BCO322 BUDGETING AND CONTROL

Week 10: Activity-Based Costing (chapter 17)

BRIEF EXERCISE 17.9 Selecting Activity Bases

Listed are the eight activity cost pools used by Charvez Corporation.
1. Production set-up costs
2. Heating costs
3. Machinery power costs
4. Purchasing department costs
5. Maintenance costs
6. Design and engineering costs
7. Materials warehouse costs
8. Product inspection costs
Suggest an appropriate activity base for allocating each of the activity cost pools to products.
(Consider each cost pool independently.)

Suggested activity bases for allocating the company’s activity-cost pools are listed below:

Production set-up costs: The number of set-ups required (or, perhaps, number of production runs).

Heating costs: The square feet of production space occupied by each product line.

Machinery power costs: The total machine hours required to manufacture each product.

Purchasing department costs: The number of purchase orders related to each product line.

Maintenance costs: The number of work orders related to each product line.

Design and engineering costs: The number of design or engineering change orders generated.

Materials warehouse costs: The percent of total square feet in the materials warehouse occupied by
each product line (number of component parts per product line).

Product inspection costs: The number of inspections related to each product line (rate of defects).
BRIEF EXERCISE 17.10 Allocations in an ABC System

Danato, Inc., applies manufacturing overhead to production using an

activity-based costing system. The company's utilities cost pool has
accumulated $180,000, its maintenance cost pool has accumulated
$240,000, and its set-up cost pool has accumulated $60,000. The
company has two product lines, Deluxe and Basic. The utilities cost
pool is allocated to these product lines on the basis of machine-hours.
The maintenance pool is allocated on the basis of work orders. The set-
up pool is allocated on the basis of production runs.

a. Allocate the utilities cost pool to each product line assuming the
Deluxe model used 6,400 machine-hours and the Basic
model used 1,600 machine-hours.

STEP 1.
Machine Hours Percent

Deluxe 6,400 80%

Basic 1,600 20%

Total 8,000 100%

STEP 2.

Utility Cost

Deluxe $180,000 x 80% = $144,000

Basic $180,000 x 20% = $36,000

$180,000
b. Allocate the maintenance pool to each product line assuming the
Deluxe model required 50 work orders and the Basic model
required 150 work orders.

STEP 1.
Work Orders Percent

Deluxe 50 25%
Basic 150 75%
Total 200 100%

STEP 2.

Maintenance cost

Deluxe $240,000 x 25% = $60,000

Basic $240,000 x 75% = $180,000
$240,000

c. Allocate the set-up pool to each product line assuming the

Deluxe model required 30 production runs and the Basic
model required 70 production runs.

STEP 1.
Production runs Percent

Deluxe 30 30%
Basic 70 70%
Total 100 100%
STEP 2.

Set-up cost

Deluxe $60,000 x 30% = $18,000

Basic $60,000 x 70% = $42,000
$60,000
EXERCISE 17.14 Allocating Activity Cost Pool

Costume Kings has two product lines: machine-made costumes and

hand-made costumes. The company assigns $80,000 in
manufacturing overhead costs to two cost pools: power costs and
inspection costs. Of this amount, the power cost pool has been assigned
$32,000 and the inspection cost pool has been assigned $48,000.
Additional information about each product line is shown as follows.

Machine-Made Hand-Made
Sales revenue $240,000 $160,000
Direct labor and materials costs $ 120,000 $ 96,000
Units produced and sold 48,000 16,000
Machine-hours 96,000 4,000
Square feet of production space 1,200 800
Material orders received 150 100
Quality control inspection hours 2,000 500

a. Allocate the manufacturing overhead from the activity cost pools

to each product line. Use what you believe are the most
significant cost drivers from the information provided.

Power cost pool:

STEP 1.

Machine Hours Percent

Machine-made 96,000 96%

Hand-made 4,000 4%
Total 100,000 100%

STEP 2.

Machine-made $32,000 x 96% = $30,720

Hand-made $32,000 x 4% = $1,280
$32,000
 Inspection cost pool:

STEP 1.

Inspection Hours Percent

Machine-made 2,000 80%

Hand-made 500 20%
Total 2,500 100%

STEP 2.

Machine-made $48,000 x 80% = $38,400

Hand-made $48,000 x 20% = $9,600
$48,000

b. Compute the cost per unit of machine-made costumes and

hand-made costumes.

Machine-Made Hand-Made

Direct labor and materials costs $ 120,000 $ 96,000

Manufacturing overhead:

Power costs $30,720 $1,280

Inspection costs $38,400 $9,600

TOTAL MANUFACTURING COSTS $189,120 $106,880

Units produced and sold 48,000 16,000

COST PER UNIT $3.94 $6.68

 c. On a per-unit basis, which product line appears to be the most
profitable? Explain.

Machine-Made Hand-Made

Sales revenue $240,000 $160,000

Less: MANUFACTURING COSTS $189,120 $106,880

Profit $50,880 $53,120

Units produced and sold 48,000 16,000

PROFIT PER UNIT $1.06 $3.32

EXERCISE 17.15 Using ABC to Determine a Bid Price

Spear Custom Furniture uses an activity-based cost accounting system to

apply overhead to production. The company maintains four overhead
cost pools. The four cost pools, and their budgeted amounts for the
upcoming period, are as follows.

Maintenance $40,000
Materials handling 20,000
Set-ups 10,000
Quality control 45,000

Four cost drivers are used by Spear to allocate its overhead cost pools to
production. The four cost drivers, and their budgeted total levels of
activity for the upcoming period, are shown as follows.

Machine-hours (to allocate maintenance costs) 600 hours

Material moves (to allocate materials handling costs) 400 moves
Set-ups (to allocate set-up costs) 100 set-ups
Number of inspections (to allocate quality control costs) 300 inspections
The company has been asked by Cosmopolitan University to submit a bid
for tables to be used in a new computer lab. The plant manager feels that
obtaining this job would result in new business in future years. Estimates
for the Cosmopolitan University project are as follows.

Direct materials $14,000

Direct labor (500 hours) $15,000
Number of machine-hours 60
Number of material moves 20
Number of set-ups 4
Number of inspections 2

a. Estimate the total cost of manufacturing the tables for

Cosmopolitan University.

Direct materials $14,000

Direct labor (500 hours) $15,000

Manufacturing Overhead:

Maintenance $40,000 x 60/600 hours = $4,000

Materials handling 20,000 x 20/400 moves = $1,000

Set-ups 10,000 x 4/100 setups = $400

Quality control 45,000 x 2/300 inspections = $300

Total Manufacturing Cost $34,700

b. Determine the company’s bid price if bids are based upon the
total estimated manufacturing cost of a particular project, plus
75 percent.

Bid Price = $34,700 x 175% = $60,725

PROBLEM 17.6A Applying Overhead Costs Using ABC Page 794-795

Norton Chemical Company produces two products: Amithol and Bitrite.

The company uses activity-based costing (ABC) to allocate
manufacturing overhead to these products. The costs incurred by
Norton’s Purchasing Department average $80,000 per year and
constitute a major portion of the company’s total manufacturing
overhead.
Purchasing Department costs are assigned to two activity cost pools: (1)
the order cost pool and (2) the inspection cost pool. Costs are assigned to
the pools based on the number of employees engaged in each activity. Of
the department’s five full-time employees, one is responsible for
ordering raw materials, and four are responsible for inspecting incoming
shipments of materials.
Costs assigned to the order pool are allocated to products based on the
total number of purchase orders generated by each product line. Costs
assigned to the inspection pool are allocated to products based on the
number of inspections related to each product line.
For the upcoming year, Norton estimates the following activity levels.

Total Amithol Bitrite

Purchase orders generated 10,000 2,000 8,000
Inspections conducted 2,400 1,800 600

In a normal year, the company conducts 2,400 inspections to sample the

quality of raw materials. The large number of Amithol-related
inspections is due to quality problems experienced in the past. The
quality of Bitrite materials has been consistently good.

Instructions

a. Assign the Purchasing Department’s costs to the individual cost

pools.

1 employee responsible for ordering 1 20%

4 employees responsible for inspecting 4 80%
Total 5 100%
order cost pool $80,000 x 20% = $16,000

inspection cost pool $80,000 x 80% = $64,000

Total Purchasing Department costs $80,000

b. Allocate the order cost pool to the individual product lines.

STEP 1.

Total Amithol Bitrite

Purchase orders generated 10,000 2,000 8,000

Percent 100% 20% 80%

STEP 2.

Amithol $16,000 x 20% = $3,200

Bitrite $16,000 x 80% = $12,800

Order cost pool $16,000

c. Allocate the inspection cost pool to the individual product lines.

STEP 1.

Total Amithol Bitrite

Inspections conducted 2,400 1,800 600

Percent 100% 75% 25%

STEP 2.

Amithol $64,000 x 75% = $48,000

Bitrite $64,000 x 25% = $16,000

Inspection cost pool $64,000

d. Suggest how Norton might reduce manufacturing costs incurred

by the Purchasing Department.

Norton might control manufacturing overhead costs incurred by the

purchasing department in two ways:

(1) The company needs to work more closely with the supplier of
materials used to make Amithol in an attempt to improve the quality of
materials being received. If this quality control problem can be solved,
fewer quality control inspections will be needed, and the $48,000 of
related costs can be reduced.

(2) If possible, the company needs to consider making larger orders of

Bitrite material on a less frequent basis. This might enable the company
to cut costs by replacing the full-time order clerk with a part-time order
clerk, and to thereby reduce the $16,000 cost currently assigned to the
order cost pool.