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Activity Based Costing
Activity Based Costing
TRUE-FALSE STATEMENTS
1. Traditional costing systems use multiple predetermined overhead rates.
2. Traditionally, overhead is allocated based on direct labor cost or direct labor hours.
3. Current trends in manufacturing include less direct labor and more overhead.
4. Activity-based costing allocates overhead to multiple cost pools and assigns the cost
pools to products using cost drivers.
5. A cost driver does not generally have a direct cause-effect relationship with the resources
consumed.
6. The first step in activity-based costing is to assign overhead costs to products, using cost
drivers.
7. To achieve accurate costing, a high degree of correlation must exist between the cost
driver and the actual consumption of the activity cost pool.
8. Low-volume products often require more special handling than high-volume products.
9. When overhead is properly assigned in ABC, it will usually decrease the unit cost of high-
volume products.
14. ABC is particularly useful when product lines differ greatly in volume and manufacturing
complexity.
15. ABC is particularly useful when overhead costs are an insignificant portion of total costs.
17. Any activity that increases the cost of producing a product is a value-added activity.
19. Nonvalue-added activities increase the cost of a product but not its market value.
21. Not all activities labeled nonvalue-added are totally wasteful, nor can they be totally
eliminated.
22. The overall objective of installing ABC in service firms is no different than it is in a
manufacturing company.
24. The general approach to identifying activities, activity cost pools, and cost drivers is used
by a service company in the same manner as a manufacturing company.
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. F 6. F 11. F 16. T 21. T 26. F
2. T 7. T 12. T 17. F 22. T 27. T
3. T 8. T 13. F 18. T 23. F 28. F
4. T 9. F 14. T 19. T 24. T *29. F
5. F 10. T 15. F 20. F 25. T *30. F
4-3 Activity-Based Costing
33. An activity that has a direct cause-effect relationship with the resources consumed is a(n)
a. cost driver.
b. overhead rate.
c. cost pool.
d. product activity.
34. Which best describes the flow of overhead costs in an activity-based costing system?
a. Overhead costs Ú direct labor cost or hours Ú products
b. Overhead costs Ú products
c. Overhead costs Ú activity cost pools Ú cost drivers Ú products
d. Overhead costs Ú machine hours Ú products
37. One of Lara Dole Company's activity cost pools is machine setups, with estimated
overhead of $300,000. Dole produces flares (400 setups) and health packs (600 setups).
How much of the machine setup cost pool should be assigned to flares?
a. $0.
b. $120,000.
c. $150,000.
d. $180,000.
38. Which would be an appropriate cost driver for the ordering and receiving activity cost pool?
a. Machine setups
b. Purchase orders
c. Machine hours
d. Inspections
4-4 Test Bank for Managerial Accounting, Second Edition
40. In Japan,
a. activity-based costing is used more than in the U.S.
b. companies prefer volume measures such as direct labor hours to assign overhead costs.
c. labor cost reduction is less of a priority.
d. developing more accurate product costs is more of a priority.
46. Which of the following factors would suggest a switch to activity-based costing?
a. Product lines similar in volume and manufacturing complexity.
b. Overhead costs constitute a significant portion of total costs.
c. The manufacturing process has been stable.
d. Production managers use data provided by the existing system.
51. The presence of any of the following factors would suggest a switch to ABC except when
a. product lines differ greatly in volume.
b. overhead costs constitute a minor portion of total costs.
c. the manufacturing process has changed significantly.
d. production managers are ignoring data provided by the existing system.
56. All of the following are examples of a value-added activity in a service company except
a. delivering packages by a delivery service.
b. ordering supplies.
c. performing surgery.
d. providing legal research for legal services.
57. Activity-based costing has been found to be useful in each of the following service
industries except
a. banks.
b. hospitals.
c. telephone companies.
d. ABC has been useful in any of these industries.
65. Under just-in-time processing, all of the following are received or completed “just in time”
except
a. finished goods.
b. raw materials.
c. subassembly parts.
d. supplies.
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
31. d 37. b 43. c 49. d 55. b 61. c *67. d
32. a 38. b 44. b 50. c 56. b 62. d *68. a
33. a 39. b 45. d 51. b 57. d 63. a *69. a
34. c 40. b 46. b 52. a 58. c 64. d *70. c
35. c 41. a 47. a 53. c 59. b 65. d
36. d 42. d 48. d 54. d 60. d *66. b
EXERCISES
Ex. 71
Reese Corporation manufactures easy chairs and recliners. The following information is
available:
Easy Chairs Recliners Total Cost
Machine setups 200 600 $16,000
Inspections 250 500 $27,000
Labor hours 2,600 2,400
Reese is considering switching from one overhead rate based on labor hours to activity-based
costing.
Instructions
Perform the following analyses for these two components of overhead:
1. Compute total machine setups and inspection costs assigned to each product, using a single
overhead rate.
2. Compute total machine setups and inspection costs assigned to each product, using activity-
based costing.
3. Comment on your findings.
2. Activity-based costing
Machine setups: $16,000 ÷ 800 = $20 per setup
Solution 71 (cont.)
3. The use of activity-based costing resulted in the allocation of less cost to easy chairs and
more cost to recliners. The change in cost allocation reflects a more accurate allocation
based on cause and effect.
Ex. 72
Vid-saver, Inc. has five activity cost pools and two products (a budget tape rewinder and a deluxe
tape rewinder). Information is presented below:
Instructions
Compute the overhead cost per unit for each product. Production is 700,000 units of Budget and
200,000 units of Deluxe.
Budget Deluxe
Cost Cost Cost Cost
Activity Cost Pool Driver × Rate = Assigned Driver × Rate = Assigned
Ordering & Receiving 600 $120 $ 72,000 400 $120 $ 48,000
Machine Setup 500 330 165,000 400 330 132,000
Machining 150,000 6 900,000 100,000 6 600,000
Assembly 1,200,000 .60 720,000 800,000 .60 480,000
Inspection 550 300 165,000 450 300 135,000
$2,022,000 $1,395,000
÷ 700,000 ÷ 200,000
$2.89 per unit $6.98 per unit
4-10 Test Bank for Managerial Accounting, Second Edition
Ex. 73
Ms. Bentley owns a small department store in a metropolitan area. For twenty years, the
accountant has applied overhead to the various departments—Women's Apparel, Men's Apparel,
Cosmetics, Housewares, Shoes, and Electronics—based on the basis of employee hours
worked. Ms. Bentley's daughter, who is an accounting student at a local university, has suggested
her mother should consider using activity-based costing (ABC). In an attempt to implement ABC,
Ms. Bentley and her daughter have identified the following activities.
Instructions
Determine a cost driver for each of the activities listed below.
Cost Pool Cost Driver
a. Placing orders ______________________________
b. Stocking merchandise ______________________________
c. Waiting on customers ______________________________
d. Janitorial and Maintenance ______________________________
e. Training employees ______________________________
f. Administrative ______________________________
g. Advertising and Marketing ______________________________
h. Accounting and Legal Services ______________________________
i. Wrapping packages ______________________________
Ex. 74
A list of possible cost drivers is presented below:
Code Code
A Engineering hours D Number of subassemblies
B Setups E Boxes
C Machine hours F Orders
Instructions
For each of the following activity cost pools, select the most appropriate cost driver:
_____ 5. Machining
_____ 6. Assembly
1. B 4. A
2. F 5. C
3. E 6. D
Ex. 75
Identify appropriate cost drivers for the following activity cost pools:
1. Human resources
2. Security
3. Receiving
4. Data processing
Ex. 76
Two of the activity cost pools for Sabrina Company are (a) machining ($800,000) and (b)
inspections ($84,000). Possible cost drivers are direct labor hours (5,000), machine hours
(25,000), square footage (4,000), and number of inspections (300).
Instructions
Compute the overhead rate for each activity.
$84,000
(b) Inspections: ———————- = $280 per inspection
300 inspections
Ex. 77
Tanner, Inc. produces two models of cameras, Standard and Luxury. They sell 100,000 Standard
cameras and 15,000 Luxury cameras annually. Tanner switched from traditional costing to
activity-based costing and discovered that the cost allocated to Luxury cameras increased so
dramatically that the Luxury was now only marginally profitable.
Instructions
Give a probable explanation for this shift.
Ex. 78
Compute activity-based costing rates from the following budgeted data for Freddy's Fashions:
Ex. 79
Cool Designs manufactures metal trim used for a variety of projects. Cool Designs' activity-based
costing overhead rates are:
Purchasing $170 per order
Storing $1 per square foot/days
Machining $50 per machine hour
Supervision $2 per direct labor hour
Job 319 involved three purchase orders, 4,000 square feet/days, 60 machine hours, and 30 direct
labor hours. The cost of direct materials on the job was $8,500 and the direct labor rate is $15
per hour.
Instructions
Determine the total cost of Job 319.
Ex. 80
Label the following costs as value-adding (VA) or nonvalue-adding (NVA):
____ 1. Engineering design
____ 2. Machine repair
____ 3. Inventory storage
____ 4. Machining
____ 5. Assembly
____ 6. Painting
____ 7. Inspections
____ 8. Packaging
4-14 Test Bank for Managerial Accounting, Second Edition
Ex. 81
Borke and Falvery is a law firm that uses activity-based costing. Classify these activities as value-
added or nonvalue-added:
_______________ 1. Taking appointments
_______________ 2. Reception
_______________ 3. Meeting with clients
_______________ 4. Bookkeeping
_______________ 5. Court time
_______________ 6. Meeting with opposing attorneys
_______________ 7. Billing
_______________ 8. Advertising
Ex. 82
Brewer & Carr, PSC is an architectural firm that uses activity-based costing. The three activity
cost pools used by Brewer & Carr are: Salaries and Wages, Travel Expense, and Plan
Reproduction Expense. The firm has provided the following information concerning activity and
costs:
Salaries and wages $360,000
Travel expense 80,000
Plan reproduction expense 120,000
Total $560,000
Activity Cost Pools
Project Business
Assignment Development Other
Salaries and wages 60% 30% 10%
Travel expense 40% 40% 20%
Plan reproduction expense 30% 40% 30%
4-15 Activity-Based Costing
Ex. 82 (cont.)
Instructions
Calculate the total cost to be allocated to the (a) Project Assignment, (b) Business Development,
and (c) Other activity cost pools.
Ex. *83
Tim Taylor Tool Company manufactures small tools. Classify each of the following activity costs
of the tool company as either unit level, batch level, product level, or facility level:
_______________ 1. Plant management
_______________ 2. Drilling
_______________ 3. Painting
_______________ 4. Machine setups
_______________ 5. Product design
_______________ 6. Cutting
_______________ 7. Inspection
_______________ 8. Inventory management
COMPLETION STATEMENTS
84. In traditional costing systems, direct labor cost is often used for the assignment of all
____________________.
85. A __________________ is any activity that has a direct cause-effect relationship with the
resources consumed.
87. The number of ___________________ is an appropriate cost driver for the ordering and
receiving activity cost pool.
89. When product lines differ greatly in volume and manufacturing complexity, a switch from
traditional costing to ___________________ is indicated.
*93. In the hierarchy of activity levels, the four levels are __________, ___________,
____________, and _____________.
MATCHING
95. Match the items in the two columns below by entering the appropriate code letter in the
space provided.
_____ 1. Allocates overhead to multiple activity cost pools, then assigns the activity cost pools
to products.
_____ 2. An activity that has a direct cause-effect relationship with the resources consumed.
_____ 8. Assembling.
Answers to Matching
1. E 6. H
2. B 7. G
3. J 8. D
4. I 9. F
5. C 10. A
4-18 Test Bank for Managerial Accounting, Second Edition
Solution 96
Borg Corporation must first identify the major activities that pertain to the manufacture of specific
products, then allocate manufacturing overhead to activity cost pools. Next, Borg must identify
the cost drivers that accurately measure each activity's contribution to the finished product and
compute activity-level overhead rates for each pool. Finally, the manufacturing overhead costs
for each activity pool must be allocated to products, using the activity-based overhead rates.
S-A E 97
Seven Company produces phasers (sales of 200,000 units per year) and force field enhancers
(sales of 25,000 units per year). If Seven switches from traditional costing to activity-based
costing, what is the likely effect on overhead assigned to the two products?
Solution 97
When overhead is properly assigned in ABC, it will usually increase the unit cost of low-volume
products like the force field enhancers. This is because low-volume products often require more
special handling, such as machine setups and inspections, than high-volume products. Also,
overhead costs incurred by low-volume products often are disproportionate to a traditional
allocation base.
S-A E 98
What are the conditions that would indicate to the management of a firm that they should switch
from traditional costing to activity-based costing?
Solution 98
The presence of one or more of the following conditions indicates ABC as the superior costing
system:
1) Product lines differ greatly in volume and manufacturing complexity.
2) Product lines are numerous, diverse, and require differing degrees of support services.
3) Overhead costs constitute a significant portion of total costs.
4) The manufacturing process or the number of products has changed significantly.
5) Production or marketing managers are ignoring data provided by the existing system and are,
instead, using alternative data in decision-making.