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Chapter 09 - Activity-Based Costing

Chapter

Activity-Based Costing
Solutions to Review Questions
9-1.
Common allocation bases are direct labor-hours, direct labor costs, and machine-hours.
Somewhat less common is direct material costs.
9-2.
False. Department allocation is a two-stage process, so the first-stage assignment of
costs and the choice of cost drivers affects the allocation of costs to products. The total
product costs are the same under either approach, but the individual product costs
differ. This can affect the decisions managers make regarding individual products.
9-3.
Most companies produce multiple products and simply adding them up does not
account for differences in complexity of the use of resources. As an extreme example,
suppose a company produced airplanes and staplers. Allocating overhead on the basis
of units would assign the same overhead cost to a stapler and a plane.
9-4.
The costs include the systems and the software, but the most important cost is
managers time. Managers need to make many decisions about the activities and the
cost drivers and managers need to make many of the first-stage allocations. The
benefits come from having better information about the use of resources and better
information for decisions.
9-5.
1.Identify activities that consume resources.
2.Identify the cost driver associated with each activity.
3.Compute a cost rate per activity unit (e.g., rate per setup, rate per part, rate per
machine-hour).
4.Allocate costs to products by multiplying the activity rate times the volume of activity
consumed by the product.
9-6.
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Chapter 09 - Activity-Based Costing

False. While the total cost allocated is the same, the reported costs for individual
products will differ. Because managers make decisions at the product level, it is
important that the reported costs reflect, to the extent possible, the use of resources by
the products.
9-7.
Activity-based costing will benefit most companies with high overhead costs and diverse
products and processes. If there is little overhead or if there is a single product, the
allocation process will not result in significantly different product costs. (Even if there are
only a few, relatively homogeneous products, activity-based costing may be useful for
cost management. See chapter 10 for a discussion.)
9-8.
A personnel department provides its services by completing a set of activities using
resources. In this way, implementing activity-based costing in an administrative function
is the same as implementing it in a manufacturing firm. However, the products and
activities may be much harder to define, making it less like a manufacturing
environment.

Solutions to Critical Analysis and Discussion Questions


9-9.
Direct labor is already measured, so no new data needs to be collected to use it as an
allocation base. In addition, direct labor historically was the most important resource in
manufacturing.
9-10.
Activity-based costing does not change the process for direct costs, so the statement is
false. For indirect cost, it is uncertain, because it depends on the cost drivers used and
the diversity in the processes. For processes that are used in the same way for all
products, the particular allocation process is not that important.
9-11.
False. The services in a business school, as in any service business, require activities
(preparing classrooms, organizing recruiting, etc.). The costs of the business school can
be assigned to these activities and then allocated to services (e.g., degree programs)
using appropriate cost drivers (e.g., number of students, number of classes, number of
faculty, etc.).
9-2
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-12.
False. Activity-based costing is most useful when the first-stage allocation is to activities,
not departments. Further, an activity-based costing system also uses cost drivers that
form a hierarchy of costs, as appropriate, whereas most department allocation costing
systems use volume-based cost drivers.
9-13.
There is no rule that the price charged for a product has to exceed its cost. There may
be important marketing or strategic reasons why a company wants to be in a particular
market. However, to ensure that this is a good decision, the firm should have the best
information on cost that it can get. Managing a company by fooling yourself into thinking
something costs less than it does is not smart.
9-14.
Activity-based costing is like any other information system; it has its benefits and its
costs. It is not appropriate in all situations and the benefits may not justify its costs in
others.
9-15.
False. The lesson learned from activity-based costing is that costs are a function not
only of output volume, but also of other factors such as complexity. For example, a
complex multiproduct operation will cost more than a simple single-product operation.
9-16.
False. activity-based costing breaks down the costs into cost pools according to the
activities that cause the costs. While several departments may have the same cost
drivers, each department should individually determine which activities cause their
costs.
9-17.
There are two important characteristics you should look for. Are the first-stage cost
pools activities? Second, do the cost drivers in the second stage form a cost hierarchy
(e.g., volume related, batch related, etc.) or are they all volume-related costs?
9-18.
Without information on the use of overhead resources by products, it is difficult for
managers to make decisions that appropriately account for the use of these resources
by the products. Although the specific allocation base to be used may not be clear,
products that require more handling, perhaps because of toxicity, use more overhead
resources. Allocating no overhead costs to a product is as likely to distort decision
making as allocating costs based on an arbitrary allocation base.
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Chapter 09 - Activity-Based Costing

9-19.
Disagree. The cost of implementing activity-based costing for inventory valuation
generally is not worth the small benefits that might be realized. It is most worthwhile
when managers use product cost data to make decisions at the product level.
9-20.
Answers will vary. The function selected will determine the activities, but some examples
of activities are processing payments, processing job applications, checking
backgrounds, processing bills, answering customer questions, and so on. Some
examples of cost drivers are number of payments, number of applications, time spent,
number of questions, and so on. Example cost objects might be departments or
divisions, if the function provides support, or products or services, if the departments
provide service to customer activities.
9-21.
Answers will vary. Elements of the system that suggest it is an ABC system include cost
pools that are activities, multiple cost pools, and multiple cost drivers. However, the two
drivers are both volume-based, meaning there really is no cost hierarchy. The system
will suffer from many of the problems of a traditional system, including the assignment of
costs to products based on volume alone.

Solutions to Exercises
922.

(30 min.) Plantwide versus Department Allocation: Munoz Sporting


Equipment.
Baseball
Tennis
Bats
rackets

a. Sales revenue......................................................
$2,700,000
$1,800,000
Direct Labor.........................................................
500,000
250,000
Direct Materials....................................................
1,100,000
550,000
Overhead.............................................................
1,000,000 a
500,000 b
Profit....................................................................
$100,000
$500,000
a $1,000,000
b $500,000

= $500,000 direct labor x 200%.

= $250,000 direct labor x 200%.

b. Maria was wrong; Baseball bats were more profitable.


Baseball
Tennis
Bats
rackets
9-4
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

Sales revenue......................................................
$2,700,000
$1,800,000
Direct Labor.........................................................
500,000
250,000
Direct Materials....................................................
1,100,000
550,000
Overhead.............................................................
750,000 a
750,000 b
Profit....................................................................
$350,000
$250,000
a $750,000

= $500,000 direct labor x 150%.

b $750,000

= $250,000 direct labor x 300%.

c.The plantwide allocation method allocates overhead at 200% of direct labor for both
types of equipment. While this is the simplest method, it is usually not very accurate. It
assumes that overhead in both departments has the same rate. When overhead costs
are broken down into department cost pools, we see that Department B is allocated a
smaller share of the overhead. Each department should try to assess what causes its
overhead, and use that as its allocation base.
9-23. (35 min.)Plantwide versus Department Allocation: Main Street Ice Cream
Company.
Strawberry
Vanilla
Chocolate
a. Direct Labor (per 1,000 gallons)..........................
$750
Raw Materials (per 1,000 gallons)......................
800
Overhead.............................................................
150 a
Total cost (per 1,000 gallons)..............................
$1,700
a$150

= 50 labor-hours x $3 per hour.

b$165

= 55 labor-hours x $3 per hour.

c$225

= 75 labor-hours x $3 per hour.

$825
500
165 b
$1,490

$1,125
600
225 c
$1,950

b. Department SV has an overhead allocation rate of $4.20 per machine-hour


($105,840 25,200 machine hours). Department C has an overhead allocation rate
of $1.32 per labor-hour ($23,760 18,000 labor-hours).

9-5
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

c.
Strawberry
Direct Labor (per 1,000 gallons)..........................
$750
Raw Materials (per 1,000 gallons)......................
800
Overhead.............................................................
210 a
Total cost (per 1,000 gallons)..............................
$1,760
a$210

= 50 machine-hours x $4.20 per machine-hour.

b$231

= 55 machine-hours x $4.20 per machine-hour.

c$99

Vanilla
Chocolate
$825
$1,125
500
600
231 b
99 c
$1,556
$1,824

= 75 labor-hours x $1.32 per labor-hour.

d. Charlene was correct in her belief that she was being allocated some of Department
SVs overhead. Plantwide allocation does not correctly allocate the overhead by
department; it simply uses one allocation rate for all products in all departments.
Under plantwide allocation, 1,000 gallons of chocolate cost $1,950. Once the
overhead was reallocated into department cost pools, the cost of chocolate fell to
$1,824. Although it requires more time and skill to collect and process the
information, department allocation generally yields more accurate product cost
information.

924. (30 min.) Unitwide versus Department Allocation: Drumm Corporation.


a.

Illinois
Ohio
Employees...........................................................
1,200
300
Rate per employee..............................................
$500
$500
Allocated cost......................................................
$600,000
$150,000

9-6
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

b.
Illinois
Ohio
Employees...........................................................
1,200
300
Rate per employee..............................................
$200
$200
Allocated cost......................................................
$240,000
$60,000
Transitions...........................................................
30
50
Rate per transition...............................................
$5,625
$5,625
Allocated cost......................................................
$168,750
$281,250
$
Total allocated cost..............................................
$408,750
$341,250
$

925. (30 min.) Unit wide versus Department Allocation: Drumm Corporation.
a. First, note that the total to be allocated is $750,000 (= $600,000 + $150,000 in the
current system or $408,750 + $341,250 in the revised system). Then we just need to
compute the variable cost to be allocated to Ohio; the difference between this and
$750,000 will be allocated to Illinois.
Ohio
Employees...........................................................
300
Rate per employee..............................................
$50
Allocated cost......................................................
$15,000
Transitions...........................................................
50
Rate per transition...............................................
$2,000
Allocated cost......................................................
$100,000
$
Total allocated cost..............................................
$115,000
$
The amount allocated to Illinois will be $635,000 ($750,000 $115,000).
b. Kurt is correct that the incremental cost to Drumm from the activities of Ohio is
measured by the $115,000. There is a danger that as Ohio grows relative to Illinois, the
costs and activities of Personnel will be more highly influenced by the Ohio unit.
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

926. (30 min.) Activity-Based Costing: Joplin Industries.


a.
Direct material...............................................................
Direct labor
Assembly..................................................................
Packaging.................................................................
Total direct labor...................................................
Direct costs....................................................................
Overhead
Assembly building
Assembling (@ $30/mh)...........................................
Setting up machine (@$900/setup-hour)a...............
Handling material (@$3,000/run).............................
Packaging building
Inspecting and Packaging (@$5/direct labor-hour)..
Shipping (@$1,320/shipment)..................................
Total ABC O/H.......................................................
Total ABC cost...............................................................
Number of units.............................................................
Unit cost.........................................................................

J25P

J40X

$1,500,000

$2,400,000

$ 750,000
990,000
$1,740,000
$3,240,000

$ 600,000
360,000
$960,000
$3,360,000

$ 180,000 $
27,000
24,000
300,000
132,000
$ 663,000
$3,903,000
100,000
$39.03

900,000
270,000
120,000

114,000
264,000
$1,668,000
$5,028,000
40,000
$125.70

75% of the amounts in Exhibit 9.16. ($27,000 = .75 $36,000; $270,000 = .75
$360,000).
a

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Chapter 09 - Activity-Based Costing

9-26. (continued)
b. Kris could have made the reductions he planned, but the effect on the product costs
would have been different. The $99,000 reduction in setup costs (25% of $396,000),
would have been spread between the two products based on labor or machinehours.
ABC provides more detailed measures of costs than do plantwide or department
allocation methods. In this case, ABC shows the costs of machining, setting up
equipment, handling materials, inspecting, packaging products, and shipping. The
plantwide and department allocation methods did not reveal any of these detailed
cost drivers. With ABCs more detailed information, management has an opportunity
to manage costs by managing cost drivers. For example, are there less costly ways
to inspect and package products? Or perhaps spending additional resources to
improve quality would more than pay for itself with reduced inspections.
ABC also provides better measures of product costs than plantwide and department
allocation methods, which leads to better decisions about product pricing and
whether to keep or drop products.
ABC requires more record keeping than plantwide or department allocation methods.
ABC also requires more teamwork among accountants, production people,
marketing, and management, which can be both costly and beneficial. In the end,
management must decide whether the benefits of ABC, outlined above, are worth
these costs.

9-9
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-27. (30 min.)Activity-Based Costing in a Nonmanufacturing Environment:


Cathys Catering.
a. & b.
a.
b.
Activities
Afternoon
Formal
Picnic
Dinner
Advertising (parties).................................
$ 80
$ 80
Planning (parties)....................................
60
100
Equipment rental (parties, guests)..........
200 a
380 b
Insurance (parties)...................................
160
320
Server cost (parties)................................

160 c

240 d

Food (guests)...........................................

320 e

480 f

Total...........................................................
a

$200 = $40 + ($8 x 20 guests).

$380 = $60 + ($16 x 20 guests).

$160 = $40 x 4 servers.

$240 = $60 x 4 servers.

$320 = $16 x 20 guests.

$480 = $24 x 20 guests.

$980

$1,600

c. If Cathy wants to cover her costs she should charge $49 per guest for the picnic
($980 20 guests), and $80.00 per guest for the formal dinner ($1,600 20 guests).

9-10
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-28. (35 min.)Activity-Based versus Traditional Costing: Rodent Corporation .


a.
Rate
Wired
Wireless
Total
Direct labora........................................................
$290,100
$ 109,900
$400,000
Direct materialsb..................................................
$187,500
$ 171,000
$358,500
Overhead costs
Prod. runs........................................................
$6,600 c $ 132,000 f
$ 33,000 $ 165,000
Quality tests.....................................................
9,900 d
59,400 g
89,100
148,500
Ship. orders.....................................................
620 e
31,000 h
15,500
46,500
Total overhead.................................................
$ 222,400
$ 137,600
$360,000
Total costs...........................................................
$700,000
$418,500 $1,118,500
Total unit cost......................................................
$5.00 i
$8.37 j
aData

given in the first table of the exercise in the text.

bData

given in the first table of the exercise in the text.

c$6,600

per run = $165,000 in production run costs 25 total runs.

d$9,900

per test = $148,500 in quality costs 15 total tests.

e$620

per order = $46,500 in shipping costs 75 processed orders.

f$132,000

= $6,600 per production run x 20 runs for Wired.

g$59,400

= $9,900 per quality test x 6 tests for Wired.

h$31,000

= $620 per order shipped x 50 orders shipped for Wired.

i$5.00

= $700,000 total costs for Wired 140,000 units produced.

j$8.27

= $418,500 50,000 units produced.

Reading from the table above, we can see that the total overhead assigned is $222,400
and $137,600 for Wired and Wireless, respectively. The total cost per unit is the total
cost per product divided by the total units produced; $5.00 per Wired mouse and $8.37
per Wireless mouse.

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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-28. (continued)
b.

Rate

Wired

Direct labora........................................................
$290,100
Direct materialsb..................................................
187,500
Total overhead.....................................................
90% c
261,090 d
Total costs...........................................................
$738,690
Total unit cost......................................................
$5.28 e

Wireless

Total

$109,900
171,000
98,910
$379,810
$7.60

$400,000
358,500
360,000
$1,118,500

aData

given in the first table in the exercise.

bData

given in the first table in the exercise.

c90%

= $360,000 total overhead $400,000 total direct labor.

d$261,090
e$5.28

= $290,100 0.90

= $738,690 140,000 units produced (rounded).

From the table above, total overhead allocated to Wired and Wireless is $261,090 and
$98,910 respectively. The unit cost for Wired and Wireless is $5.28 and $7.60
respectively.

c. By allocating overhead on the basis of direct labor, Rodent has been understating
the cost to manufacture Wireless mice thereby overstating the profits on the Wireless
model.

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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-29. (35 min.)Activity-Based versus Traditional Costing: Doaktown Products .


a.
Rate
M-008
M-123
Total
Direct materialsa..................................................
$100,000
$ 80,000
$180,000
Direct laborb........................................................
$100,000
$ 40,000
$140,000
Overhead costs
Machine-hours.................................................
$ 15 c $ 75,000 f
$ 45,000 $ 120,000
Production runs................................................
3,500 d
35,000 g
35,000
70,000
Inspections.......................................................
1,500 e
30,000 h
60,000
90,000
Total overhead.................................................
$140,000
$140,000
$280,000
Total costs...........................................................
$340,000
$260,000
$600,000
Total unit cost......................................................
$28.33 i
$130.00 j
aData

given in the first table of the exercise in the text.

bData

given in the first table of the exercise in the text.

c$15

per machine-hour = $120,000 in production run costs 8,000 machine-hours.

d$3,500

per run = $70,000 in quality costs 20 total runs.

e$1,500

per inspection = $90,000 in shipping costs 60 inspections.

f$75,000

= $15 per machine-hour x 5,000 machine-hours for M-008.

g$35,000

= $3,500 per run x 10 runs for M-008.

h$30,000

= $1,500 per inspection x 20 inspections for M-008.

i$28.33
j$130

= $340,000 total costs for M-008 12,000 units produced (rounded).

= $260,000 2,000 units produced.

Reading from the table above, we can see that the total overhead assigned is $140,000
for both M-008 and M-123. The total cost per unit is the total cost per product divided by
the total units produced; $28.33 per M-008 and $130 per M-123.

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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-29. (continued)
b.

Rate

M-008

Direct materialsa..................................................
$100,000
Direct laborb........................................................
100,000
Total overhead.....................................................
200% c
200,000 d
Total costs...........................................................
$400,000
Total unit cost......................................................
$33.33 e
aData

given in the first table in the exercise.

bData

given in the first table in the exercise.

c200%

M-123
$80,000
40,000
80,000
$200,000
$100.00

Total
$180,000
140,000
280,000
$600,000

= $280,000 total overhead $140,000 total direct labor.

d$200,000
e$33.33

= $100,000 2.0.

= $400,000 12,000 units produced (rounded).

From the table above, total overhead allocated to M-008 and M-123 is $200,000 and
$80,000 respectively. The unit cost for M-008 and M-123 is $33.33 and $100.00
respectively.

c. By allocating overhead on the basis of direct labor, Doaktown Products has been
understating the cost to manufacture M-123, thereby overstating the profits on M123.

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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-30. (30 min.)Activity-Based Costing in a Service Environment: We-Clean, Inc .


Note: Answers may vary slightly due to rounding.
a.

Commercial
Revenuea.............................................................
$378,000
Direct Laborb.......................................................
210,000
Overheadc...........................................................
43,400
Profit....................................................................
$124,600

Residential

Total

$910,000
390,000
80,600
$439,400

$1,288,000
600,000
124,000
$ 564,000

a$378,000

= 14,000 hours x $27 per hour; $910,000 = 26,000 hours x $35 per hour.

b$210,000

= 14,000 hours x $15 per hour; $390,000 = 26,000 hours x $15 per hour.

c$43,400

= ($124,000 40,000 hours) x 14,000 hours;


$80,600 = ($124,000 40,000 hours) x 26,000 hours.

b.

Rate
Commercial
Residential
Revenue..............................................................
$378,000
$910,000
Direct Labor.........................................................
210,000
390,000
Overhead
Traveling...........................................................
$250.00 a
$ 4,250 b
$ 11,750 c
Equipment........................................................
6.00 d
22,500 e
13,500 f
Supplies...........................................................
0.36 g
46,800 h
25,200 i
Total Overhead....................................................
$ 73,550
$ 50,450
Profit....................................................................
$94,450
$469,550

a $250

= 47 clients x $250 per client.

per hour = $36,000 6,000 equipment hours.

e $22,500

= 3,750 equipment-hours x $6 per equipment-hour.

f $13,500

= 2,250 equipment-hours x $6 per equipment-hour.

h
i

16,000
36,000
72,000
$ 124,000
$ 564,000

= 17 clients x $250 per client.

c $11,750

g $0.36

per client = $16,000 64 clients served.

b $4,250
d $6.00

Total
$1,288,000
600,000

per square yard = $72,000/200,000 square yards.

$46,800 = 130,000 square yards x $0.36 per square yard.


$25,200 = 70,000 square yards x $0.36 per square yard.

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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-30. (continued)
c. The recommendation to Ms. Lodge is that she should reconsider dropping residential
services in favor of the commercial business. From the table in part b of the solution,
we can show Ms. Lodge that commercial work has a profit margin of 25%, while the
residential business has a profit margin of greater than 50%. We can explain the
differences in profits under the two cost methods by showing Ms. Lodge that there is
little correlation in costs between direct labor and the overhead costs.
9-31. (35 min.)Activity-Based versus Traditional Costing: Isadores Implements,
Inc.
a. Cost Driver
Rate
Setting up............................................................
$1,440 a
Inspecting............................................................
2,160 b
Packaging and Shipping......................................
0.36 c
Total Overhead....................................................
a $1,440

per setup = $72,000 50 setups.

b $2,160

per part = $21,600 10 parts.

c $0.36

e $8,640

= $1,440 x 20 setups.

= $2,160 x 4 parts.

f $16,200

= $0.36 x 45,000 boxes shipped.

Pencils
Pens
Direct Labor Hours..............................................
4,500 a
15,000
Overhead.............................................................
$31,569 b
$105,231

a 4,500

Pens
$ 43,200
12,960
27,000
$83,160

per unit shipped = $43,200 120,000 boxes shipped.

d $28,800

b.

Pencils
$28,800 d
8,640 e
16,200 f
$53,640

Total
19,500
$136,800

hours = 0.1 hours per box of pencils x 45,000 boxes produced.

b $31,569

= ($136,800 OH 19,500 hours) x 4,500 hours (rounded).

9-16
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

c. Not necessarily. Activity-based costing provides a more accurate allocation of


overhead costs. However, the more accurate method is also more expensive. The
ABC system should be adopted if the benefits from improved information exceed the
additional costs required to obtain the information.
9-32. (35 min.)Activity-Based versus Traditional CostingEthical Issues:
Windy City Coaching.
Teen
Executive
a.
Account
Rate
Counseling
Coaching
Total
Revenue..............................................................
$66,000
$135,000 $201,000
Expenses:
Administrative support.....................................
$4,000 a
24,000 d
16,000
40,000
Transportation..................................................
144 b
14,400 e
21,600
36,000
Equipment........................................................
12.50 c
11,250 f
8,750
20,000
Profit....................................................................
$16,350
$88,650 $105,000
a $4,000
b $144

per client = $40,000 10 clients.

per visit = $36,000 250 visits.

c $12.50

per computer hour = $20,000 1,600 hours.

d $24,000

= $4,000 per client x 6 clients.

e $14,400

= $144 per hour x 100 visits.

f $11,250

= $12.50 per computer hour x 900 hours.

b.

Teen
Account
Rate Counseling
Revenue..............................................................
$66,000
Expenses.............................................................
$143.2836 a
31,522 b
Profit....................................................................
$34,478

Executive
Coaching
$135,000
64,478
$ 70,522

Total
$201,000
96,000
$105,000

$201,000 revenue $300 per hour = 670 hours of labor.


$143.2836 per labor hour = $96,000 of expenses 670 hours.
$31,522 = $143.28 per labor hour x 220 hours of labor.

c. Under labor-based costing, teen counseling and executive coaching appear equally
profitable (relative to revenues), so Wendy will not emphasize one or the other.
However, using ABC, executive coaching appears to be much more profitable.
d. ABC and traditional costing systems generally yield comparable product-line profits
when overhead is a small portion of costs, or when cost drivers are highly correlated
with the volume-related allocation base. In this case, labor-hours were distributed
32.8% to Teen Counseling and 67.2% to Executive Coaching. If Wendys three cost
9-17
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

drivers were each also distributed 32.8% to Teen Counseling and 67.2% to
Executive Coaching, the labor-hour allocation and ABC would have been identical.
9-32. (continued)
e. Activity-based costing assigns higher costs to teen counseling than the traditional
method does, so using this would increase the chances of receiving the grant. If teen
counseling uses more activities and these activities generate higher costs, there is
nothing unethical about using and reporting ABC costs. Choosing to use ABC simply
to increase the chances of receiving the grant, if there is no reason to believe these
activities actually increase the costs, could be unethical.
9-33.

(30 min.)Activity-Based CostingCost Flows Through T-accounts: Delta


Parts, Inc.
Materials Inventory
$300,000
Wages Payable
$150,000
Overhead Applied:
Materials Handling
3,750 pounds x
$18.00 per pound =
$67,500 to WIP

Overhead Applied:
Quality Inspections
750 inspections x
$225 per inspection
= $168,750 to WIP

Overhead Applied:
Machine Setups
40 setups x $2,700
per setup =
$108,000 to WIP

Overhead Applied:
9-18
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Chapter 09 - Activity-Based Costing

Running Machines
15,000 hours x
$22.50 per hour =
$337,500 to WIP
9-33. (continued)
Work in Process (WIP) Inventory
Fabrication Department
Direct Materials
300,000
Direct Labor
150,000
Material Handling OH
67,500
Quality Inspect. OH
168,750
Machine Setup OH
108,000
Running Machines OH 337,500 1,131,750
Finished Goods Inventory
1,131,750

9-34. (30 min.) Activity-Based CostingCost Flows Through T-accounts:


Carolina Fashions.
Materials Inventory
$200,000 to WIP
Wages Payable
$100,000 to WIP
Overhead Applied:
Materials Handling
40,000 yards x $1
per yard = $40,000
to WIP

9-19
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

Overhead Applied:
Quality Inspections
800 inspections x
$100 per inspection
= $80,000 to WIP
Overhead Applied:
Machine Setups
100 setups x $800
per setup = $80,000
to WIP
Overhead Applied:
Running Machines
20,000 hours x $10
per hour = $200,000
to WIP
9-34. (continued)
Work in Process (WIP) Inventory
Building S
Direct Materials
200,000
Direct Labor
100,000
Material Handling
40,000
Quality Inspect.
80,000
Machine Setup
80,000
Running Machines
200,000 700,000

Finished Goods Inventory


700,000

9-20
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-35. (20 min.)Activity-Based Costing for an Administrative Service: LastCall


Enterprises.
a.
Rate
LaidBack
StressedOut
Total
Allocated costsa...................................................
$1,100
$220,000 b
$55,000 c $275,000
a

$1,100 per employee = $275,000 Personnel cost 250 average employees.

b $220,000
c $55,000

b.

= $1,100 x 200 employees for LaidBack.

= $1,100 per employee x 50 employees for StressedOut


Rate

LaidBack

Employee maintenancea.....................................
$6,000
$60,000 b
Payrolld................................................................
$140
28,000 e
Total allocated costs............................................
$88,000

StressOut
$180,000 c
7,000 f
$187,000

Total
$240,000
35,000
$275,000

a $6,000

= $240,000 Employee maintenance costs 40 employees hired/leaving.

b 60,000

= $6,000 10 employees hired/leaving.

c 180,000
d $140

= $35,000 Payroll costs 250 employees (average).

e $28,000
f

= $6,000 30 employees hired/leaving.


= $140 200 employees (average).

$7,000 = $140 50 employees (average).


Allocating Personnel costs solely on number of employees understates the costs of
employee turnover, which is much higher in StressedOut.

9-21
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-36. (20 min.)Activity-Based Costing for an Administrative Service: Johns


Custom Computer Shop.
a.
Rate
Personal
Business
Total
Allocated costsa...................................................
$84
$50,400 b
$33,600 c
$84,000
a

$84 per bill = $84,000 Accounts receivable cost 1,000 bills prepared.

b $50,400

= $84 x 600 bills prepared for Personal.

c $33,600

= $84 x 400 bills prepared for Business.

b.

Rate

Personal

Billinga.................................................................
$48
$28,800 b
Dispute resolutiond..............................................
$500
30,000 e
Total allocated costs............................................
$58,800
a $48

$19,200 c
6,000 f
$25,200

Total
$48,000
36,000
$84,000

= $48,000 Billing costs 1,000 bills prepared.

b 28,800

= $48 600 bills prepared.

c 19,200

= $48 400 bills prepared.

d $500

= $36,000 Dispute resolution costs 72 disputes.

e $30,000
f

Business

= $500 60 disputes.

$6,000 = $500 12 disputes.


Allocating Accounts Receivable costs solely on number of bills prepared understates
the costs of billing disputes, which is much higher in Personal.

9-22
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

Solutions to Problems
9-37. (40 min.)Comparative Income Statements and Management Analysis: EZSeat, Inc.
a. EZ-Seat, Inc. Income Statement
Account
Rate
Ergo
Sales revenue......................................................
$2,925,000
Direct materials....................................................
$ 550,000
Direct labor..........................................................
400,000
Overhead costs:
Administration..................................................
78% a
312,000
Production setup..............................................
$7,200 b
360,000
Quality control..................................................
$1,800 c
360,000
Distribution.......................................................
$192 d
288,000
Total overhead costs...........................................
1,320,000
Operating profit....................................................
$655,000
a78%

Standard
$2,760,000
$ 500,000
200,000

Total
$5,685,000
$1,050,000
600,000

156,000
f
720,000
g
360,000
h
1,152,000
2,388,000
$ (328,000)

468,000
1,080,000
720,000
1,440,000
3,708,000
$327,000

= $468,000 of Administrative costs $600,000 of direct labor costs

b$7,200

= $1,080,000 of Production setup costs 150 production runs

c$1,800

= $720,000 of Quality control costs 400 inspections

d$192

= $1,440,000 of Distribution costs 7,500 units shipped

e$312,000

= 0.78 x $400,000 direct labor costs

f$360,000

= $7,200 per setup x 50 production runs

g$360,000

= $1,800 per inspection x 200 inspections

h$288,000

= $192 per unit x 1,500 units shipped

b. Activity-based costing highlights the activities that cause costs, and provides insight
into which costs could be reduced. For example, management may be able to
operate with fewer but larger production runs, thereby reducing setup costs.
Focusing on activities can identify non-value-adding activities that can be eliminated
without reducing the products value.

9-23
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-37. (continued)
c. EZ-Seat, Inc. Income Statement
Account
Rate
Ergo
Standard
Sales revenue......................................................
$2,925,000
$2,760,000
Direct Materials....................................................
550,000
500,000
Direct Labor.........................................................
400,000
200,000
Overhead Costs..................................................
618% a
2,472,000 b
1,236,000
Operating Profit...................................................
$ (497,000 ) $824,000
a 618%

Total
$5,685,000
1,050,000
600,000
3,708,000
$327,000

= $3,708,000 Overhead Costs $600,000 Direct Labor Costs.

b $2,472,000

= 6.18 Overhead Rate x $400,000 Direct Labor Costs.

d. Dear Members of the Management Board:


The purpose of this report is to explain the differences between the profits of our
Ergo and Standard product lines using activity-based costing versus our traditional
labor-based overhead allocation methods.
The two costing methods differ in their results because of the way overhead costs
are allocated between our products; direct costs do not differ under the two methods.
Under the labor-based approach, all overhead costs are pooled together and
allocated to our products on the basis of direct-labor costs. Under activity-based
costing, cost drivers, such as inspections and set-ups, are identified and their costs
are applied to the products in relation to usage.
Traditional labor-based allocation is less accurate than activity-based allocations
because many overhead costs are not well correlated with labor costs. For instance,
our Ergo product receives 200% more overhead under our traditional approach than
does our Standard product because it uses twice as much labor. However, after
analyzing the factors driving the overhead and applying these costs to our products,
we find that the Ergo line should receive only about 55% as much overhead as the
Standard product.
Our findings suggest that management might make sub-optimal decisions if it were
to continue to use labor-based overhead allocations. Under our traditional method,
the Ergo product line is not profitable (losses of $497,000), and management might
wish to eliminate the Ergo model. Under the more accurate method of activity-based
costing, the Ergo model is shown to contribute $655,000 towards profits.
Management should not drop the Ergo line, instead we should pursue ways to
reduce our costs, such as reducing the number of setups required.

9-24
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-38. (40 min.)Comparative Income Statements and Management Analysis:


Bobs Baskets, Inc.
a. Bobs Baskets, Inc.: Income Statement
Account
Rate
Deluxe
Sales revenue......................................................
$216,000
Direct materials....................................................
20,000
Direct labor..........................................................
48,000
Overhead costs:
Administration..................................................
25% a
12,000 e
Setting up.........................................................
$2,000 b
40,000 f
Performing quality control................................
$375 c
22,500 g
Distribution.......................................................
$0.12 d
9,600 h
Total overhead costs...........................................
84,100
Operating profit (loss)..........................................
$63,900
a 25%

Total
$456,000
40,000
120,000

18,000
30,000
20,000
60,000
7,500
30,000
14,400
24,000
59,900
144,000
$ 88,100 $152,000

= $30,000 administrative costs $120,000 direct labor costs.

b $2,000
c $375

Standard
$240,000
20,000
72,000

= $60,000 production setup costs 30 production runs.

= $30,000 quality control costs 80 inspections.

d $0.12

= $24,000 distribution costs 200,000 units shipped.

e $12,000

= 0.25 x $48,000 direct labor costs.

f $40,000

= $2,000 per run x 20 runs.

g $22,500

= $375 per inspection x 60 inspections.

h $9,600

= $0.12 per unit shipped x 80,000 units.

b. Activity-based costing highlights the activities that cause costs, and provides insight
into which costs may be reduced. For instance, Bobs Baskets management has
identified three cost driving activities; production setups, quality control inspections,
and distribution. Setups cost $2,000 each and inspections cost $375 each.
Therefore, between setups and inspections, the effort of making a one unit reduction
in an activity should be directed at setups, as the savings would be greater than the
same effort would produce if directed at inspections.

9-25
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-38. (continued)
c.

Bobs Baskets, Inc.


Income Statement
Account
Rate
Deluxe
Standard
Total
Sales revenue......................................................
$216,000
$240,000 $456,000
Direct Materials....................................................
20,000
20,000
40,000
Direct Labor.........................................................
48,000
72,000
120,000
Overhead Costs..................................................
120% a
57,600 b
86,400
144,000
Operating Profit (loss).........................................
$90,400
$61,600 $152,000

a 120%

= $144,000 of Overhead Costs $120,000 Direct Labor Costs.

b $57,600

= 120% Overhead rate x $48,000 Direct Labor Costs.

d. Dear Members of the Management Board:


The purpose of this report is to explain the differences between the profits in our
Deluxe and Standard product lines using activity-based costing versus our traditional
labor-based overhead allocation method.
The two costing methods differ in their results because of the way overhead costs
are allocated between our products; direct costs, such as Materials and Labor do not
differ under the two methods. Under the labor-based approach, all overhead costs
are pooled together and allocated to our products on the basis of direct-labor costs.
Under activity-based costing, cost drivers, such as inspections and set-ups, are
identified and their costs are applied to the products in relation to usage.
Traditional labor-based allocation is less accurate than activity-based allocations
because many overhead costs are not well correlated with labor costs. For instance,
our Deluxe basket receives two-thirds as much overhead under our labor-based
allocation approach as does our Standard basket because it uses two-thirds as
much labor. However, after analyzing the factors driving the overhead and applying
these costs to our products, we find that the Deluxe line should receive $84,100, or
about 40% more than the standard basket, in overhead.
Our findings suggest that management might make sub-optimal decisions if it were
to continue to use labor-based overhead allocations. Under our traditional method,
the Standard Basket is less profitable than the Deluxe. Under the more accurate
activity-based costing, the Standard basket line earns about 38% more than the
Deluxe baskets in profits.

9-26
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-39. (15 min.) Ethics and Choice of Accounting Methods: Bobs Baskets, Inc.
Yes, you should show the results to management. You have an ethical responsibility
to communicate information fairly and objectively. Recall that the Institute of
Management Accountants requires its members to Disclose fully all relevant
information that could be reasonably expected to influence an intended users
understanding of the reports, comments, and recommendations presented.
9-40. (50 min.)Activity-Based Costing and Predetermined Overhead Allocation
Rates: Kitchen Supply, Inc.
a. Computing overhead allocation rates
Cost
Est.
Activity
Driver
Costs
Processing orders.......... No. of orders
$54,000
Setting up production.....
No. of runs
216,000
Handling materials.........
Pounds
360,000
Using machines............. Machine-hrs.
288,000
Performing quality control No. of insp.
72,000
Packing..........................
No. of units
144,000
Total est. overhead........
$1,134,000
Predetermined rate
for direct labor-hour

Driver
Units
200
100
120,000
12,000
45
480,000

=
=
=
=
=
=

Rate
$270
2,160
3.00
24
1,600
0.30

Estimated activity Estimated allocation base

= $1,134,000 7,500 hours


= $151.20 per hour

b. Production Costs using Direct Labor-Hours


Account Institutional
Standard
Direct materials....................................................
$ 39,000
$24,000
Direct labora........................................................
6,750
6,750
Indirect costsb......................................................
68,040
68,040
Total cost.............................................................
$113,790
$98,790
a Number

of labor-hours x $15 per hour.

b Number

of labor-hours x $151.20 per hour.

Silver
$15,000
9,000
90,720
$114,720

Total
$ 78,000
22,500
226,800
$327,300

9-27
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-40. (continued)
c. Production Costs using ABC
Account
Institutional
Standard
Direct materials....................................................
$39,000
$24,000
Direct labor..........................................................
6,750
6,750
Indirect costs
Processing orders.............................................
3,240
2,430
Setting up production........................................
6,480
6,480
Handling materials.............................................
45,000
18,000
Using machines.................................................
13,920
3,360
Performing quality control.................................
4,800
4,800
Packing..............................................................
18,000
7,200
Total cost.............................................................
$137,190
$73,020

Silver
$15,000
9,000

Total
$78,000
22,500

1,620
12,960
9,000
1,920
4,800
2,700
$57,000

7,290
25,920
72,000
19,200
14,400
27,900
$267,210

d. Internal Memorandum
The discrepancy between our product costs using direct-labor hours as the
allocation base versus activity-based costing is found in the way overhead costs are
allocated. Our existing direct-labor cost method distorts our product costs because
there is little correlation between our direct-labor costs and overhead. Activity-based
overhead is more accurate. It allocates the individual components of our overhead to
our products based upon the products use of that overhead component.
With the more accurate product costs, we should begin to concentrate our efforts
upon reducing the costs of our more expensive overhead operations. As seen in the
activity-based costing report, a large share of our total overhead is comprised of
materials handling and maintenance costscosts, which were not visible under the
direct-labor approach. Reducing our materials handling and machine depreciation
and maintenance costs should be a new priority.
We recommend assessing the cost of using an activity-based system in our
company. We will proceed with activity-based costing if we find the cost of the new
system is less than the benefits of the more accurate information we will receive.

9-28
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-41. (50 min.)Activity-Based Costing and Predetermined Overhead Rates:


College Supply Company.
a.

Activity
Recommended Base
Setting up production. . .
No. of runs
Processing orders........
No. of orders
Handling materials........
Lbs. of material
Using machines............
Machine-hours
Performing quality
management................ No. of inspections
Packing & shipping.......
Units shipped
Direct labor hour rate....

b.

Allocation Rate
$360 per run ($36,000 100 runs)
$300 per order ($60,000 200 orders)
$3.00 per lb. ($24,000 8,000 lbs.)
$7.20 per hour ($72,000 10,000 hrs.)
$1,500 per insp. ($60,000 40 insp.)
$2.40 per unit ($48,000 20,000
units)
$150 per hour ($300,000 2,000 hrs.)

Short
Direct materials....................................................
$6,000
Direct labora........................................................
3,000
Overheadb...........................................................
15,000
Total costs...........................................................
$24,000

a Number

of hours x $30 per hour.

b Number

of hours x $150 per hour.

Medium

Tall

$3,750
3,600
18,000
$25,350

$3,000
3,300
16,500
$22,800

9-29
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-41 (continued)
c.

Short
Direct materials....................................................
$6,000
Direct labor..........................................................
3,000
Setting up production..........................................
720 a
Processing orders...............................................
2,400 b
Handling materials...............................................
1,200 c
Using machines...................................................
3,600 d
Performing quality management.........................
3,000 e
Shipping...............................................................
2,400 f
Total cost.............................................................
$22,320

a $720

Medium
$3,750
3,600
1,440
2,400
2,400
2,160
3,000
1,200
$19,950

Tall
$3,000
3,300
2,880
1,200
600
2,160
3,000
720
$16,860

= $360 per run x 2 runs.

b $2,400

= $300 per order x 8 orders.

c $1,200

= $3.00 per lb. x 400 lbs.

d $3,600

= $7.20 per hour x 500 hours.

e $3,000

= $1,500 per inspection x 2 inspections.

f $2,400

= $2.40 per unit x 1,000 units.

d. Internal Memorandum
Re: Product Cost Discrepancy
The discrepancy between our product costs using direct labor-hours as the allocation
base versus activity-based costing is found in the way overhead costs are allocated.
Our existing direct-labor cost method distorts our product costs because there is little
correlation between our direct-labor costs per product and overhead. Activity-based
overhead is more accurate. It allocates the individual components of our overhead to
our products based upon the products use of that overhead component.
With the more accurate product costs, we should begin to concentrate our efforts
upon reducing the costs of our more expensive overhead operations. As seen in the
activity-based costing report, a large share of our total overhead is comprised of
order processing, quality management, equipment maintenance, and shipping costs
costs that were not visible under the direct-labor approach. Reducing these
overhead costs should be a top priority.
We should use activity-based costing if we find the benefits from the new system
exceed its costs.

9-30
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-42.
a.

(40 min.)Choosing an Activity-Based Costing System: Pickle


Motorcycles, Inc.
Pickle Motorcycles
Income Statement

Route 66
Main Street
Alley Cat
Sales revenue......................................................
$7,600,000 $11,200,000 $9,500,000
Direct costs:
Direct material..................................................
3,000,000
4,800,000
4,000,000
Direct labor......................................................
288,000
480,000
1,080,000
Var. OHa...........................................................
939,600
1,503,360
2,255,040
Cont. margin....................................................
$3,372,400 $4,416,640 $2,164,960
Fixed OH:
Plant admin. ....................................................
Other................................................................
Gross profit..........................................................
a

Total
$28,300,000
11,800,000
1,848,000
4,698,000
$ 9,954,000
1,760,000
2,800,000
$ 5,394,000

Rate = $93.96 (= $4,698,000 50,000 machine-hours) per machine-hour.

9-31
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-42. (continued)
b.

Pickle Motorcycles
Income Statement
Route 66
Main Street
Sales revenue......................................................
$7,600,000 $11,200,000
Direct costs:
Direct material..................................................
3,000,000
4,800,000
Direct labor
288,000
480,000
Var. OH:
Mach. setup.....................................................
102,960 a
159,120
Order proc........................................................
288,000 b
432,000
Warehousing....................................................
418,500 c
418,500
Energy..............................................................
151,200 d
241,920
Shipping...........................................................
43,200 e
172,800
Cont. margin........................................................
$3,308,140
$4,495,660
Fixed OH:
Plant admin......................................................
Other................................................................
Gross profit..........................................................

a $4,680
b $720

Back Alley
$9,500,000

Total
$28,300,000

4,000,000
1,080,000

11,800,000
1,848,000

205,920
432,000
837,000
362,880
432,000
$ 2,150,200

468,000
1,152,000
1,674,000
756,000
648,000
$ 9,954,000
1,760,000
2,800,000
$ 5,394,000

(= $468,000 100 runs) per run x 22 runs = $102,960.

(= $1,152,000 1,600 orders) per order x 400 orders = $288,000.

c $2,092.50

(= $1,674,000 800 units) per unit x 200 units = $418,500.

d $15.12

(= $756,000 50,000 machine-hours) per machine-hour x 10,000 machinehours = $151,200.

e $43.20

(= $648,000 15,000 units) per unit shipped x 1,000 units shipped = $43,200

c. The activity-based costing method provides a more detailed breakdown of the costs.
This additional information should enable PMIs management to make better
decisions. For example, if PMI wants to reduce costs then activity-based costing will
list the activities on which management should focus its cost-reducing efforts. Also,
the company will probably have more accurate product cost information for pricing
and other decisions.
d. Some costs may have no relationship to any volume or activity base. To artificially
allocate these costs would distort the accounting information used for pricing,
evaluation, etc. A preferable method of handling such costs might be to require a
contribution margin from each product that must cover a portion of these costs.
9-32
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-43. (40 min.)Activity-Based Costing, Cost Flow Diagram, and Predetermined


Overhead Rates: Huron Furniture.
a.
Burden rate = (Total overhead costs Budgeted total direct labor-hours)
Budgeted total direct labor-hours = 3,200 + 1,800 + 5,000 = 10,000 hours
Total overhead costs = $450,000 +$450,000 + $1,200,000 = $2,100,000
Burden rate = $2,100,000 10,000 = $210 per DLH
Unit costs:
Direct costs......................................
Overhead (@ $210 per DLH)..........
Total costs.......................................

Oval
$ 80,000
672,000
$752,000

Round
$ 80,000
378,000
$458,000

Number of units...............................
Unit cost..........................................

4,000
$188

2,000
$229

Square
$ 80,000
1,050,000
$1,130,00
0
6,000
$188.33

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Chapter 09 - Activity-Based Costing

9-43. (continued)
b.

c.
Utilities............................... $450,000 60,000 MH
Scheduling and setup........ $450,000 600 Setups
Material handling...............$1,200,000 1,600,000 lbs.

= $7.50 per machine-hour.


= $750 per setup.
= $0.75 per pound.

9-34
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-43. (continued)
d.

Unit Costs:

Oval
Direct Costs.............................................$ 80,000
Overhead:
Utilities................................................225,000a
Scheduling and setup......................... 60,000b
Material handling................................375,000c
Total costs................................................$740,000
Number of units....................................... 4,000
Unit cost................................................... $185.00

Round
$ 80,000

Square
$ 80,000

75,000
225,000
225,000
$605,000
2,000
$302.50

150,000
165,000
600,000
$995,000
6,000
$165.83

$225,000 = $7.50 per machine-hour x 30,000 machine-hours.

$60,000 = $750 per setup x 80 setups.

$375,000 = $0.75 per pound x 500,000 pounds of material.

e. If management implemented an activity-based costing system it should be provided


with a more thorough understanding of product costs. By breaking down costs into
cost drivers, i.e., those activities that drive the costs, management should be able to
see the relationship between product complexity, product volume, and product cost.
This would be vital information for pricing decisions and profitability strategies.
Management should also be able to streamline the production process by reducing
those nonvalue-adding activities such as setups and travel time between activity
centers or departments. (Management might consider running larger batches, or
redesigning the plant layout.)

9-35
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-44. (40 min.)Activity-Based Costing, Cost Flow Diagram, and Predetermined


Overhead Rates: Utica Manufacturing.
a.
Burden rate = (Total overhead costs Budgeted total machine-hours)
Budgeted total machine-hours = 60,000 + 90,000 = 150,000 hours
Total overhead costs = $170,000 +$1,500,000 + $700,000 + $480,000= $2,850,000
Burden rate = $2,850,000 150,000 machine-hours = $19 per machine-hour
Unit costs:
308
Direct costs.......................................................$216,000
Overhead (@ $19 per machine-hour)..............1,140,000
Total costs........................................................
$1,356,000
Number of units................................................ 30,000
Unit cost............................................................ $45.20

510
$216,000
1,710,000
$1,926,000
18,000
$107.00

9-36
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Chapter 09 - Activity-Based Costing

9-44. (continued)
b.
Inspection...........................
$170,000 $68,000 material dollars
Production..........................
$1,500,000 150,000 machine-hours
Machine setup....................
$700,000 140 Setups
Shipping.............................
$480,000 48,000 units

=
=
=
=

250% of material dollars.


$10.00 per machine-hour
$5,000 per setup.
$10.00 per unit.

c.

Unit Costs:

308
Direct Costs.............................................$216,000
Overhead:
Incoming inspection............................125,000a
Production...........................................600,000b
Machine setup....................................250,000c
Shipping..............................................300,000d
Total costs................................................
$1,491,000
Number of units....................................... 30,000
Unit cost................................................... $49.70

510
$216,000
45,000
900,000
450,000
180,000
$1,791,000
18,000
$99.50

$125,000 = 250% of material dollars x $50,000.

$600,000 = $10.00 per machine-hour x 60,000 machine-hours.

$250,000 = $5,000 per setup x 50 setups.

$300,000 = $10.00 per unit x 30,000 units.

d. If management implemented an activity-based costing system it should be provided


with a more thorough understanding of product costs. By breaking down costs into
cost drivers, i.e., those activities that drive the costs, management should be able to
see the relationship between product complexity, product volume, and product cost.
This would be vital information for pricing decisions and profitability strategies.
Management should also be able to streamline the production process by reducing
those nonvalue-adding activities such as setups and travel time between activity
centers or departments. (Management might consider running larger batches, or
redesigning the plant layout.)

9-37
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-45. (40 min.)Activity-Based Costing and Predetermined Overhead Rates:


Cain Components.
a.
Burden rate = (Total overhead costs Budgeted total machine-hours)
Budgeted total machine-hours = 150,000 + 100,000 = 250,000 hours
Total overhead costs = $600,000 +$5,500,000 + $900,000 + $1,000,000 = $8,000,000
Burden rate = $8,000,000 250,000 machine-hours = $32 per machine-hour
Unit costs:
Standard
Direct costs.......................................................$895,000
Overhead (@ $32 per machine-hour)..............4,800,000
Total costs........................................................
$5,695,000
Number of units................................................ 20,000
Unit cost............................................................ $284.75

Deluxe
$405,000
3,200,000
$3,605,000
5,000
$721.00

9-45. (continued)
b.
Receiving...........................
$600,000 $400,000 material dollars
Production..........................
$5,500,000 250,000 machine-hours
Machine setup....................
$900,000 200 Setups
Shipping.............................
$1,000,000 25,000 units

=
=
=
=

150% of material dollars.


$22.00 per machine-hour
$4,500 per setup.
$40.00 per unit.

9-38
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

Unit Costs:

Standard
Direct Costs.............................................$895,000
Overhead:
Receiving............................................367,500a
Manufacturing.....................................
3,300,000b
Machine setup....................................337,500c
Shipping..............................................800,000d
Total costs................................................
$5,700,000
Number of units....................................... 20,000
Unit cost................................................... $285.00

Deluxe
$405,000
232,500
2,200,000
562,500
200,000
$3,600,000
5,000
$720.00

$367,500 = 150% of material dollars x $245,000.

$3,300,000 = $22.00 per machine-hour x 150,000 machine-hours.

$337,500 = $4,500 per setup x 75 setups.

$800,000 = $40.00 per unit x 20,000 units.

c. If these results are typical, it will probably not be worth adopting the ABC system.
The difference in the reported product costs are not significant, meaning they would
be unlikely to distort any decisions. It is important to note that this is true as long as
these results (number of units, costs, and so on) remain in roughly these
proportions. If there are large changes in the relative proportions, the two costs
systems might no longer report similar results.

9-46. (40 min.)Activity-Based Costing and Predetermined Overhead Rates:


Cain Components.
a.
Receiving...........................
$600,000 $400,000 material dollars
Manufacturing....................
$3,300,000 250,000 machine-hours
Engineering........................
$2,200,000 200 Setups
Machine setup....................
$900,000 200 Setups
Shipping.............................
$1,000,000 25,000 units

=
=
=
=
=

150% of material dollars.


$13.20 per machine-hour
$11,000 per setup
$4,500 per setup.
$40.00 per unit.

9-39
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

Unit Costs:

Standard
Direct Costs.............................................$895,000
Overhead:
Receiving............................................367,500a
Manufacturing.....................................
1,980,000b
Engineering........................................825,000c
Machine setup....................................337,500d
Shipping..............................................800,000e
Total costs................................................
$5,205,000
Number of units....................................... 20,000
Unit cost................................................... $260.25

Deluxe
$405,000
232,500
1,320,000
1,375,000
562,500
200,000
$4,095,000
5,000
$819.00

$367,500 = 150% of material dollars x $245,000.

$1,980,000 = $13.20 per machine-hour x 150,000 machine-hours.

c $825,000

= $11,000 per setup x 75 setups.

$337,500 = $4,500 per setup x 75 setups.

$800,000 = $40.00 per unit x 20,000 units.

b. If these results are typical, it will probably be worth adopting the ABC system. The
difference in the reported product costs is now significant, meaning they could be
distort decisions.

9-47. (15 min.)Benefts of Activity-Based Costing: Cawker Products.


Activity-based costing would help to clear his confusion by identifying the activities that
drive overhead costs.
In the old process, direct labor was used to move material. The costing system treats
this cost as direct labor cost and so overhead is artificially low and direct labor cost is
artificially high.
An activity-based costing system would help by identifying the activities used in the
plants. Even if direct labor was used to move the products, the cost could be accounted
for as overhead (material handling) cost.
The overhead rates would better reflect the comparison between the two plants. In
addition, an investigation of the different material handling overhead rates would reveal
the use of lower-cost labor used at the Russell plant. Managers at the Lucas plant could
then evaluate whether they would also benefit by using different labor for this activity.
9-40
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-41
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-48. (40 min.)Choosing an Activity-Based Costing System: MTI.


a. Total overhead to allocate is $8,700,000 (= $2,400,000 + $1,800,000 + $2,400,000 +
$1,200,000 + $900,000).
The overhead rate is $348 per machine-hour (= $8,700,000 25,000 machine-hours).
MTI
Income Statement
M3100
M4100
M6100
Sales revenue......................................................
$9,000,000 $15,000,000 $13,500,000
Direct costs:
Direct material..................................................
3,000,000
4,500,000
3,300,000
Direct labor......................................................
600,000
900,000
1,800,000
Var. overhead......................................................
2,088,000 a
3,132,000
3,480,000
Contribution margin.............................................
$3,312,000
$6,468,000
$4,920,000
Plant admin......................................................
Gross profit..........................................................
a

Total
$37,500,000
10,800,000
3,300,000
8,700,000
$14,700,000
6,000,000
$8,700,000

$2,088,000 = $348 per machine-hour 6,000 machine-hours.

b. Cost driver rates:


Activity
Setting up machines.....
Processing sales orders
Warehousing................
Operating machines.....
Shipping.......................

Cost
$2,400,000
$1,800,000
$2,400,000
$1,200,000
$900,000

Activity Volume
50 runs
800 orders
400 units
25,000 machine-hrs
37,500 units shipped

=
=
=
=
=

Unit Rate
$48,000 per run
2,250 per order
6,000 per unit
48 per machine-hr.
24 per unit shipped

9-42
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-48. (continued)
Income Statement
M3100
M4100
M6100
Sales revenue......................................................
$9,000,000 $15,000,000 $13,500,000
Direct costs:
Direct material..................................................
3,000,000
4,500,000
3,300,000
Direct labor......................................................
600,000
900,000
1,800,000
Var. overhead......................................................
Setting up machines............................................
480,000 a
960,000
960,000
Processing orders ..............................................
405,000 b
900,000
495,000
Warehousing.......................................................
600,000 c
1,200,000
600,000
Operating machines............................................
288,000 d
432,000
480,000
Shipping...............................................................
240,000 e
420,000
240,000
Cont. margin........................................................
$3,387,000 $5,688,000 $ 5,625,000
Plant admin......................................................
Gross profit..........................................................
a

$480,000 = $48,000 per run 10 runs.

$405,000 = $2,250 per order 180 orders.

$600,000 = $6,000 per unit 100 units.

$288,000 = $48 per machine-hour 6,000 machine-hours.

$240,000 = $24 per unit shipped 10,000 units shipped.

Total
$37,500,000
10,800,000
3,300,000
2,400,000
1,800,000
2,400,000
1,200,000
900,000
$14,700,000
6,000,000
$8,700,000

c. Although both methods yield similar product costs, the activity-based costing method
provides a more detailed breakdown of the costs. This additional information should
enable MTI management to make better decisions. For example, if MTI wants to
reduce costs, then activity-based costing will list the activities on which management
should focus its cost-reducing efforts. Further, activity-based costing should increase
the accuracy of product costs, which would help decision making (e.g., pricing,
make-or-buy decision).
d. If plant administration costs were to be allocated to products, the costs should be
allocated in some manner that bears a relationship to the benefits received by the
products. In this case, we would want to know more about the contents of the plant
administration costs. If the costs are mainly personnel costs, for example, such as
the costs of a training program or of a plant cafeteria, we could allocate the costs
based upon direct labor-hours.

9-43
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

Solutions to Integrative Cases


9-49. Decision Making and Distorted Costs: ACE Industries.
This problem is a simple illustration of the death spiral.
a.
A

Total

Sales revenue........................
$270,000

$165,000

$305,000

$740,000

Material costs......................... 70,000

65,000

145,000

280,000

Labor costs............................. 20,000

12,000

28,000

60,000

Manufacturing overhead........

240,000

Operating profit......................

$160,000

b. You will drop product E. The profit margin is 7%.


The overhead rate, based on direct labor costs, is 400% (= $240,000 $60,000).
Product line profits and profit margins are:
A

Sales revenue..........................................$270,000

$165,000

$305,000

Material costs........................................... 70,000

65,000

145,000

Labor costs.............................................. 20,000

12,000

28,000

Manufacturing overhead (@400%)......... 80,000

48,000

112,000

Product line profit.....................................$100,000

$40,000

$20,000

24%

7%

Profit margin............................................

37%

9-44
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-49. (continued)
c.
A

Total

Sales revenue........................
$270,000

$165,000

$435,000

Material costs......................... 70,000

65,000

135,000

Labor costs............................. 20,000

12,000

32,000

Manufacturing overhead........

208,000

Operating profit......................

$60,000

d. You will drop product C. The profit margin is 6%.


The overhead rate, based on direct labor costs, is 650% (= $208,000 $32,000).
Product line profits and profit margins are:
A

Sales revenue..........................................$270,000

$165,000

Material costs........................................... 70,000

65,000

Labor costs.............................................. 20,000

12,000

Manufacturing overhead (@650%)......... 130,000

78,000

Product line profit..................................... $50,000

$10,000

Profit margin............................................

19%

6%

9-45
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-49. (continued)
e.
A

Total

Sales revenue........................
$270,000

$270,000

Material costs......................... 70,000

70,000

Labor costs............................. 20,000

20,000

Manufacturing overhead........

190,000

Operating profit......................

$(10,000)

f. The problem is that some part of the overhead is unavoidable, so that when products
are dropped, the overhead does not decline proportionately. The reported profit
margin, computed by using an overhead rate that includes both fixed and variable
overhead costs is not useful for decision making.

9-50. (50 Min) Cost Allocation and Environmental ProcessesEthical Issues:


California Circuits Company.
a.
Raw material...................................
Direct labor Production.................
Direct labor Assembly..................
Overhead @ 120%a........................
Total.................................................
a Overhead

$2.00
8.00

XL-D
$12.00
10.00
12.00
$34.00

$2.00
8.00

XL-C
$14.00
10.00
12.00
$36.00

rate = Total overhead Total direct labor cost

= ($1,000,000 + $500,000) [(100,000 $10) + (25,000 $10)]


= 120% of direct labor costs

9-46
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Chapter 09 - Activity-Based Costing

b.

XL-D
$12.00
$2.00
8.00
10.00

Raw material.....................................
Direct labor Production..................
Direct labor Assembly....................

Overhead Production @ $5 per MHa...............


$8.00
Overhead - Assembly @ $10 per DLHb..............
4.00
Total..................................................
a

12.00
$34.00

$2.00
8.00
$8.00
4.00

XL-C
$14.00
10.00

12.00
$36.00

Overhead rateProduction Department = Production overhead Total machine-hours


= $1,000,000 [(100,000 1.6) + (25,000 1.6)]
= $5 per machine-hour

Overhead RateAssembly Department = Assembly overhead Total direct labor-hrs


= $500,000 [(100,000 0.4) + (25,000 0.4)]
= $10 per direct labor-hour

c. Since both products use machine time and direct labor time in the same proportion
(in fact, in equal amounts), it is irrelevant whether machine-hours or direct laborhours are used to allocate overhead costs to the final products or whether it is done
by manufacturing department or using a plantwide rate.
9-50. (continued)
d.

Raw material..........................................
Direct labor Production.......................
Direct labor Assembly.........................
Overhead Productiona
Supervision @ $8/direct labor-hour....
Material handling @ 6% matl. cost....
Testing @ $0.40/ test hour..................
Waste treatment @ $0.25/gallon........
Depreciation @ $2/mach. hr...............
Shipping @ $0.05/pound....................
Total production overhead......................

$2.00
8.00
$0.80
0.72
1.20
2.50
3.20
0.05

XL-D
$12.00
10.00

8.47

XL-C
$14.00
$2.00
8.00
10.00
$0.80
0.84
1.20
0.00
3.20
0.08

6.12

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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

Overhead Assembly @ $10/DLHb......


Total........................................................
a Production

4.00
$34.47

Department Overhead Calculations (Rate = Activity cost Driver volume):

Activity
Activity
Cost
Driver
Driver Volume
Supervision..........................................................
$100,000 Direct
100,000 .1 + 25,000 .1
labor-hrs = 12,500 hours
Materials
93,000 Material 100,000 $12 + 25,000 $14
handling...............................................................
cost
= $1,550,000
Testing.................................................................
150,000 Test
100,000 3 + 25,000 3
hours
= 375,000 hours
Wastewater
250,000 Waste
100,000 10 + 25,000 0
treatment.............................................................
= 1,000,000 gallons
Depreciation........................................................
400,000 Machine 100,000 1.6 + 25,000 1.6
- hours
= 200,000 machine-hours
Shipping...............................................................
7,000 Weight
100,000 1.0 + 25,000 1.6
= 140,000 pounds
b Overhead

4.00
$34.12

Rate
$8.00
6%
$0.40
$0.25
$2.00
$0.05

RateAssembly Department = Assembly overhead Total direct labor-hrs

= $500,000 [(100,000 0.4) + (25,000 0.4)]


= $10 per direct labor-hour

9-48
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-50. (continued)
e. This question raises the issue of costs that are missing in the typical accounting
records of the firm. In this case, the ABC system suggests that XL-C, the model that
generates no wastewater, is actually less expensive. However, as the calculations
show, the difference is relatively small.
A question that is important to answer is what costs are associated with the
wastewater that are not recorded by the firm. These environmental costs could be
important and might affect the firm indirectly, perhaps through the health of its
employees or because of problems with the community.
It is difficult to argue with the controller that the decision should be made on the basis
of costs. The relevant question is whether the cost system includes all the costs of
production.
9-51. (60 min.)Distortions Caused By Inappropriate Overhead Allocation Base:
Chocolate Bars, Inc.
a.
Almond
Krispy
Creamy
Dream
Krackle
Crunch
Product costs:
Labor-hours per case.......................................7
3
1
Total cases produced.......................................
1,000
1,000
1,000
Material cost per case......................................
$8.00
$2.00
$9.00
Direct labor cost per case................................
$42.00
$18.00
$6.00
Labor-hours per product..................................
7,000
3,000
1,000
Total overhead = $69,500
Total labor-hours = 11,000
Direct labor costs per hour = $6.00
Allocation rate per labor-hour = $6.32 per labor-hour (rounded)
Costs of products:
Material cost per case......................................
$ 8.00
Direct labor cost per case................................
42.00
Allocated overhead per case...........................
44.24
Product cost.....................................................
$94.24

$ 2.00
18.00
18.96
$38.96

$9.00
6.00
6.32
$21.32

Selling price.........................................................
$85.00
Gross profit margin..............................................
(10.87 )%
Drop product?......................................................
Yes

$55.00
29.16 %
No

$35.00
39.09 %
No

From the table above, we can see that the overhead allocation system used by CBI
would lead them to drop Almond Dream and keep the remaining two bars, Krispy
Krackle and Creamy Crunch.
9-49
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

b. Almond Dream has a much higher proportion of direct labor-hours than Krispy
Krackle or Creamy Crunch, so Almond Dream is allocated a greater share of the
overhead costs.
9-51. (continued)
c.
Direct labor cost per hour....................................
Direct labor-hours per case.................................
Total cases produced..........................................
Labor-hours per product......................................
Total labor-hours: 5,000

Krispy
Krackle
$6.00
3
1,000
3,000

Creamy
Crunch
$6.00
1
2,000
2,000

Allocation rate per labor-hour = Total overhead Total labor-hours


= $69,500/5,000
= $13.90 per labor-hour
Krispy
Allocated production costs:
Krackle
Material cost per case.........................................
$2.00
Direct labor cost per case...................................
18.00
Allocated overhead per case
($13.90 per labor-hour)....................................
41.70
Product cost.........................................................
$61.70
Gross profit margins:
Selling price.........................................................
$55.00
Product costdirect labor allocation
(61.70 )
base.....................................................................
$ (6.70 )
Profit margin percentage.....................................
$(6.70) $55.00
= (12.2) %

Creamy
Crunch
$9.00
6.00
13.90
$28.90
$35.00
(28.90

$6.10
$6.10 $35.00
= 17.4
%

The recommendation to management is to drop Krispy Krackle and increase


production of Creamy Crunch.

9-50
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-51. (continued)
d.
Direct labor cost per hour....................................
Direct labor hours per case.................................
Total cases produced..........................................
Labor hours per product......................................
Total labor hours: 3,000

Creamy
Crunch
$6.00
1
3,000
3,000

Allocation rate per labor hour = Total overhead/Total labor hours


= $69,500/3,000
= $23.17 per labor hour

Allocated Production Costs:


Material cost per case.........................................
Direct labor cost per case...................................
Allocated overhead per case...............................
Product cost.........................................................
Gross profit margins:
Selling price.........................................................
Product costdirect labor allocation base..........

Creamy
Crunch
$9.00
6.00
23.17
$38.17
$35.00
(38.17 )
$ (3.17 )

Profit margin percentage.....................................


$(3.17) $35.00
= (9.1)%
The recommendation to management is to drop Creamy Crunch and sell out!
e. The policies and allocation method employed by CBI encourage poor decision
making. The direct labor-hours are inappropriate as an allocation base and give
misleading information. The allocation method and policy to drop products with gross
profit margins less than 10 percent could lead to the systematic elimination of all
products. CBI is a profitable firm, in total, and misallocation of overhead can lead
management to make unprofitable decisions.

9-51
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-52. (90 min.)Multiple Allocation Bases: Chocolate Bars, Inc.


a.
Almond
Krispy
Creamy
Dream
Krackle
Crunch
Total direct
labor hoursa.....................................................
7,000 (63.6%) 3,000 (27.3%) 1,000 (9.1%)
Total machine
hoursa..............................................................
2,000 (13.3%) 7,000 (46.7%) 6,000 (40%)
Factory space
(sq. ft.)..............................................................
1,000
(10%) 4,000
(40%) 5,000 (50%)
Total rent for factory space:
Total machine operating costs:
Total other overhead:
Total cases produced/month:

Total
11,000 (100%)
15,000 (100%)
10,000 (100%)

$15,000 per month


$30,000 per month
$24,500 per month (= $69,500 $15,000 $30,000)
3,000 cases

Product allocation base:


Fraction:
Labor (%)
Machine hours (%)
Almond Dream....................................................
63.6%
13.3%
Krispy Krackle.....................................................
27.3
46.7
Creamy Crunch...................................................
9.1
40.0
Allocated Costs:
Almond Dream (63.6% x $24,500) + (13.3% x $30,000) +
(10% x $15,000)............................................................. =
Krispy Krackle (27.3% x $24,500) + (46.7% x $30,000) +
(40% x $15,000)............................................................. =
Creamy Crunch (9.1% x $24,500) + (40% x $30,000) +
(50% x $15,000)............................................................. =

Factory space (%)


10%
40
50
Total

Per Case

$21,072

$21.07

26,699

26.70

21,730

21.73

Almond
Krispy
Allocated production costs:
Dream
Krackle
Material cost........................................................
$8.00
$2.00
Direct labor..........................................................
42.00
18.00
Allocated OH.......................................................
21.07
26.70
Production cost per case.....................................
$71.07
$46.70

Creamy
Crunch
$9.00
6.00
21.73
$36.73

Selling price.........................................................
$85.00
$55.00
Product cost.........................................................
(71.07)
(46.70)
Profit (loss)..........................................................
$13.93
$8.30

$35.00
(36.73)
$ (1.73)

Profit margin ratio................................................


16.4%
aTotals

15.1%

(4.9)%

equal hours per case times 1,000 cases.


9-52

2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

952.(continued)
b. Based upon the table above and the gross profit margin rule, management would
recommend dropping Creamy Crunch. Two characteristics of Creamy Crunch appear
to make it appear relatively unprofitable: one, the selling price is comparatively low
as compared to the other two products; two, Creamy Crunch uses 50% of the factory
space and, thus, is allocated half of the rent costs.
c.

Almond
Dream
Direct labor hours per case.................................7
Machine hours per case......................................2
Factory space (sq. ft.)a........................................
2,000 (33.3%)
Case of output per month....................................
2,000
Labor hours required...........................................
14,000 (82.4%)
Machine hours required.......................................
4,000 (36.4%)
Total rent for factory space:
Total machine operating costs:
Total other overhead:
Total labor hours/month:
Total cases produced/month:
Total machine hours

$15,000 per month


$30,000 per month
$24,500 per month
17,000
3,000 cases
11,000 hours

Product allocation base:


Fraction:
Labor (%)
Machine hours (%)
Almond Dream....................................................
82.4%
36.4%
Krispy Krackle.....................................................
17.6
63.6
aThis

Krispy
Krackle
3
7
4,000 (66.7%)
1,000
3,000 (17.6%)
7,000 (63.6%)

Factory space (%)


33.3% (rounded)
66.7 (rounded)

product mix leaves 4,000 square feet of space available.

9-53
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-52. (continued)
Allocated Cost:
Total
Almond Dream (82.4% x $24,500) +
(36.4% x $30,000) + (33.3% x $15,000)............... = $36,108
Krispy Krackle (17.6% x $24,500) +
(63.6% x $30,000) + (66.7% x $15,000)............... =
33,392
Allocated production costs:
Material cost........................................................
Direct labor..........................................................
Allocated OH.......................................................
Production cost per case.....................................
Selling price.........................................................
Product cost.........................................................
Profit margin ratio:
Ratio = Gross Margin/Price.................................

Per Case
$18.05
33.39

Almond
Dream
$8.00
42.00
18.05
$68.05

Krispy
Krackle
$2.00
18.00
33.39
$53.39

$85.00
(68.05)
$16.95

$55.00
(53.39)
$1.61

19.9%

2.9%

Based on the gross profit margins of Almond Dream and Krispy Krackle,
management should drop Krispy Krackle and continue to produce Almond Dream.
Almond Dream appears to be the most profitable product. In fact, its margin ratio is
only 13.9%, computed as follows:
Cases Produced = 3,000
Overhead Allocation = $69,500 3,000 = $23.17
Allocated production costs:
Material cost........................................................
Direct labor..........................................................
Allocated OH.......................................................
Production cost per case.....................................
Selling price.........................................................
Product cost.........................................................
Profit margin ratio:
Ratio = Gross Margin/Price.................................

Almond
Dream
$8.00
42.00
23.17
$73.17
$85.00
(73.17)
$11.83
13.9%

9-54
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-52. (continued)
If we compute the gross margin for the three products at maximum production, we
find Almond Dream and Krispy Krackle to be equally profitable, computed as follows:
Almond
Krispy
or
or
Dream
Krackle
Cases..................................................................
3,000
3,000

Creamy
Crunch
3,000

Costs
Materials..........................................................
$24,000
$ 6,000
$27,000
Labor...............................................................
126,000
54,000
18,000
Overhead.........................................................
+
69,500 +
69,500 +
69,500
$219,500
$129,500
$114,500
Revenue..............................................................
$255,000
$165,000
$105,000
Total costs...........................................................

219,500
129,500 114,500
Gross margin.......................................................
$35,500
$35,500
$ (9,500)
Moral: Dont make too much of allocated cost numbers in decision making.

9-55
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-53. (90 min.)Activity-Based Costing The Grape Cola Caper.


a. Percentage utilization of resource by activities:
Activity
Production
Setups
Indirect labor (including fringe benefits)

Runs

Machine
Products

Time

50%

40%

10%

0%

Information technology (IT)

80

20

Machinery depreciation

100

Machinery maintenance

100

Energy

100

Costs assigned to activiities:


Activity
Production
Cost
Indirect labor

Setups

Runs

Machine
Products

Time

$28,000

$14,000

$11,200

$2,800

10,000

8,000

2,000

Machinery depreciation

8,000

8,000

Machinery maintenance

4,000

4,000

Energy

2,000

2,000

Total

$52,000

$14,000

$19,200

$4,800

$14,000

IT

Activity

560 hours

110 runs

4 products 10,000 hrs

Cost driver rates

$25

$174.55

$1,200

$1.40

Chapter 09 - Activity-Based Costing

9-53. (continued)
b.
Unit Costs on Cola Bottling Line
Materials
Direct labor

Diet

Regular

$ 25,000

$ 20,000

$ 4,680

10,000

8,000

1,800

200

20,000

3,200

720

80

8,000

1,500

6,000

1,500

14,000

5,236

5,236

1,746

19,200

1,200

1,200

1,200

4,800

5,600

1,260

140

14,000

$59,182

$44,736

$20,896

$ 5,416

$130,230

50,000

40,000

9,000

1,000

$1.18

$1.12

$2.32

$5.42

Setup costs

5,000

Production run costs

6,982

Product costs

1,200

Machine costs

7,000

Cost per unit


a
b
c
d

a
b
c
d

Total
$ 50,230

4,000

Volume

Grape
550

Fringe benefits on direct labor

Total costs

Cherry

$5,000 = $25 per setup hour x 200 setup hours.


$6,928 = $174.55 per production run x 40 production runs.
$1,200 = $1,200 per product.
$7,000 = $1.40 per machine hour x 5,000 machine hours.

9-57
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied,
scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Activity-Based Costing

9-53. (continued)
c.
Monthly Report on Cola Bottling Line
Diet
Sales revenue
Costs
Gross margin

Regular

Cherry

Grape

Total

$75,000

$60,000

$13,950

$1,650

$150,600

59,182

44,736

20,896

5,416

130,230

$15,818

$15,264

$(6,946)

$(3,766)

$20,370

d. Mr. Rockness:
The activity-based costing analysis shows that Diet and Regular Cola are profitable, but the Cherry and Grape flavors are
unprofitable. The primary cause of their high costs is the large demands they place on setup resources. We recommend
an analysis of whether we can reduce the costs of Cherry and Grape by improving our ability to get the flavors right on
these two products. If that is not possible, we recommend that you consider dropping these products, unless there are
strategic reasons for offering these as part of the product portfolio.

9-58
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied,
scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.