Chap 005

CHAPTER 5 Activity-Based Costing and Management
Answers to Review Questions 5-1 In a traditional, volume-based product-costing system, only a single predetermined overhead rate is used. All manufacturing-overhead costs are combined into one cost pool, and they are applied to products on the basis of a single cost driver that is closely related to production volume. The most frequently used cost drivers in traditional product-costing systems are direct-labor hours, direct-labor dollars, machine hours, and units of production. Management was being misled by the traditional product-costing system, because the high-volume product lines were being overcosted and the low-volume product line was being undercosted. The high-volume products essentially were subsidizing the low-volume line. The traditional product-costing system failed to show that the low-volume products were driving more than their share of overhead costs. As a result of these misleading costs, the company's management was mispricing its products. An activity-based costing system is a two-stage process of assigning costs to products. In stage one, activity-cost pools are established. In stage two a cost driver is identified for each activity-cost pool. Then the costs in each pool are assigned to each product line in proportion to the amount of the cost driver consumed by each product line. A cost driver is a characteristic of an event or activity that results in the incurrence of costs by that event or activity. In activity-based costing systems, the most significant cost drivers are identified. Then a database is created that shows how these cost drivers are distributed across products. This database is used to assign costs to the various products depending on the extent to which they use each cost driver. The four broad categories of activities identified in an activity-based costing system are as follows: (a) (b) (c) Unit-level activities: Must be done for each unit of production. Batch-level activities: Must be performed for each batch of products. Product-sustaining activities: Needed to support an entire product line.
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McGraw-Hill/Irwin Managerial Accounting, 8/e
2009 The McGraw-Hill Companies, Inc. 5-1
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Facility-level (or general-operations-level) activities: Required for the entire production process to occur.
An activity-based costing system alleviated the problems management was having under its traditional, volume-based product-costing system by more accurately assigning costs to products. Products were assigned costs based on the extent to which they used various cost drivers that were determined to be closely related to the incurrence of a variety of overhead costs. Product-costing systems based on a single, volume-based cost driver tend to overcost high-volume products, because all overhead costs are combined into one pool and distributed across all products on the basis of only one cost driver. This simple averaging process fails to recognize the fact that a disproportionate amount of costs often is associated with low-volume or complex products. The result is that low-volume products are assigned less than their share of manufacturing costs, and high-volume products are assigned more than their share of the costs. In traditional, volume-based costing systems, only direct material and direct labor are considered direct costs. In contrast, under an activity-based costing system, an effort is made to account for as many costs as possible as direct costs of production. Any cost that can possibly be traced to a particular product line is treated as a direct cost of that product. The pool rate is calculated by dividing the budgeted amount of an activity cost pool by the budgeted total quantity of the associated cost driver. The pool rate is the cost of a particular activity that is expected per unit of the associated cost driver. Two factors that tend to result in product cost distortion under traditional, volumebased product-costing systems are as follows: (a) Non-unit level overhead costs: Many overhead costs vary with cost drivers that are not unit-level activities. Use of a unit-level cost driver to assign such costs tends to result in cost distortion. (b) Product diversity: When a manufacturer produces a diverse set of products, which exhibit different consumption ratios for overhead activities, use of a single cost driver to assign costs results in cost distortion.
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Three important factors in selecting cost drivers for an ABC system are as follows: (a) Degree of correlation between consumption of an activity and consumption of the cost driver. (b) Cost of measurement of the cost driver.
McGraw-Hill/Irwin 5-2
2009 The McGraw-Hill Companies, Inc. Solutions Manual
(c) Behavioral effects, that is, how the cost driver selected will affect the behavior of the individuals involved in the activity related to the cost driver. 5-12 An activity dictionary lists all of the activities identified and used in an activity-based costing analysis. The activity dictionary provides for consistency in the terminology and level of complexity in the ABC analysis in the organizations various subunits. Line managers are close to the production process and may realize that a complex product, which is difficult to manufacture, is undercosted by a traditional, volumebased costing system. Because of the cost distortion that is common in such systems, the undercosted product may appear to be profitable when it is really losing money. Line managers may have a "gut feeling" for this situation, even if the cost-accounting system suggests otherwise. Diverse products typically consume support activities (such as purchasing, material handling, engineering, and inspection) in differing degrees. When there are significant differences among product lines in the ways that they consume support services (and thereby cause overhead costs), a traditional, volume-based costing system may distort product costs. Some products are overcosted; others are undercosted. An ABC system can eliminate (or at least alleviate) such cost distortion. Activity-based costing is just as appropriate in the service industry as in the manufacturing industry. Just as in manufacturing firms, diverse services typically consume support activities in varying degrees. ABC systems are more accurate in tracking the usage of these support activities to the services (products) that are produced than are traditional, volume-based costing systems. As indicated in the chapter, Pennsylvania Blue Shield, like many manufacturers, classifies activities as unit level, batch level, product-sustaining level, or facility level. Maintenance of the medical-services provider network (i.e., the physicians and hospitals that provide medical care to claimants) is a product-sustaining-level activity because it benefits an entire product line (service line, in this case) of personal health insurance policies. Management could use the ABC information about the cost of various types of patient appointments for determining charges for appointments, making appointment staffing decisions (e.g., physician versus nurse practitioner), and justifying reimbursements from insurance companies or government agencies.
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At Patio Grill Company, every unit of each product line manufactured requires all eight of the support activities covered by the ABC system. In contrast, at Delaware Medical Center, each patient sees a physician, or a nurse practitioner, or an intern, or a resident. Moreover, each patient is either a new patient or a continuing patient, but not both. Therefore, in determining the cost a patient appointment, the cost analyst would include only the relevant activity costs in the cost of a patient appointment. The two-dimensional activity-based costing model provides one way of picturing the relationship between ABC and ABM. The vertical dimension of the model depicts the cost assignment view of an ABC system. From the cost assignment viewpoint, the ABC system uses two-stage cost allocation to assign the costs of resources to the firm's cost objects. These cost objects could be products manufactured, services produced, or customers served. Depicted in the horizontal dimension of the model that follows is the process view of an ABC system. The emphasis now is on the activities themselves, the processes by which work is accomplished in the organization. The left-hand side of the model depicts activity analysis, which is the detailed identification and description of the activities conducted in the enterprise. Activity analysis entails the identification not only of the activities, but also of their root causes, the events that trigger activities, and the linkages among activities. The right-hand side of the model depicts the evaluation of activities through performance measures. These processes of activity analysis and evaluation constitute activity-based management. The two-dimensional ABC model is depicted in the diagram on the next page. Activity analysis is the detailed identification and description of the activities conducted in an enterprise. Activity analysis entails the identification not only of activities, but also of their root causes, of the events that trigger them, and of the linkages among them. Three criteria for determining whether an activity adds value are as follows: (a) Is the activity necessary? (b) Is the activity efficiently performed? (c) Is the activity sometimes value-added and sometimes non-value-added?
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Diagram of two-dimensional ABC model (from review question 5-19 on preceding page): Cost Assignment View RESOURCE COSTS Assignment of resource costs to activity cost pools associated with significant activities Activity evaluation ACTIVITIES PERFORMANCE MEASURES
Process View Activity analysis ROOT ACTIVITY CAUSES TRIGGERS
Assignment of activity costs to cost objects using second-stage cost drivers COST OBJECTS (products or services produced; customers)
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An activity's trigger is the preceding event that indicates that the activity should be performed. The activity's root cause is the event or activity that, if it had not occurred, would have prevented the activity in question from happening. For example, the event that triggers the activity of rework is the identification of a defective part during inspection. However, the inspection is not the root cause of the rework activity. The root cause of the defective part, and hence the need for rework, could lie in erroneous part specifications, in an unreliable vendor, or in faulty production. Customer profitability analysis refers to using the concepts of activity-based costing to determine how serving particular customers causes activities to be performed and costs to be incurred. Examples of activities that can be differentially demanded by customers include order frequency, order size, special packaging or handling, customized parts or engineering, and special machine setups. Such activities can make some customers more profitable than others. Activity-based costing is used to analyze customer-related costs and determine the cost drivers for these costs. This ABC data then forms the basis for the customer profitability analysis by assigning the appropriate amount of customer-related costs to each customer. A customer profitability profile, usually expressed in graphical form, shows the companys cumulative operating income as a percentage of total operating income. The customers included in the profile generally are ranked either by operating income or by sales revenue. In a just-in-time (JIT) production system, raw materials and parts are purchased or produced just in time to be used at each stage of the production process. This approach to inventory and production management brings considerable cost savings from reduced inventory levels. The key to the JIT system is the "pull" approach to controlling manufacturing. The diagram on the next page displays a simple multistage production process. The flow of manufacturing activity is depicted by the solid arrows running down the diagram from one stage of production to the next. However, the signal that triggers more production activity in each stage comes from the next stage of production. These signals, depicted by the dashed-line arrows, run up the diagram. We begin with sales at the bottom of the exhibit. When sales activity warrants more production of finished goods, the goods are "pulled" from production stage III by a signal that more goods are needed. Similarly, when production employees in stage III need more inputs, they send a signal back to stage II. This signal triggers production
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activity in stage II. Working our way back up to the beginning of the process, purchases of raw materials and parts are triggered by a signal that they are needed in stage I.
The Pull Method in a JIT System

Purchasing
Demand for raw materials and parts is signaled when there is a need in stage I for more inputs.
Production Stage I
Demand for production activity in stage I is signaled when there is a need in stage II for more inputs.
Production Stage II
Demand for production activity in stage II is signaled when there is a need in stage III for more inputs.
Production Stage III
Sales
Demand for finished goods is signaled when sales activity warrants more finished units. This signal triggers manufacturing activity in the final stage of production (stage III).
Denotes flow of materials, parts, partially finished goods, and finished goods.
Denotes a signal that more goods are needed at the next stage of production.
This pull system of production management, which characterizes the JIT approach, results in a smooth flow of production and significantly reduced inventory levels.
Solutions to exercises EXERCISE 5-26 (15 MINUTES) 1. Material-handling cost per mirror:
$90,000 250 = $1,500 [(30)(250) + (30)(250)] *
*The total number of direct-labor hours. An alternative calculation, since both types of product use the same amount of the cost driver, is the following:
$90,000 = $1,500 60 *
*The total number of units (of both types) produced. 2. 3. Material-handling cost per lens = $1,500. The analysis is identical to that given for requirement (1). Material-handling cost per mirror:
$90,000 4 (4 + 16) * = $600 30

*The total number of material moves. The number of material moves for the mirror product line. 4. Material-handling cost per lens:
$90,000 16 * (4 + 16) = $2,400 30
*The number of material moves for the lens product line.
EXERCISE 5-27 (20 MINUTES) There is no single correct answer to this exercise. There are many reasonable solutions. Cost pool 1: Raw materials and components................................................................... Inspection ..................................................................................................... Total................................................................................................................ Cost driver: raw-material cost Cost pool 2: Depreciation, machinery............................................................................... Electricity, machinery.................................................................................... Equipment maintenance, wages.................................................................. Equipment maintenance, parts..................................................................... Total................................................................................................................ Cost driver: number of units produced. Cost pool 3: Setup wages................................................................................................... Total................................................................................................................ Cost driver: number of production runs. Cost pool 4: Engineering design....................................................................................... Total................................................................................................................ Cost driver: number of parts in a product. 793,000 yen 793,000 yen 52,000 yen 52,000 yen 1,820,000 yen 156,000 yen 195,000 yen 39,000 yen 2,210,000 yen 3,835,000 yen 39,000 yen 3,874,000 yen
EXERCISE 5-27 (CONTINUED) Cost pool 5: Depreciation, plant........................................................................................ Insurance, plant............................................................................................. Electricity, light.............................................................................................. Custodial wages, plant.................................................................................. Property taxes................................................................................................ Natural gas, heating...................................................................................... Total................................................................................................................ 910,000 yen 780,000 yen 78,000 yen 52,000 yen 156,000 yen 39,000 yen 2,015,000 yen
Cost driver: for costs allocated to support departments, square footage; for costs assigned to products, number of units produced. EXERCISE 5-28 (5 MINUTES) Cost pool 1: unit-level Cost pool 2: unit-level Cost pool 3: batch-level Cost pool 4: product-sustaining-level Cost pool 5: facility-level EXERCISE 5-29 (15 MINUTES) 1. a. Quality-control costs assigned to the enamel paint line under the traditional system: Quality-control costs = 16% direct-labor cost Quality-control costs assigned to enamel paint line = 16% $98,000 = $15,680
EXERCISE 5-29 (CONTINUED) b. Quality-control costs assigned to the enamel paint line under activity-based costing: Quantity for Activity Pool Rate Enamel Paint Incoming material inspection....... $23.00 per type..... 24 types......... In-process inspection................... .28 per unit...... 35,000 units... Product certification..................... 144.00 per order... 50 orders....... Total quality-control costs assigned.......................................................... 2. Assigned Cost $ 552 9,800 7,200 $17,552
The traditional product-costing system undercosts the enamel paint product line, with respect to quality-control costs, by $1,872 ($17,552 $15,680).
EXERCISE 5-30 (20 MINUTES) 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 DC16 wheel at a price lower than Wheelco's reported manufacturing cost. In contrast, Wheelco is selling its specialty JY16 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 DC16 and a substantially higher cost for wheel JY16. 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 DC16. The prices of the specialty wheels probably will need to be raised. It is possible that Wheelco should discontinue low-volume products.
EXERCISE 5-31 (15 MINUTES) 1. Key features of an activity-based costing system: (a) (b) (c) Two-stage procedure for cost assignment. Stage one: Establish activity cost pools. 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.
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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. Strategic options: (a) (b) (c) Lower the prices on the firm's high-volume products to compete more effectively. Increase the prices on low-volume specialty products. 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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EXERCISE 5-32 (20 MINUTES) The activities of the Seneca Falls Winery may be classified as follows: U: Unit-level B: Batch-level P: Product-sustaining-level F: Facility-level
EXERCISE 5-32 (CONTINUED) Activity (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) Classification P P P P P P P B B B Activity (11) (12) (13) (14) (15) (16) (17) (18) (19) Classification B B U U U U B F F
EXERCISE 5-33 (30 MINUTES) 1. ZODIAC MODEL ROCKETRY COMPANY COMPUTATION OF SELLING COSTS BY ORDER SIZE AND PER MOTOR WITHIN EACH ORDER SIZE Small Sales commissions (Unit cost: $675,000/225,000 = $3.00 per box).................... box)........................................... Catalogsb (Unit cost: $295,400/590,800 = $.50 per catalog)................ catalog)..................................... Costs of catalog salesc (Unit cost: $105,000/175,000 = $.60 per motor).................. skein)........................................ Credit and collectiond (Unit cost: $60,000/6,000 = $10.00 per order)................ order)........................................ Total cost for all orders of a given size..................................... Units (motors) solde..................... Unit cost per order of a given sizef............................................... Retail sales in boxes unit cost: Small, 2,000 $3 Medium, 45,000 $3 Large, 178,000 $3 b Catalogs distributed unit cost c Catalog sales unit cost
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Order Size Medium Large $135,000 $534,000
Total $ 675,000
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$185,400 103,000 $1.80
$296,000 592,000 $.50
$654,000 2,180,000 $.30
$1,135,400
Number of retail orders unit cost Small: (2,000 12) + 79,000 = 103,000 Medium: (45,000 12) + 52,000 = 592,000 Large: (178,000 12) + 44,000 = 2,180,000 f Total cost for all orders of a given size units sold
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EXERCISE 5-33 (CONTINUED) 2. The analysis of selling costs shows that small orders cost more than large orders. This fact could persuade management to market large orders more aggressively and/or offer discounts for them.
EXERCISE 5-34 (20 MINUTES) The definitions used by Carrier Corporation for each of the activity levels are given below. (See Robert Adams and Ray Carter, "United Technologies' Activity-Based Accounting Is a Catalyst for Success As Easy as ABC, 18, p.4.) Note that United Technologies uses the term structural-level activity, instead of facility-level activity as used in the text. Unit: This activity or cost occurs every time a unit is produced. An example is the utility cost for production equipment. This level of activity usually relates directly to production volume. Batch: This activity is performed for each batch produced or acquired. Examples include moving raw material between the stock room and production line or setting up a machine for a run. Product-sustaining: This activity is performed to maintain product designs, processes, models, and parts. Examples include expediting purchasing, maintaining tools and dies, or assuring quality. Sustaining activities are required for supporting a key manufacturing capability or process. Facility: These activities are performed to enable production. They are fundamental to supporting the business entity at the most basic level. Examples are managing or cleaning the building. These definitions are consistent with those given in the chapter. An argument for the ABC project team's classification would be that the activity or account in question was characterized by the definition of the activity-level classification given above. An argument against the team's classification would be that the particular activity or account did not satisfy the definition.
For example, moving materials is a batch-level activity because a raw material must be moved to the product area when a production run or batch is started. Depreciation is a facility-level account because depreciation on plant and equipment represents the cost of providing production facilities in which manufacturing can take place.
EXERCISE 5-35 (30 MINUTES) Answers will vary widely, depending on the college or university and the activities chosen.
EXERCISE 5-36 (30 MINUTES) Answers will vary widely, depending on the website chosen. In general, though, activitybased costing could be a useful tool in helping any governmental unit understand what its cost drivers are for the various activities in which it engages.
EXERCISE 5-37 (25 MINUTES) 1. Airline: (a) "Deadheading," the practice of flying a nonworking flight-crew member to another city to work on a flight departing from that location. The crew member sometimes displaces a paying customer. Preparing excess food for a flight, which is not consumed, because the flight occupancy was misforecast. Returning, repairing, or replacing lost or mishandled luggage.
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(d) Canceling a flight because of an aircraft maintenance problem that should have been prevented by routine maintenance. 2. Bank: (a) (b) (c) (d) (e) Correcting customer account errors due to keypunch errors in the bank. Following up on checks or deposit slips lost by the bank. Performing banking procedures manually when the computer is down. Defaulted loans made to risky borrowers as a result of inadequate credit checks. Losses due to employee embezzlement and petty theft.
EXERCISE 5-37 (CONTINUED)
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Hotel: (a) (b) (c) (d) Breakage of dishes and glassware; loss of or damage to linens and towels. Loss of room keys. Overstaffing the front desk during nonpeak hours. Preparing excess food.
EXERCISE 5-38 (30 MINUTES) The skys the limit on this exercise. After inventing a product and describing its production process, students can draw the discussion in the text of how to identify nonvalue-added costs.
EXERCISE 5-39 (15 MINUTES) Several activities performed (or at least supported) by an airline's ground employees, along with possible performance measures, are as follows: Activity Making reservations over the phone Performance Measure Reservations booked per hour Percentage of reservations with errors Number of customer complaints Bags tagged per hour Percentage of bags incorrectly tagged Bags handled per hour, per employee Number of bags damaged Percentage of bags sent to wrong destination
Tagging luggage Handling luggage
EXERCISE 5-39 (CONTINUED) Maintaining aircraft Maintenance procedures per shift, per employee (both routine and repair) Number of repair incidents per month Number of flight delays due to maintenance problems Number of passengers enplaned Number of customer complaints Average time required at gate to enplane passengers Number of aircraft departures per month Percentage of flights with delays Average delay per flight delayed
Enplaning passengers
Preparing aircraft for departure
EXERCISE 5-40 (40 MINUTES, PLUS TIME AT RESTAURANT) Several restaurant activities are listed in the following table, along with the required characteristics for each activity. Many other possibilities could be listed, depending on the level of detail. Value-Added or Non-ValueAdded VA NVA
Activity Description Taking reservations Customers waiting for a table
Activity Trigger Customer calls on phone Customer arrives, but no table is ready
Root Cause Customer desires reservation An error was made in reservation; service is slow; customers are slow; customers arrive without reservations Customer's reservation (or turn in line) comes up; table becomes ready Kitchen staff needs to know what to prepare Meals are ready; customers are hungry An error was made in explaining the menu; there is an error in the printed menu description; meal was prepared wrong; customer is picky Customers are hungry Customers have finished eating
Seating customers
VA
Table becomes available Customers indicate readiness to order Meals are ready Customer complains about meal
Taking orders Serving meals to customers Returning meal to kitchen for revised preparation
VA VA NVA
Customers eating meal Clearing the table
VA VA
Meals are served and are satisfactory Customers are finished
EXERCISE 5-40 (CONTINUED) Delivering check to table Collecting payment VA Customers are finished ordering and eating Customers have produced cash or credit card Customers need to know amount of bill Restaurant needs to collect payment for services rendered
VA
EXERCISE 5-41 (30 MINUTES) Answers will vary widely, depending upon the registration procedures in place at a particular institution.
EXERCISE 5-42 (25 MINUTES) 1. Customers ranked by sales revenue: (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) 108 114 112 116 110 124 121 127 125 128 (11) (12) (13) (14) (15) (16) (17) (18) (19) (20) 113 135 106 111 133 107 134 119 136 137
Yes, the ranking by sales revenue is different from that based on operating income. 2. 3. No, the least profitable customers are not the ones with the lowest sales revenue. The least profitable customers are numbers 119 and 134. Yes, the profile would be different, because the ordering of the customers along the horizontal axis would match the order in requirement (1) instead of the ordering in Exhibit 5-15.
EXERCISE 5-42 (CONTINUED) 4. A customer characterized by high sales revenue would not necessarily be the most profitable, because the customer may demand costly services such as special handling or packaging, frequent small shipments, or unique design features.
EXERCISE 5-43 (30 MINUTES) Memorandum Date: To: From: Subject: Today President, Windy City Design Company I. M. Student, Controller, Windy City Design Company Customer-Profitability Analysis
The customer-profitability analysis ranks customers on the basis of operating income. As the graph shows, customers 5 and 6 are not profitable for Windy City Design Company. There are several possible courses of action, including the following four: Drop customers 5 and 6. Raise the prices for customers 5 and 6. Cut the costs of serving customers 5 and 6 by cutting back on services. Try to increase higher-margin services to customers 5 and 6 in order to make these customer relationships profitable.
EXERCISE 5-44 (20 MINUTES) There are many key activities that can be suggested for each business. Some possibilities are listed below. After each activity, a suggested cost driver is given in parentheses. (1) airline: (a) (b) (c) (d) (e) (a) (b) (c) (d) (e) (a) (b) (c) (d) (e) (a) (b) (c) (d) (e) (a) (b) (c) (d) (e) (a) (b) (c) (d) (e) reservations (reservations booked) baggage handling (pieces of baggage handled) flight crew operations (air miles flown) aircraft operations (air miles flown) in-flight service (number of passengers) purchasing (pounds or cost of food purchased) kitchen operations (meals prepared) table service (meals served) table clearing (meals served) dish washing (dishes washed) front desk operations (number of patrons) membership records (number of records) personnel (number of employees) equipment maintenance (maintenance hours) fitness consultation (hours of service) teller window operations (number of customers) loan processing (loan applications) check processing (checks processed) personnel (number of employees) security (number of customers) front desk operations (number of guests) bell service (pieces of luggage handled) housekeeping service (number of guest-days) room service (meals delivered) telephone service (phone calls made) admissions (patients admitted) diagnostic lab (tests performed) nursing (nursing hours) surgery (hours in operating room) general patient care (patient-days of care)
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restaurant
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fitness club:
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bank:
(5) hotel:
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hospital:
solutions to Problems PROBLEM 5-45 (35 MINUTES) 1. Activity-based costing results in improved costing accuracy for two reasons. First, companies that use ABC are not limited to a single driver when allocating costs to products and activities. Not all costs vary with units, and ABC allows users to select a host of nonunit-level cost drivers. Second, consumption ratios often differ greatly among activities. No single cost driver will accurately assign costs for all activities in this situation. Allocation of administrative cost based on billable hours: E-commerce consulting: 2,400 6,000 = 40%; $381,760 x 40% = $152,704 Information systems: 3,600 6,000 = 60%; $381,760 x 60% = $229,056 E-Commerce Consulting Billings: 3,600 hours x $140 2,400 hours x $140 Less: Professional staff cost: 3,600 hours x $50 2,400 hours x $50 Administrative cost. Income Income billings. $336,000 (180,000) (120,000) (152,704) $ 63,296 18.84% ( 229,056) $ 94,944 18.84% Information Systems Services $504,000
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PROBLEM 5-45 (CONTINUED) 3. Activity-based application rates: Activity Staff support In-house computing Miscellaneous office charges Cost $207,000 145,000 29,760 Activity Driver 300 clients 5,000 computer hours (CH) 1,200 client transactions (CT) = = = Application Rate $690 per client $29 per CH $24.80 per CT
Staff support, in-house computing, and miscellaneous office charges of e-commerce consulting and information systems services: E-Commerce Consulting Information Systems Services $165,600 $ 41,400 84,100 60,900 11,904 17,856 $120,156 $261,604
Activity Staff support: 240 clients x $690... 60 clients x $690. In-house computing: 2,900 CH x $29. 2,100 CH x $29. Miscellaneous office charges: 480 CT x $24.80... 720 CT x $24.80... Total .
PROBLEM 5-45 (CONTINUED) Profitability e-commerce consulting and information systems services: E-Commerce Consulting Billings: 3,600 hours x $140.. 2,400 hours x $140.. Less: Professional staff cost: 3,600 hours x $50 2,400 hours x $50 Administrative cost. Income.. Income billings... 4. $336,000 (180,000) (120,000) (120,156) $ 95,844 28.53% ( 261,604) $ 62,396 12.38% Information Systems Services $504,000
Yes, his attitude should change. Even though both services are needed and professionals are paid the same rate, the income percentages show that e-commerce consulting provides a higher return per sales dollar than information systems services (28.53% vs. 12.38%). Thus, all other things being equal, professionals should spend more time with e-commerce. Probably not. Although both services produce an attractive return for Clark and Shiffer, the firm is experiencing a very tight labor market and will likely have trouble finding qualified help. In addition, the professional staff is currently overworked, which would probably limit the services available to new clients.
5.
PROBLEM 5-46 (60 MINUTES) 1. The predetermined overhead rate is calculated as follows: Predetermined overhead rate = Budgeted manufacturing overhead/budgeted directlabor hours = $1,224,000/102,000* = $12 per hour *Direct labor, budgeted hours: REG: 5,000 units 9 hours..................................... ADV: 4,000 units 11 hours................................... SPE: 1,000 units 13 hours.................................... Total direct-labor hours........................................................ 45,000 hours 44,000 hours 13,000 hours 102,000 hours
PROBLEM 5-46 (CONTINUED) 2. Activity-based-costing analysis:

Cost Driver Quantity for Product Line 50,000 48,000 17,000 115,000 40 40 20 100 100 96 104 300 40 40 20 100 400 400 300 1,100 500 400 200 1,100 250 200 200 650 50,000 48,000 17,000 115,000 Activity Cost for Product Line $135,000 129,600 45,900 $310,500 $ 21,000 21,000 10,500 $ 52,500 $ 25,000 24,000 26,000 $ 75,000 $ 34,000 34,000 17,000 $ 85,000 $ 10,000 10,000 7,500 $ 27,500 $ 30,000 24,000 12,000 $ 66,000 $ 12,500 10,000 10,000 $ 32,500 $250,000 240,000 85,000 $575,000 $1,224,000 Product Line Prod. Volume 5,000 4,000 1,000 5,000 4,000 1,000 5,000 4,000 1,000 5,000 4,000 1,000 5,000 4,000 1,000 5,000 4,000 1,000 5,000 4,000 1,000 5,000 4,000 1,000 Activity Cost per Unit of Product $27.00 32.40 45.90 4.20 5.25 10.50 5.00 6.00 26.00 6.80 8.50 17.00 2.00 2.50 7.50 6.00 6.00 12.00 2.50 2.50 10.00 50.00 60.00 85.00
Activity Machine Related Material Hand. Purch.
Activity Cost Pool $310,500
Cost Driver Machine Hours Prod. Runs Purch. Orders Prod. Runs Inspect. Hours Ship.
Cost Driver Quantity 115,000
Pool Rate $ 2.70
Product Line REG ADV GMT Total REG ADV GMT Total REG ADV GMT Total REG ADV GMT Total REG ADV GMT Total REG ADV GMT Total REG ADV GMT Total REG ADV GMT Total Grand Total
52,500
100
525.00
75,000
300
250.00
Setup
85,000
100
850.00
Inspect.
27,500
1,100
25.00
Ship.
66,000
1,100
60.00
Eng.
32,500
Eng. Hours Machine Hours
650
50.00
Fac.
575,000
115,000
5.00
Grand Total
$1,224,000
PROBLEM 5-46 (CONTINUED) 3. Calculation of new product costs under ABC.

REG $129.00 171.00 (9 hr. @ $19) $300.00 ADV $151.00 209.00 (11 hr. @ $19) $360.00 GMT $203.00 247.00 (13 hr. @ $19) $450.00
Direct material................................. Direct labor (not including set-up time)................................. Total direct costs per unit..............
Manufacturing overhead (based on ABC): Machine-related.......................... $ 27.00 Material handling....................... 4.20 Purchasing.................................. 5.00 Setup........................................... 6.80 Inspection................................... 2.00 Packing/shipping....................... 6.00 Engineering design.................... 2.50 Facility......................................... 50.00 Total ABC overhead cost per unit................................ $103.50 Total product cost per unit............. $403.50
$ 32.40 5.25 6.00 8.50 2.50 6.00 2.50 60.00 $123.15 $483.15
$ 45.90 10.50 26.00 17.00 7.50 12.00 10.00 85.00 $213.90 $663.90
McGraw-Hill/Irwin Inc. Managerial Accounting, 8/e
2009 The McGraw-Hill Companies,

5- 29
PROBLEM 5-46 (CONTINUED) 4. Comparison of costs and target prices under two alternative product-costing systems: REG Reported unit overhead cost: Traditional, volume-based costing system ................................................................................... Activity-based costing system ................................................................................... Reported unit product cost (direct material, direct labor and overhead): Traditional, volume-based costing system ................................................................................... Activity-based costing system ................................................................................... Sales price data: Original target price (130% of product cost based on traditional, volume-based costing system) ................................................................................... New target price (130% of product cost based activity-based costing system) ................................................................................... Actual current selling price.......................................... 5. $108.00 103.50 ADV $132.00 123.15 GMT $156.00 213.90
408.00 403.50 530.40 524.55 525.00
492.00 483.15 639.60 628.10 628.00
606.00 663.90 787.80 863.07 800.00
The REG and ADV products were overcosted by the traditional system, and the GMT product was undercosted by the traditional system $408.00 403.50 $ 4.50 $492.00 483.15 $ 8.85 ($ 57.90) $606.00 663.90
Reported unit product cost: Traditional, volume-based costing system ................................................................................... Activity-based costing system ................................................................................... Cost distortion: REG and ADV overcosted by traditional system ................................................................................... GMT undercosted by traditional system................
McGraw-Hill/Irwin Inc. 5-30

Solutions Manual
6.
The electronic version of the Solutions Manual BUILD A SPREADSHEET SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website: www.mhhe.com/hilton8e.

5- 31
PROBLEM 5-47 (25 MINUTES) The information supplied by the ABC project team is in columns A, B, C, D, F, G, and I.
Cost Driver Quantity for Product Line 40 40 20 100 Activity Cost per Unit of Product $ 4.20 5.25 10.50
Activity
Activity Cost Pool
Cost Driver
Cost Driver Quantity 100
Pool Rate
Product Line
Activity Cost for Product Line $21,000 21,000 10,500 $52,500
Product Line Production Volume 5,000 4,000 1,000
Material $52,500 Production Handling Runs
$525.00 REG ADV GMT Total
The results of the ABC calculations are in columns E, H and J. The ABC calculations are as follows: (1) Compute pool rate for material-handling activity: Activity cost pool cost driver quantity = pool rate $52,500 100 = $525.00
(2) Compute total activity cost for each product line: Product Line REG ADV GMT Pool Rate Cost Driver Quantity for x Product Line 40 40 20 = = = = Activity Cost for Each Product Line $21,000 21,000 10,500
$525.00 x 525.00 x 525.00 x
(3) Compute product cost per unit for each product line: Activity Cost for Each Product Product Line Line REG ADV GMT $21,000 21,000 10,500 Activity Cost per Unit of Product $ 4.20 5.25 10.50
Product Line Production Volume 5,000 4,000 1,000
= = = =

Solutions Manual
PROBLEM 5-48 (30 MINUTES) 1. Deluxe manufacturing overhead cost: 32,000 machine hours x $80 = $2,560,000 $2,560,000 16,000 units = $160 per unit Executive manufacturing overhead cost: 45,000 machine hours x $80 = $3,600,000 $3,600,000 30,000 units = $120 per unit Deluxe Direct material. Direct labor.. Manufacturing overhead. Unit cost 2. Activity-based application rates: Activity Manufacturing setups Machine processing Product shipping Cost $1,344,000 3,696,000 1,120,000 Activity Driver 160 setups (SU) 77,000 machine hours (MH) Application Rate = $8,400 per SU = $48 per MH $ 40 25 160 $225 Executive $ 65 25 120 $210
350 outgoing = $3,200 per OS shipments (OS)

5- 33
PROBLEM 5-48 (CONTINUED) Manufacturing setup, machine processing, and product shipping costs of a Deluxe unit and an Executive unit: Activity Manufacturing setups: 100 SU x $8,400.. 60 SU x $8,400.. Machine processing: 32,000 MH x $48... 45,000 MH x $48... Product shipping: 200 OS x $3,200 150 OS x $3,200.. Total . Production volume (units). Cost per unit.. Deluxe $ 840,000 $ 504,000 1,536,000 2,160,000 640,000 $3,016,000 16,000 $188.50* 480,000 $3,144,000 30,000 $104.80** Executive
* $3,016,000 16,000 units = $188.50 ** $3,144,000 30,000 units = $104.80 The manufactured cost of a Deluxe cabinet is $253.50, and the manufactured cost of an Executive cabinet is $194.80. The calculations follow: Deluxe Direct material Direct labor. Manufacturing setup, machine processing, and outgoing shipments.. Total cost. $ 40.00 25.00 188.50 $253.50 Executive $ 65.00 25.00 104.80 $194.80
3. The Deluxe storage cabinet is undercosted. The use of machine hours produced a unit cost of $225; in contrast, the more accurate activity-based-costing approach shows a unit cost of $253.50. The difference between these two amounts is $28.50.

Solutions Manual
PROBLEM 5-48 (CONTINUED) 4. Cost distortion: The Deluxe cabinet product line is undercosted by $456,000, and the Executive cabinet product line is overcosted by $456,000. Supporting calculations follow: Deluxe $28.50* 16,000 = $456,000 *$253.50 $225.00 5. Executive $(15.20) 30,000 = $(456,000)
$194.80 $210.00
No, the discount is not advisable. The regular selling price of $270, when compared against the more accurate ABC cost figure, shows that each sale provides a profit to the firm of $16.50 ($270.00 - $253.50). However, a $30 discount will actually produce a loss of $13.50 ($253.50 - $240.00), and the more units that are sold, the larger the loss. Notice that with the less-accurate, machine-hour-based figure ($225), the marketing manager will be misled, believing that each discounted unit sold would boost income by $15 ($240 - $225).

5- 35
PROBLEM 5-49 (25 MINUTES) 1. a. Manufacturing overhead costs include all indirect manufacturing costs (all production costs except direct material and direct labor). Typical overhead costs include:
Indirect labor (e.g., a lift-truck driver, maintenance and inspection labor,

engineering labor, and supervisors).
Indirect material. Other indirect manufacturing costs (e.g., building maintenance, machine and
tool maintenance, property taxes, insurance, depreciation on plant and equipment, rent, and utilities). b. Companies develop overhead rates before production to facilitate the costing of products as they are completed and shipped, rather than waiting until actual costs are accumulated for the period of production. The increase in the overhead rate should not have a negative impact on the company, because the increase in indirect costs was offset by a decrease in direct labor. Rather than using a plantwide overhead rate, Digital Light could implement separate activity cost pools. Examples are as follows:
2.
3.
Separate costs into departmental overhead accounts (or other relevant pools),
with one account for each production and service department. Each department would allocate its overhead to products on the basis that best reflects the use of these overhead services.
Treat individual machines as separate cost centers, with the machine costs
collected and charged to the products using machine hours. 4. An activity-based costing system might benefit Digital Light because it assigns costs to products according to their usage of activities in the production process. More accurate product costs are the result.

Solutions Manual
PROBLEM 5-50 (30 MINUTES) 1. Predetermined overhead rate = budgeted overhead budgeted direct-labor hours = $710,000 20,000* = $35.50 per direct labor hour *20,000 budgeted direct-labor hours = (2,500 units of Medform)(3 hrs./unit) + (3,125 units of Procel)(4 hrs./unit) Medform Direct material................................. Direct labor: 3 hours x $15............................. 4 hours x $15............................. Manufacturing overhead: 3 hours x $35.50........................ 4 hours x $35.50........................ Total cost......................................... 2. Activity-based overhead application rates: Activity Order processing Machine processing Product inspection Cost $120,000 500,000 90,000 Activity Cost Driver 600 orders processed (OP) 50,000 machine hrs. (MH) 15,000 inspection hrs. (IH) Application Rate = $200 per OP = $10 per MH = $6 per IH $ 30.00 45.00 60.00 106.50 $181.50 142.00 $247.00 Procel $ 45.00

5- 37
PROBLEM 5-50 (CONTINUED) Order processing, machine processing, and product inspection costs of a Medform unit and an Procel unit: Activity Order processing: 350 OP x $200........................ 250 OP x $200........................ Machine processing: 23,000 MH x $10.................... 27,000 MH x $10.................... Product inspection: 4,000 IH x $6........................ 11,000 IH x $6........................ Total Production volume (units) Cost per unit * $324,000 2,500 units = $129.60 ** $386,000 3,125 units = $123.52 The manufactured cost of a Medform unit is $204.60, and the manufactured cost of a Procel unit is $228.52: Medform Direct material. Direct labor: 3 hours x $15 4 hours x $15 Order processing, machine processing, and product inspection.. Total cost. $ 30.00 45.00 60.00 129.60 $204.60 123.52 $228.52 Procel $ 45.00 Medform $ 70,000 $ 50,000 230,000 270,000 24,000 $324,000 2,500 $129.60* 66,000 $386,000 3,125 $123.52** Procel

Solutions Manual
PROBLEM 5-50 (CONTINUED) 3. a. The Procel product is overcosted by $18.48 ($247.00 - $228.52) under the traditional product-costing system. The labor-hour application base resulted in a $247 unit cost; in contrast, the more accurate ABC approach yielded a lower unit cost of $228.52. The opposite situation occurs with the Medform product, which is undercosted by $23.10 under the traditional approach ($181.50 vs. $204.60 under ABC). The traditional costing system overcosts the Procel product line by a total of $57,750 ($18.48 x 3,125 units), and it undercosts the Medform product line by the same amount, $57,750 ($23.10 x 2,500 units). b. Yes, especially since Meditechs 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 products more accurate (higher) cost. This situation is also troublesome and will result in lower income reported for the company.
4.

5- 39
PROBLEM 5-51 (30 MINUTES) 1. Valdosta Vinyl Company (VVC) is currently using a plantwide overhead rate that is applied on the basis of direct-labor dollars. In general, a plantwide manufacturingoverhead rate is acceptable only if a similar relationship between overhead and direct labor exists in all departments or the company manufactures products that receive the same proportional services from each department In most cases, departmental overhead rates are preferable to plantwide overhead rates because plantwide overhead rates do not provide the following:
A framework for reviewing overhead costs on a departmental basis, identifying

departmental cost overruns, or taking corrective action to improve departmental cost control.
Sufficient information about product profitability, thus increasing the difficulties

associated with management decision making. 2. Because the company uses a plantwide overhead rate applied on the basis of directlabor dollars, the elimination of direct labor in the Molding Department through the introduction of robots may appear to reduce the overhead cost of the Molding Department to zero. However, this change will not reduce fixed manufacturing costs such as depreciation and plant supervision. In reality, the use of robots is likely to increase fixed costs because of increased depreciation. Under the current method of allocating overhead costs, these costs merely will be absorbed by the remaining departments.

Solutions Manual
PROBLEM 5-51 (CONTINUED) 3. a. In order to improve the allocation of overhead costs in the Cutting and Finishing departments, management should move toward an activity-based costing system. The firm should:
Establish activity-cost pools for each significant activity. Select a cost driver for each activity that best reflects the relationship of the
activity to the overhead costs incurred.
b.
In order to accommodate the automation of the Molding Department in its overhead accounting system, the company should:
Establish a separate overhead pool and rate for the Molding Department. Identify fixed and variable overhead costs and establish fixed and variable
overhead rates.
Apply overhead costs to the Molding Department on the basis of robot or

machine hours.

5- 41
PROBLEM 5-52 (40 MINUTES) 1. Overhead to be assigned to development chemical order: Activity Cost Pool Machine setups Material handling Hazardous waste control Quality control Other overhead costs Total 2. 3. Overhead cost per box of chemicals Predetermined overhead rate = =
$93,200 = $93.20 per box 1,000 boxes
$2,500,000 total budgeted overhead cost = total budgeted machine hours 40,000
Pool Rate $4,000 per setup $4 per pound $10 per pound $150 per inspection $20 per machine hour
Level of Cost Driver 6 setups 9,000 pounds 2,100 pounds 8 inspections 550 machine hours
Assigned Overhead Cost $24,000 36,000 21,000 1,200 11,000 $93,200
= $62.50 per machine hr. 4. Overhead to be assigned to film development chemical order, given a single predetermined overhead rate: a. Total overhead assigned = $62.50 per machine hr. 550 machine hr. = $34,375 b. Overhead cost per box of chemicals =
$34,375 = $34.375 per box 1,000 boxes
5.
The radiological development chemicals entail a relatively large number of machine setups, a large amount of hazardous materials, and several inspections. Thus, they are quite costly in terms of driving overhead costs. Use of a single predetermined overhead rate obscures this characteristic of the production job. Underestimating the overhead cost per box could have adverse consequences for Rapid City Radiology, Inc. For example, it could lead to poor decisions about product pricing. The activitybased costing system will serve management much better than the system based on a single, predetermined overhead rate.
Solutions Manual
PROBLEM 5-52 (CONTINUED)
6.
PROBLEM 5-53 (20 MINUTES) 1. Calculation of unit cost: (a) Overhead assigned to plates: Activity Cost Pool Pool Rate Machine setups $4,000 per setup Material handling $4 per pound Hazardous waste control $10 per pound Quality control $150 per inspection Other overhead costs $20 per machine hour Total
Overhead cost per unit = $25,000 = $250 100 plates
Level of Cost Driver 4 setups 800 pounds 400 pounds 4 inspections 60 machine hours
Assigned Overhead Cost $16,000 3,200 4,000 600 1,200 $25,000
(b)
Unit cost per plate: Direct material................................ Direct labor.................................... Manufacturing overhead............... Total cost per plate........................ $210 60 250 $520
2. The electronic version of the Solutions Manual BUILD A SPREADSHEET SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website: WWW.MHHE.COM/HILTON8E.

5- 43
PROBLEM 5-54 (50 MINUTES) 1. Activity Cost Pool I: Machine-related costs II: Setup and inspection III: Engineering IV: Plant-related costs Calculation of pool rates: I: Machine-related costs:
$1,800,000 18,000 machine hrs.
Type of Activity Unit-level Batch-level Product-sustaining-level Facility-level
2.
= $100 per machine hr.
II. Setup and inspection:

$720,000 80 runs
= $9,000 per run
III. Engineering:
$360,000 200 change orders
= $1,800 per change order
IV. Plant-related costs:

$384,000 3,840 sq. ft.
= $100 per sq. ft.

Solutions Manual
PROBLEM 5-54 (CONTINUED) 3. Unit costs for odds and ends: I: Machine-related costs: Odds: $100 per machine hr. 8 machine hr. per unit Ends: $100 per machine hr. 2 machine hr. per unit II: Setup and inspection: Odds: $9,000 per run 25 units per run Ends: $9,000 per run 125 units per run III: Engineering: Odds: = $360 per unit = $72 per unit = $800 per unit = $200 per unit
$1,800 per change order 200 change orders 75% 1,000 units
= Ends:
$270,000 = $270 per unit 1,000 units $1,800 per change order 200 change orders 25% 5,000 units $90,000 = $18 per unit 5,000 units
= IV. Plant-related costs: Odds:
$100 per sq. ft. 3,840 sq. ft. 80% 1,000 units
= Ends:
$307,200 = $307.20 per unit 1,000 units $100 per sq. ft. 3,840 sq. ft. 20% 5,000 units $76,800 = $15.36 per unit 5,000 units

5- 45
PROBLEM 5-54 (CONTINUED) 4. New product cost per unit using the ABC system: Direct material............................................... Direct labor.................................................... Manufacturing overhead: Machine-related...................................... Setup and inspection............................. Engineering............................................. Plant-related............................................ Total cost per unit......................................... 5. New target prices: New product cost (ABC)............................... Pricing policy................................................. New target price............................................ 6. Full assignment of overhead costs: Odds Manufacturing overhead costs: Machine-related...................................... Setup and inspection............................. Engineering............................................. Plant-related............................................ Total overhead cost per unit......................... Production volume.................................... Total overhead assigned.............................. Ends Odds $2,017.20 120% $2,420.64 Ends $725.36 120% $870.43 (rounded) Odds $ 160.00 120.00 800.00 360.00 270.00 307.20 $2,017.20 Ends $240.00 180.00 200.00 72.00 18.00 15.36 $725.36
$ 800.00 $ 200.00 360.00 72.00 270.00 18.00 307.20 15.36 $1,737.20 $ 305.36 1,000 5,000 $1,737,200 $1,526,800 Total = $3,264,000

Solutions Manual
PROBLEM 5-54 (CONTINUED) 7. Cost distortion: Odds Traditional volume-based costing system: reported product cost................................................ Activity-based costing system: reported product cost................................................ Amount of cost distortion per unit.................................. $ 664.00 Ends $996.00 725.36 $270.64 Traditional system overcosts ends by $270.64 per unit 5,000 $1,353,200
2,017.20 $(1,353.20) Traditional system undercosts odds by $1,353.20 per unit
Production volume.......................................................... Total amount of cost distortion for entire product line...............................................................
1,000 $(1,353,200)
Sum of these two amounts is zero.

5- 47
PROBLEM 5-55 (45 MINUTES) 1. a. GSCC's predetermined overhead rate, using direct-labor cost as the single cost driver, is $10 per direct labor dollar, calculated as follows: Overhead rate =
total manufacturing-overhead cost budgeted direct-labor cost
= $12,000,000/$1,200,000 = $10 per direct-labor dollar b. The full product costs and selling prices of one pound of Jamaican and one pound of Colombian coffee are calculated as follows: Jamaican Direct material........................................ Direct labor............................................. Overhead (.40 $10)............................. Full product cost................................... Markup (30%)......................................... Selling price........................................... 2. $2.90 .40 4.00 $7.30 2.19 $9.49 Colombian $ 3.90 .40 4.00 $8.30 2.49 $10.79
The new product cost, under an activity-based costing approach, is $11.06 per pound of Jamaican and $4.62 per pound of Columbian coffee, calculated as follows: Activity Purchasing Material handling Quality control Roasting Blending Packaging Cost Driver Purchase orders Setups Batches Roasting hours Blending hours Packaging hours Budgeted Activity 2,316 3,600 1,440 192,200 67,200 52,000 Budgeted Cost $2,316,000 2,880,000 576,000 3,844,000 1,344,000 1,040,000 Unit Cost $1,000 800 400 20 20 20

Solutions Manual
PROBLEM 5-55 (CONTINUED) Jamaican Coffee Standard cost per pound: Direct material....................................................................................... Direct labor............................................................................................ Purchasing (4 orders* $1,000/2,000 lb.)........................................... Material handling (12 setups $800/2,000 lb.)................................... Quality control (4 batches $400/2,000 lb.)....................................... Roasting (10 hours $20/2,000 lb.)..................................................... Blending (5 hours $20/2,000 lb.)....................................................... Packaging (1 hours $20/2,000 lb.).................................................... Total cost............................................................................................... *Budgeted sales purchase order size 2,000 lbs. 500 lbs. = 4 orders Colombian Coffee Standard cost per pound: Direct material....................................................................................... Direct labor............................................................................................ Purchasing (2 orders* $1,000/100,000 lb.)....................................... Material handling (15 setups $800/100,000 lb.)............................... Quality control (5 batches $400/100,000 lb.)................................... Roasting (500 hours $20/100,000 lb.)............................................... Blending (250 hours $20/100,000 lb.)............................................... Packaging (50 hours $20/100,000 lb.).............................................. Total cost............................................................................................... *Budgeted sales purchase order size 100,000 lbs. 50,000 lbs. = 2 orders $3.90 .40 .02 .12 .02 .10 .05 .01 $4.62 $2.90 .40 2.00 4.80 .80 .10 .05 .01 $11.06

5- 49
PROBLEM 5-55 (CONTINUED) 3. a. The ABC analysis indicates that several activities other than direct labor drive overhead. The cost computations show that the current system significantly undercosted Jamaican coffee, the low-volume product, and significantly overcosted the high-volume product, Colombian coffee. The implication of the ABC analysis is that the low-volume products are using resources but are not covering their share of the cost of those resources. The Jamaican blend is currently priced at $9.49 [see requirement 1(b)], which is significantly below its activity-based cost of $11.06. The company should set long-run prices above cost. If there is excess capacity and many of the costs are fixed, it may be acceptable to price some products below full activity-based cost temporarily in order to build demand for the product. Otherwise, the high-volume, high-margin products are subsidizing the low-volume, low-margin products.
b.

Solutions Manual
PROBLEM 5-56 (60 MINUTES) 1. Kara Lindley's predecessor at Pensacola Air Industries (PAI) would have used a 10 percent material-handling rate, calculated as follows: Payroll................................................................................... Employee benefits................................................................ Telephone............................................................................. Other utilities........................................................................ Materials and supplies......................................................... Depreciation.......................................................................... Total Material-Handling Department costs......................... Material-handling rate = =
total Material-Handling Department costs total direct -material costs
$432,000 $3,009,000 +$1,311,000
$270,000 54,000 57,000 33,000 9,000 9,000 $432,000
= 10% 2. a. The revised material-handling costs to be allocated on a per-purchase-order basis is $1.00, calculated as follows: Total Material-Handling Department costs......................................... Deduct: Direct costs: Direct government payroll.................................... $54,000 10,800 Fringe benefits (20% $54,000)........................... Direct phone line.................................................... 4,200 Material-handling costs applicable to purchase orders.................... Total number of purchase orders Material-handling cost per purchase order b. $432,000
69,000 $363,000 363,000 $ 1.00
Purchase orders might be a more reliable cost driver than is the dollar amount of direct material, because resources are consumed in processing a purchase order. The size of the order does not necessarily have an impact on the consumption of resources.

5- 51
PROBLEM 5-56 (CONTINUED) 3. There is a $111,900 reduction in material-handling costs allocated to government contracts by PAI as a result of the new allocation method, calculated as follows: Previous method: Government material........................................................... Material-handling rate...................................................... Total (previous method)...................................................... New method: Directly traceable material-handling costs [$54,000 + (20% $54,000) + $4,200]........................... Purchase orders (120,000 $1.00)..................................... Total (new method).............................................................. Net reduction........................................................................ $69,000 120,000 $189,000 $111,900 $ 3,009,000 10% $300,900

Solutions Manual
PROBLEM 5-56 (CONTINUED) 4. A forecast of the cumulative dollar impact over a three-year period from 20x4 through 20x6 of Kara Lindley's recommended change for allocating Material-Handling Department costs to the Government Contracts Unit is $351,519, calculated as follows: 20x5 Calculation of forecasted variable material-handling costs: Direct-material (DM) cost: 20x5 ($4,320,000 1.025)................................. 20x6 ($4,428,000 1.025)................................. Material-handling rate (10% of DM cost)................ Deduct: Direct traceable costs............................... Variable material-handling costs............................ Calculation of forecasted purchase orders: 20x5 (363,000 1.05)............................................... 20x6 (381,150 1.05)............................................... 381,150 400,208 (rounded) 132,069(rounded) $4,428,000
20x6
$4,538,700 $ 453,870 69,000a $384,870
$ 442,800 69,000a $373,800
Government purchase orders (33% of total).......... 125,780
Calculation of material-handling costs allocated to government contracts: Variable material-handling costs............................ Purchase orders....................................................... Variable material-handling costs per purchase order (rounded)................................................. Government purchase orders................................. Projected variable material-handling costs (rounded)................................................. Fixed material-handling costs................................ Total material-handling costs allocated to government contracts......................................
a
$373,800 381,150
$ 384,870 400,208
$ .98 $ .96 125,780 132,069 $ 123,264 69,000a $ 192,264 $ 126,786 69,000a $ 195,786
$54,000 + (20% $54,000) + $4,200 = $69,000

5- 53
PROBLEM 5-56 (CONTINUED) Calculation of cumulative dollar impact: Government material at 70%....................................... Material-handling at 10% (previous method)............. Deduct: Material-handling costs allocated to government contracts (new method)................... Net reduction in government contract material-handling costs........................................ 70% $4,428,000 = $3,099,600 70% $4,538,700 = $3,177,090 d 10% $3,099,600 = $309,960 e 10% $3,177,090 = $317,709
b c
$ 3,099,600b $ 309,960d 192,264 $ 117,696
$ 3,177,090 c $ 317,709e 195,786 $121,923
In summary, the cumulative dollar impact of the recommended change in allocating Material-Handling Department costs is $351,519, calculated as follows: 20x4 [from requirement (3)]................ 20x5....................................................... 20x6....................................................... Total...................................................... 5. a. $111,900 117,696 121,923 $351,519
Referring to the standards of ethical conduct for management accountants, Kara Lindley faces the following ethical issues: Competence:
Prepare complete and clear reports and recommendations after appropriate

analysis of relevant and reliable information. Lindley has an obligation to prepare the most relevant and reliable report. Integrity:
Refrain from engaging in any activity that would prejudice Lindley's ability to
carry out her duties ethically.

Solutions Manual
PROBLEM 5-56 (CONTINUED)
Communicate unfavorable as well as favorable information and professional

judgments and opinions.
Refrain from engaging in or supporting any activity that would discredit

Lindley's profession. Objectivity:
Disclose fully all relevant information that could reasonably be expected to

influence an intended user's understanding of reports and recommendations presented. Lindley has information that the company president should see if he is going to make a reliable judgment about the results of the Government Contracts Unit. b. The steps Kara Lindley could take to resolve this ethical conflict are as follows:
Lindley should first follow the established policies at PAI. If this approach does not resolve the conflict or if such policies do not exist,
she should discuss the problem with her immediate superior, except when it appears that the superior is involved. If the Government Contracts Unit manager, Paul Anderson, is her superior, then she obviously cannot discuss the problem with him. In this case she should go to the next-higher managerial level and continue, up to the audit committee of the board of directors, until the conflict is resolved.
She should also discuss the situation with an objective advisor to clarify the
issues involved and obtain an understanding of possible courses of action.
If the ethical conflict still exists after exhausting all levels of internal review,
then she may have no other course of action than to resign from the company and submit an informative memorandum to an appropriate representative of the company.

5- 55
PROBLEM 5-57 (45 MINUTES) 1. An activity-based costing system is a two-stage process of assigning costs to products. In stage one, activity-cost pools are established. In stage two a cost driver is identified for each activity-cost pool. Then the costs in each pool are assigned to each product line in proportion to the amount of the cost driver consumed by each product line. Queensland Electronics should not continue with its plans to emphasize the Zodiac model and phase out the Novelle model. As shown in the following activity-based costing analysis, the Zodiac model has a gross margin of less than 1 percent, while the Novelle model generates a gross margin of nearly 42 percent. Cost per event for each cost driver: Soldering.................... Shipments................... Quality control............ Purchase orders......... Machine power........... Machine setups.......... Costs per model: Zodiac Direct costs: Materiala................................................................... Direct laborb............................................................. Machine hoursc....................................................... Total direct costs........................................................... Assigned costs: Solderingd................................................................ Shipmentse.............................................................. Quality controlf........................................................ Purchase ordersg.................................................... Machine powerh....................................................... Machine setupsi...................................................... Total assigned costs...................................................... Total cost........................................................................ $2,316,000 196,000 304,000 $2,816,000 $ 220,000 167,200 315,900 632,700 3,800 450,000 $1,789,600 $4,605,600 Novelle $ 4,642,000 462,000 3,344,000 $ 8,448,000 $ 660,000 668,800 854,100 477,300 43,700 498,500 $ 3,202,400 $11,650,400 $880,000 836,000 1,170,000 1,110,000 47,500 948,500
2.
1,600,000 = 19,000 = 78,000 = 185,000 = 190,000 = 9,485 =
$.55 44.00 15.00 6.00 .25 100.00
per solder joint per shipment per inspection per order per hour per setup

Solutions Manual
PROBLEM 5-57 (CONTINUED) Calculations: Zodiac

a
Novelle 22,000 $211 22,000 $21 22,000 $152 1,200,000 $.55 15,200 $44 56,940 $15 79,550 $6 174,800 $.25 4,985 $100
Material......................................... Direct labor................................... c Machine hours.............................. d Soldering...................................... e Shipments..................................... f Quality control.............................. g Purchase orders........................... h Machine power............................. i Machine setups.............................
b
4,000 $579 4,000 $49 4,000 $76 400,000 $.55 3,800 $44 21,060 $15 105,450 $6 15,200 $.25 4,500 $100
Profitability analysis: Sales............................................................. Less: Cost of goods sold............................ Gross margin................................................ Units sold..................................................... Per-unit calculations: Selling price.......................................... Less: Cost of goods sold..................... Gross margin........................................ Gross margin percentage....................
a b
Zodiac Novelle $4,640,000 $20,020,000 4,605,600 11,650,400 $ 34,400 $8,369,600 4,000 22,000 $1,160.00 1,151.40 $ 8.60 0.7%a $910.00 529.56 $380.44 41.8%b
Total $24,660,000 16,256,000 $ 8,404,000
$8.60/$1,160.00 = 0.7% $380.44/$910.00 = 41.8%

5- 57
PROBLEM 5-58 (60 MINUTES) 1. General advantages associated with activity-based costing include the following:
Provides management with a more thorough understanding of complex product

costs and product profitability for improved resource management and pricing decisions.
Allows management to focus on value-added and non-value-added activities, so

that non-value-added activities can be controlled or eliminated, thus streamlining production processes.
Highlights the relationship between activities and identifies opportunities to

reduce costs (i.e., designing products with fewer parts in order to reduce the cost of the manufacturing process).
Provides a more appropriate means of charging overhead costs to products.

Solutions Manual
PROBLEM 5-58 (CONTINUED) 2. Using Ultratechs unit cost data, the total contribution margin expected from the PC board is $4,720,000, calculated as follows: Total for 40,000 Units $24,000,000 $11,200,000 1,120,000 4,480,000 1,280,000 1,200,000 $19,280,000 $4,720,000
Revenue................................................................................ Direct material...................................................................... Material-handling charge (10% of material)....................... Direct labor ($28 per hr. 4 hr.)......................................... Variable overhead ($8 per hr. 4 hr.)*............................... Machine time ($20 per hr. 1.5 hr.).................................... Total cost....................................................................... Unit contribution margin..................................................... Total contribution margin (40,000 $118)......................... *Variable overhead rate: $2,240,000 280,000 hr. = $8 per hr.
Per Unit $600 $280 28 112 32 30 $482 $118
The total contribution margin expected from the TV board is $3,900,000, calculated as follows: Total for 65,000 Units $19,500,000 $10,400,000 1,040,000 2,730,000 780,000 650,000 $15,600,000 $ 3,900,000
Revenue................................................................................ Direct material...................................................................... Material-handling charge (10% of material)....................... Direct labor ($28 per hr. 1.5 hr.)...................................... Variable overhead ($8 per hr. 1.5 hr.)*............................ Machine time ($20 per hr. .5 hr.)..................................... Total cost....................................................................... Unit contribution margin..................................................... Total contribution margin (65,000 $60)........................... *Variable-overhead rate: $2,240,000 280,000 hr. = $8 per hr.
Per Unit $300 $160 16 42 12 10 $240 $60

5- 59
PROBLEM 5-58 (CONTINUED) 3. The pool rates, which apply to both the PC board and the TV board, are calculated as follows: Procurement............................ $800,000/4,000,000 = $.20 per part Production scheduling........... $440,000/110,000 = $4.00 per board Packaging and shipping......... $880,000/110,000 = $8.00 per board Machine setup......................... $892,000/278,750 = $3.20 per setup Hazardous waste disposal..... $96,000/16,000 = $6.00 per lb. Quality control......................... $1,120,000/160,000 = $7.00 per inspection General supplies..................... $132,000/110,000 = $1.20 per board Machine insertion.................... $2,400,000/3,000,000 = $.80 per part Manual insertion...................... $8,000,000/1,000,000 = $8.00 per part Wave soldering........................ $264,000/110,000 = $2.40 per board Using activity-based costing, the total contribution margin expected from the PC board is $3,464,000, calculated as follows: Total for 40,000 Units $24,000,000 $11,200,000 440,000 160,000 320,000 384,000 96,000 560,000 48,000 1,152,000 6,080,000 96,000 $20,536,000 $3,464,000
Revenue.................................................................................. Direct material........................................................................ Procurement ($.20 per part 55 parts)............................... Production scheduling.......................................................... Packaging and shipping........................................................ Machine setup ($3.20 per setup 3 setups)....................... Hazardous waste disposal ($6 per lb. .40 lb.).................. Quality control ($7.00 per inspection 2 inspections)......................... General supplies.................................................................... Machine insertion ($.80 per part 36 parts)....................... Manual insertion ($8 per part 19 parts)............................ Wave soldering...................................................................... Total cost Unit contribution margin Total contribution margin
Per Unit $600.00 $280.00 11.00 4.00 8.00 9.60 2.40 14.00 1.20 28.80 152.00 2.40 $513.40 $86.60

Solutions Manual
PROBLEM 5-58 (CONTINUED) Using activity-based costing, the total contribution margin expected from the TV board is $5,045,300, calculated as follows: Total for 65,000 Units $19,500,000 $10,400,000 338,000 260,000 520,000 416,000 11,700 455,000 78,000 1,300,000 520,000 156,000 $14,454,700 $ 5,045,300
Revenue................................................................................ Direct material...................................................................... Procurement ($.20 per part 26 parts).............................. Production scheduling........................................................ Packaging and shipping...................................................... Machine setups ($3.20 per setup 2 setups).................... Hazardous waste disposal ($6 per lb. .03 lb.)................ Quality control ($7.00 per inspection x 1 inspection)........ General supplies.................................................................. Machine insertion ($.80 per part 25 parts)..................... Manual insertion ($8.00 per part x 1 part)........................... Wave soldering..................................................................... Total cost......................................................................... Unit contribution margin..................................................... Total contribution margin.................................................... 4.
Per Unit $ 300.00 $160.00 5.20 4.00 8.00 6.40 .18 7.00 1.20 20.00 8.00 2.40 $222.38 $77.62
The analysis using the previously reported costs indicates that the unit contribution of the PC board is almost double that of the TV board. On this basis, 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 costing does not support this decision. This analysis shows that the unit dollar contribution from each of the boards is not as different as previously believed, and the total contribution from the TV board exceeds that of the PC board by almost $1.6 million. As a percentage of selling price, the contribution from the TV board is almost double that of the PC board (26 percent versus 14 percent).

5- 61
PROBLEM 5-59 (50 MINUTES) 1. a. The calculation of total budgeted costs for the Manufacturing Department at Scott Manufacturing is as follows: Direct material: Tuff Stuff ($15.00 per unit 20,000 units)........... Ruff Stuff ($9.00 per unit 20,000 units)............. Total direct material.................................................... Direct labor.................................................................. Overhead: Indirect labor.......................................................... Fringe benefits....................................................... Indirect material..................................................... Power...................................................................... Setup....................................................................... Quality assurance.................................................. Other utilities.......................................................... Depreciation........................................................... Total overhead............................................................ Total Manufacturing Department budgeted cost..... b. $300,000 180,000 $ 480,000 2,400,000 $ 72,000 15,000 93,000 540,000 225,000 30,000 30,000 45,000
1,050,000 $3,930,000
The unit costs of Tuff Stuff and Ruff Stuff, with overhead assigned on the basis of direct-labor hours, are calculated as follows: Tuff Stuff: Direct material........................................................ Direct labor ($24.00 per hour 2 hours)*............ Overhead ($10.50 per hour 2 hours)*............... Tuff Stuff unit cost........................................... *Budgeted direct labor hours: Tuff Stuff (20,000 units 2 hours)............................ Ruff Stuff (20,000 units 3 hours)............................ Total budgeted direct-labor hours............................ Direct-labor rate: $2,400,000 per 100,000 hours Overhead rate: $1,050,000 per 100,000 hours $15.00 48.00 21.00 $84.00 40,000 60,000 100,000
= $24.00 per hour = $10.50 per hour

Solutions Manual
PROBLEM 5-59 (CONTINUED) Ruff Stuff: Direct material........................................................ Direct labor ($24.00 per hour 3 hours)*............ Overhead ($10.50 per hour 3 hours)*............... Ruff Stuff unit cost........................................... *Budgeted direct labor hours Tuff Stuff (20,000 units 2 hours)............................ Ruff Stuff (20,000 units 3 hours)............................ Total budgeted direct-labor hours............................ Direct-labor rate: $2,400,000 per 100,000 hours Overhead rate: $1,050,000 per 100,000 hours 2. $ 9.00 72.00 31.50 $112.50 40,000 60,000 100,000 = $24.00 per hour = $10.50 per hour
The total budgeted cost of the Fabricating and Assembly Departments, after separation of costs into the activity cost pools, is calculated as follows: Total Fabricating Percent Dollars 100% $ 480,000 74% 1,776,000 76% 80% 54,720 12,000 60,000 480,000 15,000 24,000 15,000 35,100 $ 695,820 $2,951,820 $ Assembly Percent Dollars 26% 24% 20% $624,000 $ 17,280 3,000 33,000 60,000 210,000 6,000 15,000 9,900 $354,180 $978,180
Direct material........... Direct labor............... Overhead: Indirect labor Fringe benefits Indirect material Power Setup Quality assurance Other utilities Depreciation Total overhead Total cost
$480,000 2,400,000 $ 72,000 15,000 93,000 540,000 225,000 30,000 30,000 45,000 $1,050,000 $3,930,000
80% 50% 78%
20% 50% 22%

5- 63
PROBLEM 5-59 (CONTINUED) 3. The unit costs of the products using activity-based costing are calculated as follows: $2,951,820 480,000 1,776,000 $ 695,820 88,000 hours 120,000 hours 208,000 hours
Fabricating: Total cost............................................................................... Less: Direct material............................................................. Less: Direct labor.................................................................. Pool overhead cost............................................................... Hours: Tuff Stuff (4.4 hours 20,000 units)................... Ruff Stuff (6.0 hours 20,000 units).................. Total machine hours.................................
Pool rate per machine hour ($695,820/208,000).................. $3.35 per hour (rounded) Fabricating cost per unit: Tuff Stuff ($3.35 4.4 hours).. $14.74 per unit (rounded) Ruff Stuff ($3.35 6.0 hours). $20.10 per unit (rounded) Assembly: Total cost............................................................................... Less: Direct labor.................................................................. Pool overhead cost............................................................... Setups: Tuff Stuff............................................................ Ruff Stuff............................................................ Total setups.............................................. $978,180 624,000 $354,180 1,000 272 1,272
Pool rate per setup ($354,180/1,272).................................... $278.44 per setup (rounded) Setup cost per unit: Tuff Stuff: $278.44 per setup x (1,000 setups / 20,000 units) $13.92 per unit (rounded) Ruff Stuff: $278.44 per setup x (272 setups / 20,000 units)... $3.79 per unit (rounded) Tuff Stuff unit cost: Direct material....................................................................... Direct labor (2 hours $24 per hour).................................. Fabrication overhead............................................................ Assembly overhead............................................................... Tuff Stuff unit cost........................................................
$15.00 48.00 14.74 13.92 $91.66

Solutions Manual
PROBLEM 5-59 (CONTINUED) Ruff Stuff unit cost: Direct material....................................................................... Direct labor (3 hours $24 per hour).................................. Fabrication overhead............................................................ Assembly overhead............................................................... Ruff Stuff unit cost........................................................ 4. Ruff Stuff unit costs: Cost with overhead assigned on direct-labor hours.......... Cost using activity-based costing....................................... $112.50 $104.89 $ 9.00 72.00 20.10 3.79 $104.89
The activity-based costing unit costs may lead the company to decide to lower its price for Ruff Stuff in order to be more competitive in the market and continue production of the product. It now appears that Ruff Stuff has lower unit costs and can afford lower prices. Using ABC for assigning overhead costs generally leads to a more accurate estimate of the costs incurred to produce a product. Management should be able to make better informed decisions regarding pricing and production of the companys products.

5- 65
PROBLEM 5-60 (60 MINUTES) 1. Based on the cost data from Gigabyte's traditional, volume-based product-costing system, product G is the firm's least profitable product. Its reported actual gross margin is only $66.00, as compared with $254.25 and $313.50 for products T and W, respectively. However, the validity of this conclusion depends on the accuracy of the product costs reported by Gigabyte's product-costing system. Again, based on the product costs reported by the firm's traditional, volume-based product-costing system, product W appears to be very profitable. As in requirement (1), however, the validity of this assessment depends on the accuracy of the reported product costs. Gigabyte's competitors have moved aggressively into the market for gismos (product G), but they have abandoned the whatchamacallit (product W) market to Gigabyte. These competing firms apparently believe they can sell gismos at a much lower price than Gigabyte's management feels is feasible. This evidence suggests that Gigabyte's competitors may believe their product cost for gismos is below Gigabyte's reported product cost. In contrast, Gigabyte's competitors apparently believe that they cannot afford to sell whatchamacallits at Gigabyte's current price of $600. Perhaps the competing firms' reported production costs for product W are higher than the cost reported by Gigabyte's product-costing system. The danger to Gigabyte is that the company will be forced out of the market for its second largest selling product. This could be disastrous to Gigabyte, Inc. 4. Percentages for raw-material costs: Annual Raw-Material Cost $ 840,000 2,362,500 210,000 $3,412,500 Percentage of Total Raw-Material Cost* 25% 69% 6% 100%
2.
3.
Product G T W Total
Raw-Material Cost per Unit $105.00 157.50 52.50
Annual Volume 8,000 15,000 4,000
*Percentages rounded to nearest whole percent.

Solutions Manual
PROBLEM 5-60 (CONTINUED) 5. Product costs based on an activity-based costing system: Product G Direct material................................................ Direct labor..................................................... Machinerya...................................................... Machine setupb............................................... Inspectionc...................................................... Material handlingd.......................................... Engineeringe................................................... Total................................................................
a
Product T $157.50 36.00 122.50 .32 46.20 120.75 6.90 $490.17
Product W $52.50 24.00 238.88 1.89 157.50 39.38 142.21 $656.36
$105.00 48.00 110.25 .43 31.50 82.03 45.25 $422.46
Machinery: Product G: ($3,675,000 24%) Product T: ($3,675,000 50%) Product W: ($3,675,000 26%) b Machine setup: Product G: ($15,750 22%) Product T: ($15,750 30%) Product W: ($15,750 48%) c Inspection: Product G: ($1,575,000 16%) Product T: ($1,575,000 44%) Product W: ($1,575,000 40%) d Material handling: Product G: ($2,625,000 25%) Product T: ($2,625,000 69%) Product W: ($2,625,000 6%) e Engineering: Product G: ($1,034,250 35%) Product T: ($1,034,250 10%) Product W: ($1,034,250 55%)
8,000 units = 15,000 units = 4,000 units = 8,000 units = 15,000 units = 4,000 units = 8,000 units = 15,000 units = 4,000 units = 8,000 units = 15,000 units = 4,000 units = 8,000 units = 15,000 units = 4,000 units =
$110.25 $122.50 $238.88 $.43 $.32 $1.89 $ 31.50 $ 46.20 $157.50 $ 82.03 $120.75 $ 39.38 $ 45.25 $ 6.90 $142.21

5- 67
PROBLEM 5-60 (CONTINUED) 6. Comparison of reported product costs, new target prices, and actual selling prices: Product G Reported product costs: Traditional, volume-based costing system Activity-based costing system Target price based on new product costs (150% new product cost) Current actual selling price $573.00 422.46 633.69 639.00 Product T $508.50 490.17 735.26 762.75 Product W $286.50 656.36 984.54 600.00
7. The electronic version of the Solutions Manual BUILD A SPREADSHEET SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website: WWW.MHHE.COM/HILTON8E.

Solutions Manual
PROBLEM 5-61 (20 MINUTES) MEMORANDUM Date: To: From: Subject: Today President, Gigabyte, Inc. I.M. Student Gigabyte's competitive position
Gigabyte's product-costing system has been providing misleading product cost information. Our traditional, volume-based costing system overcosted gismos and thingamajigs, but it substantially undercosted whatchamacallits. As a result Gigabyte has been overpricing gismos and thingamajigs and underpricing whatchamacallits. The company has been losing money on every sale in the product W market. Our competitors have taken advantage of our mispricing by moving aggressively into the gismo market and abandoning the whatchamacallit market to Gigabyte. As a result, our profitability has suffered. I recommend the following courses of action: 1. 2. 3. 4. Implement the new activity-based costing system and revise its database frequently. Lower the target price of gismos to $639, the current actual selling price. This price is slightly over our usual 50 percent markup over product cost. Consider lowering the price of thingamajigs to $736 in order to increase demand. The lower price still yields Gigabyte a 50 percent markup over product cost. Raise the price of whatchamacallits to $985. If the product does not sell at that price, consider discontinuing the product line.

5- 69
PROBLEM 5-62 (20 MINUTES) Product G Traditional, volume-based costing system: reported product cost.................................... Activity-based costing system: reported product cost.................................... Amount of cost distortion per unit...................... $573.00 422.46 $150.54 Traditional system overcosts product G by $150.54 per unit Product volume...................................................... Total amount of cost distortion for entire product line...................................................... 8,000 $1,204,320 Product T $508.50 490.17 $ 18.33 Traditonal system overcosts product T by $18.33 per unit 15,000 $ 274,950 Product W $286.50 656.36 $(369.86) Traditional system undercosts product W by $369.86 per unit 4,000 $(1,479,440)
Sum of these three amounts is $(170). It would be zero except for the slight rounding errors in the calculation of the new product costs to the nearest cent.
EXERCISE 5-63 (25 MINUTES) 1. Process time: steps 3, 5, 6, 7, 8, 10, 11 Inspection time: steps 1, 9 Move time: steps 2, 5, 6, 7, 10, 11 Waiting time: steps 4, 5, 7 Storage time: steps 1, 11

Solutions Manual
EXERCISE 5-63 (CONTINUED) 2. Candidates for non-value-added activities follow. (Note that elimination of some of these activities would require reconfiguring the production process.) (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) Step 1: Step 2: Step 4: Step 5: Step 5: Step 6: Step 7: Step 7: Step 7: Step 9: Step 10: Step 11: Storing ingredients (Could move toward JIT system.) Carrying ingredients on hand carts. Storing dough until bagel machine is free. (Could move toward a JIT system for dough mixing.) Carrying board of dough into bagel room. Keeping cut-out bagels until boiling vat is free. (Could move toward a JIT system.) Carrying uncooked bagels to adjoining room. Carrying bagels to oven room. Holding bagels until oven rack is free. Continual opening and closing of oven door. Consumption of misshapen bagels by the staff. (Could these faulty products be sold at a reduced price?) Carrying wire baskets to the packaging room. Driving forklift to freezer. Storing frozen bagels.
(m) Step 11:

5- 71
EXERCISE 5-64 (40 MINUTES) (1) Redesigned bagel production process: (a) Ingredients, such as flour and raisins, are received and inspected in the morning or afternoon they are to be used. Then they are placed on a conveyor belt that transports the ingredients to the mixing room next door. Dough is mixed in 40-pound batches in four heavy-duty mixers. The dough is placed on large boards, which are set on the conveyor. The conveyor transports the boards of dough into the bagel room next door. The board is tipped automatically and the dough slides into the hopper of a bagel machine. This machine pulls off a piece of dough, rolls it into a cylindrical shape, and then squeezes it into a doughnut shape. The bagel machines can be adjusted in a setup procedure to accommodate different sizes and styles of bagels. Workers remove the uncooked bagels and place them on a tray. The trays are set on the conveyor, which carries the uncooked bagels into an adjoining room. This room houses three 50-gallon vats of boiling water. The bagels are boiled for approximately one minute. Bagels are removed from the vats with a long-handled strainer and placed on a wooden board. The boards full of bagels are placed on the conveyor, which transports them to the oven room. The two ovens contain eight racks that rotate but remain upright, much like the seats on a Ferris wheel. A rack full of bagels is finished baking after one complete revolution in the oven. When a rack full of bagels is removed from the oven, a fresh rack replaces it. The oven door automatically opens and closes as each rack completes a revolution in the oven. After the bagels are removed from the oven, they are placed in baskets for cooling. While the bagels are cooling, they are inspected. Misshapen bagels are removed and set aside for sale at a reduced price.
(b)
(c)
(d) (e)
(f)
(g) (h)

Solutions Manual
EXERCISE 5-64 (CONTINUED) (i) (j) After the bagels are cool, the wire baskets are placed on the conveyor and transported to the packaging room next door. Here the bagels are dumped automatically into the hopper on a bagging machine. This machine packages a half dozen bagels in each bag and seals the bag with a twist tie. Then the packaged bagels are placed in cardboard boxes, each holding 24 bags. The boxes are placed in the freezer, where the bagels are frozen and stored for shipment. The freezer has a door in the packaging room, and another door in the shipping/receiving room.
(k) (l)
(2)
Key features of a JIT system: The new production process of Bodacious Bagels, Inc. has a smooth, uniform production rate with each part of the process being initiated by the subsequent operation. Thus, the bagelry uses a pull method of coordinating production steps. The ingredients are purchased as needed in small lot sizes, delivered twice daily, and sent immediately to the mixing room. The bagel machine is designed for quick setups for different bagel sizes and consistency. Only high-quality ingredients are used in order to eliminate down time and to follow a total quality control philosophy. The machinery is carefully maintained. The bagelry's employees are encouraged to suggest improvements in the product or production process. Employees whose suggestions are adopted receive cash awards or peer recognition. All of the bagelry's employees are trained in each phase of the production process. Thus, Bodacious Bagel's multiskilled work force enables the firm to operate with fewer employees.
(3)
New equipment: Bodacious Bagels, Inc. would need to purchase a new conveyor system that would transport partially completed bagels between production steps. The conveyor would tip the bagels automatically into appropriate production machines at various points in the process. Also needed would be an efficient oven that would open and close automatically (and quickly) to minimize heat loss.

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PROBLEM 5-65 (45 MINUTES) 1. Two dimensional ABC: Cost Assignment View RESOURCE COSTS Assignment of resource costs to activity cost pools associated with significant activities
6
Process View
1 7 11
Activity analysis
2 8 3 9 4 10 5 12 13 14 15 16
Activity evaluation PERFORMANCE MEASURES

(see req. (4) for examples)
ROOT CAUSES
(see req. (3) for (see req. (2) for examples) examples)
ACTIVITY TRIGGERS
ACTIVITIES
Assignment of activity costs to cost objects using second-stage cost drivers COST OBJECTS (Product lines: cooking utensils, tableware, flatware)

Solutions Manual
PROBLEM 5-65 (CONTINUED) 2. Triggers for selected activities: Activity Number Trigger (2) Realization by purchasing personnel that they do not fully understand the part specifications (9) (11) (12) (13) 3. Realization by purchasing personnel that the ordered part will be (or may be) late in arriving Receipt of order Discovery during inspection that parts do not meet specifications Discovery that parts do not satisfy intended purpose
Possible root causes: Activity Number Possible Root Causes* (2) Unclear specifications Incomplete specifications Clear, but apparently wrong, specifications Undertrained purchasing personnel (9) Vendor delay Delay in placing order Failure by purchasing personnel to make deadline clear Use of vendor that has not been fully certified as a reliable supplier Critical importance of parts Misspecification of parts Error by purchasing personnel in placing order Vendor error Inspector error Misspecification of parts Incomplete specifications Poor product design Error by purchasing personnel in placing order Vendor error
(11) (12)
(13)
*This list is not necessarily complete. Other root causes may exist.

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PROBLEM 5-65 (CONTINUED) 4. Suggested performance measures: Activity Performance Number Measures (5) Average price paid (6) (10) (12) (16) Number of vendors Number of vendors that are precertified as dependable Percentage of orders received on time Average delay for delinquent orders Number of orders returned Percentage of orders returned Average dollar value tied up in parts inventory
PROBLEM 5-66 (40 MINUTES) 1. Customer-profitability analysis: Caltex Computer Sales revenue...................................................................... Cost of goods sold.............................................................. Gross margin....................................................................... Selling and administrative costs: General selling costs.................................................... General administrative costs....................................... Customer-related costs: Sales activity........................................................... Order taking............................................................. Special handling...................................................... Special shipping...................................................... Total selling and administrative costs............................... Operating income................................................................ $380,000 160,000 $220,000 $ 48,000 38,000 16,000 6,000 80,000 18,000 $206,000 $ 14,000 Trace Telecom $247,600 124,000 $123,600 $ 36,000 32,000 12,000 8,000 60,000 20,000 $168,000 $ (44,400)

Solutions Manual
PROBLEM 5-66 (CONTINUED) 2. The electronic version of the Solutions Manual BUILD A SPREADSHEET SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website: www.mhhe.com/hilton8e.
PROBLEM 5-67 (45 MINUTES) 1. Customer-profitability profile (supporting details in the table following the profile):
Cumulative Operating Income as a Percentage of Total Operating Income

120% 110% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1 2 3 4 5 6 7 8
Customers*
*Customers ranked by operating income.

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PROBLEM 5-67 (CONTINUED) Supporting details for customer-profitability profile: Cumulative Operating Income as a Percentage of Total Operating Income 39% 69% 94% 111% 114% 117% 109% 100%
Customer Numbera (1) (2) (3) (4) (5) (6) (7) (8)
a b
Customer Network-All, Inc. Golden Gate Service Associates Graydon Computer Company Mid-State Computing Company Caltex Computerb The California Group Tele-Install, Inc. Trace Telecomc
Operating Income $186,000 142,000 120,000 84,000 14,000 12,000 (36,000) (44,400)
Cumulative Operating Income $186,000 328,000 448,000 532,000 546,000 558,000 522,000 477,600
Customer numbers are ranked by operating income. From solution to preceding problem. c From solution to preceding problem. 2. Date: Memorandum Today I. Sellit, Vice President for Marketing I. M. Student Customer-profitability profile
To:
From: Subject:
The attached customer-profitability profile shows that two of our customer relationships are unprofitable (Tele-Install, Inc. and Trace Telecom). As the profile shows, over half of our operating income is generated by our two most profitable customer relationships, and 94 percent of our operating profit is generated by our three most profitable customers. An activity-based costing analysis of customer-related costs provided the data for the customer-profitability analysis portrayed in the profile.

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SOLUTIONS TO CASES
CASE 5-68 (45 MINUTES) 1. Activity-based costing (ABC) differs from traditional costing in that it focuses on activities that consume resources as the fundamental cost drivers. ABC is a two-stage cost assignment process focused on causality and the determination of cost drivers. It usually uses several different activities to assign costs to products or services. Therefore, it is more detailed and more accurate than traditional costing. It also helps managers distinguish between value added and non-value added activities. Calculations of total activity cost pools and pool rates: Material handling..... ($113,208 1.06) [(5 parts 5,000 units) + (10 parts 5,000 units)] = $120,000* (25,000 parts + 50,000 parts) = $120,000 75,000 parts = $1.60 per part *Rounded Inspection................. ($235,850 1.06) (5,000 hours + 7,500 hours) = $250,000* 12,500 hours = $20 per inspection hour *Rounded Machining................. ($849,056 1.06) (15,000 hours + 30,000 hours) = $900,000* 45,000 hours = $20 per machine hour *Rounded Assembly.................. ($433,962 1.06) (6,000 hours + 5,500 hours) = $460,000* 11,500 hours = $40 per assembly hour *Rounded
2.

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CASE 5-68 (CONTINUED) 3. JY-63 20x4 Cost Data Direct material: No cost increase.............. Direct labor: Direct labor $370,370 1.08 cost increase*.... Material handling: Number of parts 5 units produced.......... 5,000 25,000 $1.60 per unit............. Inspection: Inspection hours 5,000 $20 per hour............... Machining: Machining activity in 15,000 hours $20 per hour............... Assembly: Assembly activity in 6,000 hours $40 per hour............... Total cost........................... *$400,000 and $200,000 are both rounded. JY-63 Estimated 20x5 Product Cost $2,000,000 $185,186 400,000 10 5,000 50,000 40,000 7,500 100,000 30,000 300,000 5,500 240,000 $3,080,000 220,000 $4,750,000 600,000 150,000 80,000 200,000 RX-67 20x4 Cost Data RX-67 Estimated 20x5 Product Cost $3,500,000

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CASE 5-68 (CONTINUED) 4. CINCINNATI CYCLE COMPANY BUDGETED STATEMENT OF GROSS MARGIN FOR 20X5 Sales revenue.................................................. Cost of goods manufactured and sold: Beginning finished-goods inventory............. Add: Direct material..................................... Direct labor.......................................... Material handling................................. Inspection............................................ Machining............................................ Assembly............................................. Cost of goods available for sale.................... Less: Ending finished-goods inventory*.... Cost of goods sold......................................... Gross margin................................................... JY-63 $3,621,000 $ 480,000 2,000,000 400,000 40,000 100,000 300,000 240,000 $3,560,000 431,200 $3,128,800 $ 492,200 RX-67 $4,459,000 $ 600,000 3,500,000 200,000 80,000 150,000 600,000 220,000 $5,350,000 665,000 $4,685,000 $ (226,000) Total $8,080,000 $1,080,000 5,500,000 600,000 120,000 250,000 900,000 460,000 $8,910,000 1,096,200 $7,813,800 $ 266,200
*Ending finished-goods inventory = (total product cost inventory in units:
units produced) ending
JY-63: ($3,080,000 5,000 units) 700 units = $431,200 RX-67: ($4,750,000 5,000 units) 700 units = $665,000

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CASE 5-69 (60 MINUTES) 1. Regular Model Product costs based on traditional, volumebased costing system............................... 110%.............................................................. Target price...................................................... $210.00 110% $231.00 Advanced Model $430.00 110% $473.00 Deluxe Model $464.00 110% $510.40
2.
Product costs based on activity-based costing system: Regular Model $ 20.00 20.00 62.40 34.08 30.55 24.99 $192.02 Advanced Model $50.00 40.00 416.00 87.00 104.00 178.50 $875.50 Deluxe Model $84.00 40.00 153.60 68.15 58.50 51.17 $455.42
Direct material.................................................. Direct labor...................................................... Machinery depreciation and maintenancea. . . Engineering, inspection and repair of defectsb........................................ Purchasing, receiving, shipping, and material handlingc...................................... Factory depreciation, taxes, insurance, and miscellaneous overhead costsd........ Total..................................................................
a
Pool I: Depreciation, machinery............................................................... Maintenance, machinery............................................................... Total................................................................................................ Regular: Advanced: Deluxe: ($3,200,000 39%) 20,000 = ($3,200,000 13%) 1,000 = ($3,200,000 48%) 10,000 = $ 62.40 $416.00 $153.60
$2,960,000 240,000 $3,200,000

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CASE 5-69 (CONTINUED)

b
Pool II: Engineering.................................................................................... Inspection and repair of defects.................................................. Total................................................................................................ Regular: Advanced: Deluxe: ($1,450,000 47%) 20,000 = ($1,450,000 6%) 1,000 = ($1,450,000 47%) 10,000 = $ 34.08 $ 87.00 $ 68.15
$ 700,000 750,000 $1,450,000
Pool III: Purchasing, receiving, and shipping........................................... Material handling........................................................................... Total................................................................................................ Regular: Advanced: Deluxe: ($1,300,000 47%) 20,000 = ($1,300,000 8%) 1,000 = ($1,300,000 45%) 10,000 = $ 30.55 $104.00 $ 58.50
$ 500,000 800,000 $1,300,000
Pool IV: Depreciation, taxes, and insurance for factory........................... Miscellaneous manufacturing overhead..................................... Total................................................................................................ Regular: Advanced: Deluxe: ($1,190,000 42%) ($1,190,000 15%) ($1,190,000 43%) 20,000 = 1,000 = 10,000 = $ 24.99 $178.50 $51.17
$ 600,000 590,000 $1,190,000
3. Regular Model Product costs based on activity-based costing system.................................................. 110%....................................................................... New target price........................................................ $192.02 110% $211.22 Advanced Model $875.50 110% $963.05 Deluxe Model $455.42 110% $500.96
The new target price of the regular model, $211.22, is lower than the current actual selling price, $220.

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CASE 5-69 (CONTINUED) 4. Date: To: From: Subject: Today President Madison Electric Pump Corporation I.M. Student Product costing MEMORANDUM
Based on the cost data from our traditional, volume-based product-costing system, our regular model is not very profitable. Its reported actual contribution margin is only $10 ($220 $210). However, the validity of this conclusion depends on the accuracy of the product costs reported by our product-costing system. Our competitors are selling motors like our standard model for $212. This price suggests that their product cost is substantially below our previously reported cost of $210. Our new, activity-based costing system reveals serious product cost distortions stemming from our old costing system. The new costing system shows that the regular model costs only $192.02, which implies a target price of $211.22. This price is lower than our current actual selling price and roughly consistent with the price our competitors are charging. In contrast, our new product-costing system reveals that the advanced model's product cost is $875.50 instead of the previously reported cost of $430. The new product cost suggests a target price of $963.05 for the advanced model, rather than $473, which was our previous target price for the advanced model.

Solutions Manual
CASE 5-69 (CONTINUED) 5. The company should adopt and maintain the activity-based costing system. The price of the regular model should be lowered to the $212. Lowering the price should enable the firm to regain its competitive position in the market for the regular model. Further price cuts should be considered if marketing studies indicate such a move will increase demand. The price of the advanced model should be set near the target price of $963.05. If the advanced model does not sell at this price, management should consider discontinuing the product line. Input from the marketing staff should be sought before such an action is taken. An important consideration is the extent to which sales in the regular model and deluxe model markets depend on the firm's offering a complete product line. A slight price reduction should be considered for the deluxe model (from $510.40 down to $500.96). However, the product cost distortion from the old costing system did not affect this model as seriously as it did the other two.

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CASE 5-70 (20 MINUTES) Regular Model Traditional, volume-based costing system: reported product cost....................................... Activity-based costing system: reported product cost....................................... Amount of cost distortion per unit.......................... $210.00 192.02 $ 17.98 Traditional system overcosts Regular model by $17.98 per unit Product volume...................................................... Total amount of cost distortion for entire product line........................................................ 20,000 $359,600 Advanced Model $ 430.00 875.50 $(445.50) Traditonal system undercosts Advanced model by $445.50 per unit 1,000 $(445,500) Deluxe Model $464.00 455.42 $ 8.58 Traditional system overcosts Deluxe model by $8.58 per unit 10,000 $85,800
Sum of these three amounts is $(100). It would be zero except for the slight rounding errors in the calculation of the new product costs to the nearest cent.

Solutions Manual
CASE 5-71 (20 MINUTES) 1. The controller, Erin Jackson, has acted ethically up to this point. She correctly pointed out to the president that the firm's traditional, volume-based product-costing system was distorting the reported product cost for the company's three products. She designed an activity-based costing system to provide more accurate productcosting data. The production manager, Alan Tyler, is not acting ethically. Although we can sympathize with his plight, we cannot condone his pressuring the controller to suppress or alter the new product-costing data she has compiled. What can Tyler do that is ethical and has the potential for positive results? First, he could take a hard look at the deluxe model's production process. Are there non-value-added activities that could be reduced or eliminated? Second, he could argue to the president that the company should carry a full product line, if he has reason to believe that is the firm's best strategy. 3. Jackson has an ethical obligation to the president, to the company, to her profession, and to herself to report accurate product-costing data to the president. There is nothing wrong with her offer to her friend to go over her analysis again to verify its accuracy. However, she must report what she finds with no suppression or alteration of the data. Several of the ethical standards for managerial accounting apply in this case. (See Chapter 1 for a listing of these standards.) The standards that are most clearly relevant include the following: Integrity:
2.
Communicate unfavorable as well as favorable information and professional

judgments or opinions. Credibility:
Communicate information fairly and objectively. Disclose fully all relevant information that could reasonably be expected to
influence an intended user's understanding of the reports, comments, and recommendations presented.

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CASE 5-71 (CONTINUED) Jackson is in a tough spot. Her professional obligation to report accurate product costs is clear. She cannot ethically avoid this responsibility. Yet her friend Tyler is in a tenuous position. What can Jackson ethically do for him? First, she can be compassionate and understanding of his concern, yet remain firm in meeting her professional obligations. Second, she can assist the production manager in finding ways to manufacture the deluxe model pump more efficiently and at a lower cost. For example, she can share her ABC analysis with Tyler to help him identify non-valueadded activities and costs.
FOCUS ON ETHICS (See page 198 in the text.)

This scenario explores ethical issues surrounding activity-based costing. Among the potential ethical issues in this situation are the following: How did the product proliferation problem at the Charlotte plant come about? Were product-line managers more concerned with maintaining their spheres of influence than making product discontinuance decisions that would be in the companys best interest? At the very least, the company seems to exhibit a lack of discipline and focus. Products that have been dropped as a result of sound analysis should not routinely creep back into the product line. Why did top management refuse to adopt the recommendations of the ABC analysis? It is sometimes said that top managers are compensated and rewarded with other perks in accordance with the size of the business unit they manage. More product lines, more departments, and more employees mean more prestige, higher pay and bonuses, and greater prospects for advancement in the company (or another company). Are top managers putting their own well-being ahead of the companys? Alternatively, perhaps management is genuinely concerned about the implications for their employees if a large number of products are dropped. Is it ethical for management to put the interests of their employees ahead of those of the companys shareholders? Was it ethical for Xaviers top management to sell the Engine Parts Division, probably suspecting that the Charlotte plant would be closed and people would be laid off?

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CHAPTER 5 Activity-Based Costing and Management

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Process View Activity analysis ROOT ACTIVITY CAUSES TRIGGERS

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The Pull Method in a JIT System

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$90,000 4 (4 + 16) * = $600 30

*The number of material moves for the lens product line.

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Order Size Medium Large $135,000 $534,000

$185,400 103,000 $1.80

$296,000 592,000 $.50

$654,000 2,180,000 $.30

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EXERCISE 5-37 (CONTINUED)

Tagging luggage Handling luggage

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Preparing aircraft for departure

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Activity Description Taking reservations Customers waiting for a table

Customers eating meal Clearing the table

Meals are served and are satisfactory Customers are finished

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PROBLEM 5-46 (CONTINUED) 2. Activity-based-costing analysis:

Activity Machine Related Material Hand. Purch.

Activity Cost Pool $310,500

Cost Driver Quantity 115,000

Pool Rate $ 2.70

Eng. Hours Machine Hours

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PROBLEM 5-46 (CONTINUED) 3. Calculation of new product costs under ABC.