Lanen - Fundamentals of Cost Accounting - 6e - Chapter 9 - Solution Manual

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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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.
484 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.

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.

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

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.
9-29.
Job costing and ABC systems are not mutually exclusive, although it might seem that
way. A job costing system is designed to cost certain cost objects, called jobs. It does
this by tracing direct costs (materials and labor) to the jobs and applies overhead to the
jobs based on the application base. Although in chapter 7 we assumed only one
application base, there was nothing that restricted us from developing multiple overhead
pools based on activities and then allocating costs from the activities to the individual
jobs.
9-30.
Knowing the cost per minute in the three areas can help hospital administrators make
decisions about utilizing the three areas and where to treat patients or scheduling
procedures. It cannot help make the decision about where to treat a patient who
requires certain procedures. It cannot help make medical decisions about the type of
procedure required.

Solutions to Exercises
9-31. (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
Overhead (@160%) .. 256,000 b 544,000 c 800,000
Product cost ............... $1,000,000 $1,684,000 $2,684,000
Profit ........................... $150,000 $ 421,000 $ 571,000
Margin ......................... 15% d 25% e 21.3% 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 21.3% = ($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
Overhead .................... 650,000 a 650,000
Product cost $1,790,000 $1,790,000
Profit ........................... $315,000 $ 315,000
Margin ......................... 17.6% b 17.6%
a Given.
b 17.6% = ($315,000 profit ÷ $1,790,000 product cost).

9-32. (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
Overhead (@150%) 2,400,000 b 720,000 c 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 × 150%.
c $720,000 = $480,000 direct labor × 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
Overhead .................. 2,250,000 a 2,250,000
Product cost $3,030,000 $3,030,000
Profit ......................... ($330,000) ($ 330,000)
a Given.

9-33. (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
Overhead .................... 1,000,000 a 500,000 b
Profit ........................... $100,000 $ 500,000
a $1,000,000 = $500,000 direct labor × 200%.
b $500,000 = $250,000 direct labor × 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
Overhead .................... 750,000 a 750,000 b
Profit ........................... $350,000 $ 250,000
a $750,000 = $500,000 direct labor × 150%.

b $750,000 = $250,000 direct labor × 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.

9-34. (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
Overhead ....................................... 150 a 165 b 225 c
Total cost (per 1,000 gallons) ........ $1,700 $1,490 $1,950
a$150 = 50 labor-hours × $3 per hour.
b$165 = 55 labor-hours × $3 per hour.
c$225 = 75 labor-hours × $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
Overhead ....................................... 210 a 231 b 99 c
Total cost (per 1,000 gallons) ........ $1,760 $1,556 $1,824
a$210 = 50 machine-hours × $4.20 per machine-hour.
b$231 = 55 machine-hours × $4.20 per machine-hour.
c$99 = 75 labor-hours × $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.

9-35. (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

9-36. (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.

9-37. (30 min.) Activity-Based Costing: IVC, Inc.
a.
Sport Pro
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
a75% of the amounts in Exhibit 9.16. ($27,000 = .75  $36,000; $270,000 = .75 
$360,000).

9-37. (continued)
b. Tom 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.

9-38. (15 min.) Activity-Based Costing and Cost Driver Rates: Upriver Parts.
a. $5.70 per machine hour.
Total machine hours = (10,000 V-1 units  1 mh + 1,000 V-2 units  2 mh)
= 12,000 machine hours
Predetermined rate = (Total overhead ÷ Machine hours)
= ($68,400 ÷ 12,000 mh)
= $5.70 per mh
b. ($3 per machine hour, $150 per production run, 60% direct material cost)
Cost driver rate = (Activity cost ÷ Cost driver volume)

Cost driver volumes:
Total machine hours = (10,000 V-1 units  1 mh + 1,000 V-2 units  2 mh)
= 12,000 machine hours
Total production runs = (80 V-1 runs + 40 V-2 runs)
= 120 production runs
Total material costs = (10,000 V-1 units x $2 + 1,000 V-2 units  $4)
= $24,000
Cost driver rates: = (Total overhead ÷ Machine hours)
Machine depreciation = ($36,000 ÷ 12,000 machine hours)
= $3 per machine hour
Setup labor = ($18,000 ÷ 120 production runs)
= $150 per production run
Material handling = ($14,400 ÷ $24,000 material cost)
= 60% direct material cost

9-39. (15 min.) Activity-Based Costing: Upriver Parts.
a. $7.70 per unit V-1, $15.40 per unit V-2.
V-1 V-2
Machine hours per unit ....................................... 1 2
Direct material cost ............................................. $2.00 $4.00

Applied overhead (@ $5.70 per machine hour) .. 5.70 11.40
Unit cost .......................................................... $7.70 $15.40
b. $7.40 per unit V-1, $18.40 per unit V-2.
V-1 V-2
Machine hours per unit ................................... 1 2
Production run (total) ...................................... 80 40
Direct materials cost per unit .......................... $2.00 $4,00
Direct material cost ......................................... $2.00 $4.00

Machine depreciation (@3 per machine hour) 3.00 6.00
Setup labor (@$150 per production run) ....... 1.20 (a) 6.00 (b)
Material handling (@60% direct material cost) 1.20 2.40
Unit cost...................................................... $7.40 $18.40
Notes: (a) $1.20 = (80 production runs  $150 per run) ÷ 10,000 units.
(b) $6.00 = (40 production runs  $150 per run) ÷ 1,000 units.

9-40. (15 min.) Activity-Based Costing and Cost Driver Rates: The City Museum.
a. $32.90 per visitor.
Total visitors = (1500 + 750)
= 2,250 visitors
Overhead rate = (Total overhead ÷ Visitors)
= ($74,025 ÷ 2,250 visitors)
= $32.90 per visitor
b.
Cost driver volumes:
Visitors = (1,500 Student tours + 750 Donor tours)
= 2,250 visitors
Tours = (75 Student tours + 90 Donor tours)
= 165 tours
Coordinator volume = (1 student coordinator + 1 donor coordinator)
= 2 coordinators.
Cost driver rates: = (Activity cost ÷ Cost driver volume)
Refreshments, etc. = ($27,000 ÷ 2,250 visitors)
= $12.00 per visitor
Tour guides = ($15,675 ÷ 165 tours)
= $95.00 per tour
c.
1. Visitors ............... D. Volume-related
2. Tours .................. C. Batch-related
3. Coordinators ....... A. Product-related

9-41. (15 min.) Activity-Based Costing: The City Museum.
a. $32.90 per visitor for Student Tours, $32.90 per visitor for Donor Tours.
Student Donor
Visitors 1 1
Applied overhead (@ $32.90 per visitor)............. 32.90 32.90

Unit cost .......................................................... $32.90 $32.90
b. Students Donors
Visitors 1 1
Tours .............................................................. 75 90
Coordinators ................................................... 1 1
Refreshments, and so on................................ $12.00 $12.00

Tour leaders (@$95 per tour) ........................ 4.75 (a) 11.40 (b)
Coordinators (@$15,675 per coordinator) ...... 10.45 (c) 20.90 (d)
Unit cost...................................................... $27.20 $44.30
Notes: (a) $4.75 = (75 tours  $95 per tour) ÷ 1,500 visitors.
(b) $11.40 = (90 tours  $95 per tour) ÷ 750 visitors.
(c) $10.45 = (1 coordinator  $15,675 per coordinator) ÷ 1,500 visitors.
(d) $20.90 = (1 coordinator  $15,675 per coordinator) ÷ 750 visitors.

9-42. (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  20 guests).
b $475 = $75 + ($20  20 guests).
c $200 = $50  4 servers.
d $300 = $75  4 servers.
e $400 = $20  20 guests.
f $600 = $30  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).

9-43. (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
Prod. runs ........... $13,200 c $ 528,000 f $ 132,000 $ 660,000
Quality tests ........ 19,800 d 237,600 g 356,400 594,000
Ship. orders ........ 1,2400 e 124,000 h 62,000 186,000
Total overhead ... $ 889,600 $ 550,400 $1,440,000
Total costs.............. $2,800,000 $1,674,000 $4,474,000
Total unit cost......... $100.00 i $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.

9-43. (continued)
b. Rate Handheld Home Total

Direct labora ............. $1,160,400 $ 439,600 $1,600,000
Direct materialsb ...... 750,000 684,000 1,434,000
d
Total overhead ......... 90% c 1,044,360 395,640 1,440,000
Total costs................ $2,954,760 $1,519,240 $4,474,000
Total unit cost........... $105.53 e $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.

9-44. (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
Machine-hours ...... $ 15 c $ 75,000 f $ 45,000 $ 120,000
Production runs .... 3,500 d 35,000 g 35,000 70,000
Inspections ........... 1,500 e 30,000 h 60,000 90,000
Total overhead ..... $140,000 $140,000 $280,000
Total costs................ $340,000 $260,000 $600,000
Total unit cost........... $28.33 i $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 machine costs ÷ 8,000 machine-hours.
d$3,500 per run = $70,000 in production run costs ÷ 20 total runs.
e$1,500 per inspection = $90,000 in inspection costs ÷ 60 inspections.
f$75,000 = $15 per machine-hour  5,000 machine-hours for M-008.
g$35,000 = $3,500 per run  10 runs for M-008.
h$30,000 = $1,500 per inspection  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.

9-44. (continued)
b. Rate M-008 M-123 Total

Direct materialsa ......... $100,000 $ 80,000 $180,000
Direct laborb ................ 100,000 40,000 140,000
d
Total overhead ............ 200% c 200,000 80,000 280,000
Total costs................... $400,000 $200,000 $600,000
Total unit cost.............. $33.33 e $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.

9-45. (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
Direct Laborb ........................... 175,000 325,000 500,000
Overheadc ............................... 71,750 133,250 205,000
Profit ........................................ $ 68,250 $321,750 $ 390,000
a$315,000 = 7,000 hours  $45 per hour; $780,000 = 13,000 hours  $60 per hour.
b$175,000 = 7,000 hours  $25 per hour; $325,000 = 13,000 hours  $25 per hour.
c$71,750 = ($205,000 ÷ 20,000 hours)  7,000 hours;
$133,250 = ($205,000 ÷ 20,000 hours)  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
Traveling .......... $250.00 a $ 6,000 b $ 19,000 c $ 25,000
Equipment ........ 20.00 d 35,500 e 24,500 f 60,000
Supplies ........... 1.20 g 78,000 h 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  $250 per client.
c $19,000 = 76 clients  $250 per client.
d $20.00 per hour = $60,000 ÷ 3,000 equipment hours.
e $35,500 = 1,775 equipment-hours  $20 per equipment-hour.
f $24,500 = 1,225 equipment-hours  $20 per equipment-hour.
g $1.20 per square yard = $120,000/100,000 square yards.
h $78,000 = 65,000 square yards  $1.20 per square yard.
i $42,000 = 35,000 square yards  $1.20 per square yard.

9-45. (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.

9-46. (35 min.) Activity-Based versus Traditional Costing: Isadore’s
Implements, Inc.
a. Cost Driver Rate Pencils Pens

Setting up................................... $1,440 a $28,800 d $ 43,200
Inspecting .................................. 2,160 b 8,640 e 12,960
Packaging and Shipping ............ 0.36 c 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  20 setups.
e $8,640 = $2,160  4 parts.
f $16,200 = $0.36  45,000 boxes shipped.
b. Pencils Pens Total

Direct Labor Hours ........ 4,500 a 15,000 19,500
Overhead ...................... $31,569 b $105,231 $ 136,800
a 4,500 hours = 0.1 hours per box of pencils  45,000 boxes produced.
b $31,569 = ($136,800 OH ÷ 19,500 hours)  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.

9-47. (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:
Administrative support ... $4,000 a 24,000 d 16,000 40,000
Transportation ............... 144 b 14,400 e 21,600 36,000
Equipment. .................... 12.50 c 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  6 clients.
e $14,400 = $144 per hour  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
Expenses ...................... $143.2836 a 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  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.

9-47. (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.

9-48. (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 
$36.00 per pound =
$108,000 to WIP
Overhead Applied:
Quality Inspections
500 inspections 
$450 per inspection
= $225,000 to WIP
Overhead Applied:
Machine Setups
25 setups  $5,400
per setup =
$135,000 to WIP
Overhead Applied:
Running Machines
10,000 hours  $45
per hour = $450,000
to WIP

9-48. (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

9-49. (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  $3
per yard = $60,000
to WIP
Overhead Applied:
Quality Inspections
400 inspections 
$300 per inspection
= $120,000 to WIP
Overhead Applied:
Machine Setups
50 setups  $2,400
per setup =
$120,000 to WIP
Overhead Applied:
Running Machines
10,000 hours  $30
per hour = $300,000
to WIP

9-49. (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

9-50. (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 StressedOut 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.

9-51. (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.

9-52. (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  50 weeks  40 hours per week  0.85  60 minutes per hour
.
b. $23.76
Taking Picking Packaging
Orders Orders Orders Total
Minutes per order ..... 10 + 14 + 20 = 44
Cost per minute ........  $0.54
Total costs................ $23.76
c. 306,000 minutes.
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  $0.54 per minute).

9-53. (20 min.) Time-Driven ABC for an Administrative Service: 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  $2.25 per minute).

Solutions to Problems
9-54. (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:
Administration ......... 78% a 312,000 e 156,000 468,000
Production setup ..... $7,200 b 360,000 f 720,000 1,080,000
Quality control ......... $1,800 c 360,000 g 360,000 720,000
Distribution .............. $192 d 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  $400,000 direct labor costs
f$360,000 = $7,200 per setup  50 production runs
g$360,000 = $1,800 per inspection  200 inspections
h$288,000 = $192 per unit  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.

9-54. (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
Overhead Costs .............. 618% a 2,472,000 b 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 × $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.

9-55. (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:
Administration ............... 25% a 2,400 e 3,600 6,000
Setting up ...................... $800 b 8,000 f 4,000 12,000
Performing quality control $150 c 4,500 g 1,500 6,000
Distribution .................... $0.12 d 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 × $48,000 direct labor costs.
f $8,000 = $800 per run × 10 runs.
g $4,500 = $150 per inspection × 30 inspections.
h $1,920 = $0.12 per unit shipped × 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.

9-55. (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
Overhead Costs ................ 120% a 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 × $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.

9-56. (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.”
9-57. (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 × $15 per hour.

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

9-57. (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.

9-58. (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
Direct labora .......................................... 3,000 3,600 3,300
Overheadb ............................................ 15,000 18,000 16,500
Total costs ............................................ $24,000 $25,350 $22,800
a Number of hours × $30 per hour.
b Number of hours × $150 per hour.

9-58 (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
Processing orders .............................. 2,400 b 2,400 1,200
Handling materials ............................. 1,200 c 2,400 600
Using machines ................................. 3,600 d 2,160 2,160
Performing quality management ........ 3,000 e 3,000 3,000
Shipping ............................................. 2,400 f 1,200 720
Total cost ........................................... $22,320 $19,950 $16,860
a $720 = $360 per run × 2 runs.
b $2,400 = $300 per order × 8 orders.
c $1,200 = $3.00 per lb. × 400 lbs.
d $3,600 = $7.20 per hour × 500 hours.
e $3,000 = $1,500 per inspection × 2 inspections.
f $2,400 = $2.40 per unit × 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.

9-59. (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
Var. OHa ............... 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.

9-59. (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:
Mach. setup...... 102,960 a 159,120 205,920 468,000
Order proc. ....... 288,000 b 432,000 432,000 1,152,000
Warehousing .... 418,500 c 418,500 837,000 1,674,000
Energy .............. 151,200 d 241,920 362,880 756,000
Shipping ........... 43,200 e 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 × 22 runs = $102,960.
b $720 (= $1,152,000 ÷ 1,600 orders) per order × 400 orders = $288,000.
c $2,092.50 (= $1,674,000 ÷ 800 units) per unit × 200 units = $418,500.
d $15.12 (= $756,000 ÷ 50,000 machine-hours) per machine-hour × 10,000 machine-
hours = $151,200.
e $43.20 (= $648,000 ÷ 15,000 units) per unit shipped × 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.

9-60. (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

9-60. (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.

9-60. (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 $675,000 = $15 per machine-hour × 45,000 machine-hours.
b $180,000 = $1,500 per setup × 120 setups.
c $1,125,000 = $1.50 per pound × 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.)

9-61. (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

9-61. (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 × $50,000.
b $600,000 = $10.00 per machine-hour × 60,000 machine-hours.
c $250,000 = $5,000 per setup × 50 setups.
d $300,000 = $10.00 per unit × 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.)

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

9-62. (continued)
b.
Receiving .. $600,000 ÷ $400,000 material dollars = 150% of material dollars.
Manufacturing $5,500,000 ÷ 250,000 machine-hours = $22.00 per machine-hour
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
b $3,300,000 = $22.00 per machine-hour × 150,000 machine-hours.
d $800,000 = $40.00 per unit × 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.

Cain Components.
a.
Receiving .. $600,000 ÷ $400,000 material dollars = 150% of material dollars.

Production.. $3,300,000 ÷ 250,000 machine-hours = $13.20 per machine-hour
Engineering $2,200,000 ÷ 200 Setups = $11,000 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
Production ............................ 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
b $1,980,000 = $13.20 per machine-hour × 150,000 machine-hours.
d $337,500 = $4,500 per setup × 75 setups.
e $800,000 = $40.00 per unit × 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.

9-64. (40 min.) Activity-Based Costing of Jobs: Lillis Manufacturing.
a.
The predetermined rate using the traditional system at Lillis is calculated using direct-
labor cost, which is not given in the problem. However, we know that the cost analyst
estimates 16,000 direct-labor hours for the coming year and that an hour of direct labor
costs $25 on average. Therefore, the annual direct-labor cost at Lillis is estimated to be
$400,000 (= $25 × 16,000 hours).
The predetermined overhead rate is 300% of direct-labor cost (= $1,200,000 ÷
$400,000).
The cost of each of the jobs using the traditional system:
Job 1101 Job 1102 Job 1103

Direct materials ............ $ 4,000 $ 6,000 $ 5,000
Direct labor................... 10,000 16,000 13,000
Overhead (@300%) ..... 30,000 48,000 39,000
Total cost ..................... $44,000 $70,000 $57,000
Number of units............ 200 500 400
Unit cost ....................... $220.00 $140.00 $142.50

9-64. (continued)
b.
The first step in calculating the unit costs using the ABC system is to calculate the cost-
driver rates.
Machining .. $400,000 ÷ $20,000 machine-hours = $20 per machine-hour

Assembly... $200,000 ÷ 16,000 direct-labor hours = $12.50 per labor-hour
Setup labor $320,000 ÷ 80 Run = $4,000 per run
Packaging . $180,000 ÷ 120,000 units = $1.50 per unit.
Compliance $100,000 ÷ 20 orders = $5,000 per order tested.
Unit Costs:
Job 1101 Job 1102 Job 1103
Direct materials ............ $ 4,000 $ 6,000 $ 5,000
Direct labor................... 10,000 16,000 13,000
Overhead:
Machining..................
10,000 (a) 14,000 12,000
Assembly ..................
3,000 (b) 10,000 4,500
Setup labor................
4,000 (c) 8,000 4,000
Packaging .................
300 (d) 750 600
Compliance testing ... 5,000 0 5,000
(e)
Total cost ..................... $36,300 $54,750 $44,100
Number of units............ 200 500 400
Unit cost ....................... $181.50 $109.50 $110.25
a $10,000 = $20 per machine-hour × 500 machine-hours.

b $3,000 = $12.50 per labor-hour × 240 labor-hours.
c $4,000 = $4,000 per run × 1 run.
d $300 = $1.50 per unit × 200 units.
e $5000 = $5,000 per order tested × 1 order tested.

9-65. (40 min.) Activity-Based Costing of Jobs: DP, Inc.
a.
The predetermined rate using the traditional system at DP is calculated using machine-
hours. The predetermined overhead rate is $80 per machine-hour (= $16,00,000 ÷
200,000).
The cost of each of the jobs using the traditional system:
Job 0404 Job 0407 Job 0411

Direct materials ............ $ 30,000 $ 56,000 $100,000
Overhead (@$80) ........ 128,000 (a) 160,000 320,000
Total cost ..................... $158,000 $216,000 $420,000
Number of units............ 1,000 1,200 2,000
Unit cost ....................... $158 $180 $210
a. $128,000 = $80 per machine-hour × 1,600 machine-hours.

9-65. (continued)
b.
The first step in calculating the unit costs using the ABC system is to calculate the cost-
driver rates.
Material handling $3,000,000 ÷ $6,000,000 = 50% direct material cost

Machining .......... $6,000,000 ÷ 200,000 machine-hours = $30 per machine-hour
Finishing ............ $2,000,000 ÷ 125,000 units = $16 per unit
Shipping ............ $1,500,000 ÷ 100 orders = $15,000 per order.
Setups ............... $3,500,000 ÷ 175 runs = $20,000 per run.
Unit Costs:
Job 0404 Job 0407 Job 0411
Direct materials ............ $30,000 $ 56,000 $100,000
Overhead:
Material handling ....... 15,000 (a) 28,000 50,000
Machining.................. 48,000 (b) 60,000 120,000
Finishing.................... 16,000 (c) 19,200 32,000
Shipping .................... 15,000 (d) 30,000 15,000
Setups ....................... 20,000 (e) 60,000 20,000
Total cost ..................... $144,000 $253,200 $337,000
Number of units............ 1,000 1,200 2,000
Unit cost ....................... $144.00 $211.00 $168.50
a $15,000 = 50% direct material cost × $30,000.

b $48,000 = $30 per machine-hour × 1,600 machine-hours.
c $16,000 = $16 per unit × 1,000 units.
d $15,000 = $15,000 per order × 1 order.
e $20,000 = $20,000 per production run × 1 production run.

9-66. (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.

9-67. (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
Var. overhead ........... 2,088,000 a 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

9-67. (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 ...........
Setting up machines . 480,000 a 960,000 960,000 2,400,000
Processing orders .... 405,000 b 900,000 495,000 1,800,000
Warehousing............. 600,000 c 1,200,000 600,000 2,400,000
Operating machines.. 288,000 d 432,000 480,000 1,200,000
Shipping .................... 240,000 e 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.

9-68. (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 9-52 (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 × 50 weeks × 40 hours per week × 0.85 × 60 minutes per
hour.
The cost for a complex order from a new retailer will be:
Minutes per order ..... (10 + 30) + (14 + 20) + 20 = 94
Cost per minute ........ × $0.54
Total costs................ $50.76

9-69. (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 9-53 (a):
Total cost in Personnel.... $972,000

Total minutes availablea .. 432,000
Cost per minute ............... $2.25 (= $972,000 ÷ 432,000)
a 5 employees × 48 weeks × 30 hours per week × 60 minutes per hour .
The cost of hiring a manager will be:

$371.25 [= (45 minutes + 120 minutes) × $2.25 per minute].
The cost of hiring an executive will be:
$1,181.25 [= (45 minutes + 120 minutes + 360 minutes) × $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 × $2.25 per minute).
The cost of separation processing for an involuntary separation will be:
$607.50 [= (90 minutes + 180 minutes) × $2.25 per minute.

Solutions to Integrative Cases
9-70. (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 DLHb 4.00 12.00 4.00 12.00
Total ................................................ $34.00 $36.00
aOverhead 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.
9-70. (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
Supervision .. $100,000 Direct 100,000  .1 + 25,000  .1 $8.00
labor-hrs = 12,500 hours
Materials 93,000 Material 100,000  $12 + 25,000  $14 6%
handling ....... cost = $1,550,000
Testing ......... 150,000 Test 100,000  3 + 25,000  3 $0.40
hours = 375,000 hours
Wastewater 250,000 Waste 100,000  10 + 25,000  0 $0.25
treatment ...... = 1,000,000 gallons
Depreciation . 400,000 Machine 100,000  1.6 + 25,000  1.6 $2.00
- hours = 200,000 machine-hours
Shipping ....... 7,000 Weight 100,000  1.0 + 25,000  1.6 $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
9-70. (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.

9-71. (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.

9-71. (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.

9-71. (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.

9-72. (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% × $24,500) + (13.3% × $30,000) +
(10% × $15,000) ........................................................... = $21,072 $21.07
Krispy Krackle (27.3% × $24,500) + (46.7% × $30,000) +
(40% × $15,000) ........................................................... = 26,699 26.70
Creamy Crunch (9.1% × $24,500) + (40% × $30,000) +
(50% × $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.

9–72. (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.

9-72. (continued)
Allocated Cost: Total Per Case

Almond Dream (82.4% × $24,500) +
(36.4% × $30,000) + (33.3% × $15,000) .............. = $36,108 $18.05
Krispy Krackle (17.6% × $24,500) +
(63.6% × $30,000) + (66.7% × $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%

9-72. (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

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

9-73. (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

9-73. (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 × 200 setup hours.
b
$6,982 = $174.55 per production run × 40 production runs.
c
$1,200 = $1,200 per product.
d
$7,000 = $1.40 per machine hour × 5,000 machine hours.

Copyright 2020 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
9-73. (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.

Copyright 2020 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.

Lanen - Fundamentals of Cost Accounting - 6e - Chapter 9 - Solution Manual

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9

Solutions to Review Questions

Solutions Manual, Chapter 9 483

484 Fundamentals of Cost Accounting

Solutions Manual, Chapter 9 485

486 Fundamentals of Cost Accounting

Solutions Manual, Chapter 9 487

488 Fundamentals of Cost Accounting

9-31. (15 min.) Reported Costs and Decisions: McNulty, Inc.

Chairs Desks Total

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

b 17.6% = ($315,000 profit ÷ $1,790,000 product cost).

Solutions Manual, Chapter 9 489

Standard Galaxy Total

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

490 Fundamentals of Cost Accounting

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

a $750,000 = $500,000 direct labor × 150%.

Solutions Manual, Chapter 9 491

Strawberry Vanilla Chocolate

492 Fundamentals of Cost Accounting

Miami New York

Transitions .................. 50 150

Solutions Manual, Chapter 9 493

Transitions .................. 150

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

494 Fundamentals of Cost Accounting

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

Solutions Manual, Chapter 9 495

496 Fundamentals of Cost Accounting

Cost driver rate = (Activity cost ÷ Cost driver volume)

Solutions Manual, Chapter 9 497

Direct material cost ............................................. $2.00 $4.00

b. $7.40 per unit V-1, $18.40 per unit V-2.

Direct material cost ......................................... $2.00 $4.00

498 Fundamentals of Cost Accounting

Solutions Manual, Chapter 9 499

Applied overhead (@ $32.90 per visitor)............. 32.90 32.90

Refreshments, and so on................................ $12.00 $12.00

500 Fundamentals of Cost Accounting

Solutions Manual, Chapter 9 501

502 Fundamentals of Cost Accounting

b. Rate Handheld Home Total

Solutions Manual, Chapter 9 503

504 Fundamentals of Cost Accounting

b. Rate M-008 M-123 Total

Solutions Manual, Chapter 9 505

a. Commercial Residential Total

b. Rate Commercial Residential Total

506 Fundamentals of Cost Accounting

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

Solutions Manual, Chapter 9 507

a. Cost Driver Rate Pencils Pens

b. Pencils Pens Total

c. Not necessarily. Activity-based costing provides a more accurate allocation of

508 Fundamentals of Cost Accounting

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

Solutions Manual, Chapter 9 509

510 Fundamentals of Cost Accounting

Solutions Manual, Chapter 9 511

Work in Process (WIP) Inventory

Finished Goods Inventory

512 Fundamentals of Cost Accounting