CHAPTER 5

SOLUTIONS TO EXERCISES
EXERCISE 5-26 (15 MINUTES)

1. Material-handling cost per lens:

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

*The total number of direct-labor hours.

An alternative calculation, since both types of product use the same amount of the
cost driver, is the following:

$50,000
 $1,000
50*

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

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

3. Material-handling cost per lens:

$50,000
 5†
(5  15) *
 $500
25

*The total number of material moves.

†The number of material moves for the lens product line.

4. Material-handling cost per mirror:

$50,000
 15 *
(5  15)
 $1,500
25

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

5-1
EXERCISE 5-27 (15 MINUTES)

1. a. Quality-control costs assigned to the Satin Sheen line under the traditional system:

Quality-control costs = 14.5%  direct-labor cost

Quality-control
costs assigned to
Satin Sheen line = 14.5%  $27,500
= $3,988 (rounded)

b. Quality-control costs assigned to the Satin Sheen line under activity-based costing:

Quantity for Assigned

Activity Pool Rate Satin Sheen Cost
Incoming material inspection ....... $11.50 per type .... 12 types ........ $ 138
In-process inspection ................... .14 per unit ..... 17,500 units .. 2,450
Product certification...................... 77.00 per order ... 25 orders....... 1,925
Total quality-control costs assigned ........................................................... $4,513

2. The traditional product-costing system undercosts the Satin Sheen product line, with
respect to quality-control costs, by $525 ($4,513 – $3,988).

SOLUTIONS TO PROBLEMS
PROBLEM 5-46 (30 MINUTES)

1. Predetermined overhead rate = budgeted overhead ÷ budgeted direct-labor hours

= $800,000 ÷ 25,000* = $32 per direct labor hour

*25,000 budgeted direct-labor hours = (3,000 units of Standard)(3 hrs./unit) +

(4,000 units of Enhanced)(4 hrs./unit)

Standard Enhanced

Direct material……………. $ 25 $ 40
Direct labor:
3 hours x $12………… 36
4 hours x $12………… 48
Manufacturing overhead:
3 hours x $32………… 96
4 hours x $32………… 128
Total cost…………………. $157 $216

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2. Activity-based overhead application rates:

Activity Cost Application

Activity Cost Driver Rate

Order $150,000 ÷ 500 orders = $300 per OP

processing processed (OP)

Machine 560,000 ÷ 40,000 machine = $14 per MH

processing hrs. (MH)

Product 90,000 ÷ 10,000 inspection = $9 per IH

inspection hrs. (IH)

Order processing, machine processing, and product inspection costs of a Standard

unit and an Enhanced unit:

Activity Standard Enhanced

Order processing:
300 OP x $300……………... $ 90,000
200 OP x $300……………... $ 60,000
Machine processing:
18,000 MH x $14…………... 252,000
22,000 MH x $14…………... 308,000
Product inspection:
2,000 IH x $9……………….. 18,000
8,000 IH x $9………………. 72,000
Total $360,000 $440,000
Production volume (units) 3,000 4,000
Cost per unit $120* $110**

* $360,000 ÷ 3,000 units = $120

** $440,000 ÷ 4,000 units = $110

The manufactured cost of a Standard unit is $181, and the manufactured cost of an
Enhanced unit is $198:

Standard Enhanced

Direct material………………………………. $ 25 $ 40
Direct labor:

5-3
 3 hours x $12…………………………… 36
4 hours x $12…………………………… 48
Order processing, machine processing,
and product inspection……………….. 120 110
Total cost……………………………………. $181 $198

3. a. The Enhanced product is overcosted by the traditional product-costing

system. The labor-hour application base resulted in a $216 unit cost; in
contrast, the more accurate ABC approach yielded a lower unit cost of $198.
The opposite situation occurs with the Standard product, which is
undercosted by the traditional approach ($157 vs. $181 under ABC).

b. Yes, especially since the company’s selling prices are based heavily on cost.
An overcosted product will result in an inflated selling price, which could
prove detrimental in a highly competitive marketplace. Customers will be
turned off and will go elsewhere, which hurts profitability. With undercosted
products, selling prices may be too low to adequately cover a product’s more
accurate (higher) cost. This situation is also troublesome and will result in a
lower income being reported for the company.

4. In the electronic version of the solutions manual, press the CTRL key and click on
the following link: Build a Spreadsheet 05-46.xls

PROBLEM 5-49 (30 MINUTES)

1. Type A manufacturing overhead cost:

16,000 machine hours x $80 = $1,280,000
$1,280,000 ÷ 8,000 units = $160 per unit

Type B manufacturing overhead cost:

22,500 machine hours x $80 = $1,800,000
$1,800,000 ÷ 15,000 units = $120 per unit

Type A Type B

Direct material………………. $ 35 $ 60
Direct labor………………….. 20 20
Manufacturing overhead…. 160 120
Unit cost………………… $215 $200

5-4
2. Activity-based application rates:

Activity Application
Activity Cost Driver Rate

Manufacturing $ 672,000 ÷ 80 setups (SU) = $8,400 per SU

setups

Machine 1,848,000 ÷ 38,500 machine = $48 per MH

processing hours (MH)

Product 560,000 ÷ 175 outgoing = $3,200 per OS

shipping shipments (OS)

Manufacturing setup, machine processing, and product shipping costs of a Type A

unit and a Type B unit:

Activity Type A Type B

Manufacturing setups:
50 SU x $8,400…………….. $ 420,000
30 SU x $8,400…………….. $ 252,000
Machine processing:
16,000 MH x $48…………... 768,000
22,500 MH x $48…………... 1,080,000
Product shipping:
100 OS x $3,200…………… 320,000
75 OS x $3,200…………….. 240,000
Total ……………………………. $1,508,000 $1,572,000

Production volume (units)…. 8,000 15,000

Cost per unit………………….. $188.50* $104.80**

* $1,508,000 ÷ 8,000 units = $188.50

** $1,572,000 ÷ 15,000 units = $104.80

The manufactured cost of a Type A cabinet is $243.50, and the manufactured cost of
a Type B cabinet is $184.80. The calculations follow:

5-5
 Type A Type B

Direct material………………………………… $ 35.00 $ 60.00

Direct labor……………………………………. 20.00 20.00
Manufacturing setup, machine
processing, and outgoing shipments.. 188.50 104.80
Total cost………………………………………. $243.50 $184.80

3. Yes, the Type A storage cabinet is undercosted. The use of machine hours
produced a unit cost of $215; in contrast, the more accurate activity-based-costing
approach shows a unit cost of $243.50. The difference between these two amounts
is $28.50.

4. No, the discount is not advisable. The regular selling price of $260, when compared
against the more accurate ABC cost figure, shows that each sale provides a profit to
the firm of $16.50 ($260.00 - $243.50). However, a $30 discount will actually produce
a loss of $13.50 ($243.50 - $230.00), and the more units that are sold, the larger the
loss. Notice that with the less-accurate, machine-hour-based figure ($215), the
marketing manager will be misled, believing that each discounted unit sold would
boost income by $15 ($230 - $215).

5-6
PROBLEM 5-50 (35 MINUTES)

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

2. Allocation of administrative cost based on billable hours:

Information systems: 3,100 ÷ 5,000 = 62%; $342,000 x 62% = $212,040

E-commerce consulting: 1,900 ÷ 5,000 = 38%; $342,000 x 38% = $129,960

Information
Systems E-Commerce
Services Consulting
Billings:
3,100 hours x $125………… $387,500
1,900 hours x $125………… $237,500
Less: Professional staff cost:
3,100 hours x $45……. (139,500)
1,900 hours x $45……. (85,500)
Administrative cost……. (212,040) (129,960)
Income…………………………… $ 35,960 $ 22,040

Income ÷ billings………………. 9.28% 9.28%

3. Activity-based application rates:

Activity Application
Activity Cost Driver Rate

Staff support $180,000 ÷ 250 clients = $720 per client

In-house 136,400 ÷ 4,400 computer = $31 per CH

computing hours (CH)

Miscellaneous 25,600 ÷ 1,000 client = $25.60 per CT

office charges transactions (CT)

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

systems services and e-commerce consulting:

5-7
 Information
Systems E-Commerce
Activity Services Consulting

Staff support:
200 clients x $720…………... $144,000
50 clients x $720……………. $ 36,000
In-house computing:
2,600 CH x $31………………. 80,600
1,800 CH x $31………………. 55,800
Miscellaneous office charges:
400 CT x $25.60……………... 10,240
600 CT x $25.60……………... 15,360
Total ………………………………. $234,840 $107,160

Profitability of information systems services and e-commerce consulting:

Information
Systems E-Commerce
Services Consulting
Billings:
3,100 hours x $125……….. $387,500
1,900 hours x $125……….. $237,500
Less: Professional staff cost:
3,100 hours x $45…… (139,500)
1,900 hours x $45…… (85,500)
Administrative cost……. (234,840) (107,160)
Income………………………….. $ 13,160 $ 44,840

Income ÷ billings……………... 3.40% 18.88%

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

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

5-8
PROBLEM 5-52 (40 MINUTES)

1. Overhead to be assigned to film development chemical order:

Assigned
Activity Cost Pool Level of Overhead
Pool Rate Cost Driver Cost
Machine setups $2,000 per setup  5 setups $10,000
Material handling $2 per pound  10,000 pounds 20,000
Hazardous waste control $5 per pound  2,000 pounds 10,000
Quality control $75 per inspection  10 inspections 750
Other overhead costs $10 per machine  500 machine hours 5,000
hour
Total $45,750

2. Overhead cost per 45,750

=  $45.75 per box
box of chemicals 1,000 boxes

3. Predetermined total budgeted overhead cost $625,000

= 
overhead rate total budgeted machine hours 20,000
= $31.25 per machine hr.

4. Overhead to be assigned to film development chemical order, given a single

predetermined overhead rate:

a. Total overhead assigned = $31.25 per machine hr.  500 machine hr.
= $15,625

b. Overhead cost per $15,625

=  $15.625 per box
box of chemicals 1,000 boxes

5. The film development chemicals entail a relatively large number of machine setups, a
large amount of hazardous materials, and several inspections. Thus, they are quite
costly in terms of driving overhead costs. Use of a single predetermined overhead rate
obscures this characteristic of the production job. Underestimating the overhead cost
per box could have adverse consequences for the company. For example, it could
lead to poor decisions about product pricing. The activity-based costing system will
serve management much better than the system based on a single, predetermined
overhead rate.

5-9
PROBLEM 5-53 (20 MINUTES)

1. Unit cost calculation:

(a) Overhead assigned to photographic plates:

Assigned
Activity Cost Pool Level of Overhead
Pool Rate Cost Driver Cost
Machine setups $2,000 per setup  3 setups $ 6,000
Material handling $2 per pound  900 pounds 1,800
Hazardous waste control $5 per pound  300 pounds 1,500
Quality control $75 per inspection  3 inspections 225
Other overhead costs $10 per machine hour  50 machine hours 500
Total $10,025

$10,025
Overhead cost per unit   $100.25
100 plates

(b) Unit cost per plate:

Direct material ............................... $120.00

Direct labor .................................... 40.00
Manufacturing overhead .............. 100.25
Total cost per plate ....................... $260.25

5-10
PROBLEM 5-54 (45 MINUTES)

1. AN ABC SYSTEM IS A TWO-STAGE PROCESS OF ASSIGNING COSTS TO PRODUCTS.

IN STAGE ONE, ACTIVITY-COST POOLS ARE ESTABLISHED. IN STAGE TWO A COST
DRIVER IS IDENTIFIED FOR EACH ACTIVITY-COST POOL. THEN THE COSTS IN EACH
POOL ARE ASSIGNED TO EACH PRODUCT LINE IN PROPORTION TO THE AMOUNT OF
THE COST DRIVER CONSUMED BY EACH PRODUCT LINE.

2. Montreal Electronics should not continue with its plans to emphasize the Royal model
and phase out the Nova model. As shown in the following activity-based costing
analysis, the Royal model has a contribution margin of less than 3 percent, while the
Nova model generates a contribution margin of nearly 43 percent.

Cost per event for each cost driver:

Soldering .................... $ 942,000  1,570,000 = $ .60 per solder joint

Shipments .................. 860,000  20,000 = 43.00 per shipment
Quality control ........... 1,240,000  77,500 = 16.00 per inspection
Purchase orders ........ 950,400  190,080 = 5.00 per order
Machine power .......... 57,600  192,000 = .30 per hour
Machine setups ......... 750,000  30,000 = 25.00 per setup
Costs per model:

Royal Nova
Direct costs:
Materiala ...................................................................... $2,336,000 $ 4,576,000
Direct laborb................................................................ 168,000 396,000
Machine hoursc .......................................................... 288,000 3,168,000
Total direct costs............................................................... $2,792,000 $ 8,140,000

Assigned costs:
Solderingd ................................................................... $ 231,000 $ 711,000
Shipmentse ................................................................. 163,400 696,600
Quality controlf ........................................................... 340,800 899,200
Purchase ordersg ....................................................... 549,900 400,500
Machine powerh.......................................................... 4,800 52,800
Machine setupsi ......................................................... 350,000 400,000
Total assigned costs ......................................................... $1,639,900 $ 3,160,100
Total cost ........................................................................... $4,431,900 $11,300,100

Calculations follow.

5-11
PROBLEM 5-54 (CONTINUED)

Calculations:
Royal Nova

aMaterial .........................................
4,000  $584 22,000  $208
bDirect labor................................... 4,000  $42 22,000  $18
cMachine hours ............................. 4,000  $72 22,000  $144
dSoldering ......................................
385,000  $.60 1,185,000  $.60
eShipments ....................................
3,800  $43 16,200  $43
fQuality control ..............................
21,300  $16 56,200  $16
gPurchase orders ..........................
109,980  $5 80,100  $5
hMachine power.............................
16,000  $.30 176,000  $.30
iMachine setups ............................
14,000  $25 16,000  $25

Profitability analysis:

Royal Nova Total

Sales ............................................................... $4,560,000 $19,800,000 $24,360,000
Less: Cost of goods sold ............................. 4,431,900 11,300,100 15,732,000
Gross margin ................................................. $ 128,100 $ 8,499,900 $ 8,628,000
Units sold ....................................................... 4,000 22,000

Per-unit calculations:
Selling price ........................................... $1,140.00 $900.00
Less: Cost of goods sold...................... 1,107.98 513.64
Contribution margin .............................. $ 32.02 $386.36
Contribution margin percentage .......... 2.8%a 42.9%b

a$32.02/$1,140.00 = 2.8%
b$386.36/$900.00 = 42.9%

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