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9

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.
The term “death spiral” refers to a process that begins by attempting to increase prices
to meet reported product costs. Higher prices reduce demand, leading to production
and still higher reported product costs. Eventually, the firm loses products as the market
will not support them and goes out of business. The death spiral is not the result of the
cost system directly, but the result of managers making decisions (in this case raising
prices) based on the cost system that is (often inaccurately) signaling increased costs.

9-3.
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.

9-4.
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.

9-5.
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.

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Solutions Manual, Chapter 9 409
9-6.
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.

9-7.
The cost hierarchy is a classification of costs into general levels of activity. Costs
assigned to the different levels of the hierarchy tend to be related to the volume of the
activity volume.

9-8.
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.

9-9.
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.)

9-10.
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.

9-11.
Complexity adds costs by requiring additional resources for overhead (support)
activities for the same volume. It is important to include complexity in cost system
designs to avoid spreading the cost of complexity across both simple and complex
products.

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410 Fundamentals of Cost Accounting
9-12.
The two questions a manager must answer when implementing time-driven activity-
based costing are (1) what is the cost of the resources supplied to a department and (2)
how much time it takes to complete the various activities of the department.

9-13.
Time equations allow managers to adjust the time required for activities for selected
characteristics of products or services.

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Solutions Manual, Chapter 9 411
Solutions to Critical Analysis and Discussion Questions

9-14.
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.

9-15.
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.

9-16.
Disagree. 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.).

9-17.
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.

9-18.
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.

9-19.
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.

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412 Fundamentals of Cost Accounting
9-20.
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.

9-21.
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.

9-22.
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?

9-23.
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.

9-24.
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.

9-25.
Answers will vary based on the degrees offered and the nature of the school. Some
common activities would include: teach classes; operate recruiting office; operate
library; offer counseling; and, so on. Common cost drivers would include number of
students, number of classes; number of interviews; and so on.

9-26.
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

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Solutions Manual, Chapter 9 413
divisions, if the function provides support, or products or services, if the departments
provide service to customer activities.

9-27.
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.

9-28.
Although it appears that a time-driven activity-based cost system lacks a cost hierarchy,
one is implicit in the identification of the activities. For example, there are still batch
related costs, such as setups. The difference is that all (or almost all) activities have
cost drivers based on time rather than on transactional drivers, such as setups, orders,
and so on.

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414 Fundamentals of Cost Accounting
Solutions to Exercises

9-29. (15 min.) Reported Costs and Decisions: McNulty, Inc.

Chairs Desks Total


a. Sales revenue ....................................................
$1,150,000 $2,105,000 $3,255,000
Direct material....................................................
584,000 800,000 1,384,000
Direct labor ........................................................
160,000 340,000 500,000
a b c
Overhead (@160%) .........................................
256,000 544,000 800,000
Product cost ......................................................
$1,000,000 $1,684,000 $2,684,000
Profit ..................................................................
$150,000 $ 421,000 $ 571,000
15% d
Margin ................................................................ 25% e 21.2% f

a 160% = ($800,000 overhead ÷ $500,000 direct labor).

b $256,000 = $160,000 direct labor x 160%.


c $544,000 = $340,000 direct labor x 160%.
d 15% = ($150,000 profit ÷ $1,000,000 product cost).

e 25% = ($421,000 profit ÷ $1,684,000 product cost).


f 21.2% = ($571,000 profit ÷ $2,684,000 product cost).

b. After dropping chairs, the profit margin on desks falls below 20 percent.

Desks Total
Sales revenue ....................................................
$2,105,000 $2,105,000
Direct Labor .......................................................
800,000 800,000
Direct materials ..................................................
340,000 340,000
650,000 a
Overhead ...........................................................650,000
Product cost $1,790,000 $1,790,000
Profit ..................................................................
$315,000 $ 315,000
17.6% b
Margin ................................................................
17.6%
a Given.
b 17.6% = ($315,000 profit ÷ $1,790,000 product cost).

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Solutions Manual, Chapter 9 415
9-30. (15 min.) Reported Costs and Decisions: Kima Company.

Standard Galaxy Total


a. Sales revenue ....................................................
$6,000,000 $2,700,000 $8,700,000
Direct material....................................................
2,400,000 300,000 2,700,000
Direct labor ........................................................
1,600,000 480,000 2,080,000
a b c
Overhead (@150%) .........................................
2,400,000 720,000 3,120,000
Product cost ......................................................
$6,400,000 $1,500,000 $7,900,000
Profit ..................................................................
($ 400,000) $1,200,000 $ 800,000

a 150% = ($3,120,000 overhead ÷ $2,080,000 direct labor).


b $2,400,000 = $1,600,000 direct labor x 150%.
c $720,000 = $480,000 direct labor x 150%.

b. After dropping the standard model, the profit on the Galaxy model (and for the
company) becomes negative.

Galaxy Total
Sales revenue ....................................................
$2,700,000 $2,700,000
Direct Labor .......................................................
300,000 300,000
Direct materials ..................................................
480,000 480,000
2,250,000 a
Overhead ...........................................................
2,250,000
Product cost $3,030,000 $3,030,000
Profit ..................................................................
($330,000) ($ 330,000)
a Given.

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416 Fundamentals of Cost Accounting
9-31. (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
a
Overhead ...........................................................
1,000,000 500,000 b
Profit ..................................................................
$100,000 $ 500,000
a $1,000,000 = $500,000 direct labor x 200%.
b $500,000 = $250,000 direct labor x 200%.

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


Baseball Tennis
Bats rackets
Sales revenue ....................................................
$2,700,000 $1,800,000
Direct Labor .......................................................
500,000 250,000
Direct Materials ..................................................
1,100,000 550,000
a
Overhead ...........................................................
750,000 750,000 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.

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Solutions Manual, Chapter 9 417
9-32. (35 min.) Plantwide versus Department Allocation: Main Street Ice Cream
Company.
Strawberry Vanilla Chocolate
a. Direct Labor (per 1,000 gallons) ........................
$750 $825 $1,125
Raw Materials (per 1,000 gallons) ..................... 800 500 600
150 a
Overhead ........................................................... 165 b 225 c
Total cost (per 1,000 gallons) ............................
$1,700 $1,490 $1,950
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.

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).

c.

Strawberry Vanilla Chocolate


Direct Labor (per 1,000 gallons) ........................
$750 $825 $1,125
Raw Materials (per 1,000 gallons) ..................... 800 500 600
210 a
Overhead ........................................................... 231 b 99 c
Total cost (per 1,000 gallons) ............................
$1,760 $1,556 $1,824
a$210 = 50 machine-hours x $4.20 per machine-hour.
b$231 = 55 machine-hours x $4.20 per machine-hour.
c$99 = 75 labor-hours x $1.32 per labor-hour.

d. Charlene was correct in her belief that she was being allocated some of Department
SV’s 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.

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418 Fundamentals of Cost Accounting
9-33. (30 min.) Unitwide versus Department Allocation: Hernandez Bros.
a.
Miami New York
Employees .........................................................
1,900 600
Rate per employee ............................................
$300 $300
Allocated cost ....................................................
$570,000 $180,000

b.

Miami New York


Employees .........................................................
1,900 600
Rate per employee .............................................
$80 $80
Allocated cost .....................................................
$152,000 $48,000

Transitions .........................................................
50 150
Rate per transition ..............................................
$2,750 $2,750
Allocated cost .....................................................
$137,500 $412,500
$
Total allocated cost ............................................
$289,500 $460,500
$

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Solutions Manual, Chapter 9 419
9-34. (30 min.) Unit wide versus Department Allocation: Hernandez Bros.
a. First, note that the total to be allocated is $750,000 (= $570,000 + $180,000 in the
current system or $289,500 + $460,500 in the revised system). Then we just need to
compute the variable cost to be allocated to New York; the difference between this and
$750,000 will be allocated to Miami.

New York
Employees .........................................................
600
Rate per employee ............................................
$20
Allocated cost ....................................................
$12,000

Transitions .........................................................
150
Rate per transition .............................................
$750
Allocated cost ....................................................
$112,500 $
Total allocated cost ............................................
$124,500 $

The amount allocated to Miami will be $625,500 ($750,000 – $124,500).

b. Orlando is correct that the incremental cost to Hernandez Bros. from the activities of
New York is measured by the $124,500. However, New York is almost one-third the
size of Miami and there is a question of whether this is really incremental. There is a
danger that as New York grows relative to Miami, the costs and activities of Personnel
will be more highly influenced by the New York unit.

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420 Fundamentals of Cost Accounting
9-35. (30 min.) Activity-Based Costing: Joplin Industries.
a.
J25P J40X

Direct material .............................................................. $1,500,000 $2,400,000


Direct labor
Assembly ................................................................. $ 750,000 $ 600,000
Packaging ............................................................... 990,000 360,000
Total direct labor.................................................. $1,740,000 $960,000
Direct costs .................................................................. $3,240,000 $3,360,000
Overhead
Assembly building
Assembling (@ $30/mh) .......................................... $ 180,000 $ 900,000
Setting up machine (@$900/setup-hour)a ............... 27,000 270,000
Handling material (@$3,000/run) ............................ 24,000 120,000
Packaging building
Inspecting and Packaging (@$5/direct labor-hour) . 300,000 114,000
Shipping (@$1,320/shipment) ................................. 132,000 264,000
Total ABC O/H...................................................... $ 663,000 $1,668,000
Total ABC cost ............................................................. $3,903,000 $5,028,000
Number of units ............................................................ 100,000 40,000
Unit cost ....................................................................... $39.03 $125.70
a 75% of the amounts in Exhibit 9.16. ($27,000 = .75  $36,000; $270,000 = .75 
$360,000).

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Solutions Manual, Chapter 9 421
9-35. (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 machine-
hours.
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 ABC’s 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.

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422 Fundamentals of Cost Accounting
9-36. (30 min.) Activity-Based Costing in a Nonmanufacturing Environment:
Cathy’s Catering.
a. & b.
a. b.
Activities Afternoon Formal
Picnic Dinner
Advertising (parties) ............................... $ 100 $ 100
Planning (parties) ................................... 75 125
Equipment rental (parties, guests) ......... 250 a 475 b
Insurance (parties) ................................. 200 400
Server cost (parties) ............................... 200 c 300 d
Food (guests) ......................................... 400 e 600 f
Total ........................................................... $1,225 $2,000
a $250 = $50 + ($10 x 20 guests).
b $475 = $75 + ($20 x 20 guests).
c $200 = $50 x 4 servers.
d $300 = $75 x 4 servers.
e $400 = $20 x 20 guests.
f $600 = $30 x 20 guests.

c. If Cathy wants to cover her costs she should charge at least $61.25 per guest for the
picnic ($1,225 ÷ 20 guests), and at least $100.00 per guest for the formal dinner
($2,000 ÷ 20 guests).

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Solutions Manual, Chapter 9 423
9-37. (35 min.) Activity-Based versus Traditional Costing: Maglie Company.
a. Rate Handheld Home Total
Direct labora .......................................................
$1,160,400 $ 439,600 $1,600,000
Direct materialsb ................................................
$750,000 $ 684,000 $1,434,000
Overhead costs
$13,200 c $ 528,000 f
Prod. runs ........................................................ $ 132,000 $ 660,000
19,800 d 237,600 g
Quality tests ..................................................... 356,400 594,000
1,2400 e 124,000 h
Ship. orders ..................................................... 62,000 186,000
Total overhead .................................................
$ 889,600 $ 550,400 $1,440,000
Total costs..........................................................
$2,800,000 $1,674,000 $4,474,000
$100.00 i
Total unit cost ..................................................... $167.40 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$13,200 per run = $660,000 in production run costs ÷ 50 total runs.


d$19,800 per test = $594,000 in quality costs ÷ 30 total tests.
e$1,240 per order = $186,000 in shipping costs ÷ 150 processed orders.

f$528,000 = $13,200 per production run x 40 runs for Handheld.


g$237,600 = $19,800 per quality test x 12 tests for Handheld.
h$124,000 = $1,240 per order shipped x 100 orders shipped for Handheld.

i$100.00 = $2,800,000 total costs for Handheld ÷ 28,000 units produced.


j$167.40 = $1,674,000 total costs for Home ÷ 10,000 units produced.

Reading from the table above, we can see that the total overhead assigned is $889,600
and $550,400 for Handheld and Home, respectively. The total cost per unit is the total
cost per product divided by the total units produced; $100.00 per handheld console and
$167.40 per home console.

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424 Fundamentals of Cost Accounting
9-37. (continued)

b. Rate Handheld Home Total


Direct labora .......................................................
$1,160,400 $ 439,600 $1,600,000
b
Direct materials ................................................
750,000 684,000 1,434,000
c d
Total overhead ...................................................
90% 1,044,360 395,640 1,440,000
Total costs..........................................................
$2,954,760 $1,519,240 $4,474,000
$105.53 e
Total unit cost ..................................................... $151.92
aData given in the first table in the exercise.
bData given in the first table in the exercise.
c90% = $1,440,000 total overhead ÷ $1,600,000 total direct labor.
d$1,044,360 = $1,160,400  0.90
e$105.53 = $2,954,760 ÷ 28,000 units produced (rounded).

From the table above, total overhead allocated to Handheld and Home is $1,044,360
and $395,640 respectively. The unit cost for Handheld and Home is $105.53 and
$151.92 respectively.

c. By allocating overhead on the basis of direct labor, Maglie has been understating the
cost to manufacture home consoles thereby overstating the profits on that model.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 425
9-38. (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
$ 15 c $ 75,000 f
Machine-hours ................................................. $ 45,000 $ 120,000
3,500 d 35,000 g
Production runs ................................................ 35,000 70,000
1,500 e 30,000 h
Inspections ....................................................... 60,000 90,000
Total overhead .................................................
$140,000 $140,000 $280,000
Total costs..........................................................
$340,000 $260,000 $600,000
$28.33 i
Total unit cost ..................................................... $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 = $340,000 total costs for M-008 ÷ 12,000 units produced (rounded).
j$130 = $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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426 Fundamentals of Cost Accounting
9-38. (continued)

b. Rate M-008 M-123 Total


Direct materialsa ................................................
$100,000 $ 80,000 $180,000
b
Direct labor .......................................................
100,000 40,000 140,000
c d
Total overhead ...................................................
200% 200,000 80,000 280,000
Total costs..........................................................
$400,000 $200,000 $600,000
$33.33 e
Total unit cost ..................................................... $100.00
aData given in the first table in the exercise.
bData given in the first table in the exercise.
c200% = $280,000 total overhead ÷ $140,000 total direct labor.
d$200,000 = $100,000  2.0.
e$33.33 = $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 M-
123.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 427
9-39. (30 min.) Activity-Based Costing in a Service Environment: EL&P.
Note: Answers may vary slightly due to rounding.

a. Commercial Residential Total


Revenuea ...........................................................
$315,000 $780,000 $1,095,000
b
Direct Labor .....................................................
175,000 325,000 500,000
c
Overhead .........................................................
71,750 133,250 205,000
Profit ..................................................................
$ 68,250 $321,750 $ 390,000
a$315,000 = 7,000 hours x $45 per hour; $780,000 = 13,000 hours x $60 per hour.
b$175,000 = 7,000 hours x $25 per hour; $325,000 = 13,000 hours x $25 per hour.

c$71,750 = ($205,000 ÷ 20,000 hours) x 7,000 hours;


$133,250 = ($205,000 ÷ 20,000 hours) x 13,000 hours.

b. Rate Commercial Residential Total


Revenue ............................................................
$315,000 $780,000 $1,095,000
Direct Labor .......................................................
175,000 325,000 500,000
Overhead
$250.00 a $ 6,000 b
Traveling .......................................................... $ 19,000 c $ 25,000
20.00 d 35,500 e
Equipment ....................................................... 24,500 f 60,000
1.20 g 78,000 h
Supplies ........................................................... 42,000 i 120,000
Total Overhead ..................................................
$ 119,500 $ 85,500 $ 205,000
Profit ..................................................................
$ 20,500 $369,500 $ 390,000
a $250 per client = $25,000 ÷ 100 clients served.
b $6,000 = 24 clients x $250 per client.
c $19,000 = 76 clients x $250 per client.
d $20.00 per hour = $60,000 ÷ 3,000 equipment hours.
e $35,500 = 1,775 equipment-hours x $20 per equipment-hour.
f $24,500 = 1,225 equipment-hours x $20 per equipment-hour.
g $1.20 per square yard = $120,000/100,000 square yards.
h $78,000 = 65,000 square yards x $1.20 per square yard.
i $42,000 = 35,000 square yards x $1.20 per square yard.

©The McGraw-Hill Companies, Inc., 2017


428 Fundamentals of Cost Accounting
9-39. (continued)

c. The recommendation to EL&P is that they should reconsider dropping residential


services in favor of the commercial business. From the table in part b of the solution,
we can show EL&P that commercial work has a profit margin of 6.5%, while the
residential business has a profit margin of almost 50%. We can explain the
differences in profits under the two cost methods by showing EL&P that there is little
correlation in costs between direct labor and the overhead costs.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 429
9-40. (35 min.) Activity-Based versus Traditional Costing: Isadore’s
Implements, Inc.

a. Cost Driver Rate Pencils Pens


$1,440 a
Setting up .......................................................... $28,800 d $ 43,200
2,160 b
Inspecting .......................................................... 8,640 e 12,960
0.36 c
Packaging and Shipping .................................... 16,200 f 27,000
Total Overhead .................................................. $53,640 $83,160
a $1,440 per setup = $72,000 ÷ 50 setups.

b $2,160 per part = $21,600 ÷ 10 parts.


c $0.36 per unit shipped = $43,200 ÷ 120,000 boxes shipped.
d $28,800 = $1,440 x 20 setups.

e $8,640 = $2,160 x 4 parts.


f $16,200 = $0.36 x 45,000 boxes shipped.

b. Pencils Pens Total


4,500 a
Direct Labor Hours .............................................
15,000 19,500
$31,569 b
Overhead ...........................................................
$105,231 $ 136,800
a 4,500 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).

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.

©The McGraw-Hill Companies, Inc., 2017


430 Fundamentals of Cost Accounting
9-41. (35 min.) Activity-Based versus Traditional Costing—Ethical Issues:
Windy City Coaching.
a. Teen Executive
Account Rate Counseling Coaching Total
Revenue ............................................................
$66,000 $135,000 $201,000
Expenses:
$4,000 a
Administrative support ..................................... 24,000 d 16,000 40,000
144 b
Transportation ................................................. 14,400 e 21,600 36,000
12.50 c
Equipment. ......................................................11,250 f 8,750 20,000
Profit ..................................................................
$ 16,350 $88,650 $105,000

a $4,000 per client = $40,000 ÷ 10 clients.


b $144 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 Executive
Account Rate Counseling Coaching Total
Revenue.............................................................
$66,000 $135,000 $201,000
$143.2836 a
Expenses ...........................................................31,522 b 64,478 96,000
Profit...................................................................
$34,478 $ 70,522 $105,000
a
$201,000 revenue ÷ $300 per hour = 670 hours of labor.
$143.2836 per labor hour = $96,000 of expenses ÷ 670 hours.
b
$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 Wendy’s three cost
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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 431
9-41. (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.

©The McGraw-Hill Companies, Inc., 2017


432 Fundamentals of Cost Accounting
9-42. (30 min.) Activity-Based Costing—Cost Flows Through T-accounts:
Southwest Components.

Materials Inventory
$600,000

Wages Payable
$300,000

Overhead Applied:
Materials Handling
3,000 pounds x
$36.00 per pound =
$108,000 to WIP

Overhead Applied:
Quality Inspections
500 inspections x
$450 per inspection
= $225,000 to WIP

Overhead Applied:
Machine Setups
25 setups x $5,400
per setup =
$135,000 to WIP

Overhead Applied:
Running Machines
10,000 hours x $45
per hour = $450,000
to WIP

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 433
9-42. (continued)

Work in Process (WIP) Inventory


Fabrication Department
Direct Materials 600,000
Direct Labor 300,000
Material Handling OH 108,000
Quality Inspect. OH 225,000
Machine Setup OH 135,000
Running Machines OH 450,000 1,818,000

Finished Goods Inventory


1,818,000

©The McGraw-Hill Companies, Inc., 2017


434 Fundamentals of Cost Accounting
9-43. (30 min.) Activity-Based Costing—Cost Flows Through T-accounts:
Catalina Sails.

Materials Inventory
$550,000 to WIP

Wages Payable
$275,000 to WIP

Overhead Applied:
Materials Handling
20,000 yards x $3
per yard = $60,000
to WIP

Overhead Applied:
Quality Inspections
400 inspections x
$300 per inspection
= $120,000 to WIP

Overhead Applied:
Machine Setups
50 setups x $2,400
per setup =
$120,000 to WIP

Overhead Applied:
Running Machines
10,000 hours x $30
per hour = $300,000
to WIP

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 435
9-43. (continued)

Work in Process (WIP) Inventory


Department Y
Direct Materials 550,000
Direct Labor 275,000
Material Handling 60,000
Quality Inspect. 120,000
Machine Setup 120,000
Running Machines 300,000 1,425,000

Finished Goods Inventory


1,425,000

©The McGraw-Hill Companies, Inc., 2017


436 Fundamentals of Cost Accounting
9-44. (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 = $1,100 x 200 employees for LaidBack.


c $55,000 = $1,100 per employee x 50 employees for StressedOut

b. Rate LaidBack StressOut Total


Employee maintenancea ....................................
$6,000 $60,000 b $180,000 c $240,000
Payrolld ..............................................................
$140 28,000 e 7,000 f 35,000
Total allocated costs ..........................................
$88,000 $187,000 $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 = $6,000  30 employees hired/leaving.


d $140 = $35,000 Payroll costs ÷ 250 employees (average).
e $28,000 = $140  200 employees (average).

f $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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 437
9-45. (20 min.) Activity-Based Costing for an Administrative Service: John’s
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 Business Total


Billinga ................................................................
$48 $28,800 b $19,200 c $48,000
Dispute resolutiond .............................................
$500 30,000 e 6,000 f 36,000
Total allocated costs ..........................................
$58,800 $25,200 $84,000
a $48 = $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 = $500  60 disputes.

f $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.

©The McGraw-Hill Companies, Inc., 2017


438 Fundamentals of Cost Accounting
9-46. (20 min.) Time-Driven Activity-Based Costing: Kim Distribution Services.

a. $0.54
Total cost in Distribution .....................................
$826,200
Total minutes availablea .....................................
1,530,000
Cost per minute ..................................................
$0.54 (= $826,200 ÷ 1,530,000)
a 15 employees x 50 weeks x 40 hours per week x 0.85 x 60 minutes per hour .

b. $23.76
Taking Picking Packaging
Orders Orders Orders Total
Minutes per order ...............................................
10 + 14 + 20 = 44
Cost per minute .................................................. x $0.54
Total costs.......................................................... $23.76

c. 306,000 minutes.
Taking Picking Packaging
Orders Orders Orders Total
1,530,000
Minutes per order ...............................................
10 14 20
Number of orders ...............................................
25,000 30,000 27,700
Minutes used......................................................
250,000 + 420,000 + 554,000 = 1,224,000
Unused minutes ................................................. 306,000

d. $165,240 (= 306,000 minutes x $0.54 per minute).

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 439
9-47. (20 min.) Time-Driven Activity-Based Costing: City Enterprises.

a. $2.25
Total cost in Personnel.......................................
$972,000
Total minutes availablea .....................................
432,000
Cost per minute ..................................................
$2.25 (= $972,000 ÷ 432,000)
a 5 employees x 48 weeks x 30 hours per week x 60 minutes per hour .

b. $236.25
Interviewing Hiring Total
Minutes per activity ............................................
45 + 60 = 105
Cost per minute .................................................. $2.25
Total costs.......................................................... $236.25

c. 108,000 minutes.
Sep.
Interview Hire Assess Process Total
432,000
Minutes per order ...............................................
45 60 75 90
Number of orders ...............................................
1,200 375 3,000 250
Minutes used ......................................................
54,000 + 22,500 + 225,000 + 22,500 = 324,000
Unused minutes ................................................. 108,000

d. $243,000 (= 108,000 minutes x $2.25 per minute).

©The McGraw-Hill Companies, Inc., 2017


440 Fundamentals of Cost Accounting
Solutions to Problems

9-48. (40 min.) Comparative Income Statements and Management Analysis: EZ-
Seat, Inc.
a. EZ-Seat, Inc. Income Statement

Account Rate Ergo Standard Total


Sales revenue ....................................................
$2,925,000 $2,760,000 $5,685,000
Direct materials ..................................................
$ 550,000 $ 500,000 $1,050,000
Direct labor ........................................................
400,000 200,000 600,000
Overhead costs:
78% a 312,000 e
Administration .................................................. 156,000 468,000
$7,200 b
Production setup ..............................................
360,000 f 720,000 1,080,000
$1,800 c
Quality control..................................................
360,000 g 360,000 720,000
$192 d
Distribution.......................................................
288,000 h 1,152,000 1,440,000
Total overhead costs .........................................
1,320,000 2,388,000 3,708,000
Operating profit ..................................................
$ 655,000 $ (328,000) $ 327,000
a78% = $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 product’s value.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 441
9-48. (continued)

c. EZ-Seat, Inc. Income Statement

Account Rate Ergo Standard Total


Sales revenue ....................................................
$2,925,000 $2,760,000 $5,685,000
Direct Materials ..................................................
550,000 500,000 1,050,000
Direct Labor .......................................................
400,000 200,000 600,000
618% a 2,472,000 b
Overhead Costs ................................................. 1,236,000 3,708,000
Operating Profit..................................................
$ (497,000 ) $ 824,000 $ 327,000
a 618% = $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.

©The McGraw-Hill Companies, Inc., 2017


442 Fundamentals of Cost Accounting
9-49. (40 min.) Comparative Income Statements and Management Analysis:
Pepper’s Products.
a. Pepper’s Products: Income Statement

Account Rate Squeaky Silent Total


Sales revenue ....................................................$43,200 $48,000 $91,200
Direct materials .................................................. 4,000 4,000 8,000
Direct labor ........................................................ 9,600 14,400 24,000
Overhead costs:
25% a
Administration .................................................. 2,400 e 3,600 6,000
$800 b
Setting up ........................................................ 8,000 f 4,000 12,000
$150 c
Performing quality control ................................ 4,500 g 1,500 6,000
$0.12 d
Distribution....................................................... 1,920 h 2,880 4,800
Total overhead costs .........................................16,820 11,980 28,800
Operating profit (loss) ........................................$ 12,780 $ 17,620 $ 30,400
a 25% = $6,000 administrative costs ÷ $24,000 direct labor costs.
b $800 = $12,000 production setup costs ÷ 15 production runs.

c $150 = $6,000 quality control costs ÷ 40 inspections.


d $0.12 = $4,800 distribution costs ÷ 40,000 units shipped.
e $12,000 = 0.25 x $48,000 direct labor costs.

f $8,000 = $800 per run x 10 runs.


g $4,500 = $150 per inspection x 30 inspections.
h $1,920 = $0.12 per unit shipped x 16,000 units.

b. Activity-based costing highlights the activities that cause costs, and provides insight
into which costs may be reduced. For instance, Pepper’s Products’ management
has identified three cost driving activities; production setups, quality control
inspections, and distribution. Setups cost $800 each and inspections cost $150
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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 443
9-49. (continued)

c.
Pepper’s Products
Income Statement
Account Rate Squeaky Silent Total
Sales revenue ....................................................
$43,200 $48,000 $91,200
Direct Materials ..................................................4,000 4,000 8,000
Direct Labor .......................................................9,600 14,400 24,000
120% a
Overhead Costs ................................................. 11,520 b 17,280 28,800
Operating Profit (loss) ........................................ $18,080 $12,320 $ 30,400
a 120% = $28,800 of Overhead Costs ÷ $24,000 Direct Labor Costs.
b $11,520 = 120% Overhead rate x $9,600 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
Squeaky and Silent 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 Squeaky toy receives two-thirds as much overhead under our labor-based
allocation approach as does our Silent toy 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 Squeaky line should receive $16,820, or about 40%
more than the Silent toy, 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 Silent toy is less profitable than the Squeaky. Under the more accurate activity-
based costing, the Silent toy line earns about 38% more than the Squeaky toys in
profits.

©The McGraw-Hill Companies, Inc., 2017


444 Fundamentals of Cost Accounting
9-50. (15 min.) Ethics and Choice of Accounting Methods: Pepper’s Products.
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 user’s
understanding of the reports, comments, and recommendations presented.”

9-51. (50 min.) Activity-Based Costing and Predetermined Overhead Allocation


Rates: Kitchen Supply, Inc.
a. Computing overhead allocation rates

Cost Est. Driver


Activity Driver Costs Units Rate
Processing orders ......... No. of orders $ 54,000 ÷ 200 = $ 270
Setting up production .... No. of runs 216,000 ÷ 100 = 2,160
Handling materials ........ Pounds 360,000 ÷ 120,000 = 3.00
Using machines ............ Machine-hrs. 288,000 ÷ 12,000 = 24
Performing quality control No. of insp. 72,000 ÷ 45 = 1,600
Packing ......................... No. of units 144,000 ÷ 480,000 = 0.30
Total est. overhead ....... $1,134,000

Predetermined rate
= Estimated activity ÷ Estimated allocation base
for direct labor-hour
= $1,134,000 ÷ 7,500 hours
= $151.20 per hour

b. Production Costs using Direct Labor-Hours

Account Institutional Standard Silver Total


Direct materials ..................................................
$ 39,000 $24,000 $15,000 $ 78,000
Direct labora .......................................................
6,750 6,750 9,000 22,500
Indirect costsb ....................................................
68,040 68,040 90,720 226,800
Total cost ...........................................................
$113,790 $98,790 $114,720 $327,300

a Number of labor-hours x $15 per hour.

b Number of labor-hours x $151.20 per hour.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 445
9-51. (continued)

c. Production Costs using ABC

Account Institutional Standard Silver Total


Direct materials ..................................................
$39,000 $ 24,000 $15,000 $78,000
Direct labor ........................................................
6,750 6,750 9,000 22,500
Indirect costs
Processing orders ............................................
3,240 2,430 1,620 7,290
Setting up production .......................................
6,480 6,480 12,960 25,920
Handling materials ...........................................
45,000 18,000 9,000 72,000
Using machines ...............................................
13,920 3,360 1,920 19,200
Performing quality control ................................
4,800 4,800 4,800 14,400
Packing ............................................................
18,000 7,200 2,700 27,900
Total cost ...........................................................
$137,190 $73,020 $57,000 $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 product’s 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 costs—costs, 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.

©The McGraw-Hill Companies, Inc., 2017


446 Fundamentals of Cost Accounting
9-52. (50 min.) Activity-Based Costing and Predetermined Overhead Rates:
College Supply Company.

a. Activity Recommended Base Allocation Rate


Setting up production ... No. of runs $360 per run ($36,000 ÷ 100 runs)
Processing orders ........ No. of orders $300 per order ($60,000 ÷ 200 orders)
Handling materials ....... Lbs. of material $3.00 per lb. ($24,000 ÷ 8,000 lbs.)
Using machines............ Machine-hours $7.20 per hour ($72,000 ÷ 10,000 hrs.)
Performing quality
management ................ No. of inspections $1,500 per insp. ($60,000 ÷ 40 insp.)
Packing & shipping....... Units shipped $2.40 per unit ($48,000 ÷ 20,000 units)
Direct labor hour rate ... $150 per hour ($300,000 ÷ 2,000 hrs.)

b. Short Medium Tall


Direct materials ..................................................
$ 6,000 $ 3,750 $ 3,000
a
Direct labor .......................................................
3,000 3,600 3,300
b
Overhead .........................................................
15,000 18,000 16,500
Total costs .........................................................
$24,000 $25,350 $22,800
a Number of hours x $30 per hour.
b Number of hours x $150 per hour.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 447
9-52 (continued)

c. Short Medium Tall


Direct materials ..................................................
$ 6,000 $ 3,750 $ 3,000
Direct labor ........................................................
3,000 3,600 3,300
Setting up production ......................................... 720 a 1,440 2,880
2,400 b
Processing orders .............................................. 2,400 1,200
1,200 c
Handling materials ............................................. 2,400 600
3,600 d
Using machines ................................................. 2,160 2,160
Performing quality management ........................ 3,000 e 3,000 3,000
2,400 f
Shipping ............................................................. 1,200 720
Total cost ...........................................................
$22,320 $19,950 $16,860
a $720 = $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 product’s 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.

©The McGraw-Hill Companies, Inc., 2017


448 Fundamentals of Cost Accounting
9-53. (40 min.) Choosing an Activity-Based Costing System: Pickle
Motorcycles, Inc.
a.
Pickle Motorcycles
Income Statement

Route 66 Main Street Alley Cat Total


Sales revenue ....................................................
$7,600,000 $11,200,000 $9,500,000 $28,300,000
Direct costs:
Direct material ..................................................
3,000,000 4,800,000 4,000,000 11,800,000
Direct labor ......................................................
288,000 480,000 1,080,000 1,848,000
a
Var. OH ..........................................................
939,600 1,503,360 2,255,040 4,698,000
Cont. margin ....................................................
$3,372,400 $4,416,640 $ 2,164,960 $ 9,954,000
Fixed OH:
Plant admin. .................................................... 1,760,000
Other ................................................................ 2,800,000
Gross profit ........................................................ $ 5,394,000
a Rate = $93.96 (= $4,698,000 ÷ 50,000 machine-hours) per machine-hour.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 449
9-53. (continued)

b.
Pickle Motorcycles
Income Statement

Route 66 Main Street Alley Cat Total


Sales revenue ....................................................
$7,600,000 $11,200,000 $9,500,000 $28,300,000
Direct costs:
Direct material .................................................
3,000,000 4,800,000 4,000,000 11,800,000
Direct labor 288,000 480,000 1,080,000 1,848,000
Var. OH:
102,960 a
Mach. setup .....................................................
159,120 205,920 468,000
b
Order proc. ......................................................
288,000 432,000 432,000 1,152,000
c
Warehousing ...................................................
418,500 418,500 837,000 1,674,000
d
Energy .............................................................
151,200 241,920 362,880 756,000
e
Shipping...........................................................
43,200 172,800 432,000 648,000
Cont. margin ......................................................
$3,308,140 $4,495,660 $ 2,150,200 $ 9,954,000
Fixed OH:
Plant admin...................................................... 1,760,000
Other................................................................ 2,800,000
Gross profit ........................................................ $ 5,394,000
a $4,680 (= $468,000 ÷ 100 runs) per run x 22 runs = $102,960.
b $720 (= $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 machine-
hours = $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 PMI’s 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.

©The McGraw-Hill Companies, Inc., 2017


450 Fundamentals of Cost Accounting
9-54. (40 min.) Activity-Based Costing, Cost Flow Diagram, and Predetermined
Overhead Rates: Churchill Products.
a.
Burden rate = (Total overhead costs ÷ Budgeted total direct labor-hours)
Budgeted total direct labor-hours = 4,800 + 2,700 + 7,500 = 15,000 hours
Total overhead costs = $1,350,000 + $1,350,000 + $3,600,000 = $6,300,000
Burden rate = $6,300,000 ÷ 15,000 = $420 per DLH
Unit costs:

Oval Round Square


Direct costs .................................... $ 240,000 $ 240,000 $240,000
Overhead (@ $420 per DLH) ......... 2,016,000 1,134,000 3,150,000
Total costs ...................................... $2,256,000 $1,374,000 $3,390,000
Number of units .............................. 6,000 3,000 9,000
Unit cost ......................................... $376 $458 $376.67

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 451
9-54. (continued)

b.

c.
Utilities............................... $1,350,000 ÷ 90,000 MH = $15 per machine-hour.
Scheduling and setup ........ $1,350,000 ÷ 900 Setups = $1,500 per setup.
Material handling ...............$3,600,000 ÷ 2,400,000 lbs. = $1.50 per pound.

©The McGraw-Hill Companies, Inc., 2017


452 Fundamentals of Cost Accounting
9-54. (continued)

d.
Unit Costs:

Oval Round Square


Direct Costs ............................................$240,000 $240,000 $240,000
Overhead:
Utilities ...............................................675,000a 225,000 450,000
Scheduling and setup ........................180,000b 675,000 495,000
Material handling ............................... 1,125,000c 675,000 1,800,000
Total costs ..............................................
$2,220,000 $1,815,000 $2,985,000
Number of units ...................................... 6,000 3,000 9,000
Unit cost ................................................. $370.00 $605.00 $331.67
a $225,000 = $15 per machine-hour x 45,000 machine-hours.
b $60,000 = $1,500 per setup x 120 setups.

c $375,000 = $1.50 per pound x 750,000 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.)

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 453
9-55. (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:

308 510
Direct costs .....................................................$216,000 $216,000
Overhead (@ $19 per machine-hour)..............1,140,000 1,710,000
Total costs .......................................................
$1,356,000 $1,926,000
Number of units ............................................... 30,000 18,000
Unit cost .......................................................... $45.20 $107.00

©The McGraw-Hill Companies, Inc., 2017


454 Fundamentals of Cost Accounting
9-55. (continued)

b.
Inspection ..........................
$170,000 ÷ $68,000 material dollars = 250% of material dollars.
Production .........................
$1,500,000 ÷ 150,000 machine-hours = $10.00 per machine-hour
Machine setup ...................$700,000 ÷ 140 Setups = $5,000 per setup.
Shipping ............................
$480,000 ÷ 48,000 units = $10.00 per unit.
c.
Unit Costs:

308 510
Direct Costs ............................................$216,000 $216,000
Overhead:
Incoming inspection ...........................125,000a 45,000
Production .........................................600,000b 900,000
Machine setup ...................................250,000c 450,000
Shipping.............................................300,000d 180,000
Total costs ..............................................
$1,491,000 $1,791,000
Number of units ...................................... 30,000 18,000
Unit cost ................................................. $49.70 $99.50
a $125,000 = 250% of material dollars x $50,000.
b $600,000 = $10.00 per machine-hour x 60,000 machine-hours.

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


d $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.)

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 455
9-56. (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 Deluxe
Direct costs .....................................................$895,000 $405,000
Overhead (@ $32 per machine-hour)..............4,800,000 3,200,000
Total costs .......................................................
$5,695,000 $3,605,000
Number of units ............................................... 20,000 5,000
Unit cost .......................................................... $284.75 $721.00

©The McGraw-Hill Companies, Inc., 2017


456 Fundamentals of Cost Accounting
9-56. (continued)

b.
Receiving ..........................
$600,000 ÷ $400,000 material dollars = 150% of material dollars.
Production .........................
$5,500,000 ÷ 250,000 machine-hours = $22.00 per machine-hour
Machine setup ...................$900,000 ÷ 200 Setups = $4,500 per setup.
Shipping ............................
$1,000,000 ÷ 25,000 units = $40.00 per unit.

Unit Costs:

Standard Deluxe
Direct Costs ............................................$895,000 $405,000
Overhead:
Receiving ...........................................367,500a 232,500
Manufacturing .................................... 3,300,000b 2,200,000
Machine setup ...................................337,500c 562,500
Shipping.............................................800,000d 200,000
Total costs ..............................................
$5,700,000 $3,600,000
Number of units ...................................... 20,000 5,000
Unit cost ................................................. $285.00 $720.00
a $367,500 = 150% of material dollars x $245,000.
b $3,300,000 = $22.00 per machine-hour x 150,000 machine-hours.
c $337,500 = $4,500 per setup x 75 setups.

d $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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 457
9-57. (40 min.) Activity-Based Costing and Predetermined Overhead Rates:
Cain Components.
a.

Receiving ..........................
$600,000 ÷ $400,000 material dollars = 150% of material dollars.
Manufacturing ...................
$3,300,000 ÷ 250,000 machine-hours = $13.20 per machine-hour
Engineering .......................
$2,200,000 ÷ 200 Setups = $11,000 per setup
Machine setup ...................$900,000 ÷ 200 Setups = $4,500 per setup.
Shipping ............................
$1,000,000 ÷ 25,000 units = $40.00 per unit.

Unit Costs:

Standard Deluxe
Direct Costs ............................................$895,000 $405,000
Overhead:
Receiving ...........................................367,500a 232,500
Manufacturing .................................... 1,980,000b 1,320,000
Engineering .......................................825,000c 1,375,000
Machine setup ...................................337,500d 562,500
Shipping.............................................800,000e 200,000
Total costs ..............................................
$5,205,000 $4,095,000
Number of units ...................................... 20,000 5,000
Unit cost ................................................. $260.25 $819.00
a $367,500 = 150% of material dollars x $245,000.
b $1,980,000 = $13.20 per machine-hour x 150,000 machine-hours.

c $825,000 = $11,000 per setup x 75 setups.


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

©The McGraw-Hill Companies, Inc., 2017


458 Fundamentals of Cost Accounting
9-58. (15 min.) Benefits 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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 459
9-59. (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 Total


Sales revenue ....................................................
$9,000,000 $15,000,000 $13,500,000 $37,500,000
Direct costs:
Direct material. ................................................
3,000,000 4,500,000 3,300,000 10,800,000
Direct labor ......................................................
600,000 900,000 1,800,000 3,300,000
a
Var. overhead ....................................................
2,088,000 3,132,000 3,480,000 8,700,000
Contribution margin ...........................................
$3,312,000 $6,468,000 $4,920,000 $14,700,000
Plant admin...................................................... 6,000,000
Gross profit ........................................................ $ 8,700,000
a $2,088,000 = $348 per machine-hour  6,000 machine-hours.

b. Cost driver rates:

Activity Cost Activity Volume Unit Rate


Setting up machines .... $2,400,000 ÷ 50 runs = $48,000 per run
Processing sales orders ....................................
$1,800,000 ÷ 800 orders = 2,250 per order
Warehousing................ $2,400,000 ÷ 400 units = 6,000 per unit
Operating machines..... $1,200,000 ÷ 25,000 machine-hrs = 48 per machine-hr.
Shipping ....................... $900,000 ÷ 37,500 units shipped = 24 per unit shipped

©The McGraw-Hill Companies, Inc., 2017


460 Fundamentals of Cost Accounting
9-59. (continued)

Income Statement

M3100 M4100 M6100 Total


Sales revenue ....................................................
$9,000,000 $15,000,000 $13,500,000 $37,500,000
Direct costs:
Direct material. ................................................
3,000,000 4,500,000 3,300,000 10,800,000
Direct labor ......................................................
600,000 900,000 1,800,000 3,300,000
Var. overhead ....................................................
480,000 a
Setting up machines .......................................... 960,000 960,000 2,400,000
405,000 b
Processing orders ............................................. 900,000 495,000 1,800,000
600,000 c
Warehousing......................................................
1,200,000 600,000 2,400,000
288,000 d
Operating machines ........................................... 432,000 480,000 1,200,000
240,000 e
Shipping .............................................................
420,000 240,000 900,000
Cont. margin ......................................................
$3,387,000 $ 5,688,000 $ 5,625,000 $14,700,000
Plant admin...................................................... 6,000,000
Gross profit ........................................................ $ 8,700,000

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

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


c $600,000 = $6,000 per unit  100 units.
d $288,000 = $48 per machine-hour  6,000 machine-hours.

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

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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 461
9-60. (15 min.) Time-Based ABC – Time Equations: Kim Distribution Systems.

a.
Taking order = 10 minutes + 30 minutes (if retailer is new).
b.
Picking order = 14 minutes + 20 minutes (if order is complex).
c.
From the solution to Exercise 9-46 (a):

Total cost in Distribution .....................................


$826,200
Total minutes availablea .....................................
1,530,000
Cost per minute ..................................................
$0.54 (= $826,200 ÷ 1,530,000)
a 15 employees x 50 weeks x 40 hours per week x 0.85 x 60 minutes per hour .

The cost for a complex order from a new retailer will be:
Taking Picking Packaging
Orders Orders Orders Total
Minutes per order ...............................................
(10 + 30) + (14 + 20) + 20 = 94
Cost per minute .................................................. x $0.54
Total costs.......................................................... $50.76

©The McGraw-Hill Companies, Inc., 2017


462 Fundamentals of Cost Accounting
9-61. (15 min.) Time-Based ABC – Time Equations: City Enterprises.

a.
Interviewing = 45 minutes + 120 minutes (if interviewee is a manager level)
+ 360 minutes (if interviewee is an executive level).
b.
Separation processing = 90 minutes + 180 minutes (if separation is involuntary).
c.
From the solution to Exercise 9-47 (a):

Total cost in Personnel.......................................


$972,000
Total minutes availablea .....................................
432,000
Cost per minute ..................................................
$2.25 (= $972,000 ÷ 432,000)
a 5 employees x 48 weeks x 30 hours per week x 60 minutes per hour .

The cost of hiring a manager will be:


$371.25 [= (45 minutes + 120 minutes) x $2.25 per minute].
The cost of hiring an executive will be:
$1,181.25 [= (45 minutes + 120 minutes + 360 minutes) x $2.25 per minute].
d.
As shown in part c, the cost per minute is $2.25.

The cost of separation processing for a voluntary separation will be:


$202.50 (= 90 minutes x $2.25 per minute).
The cost of separation processing for an involuntary separation will be:
$607.50 [= (90 minutes + 180 minutes) x $2.25 per minute.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 463
Solutions to Integrative Cases

9-62. (50 Min) Cost Allocation and Environmental Processes—Ethical Issues:


California Circuits Company.

a.
XL-D XL-C
Raw material .................................. $12.00 $14.00
Direct labor – Production ................ $2.00 $2.00
Direct labor – Assembly ................. 8.00 10.00 8.00 10.00
Overhead @ 120%a ....................... 12.00 12.00
Total ............................................... $34.00 $36.00

a Overhead rate = Total overhead ÷ Total direct labor cost

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


= 120% of direct labor costs

b.
XL-D XL-C
Raw material ................................... $12.00 $14.00
Direct labor – Production ................. $2.00 $2.00
Direct labor – Assembly .................. 8.00 10.00 8.00 10.00

Overhead – Production @ $5 per MHa .............. $8.00 $8.00


Overhead - Assembly @ $10 per DLH ............. b 4.00 12.00 4.00 12.00
Total ................................................ $34.00 $36.00

a Overhead rate—Production Department = Production overhead ÷ Total machine-


hours
= $1,000,000 ÷ [(100,000  1.6) + (25,000  1.6)]
= $5 per machine-hour
b Overhead Rate—Assembly 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 labor-
hours are used to allocate overhead costs to the final products or whether it is done
by manufacturing department or using a plantwide rate.
©The McGraw-Hill Companies, Inc., 2017
464 Fundamentals of Cost Accounting
9-62. (continued)

d.

XL-D XL-C
Raw material ......................................... $12.00 $14.00
Direct labor – Production ....................... $2.00 $2.00
Direct labor – Assembly ........................ 8.00 10.00 8.00 10.00
Overhead – Productiona
Supervision @ $8/direct labor-hour .... $0.80 $0.80
Material handling @ 6% mat’l. cost .... 0.72 0.84
Testing @ $0.40/ test hour ................. 1.20 1.20
Waste treatment @ $0.25/gallon ........ 2.50 0.00
Depreciation @ $2/mach. hr ............... 3.20 3.20
Shipping @ $0.05/pound .................... 0.05 0.08
Total production overhead ..................... 8.47 6.12

Overhead – Assembly @ $10/DLHb ...... 4.00 4.00


Total ...................................................... $34.47 $34.12
a Production Department Overhead Calculations (Rate = Activity cost ÷ Driver volume):

Activity
Activity Cost Driver Driver Volume Rate
$100,000 Direct 100,000  .1 + 25,000  .1
Supervision ........................................................ $8.00
labor-hrs = 12,500 hours
Materials 93,000 Material 100,000  $12 + 25,000  $14 6%
handling .............................................................
cost = $1,550,000
150,000 Test 100,000  3 + 25,000  3
Testing ............................................................... $0.40
hours = 375,000 hours
Wastewater 250,000 Waste 100,000  10 + 25,000  0 $0.25
treatment ............................................................
= 1,000,000 gallons
400,000 Machine 100,000  1.6 + 25,000  1.6
Depreciation ....................................................... $2.00
- hours = 200,000 machine-hours
7,000 Weight 100,000  1.0 + 25,000  1.6
Shipping ............................................................. $0.05
= 140,000 pounds
b Overhead Rate—Assembly Department = Assembly overhead ÷ Total direct labor-hrs

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


= $10 per direct labor-hour
©The McGraw-Hill Companies, Inc., 2017
Solutions Manual, Chapter 9 465
9-62. (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.

©The McGraw-Hill Companies, Inc., 2017


466 Fundamentals of Cost Accounting
9-63. (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 $ 2.00 $ 9.00
Direct labor cost per case ................................
42.00 18.00 6.00
Allocated overhead per case ........................... 44.24 18.96 6.32
Product cost.....................................................
$94.24 $38.96 $21.32
Selling price .......................................................
$85.00 $55.00 $35.00
Gross profit margin ............................................
(10.87 )% 29.16 % 39.09 %
Drop product? ....................................................
Yes No 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.
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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 467
9-63. (continued)

c. Krispy Creamy
Krackle Crunch
Direct labor cost per hour .................................. $6.00 $6.00
Direct labor-hours per case................................ 3 1
Total cases produced ........................................ 1,000 2,000
Labor-hours per product .................................... 3,000 2,000
Total labor-hours: 5,000

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


= $69,500/5,000
= $13.90 per labor-hour

Krispy Creamy
Allocated production costs: Krackle Crunch
Material cost per case ........................................ $ 2.00 $ 9.00
Direct labor cost per case .................................. 18.00 6.00
Allocated overhead per case
($13.90 per labor-hour) .................................... 41.70 13.90
Product cost ....................................................... $61.70 $28.90
Gross profit margins:
Selling price ....................................................... $55.00 $35.00
Product cost—direct labor allocation base ......... (61.70 ) (28.90 )
$ (6.70 ) $ 6.10
Profit margin percentage ...................................
$(6.70) ÷ $55.00 $6.10 ÷ $35.00
= (12.2) % = 17.4%
The recommendation to management is to drop Krispy Krackle and increase
production of Creamy Crunch.

©The McGraw-Hill Companies, Inc., 2017


468 Fundamentals of Cost Accounting
9-63. (continued)

d. Creamy
Crunch
Direct labor cost per hour .................................. $6.00
Direct labor hours per case ................................ 1
Total cases produced ........................................ 3,000
Labor hours per product .................................... 3,000
Total labor hours: 3,000

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


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

Creamy
Allocated Production Costs: Crunch
Material cost per case ........................................ $ 9.00
Direct labor cost per case .................................. 6.00
Allocated overhead per case ............................. 23.17
Product cost ....................................................... $38.17
Gross profit margins:
Selling price ....................................................... $35.00
Product cost—direct labor allocation base ......... (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.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 469
9-64. (90 min.) Multiple Allocation Bases: Chocolate Bars, Inc.
a. Almond Krispy Creamy
Dream Krackle Crunch Total
Total direct
labor hoursa ....................................................
7,000 (63.6%) 3,000 (27.3%) 1,000 (9.1%) 11,000 (100%)
Total machine
hoursa .............................................................
2,000 (13.3%) 7,000 (46.7%) 6,000 (40%) 15,000 (100%)
Factory space
(sq. ft.) ............................................................
1,000 (10%) 4,000 (40%) 5,000 (50%) 10,000 (100%)
Total rent for factory space: $15,000 per month
Total machine operating costs: $30,000 per month
Total other overhead: $24,500 per month (= $69,500 – $15,000 – $30,000)
Total cases produced/month: 3,000 cases

Product allocation base:


Fraction: Labor (%) Machine hours (%) Factory space (%)
Almond Dream ...................................................
63.6% 13.3% 10%
Krispy Krackle ....................................................
27.3 46.7 40
Creamy Crunch..................................................
9.1 40.0 50

Allocated Costs: Total Per Case


Almond Dream (63.6% x $24,500) + (13.3% x $30,000) +
(10% x $15,000) ........................................................... = $21,072 $21.07
Krispy Krackle (27.3% x $24,500) + (46.7% x $30,000) +
(40% x $15,000) ........................................................... = 26,699 26.70
Creamy Crunch (9.1% x $24,500) + (40% x $30,000) +
(50% x $15,000) ........................................................... = 21,730 21.73
Almond Krispy Creamy
Allocated production costs: Dream Krackle Crunch
Material cost ......................................................
$ 8.00 $ 2.00 $ 9.00
Direct labor ........................................................
42.00 18.00 6.00
Allocated OH......................................................
21.07 26.70 21.73
Production cost per case ...................................
$71.07 $46.70 $36.73
Selling price .......................................................
$85.00 $55.00 $35.00
Product cost .......................................................
(71.07) (46.70) (36.73)
Profit (loss).........................................................
$13.93 $ 8.30 $ (1.73)
Profit margin ratio ..............................................
16.4% 15.1% (4.9)%
aTotals equal hours per case times 1,000 cases.

©The McGraw-Hill Companies, Inc., 2017


470 Fundamentals of Cost Accounting
9–64. (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 Krispy
Dream Krackle
Direct labor hours per case ................................7 3
Machine hours per case ....................................2 7
Factory space (sq. ft.)a ......................................
2,000 (33.3%) 4,000 (66.7%)
Case of output per month ..................................
2,000 1,000
Labor hours required .........................................
14,000 (82.4%) 3,000 (17.6%)
Machine hours required .....................................
4,000 (36.4%) 7,000 (63.6%)

Total rent for factory space: $15,000 per month


Total machine operating costs: $30,000 per month
Total other overhead: $24,500 per month
Total labor hours/month: 17,000
Total cases produced/month: 3,000 cases
Total machine hours 11,000 hours
Product allocation base:
Fraction: Labor (%) Machine hours (%) Factory space (%)
Almond Dream ...................................................
82.4% 36.4% 33.3% (rounded)
Krispy Krackle ....................................................
17.6 63.6 66.7 (rounded)

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

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 471
9-64. (continued)

Allocated Cost: Total Per Case


Almond Dream (82.4% x $24,500) +
(36.4% x $30,000) + (33.3% x $15,000)............... = $36,108 $18.05
Krispy Krackle (17.6% x $24,500) +
(63.6% x $30,000) + (66.7% x $15,000)............... = 33,392 33.39
Almond Krispy
Allocated production costs: Dream Krackle
Material cost ...................................................... $ 8.00 $ 2.00
Direct labor ........................................................ 42.00 18.00
Allocated OH...................................................... 18.05 33.39
Production cost per case ................................... $68.05 $53.39
Selling price ....................................................... $85.00 $55.00
Product cost ....................................................... (68.05) (53.39)
$16.95 $ 1.61
Profit margin ratio:
Ratio = Gross Margin/Price ................................ 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

Almond
Allocated production costs: Dream
Material cost ...................................................... $ 8.00
Direct labor ........................................................ 42.00
Allocated OH...................................................... 23.17
Production cost per case ................................... $73.17
Selling price ....................................................... $85.00
Product cost ....................................................... (73.17)
$11.83
Profit margin ratio:
Ratio = Gross Margin/Price ................................ 13.9%

©The McGraw-Hill Companies, Inc., 2017


472 Fundamentals of Cost Accounting
9-64. (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 Creamy


or or
Dream Krackle Crunch
Cases .................................................................
3,000 3,000 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
– 219,500 – 129,500 – 114,500
Total costs ..........................................................
Gross margin......................................................
$ 35,500 $ 35,500 $ (9,500)
Moral: Don’t make too much of allocated cost numbers in decision making.

©The McGraw-Hill Companies, Inc., 2017


Solutions Manual, Chapter 9 473
9-65. (90 min.) Activity-Based Costing – The Grape Cola Caper.
a. Percentage utilization of resource by activities:
Activity
Production Machine
Setups Runs Products Time
Indirect labor (including fringe benefits) 50% 40% 10% 0%
Information technology (IT) 0 80 20 0
Machinery depreciation 0 0 0 100
Machinery maintenance 0 0 0 100
Energy 0 0 0 100

Costs assigned to activiities:


Activity
Production Machine
Cost Setups Runs Products Time
Indirect labor $28,000 $14,000 $11,200 $2,800 $ 0
IT 10,000 0 8,000 2,000 0
Machinery depreciation 8,000 0 0 0 8,000
Machinery maintenance 4,000 0 0 0 4,000
Energy 2,000 0 0 0 2,000
Total $52,000 $14,000 $19,200 $4,800 $14,000
÷ Activity 560 hours 110 runs 4 products 10,000 hrs
Cost driver rates $25 $174.55 $1,200 $1.40

©The McGraw-Hill Companies, Inc., 2017


474 Fundamentals of Cost Accounting
9-65. (continued)

b.

Unit Costs on Cola Bottling Line


Diet Regular Cherry Grape Total
Materials $ 25,000 $ 20,000 $ 4,680 $ 550 $ 50,230
Direct labor 10,000 8,000 1,800 200 20,000
Fringe benefits on direct labor 4,000 3,200 720 80 8,000
a
Setup costs 5,000 1,500 6,000 1,500 14,000
b
Production run costs 6,982 5,236 5,236 1,746 19,200
c
Product costs 1,200 1,200 1,200 1,200 4,800
d
Machine costs 7,000 5,600 1,260 140 14,000
Total costs $59,182 $44,736 $20,896 $ 5,416 $130,230
Volume 50,000 40,000 9,000 1,000
Cost per unit $1.18 $1.12 $2.32 $5.42
a
$5,000 = $25 per setup hour x 200 setup hours.
b
$6,982 = $174.55 per production run x 40 production runs.
c
$1,200 = $1,200 per product.
d
$7,000 = $1.40 per machine hour x 5,000 machine hours.

©The McGraw-Hill Companies, Inc., 2014


Solutions Manual, Chapter 9 475
9-65. (continued)

c.

Monthly Report on Cola Bottling Line


Diet Regular Cherry Grape Total
Sales revenue $75,000 $60,000 $13,950 $1,650 $150,600
Costs 59,182 44,736 20,896 5,416 130,230
Gross margin $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.

©The McGraw-Hill Companies, Inc., 2017


476 Fundamentals of Cost Accounting