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DISCUSSION QUESTIONS
Q6-1. The following two sentences summarize the concepts underlying activity-based
costing:
1. Identifying activities.
2. Assigning costs to activities.
3. Determining the basis for assigning the cost of activities to cost objectives.
4. Determining the cost per unit of activity.
5. Reassigning costs from the activity to the cost objective on the basis of the
cost objective's consumption of activities.
Q6-3. An activity cost pool consists of the total costs identified that relate to a given
activity conducted as part of a process. An activity cost driver is the unit of
measurement of the activity level that causes costs to be incurred. Cost per
unit of activity is simply the total amount of the activity cost pool divided by the
level of the activity cost driver.
Q6-5. Activity-based costing is based on the premise that activities drive costs and
that the cost of activities should be assigned to cost objectives on the basis of
the activities they consume.
Q6-7. ABC often reveals product cross-subsidization problems if it produces costs for
some products that are higher, and costs for other products that are lower, than
costs produced by traditional costing methods. ABC often reveals that some
products are undercosted and others are overcosted. This is referred to as
cross- subsidization.
* (Note: (d) cannot be used because it is the most logical answer to item 6, and each
answer can be used only once.)
M6-11.
There is no single correct answer to this exercise. The purposes of the exercise are
to develop skills in thinking about activities and to organize them sequentially.
M6-12.
Introductory Graduate
Course Course
Assignment of salary:
$135,000 0.50 portion teaching 0.50 $33,750 $33,750
Annual enrollment:
Introductory course
50 students 2 semesters 100
Graduate course
30 students 2 semesters _____ 60
Assignment of
Salary
Unit level:
Supervising production 20 percent
Total 20 $26,400
Batch level:
Job scheduling 15 percent
Supervising setup 5 percent
First unit inspection 2 percent
Total 22 29,040
Product level:
Product design 12 percent
Preparing bills of materials 5 percent
Preparing operations lists 12 percent
Total 29 38,280
Facility level:
Employee training 18 percent
Facility maintenance 7 percent
Attending professional meetings 4 percent
Total 29 38,280
Grand total 100 $132,000
M6-15.
Activity cost of converting raw materials into 40 fireplace inserts:
Setup $ 60
Movement:
Batch ($15 3 moves) $ 45
Weight
($0.10 50 units 150 lbs. 3 moves) 2,250 2,295
Inspection ($2 2 50) 200
Drilling ($3 5 50) 750
Welding ($4 80 50) 16,000
Shaping ($25 0.50 50) 625
Assembly ($18 1 50) 900
Total $20,830
Machine setup cost = $600,000 12,000 setup hours = $50 per setup hour
Material handling cost = $120,000 2,000 tons = $60 per ton of materials
Machine operation = $500,000 10,000 = $50 per machine hour
M6-17.
Activity cost calculations:
Machine setup cost = $950,000 2,500 setups = $380 per setup hour
Material handling cost = $820,000 5,000 = $164 per material move
Machine operation = $200,000 20,000 = $10 per machine hour
Product costs:
Mirlite Subdue
The instructor may want to ask the students to comment on the usefulness of this
type analysis, and ask what reasonable actions HyStandard might take as a result of
this analysis (see discussion below).
This analysis is beneficial to HyStandard because it shows that the Alpine Company
is a definite outlier among the three builders in terms of support services required.
Alpine is a significantly larger consumer of activities for refinishes, touchups and
communication. Note that Alpine requires 360 communications (calls, emails, etc.)
for 230 refinishes and touchup procedures, or 1.57 communications per procedure;
whereas, the ratios for Blue Ridge and Pineola are 1.41 and 1.21, respectively.
HyStandard should consider sharing some of these data with the Alpine Company to
demonstrate to them that they are not in line with the other builder/customers in
terms of the level of support required. If Alpine cannot be brought in line,
HyStandard may consider replacing Alpine, possibly by seeking another builder as a
third customer. Of course, despite Alpines poor performance as a customer, it is still
quite profitable this analysis may simply serve to help make it more profitable.
Also, by determining the cost of each unit of activity for refinishes, touchups, and
communications, HyStandard should assess its cost management of these activities
and attempt to lower the cost per unit without reducing the level of effectiveness.
The instructor may want to ask the students to comment on the adequacy of
Merlots cost system (see below).
e. Part c. allocation rates, which use machine hours as the allocation base in the
Milling Department and direct labor hours as the allocation base in the Finishing
Department, are probably the best of the four alternatives illustrated, because
they reflect the nature of the activity in the respective departments. The
processes in the Milling Department are machine-activity intensive whereas the
Finishing Department conducts processes that are direct-labor-activity intensive.
b. Job 845
Direct materials cost $ 7,000
Direct labor cost 1,000
Manufacturing overhead costs:
Setup costs (5 hours $144) 720
Production scheduling (1 batch $150) 150
Production engineering (3 orders $2,000) 6,000
Supervision (40 direct labor hours $28) 1,120
Machine operations (30 machine hours $7) 210
Total Job 845 cost $16,200
c. Cost of Job 845 using a plantwide overhead rate based on machine hours
Job 845
Direct materials cost $7,000
Direct labor cost 1,000
Manufacturing overhead cost:
(30 machine hours $38.67)* 1,160
Total Job 845 cost $9,160
*$464,000/12,000 = $38.67 per machine hour
d. Cost of Job 845 using departmental overhead rates based on machine hours in
the Milling Department and direct labor hours in the Finishing Department
Job 845
Direct materials cost $ 7,000
Direct labor cost 1,000
Manufacturing overhead cost
Milling Department (25 machine hours $34.40) 860
Finishing Department (35 labor hours $120) 4,200
Total Job 845 cost $13,060
The instructor may want to ask the students what additional data management
will need for Job 845 to adequately evaluate its price and profitability. This
problem takes into account only manufacturing costs, which are all that are
allowed to be included in product costs for financial statement purposes;
however, for managerial purposes, management will want to know what
additional costs are incurred with respect to Job 845. This will include shipping,
distribution, as well as service to the customer after the sale and delivery of the
job.
Cambridge Business Publishers, 2012
Solutions Manual, Chapter 6 6-11
E6-22.
a. Overhead rate per direct labor dollar: $83,000 $45,000 = 1.8444 or 184.44%
Gas Charcoal
Cooker Smoker Total
Gas Charcoal
Cooker Smoker Total
In particular, the Gas Cooker, which is more complicated and produced in much
smaller batches, may be priced too low, resulting in lost revenues and profits in
the premium grill market. The Charcoal Smoker, which is less complicated and
can be produced in very large batches, may be priced too high, resulting in lost
sales and inability to compete in the discount market. Under traditional costing,
Charcoal Smokers are subsidizing the cost of Gas Cookers because part of the
cost of the Cookers is being assigned to the Smokers.
b. Subtracting product costs from revenues will yield the gross margin on the
products, but to determine the net profitability of Cookers and Smokers, the costs
incurred after the products are manufactured, for selling and distribution
activities, must be determined. Because all customer types may not be equally
profitable (due to variations in servicing demands), management may also want
to determine the profitability for the various categories of customers (e.g.,
discount stores, buying clubs, and specialty shops) that buy Smokers and
Cookers from Hickory Grill Company.
E6-24.
a. Overhead rate per direct labor hour: $204,000 8,000 DLH = $25.50
X301 Z205
X301 Z205
Total direct materials costs $15,000 $ 15,000
Total direct labor costs 12,500 12,500
Overhead costs:
Assembly setup 50 & 100 hours
@ $30 per hour 1,500 3,000
Materials handling 25 & 50 moves
@ $50 per move 1,250 2,500
Assembly 800 & 800 assembly hours
@ $10 per assembly hour 8,000 8,000
Maintenance 10 & 40 maintenance
hours @ $20 per hour 200 800
Total costs $38,450 $41,800
Units produced 1,000 1,000
Unit cost $ 38.45 $ 41.80
c. In (a), X301 and Z205 had the same total manufacturing cost because they have
identical direct materials and direct labor costs, and because manufacturing
overhead is assigned based on direct labor hours, which were also identical.
However, in (b), using activity-based costing, the differences between the two
products and the activities required to produce them are reflected in the total
product costs. Z205 required more setup hours, more material moves, and more
maintenance hours than X301, thus causing Z205 to have $3.35 per unit more
cost than X301.
E6-25.
a. Total overhead costs:
Setup $ 936,000
Ordering 240,000
Maintenance 1,200,000
Power 120,000
$2,496,000
Direct labor hours 60,000
Overhead cost per direct labor hour $ 41.60
d. The findings in the above requirements could have multiple implications for High
Country Outfitters. The manager should be pleased that both Jobs 201 and 202
had ABC costs less than their costs under traditional overhead costing.
However, what this also means is that traditional costing would have to be
undercosting some other jobs. While it may be encouraging that the two jobs in
this exercise are more profitable than previously thought, it should be of serious
concern that other jobs are not as profitable as management previously thought.
A full cost analysis of all jobs should be conducted before management can
assess the full impact of failing to account for the actual activities used in
producing the jobs.
E6-27.
a. Dropping the two customers that have losses totaling $362,000 will not likely
cause an immediate increase in profits of $362,000 because some of those costs
are not avoidable. For example some of those costs may be fixed costs that will
continue, even if the two customers to which some of the costs are assigned
cease to be customers. In the long run, the company should be able to use
those costs to help serve new, hopefully profitable, customers, or possibly
eliminate the costs.
b. The benefit of this type analysis is that it clearly focuses managements attention
on the fact that not all customers are equally profitable because the activities
consumed in serving customers are not equal for all customers. Without
customer profitability analysis, management may not even be aware that some
customers are unprofitable, and that the customers that produce the most sales
revenue may not be producing the most profits.
b. Although the unit materials cost of the specialty products is somewhat higher
than the average materials cost of the standard products, the primary cause of
the high unit cost of the specialty products is the small number of units in each
batch:
Consequently, setup costs and first unit inspection costs are averaged over a
smaller number of units.
P6-29.
Calculation of meals & residential cost per resident day:
a. Total cost of medical services Annual assistance hours = Cost per hour
b. Total cost of medical services No. of assistance contacts = Cost per contact
P6-30.
a. Activity cost per unit of activity
b. Loan # 5066
Taking applications ($25.00 per hour 1.5) $ 37.50
Investigations ($27.27 per hour 4.0) 109.08
Underwriting ($52.50 per hour 2.50) 131.25
Loan packages ($25 per hour 3.5) 87.50
Closing loans ($100 per hour 1.5) 150.00
$515.33
Loan # 5429
Taking applications ($25.00 per hour 2.75) $ 68.75
Investigations ($27.27 per hour 3.0) 81.81
Underwriting ($52.50 per hour 4.75) 249.38
Loan packages ($25 per hour 3.0) 75.00
Closing loans ($100 per hour 1.5) 150.00
$624.94
d. Both loan 5066 and loan 5429 are undercosted when using average cost
compared with ABC:
Since individual jobs use different mixes of the various categories of labor, ABC
accounts for these differences; whereas, the average method does not. ABC
recognizes the unique combination of the various activities used to process each
individual loan and provides a more accurate measure of cost.
b. Activity costs:
Routine Maintenance
Trips Hour
Less expenses:
Sales commissions (@ 5%) 850.0 600.0 150.0 200.0 150.0
Sales visits (@1,200) 127.2 156.0 62.4 40.8 19.2
Product adjustments (@ 1,500) 34.5 54.0 15.0 9.0 7.5
Phone and other remote contacts (@ $150) 33.0 53.1 27.0 20.7 15.6
Promotion and entertainment (@ $1,500) 123.0 99.0 111.0 27.0 15.0
Corporate jet expense 19.2 28.8 4.0 0.0 4.8
*Corporate jet cost previously assigned to the customers is subtracted from total G&A overhead in
this calculation.
Management should be cautioned about placing too much reliance on the Net
Customer Profitability calculations since G&A expenses (except for the cost of
the corporate jet assigned to the customers) are allocated based on total sales,
not based on activity incurred for the customers. There may be a temptation to
conclude that Customer 3 is barely breaking even and that the company should
consider dropping the customer. However, unless the G&A costs allocated to
Customer 3 could be eliminated, the total profits of the company would decline
from such an action. On the other hand, the net profitability numbers provide
some insight into how well the various customers are bearing what may be
regarded as their reasonable share of corporate overhead. In that sense, one
could conclude that Customer 3 is covering its share of overhead, but adding
little additional profit to the company.
d. A golf and country club seems to be a reasonable situation for applying ABC.
Even though it requires considerable judgment in determining the key activities,
assigning resource costs to activity pools, and selecting activity cost drivers, it
should provide results that are more reliable on some sort of direct cost allocation
of overhead costs to the three membership categories. To ensure that the results
are perceived by the members to be fair and reasonable, Dess Rosmond should
form an implementation committee of staff, and possibly Club members. Hiring
an ABC consultant who has worked on such implementations in various types of
service organizations may also lead to more successful results.
MA6-35.
Traditional cost accounting allocated $9,800,000 of ATI's total overhead cost of
$17,500,000 to "Published Advertising" and $7,700,000 to "Online, based on Direct
Labor Cost 56% of which must have been incurred by "Published" and 44% by
"Online ($9.8 million/$17.5 million = 56%, and $7.7 million/$17.5 million = 44%)."
The following analysis shows that ABC results in a very different cost allocation:
$14,825,000 to Published Advertising and only $2,675,000 to Online. The first step
in the ABC analysis assigns the $17.5 million total overhead cost to the primary
process activities related to the product lines. These were given in the problem:
Selling $7,500,000
Design 3,000,000
Creative services 5,000,000
Customer services 2,000,000
Does the charge of predatory pricing seem valid? No! Predatory pricing involves
selling below cost to try to drive the competition from the market. At a price of $1
per minute, Tel-a-Ad was probably making a profit almost 25%.
Why are customers willing to pay a higher price to get publishing services? At a
price of $200 per unit, there is not likely to be a great deal of competition because it
produces a margin of only 10%, compared to almost 25% in the "online" sector of
the market. The closer the selling price is to total cost, the more likely the market
will tolerate a price increase.
Purchasing Department
The activity driving the purchasing department costs is the number of purchase
orders. With 100 purchase orders and costs of $6,000, the cost per purchase
order is $60. The final assignment of costs to products is then made based on
the quantity of materials used in producing each product. For example, 10,000
sq. yds. of leather were used in producing standard briefcases and 1,250 sq. yds.
(0.5 2,500) were used in producing specialty briefcases. Using these quantities
assigns 88.9 percent (10,000 11,250) of the purchasing department costs for
leather to standard briefcases and 11.1 percent (1,250 11,250) to specialty. As
shown in the following, similar calculations are used for the other materials.
Standard Specialty
Leather (20 $60 .889) $1,067 (20 $60 .111) $ 133
Fabric (30 $60 .80) 1,440 (30 $60 .20) 360
Synthetic _____ (50 $60) 3,000
$2,507 $3,493
Standard Specialty
Leather (30 $50 .889) $1,333 (30 $50 .111) $ 167
Fabric (40 $50 .80) 1,600 (40 $50 .20) 400
Synthetic _____ (80 $50) 4,000
$2,933 $4,567
Equipment-Related Costs
Although the equipment-related costs are caused by the process rather than a
specific product, they must be allocated to determine the total costs for each
product. The cost per machine hours is $0.60 ($6,000 10,000), and the cost
assigned to each product is $3,000 (5,000 $0.60).
Plant-Related Costs
Plant related costs are also allocated on the basis of machine hours. The cost is
$1.30 ($13,000 10,000) per machine hour, and the cost assigned each product
is $6,500 (5,000 $1.30).
Standard Specialty
Purchasing Department:
Leather $ 1,067 $ 133
Fabric 1,440 360
Synthetic _____ 3,000
2,507 3,493
Receiving & Inspecting Materials:
Leather 1,333 167
Fabric 1,600 400
Synthetic ______ 4,000
2,933 4,567
Other:
Setup activities 2,000 8,000
Inspecting final products 3,000 5,000
Machine-related costs 3,000 3,000
Plant-related costs 6,500 6,500
14,500 22,500
Total costs $19,940 $30,560
Standard Specialty
Direct materials $20.00 $17.50
Direct labor 6.00 3.00
Overhead ($19,940 10,000) 1.99 ($30,560 2,500) 12.22
Total $27.99 $32.72
If these ABC costs are compared with the traditional systems product costs, the
standard briefcase shows a lower cost while the specialty briefcase shows a
higher cost. The differences in the unit costs using the two systems are:
Product Costs
Standard Specialty
Traditional $30.49 $22.75
ABC 27.99 32.72
Difference $ 2.50 $(9.97)
Difference as a percent of traditional cost 8.20% (43.82)%
c. With ABC costing, the standard briefcase line now shows a gross profit of $2.01
($30.00 $27.99) per unit while the specialty line shows a loss of $0.72 ($32.00
$32.72) per unit. Thus, CarryAll is really making a profit on the product which
shows the loss using a direct labor hour basis for allocating overhead and losing
on the specialty line which appears profitable using traditional allocation
procedures. The president was correct in being concerned about the profitability
of the products, but the problem is with the specialty product line, not with the
standard line. Traditional allocation using a volume-based measure results in the
high-volume product subsidizing the low-volume product, affecting the profitability
of each. When costs are traced to products based on the activity causing the
costs, better costing data are available for evaluating the profitability of the
various products.
d. It is certainly important for CarryAll to determine that its traditional cost system
was distorting the cost of its products; and this should lead to important strategic
changes regarding the companys product mix and efforts. However, a
potentially greater benefit is that it can now move to the next level of using ABC
to manage its activities better, and better control the cost of activities. By
measuring the cost of key activities, CarryAll can determine whether all activities
are adding value to the products and, if so, whether there may be ways to
improve its processes so that the activities can be performed more efficiently and
possibly more effectively. Alternatively, it may want to consider outsourcing some
of its key activities, if it is determined that outsourcing can lead to more cost-
effectiveness.