/ABM: A


profitability Model for SMEs Manufacturing Clothing in the UK, Journal of
Fashion Marketing and Management, 2005, Vol 9 Is 1, pp8-19. (SME
means small to medium size company)

5-38 Service Industry GWS Hospital (10 min)


Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-18 The McGraw-Hill Companies, Inc., 2008
1.GWSs ICU overhead costs for the month of June using:
a. Hospital Wide Rate Based on Nurse-Hours
Per nurse-hour: $69,120,000 /1,152,000 = $60
Total ICU applied overhead costs:$60 x 5,900 =
$354,000
b. The ICU Department Wide Rate Based on Patient-Day
Total budgeted ICU overhead:
$810,000 + $422,500 + $457,500 = $1,690,000
Overhead rate per patient-day:
$1,690,000 / 845 = $2,000
Total ICU applied overhead costs: $2,000 x 870 = $1,740,000
c. Activity Cost Driver Rates
Budgeted Budgeted Budgeted Total Applied
Cost Pool Cost Activity OH Rate Activity Overhead
Beds $810,000 900 $900.00 900 $810,000
Equipment 422,500 845 500.00 870 435,000
Personnel 457,500 6,000 76.25 5,900 449,875
Total applied overhead costs $1,694,875

2. The first method uses a hospital-wide overhead rate, which likely


bears no relationship with the overhead activities performed in the
intensive care unit (ICU). The second method uses the patient-day
overhead rate for the ICU department. This is an improvement over
the first method. But a single patient-day cost driver may not have
direct relationships with some of the activities performed in the ICU
department. The third method is the preferred method because it
uses a cost driver for each of the cost pools that reflects the
resources consumed by activities of the cost pool.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-19 The McGraw-Hill Companies, Inc., 2008


5-39 Product Selection (5 min)

Before deciding on which of the two products the firm should


focus, the company should review its costing system. It is likely
that Johans product costing system is providing misleading cost
information. The company is probably using a volume-based
product costing system, which tends to overcost the high-volume
product (Desktop Computer) and undercost the low-volume
product (Tablet Computer). When competitors can sell a product
at a price ($380) much lower than our cost for the desktop model
($550), it is likely that the costing system fails to determine
product costs properly or that the applied manufacturing process
is very inefficient.
The company should install an activity-based product costing
system. If the reported product cost indicates that the price of the
high-volume desktops is too high compared to the competitors
price, then the company should adjust the price accordingly.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-20 The McGraw-Hill Companies, Inc., 2008


5-40 High-value-added and Low-value-added ActivitiesRadiology (5
min)
(Note to instructor: Answer may vary if students perceive a different
operation)
a. High-value-added
b. Low-value-added (Patients are likely to perceive waiting to have
low-value)
c. Low-value-added (Any need for lab work should have been
determined prior to arriving at the Radiology Department)
d. Low-value-added
e. High-value-added
f. High-value-added
g. Low-value-added
h. Low-value-added
i. High-value-added

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-21 The McGraw-Hill Companies, Inc., 2008


5-41 High-value-added and Low-value-added ActivitiesNurse (5 min)
(Note to instructor: Answer may vary if students perceive a different
operation)
a. High-value-added f. High-value-added
b. High-value-added g. High-value-added
c. High-value-added h. Low-value-added
d. Low-value-added i. High-value-added
e. Low-value-added

5-42 High-value-added and Low-value-added Activitiese-Retailing (5


min)
(Note to instructor: Answer may vary if students perceive a different
operation)
a. Low-value-added e. Low-value-added
b. Low-value-added f. High-value-added
c. Low-value-added g. Low-value-added
d. Low-value-added h. High-value-added

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-22 The McGraw-Hill Companies, Inc., 2008


5-43 ABC and Job-Costing (20 min)

A: $0.15 x 30 = $ 4.50

B: $37 / 1.85 = $20.00

C: $35.50 / 5 = $ 7.10

D: $0.08 x 100 = $ 8.00

Cost per board that passed the final inspection $240.00

Rejection rate x 50%

Cost per completed board $120.00

Direct materials $25.00

Direct labor 5.00

Other manufacturing overhead:

Axial insertion $ 4.50

Hardware insertion37.00

Hand load 35.50

Masking 8.00 85.00 115.00

Manufacturing overhead for final test (E) $5.00

Units of cost driver for final test 10

Manufacturing overhead rate per unit of test time(F) $0.50

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-23 The McGraw-Hill Companies, Inc., 2008


5-44 Cost of Meal (5 min)

Below is a suggestion for Annies response:

Dear Totem Pole: If these are business-related dinners, you should


talk to your accountant about deducting them from your expenses or
billing your share to the clients. If that isnt feasible, agree to meet
these folks for cocktails, but leave before dinner, claiming you have to
be elsewhere. No other excuse is needed.

Note: This example illustrates the advantages of ABC in a familiar


situation. Put all in one check and then split the bill equally is an
example of volume-based overhead rate. Split-up the bill based on the
number of meals is like using machine hours, labor hours, or other
measures, rather than the activities themselves, to determine costs of
products or services. Products having the same total machine hours
pay for the same amount of overhead, regardless of the differences in
the amount of setup times, product design hours, etc. these products
might have used.
Having separate checks is an ABC system. Each check tracks
activities of an activity cost center. The person who engages in more
activities drinks or eats more than others pays a higher bill.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-24 The McGraw-Hill Companies, Inc., 2008


5-45 Product-line Profitability, ABC (25 min)
1. Product-line profitability under the current costing system
Frozen Food Baked Goods Fresh Produce
Sales $120,000 $90,000 $158,125
Cost of goods sold 105,000 67,000 110,000
Gross margin $ 15,000 $23,000 $ 48,125
Store support (20% of Sales) 24,000 18,000 31,625
Operating income ($ 9,000) $ 5,000 $ 16,500
Operating margin (OI/S) -7.50% 5.56% 10.43%

2. Product-line profitability under ABC


Frozen Food Baked Goods Fresh Produce
Sales $120,000 $90,000 $158,125
Cost of goods sold 105,000 67,000 110,000
Gross margin $ 15,000 $23,000 $ 48,125
Store support:
Order processing 800 4,400 7,200
Receiving 1,100 7,700 13,200
Shelf-stocking 300 525 7,200
Customer support 6,000 8,000 17,200
Total store support cost 8,200 20,625 44,800
Operating income $ 6,800 $ 2,375 $ 3,325
Operating margin (OI/S) 5.67% 2.64% 2.10%

3. Both baked goods and fresh produce have a drop in profitability when
ABC is used. The decrease in profitability of fresh produce is most
noticeable. The profitability of fresh produce decreases from 10.43
percent of the sales revenues under the current system, the highest of
the three products, to 2.10 percent under ABC, the lowest of the three.
This is because fresh produce requires more support activities than the
other two products.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-25 The McGraw-Hill Companies, Inc., 2008


5-46 Customer Profitability Analysis (25 minutes)

Requirement 1
Jerry Inc. Donald Co.
Customer unit-level cost -
Sales returns(40x5;175x5) $200 $875
Customer batch-level costs:
Order processing(5x300;30x300) $1,500 $9,000
Sales returns(2x100;5x100) 200 500
Delivery(5x500;30x500) 2,500 15,000
Customer sustaining costs:
Sales calls(12x1000;4x1000) 12,000 4,000
TOTAL $16,400 $29,375

Requirement 2
Jerry Inc. Donald Co.
Sales(5x1000x200;200x30x200) $1,000,000 $1,200,000
Sales return(40x200;175x200) 8,000 35,000
Net Sales $992,000 $1,165,000
Cost of goods sold(75%) 744,000 873,750
Gross margin(25%) $248,000 $291,250
Sales support cost (from req. 1) 16,400 29,375
Operating income $231,600 $261,875

Operating margin % 23.35% 22.48%

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-26 The McGraw-Hill Companies, Inc., 2008


5-47 Customer Profitability Analysis (25 min)

1. Determination of the $100.50 order-filling cost per unit


Total number of orders: 2 x 100 PCs + 10 x 4,000 SCs = 40,200
Total number of orders 40,200
Number of orders per block 60
Total number of blocks 670
Cost per block x $60,000
Total cost of order blocks $ 40,200,000
Total number of orders 40,200
Per order order-filling cost x $1,500
Total cost per order + 60,300,000
Total order-filling cost $100,500,000
Total units sold 1,000,000
Order-filling cost per unit $100.50

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-27 The McGraw-Hill Companies, Inc., 2008


5-47 (continued)

2. Order filling cost per unit sold to PC:

Total number of orders 2


Number of orders per block 60
Total number of blocks 1/30
Cost per block x $60,000
Total block cost $2,000
Total number of orders 2
Order-filling cost per order x $1,500
Total cost per order + 3,000
Total order-filling cost $5,000
Total units sold 5,000
Order-filling cost per unit $1.00

Net profit per unit at $700 selling price per unit to preferred customers:

Preferred Customer
Selling price per unit $700.00
Manufacturing cost $600.00
Order-filling cost/unit + 1.00
Total cost per unit 601.00
Net Profit per unit $ 99.00

Profit margin per unit 14.14%

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-28 The McGraw-Hill Companies, Inc., 2008


5-47 (continued-2)

3. Order filling cost per order by SC:

Cost per block $60,000


Number of orders per block 60
Block cost per order $1,000
Number of orders per SC x 10
Total block cost per SC $10,000
Order-filling cost per order $1,500
Number of orders per SC x 10
Total cost per order + 15,000
Total order-filling cost $25,000
Total units sold 125
Order-filling cost/unit $200

Profitability per unit at $800 selling price per unit to SC

Selling price per unit $800.00


Manufacturing cost $600.00
Order-filling cost/unit + 200.00
Total cost per unit 800.00
Net profit or loss per unit $ 0

Profit margin 0

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-29 The McGraw-Hill Companies, Inc., 2008


PROBLEMS

5-48 Activity-Based Costing; Customer Group Cost Analysis (30


minutes)

1. First, obtain the total levels for activity cost drivers:

Product Lines Value Quality Luxury Total


Units Produced 15,000 5,000 500 20,500
Direct Materials cost per unit $ 80 $ 50 $ 110 $ 240
Total Direct Materials Cost $ 1,505,000
Number of Parts per unit 30 50 120 200
Total parts 760,000
Direct Labor Hours per unit 4 5 7 16
Total Labor hours 88,500
Machine Hours per unit 3 7 15 25
Total Machine Hours 87,500
Production Orders 50 70 200 320
Production Setups 20 50 50 120
Orders Shipped 1,000 2,000 300 3,300

Then, obtain the activity rates:


Budgeted Cost Activity
Cost Driver Rate
Materials handling $ 349,600 Number of Parts $ 0.460 =$349,600/760,000
Product Scheduling 160,000 Number of Production orders 500.00 =160,000/320
Setup Labor 216,000 Number of setups 1,800.00 =216,000/120
Automated Machinery 1,750,000 Machine hours 20.00 =1,750,000/87,500
Finishing 619,500 Direct labor hours 7.00 =619,500/88,500
Pack and Ship 285,000 Number of orders shipped 86.364 =285,000/3,300

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-30 The McGraw-Hill Companies, Inc., 2008


5-48 (continued)

The activity-based unit and total cost is as follows:

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-31 The McGraw-Hill Companies, Inc., 2008


5-48 (continued)

3. The new activity rates based on practical capacity are as follows.

Note that the rates have changed significantly from the calculations in part 1
above, because there is a significant level of unused capacity in many of the
activities. This information could be used by management to calculate unit
ABC-based costs using the practical capacity rates, and thereby identify the
cost of unused capacity. Moreover, the information about capacity
utilization can be used to help bring resource spending in line with resource
usage. As the firm plans to grow (particularly in the Luxury line), some
additional capacity will be needed, but careful planning will allow a balance
of planned future capacity needs versus current spending on these
resources, probably allowing some capacities to be reduced. The potential
for overcapacity appears to be greatest in product scheduling and pack and
ship.
Perhatikan bahwa harga telah berubah secara signifikan dari perhitungan di
bagian 1 di atas, karena ada tingkat signifikan kapasitas yang tidak terpakai
di banyak kegiatan. Informasi ini dapat digunakan oleh manajemen untuk
menghitung biaya unit berbasis ABC menggunakan tarif kapasitas praktis, dan
dengan demikian mengidentifikasi biaya kapasitas yang tidak terpakai. Selain
itu, informasi tentang pemanfaatan kapasitas dapat digunakan untuk membantu
membawa pengeluaran sumber daya sejalan dengan penggunaan sumber daya. Sebagai
perusahaan berencana untuk tumbuh (terutama di garis mewah), beberapa
kapasitas tambahan akan diperlukan, tetapi perencanaan yang cermat akan
memungkinkan keseimbangan kebutuhan kapasitas di masa mendatang direncanakan
versus pengeluaran saat ini pada sumber daya ini, mungkin memungkinkan
beberapa kapasitas harus dikurangi. Potensi kelebihan kapasitas tampak
tertinggi dalam penjadwalan produk dan paket dan kapal.

3. The ABC costing shows clearly how expensive the Luxury line is to
produce. The volume-based approach fails to account for the activity
usage of the Luxury line, and undercosts it significantly. ABC allows HPI
to better understand how its costs will increase with the expected

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-32 The McGraw-Hill Companies, Inc., 2008


increased production of the Luxury line, and how it will have to adapt its
pricing practices accordingly. Continued use of the volume-based
approach at a time when sales of the Luxury line are increasing would
mean significantly under-pricing the Luxury line, and undermining the
profitability of the entire firm.
4. ABC costing menunjukkan dengan jelas seberapa mahal garis Luxury adalah
untuk menghasilkan. Pendekatan berbasis volume gagal untuk menjelaskan
penggunaan aktivitas garis mewah, dan undercosts secara signifikan. ABC
memungkinkan HPI untuk lebih memahami bagaimana yang biaya akan meningkat
dengan yang diharapkan peningkatan produksi Luxury line, dan bagaimana
hal itu harus beradaptasi nya harga praktik sesuai. Terus menggunakan
pendekatan berbasis volume pada saat penjualan garis mewah meningkat
berarti secara signifikan di bawah-pricing garis mewah, dan merusak
profitabilitas seluruh perusahaan.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-33 The McGraw-Hill Companies, Inc., 2008


5-49 Cost Pools and Cost Drivers (20 min)
Note to instructor: The answer below is but one possible solution.
1. Cost pool 1: Cost driver: Number of purchase orders
Receiving $10,000
Inspection of direct materials 3,000
Purchasing 20,000
Total $33,000

Cost pool 2: Cost driver: Number of production runs


Setup wages $20,000

Cost pool 3: Cost driver: Machine hours


Depreciation, machine $40,000
Electrical power (machining) 30,000
Machine maintenance - labor 11,000
Machine maintenance - materials 9,000
Total $90,000

Cost pool 4: Cost driver: Factory space


Depreciation, building $ 50,000
Electrical power (factory building) 6,000
Insurance 20,000
Property taxes 15,000
Natural gas (for heating) 8,000
Custodial labor 51,000
Total $150,000

Note: However, the problem indicated that the firm uses machine
hours as the base for assigning facility-level costs. An
alternative solution is to combine cost pools 3 and 4.

Cost pool 5: Cost driver: production (in units)


Inspection of finished goods $7,000

Cost pool 6: Cost driver: engineering hours


Engineering design $600,000
Total $600,000

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-34 The McGraw-Hill Companies, Inc., 2008


5-49 (continued)

2. Overhead Rates:
Cost pool 1: Total cost $33,000
Number of purchase orders 6
Cost per purchase order $5,500

Cost pool 2: Total cost $20,000


Number of production runs 40
Cost per production run $500

Cost pool 3: Total cost $ 90,000


Number of machine hours 100,000
Cost per machine hour $0.90

Cost pool 4: Total cost $150,000


Number of machine hours 100,000
Cost per machine hour $1.50

Cost pool 5: Total cost $ 7,000


Number of units 100,000
Cost per unit $0.07

Cost pool 6: Total cost $600,000


Total engineering hours 20,000
Cost per engineering hour $30.00

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-35 The McGraw-Hill Companies, Inc., 2008


5-49 (continued-2)

Manufacturing overheads:
Unit level:
Cost pool 3 Cost per machine hour $ 0.90
Number of machine hours x 4,250 $ 3,825

Cost pool 5 Cost per unit $ 0.07


Number of units x 4,000 280
Batch level:
Cost pool 2 Cost per production run $500
Number of production runs
(4,000 units / 2,500 = 1.6) x 2 1,000

Product-level level:
Cost pool 1 Cost per purchase order $5,500
Number of purchase orders x 1 5,500

Cost pool 6 Cost per engineering hour $ 30


Number of engineering hours x 100 3,000

Facility-level level*:
Cost pool 4 Cost per machine hour $ 1.50
Number of machine hours x 4,250 6,375
Total manufacturing overhead $19,980
Number of units 4,000
Manufacturing overhead per unit $4.995

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-36 The McGraw-Hill Companies, Inc., 2008


5-49 (continued-3)

* There are at least two alternative activity consumption drivers for


assigning facility-level cost:

Based on machine hours:


Total facility-level cost (Cost pool 4) $150,000
Number of machine hours 100,000
Cost per machine hour $1.50

Which is the cost driver for the answer above.

Alternatively, the firm may use number of units to assign facility-level


cost.
Based on number of units:
Total facility-level cost (Cost pool 4) $150,000
Units of production 100,000
Cost per unit $1.50

Unit level:
Cost pool 3 $ 3,825
Cost pool 5 280

Batch level:
Cost pool 2 1,000

Product-level level:
Cost pool 1 5,500
Cost pool 6 3,000

Facility-level level:
Cost pool 4 Cost per unit $ 1.50
Number of units x 4,000 6,000
Total manufacturing overhead $ 19,605
Number of units 4,000
Manufacturing overhead per unit $4.90125

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-37 The McGraw-Hill Companies, Inc., 2008


5-50 Activity-Based Costing, Value Chain Activities (25 min)

1. Prime costs 80 x $1,200 = $ 96,000


Manufacturing overheads:
Material handling 80 x 105 x $0.45 = 3,780
Machining 80 x 3x $51 = 12,240
Assembly 80 x 105 x $2.85 = 23,940
Inspection 80 x $30 = 2,400
Total manufacturing costs $138,360
Number of units 80
Cost per unit $1,729.50

2. Upstream activities $180.00 8.33%


Manufacturing 1,729.50 80.09%
Downstream activities 250.00 11.58%
Full product cost per unit $2,159.50 100%

Strategic implications:
(1) Knowing the full cost of a product including upstream and
downstream costs allows the firm to be aware of all costs
attributable to the product.
(2) The amounts and proportions of upstream, manufacturing, and
downstream costs facilitate comparisons with competitors.
(3) The company should consider ways of spending less cost in the
manufacturing activity, and more on upstream and downstream
activities in order to improve its competitive position by pursuing the
differentiation strategy in both the new product design and the
customer service.

3. The total value chain cost provides the firm a long-term perspective of
the product cost, in addition to the short term manufacturing cost.
Different industries have different cost structures. For example, firms
in the computer software industry are likely to have high upstream
costs while firms in the retailing industry tend to have high
downstream costs.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-38 The McGraw-Hill Companies, Inc., 2008


5-51 Volume-based Costing Versus ABC (10 min)

1. Predetermined overhead rate based on machine hours


= Total budgeted overhead cost / Selected level of production activity
= ($100,000 + $80,000 + $200,000 + $100,000) / 10,000 machine-hours
= $480,000 / 10,000 machine-hours
= $48.00 per machine-hour

Product Total Manufacturing Overhead Barrel OH per Barrel


P5 $48.00 x 1,000 MH = $48,000 500 $96.00
G23 $48.00 x 1,000 MH = $48,000 500 $96.00
2. Overhead Rates:
Overhead Budgeted Level of Predetermined
Cost Pool Overhead Cost Driver Overhead Rate
Machine set-ups $100,000 100 setups $1,000 per setup
Material handling 80,000 8,000 barrels $10 per barrel
Quality control 200,000 1,000 inspections $200 per inspection
Other overheads 100,000 10,000 machine hrs $10 per MH
Overhead Per Barrel:
Manufacturing Overhead
Overhead P5 G23
Cost Pool Rate Activity Overhead Activity Overhead
Machine set-ups $1,000 1 $ 1,000 50 $50,000
Material handling $10 500 5,000 500 5,000
Quality control $200 2 400 20 4,000
Other overheads $10 1,000 10,000 1,000 10,000
Total overhead $16,400 $69,000
Number of barrels 500 500
Cost per barrel $ 32.80 $138.00
5-51 (continued)

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-39 The McGraw-Hill Companies, Inc., 2008


j. The volume-based rate significantly undercosts the G23 product which
requires several times the amount of machine setup and quality
inspection effort relative to product P5. This means that pricing and
analysis of product line profitability will be distorted. Strategic
planning based on profitability analysis will also be misguided as a
result. Suppose, for example, that CCO, using volume-based
accounting, is asked to bid on a rather larger order for the G23
product; it is likely to win the order because the volume-based cost is
distorted too low. The problem then is that CCO must produce and
sell this order at very low or negative profits, because its actual costs
of producing the order will be closer to the ABC costs. Similarly,
bidding for a potential order on the P5 product will likely fail under the
volume-based system, as CCOs costs are distorted again this time
too high. CCO will lose these potentially profitable orders.

Under volume-based costing, CCO will likely see its order mix shift to
G23 and away from P5, as competitors that use ABC costing will use
proper pricing and get the most profitable orders. The result might be
that CCOs sales will continue to increase (lots of G23), but its
profitability will decline (G23 is not priced properly). This is a good
signal of a firm that needs ABC costing sales up but profits down, in
this case, because of an unprofitable shift in the product mix due to cost
distortions in volume-based costing.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-40 The McGraw-Hill Companies, Inc., 2008


5-52 Volume-based Costing Versus ABC (35 min)
1. Product A Product B Product C
(1) Target price $279.00 $294.00 $199.50
(2) Manufacturing cost (1) 150% $186.00 $196.00 $133.00
Prime cost - 70.00 - 126.40 - 75.00
Overhead cost per unit $116.00 $ 69.60 $ 58.00
Number of units x 1,000 x 5,000 x 500
Total overhead $116,000 $348,000 $29,000

2. Current Costing system


Product A Product B Product C
Actual selling price $280 $250 $300
Product manufacturing cost 186 196 133
Gross margin $ 94 $ 54 $167
Gross margin ratio 33.57% 21.6% 55.67%

Based on the current cost data, it is true that product B is the least
profitable product with a gross margin per unit of $54.00 (21.6%) and
product C is the most profitable product with a gross margin per unit of
$167.00 (55.67%). However, the validity of this conclusion is based on
the accuracy of the reported product costs.

Product costs based on the activity-based costing system

Product A Product B Product C


Direct materials $ 50.00 $114.40 $ 65.00
Direct labor 20.00 12.00 10.00
Factory overhead:
Setups (a) 1.60 0.80 4.80
Materials handling (b) 40.00 5.00 70.00
Hazardous control (c) 62.50 22.50 150.00
Quality control (d) 22.50 5.25 52.50
Utilities (e) 12.00 8.40 12.00
Total $208.60 $168.35 $364.30

Actual selling price $280.00 $250.00 $300.00


Product manufacturing cost 208.60 168.35 364.30
Gross margin $ 71.40 $ 81.65 ($64.30)
Gross margin ratio 25.50% 32.66% (21.43)%

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-41 The McGraw-Hill Companies, Inc., 2008


5-52 (continued)

Notes:
(a) Setups:
Cost per setup: $8,000 / (2 + 5 + 3) = $800 per setup
Product A = 2 x $800 = $1,600; $1,600 /1,000 = $1.60 per unit
Product B = 5 x $800 = $4,000; $4,000 /5,000 = $0.80 per unit
Product C = 3 x $800 = $2,400; $2,400 /500 = $4.80 per unit

(b) Materials handling:


Cost per pound = $100,000 / (400 + 250 + 350) = $100 per pound
Product A = 400 x $100 = $40,000; $40,000/1,000 = $40.00 per unit
Product B = 250 x $100 = $25,000; $25,000/5,000 = $ 5.00 per unit
Product C = 350 x $100 = $35,000; $35,000/500 = $70.00 per unit

(c) Waste and hazardous disposals:


Cost per disposal: $250,000/(25 + 45 + 30) = $2,500 per disposal
Product A = 25 x $2,500 = $ 62,500; $ 62,500/1,000 = $ 62.50/unit
Product B = 45 x $2,500 = $112,500; $112,500/5,000 = $ 22.50/unit
Product C = 30 x $2,500 = $ 75,000; $ 75,000/500 = $150.00/unit

(d) Quality inspections:


Cost per inspection = $75,000/(30 + 35 + 35) = $750 per inspection
Product A = 30 x $750 = $22,500; $22,500/1,000 = $22.50 per unit
Product B = 35 x $750 = $26,250; $26,250/5,000 = $ 5.25 per unit
Product C = 35 x $750 = $26,250; $26,250/500 = $52.50 per unit

(e) Utilities:
Cost per MH = $60,000 / (2,000 + 7,000 + 1,000) = $6.00 per MH
Product A = 2,000 x $6 = $12,000; $12,000/1,000 = $12.00 per unit
Product B = 7,000 x $6 = $42,000; $42,000/5,000 = $ 8.40 per unit
Product C = 1,000 x $6 = $ 6,000; $ 6,000/500 = $12.00 per unit

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-42 The McGraw-Hill Companies, Inc., 2008


5-52 (continued-2)

3. Comparison of reported product costs, new target price, actual selling


price, and gross margin (loss):
Product A Product B Product C
Product costs:
1. Direct-labor based system $186.00 $196.00 $133.00
2. Activity-based system $208.60 $168.35 $364.30

ABC-based product costs:


Target price (150%) $312.90 $252.53 $546.45
Actual selling price $280.00 $250.00 $300.00
Difference in price <$32.90> <$2.53> <$246.45>

Direct-labor based costing system


Gross margin $ 94 $ 54 $167
Gross margin ratio 33.57% 21.6% 55.67%

Activity-based costing system:


Gross margin $71.40 $81.65 $(64.30)
Gross margin ratio 25.50% 32.66% <21.43%>

4. Strategic and Competitive Analysis


1. Emphasizing Product C as suggested by the current direct-
labor-cost based overhead costing system is likely to harm
the firms competitiveness. The activity-based costing system
shows that the manufacturing cost of Product C is $364.30
per unit and, at the current selling price, the firm suffers a
$64.30 loss for each unit it manufactures and sells.

2. If the actual selling prices of products A & B are fair market


prices for these products and a markup of 150% is a common
industry practice, the firm needs to examine the
manufacturing cost of product A. The fact that the firms target
price, determined using 150% of the manufacturing cost, is
more than 10 percent over the fair market price of the product
suggests possible wastes and inefficiencies in the
manufacturing of product A.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-43 The McGraw-Hill Companies, Inc., 2008


5-53 Ethics, Cost System Selection (5 min)

Unfortunately, there are a number of reasons why ABC costing systems are
studied by firms and then not adopted. In some cases the reason is to
protect a product line that is favored by top executives, even though the
ABC results show it to be unprofitable. Other times it is because a customer
that is considered critical to the firm is shown to be unprofitable by the ABC
results
In the case of Aero Dynamics, the reason has to do with an ethical
issue, that is, the use of cost allocation to improperly charge a cost-plus
customer (the federal government) for overhead costs. The management
accountant should keep the professional ethics code in mind. First, he or
she should try to persuade other ABC pilot project members and the
company controller to strongly recommend that top management adopt the
more accurate ABC method. If the company top management still would not
listen, then the management accountant should report the situation to the
companys audit committee. Because of the management accountants
responsibility for confidentiality, he or she should not report the matter
outside the firm. (See the Institute of Management Accountants Code of
Ethics in Exhibit 1-4).

An interesting footnote to the case is that the Government Accounting


Office, to assist the Dept of Defense, in part due to issues of this nature,
developed in the 1970s a series of cost accounting standards. These
standards apply generally to companies contracting with the federal
government, especially the DOD. See http://www.gao.gov/casb1.htm for
the CASB website. Also, the Federal Government in 1990 created the
Federal Accounting Standards Advisory Board (www.fasab.gov) which sets
standards for financial and managerial reporting within the federal
government. The FASAB web site is an interesting place to see the
progress/continuing issues of accounting at the federal government.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-44 The McGraw-Hill Companies, Inc., 2008


5-54 Volume-Based Costing Versus ABC (25 min)

1. Current costing system (direct-labor hour)


Deluxe % Speedy %
Price $475 100 $300.00 100
Prime Cost 180 38 110.00 37
Overhead 20 4 153.60 51
Unit gross profit $275 58 $ 36.40 12

2. Multiple drivers costing system


Calculation of unit overhead costs - Deluxe:
Deluxe
Setups $2,800 x 200 = $ 560,000
Machine costs $100 x 100,000 = 10,000,000
Engineering $40 x 45,000 = 1,800,000
Packing $20 x 50,000 = 1,000,000
Total overhead $13,360,000

Number of Units 50,000

Overhead per unit $267.20

Calculation of unit overhead costs - Speedy:


Speedy
Setups $2,800 x 100 = $ 280,000
Machine costs $100 x 400,000 = 40,000,000
Engineering $40 x 120,000 = 4,800,000
Packing $20 x 200,000 = 4,000,000
Total overhead $49,080,000
Number of Units 400,000
Overhead per unit $122.70

Deluxe % Speedy %
Price $475.00100 $300.00 100
Cost
Prime cost $180.00 $110.00
Overhead 267.20 447.20 94 122.70 232.70 78
Unit gross profit $27.80 6 $67.30 22

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-45 The McGraw-Hill Companies, Inc., 2008


5-54 (continued)
3. Using the activity-based costing, a much different picture on profitability
of the Deluxe and Speedy models emerges. The Speedy model is
actually more profitable than the Deluxe model. The revised cost data
suggests that shifting the emphasis to the Deluxe model may very well be
a mistake. The Deluxe printer is a much heavier user of overhead
resources as can be seen in the table below that compares uses of
overhead.

Overhead Activity Consumption


Activity Deluxe Speedy
Setups 250 units per setup 4,000 units per setup
Machine costs 2 MH per unit 1 MH per unit
Engineering 0.9 Engr. Hr. per unit 0.3 Engr. Hr. per unit
Packing 1 unit per packing order 2 units per packing order
Supporting calculations
Activity Consumption
Deluxe Speedy
Total Per Activity Measure Total Per Activity Measure
Units 50,000 400,000
Setups 200 250 units per setup 100 4,000 units per setup
Machine
costs 100,000 2 MH per unit 400,000 1 MH per unit
Engineering 45,000 0.9 Engineering 120,000 0.3 Engineering
Hours per unit hours per unit
Packing 50,000 1 unit per packing 200,000 2 units per packing
order order

4. The ABC method is likely to provide Gorden Company a more accurate


product cost picture. It also directs the managements attention to the
high volume, more profitable Speedy printers.
Given the low profit margin of the Deluxe, the firm may want to
investigate the feasibility of raising the price, the possibility of reducing
product cost, or both.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-46 The McGraw-Hill Companies, Inc., 2008


5-55 Volume-Based Costing Versus ABC (10 min)

1. Predetermined overhead rates:

Budgeted Budgeted
Cost Pool OH Cost Cost Driver Overhead Rate
Machine depr./maint. $135,000 27,000 $5.00 per MH
Factory depr./util./insur. $120,000 30,000 $4.00 per MH
Product design $504,000 42,000 $12.00 per Design hour
Materials purch./stor. $147,000 $980,000 15.00%DM cost
Total overhead $906,000

Total overhead for each product order:


Overhead Cost Pool Men Shavers Women Shavers
Material purchase $30,000 x 15% =$4,500 $26,000 x 15% = $3,900
Product design $12 x 15 =180 $12 x 37.5 = 450
Machine depreciation $5.00 x 50 = 250 $5.00 x 40 = 200
Factory depreciation $4.00 x 50 = 200 $4.00 x 40 = 160
Total overhead cost $5,130 $4,710

2. Overhead cost per unit:


Number of units 15,000 20,000
Overhead cost per unit $ 0.342 $ 0.2355

3. Overhead rate: $906,000 / 3,020 = $300 per direct labor hour


4. Total overhead using volume-based overhead rate:
Men Shavers: $300 x 24 = $7,200
Women Shavers: $300 x 12 = $3,600

5. Men Shavers: $7,200 / 15,000 = $ 0.48


Women Shavers: $3,600 / 20,000 = $ 0.18

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-47 The McGraw-Hill Companies, Inc., 2008


5-56 Resource and Activity-Based Cost Drivers (25 min)

1. The activity based cost pools are determined from the percent-of-use
information; for example, total setup cost = $157,500 = .15 x $850,000
+ .2 x $150,000.

Inspect &
Factory Costs Setup Assembly Finishing Packaging
Salaries $ 850,000 $ 127,500 $ 467,500 $ 170,000 $ 85,000
Supplies 150,000 30,000 90,000 30,000 -
Factory Expense 550,000 - 440,000 110,000
$ 1,550,000 $ 157,500 $ 997,500 $ 310,000 $ 85,000

2. The activity rates are determined as follows:

Total Activity Activity-based


Safe-V Safe-T Consumption Activity Costs Rates
Batches 250 600 850 $ 157,500 $ 185.29
Units 60,000 72,000 132,000 997,500 7.557
Finishing hours/unit 0.2 0.3 33,600 310,000 9.226
Packaging 0.1 0.15 16,800 85,000 5.060

3. The per unit activity-based costs are $14.18 for Safe-V and $18.63 for
the Safe-T

Activity Requirements Activity-Based Costs/Unit


Safe-V Safe-T Safe-V Safe-T
Setup 250 600 $ 0.772 $ 1.544
Assembly 60,000 72,000 7.557 7.557
Inspect and Finish 0.2 0.3 1.845 2.768
Packaging 0.1 0.15 0.506 0.759
Materials per unit $ 3.50 $ 6.00 3.500 6.000
Total Cost per unit $ 14.180 $ 18.628

4. The activity-based information can be used by EEI to set prices and


assess the profitability of its two product lines.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-48 The McGraw-Hill Companies, Inc., 2008


5-57 Resource and Activity-Based Cost Drivers; Continuation of 5-56
(20 min)

1. The resource consumption cost driver rates and the activity cost polls are
determined as follows. For example the activity cost pool, setup, is
$115,000 = 1 x $50,000 + 1 x $15,000 + 2,000 x $25.

Resource Inspect &


Rate Setup Assembly Finishing Packaging
$ 50,000 $ 50,000 $ 500,000 $ 250,000 $ 50,000
15,000 15,000 75,000 60,000 -
25 50,000 275,000 125,000 100,000
$ 115,000 $ 850,000 $ 435,000 $ 150,000

2. The new activity consumption rates are shown in the right column, using
the same activity drivers as before, with the new activity cost pool amounts.

Total Activity Activity-based


Safe-V Safe-T Consumption Activity Costs Rates
Batches 250 600 850 $ 115,000 $ 135.29
Units 60,000 72,000 132,000 850,000 6.439
Finishing hours, per unit 0.2 0.3 33,600 435,000 12.946
Packaging 0.1 0.15 16,800 150,000 8.929

3. The new ABC product costs are shown below; there is very little change
from the solution in 5-56 above.

Activity Requirements Activity-Based Costs/Unit


Safe-V Safe-T Safe-V Safe-T
Setup 250 600 $ 0.564 $ 1.127
Assembly 60,000 72,000 6.439 6.439
Inspect and Finish 0.2 0.3 2.589 3.884
Packaging 0.1 0.15 0.893 1.339
Materials per unit $ 3.50 $ 6.00 3.500 6.000
Total Cost per unit $ 13.985 $ 18.790

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-49 The McGraw-Hill Companies, Inc., 2008


5-58 Volume-Based Costing vs. ABC (30 min)

1. Manufacture Costs Direct-Labor Cost Based


Luxury Pendant Ceiling Fixture
Total Per Unit Total Per Unit
Selling Price $70.00 $40.00
Direct Materials $ 80,000 20.00 $ 400,000 10.00
Direct Labor 32,000 8.00 200,000 5.00
Overhead* 64,000 16.00 400,000 10.00
Manufacturing Cost $176,000 44.00 $1,000,000 25.00
Gross Margin $26.00 $15.00

* Overhead is allocated based on direct labor costs at the rate of


$2.00 per direct labor dollar
LP: $ 32,000 x $2.00 = $ 64,000
CF: $200,000 x $2.00 = $400,000

2. Overhead Costs Reported by ABC System:


Overhead rates
Overhead Costs Total Activities Overhead Rate
Machine Operation $160,000 10,000 $16.00
Support labor 81,200 232,000 0.35
Machine Setup 68,000 2,500 27.20
Assembly 88,550 402,500 0.22
Inspection 66,250 4,000 16.5625
Total $464,000

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-50 The McGraw-Hill Companies, Inc., 2008


5-58 (continued-1)
Applied overheads
Luxury Pendants Ceiling Fixtures
Overhead Activities Overhead Activities Overhead
Rate Cost Cost
Machine Operation $ 16.00 1,500 $ 24,000 8,500 $136,000
Support labor 0.35 32,000 11,200 200,000 70,000
Machine Setup 27.20 1,000 27,200 1,500 40,800
Assembly 0.22 192,500 42,350 210,000 46,200
Inspection 16.5625 1,600 26,500 2,400 39,750
Total Overhead $131,250 $332,750

Manufacture Costs Report - ABC System


Luxury Pendants Ceiling Fixtures
Total Per Unit Total Per Unit
Number of units 4,000 40,000
Sales $280,000 $70.00 $1,600,000 $40.00
Direct Materials 80,000 $20.00 $400,000 $10.00
Direct Labor 32,000 $ 8.00 $200,000 $ 5.00
Overhead:
Machine Operation 24,000 136,000
Support Labor 11,200 70,000
Machine Setup 27,200 40,800
Assembly 42,350 46,200
Inspection 26,500 39,750
Total Overhead $131,250 $32.8125 $332,750 $ 8.3188
Total Manufacturing Costs $243,250 $60.8125 $932,750 $23.3188
Gross Margin $ 36,750 $9.1875 $667,250 $16.6813
Gross margin ratio 13.13% 41.7%

3. The above profitability analysis indicates that the Luxury Pendant is not
as profitable as the vice president of marketing thinks it is.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-51 The McGraw-Hill Companies, Inc., 2008


5-58 (continued-2)
4. Unit Cost Comparison between the current and ABC costing systems
Reported Overhead Costs
Current ABC Difference
Luxury Pendants $16.00 $32.8125 +$16.8125
Ceiling Fixtures $10.00 $ 8.3188 - $ 1.6822
According to the ABC cost data, a shift to more Luxury Pendant
units and fewer Ceiling Fixture units would be ill advised. The
apparent higher unit gross margin of the Luxury Pendants relative
to the Ceiling Fixtures indicates that the current costing system
distorted relative unit profitability.

5. Among the reasons for the difference are:


a. The current direct labor based costing system focused on only
one manufacturing activity of the entire production process. It
measures only one attribute of the individual product: the number
of direct labor hours consumed. By contrast, the ABC system
considered all activities of the manufacturing processes. Costs
were traced from activities to products based on the products
demand for these activities during the production process. The
allocation bases used in ABC were thus measures of the activities
performed. For Moden Lighting Inc., the ABC systems listed not
only the unit-level activities (machine operation, support labor
overhead) but also the batch-level ones (setup, assembly, and
inspection.)
b. Under the volume-based costing system, the high-volume ceiling
fixtures were overcosted and the low-volume luxury pendants
were undercosted. The source of this distortion is the choice of a
single volume-related allocation base, direct labor hours, for
tracing of costs from manufacturing to products. Using a volume-
related allocation base alone to trace costs to products distorted
reported product costs if some of the product-related activities
were not related to volume, such as the setup hours.
c. Differences in the complexity of the products also contribute to
cost distortion. Using a volume-based costing system, overhead
costs differ only when different number of units are manufactured.
Although the luxury pendants were low-volume products, they
actually consume more resources a result not related to volume.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-52 The McGraw-Hill Companies, Inc., 2008


5-59 Volume-Based Costing vs. ABC (30 min)

1. Current Costing System Direct-Labor-Hour Based


Overhead rate = Budgeted overhead / Budgeted direct labor hours
= $200,000 / (7,200 + 6,800 + 2,000)
= $200,000 / 16,000
= $ 12.50 per direct labor hour

Overhead cost allocation:

Diomycin Homycin Addolin


Direct labor-hours 7,200 6,800 2,000
Overhead rate $12.50 $12.50 $12.50
Total overhead $90,000 $85,000 $25,000

Cost per unit:

Diomycin Homycin Addolin


Direct Materials $205,000 $265,000 $258,000
Direct Labor 250,000 234,000 263,000
Overhead: 90,000 85,000 25,000
Total Cost $545,000 $584,000 $546,000
Packets produced 1,000,000 500,000 300,000
Cost per capsule $0.545 $1.168 $1.820

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-53 The McGraw-Hill Companies, Inc., 2008


5-59 (continued-1)

2. Overhead rates for Activity-Based Costing:


Budgeted Budgeted
Overhead Cost Driver Overhead
Activity Cost Driver Cost Volume Rate
Machine setup Setup hours $ 16,000 1,600 $10.00
Plant management Workers 36,000 1,200 $30.00
Supervision of Direct labor-
direct labor hours 46,000 1,150 $40.00
Quality inspection Inspection-
hours 50,400 1,050 $48.00
Expediting orders Customers
serviced 51,600 645 $80.00
Total overhead $200,000

Overhead Costs Assigned to Products Using Activity-Based Costing:


Diomycin Homycin Addolin
Overhead Driver Applied Driver Applied Driver Applied
Rate Volume Overhead Volume Overhead Volume Overhead
Machine setup $10 200 $2,000 600 $6,000 800 $8,000
Plant
$30 200 $6,000 400 $12,000 600 $18,000
management
Supervision of
direct labor $40 200 $8,000 300 $12,000 650 $26,000
Quality
$48 150 $7,200 200 $9,600 700 $33,600
inspection
Expediting
production $80 45 $3,600 100 $8,000 500 $40,000
orders
Total $26,800 $47,600 $125,600

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-54 The McGraw-Hill Companies, Inc., 2008


5-59 (continued-2)

Cost per capsule under Activity-Based Costing:


Diomycin Homycin Addolin
Direct Materials $205,000.00 $265,000.00 $258,000.00
Direct Labor 250,000.00 234,000.00 263,000.00
Overhead 26,800.00 47,600.00 125,600.00
Total Cost $481,800.00 $546,600.00 $646,600.00
Packets produced 1,000,000 500,000 300,000
Cost per capsule $0.4818 $1.0932 $2.1553

3. Comparison of Product Costs Using Current Costing and ABC Costing:

Diomycin Homycin Addolin


Current Costing System
Overhead $90,000 $85,000 $25,000
Cost per capsule $0.5450 $1.1680 $1.8200
Activity-Based Costing system
Overhead $26,800 $47,600 $125,600
Cost per capsule $0.4818 $1.0932 $2.1553

Analysis of the Differences


Under the current costing system, ADA applies overhead based on
direct labor hour, and high-volume products such as Diomycin
(1,000,000 capsules) are allocated relatively more overhead ($90,000)
than the low-volume products such as Addolin (300,000 capsules).
High-volume products subsidize low-volume products in this case.
Because of lack of detailed costing information, ADA ends up
undercosting Addolin ($1.82 under the current costing) and overcosting
Diomycin ($0.545 under the current costing).

5-59 (continued-3)

Activity-based costing provides ADA with more detailed and better


estimates of product costs. For example by using ABC, ADA becomes
aware that the cost of Diomycin is lower ($0.4818 per capsule
compared to $0.545 under current costing), meaning that it can set the
price of Diomycin lower and be more competitive. Also, ABC revealed

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-55 The McGraw-Hill Companies, Inc., 2008


how costly Addolin is ($2.1553 per capsule compared to $1.82 under
the current costing). Thus, this opportunity would allow ADA to properly
price Addolin or if it is not profitable, stop producing.

From the schedule, activity-based costing assigns more overhead


to the lower-volume Addolin because the production of Addolin requires
more setups, inspection, supervision, formulation and management.
The current direct-labor-hours based costing system failed to assign
costs of all activities. As a result, Diomycin and Homycin subsidized
Addolin.

The production department at ADA also benefits under ABC. ABC


provides better costing information on the cost of each of the activities
and identifies cost drivers and the activities that consume resources
and raise cost. The additional information enables production mangers
to manage cost by managing activities and cost drivers.

Adopting the ABC method is strategically important for ADA.


Because the ABC method provides ADA with a more accurate product
cost picture and directs managements attention to the high-volume,
more profitable products, the firm can gain competitive advantages and
profits by focusing on the high-volume products.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-56 The McGraw-Hill Companies, Inc., 2008


5-59 (continued-4)

4. Among major uses of ABC in the Pharmaceutical Industry are:


a. Strategic Use of ABC to Reduce Costs
One of the important ways companies develop competitive
advantages is to become a low-cost producer. Many companies in
the pharmaceutical industry have learned to use the information they
have gained from their costing systems to make substantial price
cuts to increase market share.
b. Use of ABC to Eliminate Low-Value-Added Costs
ABC can be used to identify and eliminate activities that add costs
but not value to the products in the pharmaceutical industry. A
company can eliminate low-value added activities and costs without
reducing quality or value. In the pharmaceutical industry, the
following activities typically do not add value to a product: storage,
moving items, and waiting for work. Analyses of activities facilitate
firms to identify low-value-added activities.
c. Use of ABC in Marketing and Distribution
In the pharmaceutical industry, ABC can be applied to marketing or
administrative activities. The cost of performing marketing services
such as distributing products through different distribution channels
can be computed and the information used in making informed
decisions. For example, some of the different channels of
distribution in the pharmaceutical industry are: grocery stores,
convenience stores, pharmacy shops, each having different
activities. The cost of alternative channels of distribution is useful to
marketing managers who make decisions about which channel to
use.
d. Use of ABC to Make Better Pricing Decisions
ABC enables managers to make better pricing decisions by
providing managers with more accurate product cost data for pricing
decisions.
e. Use of ABC to Make Better Product Mix Decisions
ABC provides a firm with more detailed and better estimation of
product costs. Thus, it allows a company the opportunity to decide
which products to make and which ones to eliminate.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-57 The McGraw-Hill Companies, Inc., 2008


5-60 Volume-based Costing Versus ABC Alaire Corporation (40
min)

1. a. Using the current volume-based standard costs, the total contribution


expected in 2007 by Alaire Corporation from the TV Board is
$1,950,000, calculated as follows:

Per Unit Totals for 65,000 units


Revenue $150 $ 9,750,000
Direct materials 80 5,200,000
Direct labor ($14 x 1.5 hours) 21 1,365,000
Materials overhead (10% of material) 8 520,000
Variable overhead ($4 x 1.5 hours)* 6 390,000
Machine time overhead ($10 x .5) 5 325,000
Total cost $120 $7,800,000
Contribution margin $ 30 $1,950,000

* Variable overhead rate: $1,120,000 / 280,000 hours = $4 per hour.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-58 The McGraw-Hill Companies, Inc., 2008


5-60 (continued-1)

1. b. Using traditional volume-based standard costs, the total contribution


expected in 2007 by Alaire Corporation from the PC Board is
$2,360,000, calculated as follows:

Per Unit Totals for 40,000 units


Revenue $300 $ 12,000,000
Direct materials 140 5,600,000
Direct labor ($14 x 4 hours) 56 2,240,000
Materials overhead (10% of materials) 14 560,000
Variable overhead ($4 x 4 hours)* 16 640,000
Machine time overhead ($10 x 1.5) 15 600,000
Total cost 241 9,640,000
Contribution margin $ 59 $ 2,360,000

* Variable overhead rate: $1,120,000 / 280,000 hours = $4 per hour.

2. Shown below are the calculations of the activity-based cost drivers, which
apply to both 2.a. and 2.b.

Procurement: $400,000 / 4,000,000 = $0.10 per part


Production scheduling: $220,000 / 110,000 = $2.00 per board
Packing & shipping: $440,000 / 110,000 = $4.00 per board
Machine setups: $446,000 / 278,750 = $1.60 per setup
Hazardous waste disposal: $48,000 / 16,000 = $3.00 per pound
Quality control: $560,000 / 160,000 = $3.50 per inspection
General supplies: $66,000 / 110,000 = $0.60 per board
Machine insertion: $1,200,000 / 3,000,000 = $0.40 per insertion
Manual insertion: $4,000,000 / 1,000,000 = $4.00 per insertion
Wave soldering: $132,000 / 110,000 = $1.20 per board
5-60 (continued-2)

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-59 The McGraw-Hill Companies, Inc., 2008


a. Using activity-based costing, the total contribution expected in 2007 by
Alaire Corporation from the TV Board is $2,557,100 calculated as
follows.

Per Unit Totals for 65,000 units


Revenue $150.00 $ 9,750,000
Direct materials 80.00 5,200,000
Materials overhead:
Procurement ($.10 x 25) 2.50 162,500
Production scheduling 2.00 130,000
Packaging & shipping 4.00
260,000
Variable overhead:
Machine set-ups ($1.60 x 2) 3.20 208,000

Waste disposal ($3 x .02) .06 3,900


Quality control 3.50 227,500
General supplies .60 39,000
Manufacturing overhead:
Machine insertion ($.40 x 24) 9.60 624,000
Manual insertion 4.00 260,000
Wave soldering 1.20 78,000
Total cost $110.66 $7,192,900
Contribution margin $ 39.34 $2,557,100

Note that the only cost that remains the same for both cost methods is
the cost of direct materials. Under the ABC method, direct labor cost
becomes part of the manufacturing manual insertion overhead cost.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-60 The McGraw-Hill Companies, Inc., 2008


5-60 (continued-3)

b. Using activity-based costing, the total contribution expected in 2007 by


Alaire Corporation from the PC Board is $1,594,000 calculated as
follows.

Per Unit Totals for 40,000 units


Revenue $300.00 $ 12,000,000
Direct materials 140.00 5,600,000
Materials overhead:
Procurement ($.10 x 55) 5.50 220,000
Production scheduling 2.00 80,000
Packaging & shipping 4.00 160,000
Variable overhead:
Machine set-ups ($1.60 x 3) 4.80 192,000
Waste disposal ($3 x .35) 1.05 42,000
Quality control ($3.50 x 2) 7.00 280,000
General supplies .60 24,000
Manufacturing:
Machine insertion ($.40 x 35) 14.00 560,000
Manual insertion ($4 x 20) 80.00 3,200,000
Wave soldering 1.20 48,000
`Total cost $260.15 $10,406,000
Contribution margin $ 39.85 $ 1,594,000

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-61 The McGraw-Hill Companies, Inc., 2008


5-60 (continued-4)

3. The analysis using volume-based standard costs shows that the


unit contribution of the PC Board is almost double that of the TV
Board. On this basis, Alaires management is likely to accept the
suggestion of the production manager and concentrate promotional
efforts on expanding the market for the PC Boards.
However, the analysis using activity-based costs does not
support this decision. This analysis shows that the unit dollar
contribution from each of the boards is almost equal, and the total
contribution from the TV Board exceeds that of the PC Board by
almost $1,000,000. As a percentage of selling price, the contribution
from the TV Board is double that of the PC Board, 26 percent versus
13 percent. Therefore, it may not be advisable to concentrate
promotional efforts only on expanding the market for the PC Board.
The analysis using ABC can help the company be more
competitive because it provides accurate cost information that allows
the company to make better decisions. As noted above, the ability to
correctly identify the most and least profitable products is critical to
building a successful company.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-62 The McGraw-Hill Companies, Inc., 2008


5-61 Volume-based Costing Versus ABC (40 min)

1. a. Predetermined factory overhead rate = $3,000,000 / $600,000


= $5 per direct-labor dollar
b. Product costs and selling prices
Product Costs Mona Loa Malaysian
Direct costs:
Direct materials $4.20 $3.20
Direct labor .30 .30
$4.50 $3.50
Indirect costs:
Factory overhead (0.30 x $5.00) 1.50 1.50
Total costs $6.00 $5.00

Mark-up 30% 30%


Budgeted selling prices per pound $7.80 $6.50

2. The cost per driver unit is:


Budgeted Budgeted Cost per
Activity Cost Driver Cost Activity Unit
Purchasing Purchase orders $579,000 1,158 $500
Material handling Setups 720,000 1,800 400
Quality control Batches 144,000 720 200
Roasting Roasting hours 961,000 96,100 10
Blending Blending hours 336,000 33,600 10
Packaging Packaging hours 260,000 26,000 10

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-63 The McGraw-Hill Companies, Inc., 2008


5-61 (continued-1)

The budgeted unit costs per pound are:


Mona Loa Coffee Malaysian Coffee
Direct unit costs:
Direct materials $4.20 $3.20
Direct labor 0.30 $4.50 0.30 $3.50
Indirect unit costs:
Purchasing 0.02 1.00
(4 orders x $500 /100,000 lbs.) (4 orders x $500/2,000 lbs.)
Material handling 0.12 2.40
(30 setups x $400/100,000 lbs.) (12 setups x $400/2,000 lbs.)
Quality control 0.02 0.40
(10 batches x $200/100,000 lbs.) (4 batches x $200/2,000 lbs.)
Roasting 0.10 0.10
(1,000 hours x $10/100,000 lbs.) (20 hours x $10/2,000 lbs.)
Blending 0.05 0.05
(500 hrs. x $10/100,000 lbs.) (10 hrs. x $10/2,000 lbs.)
Packaging 0.01 0.01
(100 hrs. x $10/100,000 lbs.) (2 hrs. x$10/2,000 lbs.)
Total unit cost $4.82 $7.46

The comparative cost numbers are:


Mona Loa Malaysian
Requirement 1 $6.00 $5.00
Requirement 2 4.82 7.46

The ABC system in requirement 2 reports a decreased cost for the high-
volume Mona Loa and an increased cost for the low-volume Malaysian.
The current costing system leads to cross-subsidization between the two
products.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-64 The McGraw-Hill Companies, Inc., 2008


5-61 (continued-2)
3. Three of the indirect cost items can be classified as output-unit driven:
Mona Loa Coffee Malaysian Coffee
Roasting $0.10 $0.10
Blending 0.05 0.05
Packaging 0.01 0.01
Total output-unit overhead $0.16 $0.16

The other three indirect cost items are batch-level driven:


Mona Loa Coffee Malaysian Coffee
Purchasing $0.02 $1.00
Material handling 0.12 2.40
Quality control 0.02 0.40
Total batch-level overhead $0.16 $3.80

Malaysian coffee has a greater number of setups per output unit than
does Mona Loa coffee. The result is that the unit cost of the lower-
volume Malaysian coffee is much higher than that of the higher-
volume coffee, even though its cost of direct materials is lower.
With the current costing system, the high-volume Mona Loa is
overcosted, while the low-volume Malaysian is undercosted. Pricing
of Mona Loa can be reduced to make it more competitive. In
contrast, Malaysian should be priced at a much higher level if the
strategy is to cover the current periods cost. CBI may wish to have
lower margins with its low-volume products such as Malaysian in an
attempt to build up volume. The company can use the ABC cost
information to compare its two product costs with competitors, and
decide which product has a low cost competitive advantage. Then
the company can change its pricing and product mix strategies by
using the ABC cost information.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-65 The McGraw-Hill Companies, Inc., 2008


5-61 (continued-3)

ABC cost data also point out that the reason for the Malaysian
Coffee to have a higher unit cost is not because of high-priced
ingredients. In fact, Malaysian Coffee has a lower cost of direct
materials than that of Mona Loa Coffee. The costs of roasting,
blending, and packaging are $0.16 per pound for both coffees. The
higher cost of Malaysian is because of the way in which it is
processed. The batch-level cost per pound is $0.16 for Mona Loa
and $3.80 for Malaysian. CBI can increase its profit margin or lower
its price on Malaysian Coffee if it can change the way in which it
handles purchasing, material handling, and quality control functions
of Malaysian coffee.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-66 The McGraw-Hill Companies, Inc., 2008


5.62 Cost of Capacity; Continuation of 5-61 (25 min)

1. The calculation of the new activity rates and the cost of unused capacity
is determined below.

Practical
Usage- Capacity Practical Cost of
Driver Based at Current Usage Capacity Unused Unused
Usage Cost Rate Spending Percent Rate Capacity Capacity
Purchasing 1,158 $ 579,000 $ 500 1,400 83% $ 413.57 242 $ 100,084
Materials Handling 1,800 720,000 400 2,400 75% $ 300.00 600 180,000
Quality Control 720 144,000 200 1,200 60% $ 120.00 480 57,600
Roasting 96,100 961,000 10 100,000 96% $ 9.610 3,900 37,479
Blending 33,600 336,000 10 36,000 93% $ 9.333 2,400 22,400
Packaging 26,000 260,000 10 30,000 87% $ 8.667 4,000 34,667
$ 3,000,000 $ 432,230

2. The information on cost of capacity can alert management to the total


cost of unused capacity, in this case $432,230 or approximately 14% of
total overhead cost. This information can be used to identify activities
where there is extensive over-capacity, and to consider how the capacity
might be managed to reduce overall costs. For example, the calculations in
part 1 suggest there is substantial excess capacity in materials handling,
and the cost of the unused capacity is $180,000.

3. The analysis below shows the number of employees unused in column


8. The analysis assumes that each employee (or machine) contributes an
equal share to the work of the activity. Note that the materials handling
activity appears to have as many as 5 unused employees.

1 2 3 4 5 6 7 8
Capacity Step: Number Cost per Step
Driver at Current of Employees Unused Step Size Steps
Usage Cost Spending or Machines Capacity =(2)/(4) =(3)/(4) Not Used
Purchasing 1,158 $ 579,000 1,400 8 242 $ 72,375 175 1.38
Materials Handling 1,800 720,000 2,400 20 600 36,000 120 5.00
Quality Control 720 144,000 1,200 4 480 36,000 300 1.60
Roasting 96,100 961,000 100,000 10 3,900 96,100 10,000 0.39
Blending 33,600 336,000 36,000 10 2,400 33,600 3,600 0.67
Packaging 26,000 260,000 30,000 3 4,000 86,667 10,000 0.40

5-63 Customer Profitability Analysis (30 Min)


1. Service cost rate per unit of activity

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-67 The McGraw-Hill Companies, Inc., 2008


Estimated Estimated Service
Activities Annual Cost Driver Annual Cost Cost
Expense Driver Units Per Unit
Requisition
Handling $3,000,000 Requisitions 300,000 $10.00
Warehouse $1,050,000 Cartons 70,000 $15.00
Pick
Packing $ 900,000 (PP) Lines 600,000 $ 1.50
Data Entry $ 600,000 (PP) Lines 600,000 $ 1.00
Delivery
charge $10 per delivery (requisition) + $0.30 per mile

2. Service Costs
Omega International City of Albion
Requisition Handling $3,000 $ 7,000
(300 requisitions x $10/requisition) (700 requisitions x $10/requisition)
Warehouse Activity 750 7,500
(50 cartons x $15.00 per carton) (500 cartons x $15.00 per carton)
Pick-Packing 1,350 3,150
(900 pick-pack lines x $1.50) (2,100 pick-pack lines x $1.50)
Data Entry 900 2,100
(900 lines x $1.00/line) (2,100 lines x $1.00/line)
Freight Out 3,450 8,260
($10 x 300) + ($0.30 x 5 x 300) ($10 x 700) + ($0.30 x 6 x 700)
Total Service Costs $9,450 $28,010

3. Customer Profitability Analysis-Activity Based


Omega International City of Albion
Sales $ 80,000 $80,000
Product Cost (50,000) (48,000)
Service costs ( 9,450) (28,010)
Gross Margin $20,550 $ 3,990
Gross Margin % 25.69% 4.99%

5-63 (continued-1)

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-68 The McGraw-Hill Companies, Inc., 2008


The above profitability analysis indicates that, under activity-based
costing, Omega International, not City of Albion, is more profitable
to Boston Depot. The apparent higher gross margin percentage of
the City of Albion relative to the Omega International was the result
of not recognizing differences in the service activities requested by
different customers under the firms existing costing system.
City of Albion is a much heavier user of services provided by
Boston Depot. Although both customers had the same total sales,
City of Albion made more desktop delivery requests in smaller
quantities and maintained more inventory by Boston Depot.

4. The answer depends on the competitive strategy of the firm. The


gross profit margin ratios show that Omega is the better customer
of the two.
Omega does not use much of the desktop delivery service
Boston offers. Most likely Omega is a buyer of commodity items
and does not need the convenience of desktop delivery. However,
Bostons pricing is likely to have incorporated the average cost of
desktop deliveries. If Omega realizes that it is paying for services
not used, it may buy the commodity it needs elsewhere, unless
Boston lowers the price to Omega.
All custom-printed business forms by different suppliers are
likely to be the same. Delayne wanted to differentiate its forms
from those of competitors by offering desktop delivery services. In
the long-run, Omega is not likely to be a customer staying with
Boston Depot. Boston Depot needs to be prepared to lower the
price to Omega.
If the firm desires to compete on a differentiation strategy it
needs to price accordingly. Boston Depot needs to raise prices to
City of Albion. If City of Albion is willing to pay a higher price for the
convenience of desktop delivery, it is the kind of customer that
Delayne wants.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-69 The McGraw-Hill Companies, Inc., 2008


5-64 Activity-Based Costing (35-40 min)
(Miami Valley Architects, Inc. by Beth M. Chaffman, CPA and John Talbott,
CMA, Management Accounting Campus Report, Fall 1992, p.4)

1. Overhead Cost assigned to each branch under the ABC costing:


Columbus Cincinnati Dayton Total
Direct labor dollar 37.61% 31.19% 31.20% 100%
Timesheet entries 45.11% 28.57% 26.32% 100%
Vendor invoices 44.93% 37.44% 17.62% 100%
Client invoices 52.13% 39.36% 8.51% 100%
Employees 34.33% 38.81% 26.87% 100%
New hires 42.11% 21.05% 36.84% 100%
Insurance claims filed 34.33% 38.81% 26.87% 100%
Proposals 39.22% 49.02% 11.76% 100%
Contracted sales 48.07% 36.88% 15.05% 100%
Projects shipped 39.13% 49.01% 11.86% 100%
Purchase orders 41.54% 33.85% 24.62% 100%
Copies duplicated 43.48% 39.13% 17.39% 100%
Blueprints 45.24% 36.19% 18.56% 100%

Activity-based overhead allocation


Colum. Cinci. Dayton Total Cost Driver
General administration $153.84 $127.56 $127.60 $ 409Direct labor dollar
Project costing 21.65 13.71 12.63 48Timesheet entries
Accounts payable/receiving 62.46 52.05 24.49 139Vendor invoices
Accounts receivable 24.50 18.50 4.00 47Client invoices
Payroll/Mail sort & delivery 10.30 11.64 8.06 30Employees
Personnel recruiting 16.00 8.00 14.00 38New hires
Employee insurance process. 4.81 5.43 3.76 14Insurance claims filed
Proposals 54.51 68.14 16.35 139Proposals
Sales meetings/Sales aids 97.10 74.49 30.40 202Contracted sales
Shipping 9.39 11.76 2.85 24Projects shipped
Ordering 19.94 16.25 11.82 48Purchase orders
Duplicating costs 20.00 18.00 8.00 46Copies duplicated
Blueprinting 34.84 27.87 14.29 77Blueprints
Total $529.34 $453.41 $278.26 $1,261

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-70 The McGraw-Hill Companies, Inc., 2008


5-64 (continued-1)
Calculation for general administration allocated to branches:
Total direct labor dollar: $382,413 + $317,086 + $317,188 =
$1,016,687
Allocation of general administration based on direct labor dollar:
Proportion Allocated Amount
Columbus $382,413 / $1,016,687 = 37.61% $409 x 37.61% = $153.84
Cincinnati $317,086 / $1,016,687 = 31.19% $409 x 31.19% = $127.56
Dayton $317,188 / $1,016,687 = 31.20% $409 x 31.20% = $127.60

2. Contribution of each branch:


Columbus Cincinnati Dayton Total
Sales $1,500 $1,419 $1,067 $3,986
Less: Direct labor 382 317 317 1,016
Direct materials 281 421 185 887
Direct overhead
180 270 177 627
Contribution margin
$657 $411 $388 $1,456

3. Profitability of each branch using activity-based costing:

Columbus Cincinnati Dayton Total


Sales $1,500 $1,419 $1,067 $3,986
Less: Direct labor 382 317 317 1,016
Direct materials 281 421 185 887
Direct overhead
180 270 177 627
Contribution margin
$657 $411 $388 $1,456
Activity-based overhead
529 453 278 1,261
Operating income $128 ($42) $110 $195

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-71 The McGraw-Hill Companies, Inc., 2008


5-64 (continued-2)

4. Evaluating management concerns:


Overhead costs are usually aggregated in pools and allocated to
products and other cost objects based on volume measures such
as direct labor dollars or machine hours. The cost object,
therefore, supposedly shares proportionally in those costs
necessary for its production or existence. If however, overhead
varies in accordance with variables other than volume, then
product costs and other cost objects will be erroneously
determined.
As the solution indicates, the profitability of the Cincinnati and
Dayton offices is vastly different employing direct tracing and ABC
than under the current approach. The obvious benefit to the
company is a more equitable distribution of bonuses and
resources to these locations. In addition, existing marketing
strategy may be promoting the wrong location and strategic
planning may be based on spurious assumptions concerning
relative profitability.
This case also illustrates that ABC is applicable to service
organizations as well as to manufacturing and that cost objects
can consist of projects, locations, customers, etc., as well as
products. In essence, the better information we have about the
profitability of any cost object, the better chance of keeping
organizations profitable.
However, the process of identifying activities and allocating costs
from the general ledger to the activities is a difficult, time
consuming process. Extensive interviews with functional
managers and workers are normally required. This process is
time consuming and often costly.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-72 The McGraw-Hill Companies, Inc., 2008


5.65 Customer Profitability Analysis (30 minutes)
HS Inc. Adventix Baldwin
Customer revenue analysis
Total sales $600,000 $750,000 $900,000
Less: Sales discount 12,000 22,500 18,000
Net invoice $588,000 $727,500 $882,000
Less: Sales returns 11,760 7,275 26,460
Net sales $576,240 $720,225 $855,540
Less: Cash discounts 11,525
Finance charge (7,530) 1
21,606 2

Net proceeds $572,245 $698,619 $855,540

Customer cost analysis


Customer unit-level cost:
Sales return (restocking)3 $ 200 $ 125 $ 450
Customer batch-level costs:
Order taking 500 250 2,500
Order processing 750 375 3,750
Sales return 600 800 2,000
Delivery 1,500 15,000
Expediting order 1,000 2,500
Customer sustaining costs:
Sales visits 800 800 1,600
Total customer cost $2,850 $4,850 $27,800
Net customer profit $569,395 $693,769 $827,740

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-73 The McGraw-Hill Companies, Inc., 2008


5-65 (continued)
1
Net proceeds: $576,240 - $11,525 = $564,715
Savings of not having to finance working capital:
$564,715 x 2% x 20/30 = $7,530
2
Payment received on the 60th day: $720,225 2 = $360,112.50
Finance charge for 30 days $360,112.50 x 2% = $ 7,202
Payment received on the 90th day: $720,225 2 = $360,112.50
Finance charge for 60 days $360,112.50 x 2% x 2 = 14,404
Net finance charge $21,606
3
Restocking cost: HS Inc: 10 x 100 x 2% x $10 = $200
Adventix: 5 x 250 x 1% x $10 = $125
Baldwin: 50 x 30 x 3% x $10 = $450

Customer profitability analysis helps the company become more competitive


by identifying the most profitable and least profitable customers. This
information can then be used by management to adjust pricing policies,
identify ways to reduce the cost to serve customers, and change the
customer mix for a more profitable group of customers.

Blocher,Stout,Cokins,Chen:Cost Management, 4e 5-74 The McGraw-Hill Companies, Inc., 2008

S-ar putea să vă placă și