BAP 22: Management Accounting II

Session 3, 2013
Tutorial Solutions: Week
Topic : Activity Based Costing

Questions: E5-27 E5-31 E5-32 P5-46 P5-47

Assignment: eLearning question AQ-3

Exercise 5-27

1. a. Quality-control costs assigned to the Satin Sheen line under the traditional system:

Quality-control costs = 14.5%  direct-labor cost

Quality-control

costs assigned to

Satin Sheen line = 14.5%  $27,500

= $3,988 (rounded)

b. Quality-control costs assigned to the Satin Sheen line under activity-based costing:

Quantity for Assigned

Activity Pool Rate Satin Sheen Cost

Incoming material inspection................ $11.50 per type 12 types............ $  138

In-process inspection............................ .14 per unit 17,500 units...... 2,450

Product certification.............................. 77.00 per order 25 orders.......... 1,925

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 Total quality-control costs assigned............................................................................ $4,513

2. The traditional product-costing system undercosts the Satin Sheen product line, with respect to quality-
control costs, by $525 ($4,513 – $3,988).

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Exercise 5-31

Wheelco's product-costing system probably is providing misleading cost information to management. A

common problem in a traditional, volume-based costing system is that high-volume products are
overcosted and low-volume products are undercosted. There is evidence of this in the exercise, since
Wheelco's competitors are selling the high-volume A22 wheel at a price lower than Wheelco's reported
manufacturing cost. In contrast, Wheelco is selling its specialty D52 wheel at a huge markup above the
product's reported cost. An activity-based costing system probably would report a lower product cost for
wheel A22 and a substantially higher cost for wheel D52.

The president's strategy of pushing the firm's specialty products probably will aggravate Wheelco's
problem even further. These products probably are not as profitable as the firm's traditional product-costing
system makes them appear.

Recommendation: Install an activity-based costing system. If the new reported product costs shift
as suggested in the preceding comments, then lower the price on the high-volume products, such as wheel
A22. The prices of the specialty wheels probably will need to be raised. It is possible that Wheelco should
discontinue low-volume products.

Exercise 5-32

1. Key features of an activity-based costing system:

(a) Two-stage procedure for cost assignment.

(b) Stage one: Establish activity cost pools.

(c) Stage two: Select cost drivers for each activity-cost pool. Then assign the costs in each cost
pool to the company's product lines in proportion to the amount of the related cost driver used
by each product line.

2. As described in the answer to the preceding exercise, the new system probably will reveal distortion
in the firm's reported product costs. In all likelihood, the high-volume products are overcosted and the
low-volume specialty products are undercosted.

3. Strategic options:

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(a) Lower the prices on the firm's high-volume products to compete more effectively.

(b) Increase the prices on low-volume specialty products.

(c) Consider eliminating the specialty product lines. This option may not be desirable if there is a
marketing need to produce a full product line. Also, the specialty wheels may give Wheelco
prestige.

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PROBLEM 5-46
1. Predetermined overhead rate = budgeted overhead ÷ budgeted direct-labor hours
= $800,000 ÷ 25,000* = $32 per direct labor hour

*25,000 budgeted direct-labor hours = (3,000 units of Standard)(3 hrs./unit) +

(4,000 units of Enhanced)(4 hrs./unit)
Standard Enhanced

Direct material……………. $ 25 $ 40
Direct labor:
3 hours x $12………… 36
4 hours x $12………… 48
Manufacturing overhead:
3 hours x $32………… 96
4 hours x $32………… 128
Total cost…………………. $157 $216
2. Activity-based overhead application rates:
Activity Cost Driver Application
Activity Cost Rate

Order $150,000 ÷ 500 orders = $300 per OP

processing processed (OP)

Machine 560,000 ÷ 40,000 machine = $14 per MH

processing hrs. (MH)

Product 90,000 ÷ 10,000 inspection = $9 per IH

inspection hrs. (IH)
Order processing, machine processing, and product inspection costs of a Standard unit and an
Enhanced unit:
Activity Standard Enhanced

Order processing:
300 OP x $300……………... $ 90,000
200 OP x $300……………... $ 60,000
Machine processing:
18,000 MH x $14…………... 252,000
22,000 MH x $14…………... 308,000
Product inspection:
2,000 IH x $9……………….. 18,000
8,000 IH x $9………………. 72,000
Total $360,000 $440,000
Production volume (units) 3,000 4,000
Cost per unit $120* $110**
* $360,000 ÷ 3,000 units = $120 ** $440,000 ÷ 4,000 units = $110

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 The manufactured cost of a Standard unit is $181, and the manufactured cost of an Enhanced unit
is $198:

Standard Enhanced

Direct material………………………………. $ 25 $ 40
Direct labor:
3 hours x $12…………………………… 36
4 hours x $12…………………………… 48
Order processing, machine processing, and
product inspection……………….. 120 110
Total cost……………………………………. $181 $198

3. a. The Enhanced product is overcosted by the traditional product-costing system. The labor-
hour application base resulted in a $216 unit cost; in contrast, the more accurate ABC
approach yielded a lower unit cost of $198. The opposite situation occurs with the
Standard product, which is undercosted by the traditional approach ($157 vs. $181 under
ABC).

b. Yes, especially since the company’s selling prices are based heavily on cost. An
overcosted product will result in an inflated selling price, which could prove detrimental in a
highly competitive marketplace. Customers will be turned off and will go elsewhere, which
hurts profitability. With undercosted products, selling prices may be too low to adequately
cover a product’s more accurate (higher) cost. This situation is also troublesome and will
result in a lower income being reported for the company.

4. Not required.

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PROBLEM 5-47

1. The predetermined overhead rate is calculated as follows:

Predetermined overhead rate = Budgeted manufacturing overhead/budgeted direct-labor hours =
$1,224,000/102,000* = $12 per hour
*Direct labor, budgeted hours:
REG: 5,000 units  9 hours............................................... 45,000 hours
ADV: 4,000 units  11 hours.............................................. 44,000 hours
GMT: 1,000 units  13 hours.............................................. 13,000 hours
Total direct-labor hours..................................................................... 102,000 hours

2. Activity-based-costing analysis:
Cost
Driver Activity Product Activity
Cost Qut for Cost for Line Cost per
Activity Cost Driver Pool Product Product Product Prod. Unit of
Activity Cost Pool Driver Quantity Rate Line Line Line Volume Product

Machin $ $27.00
Machine $310,500 e 115,000 2.70 REG 50,000 $135,000 5,000
Related Hours ADV 48,000 129,600 4,000 32.40
GMT 17,000 45,900 1,000 45.90
Total 115,000 $310,500
Material 52,500 Prod. 100 525.00 REG 40 $ 21,000 5,000 4.20
Hand. Runs ADV 40 21,000 4,000 5.25
GMT 20 10,500 1,000 10.50
Total 100 $ 52,500
Purch. 75,000 Purch. 300 250.00 REG 100 $ 25,000 5,000 5.00
Orders ADV 96 24,000 4,000 6.00
GMT 104 26,000 1,000 26.00
Total 300 $ 75,000
Setup 85,000 Prod. 100 850.00 REG 40 $ 34,000 5,000 6.80
Runs ADV 40 34,000 4,000 8.50
GMT 20 17,000 1,000 17.00
Total 100 $ 85,000
Inspect. 27,500 Inspect. 1,100 25.00 REG 400 $ 10,000 5,000 2.00
Hours ADV 400 10,000 4,000 2.50
GMT 300 7,500 1,000 7.50
Total 1,100 $ 27,500
Ship. 66,000 Ship. 1,100 60.00 REG 500 $ 30,000 5,000 6.00
ADV 400 24,000 4,000 6.00
GMT 200 12,000 1,000 12.00
Total 1,100 $ 66,000
Eng. 32,500 Eng. 650 50.00 REG 250 $ 12,500 5,000 2.50
Hours ADV 200 10,000 4,000 2.50
GMT 200 10,000 1,000 10.00
Total 650 $ 32,500
Machin 50.00
Fac. 575,000 e 115,000 5.00 REG 50,000 $250,000 5,000
Hours ADV 48,000 240,000 4,000 60.00
GMT 17,000 85,000 1,000 85.00
Total 115,000 $575,000

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Grand Grand $1,224,00
Total $1,224,000 Total 0

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3. Calculation of new product costs under ABC.
REG ADV GMT
Direct material............................... $129.00 $151.00 $203.00
Direct labor (not including
set-up time).............................. 171.00 (9 hr. @ $19) 209.00 (11 hr. @ 247.00 (13 hr. @
$19) $19)
Total direct costs per unit.............. $300.00 $360.00 $450.00

Manufacturing overhead (based on ABC):

Machine-related....................... $ 27.00 $ 32.40 $ 45.90
Setup........................................ 4.20 5.25 10.50
Purchasing............................... 5.00 6.00 26.00
Material handling..................... 6.80 8.50 17.00
Quality assurance.................... 2.00 2.50 7.50
Packing/shipping...................... 6.00 6.00 12.00
Engineering design.................. 2.50 2.50 10.00
Facility...................................... 50.00 60.00 85.00
Total ABC overhead
cost per unit............................. $103.50 $123.15 $213.90
Total product cost per unit............ $403.50 $483.15 $663.90

4. Comparison of costs and target prices under two alternative product-costing systems:
REG ADV GMT
Reported unit overhead cost:
Traditional, volume-based costing system $108.00 $132.00 $156.00
.............................................................................................
Activity-based costing system 103.50 123.15 213.90
.............................................................................................
Reported unit product cost (direct material, direct labor and
overhead):
Traditional, volume-based costing system 408.00 492.00 606.00
.............................................................................................
Activity-based costing system 403.50 483.15 663.90
.............................................................................................
Sales price data:
Original target price (130% of product cost based on 530.40 639.60 787.80
traditional, volume-based costing system)
.............................................................................................
New target price (130% of product cost based activity- 524.55 628.10 863.07
based costing system)
.............................................................................................
Actual current selling price....................................................... 525.00 628.00 800.00

5. The REG and ADV products were overcosted by the traditional system, and the GMT product was
undercosted by the traditional system
Reported unit product cost:
Traditional, volume-based costing system $408.00 $492.00 $606.00
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 .............................................................................................
Activity-based costing system 403.50 483.15 663.90
.............................................................................................
Cost distortion:
REG and ADV overcosted by traditional system $ 4.50 $ 8.85
.............................................................................................
GMT undercosted by traditional system............................. ($ 57.90)
6. Not required.

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