1. For plantwide rates, overhead is first collected in a plantwide pool, using direct tracing. Next, an
overhead rate is computed and used to assign overhead to products.
2. First stage: Overhead is assigned to production department pools using direct tracing, driver
tracing, and allocation. Second stage: Individual departmental rates are used to assign overhead
to products as they pass through the departments.
3. Nonunit-level overhead activities are those overhead activities that are not highly correlated with
production volume measures. Examples include setups, materials handling, and inspection.
Nonunit-based cost drivers are causal factors—factors that explain the consumption of
nonunit-level overhead. Examples include setup hours, number of moves, and hours of inspection.
4. Product diversity is present whenever products have different consumption ratios for different
overhead activities.
5. An overhead consumption ratio measures the proportion of an overhead activity consumed by
a product.
6. Activity-based product costing is an overhead costing approach that first assigns costs to
activities and then to cost objects. The assignment is made possible through the identification of
activities, their costs, and the use of cost drivers.
7. An activity dictionary is a list of activities accompanied by information that describes each
activity (called attributes).
8. Costs are assigned using direct tracing and resource drivers.
9. Activity-based customer costing can identify what it is costing to service different customers.
Once known, a firm can then devise a strategy to increase its profitability by focusing more on
profitable customers, converting unprofitable customers to profitable ones where possible, and
“firing” customers that cannot be made profitable.
10. Activity-based supplier costing traces all supplier-caused activity costs to suppliers. Often, many
costs are overlooked by traditional costing. By assigning all costs that are caused by suppliers,
a company may find that its low-cost supplier does not correspond to the one that has the
lowest purchase price.
11. Driver analysis is concerned with identifying the root causes of activity costs. Knowing the root
causes of activity costs is the key to improvement and innovation. Once a manager understands
why costs are being incurred, efforts can be taken to improve cost efficiency.
12. Value-added activities are necessary activities. Activities are necessary if they are mandated or
if they are not mandated and satisfy three conditions: (1) they cause a change of state, (2) the
change of state is not achievable by preceding activities, and (3) they enable other activities to be
performed. Value-added costs are costs caused by activities that are necessary and efficiently
executed.
ACTIVITY-BASED COSTING
5 AND MANAGEMENT
DISCUSSION QUESTIONS
5-1
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CHAPTER 5 Activity-Based Costing and Management
13. Nonvalue-added activities are unnecessary activities or activities that are necessary but inefficient
and improvable. An example is moving goods. Nonvalue-added costs are those costs caused by
nonvalue-added activities. An example is the cost of materials handling.
14. (1) Activity elimination—the identification and elimination of activities that fail to add value.
(2) Activity selection—the process of choosing among different sets of activities caused by
competing strategies.
(3) Activity reduction—the process of decreasing the time and resources required by an activity.
(4) Activity sharing—increasing the efficiency of necessary activities using economies of scale.
15. Cycle time is the length of time required to produce one unit of product; velocity is the number of
units that can be produced in a given period of time.
5-1. a
5-2. d
5-3. c
5-4. c
5-5. e
5-6. a
5-7. e
5-8. c $40,000 × 0.25 = $10,000
5-9. d $80,000/40,000 moves = $2 per move
5-10. a
5-11. d
5-12. b $1,200,000/1,500,000 pounds = 0.80 per pound shipped
Order of 10,000 pounds × 0.80 = $8,000 for shipping
5-13. d
5-14. a
5-15. e
5-16. e
5-17. b
5-18. c (10 hours/60 units) × 60 minutes in 1 hours = 10 minutes
5-19. a 60 units/10 hours = 6 units per hour
5-20. e
MULTIPLE-CHOICE QUESTIONS
5-2
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CHAPTER 5 Activity-Based Costing and Management
BE 5-21
1. Activity Driver
Cutting hours 0.43 0.57
Assembly hours 0.38 0.62
Inspection hours 0.28 0.72
Rework hours 0.25 0.75
a 4,000/9,400; 5,400/9,400
b 2,850/7,500; 4,650/7,500
c 945/3,375; 2,430/3,375
d 150/600; 450/600
2. There is evidence of product diversity, but it is not strong. The consumption ratios
vary from 0.25 to 0.43, revealing that the vaquero boots vary in their consumption
of the activities. However, the range is narrow and so the diversity is not great.
BE 5-22
Cutting: $225,600/9,400 = $24 per Cutting hour
Assembling: $300,000/7,500 = $40 per Assembling hour
Inspecting: $67,500/3,375 = $20 per Inspecting hour
Reworking: $45,000/600 = $75 per Reworking hour
BE 5-23
Processing transactions:
$0.20 × 12,000……………..………………
$0.20 × 7,200……………..…………………
Preparing statements:
$0.95 × 12,000……………..………………
$0.95 × 7,200……………..…………………
Answering questions:
$4.00 × 24,000……………..………………
$4.00 × 36,000……………..………………
Providing ATMs:
$1.50 × 48,000……………..………………
$1.50 × 14,400……………..………………
Total cost………………………………………
Unit cost………………………………………
BRIEF EXERCISES: SET A
$173,880
Vaquero Vaquera
Classic Gold
$181,800
Activity
11,400
96,000
72,000
$ 2,400
30,000
$ 5.80
7,500
$ 1,440
6,840
144,000
21,600
$ 24.24
÷ ÷
a
b
c
d
a
b
c
d
5-3
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CHAPTER 5 Activity-Based Costing and Management
BE 5-24
Comparing source documents 0.25 × $500,000 = $125,000
Resolving discrepancies 0.60 × $500,000 = $300,000
Processing payment 0.15 × $500,000 = $75,000
BE 5-25
Order Filling Rate = ($1,455,127 + $970,085)/3,636 orders = $667 per order
Selling Call Rate = ($719,820 + $479,880)/900 orders = $1,333 per sales call
Large Smaller
Cost assignment: Retailer Retailers
Ordering
$667 × 36……………………….…………… $24,012
$667 × 3,600……………………….……… $2,401,200
Sales calls
$1,333 × 18……………………….………… 23,994
$1,333 × 882……………………….……… 1,175,706
Total $48,006 $3,576,906
Activity Cost Assignment
5-4
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CHAPTER 5 Activity-Based Costing and Management
BE 5-26
Test Rate = $1,200,000/2,000* failed tests
= $600 per failed test
Reorder Rate = $300,000/100** reorders
= $3,000 per reorder
* (1,200 + 780 + 10 + 10)
** (60 + 40)
Using these rates and the activity data, the total purchasing cost per unit of each
component is computed as follows:
125X 30Y 125X 30Y
Purchase cost:
$10 × 120,000…………… $1,200,000
$26 × 60,000……………… $1,560,000
$12 × 15,000……………… $180,000
$28 × 15,000……………… $420,000
Testing components:
$600 × 1,200……………… 720,000
$600 × 780………………… 468,000
$600 × 10………………… 6,000
$600 × 10………………… 6,000
Reordering components:
$3,000 × 60………………… 180,000
$3,000 × 40………………… 120,000
$3,000 × 0………………… 0
$3,000 × 0………………… 0
Total $2,100,000 $2,148,000 $186,000 $426,000
÷ Units 120,000 60,000 15,000 15,000
Unit cost $ 17.50 $ 35.80 $ 12.40 $ 28.40
BE 5-27
Retesting: Nonvalue-Added Cost = $720,000. Retesting is a nonvalue-added activity,
and its value-added standard is therefore 0. All cost is waste.
Welding: $1,350,000/67,500 welding hours = $20 per welding hour
Nonvalue-Added Cost = (AQ – SQ)$20 = (67,500 – 54,000) × $20 = $270,000
BE 5-28
Velocity = 144,000 units/36,000 hours = 4 units per hour
Cycle Time = 36,000 hours/144,000 units = 0.25 hour (15 minutes)
Notice that cycle time is the inverse of velocity.
Alpha Electronics La Paz Company
5-5
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CHAPTER 5 Activity-Based Costing and Management
BE 5-29
1. Activity Driver Casual Formal
Cutting hours 0.40 0.60
Sewinghours 0.30 0.70
Inspection hours 0.33 0.67
Rework hours 0.40 0.60
a 12,000/30,000; 18,000/30,000
b 3,000/10,000; 7,000/10,000
c 2,000/6,000; 4,000/6,000
d 400/1,000; 600/1,000
2. There is evidence of product diversity, but it is not strong. The consumption ratios
vary from 0.30 to 0.40, revealing that the casual shirts vary in their consumption
of the activities. However, the range is narrow and so the diversity is not great.
BE 5-30
Cutting: $90,000/30,000 = $3 per Cutting hour
Sewing $100,000/10,000 = $10 per Sewing hour
Inspecting: $36,000/6,000 = $6 per Inspecting hour
Reworking: $20,000/1,000 = $20 per Reworking hour
BE 5-31
Processing transactions:
$0.20 × 20,000……………..………………
$0.20 × 12,000……………..………………
Preparing statements:
$0.85 × 20,000……………..………………
$0.85 × 12,000……………..………………
Answering questions:
$2.00 × 40,000……………..………………
$2.00 × 60,000……………..………………
Providing ATMs:
$1.80 × 80,000……………..………………
$1.80 × 24,000……………..………………
Total cost……………………………………………
Unit cost………………………………………………
BRIEF EXERCISES: SET B
Activity Silver Premium
$ 4,000
$ 2,400
17,000
10,200
80,000
120,000
144,000
43,200
$245,000 $175,800
12,500 50,000
$ 19.60 $ 3.52
÷ ÷
a
b
c
d
a
b
c
d
5-6
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CHAPTER 5 Activity-Based Costing and Management
BE 5-32
Activity
Unloading goods 0.25 × $440,000 = $110,000
Counting goods 0.35 × $440,000 = $154,000
Inspecting goods 0.40 × $440,000 = $176,000
BE 5-33
Order Filling Rate = ($646,400 + $161,600)/1,520 orders = $532 per order
Selling Call Rate = ($320,000 + $80,000)/824 orders = $485 per sales call
Large Smaller
Cost assignment: Retailer Retailers
Ordering
$532 × 20……………………….……………… $10,640
$532 × 1,500……………………….…………… $ 798,000
Sales calls
$485 × 8……………………….……………….… 3,880
$485 × 816……………………….……………… 395,760
Total $14,520 $1,193,760
Cost Assignment
5-7
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CHAPTER 5 Activity-Based Costing and Management
BE 5-34
Test Rate = $4,500,000/7,500* failed tests
= $600 per failed test
Reorder Rate = $1,125,000/375** reorders
= $3,000 per reorder
(4,500 + 2,925 + 39 + 36)
(225 + 150)
Using these rates and the activity data, the total purchasing cost per unit of each
component is computed as follows:
#625 #827 #625 #827
Purchase cost:
$30 × 450,000…………… $13,500,000
$78 × 225,000…………… $17,550,000
$36 × 56,250……………… $2,025,000
$84 × 56,250……………… $4,725,000
Testing components:
$600 × 4,500……………… 2,700,000
$600 × 2,925……………… 1,755,000
$600 × 39………………… 23,400
$600 × 36………………… 21,600
Reordering components:
$3,000 × 225……………… 675,000
$3,000 × 150……………… 450,000
$3,000 × 0………………… 0
$3,000 × 0………………… 0
Total $16,875,000 $19,755,000 $2,048,400 $4,746,600
÷ Units 450,000 225,000 56,250 56,250
Unit cost $ 37.50 $ 87.80 $ 36.42 $ 84.38
BE 5-35
Reworking: Nonvalue-Added Cost = $740,000. Reworking is a nonvalue-added
activity, and its value-added standard is therefore 0. All cost is waste.
Purchasing: $900,000/45,000 purchasing hours = $20 per purchasing hour
Nonvalue-Added Cost = (AQ – SQ)$20 = (45,000 – 24,000) × $20 = $420,000
BE 5-36
Velocity = 40,000 units/8,000 hours = 5 units per hour
Cycle Time = 8,000 hours/40,000 units = 0.20 hour (12 minutes)
Notice that cycle time is the inverse of velocity.
Otavalo Manufacturing Piura Company
5-8
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CHAPTER 5 Activity-Based Costing and Management
E 5-37
1.
Inspection hours………………………… 0.60 0.40
Setup hours……………………………… 0.70 0.30
Machine hours…………………………… 0.25 0.75
Number of moves……………………… 0.80 0.20
a 1,080/1,800; 720/1,800
b 420/600; 180/600
c 960/3,840; 2,880/3,840
d 2,880/3,600; 720/3,600
2. The consumption ratios vary significantly from driver to driver, ranging from 0.25 to
0.80 for Scented and 0.20 to 0.75 for the Regular cards. Thus, there seems to be
significant product diversity. If machine hours are used as the only driver, Scented
cards would receive 25% of the overhead, and Regular cards would receive 75% of
the overhead. Yet, the Scented cards consume well over 60% of the non-machinerelated
overhead. Thus, the Scented cards are undercosted, and the Regular cards
are overcosted. This inaccuracy can adversely affect many decisions, including
pricing, keep or drop, and cost-volume-profit.
3. Rates:
Inspecting products:
$45,000/1,800 inspection hours = $25 per inspection hour
Setting up equipment:
$28,500/600 setup hours = $47.50 per setup hour
Machining:
$30,720/3,840 machine hours = $8.00 per machine hour
Moving materials:
$16,200/3,600 moves = $4.50 per move
Note: The denominator is the total driver amount (sum of the demand of the
two products).
Cost
Hours
Cost
Rate
Scented Cards Regular Cards
EXERCISES
Rate =
Inspection Hours = = $45,000/$20 = 2,250 inspection hours
4.
a
b
c
d
a
b
c
d
5-9
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CHAPTER 5 Activity-Based Costing and Management
E 5-38
1. Molding Activity Overhead Cost = $675,000 × 0.80 = $540,000
= $540,000/3,000,000 pounds
= $0.18 per pound molded
2. Decal Application Overhead Cost = $675,000 × 0.20 = $135,000
= $135,000/375,000 decals
= $0.36 per decal applied
E 5-39
= $432,000/8,000 setup hours = $54 per setup hour
= $1,440,000/9,600 oven hours = $150 per oven hour
2. Total overhead costs assigned to Fudge (ABC rates):
= (Setup Rate × Fudge Setup Hours) + (Oven Hour Rate × Fudge Oven Hours)
= ($54 × 6,400) + ($150 × 1,600) = $585,600
3. Unit overhead assigned to Fudge:
= $585,600/8,000 units = $73.20
4. Plantwide overhead rate based on oven hours:
= $1,872,000/9,600 oven hours = $195 per oven hour
5. Total overhead costs assigned to Fudge (plantwide rate):
= Plantwide Rate × Number of Oven Hours Used by Fudge
= $195 × 1,600 = $312,000
1.
=
Activity Rate =
Activity Rate =
=
Total Overhead Costs
Total Oven Hours
Other Overhead Costs
Total Oven Hours
Total Overhead Assigned to Fudge
Total Setup Hours
Number of Fudge Units
a.
b.
Molding Activity Costs
Pounds of Plastic Molded
Decal Application Activity Costs
Setup Costs
Number of Decals Applied
Activity Rate (molding) =
Activity Rate (application) =
5-10
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CHAPTER 5 Activity-Based Costing and Management
E 5-39 (Concluded)
6. The difference in overhead assignment to Fudge between the two systems is due to
their different treatment of setup costs (i.e., both systems use oven hours to assign
“other overhead” costs). The total overhead assigned to Fudge under the ABC
system is much higher ($585,600) than under the nonABC system ($312,000)
because the ABC system recognizes that Fudge consumes 80% of the setup hours
(6,400/8,000) and, therefore, assigns 80% of the setup costs to Fudge. The nonABC
system assigns all overhead costs (including setup costs) using oven hours, which
results in Fudge being assigned only 16.67% (1,600/9,600 oven hours) of the setup
costs, rather than 80% (6,400/8,000 setup hours). This difference—80% versus
16.67%—results in the $273,600 ($585,600 – $312,000) difference in setup costs
assigned to Fudge under the two cost systems as shown in the following
breakdown:
(0.80 – 0.1667) × Total Setup Costs of $432,000 = 0.6333 × $432,000 = $273,600*
* Rounded
E 5-40
1. Treating patients: Normal Intensive
$4.00 × 6,400………………………..……………….…… $ 25,600
$4.00 × 8,000………………………..……………….…… $ 32,000
Providing hygienic care:
$5.00 × 4,800………………………..……………….…… 24,000
$5.00 × 17,600………………………..……………….… 88,000
Responding to requests:
$2.00 × 32,000………………………..……………….… 64,000
$2.00 × 80,000………………………..……………….… 160,000
Monitoring patients:
$3.00 × 6,000………………………..……………….…… 18,000
$3.00 × 72,000………………………..……………….… 216,000
Cost assigned………………………………………..……… $131,600 $496,000
2. Nursing cost per patient day: Normal Intensive
$131,600/8,000 patient days…………………………… $16.45
$496,000/6,400 patient days…………………………… $77.50
3. From Requirement 1, Total Nursing Cost = $131,600 + $496,000
= $627,600
Thus, using patient days (8,000 + 6,400):
Nursing Cost per Patient Day = $627,600/14,400
= $43.58
Both regular and intensive care patients would receive a charge of $43.58 per
patient day for nursing services. However, this is manifestly unfair because the
intensive care patients clearly place much greater demands on nursing services
than regular surgical patients. The ABC approach captures this difference as
demonstrated in Requirements 1 and 2.
5-11
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CHAPTER 5 Activity-Based Costing and Management
E 5-41
1. Resource Unloading Counting Inspecting
Equipment……………………………………… $15,000 — $ 1,200
Fuel……………………………………………… 3,600 — —
Operating……………………………………… 1,500 — 750
Labor*…………………………………………… 60,000 $37,500 52,500
Total………………………………………… $80,100 $37,500 $54,450
*(0.40 × $150,000; 0.25 × $150,000; 0.35 × $150,000)
2. Direct tracing and driver tracing are used. When the resource is used only by one
activity, then direct tracing is possible. When the activities are shared, as in the
case of labor, then resource drivers must be used.
E 5-42
1. JIT NonJIT
Sales (in units)a………………………………………………… 525,000 525,000
Salesb…………………………………………………………… $78,750,000
Allocationc……………………………………………………… $2,625,000 $2,625,000
a Sales (in units) = Average Order Size × Sales Orders;
JIT = 750 × 700 = 525,000; NonJIT = 7,500 × 70 = 525,000
b 525,000 units × $150 = $78,750,000
c $5,250,000 × 0.50 = $2,625,000
2. Activity rates:
Ordering Rate = $3,080,000/770 sales orders = $4,000 per sales order
Selling Rate = $1,120,000/140 sales calls = $8,000 per sales call
Service Rate = $1,050,000/525 sales calls = $2,000 per sales call
JIT NonJIT
Ordering costs:
$4,000 × 700……….…………….………………………….… $2,800,000
$4,000 × 70……….…………….………………………….… $ 280,000
Selling costs:
$8,000 × 70……….…………….………………………….… 560,000
$8,000 × 70……….…………….………………………….… 560,000
Service costs:
$2,000 × 350……….…………….………………………….… 700,000
$2,000 × 175……….…………….………………………….… 350,000
Total…….…………….………………………….………… $4,060,000 $1,190,000
$78,750,000
5-12
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CHAPTER 5 Activity-Based Costing and Management
E 5-42 (Concluded)
For the nonJIT distributors, the customer costs amount to $2,625,000/70 =
$37,500 per order under the original allocation. Using activity assignments, this
drops to $1,190,000/70 = $17,000 per order, a difference of $20,500 per order. For
an order of 7,500 units, the order price can be decreased by $2.73 per unit without
affecting customer profitability. Overall profitability will decrease, however, unless
the price for orders is increased to JIT distributors.
3. It sounds like the JIT buyers are switching their inventory carrying costs to
Stillwater Designs without any significant benefit to Stillwater Designs. Stillwater
Designs needs to increase prices to reflect the additional demands on customersupport
activities. Furthermore, additional price increases may be needed to
reflect the increased number of setups, purchases, and so on, that are likely
occurring inside the plant. Stillwater Designs should also immediately initiate
discussions with its JIT customers to begin negotiations for achieving some of
the benefits that a JIT supplier should have, such as long-term contracts. The
benefits of long-term contracting may offset most or all of the increased costs
from the additional demands made on other activities.
E 5-43
1. Supplier cost:
First, calculate the activity rates for assigning costs to suppliers:
Inspecting components:
$480,000/4,000 sampling hours = $120 per sampling hour
Reworking products:
$6,084,000/6,000 rework hours = $1,014 per rework hour
Warranty work:
$9,600,000/16,000 warranty hours = $600 per warranty hour
Next, calculate the cost per component by supplier:
Buckner
Manzer Inc. Company
Purchase cost:
$89 × 800,000……………………… $71,200,000
$86 × 3,200,000……………………… $275,200,000
Inspecting components:
$120 × 80…………………………… 9,600
$120 × 3,920………………………… 470,400
5-13
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CHAPTER 5 Activity-Based Costing and Management
E 5-43 (Concluded)
Buckner
Company
Reworking products:
$1,014 × 360…..….………….….…………………
$1,014 × 5,640…..….………….….………………… $ 5,718,960
Warranty work:
$600 × 800…..….………….….……………………
$600 × 15,200…..….………….….………………… 9,120,000
Total supplier cost…………………………………… $290,509,360
÷ Units supplied……………………………………… 3,200,000
Unit cost………………………………………………… $ 90.78
2. Using warranty hours, the rate is $4,000,000/16,000 = $250 per warranty hour.
The cost assigned to each component would be:
Bucker
Lost sales: Company
$250 × 800…..….………….….……………………
$250 × 15,200…..….………….….………………… $3,800,000
Total……………………………………………….. $3,800,000
÷ Units supplied……………………………………… 3,200,000
Increase in unit cost……………………………… $ 1.19
3. As with product costing, accurate assignment of costs to the cost object is essential
for well-grounded decision making. Suppliers can cause a firm to perform costly
activities such as inspection, rework, and warranty work. The total cost of a
component is thus more than its purchase price. As this example shows, the
component with the higher price is actually less expensive because it causes less
demand on internal costly activities. Thus, the company would likely decrease the
purchases of the one supplier in favor of the other. It also might attempt to work
with the one supplier which is causing significant demands on internal activities to
see if the quality of its component can be increased.
Manzer Inc.
$ 0.25
$200,000
$200,000
800,000
$ 90.07
480,000
800,000
Manzer Inc.
$ 365,040
$72,054,640
5-14
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CHAPTER 5 Activity-Based Costing and Management
E 5-44
Nonvalue-Added Cost
$9 per unit1
$300 per setup2
$120 per product3
$400,000 per year4
$250 per unit5
$900,000 per year6
1 (0.50 × $12) – (0.25 × $8) + [(8 – 7.5) × $10] = $9
2 (8 – 2) × $50 = $300
3 (6 – 0) × $20 = $120
4 $320,000 + (16,000 × $5) = $400,000
5 (6.5 – 6) × $500 = $250
6 As given
E 5-45
* For example, process design, product design, and quality approach or philosophy
E 5-46
Activity selection
Activity reduction
Activity elimination
Activity elimination
Activity selection
Activity sharing
E 5-47
1. Velocity = 80,000/20,000 = 4 units per hour
2. Cycle Time = 20,000/80,000 = 1/4 hour per unit = 15 minutes per unit
3. Cycle Time = 10 minutes = 10/60 = 1/6 hr. Velocity = 1/Cycle Time = 1 ÷ 1/6 = 6
units per hour
Units Produced/Production Hours = Velocity
Units Produced = Velocity × Production Hours
= 6 units per hour × 20,000 production hours
= 120,000 units
ef
Case
abc
Cost Reduction
d
Suppliers
de
Product design
Multiple*
f
abc
Plant layout
Process design
Product design
f
Root Cause
Case
abcde
Case
5-15
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CHAPTER 5 Activity-Based Costing and Management
E 5-48
1. Yes. Because direct materials and direct labor are directly traceable to each
product, their cost assignment should be accurate.
2. The consumption ratios for each activity (using machine hours and setup
hours as the activity drivers) are as follows:
Elegant Fina
Machining………………… 0.10 0.90 (500/5,000 and 4,500/5,000)
Setups……………………… 0.50 0.50 (100/200 and 100/200)
3. Elegant: $1.75* × $9,000/3,000 = $5.25 per briefcase
Fina: $1.75* × $3,000/3,000 = $1.75 per briefcase
* Overhead Rate = $21,000/$12,000 = $1.75 per direct labor dollar (or 175% of direct
labor cost)
More machine and setup costs are assigned to Elegant than Fina. This is
clearly a distortion because the production of Fina is automated and uses
the machine resources much more than the handcrafted Elegant. In fact,
the consumption ratios for machining are 0.1 and 0.9 (using machine
hours as the measure of usage). Thus, Fina uses 9 times the machining
resources that Elegant does. Setup costs are similarly distorted. The
products use an equal number of setup hours. Yet, if direct labor dollars
are used, then the Elegant briefcase receives three times more machining
costs than the Fina briefcase.
4. Products tend to make different demands on overhead activities, and this
should be reflected in overhead cost assignments. Usually, this means
the use of both unit- and nonunit-level activity drivers. In this example,
there is a unit-level activity (machining) and a nonunit-level activity (setting
up equipment).
Machine rate: $18,000/5,000 = $3.60 per machine hour
Setup rate: $3,000/200 = $15 per setup hour
Costs assigned to each product: Elegant Fina
Machining:
$3.60 × 500…………………………………………… $1,800
$3.60 × 4,500………………………………………… $16,200
Setups:
$15 × 100…………………………………………… 1,500 1,500
Total……………………………………………….……… $3,300 $17,700
÷ Units………………………………………………… 3,000 3,000
Unit overhead cost……………………………….. $ 1.10 $ 5.90
5-16
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CHAPTER 5 Activity-Based Costing and Management
E 5-49
1. Total overhead: $152,000 ($80,000 + $24,000 + $18,000 + $30,000)
Activity driver: Machine hours (20,000 + 20,000 = 40,000)
Rate = $152,000/40,000 = $3.80 per machine hour
Overhead assignment:
Infantry: $3.80 × 20,000 = $76,000
Special forces: $3.80 × 20,000 = $76,000
2. Consumption ratios:
Machine Receiving Packing
Hours Setups Orders Orders
Infantry……………………… 0.50 0.75 0.90 0.67
Special forces……………… 0.50 0.25 0.10 0.33
3. Activity rates:
Machining: $80,000/40,000 machine hours = $2.00 per machine hour
Setups: $24,000/400 setups = $60.00 per setup
Receiving: $18,000/1,000 receiving orders = $18.00 per receiving order
Packing: $30,000/2,400 packing orders = $12.50 per packing order
Special
4. Overhead assignment: Infantry Forces
Machining:
$2.00 × 20,000…………………………….……………… $40,000
$2.00 × 20,000…………………………….……………… $40,000
Setups:
$60.00 × 300…………………………….………………… 18,000
$60.00 × 100…………………………….………………… 6,000
Receiving:
$18.00 × 900…………………………….………………… 16,200
$18.00 × 100…………………………….………………… 1,800
Packing:
$12.50 × 1,600…………………………….……………… 20,000
$12.50 × 800…………………………….………………… 10,000
Total……………………….………………….……………… $94,200 $57,800
5. Using only machine hours undercosts the infantry product and overcosts the
special forces product. The consumption ratios reveal this before the actual
calculations are made.
Product
5-17
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CHAPTER 5 Activity-Based Costing and Management
E 5-50
Activity Dictionary:
Providing nursing care
Supervising nurses Coordinating nursing Number of nurses
activities
Feeding patients Providing meals to patients Number of meals
Laundering bedding Cleaning and delivering Pounds of laundry
and clothes clothes and bedding
Providing physical Therapy treatments Hours of therapy
therapy directed by physician
Monitoring patients Using equipment to monitor Monitoring hours
patient conditions
E 5-51
1. Activity rates:
Setups = $2,000,000/500 setups = $4,000 per setup
Machining = $80,000,000/400,000 machine hours = $200 per machine hour
Engineering = $6,000,000/150,000 engineering hours = $40 per engineering hour
Packing = $100,000/500,000 packing orders = $0.20 per packing order
2. Calculation of unit product costs: Deluxe Regular
Setups:
$4,000 × 300…………………………….…… $ 1,200,000
$4,000 × 200…………………………….…… $ 800,000
Machining:
$200 × 100,000……………………………. 20,000,000
$200 × 300,000……………………………. 60,000,000
Engineering:
$40 × 50,000…………………………….…… 2,000,000
$40 × 100,000…………………………….… 4,000,000
Packing:
$0.20 × 100,000…………………………… 20,000
$0.20 × 400,000…………………………… 80,000
Total overhead……………………………… $23,220,000 $64,880,000
÷ Units………………………………………… 100,000 800,000
Overhead per unit…………………………… $ 232 $ 81
Prime cost per unit………………………… 529 483
Unit cost…………………………………… $ 761 $ 564
* Rounded
Activity Name Activity Description Activity Driver
Satisfying patient needs Nursing hours
* *
5-18
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CHAPTER 5 Activity-Based Costing and Management
E 5-52
1. First, receiving is viewed as a value-added activity because the efficient level
of the activity is nonzero. Second, receiving enables other activities to be
performed. Third, there is a change of state—from a state of no materials
received to a state of materials received. Fourth, the receiving state should
not have been achieved by a prior activity. Fifth, it is a necessary activity—
one essential for the firm to remain in business.
Possible reasons for exceeding the value-added standard: suboptimal
inventory management policies, reorders due to bad parts being delivered
by suppliers, extra orders due to rework requirements, and additional
orders because the wrong types and quantities of materials were ordered.
2. Activity Rate = $630,000/72,000 orders = $8.75 per order
Value-Added Costs = $8.75 × 36,000 = $315,000
Nonvalue-Added Costs = $8.75 × 36,000 = $315,000
The practical capacity is currently 72,000 orders; thus, 36,000 orders are
unnecessary.
5-19
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CHAPTER 5 Activity-Based Costing and Management
P 5-53
1. Cost before addition of duffel bags:
$60,000*/100,000 = $0.60 per unit
*$120,000/2 (costs doubled with the addition of new product)
The assignment is accurate because all costs belong to the one product.
2. Activity-based cost assignment:
Stage 1:
Activity Rate = $120,000/80,000 transactions = $1.50 per transaction
Stage 2:
Overhead applied:
Backpacks: $1.50 × 40,000* = $60,000
Duffel bags: $1.50 × 40,000 = $60,000
*80,000 transactions/2 = 40,000 (number of transactions had doubled)
Unit cost:
Backpacks: $60,000/100,000 units = $0.60 per unit
Duffel bags: $60,000/25,000 units = $2.40 per unit
3. Product cost assignment:
Overhead rates:
Patterns: $30,000/15,000 direct labor hours = $2.00 per direct labor hour
Finishing: $90,000/30,000 direct labor hours = $3.00 per direct labor hour
Unit cost computation: Backpacks Duffel Bags
Patterns:
$2.00 × 0.10…………………………………… $0.20
$2.00 × 0.20…………………………………… $0.40
Finishing:
$3.00 × 0.20…………………………………… 0.60
$3.00 × 0.40…………………………………… 1.20
Total per unit………………………………………… $0.80 $1.60
PROBLEMS
5-20
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CHAPTER 5 Activity-Based Costing and Management
P 5-53 (Concluded)
4. This problem allows us to see what the accounting cost per unit should
be by providing the ability to calculate the cost with and without the duffel
bags. With this perspective, it becomes easy to see the benefits of the
activity-based approach over those of the functional-based approach. The
activity-based approach provides the same cost per unit as the singleproduct
setting. The functional-based approach used transactions to allocate
accounting costs to each producing department, and this allocation probably
reflects quite well the consumption of accounting costs by each producing
department. The problem is the second-stage allocation. Direct labor hours
do not capture the consumption pattern of the individual products as they
pass through the departments. The distortion occurs, not in using transactions
to assign accounting costs to departments, but in using direct labor hours to
assign these costs to the two products.
In a single-product environment, ABC offers no improvement in productcosting
accuracy. However, even in a single-product environment, it may be
possible to increase the accuracy of cost assignments to other cost objects
such as customers.
5-21
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CHAPTER 5 Activity-Based Costing and Management
P 5-54
1. Plantwide Rate = $990,000/440,000 DLHs = $2.25 per DLH
Overhead cost per unit:
Model A: ($2.25 × 140,000)/10,000 units = $31.50
Model B: ($2.25 × 300,000)/100,000 units = $6.75
Activity rates:
Driver
Setups Production runs $270,000/100 runs = $2,700 per run
Inspections Inspection hours $210,000/2,000 hours = $105 per hour
Machining Machine hours $240,000/220,000 hours = $1.09 per hour
Maintenance Maintenance hours $270,000/100,000 hours = $2.70 per hour
2. Overhead assignment: Model A Model B
Setups:
$2,700 × 40………………………………. $108,000
$2,700 × 60………………………………. $162,000
Inspections:
$105 × 800……………………………….. 84,000
$105 × 1,200……………………………… 126,000
Machining:
$1.09 × 20,000…………………………… 21,800
$1.09 × 200,000…………………………… 218,000
Maintenance:
$2.70 × 10,000…………………………… 27,000
$2.70 × 90,000…………………………… 243,000
Total overhead…………………………… $240,800 $749,000
÷ Units produced…………………….…… 10,000 100,000
Overhead per unit……………………… $ 24.08 $ 7.49
3. Departmental rates:
Overhead cost per unit:
Model A: ($3.50 × 10,000 machine hours) + ($0.90 × 130,000 direct labor hours)
/10,000 units = $15.20
Model B: ($3.50 × 170,000 machine hours) + ($0.90 × 270,000 direct labor hours)
/100,000 units = $8.38
4. A common justification is to use machine hours for machine-intensive departments
and labor hours for labor-intensive departments. Using activity-based costs as the
standard, we can say that departmental rates decreased the accuracy of the overhead
cost assignment for both products. The departmental rates cost A well below the ABC
method while the plantwide rate costs A well above the ABC method. However, the
rates of difference are very close. Looking at it this way, departments costs are not
clearly more wrong than the plantwide rate; they are wrong in a different direction.
Activity Activity Rate
5-22
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CHAPTER 5 Activity-Based Costing and Management
P 5-54 (Concluded)
Costing by method:
A B A/B Diff
ABC $24.08 $7.49 3.2
Department 15.20 8.38 1.8 –1.4
Plantwide 31.50 6.75 4.7 +1.5
P 5-55
1. Labor and gasoline are driver tracing.
Labor (0.75 × $120,000)…………………… $ 90,000 Time = Resource Driver
Gasoline ($3 × 6,000 moves)…………… 18,000 Moves = Resource Driver
Depreciation (0.75 × $16,000)…………… 12,000 Time = Resource Driver
Total cost……………………………… $120,000
2. Plantwide Rate = $600,000/20,000 direct labor hours
= $30 per DLH
Unit cost: Basic Deluxe
Prime costs $80.00 $160
Overhead:
$30 × 10,000 direct labor hours/40,000 units 7.50
$30 × 10,000 direct labor hours/20,000 units 15
$87.50 $175
3. Activity rates:
Maintenance: $114,000/4,000 = $28.50 per maintenance hour
Engineering: $120,000/6,000 = $20 per engineering hour
Materials handling: $120,000/6,000 = $20 per move
Setting up: $96,000/80 = $1,200 per setup
Purchasing: $60,000/300 = $200 per requisition
Receiving: $40,000/750 = $53.33 per order processed
Paying suppliers: $30,000/750 = $40 per invoice processed
Providing space: $20,000/10,000 = $2 per machine hour
Unit cost: Basic Deluxe
Prime costs ($80 × 40,000; $160 × 20,000)…………… $3,200,000 $3,200,000
Overhead:
Maintenance:
$28.50 × 1,000……….…………….…………………. 28,500
$28.50 × 3,000……….…………….…………………. 85,500
Engineering:
$20.00 × 1,500……….…………….…………………. 30,000
$20.00 × 4,500……….…………….…………………. 90,000
Materials handling:
$20.00 × 1,200……….…………….…………………. 24,000
$20.00 × 4,800……….…………….…………………. 96,000
5-23
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CHAPTER 5 Activity-Based Costing and Management
P 5-55 (Continued)
Setting up:
$1,200 × 16……….…………….………… 19,200
$1,200 × 64……….…………….………… 76,800
Purchasing:
$200 × 100……….…………….………… 20,000
$200 × 200……….…………….………… 40,000
Receiving:
$53.33 × 250……….…………….………… 13,333
$53.33 × 500……….…………….………… 26,665
Paying suppliers:
$40 × 250……….…………….…………… 10,000
$40 × 500……….…………….…………… 20,000
Providing space:
$2 × 5,000……….…………….…………… 10,000
$2 × 5,000……….…………….…………… 10,000
Total………………………….…………….… $3,355,033 $3,644,965
÷ Units produced………….…………….… 40,000 20,000
Unit cost (ABC)…………….…………….… $ 83.88 $ 182.25
Unit cost (traditional)……….…………… $ 87.50 $ 175.00
The ABC costs are more accurate (better tracing—closer representation of actual
resource consumption). This shows that the basic model was overcosted and the
deluxe model undercosted when the plantwide overhead rate was used.
4. Consumption ratios: Basic Deluxe
Maintenance……………….…………….… 0.25 0.75
Engineering………………….……………. 0.25 0.75
Materials handling………….……………. 0.20 0.80
Setups……………………….…………….… 0.20 0.80
Purchasing………………….…………….… 0.33 0.67
Receiving…………………….……………. 0.33 0.67
Paying suppliers………….…………….… 0.33 0.67
Providing space…………….……………. 0.50 0.50
5. When products consume activities in the same proportion, the activities with the
same proportions can be combined into one pool. This is so because the pooled
costs will be assigned in the same proportion as the individual activity costs. Using
these consumption ratios as a guide, we create four pools, reducing the number of
rates from 8 to 4.
* Rounded
*
5-24
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CHAPTER 5 Activity-Based Costing and Management
P 5-55 (Concluded)
Pool 1:
Maintenance…………………………………………… $114,000
Engineering……………………………………………… 120,000
Total…………………………………………………… $234,000
÷ Maintenance hours…………………………………… 4,000
Pool rate……………………………………………… $ 58.50
Note: Engineering hours could also be used as a driver. The activities are
grouped together because they have the same consumption ratios:
(0.25, 0.75).
Pool 2:
Materials handling……………………………………… $120,000
Setting up………………………………………………… 96,000
Total…………………………………………………… $216,000
÷ Number of moves…………………………………… 6,000
Pool rate……………………………………………… $ 36
Note: Materials handling and setups have the same consumption ratios:
(0.20, 0.80). The number of setups could also be used as the pool driver.
Pool 3:
Purchasing……………………………………………… $ 60,000
Receiving………………………………………………… 40,000
Paying suppliers………………………………………… 30,000
Total…………………………………………………… $130,000
÷ Orders processed…………………………………… 750
Pool rate……………………………………………… $ 173.33
Note: The three activities are all product-level activities and have the same
consumption ratios: (0.33, 0.67).
Pool 4:
Providing space………………………………………… $20,000
÷ Machine hours………………………………………… 10,000
Pool rate……………………………………………… $ 2
Note: This is the only facility-level activity.
5-25
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CHAPTER 5 Activity-Based Costing and Management
P 5-56
1. The cost of supervision is computed as follows:
Salary of supervisor (direct)………………………………… $ 80,000
Salary of secretary (direct)…………………………………… 35,000
Other costs (direct)…………………………………………… 170,000
Assistants (3 × 0.75 × $60,000)……………………………… 135,000
Total…………………………………………………………… $420,000
The total cost of care is $2,700,000 plus a $70,000 share of the cost of
supervision (25/150 × $420,000). Thus, the cost per patient day is
computed as follows:
$2,770,000/10,000 = $277 per patient day
(The total cost of care divided by patient days.) Notice that every maternity
patient—regardless of type—would pay the daily rate of $277.
2. First, the cost of the secondary activity (supervision) must be assigned to
the primary activities (various nursing care activities) that consume it
(the driver is the number of nurses):
Maternity nursing care assignment:
25/150 × $420,000 = $70,000
Thus, the total cost of nursing care is $1,200,000 + $70,000 = $1,270,000.
Next, calculate the activity rates for the two primary activities:
Occupancy and feeding:
$1,500,000/10,000 = $150.00 per day
Nursing care:
$1,270,000/50,000 = $25.40 per nursing hour
Finally, the cost per patient day type can be computed:
Patient Daily Rate
Normal…………………………………… $213.50
Cesarean………………………………… $308.75
Complications………………………… $658.00
a ($150 × 7,000) + ($25.40 × 17,500)/7,000
b ($150 × 2,000) + ($25.40 × 12,500)/2,000
c ($150 × 1,000) + ($25.40 × 20,000)/1,000
This example illustrates that activity-based costing can produce significant
product-costing improvements in service organizations that experience
product diversity.
a
b
c
5-26
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CHAPTER 5 Activity-Based Costing and Management
P 5-56 (Concluded)
3. The laundry department cost would increase the total cost of the maternity
department by $115,200 (240,000/1,250,000 × $600,000). This would
increase the cost per patient day by $11.52 ($115,200/10,000). The activity
approach would need more detailed information—specifically, the amount
of pounds of laundry caused by each patient type. The activity approach
will increase the accuracy of the cost assignment if patient types produce
a disproportionate share of laundry. For example, if patients with
complications produce 40% of the pounds with only 10% of the patient
days, then the $11.52 charge per day is not a fair assignment.
5-27
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CHAPTER 5 Activity-Based Costing and Management
P 5-57
1. Cost per Account = $6,105,000/75,000 accounts = $81.40
Average Fee per Month = $81.40/12 months = $6.78
2. Activity rates:
Opening and closing accounts:
$300,000/30,000 accounts = $10 per account
Issuing monthly statements:
$450,000/900,000 statements = $0.50 per statement
Processing transactions:
$3,075,000/30,750,000 transactions = $0.10 per transaction
Customer inquiries:
$600,000/3,000,000 minutes = $0.20 per minute
Providing ATM services:
$1,680,000/2,400,000 transactions = $0.70 per transaction
Costs assigned: Low Medium High
Opening and closing:
$10 × 22,500………………………… $ 225,000
$10 × 4,500………………………… $ 45,000
$10 × 3,000………………………… $ 30,000
Issuing monthly statements:
$0.50 × 675,000…………………… 337,500
$0.50 × 150,000…………………… 75,000
$0.50 × 75,000……………………… 37,500
Processing transactions:
$0.10 × 27,000,000………………… 2,700,000
$0.10 × 3,000,000………………… 300,000
$0.10 × 750,000…………………… 75,000
Customer inquiries:
$0.20 × 1,500,000………………… 300,000
$0.20 × 900,000…………………… 180,000
$0.20 × 600,000…………………… 120,000
Providing ATM services:
$0.70 × 2,025,000………………… 1,417,500
$0.70 × 300,000…………………… 210,000
$0.70 × 75,000……………………… 52,500
Total cost……………………………… $4,980,000 $810,000 $315,000
Number of accounts………………… 57,000 12,000 6,000
Cost per account………………… $ 87.37 $ 67.50 $ 52.50
5-28
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CHAPTER 5 Activity-Based Costing and Management
P 5-57 (Concluded)
3. Average profit per account: $90.00 – $81.40 = $8.60
ABC profit measure:
Low-balance customers………………… $80.00 – $87.37 = $(7.37)
Medium-balance customers…………… $100.00 – $67.50 = $32.50
High-balance customers………………… $165.00 – $52.50 = $112.50
4. First, calculate the profits from loans, credit cards, and other products by
customer category (using ABC data). Next, compare 50% of the cross-sales
profits from low-balance customers with the total loss from the low-balance
checking accounts. If the cross-sales profits are greater than the loss, the
president’s argument has merit.
P 5-58
1. GAAP mandates that all nonmanufacturing costs be expensed during the
period in which they are incurred. GAAP is the most likely cause of the practice.
The limitations of GAAP-produced information for cost management should be
emphasized.
The total product consists of all benefits, both tangible and intangible, that a
customer receives. One of the benefits is the order-filling service provided by
Grundvig. Thus, it can be argued that these costs should be product costs
and not assigning them to products undercosts all products. From the
information given, there are more small orders than large (100,000 orders
average 600 units); thus, these small orders consume more of the order-filling
resources. They should, therefore, receive more of the order-filling costs.
5-29
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CHAPTER 5 Activity-Based Costing and Management
P 5-58 (Continued)
2. The average order-filling cost per unit produced is computed as follows:
$9,000,000/180,000,000* units = $0.05 per unit
* (600 × 100,000) + (1,000 × 60,000) + (1,500 × 40,000) = 180,000,000
Thus, order-filling costs are about 6 to 10% of the selling price, clearly not a
trivial amount.
Furthermore, the per-unit cost for individual product families can be computed
using the number of orders as the activity driver:
Activity Rate = $9,000,000/200,000 orders = $45 per order
The per-unit ordering cost for each product family can now be calculated:
Category I: $45/600 = $0.08 per unit
Category II: $45/1,000 = $0.05 per unit
Category III: $45/1,500 = $0.03 per unit
Category I, which has the smallest batches, is the most undercosted of the
three categories. Furthermore, the unit ordering cost is quite high relative to
Category I’s selling price (10 to 16% of the selling price). This suggests that
something should be done to reduce the order-filling costs.
3. With the pricing incentive feature, the average order size has been increased
to 2,000 units for all three product families. The number of orders now
processed can be calculated as follows:
Orders = [(600 × 100,000) + (1,000 × 60,000) + (1,500 × 40,000)]/2,000
= 90,000
Reduction in Orders = 200,000 – 90,000 = 110,000
Steps That Can Be Reduced = 110,000/2,000 = 55
Reduction in resource spending:
Step-fixed costs: $50,000 × 55 = $2,750,000
Variable activity costs: $20 × 110,000 = 2,200,000
$4,950,000
5-30
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CHAPTER 5 Activity-Based Costing and Management
P 5-58 (Concluded)
Customers were placing smaller and more frequent orders than necessary.
They were receiving a benefit without being charged for it. By charging for
the benefit and allowing customers to decide whether the benefit is worth
the cost of providing it, Grundvig was able to reduce its costs (potentially
by shifting the cost of the service to the customers). The customers,
however, apparently did not feel that the benefit was worth paying for and
so increased order size. By increasing order size, the number of orders
decreased, decreasing the demand for the order-filling activity, allowing
Grundvig to reduce its order-filling costs. Other benefits may also be
realized. The order size affects activities such as scheduling, setups, and
materials handling. Larger orders should also decrease the demand for
these activities, and costs can be reduced even more.
Competitive advantage is created by providing the same customer value
for less cost or better value for the same or less cost. By reducing the
cost, Grundvig can increase customer value by providing a lower price
(decreasing customer sacrifice) or by providing some extra product
features without increasing the price (increasing customer realization,
holding customer sacrifice constant). This is made possible by the
decreased cost of producing and selling the bolts.
It may also be of value to note that we are discussing airplane bolt packages
that are priced at $0.50 to $0.80 each. For Category I, that means the range of
difference in inventory impact on the customer is $700 – $1,120 [$0.50 × (2,000 –
600) to $0.80 × (2,000 – 600)]. This is certainly manageable when they are
placing so many orders. It is likely the customers will also realize some
savings by placing fewer orders as the bolts are small and the carrying
cost should not be significant relative to ordering and receiving costs.
5-31
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CHAPTER 5 Activity-Based Costing and Management
P 5-59
1. Supplier cost:
First, calculate the activity rates for assigning costs to suppliers:
Replacing engines:
$800,000/2,000 engines = $400 per engine
Expediting orders:
$1,000,000/200 late shipments = $5,000 per late shipment
Repairing engines:
$1,800,000/2,500 engines = $720 per engine
Next, calculate the cost per engine by supplier:
Supplier cost:
Watson Johnson
Purchase cost:
$900 × 18,000………………………….…… $16,200,000
$1,000 × 4,000………………………….…… $4,000,000
Replacing engines:
$400 × 1,980………………………….……… 792,000
$400 × 20………………………….………… 8,000
Expediting orders:
$5,000 × 198………………………………… 990,000
$5,000 × 2………..…………………………… 10,000
Repairing engines:
$720 × 2,440………………………………… 1,756,800
$720 × 60………………………………..…… 43,200
Total supplier cost…………………………… $19,738,800 $4,061,200
÷ Units supplied……………………….……… 18,000 4,000
Unit cost…………………………………… $ 1,096.60 $ 1,015.30
The Johnson engine costs less when the full supplier effects are considered.
This is a better assessment of cost because it considers the costs that are
caused by the supplier due to poor quality, poor reliability, and poor delivery
performance.
2. In the short run, buy 20,000 from Johnson and 2,000 from Watson. In the
long run, one possibility is to encourage Watson to increase its quality
and maintain purchases from both sources (lowers source risk by having
two suppliers).
5-32
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 5 Activity-Based Costing and Management
P 5-60
1. Activity-based management is a system-wide, integrated approach that focuses
management’s attention on activities. It involves two dimensions: a cost dimension
and a process dimension. Key elements in activity management are identifying
activities, assessing their value, and retaining only value-adding activities. The
consultant identified the activities but did not formally classify the activities as
value-added or nonvalue-added. Nor did the consultant offer any suggestions
for increasing efficiency—at least not formally. The consultant apparently had
tentatively identified potential savings through eliminating nonvalue-added
activities. Management must still decide how to reduce, eliminate, share, and
select activities to achieve cost reductions.
2. Setting up equipment……………………………… $125,000
Materials handling………………………………… 180,000
Inspecting products……………………………… 122,000
Handling customer complaints………………… 100,000
Filling warranties…………………………………… 170,000
Storing goods……………………………………… 80,000
Expediting goods…………………………………… 75,000
Total……………………………………………… $852,000
5-33
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 5 Activity-Based Costing and Management
P 5-60 (Continued)
Units produced and sold………………………………… 120,000 *
Potential unit cost reduction……………………………… $7.10 **
* $1,920,000/$16 (Total Cost/Unit Cost)
** $852,000/120,000 = $7.10
The consultant’s estimate of cost reduction was on target. Per-unit costs
can be reduced by at least $7, and further reductions may be possible if
improvements in value-added activities are possible.
We have identified $7.10 per unit of potential cost reduction. We don’t know
for sure that costs can actually be reduced that much, and, if they can, what
the cost of doing that would be. For example, eliminating materials handling
generally involves a change in layout, which costs money (additional fixed
cost and depreciation). Setups are often the result of design changes or
improvements to the circuit boards, and, if they go to automation, that involves
reprogramming the machine rather than simply telling the worker to make
a change. They are currently making $2 per unit profit. If they can get a cost
reduction of at least $4 per unit, they can maintain current sales and profit
levels at a $14 price. Any additional cost savings contributes to profit. If
they can achieve at least a $5.34 cost savings, they can maintain their current
total profit at the increased volume. Any savings over those amounts is
more profit than they are making currently.
3. Unit cost to maintain sales = $14 – $4 = $10
Unit cost to expand sales = $12 – $4 = $8
Current cost = $16
Cost reduction to maintain = $16 – $10 = $6
Cost reduction to expand = $16 – $8 = $8
4. Total potential reduction:
$ 852,000 (from Requirement 2)
150,000 (by automating)
$1,002,000
÷ Units………………………………… 120,000
Unit savings………………………… $ 8.35
Costs can be reduced by at least $7, enabling the company to maintain
current market share. Further, if all the nonvalue-added costs are eliminated,
then the cost reduction needed to increase market share is also possible.
See also the discussion of profitability provided in Requirement 2. Activity
selection is the form of activity management used here.
5-34
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 5 Activity-Based Costing and Management
P 5-60 (Concluded)
5. Current:
Sales………………………………………… $ 2,160,000 ($18 × 120,000 units)
Costs………………………………………… (1,920,000)
Income…………………………………… $ 240,000
$14 price: (assumes that current market share is maintained):
Sales………………………………………… $1,680,000 ($14 × 120,000 units)
Costs………………………………………… (918,000) ($7.65 × 120,000 units)
Income…………………………………… $ 762,000
$12 price:
Sales………………………………………… $ 2,160,000 ($12 × 180,000 units)
Costs………………………………………… (1,377,000) ($7.65 × 180,000 units)
Income…………………………………… $ 783,000
* $16.00 – $8.35 = $7.65
The $12 price produces the greatest benefit.
P 5-61
1. Nonvalue-added usage and costs, 20X1:
Nonvalue Usage Nonvalue Cost
AQ* VAQ** AQ – VAQ (AQ – VAQ)SP
Materials……… 600,000 480,000 120,000 $ 600,000
Engineering…… 48,000 27,840 20,160 604,800
$1,204,800
* 1.25 × 6 × 80,000 = 600,000
** (4 × 6,000) + (10 × 2,400) = 48,000
(AQ for engineering represents the actual practical capacity acquired.)
*** 6 × 80,000 = 480,000
**** (0.58 × 24,000) + (0.58 × 24,000) = 27,840
Note: VAQ = Value-Added Quantity; SP = Price of Activity Quantity; SP for materials
is $5; SP for engineering is $30 (24 × $60,000)/48,000.
2. Expected values for the coming year (20X2):
Materials: EQ = 480,000 + 0.60(120,000) = 552,000 pounds
Engineering: EQ = 27,840 + 0.60(20,160) = 39,936 engineering hours
Excess
Nonvalue Usage
AQ EQ* AQ – EQ
Materials……… 584,800 552,000 32,800 $164,000 U
Engineering…… 35,400 39,936 (4,536) 136,080 F
* For engineering, the expected value is a measure of how much resource usage is needed (this year),
and so progress is measured by comparing with actual usage, not activity availability.
Excess
Nonvalue Cost
(AQ – EQ)SP
***
** ****
*
5-35
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 5 Activity-Based Costing and Management
P 5-61 (Concluded)
The company failed to meet the materials standard but beat the engineering
standard. The engineering outcome is of particular interest. The actual usage
of the engineering resource is 35,400 hours, and activity availability is 48,000.
Thus, the company has created 12,600 hours of unused engineering capacity.
Each engineer brings a capacity of 2,000 hours. Since engineers come in
whole units, the company now has six too many! Thus, to realize the savings
for the engineering activity, the company must decide how to best use these
available resources. One possibility is to simply lay off six engineers, thereby
increasing total profits by the salaries saved ($360,000). Other possibilities
include reassignment to activities that have insufficient resources (assuming
they could use engineers, e.g., perhaps new product development could use
six engineers). The critical point is that resource usage reductions must be
converted into reductions in resource spending, or the efforts have been in
vain.
P 5-62
1. Theoretical Velocity = 90,000/12,000 hours = 7.5 telescopes per hour
Theoretical Cycle Time = 60/7.5 telescopes = 8 minutes per telescope
2. Actual Velocity = 75,000/12,000 hours = 6.25 telescopes per hour
Actual Cycle Time = 60/6.25 telescopes = 9.6 minutes
3. Budgeted Conversion Costs = $7,500,000/(12,000 × 60)
= $10.42 per minute
Theoretical Conversion Costs per Telescope = $10.42 × 8 = $83.36
Actual Conversion Costs per Telescope = $10.42 × 9.6 = $100.03
Yes. By reducing cycle time, the cost per unit can be reduced. The potential
reduction is as follows:
$100.03 – $83.36 = $16.67 per telescope
5-36
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 5 Activity-Based Costing and Management
Case 5-63
1. Shipping and warehousing costs are currently assigned using tons of paper
produced, a unit-based measure. Many of these costs, however, are not driven by
quantity produced. Many products have special handling and shipping requirements
involving extra costs. These costs should not be assigned to those products that
are shipped directly to customers.
2. The new method proposes assigning the costs of shipping and warehousing
separately for the low-volume products. To do so requires three cost assignments:
receiving, shipping, and carrying. The cost drivers for each cost are tons processed,
items shipped, and tons sold.
Pool rate, receiving costs:
= $19.64 per ton processed
Pool rate, shipping costs:
Shipping Cost per Shipping Item = $2,300,000/190,000 shipping items
= $12.11 per shipping item
Pool rate, carrying cost (an opportunity cost):
Carrying Cost per Year (LLHC) = 25 × $1,665 × 0.16
= $6,660
Carrying Cost per Ton Sold = $6,660/10 = $666
Shipping and warehousing cost per ton sold:
Receiving………………………………… $ 19.64
Shipping ($12.11 × 7)…………………… 84.77
Carrying…………………………………… 666.00
Total……………………………………… $770.41
Receiving Cost
Tons Processed
CASES
= $1,100,000/56,000 tons
5-37
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CHAPTER 5 Activity-Based Costing and Management
Case 5-63 (Concluded)
3. Profit analysis:
Revised profit per ton (LLHC):
Selling price………………………………………………………………… $2,400.00
Less manufacturing cost………………………………………………… 1,665.00
Gross profit………………………………………………………………… $ 735.00
Less shipping and warehousing………………………………………… 770.41
Loss………………………………………………………………………… $ (35.41)
Original profit per ton:
Selling price………………………………………………………………… $2,400.00
Less manufacturing cost………………………………………………… 1,665.00
Gross profit………………………………………………………………… $ 735.00
Less shipping and warehousing………………………………………… 30.00
Profit………………………………………………………………………… $ 705.00
The revised profit, reflecting a more accurate assignment of shipping and
warehousing costs, presents a much different picture of LLHC. The product is,
in reality, losing money for the company. Its earlier apparent profitability was
attributable to a subsidy being received from the high-volume products (by
spreading the special shipping and handling costs over all products, using
tons produced as the cost driver). The same effect is also true for the other
low-volume products. Essentially, the system is understating the handling
costs for low-volume products and overstating the cost for high-volume
products.
4. The decision to drop some high-volume products and emphasize low-volume
products could clearly be erroneous. As LLHC has demonstrated, its apparent
profitability is attributable to distorted cost assignments. A significant change in
the image of LLHC was achieved by simply improving the accuracy of shipping
and handling costs. Further improvements in accuracy in the overhead
assignments may cause the view of LLHC to deteriorate even more. Conversely,
the profitability of high-volume products may improve significantly with increased
costing accuracy. This example underscores the importance of having accurate
and reliable accounting information. The accounting system must bear the
responsibility of providing reliable information.
5. Ryan’s strategy changed because his information concerning the individual
products changed. Apparently, the accounting system was undercosting the
low-volume products and overcosting the high-volume products. Once better
information was available, Ryan was able to respond better to competitive
conditions.
5-38
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CHAPTER 5 Activity-Based Costing and Management
Case 5-64
1. Disagree. Chuck is expressing an uninformed opinion. He has not spent the
effort to find out exactly what activity-based management and costing are
attempting to do; therefore, he has no real ability to offer any constructive
criticism of the possible benefits of these two approaches.
2. and 3.
At first glance, it may seem strange to even ask if Chuck’s behavior is unethical.
After all, what is unethical about expressing an opinion, albeit uninformed? While
offering uninformed opinions or recommendations may be of little consequence
in many settings, a serious issue arises when a person’s expertise is relied upon
by others to make decisions or take actions that could be wrong or harmful to
themselves or their organizations. This very well may be the case for Chuck’s
setting, and his behavior may be labeled professionally unethical.
Chuck’s lack of knowledge about activity-based systems is a signal of his
failure to maintain his professional competence. Standard I-1 of the IMA Statement
of Ethical Professional Practice indicates that management accountants have a
responsibility to continually develop their knowledge and skills. Failure to do so
is unethical.
5-39
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