MANAGEMENT ACCOUNTING- Solutions Manual

CHAPTER 11
SYSTEMS DESIGN: ACTIVITY-BASED COSTING
AND MANAGEMENT
I. Questions
1. The three levels available are: Level 1, in which a company uses a
plantwide overhead rate; Level 2, in which a company uses departmental
overhead rates; and Level 3, in which a company uses activity-based
costin.
2. !ew approaches to costin are needed because events o" the last "ew
decades have made drastic chanes in many orani#ations. $utomation
has reatly decreased the amount o" direct labor re%uired to manu"acture
products; product diversity has increased in that companies are
manu"acturin a wider rane o" products and these products di""er
substantially in volume, lot si#e, and comple&ity o" desin; and total
overhead cost has increased to the point in some companies that a
correlation no loner e&ists between it and direct labor.
3. The departmental approach to assinin overhead cost to products relies
solely on volume as an assinment base. 'here diversity e&ists between
products (that is, where products di""er in terms o" number o" units
produced, lot si#e, or comple&ity o" production), volume alone is not
ade%uate "or overhead costin. *verhead costin based on volume will
systematically overcost hih-volume products and undercost low-volume
products.
+. ,rocess value analysis (,-$) is a systematic approach to ainin an
understandin o" the steps associated with a product or service. It
identi"ies all resource-consumin activities involved in the production
process and labels these activities as bein either value-added or non-
value-added. Thus, it is the beinnin point in desinin an activity-based
costin system since manaement must .now what activities are involved
with each product be"ore activity centers can be desinated and cost
drivers established. $lso, ,-$ helps manaement to eliminate any non-
value-added activities and thereby streamline operations and minimi#e
costs.
/. The "our eneral levels o" activities are:
11-1
Chapter 11 Systems Design: Activity-Based Costing and Management
1. 0nit-level activities, which are per"ormed each time a unit is
produced.
2. 1atch-level activities, which are per"ormed each time a batch o" oods
is handled or processed.
3. ,roduct-level activities, which are per"ormed as needed to support
speci"ic products.
+. 2acility-level activities, which simply sustain a "acility3s eneral
manu"acturin process.
4. 2irst, activity-based costin increases the number o" cost pools used to
accumulate overhead costs. 5econd, it chanes the base used to assin
overhead costs to products. $nd third, it chanes a manaer3s perception
o" many overhead costs in that costs that were "ormerly thouht to be
indirect (such as depreciation or machine setup) are identi"ied with
speci"ic activities and thereby are reconi#ed as bein traceable to
individual products.
6. The two chie" limitations are: 2irst, the portion o" overhead costs that
relate to "acility-level activities are still usually allocated to products on
some arbitrary basis, such as machine-hours or direct labor-hours. 7ritics
o" activity-based costin arue that "acility-level activities account "or the
bul. o" all overhead costs in some companies. 5econd, hih measurement
costs are involved in operatin an activity-based costin system. That is,
the system re%uires the trac.in o" lare amounts o" detail and the
completion o" many separate computations in order to determine the cost
o" a unit or product.
8. 9es, activity-based costin can be used in service orani#ations. It has
been success"ully implemented, "or e&ample, in railroads, hospitals, ban.s
and data service companies.
:. $ resource driver is a measure o" the %uality o" resources consumed by an
activity.
1;. $n activity driver is a measure o" "re%uency and intensity o" demands
placed on activities by cost ob<ects.
11. Two-stae allocation is a procedure that "irst assins a "irm3s resource
costs, namely "actory overhead cost, to cost pools, and then to cost
ob<ects.
12. Two ma<or advantaes o" $1= are:
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Systems Design: Activity-Based Costing and Management Chapter 11
a. $1= measures the e""ectiveness o" the .ey business processes and
activities, and identi"ies how they can be improved to reduce costs and
improve the customer value.
b. $1= improves the manaement "ocus by allocatin resources to .ey
value-added activities, .ey customers, .ey products, and continuous
improvement methods to maintain the "irm3s competitive advantae.
13. 'hen direct labor is used as an allocation base "or overhead, it is
implicitly assumed that overhead cost is directly proportional to direct
labor. 'hen cost systems were oriinally developed in the 18;;s, this
assumption may have been reasonably accurate. >owever, direct labor has
declined in importance over the years while overhead has been increasin.
This suests that there is no loner a direct lin. between the level o"
direct labor and overhead. Indeed, when a company automates, direct
labor is replaced by machines; a decrease in direct labor is accompanied
by an increase in overhead. This violates the assumption that overhead
cost is directly proportional to direct labor. *verhead cost appears to be
driven by "actors such as product diversity and comple&ity as well as by
volume, "or which direct labor has served as a convenient measure.
1+. ?mployees may resist activity-based costin because it chanes the @rules
o" the ame.A $17 chanes some o" the .ey measures, such as product
costs, used in ma.in decisions and may a""ect how individuals are
evaluated. 'ithout top manaement support, employees may have little
interest in ma.in these chanes. In addition, i" top manaers continue to
ma.e decisions based on the numbers enerated by the traditional costin
system, subordinates will %uic.ly conclude that the activity-based costin
system can be inored.
1/. 0nit-level activities are per"ormed "or each unit that is produced. 1atch-
level activities are per"ormed "or each batch reardless o" how many units
are in the batch. ,roduct-level activities must be carried out to support a
product reardless o" how many batches are run or units produced.
7ustomer-level activities must be carried out to support customers
reardless o" what products or services they buy. *rani#ation-sustainin
activities are carried out reardless o" the company3s precise product mi&
or mi& o" customers.
14. *rani#ation-sustainin costs, customer-level costs, and the costs o" idle
capacity should not be assined to products. These costs represent
resources that are not consumed by the products.
II. True or False
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Chapter 11 Systems Design: Activity-Based Costing and Management
1. True 3. 2alse /. 2alse 6. True
2. True +. True 4. 2alse 8. True
III. Exercises
Exercise 1
Activity
Activity
Classification
Examples of
Traceable
Costs
Examples of
Cost
Drivers
a. =aterials are moved
"rom the receivin
doc. to product "low
lines by a material-
handlin crew
1atch-level Labor cost;
depreciation
o" e%uipment;
space cost
!umber o"
receipts;
pounds handled
b. Birect labor wor.ers
assemble various
products
0nit-level Birect labor
cost; indirect
labor cost;
labor bene"its
Birect labor-
hours
c. *noin trainin is
provided to all
employees in the
company
2acility-levelC 5pace cost;
trainin costs;
administration
costs
>ours o"
trainin time;
number trained
d. $ product is
desined by a
speciali#ed desin
team
,roduct-level 5pace cost;
supplies used;
depreciation o"
desin
e%uipment
>ours o"
desin time;
number o"
enineerin
chane orders
e. ?%uipment setups
are per"ormed on a
reular basis
1atch-level Labor cost;
supplies used;
depreciation o"
e%uipment
!umber o"
setups; hours
or setup time
". !umerical control
(!7) machines are
used to cut and
shape materials
0nit-level ,ower;
supplies used;
maintenance;
depreciation
=achine-
hours; number
o" units
C ,ersonnel administration and trainin costs miht be traceable in part to the
"acility-level and in part to other activity centers at the unit-level, product-
level, and batch-level.
Exercise 2
11-4
Systems Design: Activity-Based Costing and Management Chapter 11
1. plantwide overhead rate 4. 1atch-level
2. volume 6. ,roduct-level
3. two stae, stae, stae 8. 2acility-level
+. ,rocess value analysis :. hih-volume, low-volume, low-volume
/. 0nit-level 1;. activity centers
Exercise 3
a. -arious individuals manae the parts inventories. ,roduct-level
b. $ cler. in the "actory issues purchase orders "or a
<ob. 1atch-level
c. The personnel department trains new production
wor.ers.
*rani#ation-
sustainin
d. The "actory3s eneral manaer meets with other
department heads such as mar.etin to
coordinate plans.
*rani#ation-
sustainin
e. Birect labor wor.ers assemble products. 0nit-level
". ?nineers desin new products. ,roduct-level
. The materials store.eeper issues raw materials to
be used in <obs. 1atch-level
h. The maintenance department per"orms periodic
preventative maintenance on eneral-use
e%uipment.
*rani#ation-
sustainin
!ote: 5ome o" these classi"ications are debatable and may depend on the
speci"ic circumstances "ound in particular companies.
Exercise 4
5ales (,1,4/; per standard model lider D 1; standard
model liders E ,2,3;; per custom desined lider D 2
custom desined liders)...................................................................................... ,21,1;;
7osts:
Birect materials (,+42 per standard model lider D 1;
standard model liders E ,/64 per custom
desined lider D 2 custom desined liders)................................................. ,/,662
Birect labor (,1: per direct labor-hour D 28./ direct
labor-hours per standard model lider D 1; standard
model liders E ,1: per direct labor-hour D 32 direct
labor-hours per custom desined lider D 2 custom
desined liders).............................................................................................. 4,431
5upportin manu"acturin (,18 per direct labor-hour D
28./ direct labor-hours per standard model lider D
4,282
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Chapter 11 Systems Design: Activity-Based Costing and Management
1; standard model liders E ,18 per direct labor-
hour D 32 direct labor-hours per custom desined
lider D 2 custom desined liders).................................................................
*rder processin (,1:2 per order D 3 orders)..................................................... /64
7ustom desinin (,241 per custom desin D 2 custom
desins)............................................................................................................ /22
7ustomer service (,+24 per customer D
1 customer)....................................................................................................... +24 2;,2;:
7ustomer marin...................................................................................................... , 8:1
Exercise
Requirement 1
The predetermined overhead rate is computed as "ollows:
The unit product costs under the company3s traditional costin system are
computed as "ollows:
Special Regular
Birect materials................................................................................................................ ,4;.;; ,+/.;;
Birect labor...................................................................................................................... :.4; 6.2;
=anu"acturin overhead (;.8 BL> D ,/.8; per BL>;
;.4 BL> D ,/.8; per BL>)........................................................................................ +.4+ 3.+8
0nit product cost.............................................................................................................. ,6+.2+ ,//.48
Requirement 2
The activity rates are computed as "ollows:
(a
Estimate! (b
"ver#ea! Total (a $ (b
Activities Cost Expecte! Activity Activity Rate
5upportin direct labor............................... ,1/;,;;; /;,;;; BL>s ,3 per BL>
1atch setups............................................... ,4;,;;; 2/; setups ,2+; per setup
5a"ety testin.............................................. ,8;,;;; 1;; tests ,8;; per test
=anu"acturin overhead is assined to the two products as "ollows:
Special %ro!uct&
Activity Cost %ool
(a
Activity Rate
(b
Activity
(a ' (b
A(C Cost
5upportin direct labor.......................................................... ,3 per BL> 8,;;; BL>s ,2+,;;;
1atch setups.......................................................................... ,2+; per setup 2;; setups +8,;;;
5a"ety testin......................................................................... ,8;; per test 8; tests 4+,;;;
11-!
,redetermined
overhead rate
F
,2:;,;;;
/;,;;; BL>s
F ,/.8; per BL>
Systems Design: Activity-Based Costing and Management Chapter 11
Total ,134,;;;
Regular %ro!uct&
Activity Cost %ool
(a
Activity Rate
(b
Activity
(a ' (b
A(C Cost
5upportin direct labor.......................................................... ,3 per BL> +2,;;; BL>s ,124,;;;
1atch setups.......................................................................... ,2+; per setup /; setups 12,;;;
5a"ety testin......................................................................... ,8;; per test 2; tests 14,;;;
Total ,1/+,;;;
$ctivity-based costin unit product costs are computed as "ollows:
Special Regular
Birect materials................................................................................................... ,4;.;; ,+/.;;
Birect labor......................................................................................................... :.4; 6.2;
=anu"acturin overhead (,134,;;; G 1;,;;; units; ,1/+,;;; G
6;,;;; units).................................................................................................. 13.4; 2.2;
0nit product cost................................................................................................. ,83.2; ,/+.+;
I-. Prolems
"ro#le$ 1
Cost
Systems
%ool
Rate
Cost Driver
Consumption
Cost
Assignment
Tra%itional cost s&ste$ 3/;H ,1;,;;; ,3/,;;;
A'C s&ste$
Labor 1;H ,1;,;;; , 1,;;;
=achinin ,2/Ihour 8;; hours 2;,;;;
5etup ,1;Ihour 1;; hours 1,;;;
,roduction order ,1;;Iorder 12 orders 1,2;;
=aterial handlin ,2;Ire%uisition / re%uisitions 1;;
,arts administration ,+;Ipart 18 parts 62;
,2+,;2;
"ro#le$ 2
Requirement 1
(a)
11-(
Chapter 11 Systems Design: Activity-Based Costing and Management
Total overhead F ,2;;,;;; E ,32,;;; E ,1;;,;;; E ,12;,;;;
F ,+/2,;;;
*verhead rate F ,+/2,;;; I /;,;;; direct labor hours
F ,:.;+ per direct labor hour
*verhead assined to proposed <ob F ,:.;+ & 1,;;; direct labor hours
F ,:,;+;
(b) Total cost o" proposed <ob:
Birect materials , 4,;;;
Birect labor 1;,;;;
*verhead applied :,;+;
Total cost ,2/,;+;
(c) 7ompany3s bid F 2ull manu"acturin cost & 12;H F ,2/,;+; & 12;H
F ,3;,;+8
Requirement 2
(a) =aintenance : ,2;;,;;; I 2;,;;; F ,1; per machine hour
=aterials handlin: ,32,;;; I 1,4;; F ,2; per move
5etups: ,1;;,;;; I 2,/;; F ,+; per setup
Inspection: ,12;,;;; I +,;;; F ,3; per inspection
*verhead assined to proposed <ob:
=aintenance (,1; & /;;) ,/,;;;
=aterial handlin (,2; & 12) 2+;
5etups (,+; & 2) 8;
Inspection (,3; & 1;) 3;;
Total overhead assined to <ob ,/,42;
(b) Total cost o" proposed pro<ect:
Birect materials , 4,;;;
Birect labor 1;,;;;
*verhead applied /,42;
Total cost ,21,42;
(c) 7ompany3s bid F 2ull manu"acturin cost & 12;H F ,21,42; & 12;H
11-)
Systems Design: Activity-Based Costing and Management Chapter 11
F ,2/,:++
The bid price o" ,2/,:++ was determined as "ollows:
Birect materials ,4,;;;
Birect labor 1;,;;;
*verhead assined:
=aintenance (,1; & /;;) ,/,;;;
=aterial handlin (,2; & 12) 2+;
5etups (,+; & 2) 8;
Inspections (,3; & 1;) 3;;
Total overhead assined to <ob /,42;
Total cost ,21,42;
=ar.up 12;H
1id price ,2/,:++
"ro#le$ 3 *Acti+it&-'ase% Costin,-
Requirement 1
The "irst-stae allocation o" costs to the activity cost pools appears below:
Activity Cost %ools
Assemblin
g )nits
%rocessing
"r!ers
Supporting
Customers "t#er Total
=anu"acturin
overhead ,2/;,;;; ,16/,;;; ,2/,;;; ,/;,;;; ,/;;,;;;
5ellin and
administrative
overhead 3;,;;; 13/,;;; 6/,;;; 4;,;;; 3;;,;;;
Total cost ,28;,;;; ,31;,;;; ,1;;,;;; ,11;,;;; ,8;;,;;;
Requirement 2
The activity rates "or the cost pools are:
(a
Total Cost
(b
Total Activity
(a (b
Activity Rate
$ssemblin units ,28;,;;; 1,;;; units ,28; per unit
,rocessin orders ,31;,;;; 2/; orders ,1,2+; per order
5upportin customers ,1;;,;;; 1;; customers ,1,;;; per customer
11-.
Chapter 11 Systems Design: Activity-Based Costing and Management
Requirement *
The overhead cost attributable to Luc.y 5ale would be computed as "ollows:
Activity Cost %ools
(a
Activity Rate
(b
Activity
(a x (b
A(C Cost
$ssemblin units ,28; per unit 8; units ,22,+;;
,rocessin orders ,1,2+; per order + orders ,+,:4;
5upportin customers ,1,;;; per customer 1 customer ,1,;;;
Requirement +
The customer marin can be computed as "ollows:
5ales (,/:/ per unit & 8; units) ,+6,4;;
7osts:
Birect materials (,18; per unit & 8; units) ,1+,+;;
Birect labor (,/; per unit & 8; units) +,;;;
0nit-related overhead (above) 22,+;;
*rder-related overhead (above) +,:4;
7ustomer-related overhead (above) 1,;;; +4,64;
7ustomer marin , 8+;
"ro#le$ 4 *Acti+it&-'ase% Costin, as an Alternati+e to Tra%itional
"ro%uct Costin,-
Requirement 1
a. 'hen direct labor-hours are used to apply overhead cost to products, the
company3s predetermined overhead rate would be:
11-1/
,redetermined
overhead rate
F
,1,+8;,;;;
2;,;;; BL>s
F ,6+ per BL>
F
=anu"acturin overhead cost
Birect labor hours
Systems Design: Activity-Based Costing and Management Chapter 11
b. ,o!el
-./ AS2
Birect materials...................................................................... ,3/.;; ,2/.;;
Birect labor:
,2; per hour D ;.2 BL>, ;.+ BL>.................................... +.;; 8.;;
=anu"acturin overhead:
,6+ per hour D ;.2 BL>, ;.+ BL>.................................... 1+.8; 2:.4;
Total unit product cost............................................................ ,/3.8; ,42.4;
Requirement 2
a. ,redetermined overhead rates "or the activity cost pools:
Activity Cost %ool
(a
Estimate!
Total Cost
(b
Estimate!
Total Activity
(a $ (b
Activity Rate
=achine setups.................,18;,;;; 2/; setups ,62; per setup
5pecial millin..................,3;;,;;; 1,;;; =>s ,3;; per =>
Jeneral "actory................. ,1,;;;,;;; 2;,;;; BL>s ,/; per BL>
The overhead applied to each product can be determined as "ollows:
,o!el -./
Activity Cost %ool
(a
%re!etermine!
"ver#ea! Rate
(b
Activity
(a ' (b
"ver#ea!
Applie!
=achine setups.................................................................................... ,62; per setup 1/; setups ,1;8,;;;
5pecial millin..................................................................................... ,3;; per => 1,;;; =>s 3;;,;;;
Jeneral "actory.................................................................................... ,/; per BL> +,;;; BL>s 2;;,;;;
Total manu"acturin overhead cost (a)................................................. ,4;8,;;;
!umber o" units produced (b)............................................................. 2;,;;;
*verhead cost per unit (a) G (b).......................................................... ,3;.+;
,o!el AS2
Activity Cost %ool
(a
%re!etermine!
"ver#ea! Rate
(b
Activity
(a ' (b
"ver#ea!
Applie!
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Chapter 11 Systems Design: Activity-Based Costing and Management
=achine setups.................................................................................... ,62; per setup 1;; setups , 62,;;;
5pecial millin..................................................................................... ,3;; per => ; =>s ;
Jeneral "actory.................................................................................... ,/; per BL> 14,;;; BL>s 8;;,;;;
Total manu"acturin overhead cost (a)................................................. ,862,;;;
!umber o" units produced (b)............................................................. +;,;;;
*verhead cost per unit (a) G (b).......................................................... ,21.8;
b. The unit product cost o" each model under activity-based costin would be
computed as "ollows:
,o!el
-./ AS2
Birect materials........................................................................................................ ,3/.;; ,2/.;;
Birect labor (,2; per BL> D ;.2 BL>; ,2; per BL> D ;+.BL>)........................... +.;; 8.;;
=anu"acturin overhead (above).............................................................................. 3;.+; 21.8;
Total unit product cost............................................................................................... ,4:.+; ,/+.8;
7omparin these unit cost "iures with the unit costs in ,art 1(b), we "ind
that the unit product cost "or =odel >9/ has increased "rom ,/3.8; to
,4:.+;, and the unit product cost "or =odel $52 has decreased "rom
,42.4; to ,/+.8;.
Requirement *
It is especially important to note that, even under activity-based costin, 48H
o" the company3s overhead costs continue to be applied to products on the
basis o" direct labor-hours:
=achine setups (number o" setups)............................, 18;,;;; 12H
5pecial millin (machine-hours)................................. 3;;,;;; 2;
Jeneral "actory (direct labor-hours)........................... 1,;;;,;;; 48
Total overhead cost.....................................................,1,+8;,;;; 1;;H
Thus, the shi"t in overhead cost "rom the hih-volume product (=odel $52) to
the low-volume product (=odel >9/) occurred as a result o" reassinin only
32H o" the company3s overhead costs.
The increase in unit product cost "or =odel >9/ can be e&plained as "ollows:
2irst, where possible, overhead costs have been traced to the products rather
than bein lumped toether and spread uni"ormly over production. There"ore,
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Systems Design: Activity-Based Costing and Management Chapter 11
the special millin costs, which are traceable to =odel >9/, have all been
assined to =odel >9/ and none assined to =odel $52 under the activity-
based costin approach. It is common in industry to have some products that
re%uire special handlin or special millin o" some type. This is especially true
in modern "actories that produce a variety o" products. $ctivity-based costin
provides a vehicle "or assinin these costs to the appropriate products.
5econd, the costs associated with the batch-level activity (machine setups)
have also been assined to the speci"ic products to which they relate. These
costs have been assined accordin to the number o" setups completed "or
each product. >owever, since a batch-level activity is involved, another "actor
a""ectin unit costs comes into play. That "actor is batch si#e. 5ome products
are produced in lare batches and some are produced in small batches. T#e
smaller t#e batc#0 t#e #ig#er t#e cost per unit of t#e batc# activity1 In the
case at hand, the data can be analy#ed as shown below.
=odel >9/:
7ost to complete one setup Ksee 2(a)L......................................... ,62; (a)
!umber o" units processed per setup
(2;,;;; units G 1/; setups)...................................................133.33 (b)
5etup cost per unit (a) G (b)....................................................... ,/.+;
=odel $52:
7ost to complete one setup (above)............................................ ,62; (a)
!umber o" units processed per setup
(+;,;;; units G 1;; setups)................................................... +;; (b)
5etup cost per unit (a) G (b)....................................................... ,1.8;
Thus, the cost per unit "or setups is three times as reat "or =odel >9/, the
low-volume product, as it is "or =odel $52, the hih-volume product. 5uch
di""erences in cost are obscured when direct labor-hours (or any other volume
measure) is used as the basis "or applyin overhead cost to products.
In sum, overhead cost has shi"ted "rom the hih-volume product to the low-
volume product as a result o" more appropriately assinin some costs to the
products on the basis o" the activities involved, rather than on the basis o"
direct labor-hours.
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Chapter 11 Systems Design: Activity-Based Costing and Management
-. Multi!le C"oice Questions
1. $ 11. 1 21. B
2. B 12. B 21. $
3. 7 13. 7 22. 1
+. 1 1+. $ 23. $
/. $ 1/. 7 2+. 1
4. B 14. B 2/. B
6. $ 16. B 24. 1
8. 1 18. 7 26. 7
:. B 1:. 1 28. $
1;. 7 2;. $ 2:. 7
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