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CHAPTER 5

Activity-Based Costing and Management


EXERCISE 5-26 (15 MINUTES)
1.

Material-handling cost per lens:


$50,000
200 $1,000
[(25)(200) (25)(200)] *

*The total number of direct-labor hours.


An alternative calculation, since both types of product use the same amount of the
cost driver, is the following:
$50,000
$1,000
50*

*The total number of units (of both types) produced.


2.

Material-handling cost per mirror = $1,000. The analysis is identical to that given for
requirement (1).

3.

Material-handling cost per lens:

$50,000
5
(5 15) *
$500
25
*The total number of material moves.

The number of material moves for the lens product line.


4.

Material-handling cost per mirror:


$50,000
15 *
(5 15)
$1,500
25

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

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EXERCISE 5-28 (20 MINUTES)


There is no single correct answer to this exercise. There are many reasonable solutions.
Cost pool 1:
Raw materials and components...................................................................... 2,950,000 yen
Inspection of finished goods........................................................................... 30,000 yen
Total................................................................................................................... 2,980,000 yen
Cost driver: raw-material cost
Cost pool 2:
Depreciation, machinery.................................................................................. 1,400,000 yen
Electricity, machinery.......................................................................................
120,000 yen
Equipment maintenance, wages......................................................................
150,000 yen
Equipment maintenance, parts........................................................................ 30,000 yen
Total................................................................................................................... 1,700,000 yen
Cost driver: number of units produced.
Cost pool 3:
Setup wages......................................................................................................
Total...................................................................................................................

40,000 yen
40,000 yen

Cost driver: number of production runs.


Cost pool 4:
Engineering design...........................................................................................
Total...................................................................................................................

610,000 yen
610,000 yen

Cost driver: number of parts in a product.


Cost pool 5:
Depreciation, plant............................................................................................
Insurance, plant................................................................................................

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700,000 yen
600,000 yen

Electricity, light..................................................................................................
60,000 yen
Custodial wages, plant.....................................................................................
40,000 yen
Property taxes...................................................................................................
120,000 yen
Natural gas, heating.......................................................................................... 30,000 yen
Total................................................................................................................... 1,550,000 yen
Cost driver: for costs allocated to support departments, square footage; for costs
assigned to products, number of units produced.

5-3

EXERCISE 5-31 (20 MINUTES)


Wheelco's product-costing system probably is providing misleading cost information to
management. A common problem in a traditional, volume-based costing system is that
high-volume products are overcosted and low-volume products are undercosted. There is
evidence of this in the exercise, since Wheelco's competitors are selling the high-volume
A22 wheel at a price lower than Wheelco's reported manufacturing cost. In contrast,
Wheelco is selling its specialty D52 wheel at a huge markup above the product's reported
cost. An activity-based costing system probably would report a lower product cost for
wheel A22 and a substantially higher cost for wheel D52.
The president's strategy of pushing the firm's specialty products probably will
aggravate Wheelco's problem even further. These products probably are not as profitable as
the firm's traditional product-costing system makes them appear.
Recommendation: Install an activity-based costing system. If the new reported
product costs shift as suggested in the preceding comments, then lower the price on the
high-volume products, such as wheel A22. The prices of the specialty wheels probably will
need to be raised. It is possible that Wheelco should discontinue low-volume products.

5-4

EXERCISE 5-32 (15 MINUTES)


1.

Key features of an activity-based costing system:


(a)

Two-stage procedure for cost assignment.

(b)

Stage one: Establish activity cost pools.

(c)

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

2.

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

3.

Strategic options:
(a)

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

(b)

Increase the prices on low-volume specialty products.

(c)

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

5-5

PROBLEM 5-50 (35 MINUTES)


1.

Activity-based costing results in improved costing accuracy for two reasons. First,
companies that use ABC are not limited to a single driver when allocating costs to
products and activities. Not all costs vary with units, and ABC allows users to select
a host of nonunit-level cost drivers. Second, consumption ratios often differ greatly
among activities. No single cost driver will accurately assign costs for all activities
in this situation.

2.

Allocation of administrative cost based on billable hours:


Information systems: 3,100 5,000 = 62%; $342,000 x 62% = $212,040
E-commerce consulting: 1,900 5,000 = 38%; $342,000 x 38% = $129,960
Information
Systems
Services
Billings:
3,100 hours x $125
1,900 hours x $125
Less: Professional staff cost:
3,100 hours x $45.
1,900 hours x $45.
Administrative cost.
Income

E-Commerce
Consulting

$387,500
$237,500
(139,500)

Income billings.

5-6

(212,040)
$ 35,960

(85,500)
(129,960)
$ 22,040

9.28%

9.28%

PROBLEM 5-50 (CONTINUED)


2.

Activity-based application rates:


Activity

Activity
Driver

Cost

Staff support
In-house
computing

$180,000
136,400

Miscellaneous
office charges

25,600

Application
Rate

250 clients

$720 per client

4,400 computer
hours (CH)

$31 per CH

1,000 client
transactions (CT)

$25.60 per CT

Staff support, in-house computing, and miscellaneous office charges of information


systems services and e-commerce consulting:
Information
Systems
Services

Activity
Staff support:
200 clients x $720...
50 clients x $720.
In-house computing:
2,600 CH x $31.
1,800 CH x $31.
Miscellaneous office charges:
400 CT x $25.60...
600 CT x $25.60...
Total .

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E-Commerce
Consulting

$144,000
$ 36,000
80,600
55,800
10,240
$234,840

15,360
$107,160

PROBLEM 5-50 (CONTINUED)


Profitability of information systems services and e-commerce consulting:
Information
Systems
Services
Billings:
3,100 hours x $125..
1,900 hours x $125..
Less: Professional staff cost:
3,100 hours x $45
1,900 hours x $45
Administrative cost.
Income..

E-Commerce
Consulting

$387,500
$237,500
(139,500)

Income billings...

(234,840)
$ 13,160

(85,500)
(107,160)
$ 44,840

3.40%

18.88%

4.

Yes, his attitude should change. Even though both services are needed and
professionals are paid the same rate, the income percentages show that e-commerce
consulting provides a higher return per sales dollar than information systems
services (18.88% vs. 3.40%). Thus, all other things being equal, professionals should
spend more time with e-commerce.

5.

Probably not. Although both services produce an attractive return, the firm is
experiencing a very tight labor market and will likely have trouble finding qualified
help. In addition, the professional staff is currently overworked, which would
probably limit the services available to new clients.

5-8

PROBLEM 5-59 (50 MINUTES)


1.

a.

The calculation of total budgeted costs for the Manufacturing Department at


Marconi Manufacturing is as follows:
Direct material:
Tuff Stuff ($5.00 per unit20,000 units).............
Ruff Stuff ($3.00 per unit20,000 units).............
Total direct material....................................................
Direct labor..................................................................
Overhead:
Indirect labor..........................................................
Fringe benefits.......................................................
Indirect material.....................................................
Power......................................................................
Setup.......................................................................
Quality assurance..................................................
Other utilities..........................................................
Depreciation...........................................................
Total overhead............................................................
Total Manufacturing Department budgeted cost......

b.

$100,000
60,000
$ 160,000
800,000
$ 24,000
5,000
31,000
180,000
75,000
10,000
10,000
15,000

350,000
$1,310,000

The unit costs of Tuff Stuff and Ruff Stuff, with overhead assigned on the basis
of direct-labor hours, are calculated as follows:
Tuff Stuff:
Direct material........................................................
Direct labor ($8.00 per hour2 hours)*..............
Overhead ($3.50 per hour2 hours)*.................
Tuff Stuff unit cost...........................................

$5.00
16.00
7.00
$28.00

*Budgeted direct labor hours:


Tuff Stuff (20,000 units 2 hours).............................
Ruff Stuff (20,000 units 3 hours)............................
Total budgeted direct-labor hours.............................

40,000
60,000
100,000

Direct-labor rate: $800,000 per 100,000 hours


Overhead rate: $350,000 per 100,000 hours

5-9

=
=

$8.00 per hour


$3.50 per hour

PROBLEM 5-59 (CONTINUED)


Ruff Stuff:
Direct material........................................................
Direct labor ($8.00 per hour3 hours)*..............
Overhead ($3.50 per hour3 hours)*.................
Ruff Stuff unit cost...........................................

$ 3.00
24.00
10.50
$37.50

*Budgeted direct labor hours


Tuff Stuff (20,000 units 2 hours).............................
Ruff Stuff (20,000 units 3 hours)............................
Total budgeted direct-labor hours.............................

40,000
60,000
100,000

Direct-labor rate: $800,000 per 100,000 hours


Overhead rate: $350,000 per 100,000 hours
2.

= $8.00 per hour


= $3.50 per hour

The total budgeted cost of the Fabricating and Assembly Departments, after
separation of overhead into the activity cost pools, is calculated as follows:
Total

Direct material...........
Direct labor...............
Overhead:
Indirect labor
Fringe benefits
Indirect material
Power
Setup
Quality assurance
Other utilities
Depreciation
Total overhead
Total cost

$160,000
800,000
$ 24,000
5,000
31,000
180,000
75,000
10,000
10,000

15,000
$ 350,000
$1,310,000

Fabricating
Percent
Dollars
100%
$160,000
75%
600,000
75%
80%

80%
50%
80%

$18,000
4,000
20,000
160,000
5,000
8,000
5,000
12,000
$232,000
$992,000

5-10

Assembly
Percent
Dollars
25%

$200,000

25%
20%

$ 6,000
1,000
11,000
20,000
70,000
2,000
5,000
3,000

20%
50%
20%

$118,000
$318,000

PROBLEM 5-59 (CONTINUED)


3.

The unit costs of the products using activity-based costing are calculated as follows:

Fabricating:
Total cost..............................................................................................................
$992,000
Less: Direct material............................................................................................
160,000
Less: Direct labor................................................................................................
600,000
Pool overhead cost..............................................................................................
$232,000
88,000 hours
Tuff Stuff (4.4 hours 20,000 units).................................................
120,000 hours
Ruff Stuff (6.0 hours 20,000 units).................................................
Total machine hours................................................................
208,000 hours
Pool rate per machine hour ($232,000/208,000)................................................
$1.12 per hour (rounded)
Hours:

$4.93 per unit (rounded)


Fabricating cost per unit: Tuff Stuff ($1.12 4.4 hours)................................
$6.72 per unit (rounded)
Ruff Stuff ($1.12 6.0 hours)................................
Assembly:
Total cost..............................................................................................................
$318,000
Less: Direct labor................................................................................................
200,000
Pool overhead cost..............................................................................................
$118,000
Setups:

Tuff Stuff..........................................................................................
1,000
Ruff Stuff..........................................................................................
272
Total setups............................................................................
1,272
Pool rate per setup ($118,000/1,272)..................................................................
$92.77 per setup (rounded)
Setup cost per unit:
Tuff Stuff ($92.77 per setup 1,000 set-ups) 20,000 units
Ruff Stuff ($92.77 per setup 272 set-ups) 20,000 units

$4.64 per unit (rounded)


$1.26 per unit (rounded)

Tuff Stuff unit cost:


Direct material......................................................................................................
$5.00
16.00
Direct labor (2 hours $8 per hour)...................................................................
Fabrication overhead...........................................................................................
4.93
Assembly overhead.............................................................................................
4.64
Tuff Stuff unit cost.......................................................................................
$30.57

5-11

PROBLEM 5-59 (CONTINUED)


Ruff Stuff unit cost:
Direct material......................................................................................................
$3.00
24.00
Direct labor (3 hours $8 per hour)...................................................................
Fabrication overhead...........................................................................................
6.72
Assembly overhead.............................................................................................
1.26
Ruff Stuff unit cost......................................................................................
$34.98
4.

Ruff Stuff unit costs:


Cost with overhead assigned on basis of direct-labor hours..........................
$37.50
Cost using activity-based costing......................................................................
$34.98
The activity-based costing unit costs may lead the company to decide to lower its
price for Ruff Stuff in order to be more competitive in the market and continue
production of the product. It now appears that Ruff Stuff has lower unit costs and can
afford lower prices. Using ABC for assigning overhead costs generally leads to a
more accurate estimate of the costs incurred to produce a product. Management
should be able to make better informed decisions regarding pricing and production of
the companys products.

5-12