CHAPTER 12ACTIVITY-BASED COSTING

QUESTIONS FOR WRITING AND DISCUSSION

1. Plantwide overhead rates assign overhead to products in proportion to the amount used of the unit-based driver. If all products con-sume overhead in proportion to this unit-based driver, no distortion will occur. Cost distortion can occur if the products consume some overhead activities in different propor-tions than those assigned by the unit-based driver (the product diversity factor). No significant distortion will occur unless the activities that are consumed in different proportions make up a significant proportion of the total overhead costs. Thus, two key factors are product diversity and significant nonunit-level overhead costs.

2. Nonunit-related overhead activities are those overhead activities that are not highly correlated with production volume mea-sures. Examples include setups, material handling, and inspection. Nonunit-based cost drivers are causal factors that explain the consumption of nonunit-related over-head. Examples include setup hours, number of moves, and hours of inspection.

3. An overhead consumption ratio measures the proportion of an overhead activity con-sumed by a product.

4. Departmental rates typically use unit-based drivers. If products consume nonunit-related overhead activities in different proportions than those of unit-based measures, it is pos-sible for departmental rates to move even further away from the true consumption ra-tios, since the departmental unit-based ra-tios usually differ from the one used at the plant level.

5. Product diversity is present whenever prod-ucts have different consumption ratios for different overhead activities.

6. Agree. Prime costs can be assigned using direct tracing and therefore do not cause cost distortions. Overhead costs, however, are not directly traceable and can cause dis-tortions. For example, using unit-based driv-ers to trace nonunit-based overhead costs would cause distortions.

7. Activity-based product costing is a costing approach that first assigns costs to activities and then to products. The assignment is made possible through the identification of activities, their costs, and the use of cost drivers.

8. The six steps are: (1) identify, define, and classify activities; (2) assign the cost of re-sources to activities; (3) assign the cost of secondary activities to primary activities; (4) identify cost objects and the demands that these cost objects place on activities; (5) calculate the primary activity rates, and (6) assign the cost of activities to cost objects.

9. A primary activity is one that is consumed by a final cost object. A secondary activity is consumed by secondary or primary activi-ties. Ultimately, all secondary activities are consumed by primary activities.

10. A work distribution matrix identifies the amount of labor consumed by each activity. It is a means of collecting the data required to assign labor resource costs to activities.

11. The cost of resources is assigned to activi-ties using direct tracing and resource drivers. Resource drivers such as effort expended and material usage trace costs to activities using causal relationships. Assign-ing costs to activities requires unbundling the general ledger. General ledger accounts accumulate costs by department and by account—not by activity. Thus, the costs in the general ledger account must be reas-signed to activities—this is what unbundling means.

12. The costs of secondary activities are as-signed to primary activities using drivers and secondary activity rates.

13. A bill of activities identifies the amount of ac-tivity that will be consumed by each cost ob-ject (e.g., product).

14. Two types of activity drivers are transaction drivers and duration drivers. Transaction drivers measure the demands placed on an

347347

activity using the number of times an activity is performed. Duration drivers measure de-mands by the time it takes to perform an activity.

15. A homogeneous cost pool is a collection of overhead costs that are logically related to the tasks being performed and for which cost variations can be explained by a single activity driver. Thus, a homogeneous pool contains activities with the same process, the same activity level, and the same driver.

16. An activity is a basic unit of work performed in an organization. A homogeneous set is a collection of activities that have the same process, the same activity level, and use the same activity driver.

17. Homogeneous sets of activities are pro-duced by classifying activities by process, by level, and by consumption ratio. The purpose is to reduce the total number of overhead rates to a manageable level. The classification also increases the accuracy of assignments.

18. Unit-level activities are those that occur each time a unit of product is produced. Batch-level activities are those that are per-formed each time a batch of products is pro-duced. Product-level or sustaining activities are those that are performed as needed to support the various products produced by a company. Facility-level activities are those that sustain a factory’s general manufactur-ing process.

19. An activity-based database is a collection of data about activities and products (and other entities that may be of use to management) that are organized to support an activity-based accounting information system.

20. An activity relational table is constructed around activities. Activity is the entity. Each row of the table is associated with a different activity. An activity number that uniquely

identifies each activity is used as a primary key (usually in the first column). Activity attributes define the remaining columns and are determined by the needs of the users and the objectives of the information sys-tem. For an activity-based information sys-tem, the attributes should be chosen so that homogeneous sets of activities can be defined and pool rates calculated. A product relational table is constructed around prod-ucts. A product number uniquely identifies each product. Product attributes are chosen so that costs can be assigned to products using activity drivers and unit costs can be computed.

21. If an ABC design requires an assignment path and no ABC software has any provision for this path, then either the design must be changed or the company must develop its own software. For example, if the ABC design plans on assigning the cost of sec-ondary activities to primary activities, then this assignment path must exist within an ABC software package. Similarly, if the ABC design wants to assign activity costs to sup-pliers, then an assignment path from the activity module to the cost object module must exist, where the cost object is specifi-cally identified as a supplier. Thus, the more assignment paths, the more flexibility in the design.

22. ABC and ERP systems cannot be fully inte-grated because they have different pur-poses, scopes, cost definitions, etc. It is true that there should be “different systems for different purposes.” However, some partial integration is possible and even desired because the two systems can interface and provide information that is mutually benefi-cial. ABC, for example, is dependent on much of the data resident in an ERP sys-tem. Furthermore, ABC can send back data that is useful for operational control (e.g., the cost of nonvalue-added activities).

348348

EXERCISES

12–1

1. Yes. Direct materials and direct labor are directly traceable to each product; their cost assignment should be accurate.

2. Note: Overhead rate = $60,000/$48,000 = $1.25 per direct labor dollar (or 125 percent of direct labor dollars)

Standard: (1.25 $12,000)/3,000 = $5.00 per purseHandcrafted: (1.25 $36,000)/3,000 = $15.00 per purse

There are more machine and setup costs assigned to the handcrafted purses than the standard purses. This is clearly a distortion since the automated production of standard purses uses the setup and machine resources much more than handcrafted purses.

3. Setup rate = $18,000/600 hours= $30 per setup hour

Machine rate = $42,000/20,000= $2.10 per machine hour

Standard HandcraftedSetup rate:

$30 400 $12,000$30 200 $ 6,000

Machine rate:$2.10 18,000 37,800$2.10 2,000 4,200

Total $49,800 $10,200Units ÷ 3,000 ÷ 3,000 Unit overhead cost $ 16.60 $ 3.40

Setup hours were chosen because the time per setup differs significantly be-tween standard and handcrafted purses. Transaction drivers measure the number of times an activity is performed, while duration drivers measure the time required. Duration drivers typically provide greater accuracy whenever the time required per transaction is not the same for all products.

12–1 Concluded

This cost assignment appears more reasonable given the relative demands each product places on setup and machine resources. Direct labor dollars fail to capture the relative consumption of resources by the two products. Once a firm moves to a multiproduct setting, using only one activity driver to assign costs will likely produce product cost distortions. Products tend to make different demands on overhead activities, and this should be reflected in overhead cost assignments. Usually, this means the use of both unit and nonunit activity drivers.

12–2

1. Overhead rate = $840,000/100,000 = $8.40 per machine hour

Job bid:

Direct materials $ 8,000Direct labor 12,000Overhead 16,800 ($8.40 2,000)

Total cost $36,800Markup (25%) 9,200 Bid $46,000

2. Activity rates:

Machining: $440,000/100,000 = $4.40 per machine hourEngineering: $220,000/10,000 = $22 per hourInspecting: $180,000/6,000 = $30 per inspection

Job bid:

Direct materials $ 8,000Direct labor 12,000Overhead 9,050 ($4.40 2,000) + ($22 10) + ($30 1)

Total cost $29,050Markup (25%) 7,263 *Bid $36,313

*Rounded

12–2 Concluded

3. In a firm with product diversity and significant nonunit costs, pool rates, based on unit and nonunit activity drivers, tend to provide a more accurate assessment of product costs. This firm has one unit-level activity (machine operations) and two nonunit-level activities (engineering and inspecting). The nonunit-level activities cause about 48 percent of total overhead costs. Thus, the use of both unit-level and nonunit-level cost assignments is recom-mended.

4. If the inspection hours differ significantly for each inspection, then they be-come a better measure of a job’s consumption of inspection resources than the number of inspections. Using inspection hours, the inspection rate is $180,000/12,000 = $15 per hour. Using this rate, the job’s bid would be calcu-lated as follows:

Job bid:

Direct materials $ 8,000Direct labor 12,000Overhead 9,920 ($4.40 2,000) + ($22 10) + ($15 60)

Total cost $29,920Markup (25%) 7,480 Bid $ 37,400

12–3

1. Overhead rate = $440,000/4,000 = $110 per DLH

Job 600 Job 700Direct materials $1,500 $1,700Direct labor 1,200 1,200Overhead* 4,400 4,400 Total cost $7,100 $7,300Units ÷ 100 ÷ 50 Unit cost $ 71 $ 146*Overhead assigned = $110 40 hrs. = $4,400

2. Activity rates:

Setup: $120,000/300 = $400 per setupOrdering: $90,000/4,500 = $20 per orderMachining: $180,000/18,000 = $10 per machine hourReceiving: $50,000/50,000 = $1 per part

Job 600 Job 700Direct materials $1,500 $1,700Direct labor 1,200 1,200Overhead:

Setups 800 400 ($400 2; $400 1)Ordering 80 40 ($20 4; $20 2)Machining 800 600 ($10 80; $10 60)Receiving 20 40 ($1 20; $1 40)

Total costs $4,400 $3,980Units ÷ 100 ÷ 50 Unit cost $ 44 $ 79.60

3. In a firm with product diversity and significant nonunit overhead costs, multi -ple rates using unit and nonunit drivers produce better cost assignments be-cause the demands of the products for overhead activities are more fully considered. Specifically, there are three nonunit activities, causing $260,000 out of the $440,000 of overhead costs. These nonunit costs should be as-signed using nonunit cost drivers.

12–4

Activity Dictionary: Credit Card Department

ActivityName

ActivityDescription

ActivityType

CostObject(s)

ActivityDriver

Supervising employees

Scheduling,coordinating,and performance evaluation

Sec-ondary

Activities withindepartment

Total labor time for each activity

Processing transactions

Sorting, keying, and verifying

Primary Credit cards Number of transactions

Issuingstatements

Reviewing, print-ing, stuffing, and mailing

Primary Credit cards Number of statements

Answering questions

Answering,logging,reviewing data-base, callbacks

Primary Credit cards Number of calls

Providing automatictellers

Accessingaccounts,withdrawing funds

Primary Credit cards, checking and savingsaccounts

Number of tellertransactions

12–5

1. Labor cost is assigned to the activities using direct tracing and a resource driver (percentage of time):

Supervising employees $64,600 (direct tracing)Processing transactions $84,000 (0.40 $210,000)Issuing statements $63,000 (0.30 $210,000)Answering questions $63,000 (0.30 $210,000)

Computer, desk, and printer resources are divided evenly among the labor types and then assigned to activities using direct tracing and a resource driver (percentage of computer time):

Supervising employees $4,900 (direct tracing)Processing transactions $24,010 (0.70 $34,300)Issuing statements $6,860 (0.20 $34,300)Answering questions $3,430 (0.10 $34,300)

Note: One-eighth of the cost is assigned by even division to the supervisor [($32,000 + $7,200)/8 = $4,900]. The residual ($39,200 – $4,900 = $34,300) is assigned to the clerical group and then traced to the activities in proportion to hours of computer usage.

Telephone cost is assigned to two activities:

Supervising employees $500 (direct tracing)Answering calls $3,500 (direct tracing)

ATM cost is computed using transactions as the resource driver:

ATM $250,000 (0.20 $1,250,000)

Thus, adding the costs assigned, we obtain the following activity costs:

Supervising employees $70,000 ($64,600 + $4,900 + $500)Processing transactions $108,010 ($84,000 + $24,010)Preparing statements $69,860 ($63,000 + $6,860)Answering questions $69,930 ($63,000 + $3,430 + $3,500)Providing ATM services $250,000

12–5 Concluded

2. The cost of supervision is assigned to the following primary activities (using relative labor content of each activity):

Processing transactions $108,010 + (0.40 $70,000) = $136,010Preparing statements $69,860 + (0.30 $70,000) = $90,860Answering questions $69,930 + (0.30 $70,000) = $90,930Note: No supervision cost is assigned to providing ATMs because no super-vising time is spent on this activity.

12–6

1. Unbundling means that general ledger costs are assigned to activities. Knowing the cost of activities is the first step in assigning costs to products (or other cost objects). Costs are first traced to activities and then to prod-ucts.

2. The general ledger system collects costs by accounts. It reports what is spent. An ABC database collects costs by activities and reveals how re-sources are spent.

3. Activity Cost Creating BOMs $ 63,000a

Studying capabilities 61,500b

Improving processes 220,500c

Training employees 106,000d

Designing tools 179,000e

a(0.20 $300,000) + (0.10 $30,000)b(0.20 $300,000) + (0.05 $30,000)c[(0.40 $100,000) + (0.60 $100,000) + $50,000 + (0.20 $300,000) + (0.35

$30,000)]d(0.40 $100,000) + (0.20 $300,000) + (0.20 $30,000)e(0.60 $100,000) + $50,000 + (0.20 $300,000) + (0.30 $30,000)

The resource drivers are percent of machine usage, percent of effort, and percent of supply usage.

12–6 Concluded

4. First, assign the cost of the activity, studying manufacturing capabilities, to the other four activities. A possible driver is engineering time (assign costs in proportion to the engineering time spent on each of the four activities). A more detailed approach would be to identify the study time that is specifi-cally related to each of the four activities and use that as the driver.

Second, assign the costs of the primary activities to jobs. Creating BOMs can be assigned using number of BOMs (transaction) or time required to develop BOMs (duration). Developing tools can be assigned to jobs using number of tools developed (transaction) or development time (duration).

Third, assign the cost of the other secondary activities to primary activities that consume them (i.e., to the manufacturing activities of cutting, drilling, etc.). Training employees can be assigned using number of training sessions (transaction) or hours of training (duration). Improving processes can be as-signed using number of improvements (transaction) or hours of effort (dura-tion). Once these costs are assigned to the primary activities, then the costs of the manufacturing activities are assigned to jobs based on hours of manu-facturing activity.

12–7

1. First, calculate the secondary activity rates:

Unloading goods: $48,000/75,000 = $0.64 per unitVerifying and counting goods: $96,000/6,000 = $16 per hourInspecting goods: $229,500/13,500 = $17 per hourMoving goods: $99,000/99 = $1,000 per move

Second, assign the activity costs to the three types of materials:

Component X Component Y Oil Unloading goods:

$0.64 45,000 $ 28,800$0.64 15,000 $ 9,600$0.64 15,000 $ 9,600

Verifying and counting goods:$16 3,000 48,000$16 1,500 24,000$16 1,500 24,000

Inspecting goods:$17 9,000 153,000$17 4,500 76,500

Moving goods:$1,000 75 75,000$1,000 15 15,000$1,000 9 9,000

Total $304,800 $125,100 $ 42,600 Third, assign the oil’s share of the secondary activity costs to the machining activity by direct tracing ($42,600).

12–7 Continued

Fourth, assign the components’ share of secondary costs to the products using direct tracing (component usage) and the machining share of receiving costs using machine hours:

Deluxe Model Regular ModelComponent X:

2/3 $304,800 $203,2001/3 $304,800 $101,600

Component Y:0.80 $125,100 100,0800.20 $125,100 25,020

Oil:0.70 $42,600 29,8200.30 $42,600 12,780

Total $333,100 $139,400Note: The cost assignment ratios are based on components used (30,000/45,000; 15,000/45,000; 12,000/15,000; 3,000/15,000) and machine hours used (21,000/30,000; 9,000/30,000).

Using materials as an intermediate cost object has the advantage of tracing the receiving costs to products with strong assurance of the cause-and-ef-fect relationships. Materials consume receiving activities, and products con-sume materials.

12–7 Concluded

2. First, calculate a receiving activity rate:

Receiving rate = $472,500*/60,000 components= $7.88** per component used

*This is the total cost of all receiving activities; thus, all receiving activities are placed in one cost pool.

**Rounded to the nearest cent.

Next, assign the cost of receiving to products based on total components used:

Deluxe Model Regular Model$7.88 42,000 $330,960$7.88 18,000 $141,840The costs assigned under the cost accountant’s suggestion are about the same as those assigned under the more complex method of using materials as an intermediate cost object. The viability of the pooling approach sug-gested depends on the homogeneity of the activities that define the receiving pool.

The consumption ratio of the Deluxe Model for total components used is 0.70 (42,000/60,000). The final consumption ratio of the Deluxe Model for Compo-nent X is 0.67* (30,000/45,000); for Component Y, 0.80 (12,000/15,000); and for Machining, 0.70 (21,000/30,000). Thus, the pool assignment equals the ma-chining assignment, slightly overstates the Component X assignment, and understates the Component Y assignment. The under- and overstatement outcomes also suggest a possible diversification effect, increasing the ho-mogeneity of the pool.

The suggestion has considerable merit.

*Rounded

12–8

1. and 2.

Process Activities Level Sustaining Providing space FacilityProcurement Receiving goods Batch

Paying suppliers BatchManufacturing Cutting Unit

Sewing UnitAttaching UnitInspecting Batch

Order-filling Moving goods BatchSorting goods BatchShipping goods Batch

Design Modifying ProductDeveloping ProductProducing prototype ProductTest marketing Product

12–9

1. Manufacturing process:Unit-level: machiningBatch-level: engineering,* setups, and inspectingProduct-level: none

Sustaining process:Facility-level: providing utilities, providing space

*Engineering is batch-level because the engineering activity is carried out each time a batch is produced. Usually, it would be classified as a product-level activity. This emphasizes the situational nature of the activity classifi-cations. Another example is inspection. Inspection is often a batch-level activity, but in some cases it is unit-level because every unit produced is inspected.

12–9 Concluded

2. Pools and drivers:

Manufacturing process:

Unit-level:Pool 1:

Machine costs $200,000Activity driver: Machine hours

Batch-level:Pool 2:

Engineering costs $100,000Setup costs 90,000Inspecting costs 80,000 Total pool cost $270,000Activity driver: Engineering, inspection hours, or setups

Note: Number of setups is chosen as the driver; this driver would likely be measured readily and easily associated with product demands.

Sustaining process:

Facility-level:Pool 3:

Providing space $25,000Providing utilities 18,000 Total pool cost $43,000

3. Pool rates:Pool 1: $200,000/20,000 = $10.00 per machine hourPool 2: $270,000/150 = $1,800 per setupPool 3: $43,000/20,000 = $2.15 per machine hour

12–10

Activity Relational Table

Activity ActivityName Process Activity

LevelActivityDriver

ActivityCapacity Cost

1 Machining Manufactur-ing

Unit Machinehours

20,000 $200,000

2 Engineering Manufactur-ing

Batch No. of setups

150 $100,000

3 Setup Manufactur-ing

Batch No. of setups

150 $90,000

4 Inspecting Manufactur-ing

Batch No. of setups

150 $80,000

5 Providing space

Sustaining Facility Machine hours

20,000 $25,000

6 Providing utilities

Sustaining Facility Machine hours

20,000 $18,000

12–11

1. First key: product name and driver name. Second key: product name and driver number. Concatenated keys uniquely identify each record. This is es-sential for accessing data and using it for product costing.

2. Regular Deluxe Purchase order:

$200 1,000 $ 200,000$200 500 $ 100,000

Machine hours:$12 320,000 3,840,000$15 40,000 600,000

Engineering hours:$40 5,000 200,000$40 6,000 240,000

Packing orders:$2 400,000 800,000$2 100,000 200,000

Square footage:$100 6,000 600,000$100 4,000 400,000

Total $5,640,000 $1,540,000Units ÷ 800,000 ÷ 100,000 Unit overhead cost (total/units) $ 7.05 $ 15.40

3. The product relational table does not reveal the activities in each pool. This information comes from the activity relational table. For product costing, in-dividual activity information is not needed. Once pool rates are computed, all that is needed is the activity usage by product.

12–12

1. ABC systems attempt to assign costs using cause-and-effect relationships. Regression analysis can provide evidence regarding cause-and-effect rela-tionships, thereby helping to select activity drivers for assigning costs. An ABC system should be able to identify drivers—especially nonunit drivers—that increase our understanding of why overhead costs vary.

2. Results of the regression analysis support the use of multiple drivers. The R2

increases from 0.46 to 0.76; two of three nonunit drivers are statistically sig-nificant. The absence of statistical significance for purchase orders suggests the need to find good driver(s) for the underlying activity or activities associ-ated with purchase orders. Furthermore, the explanatory power (0.76) might be improved by searching for additional cost drivers.

3. Knowing individual activity cost behavior is important for accurate product costing, cost management, and decision making. The resource usage model which plays a big role in tactical and strategic decision making relies on knowledge of individual activity cost behavior. This behavior is also impor-tant for building homogeneous cost pools.

12–13

1. Regression analysis provides evidence on the assumed cause-and-effect re-lationships used to build the ABC information system. Initially, installing an ABC system may require managerial judgment because there may not be ac-tivity data to allow the detection of statistical relationships. After an activity database is built and time passes, then more sophisticated procedures can be used to supplement and complement judgment.

2. Process differences can create different demands for activity resources. What drives the cost of an activity in one process may not be the same driver for the same activity in the second process. For our example, the fabrication process essentially demands the same number and type of parts for each product. Thus, the activities in receiving—such as order verification, count-ing, inspecting, and moving to the production area—are probably the same for incoming materials whether they belong to the mountain bike or the rac-ing bike. Assembly, however, is a different story. The receiving activities may differ markedly in quantity because each bike places different demands on the receiving activity. Counting and inspecting are different for the mountain bike because it has fewer parts than the racing bike. This suggests that num-ber of parts would be a better driver for the assembly process.

12–13 Concluded

3. Plantwide rate = $1,250,000/100,000 orders = $12.50 per order

Mountain Bike Racing Bike$12.50 50,000 $ 625,000$12.50 50,000 $ 625,000 Total $ 625,000 $ 625,000Units ÷ 100,000 ÷ 100,000Unit cost (total/units) $ 6.25 $ 6.25 Fabrication process rate = $500,000/50,000 orders = $10 per orderAssembly process rate = $750,000/600,000 parts = $1.25 per part

Mountain Bike Racing Bike$10 25,000 orders $ 250,000$10 25,000 orders $ 250,000$1.25 150,000 parts 187,500$1.25 450,000 parts 562,500 Total $ 437,500 $ 812,500Units ÷ 100,000 ÷ 100,000Unit cost (total/units) $ 4.38 * $ 8.13 *The difference shows that process classification can affect product costing accuracy. Assuming that this is the only difference due to process differ-ences, then process classification may not be needed for this company.

*Rounded

PROBLEMS

12–14

1. Plantwide rate = $2,850,000/100,000 DLH= $28.50 per hour

Standard Deluxe Prime costs $150.00 $350.00Overhead:

$28.50 50,000 hours/20,000 units 71.25$28.50 50,000 hours/10,000 units 142.50

Unit cost $221.25 $ 492.50

2. Pool 1: Maintenance $ 420,000Engineering support 600,000

Total $ 1,020,000Maintenance hours ÷ 20,000 Pool rate $ 51

Note: Engineering hours could also be used as a driver. The activities are grouped together because they have the same process, are both product-level, and have the same consumption ratios.

Pool 2: Material handling $600,000Number of moves ÷ 30,000 Pool rate $ 20

Pool 3: Setups $480,000Number of setups ÷ 400 Pool rate $ 1,200

Note: Material handling and setups have the same process and are both batch-level activities, but they have different consumption ratios.

Pool 4: Purchasing $300,000Receiving 200,000Paying suppliers 150,000

Total $650,000Invoices processed ÷ 3,750 Pool rate $ 173.33 *

Note: The three activities have the same process, are all product-level activi-ties, and have the same consumption ratios.

12–14 Concluded

Pool 5: Providing space $100,000Machine hours ÷ 50,000 Pool rate $ 2

Note: This is the only facility-level activity.

*Rounded

3. Unit cost: Standard Deluxe

Prime costs $3,000,000 $3,500,000Overhead:

Pool 1:$51 5,000 255,000$51 15,000 765,000

Pool 2:$20 10,000 200,000$20 20,000 400,000

Pool 3:$1,200 100 120,000$1,200 300 360,000

Pool 4:$173.33 1,250 216,663*$173.33 2,500 433,325

Pool 5:$2 25,000 50,000$2 25,000 50,000

Total $3,841,663 $5,508,325Units produced ÷ 20,000 ÷ 10,000 Unit cost (ABC) $ 192.08 * $ 550.83 *Unit cost (FBC) $ 221.25 $ 492.50

*Rounded

The ABC costs are more accurate (better tracing—closer representation of actual resource consumption). This shows that the standard model was over-costed and the deluxe model undercosted when the plantwide overhead rate was used.

12–15

1. Daily rate = $6,600,000/15,000 = $440 per day

This is the amount charged to each patient regardless of severity. This ap-proach is comparable to the unit-based cost assignment found in traditional manufacturing environments.

2. Pool rates:Lodging and feeding: $2,200,000/15,000 = $146.67* per patient dayMonitoring: $1,400,000/20,000 monitoring hours = $70 per hourNursing care: $3,000,000/150,000 = $20 per hour of nursing care

*Rounded

3. Daily rates by patient type:

High severity:Pool 1: $146.67 5,000 $ 733,350Pool 2: $70 10,000 700,000Pool 3: $20 90,000 1,800,000

Total $3,233,350Patient days ÷ 5,000 Daily rate $ 646.67

Medium severity:Pool 1: $146.67 7,500 $1,100,025Pool 2: $70 8,000 560,000Pool 3: $20 50,000 1,000,000

Total $2,660,025Patient days ÷ 7,500 Daily rate $ 354.67

Low severity:Pool 1: $146.67 2,500 $366,675Pool 2: $70 2,000 140,000Pool 3: $20 10,000 200,000

Total $706,675Patient days ÷ 2,500

Daily rate $ 282.67

12–15 Concluded

4. First, we would need to determine if treatment defines more than one prod-uct, just as patient severity defined different products for daily care. There probably is a similar classification for bypass surgery—defined by things such as patient age, number of bypasses, and complications. Once we have categorized patients in this way, then we would need to identify the activities associated with the treatment, “bypass surgery,” the costs of these activi-ties, and the activity drivers. Probably the easiest way is to view treatment as a separate product group from daily care and assign costs appropriately and then add the treatment cost to the daily care cost to obtain a total product cost.

5. The results for this problem clearly indicate that ABC can be useful for ser-vice industries. Service organizations have multiple products and product di-versity is certainly possible. Furthermore, many service industries are facing increasing competition just like the manufacturing sector, and accurate cost information is needed (e.g., consider hospitals and airlines and the problems they are having).

12–16

1. Activity rates:

Providing ATM service: $100,000/200,000 = $0.50 per transactionComputer processing: $1,000,000/2,500,000 = $0.40 per transactionIssuing statements: $800,000/500,000 = $1.60 per statementCustomer inquiries: $360,000/600,000 = $0.60 per minute

12–16 Continued

2. Product costing: Checking Loans Gold VISA

ATM servicing:$0.50 180,000 $ 90,000$0.50 20,000 $ 10,000

Computer processing:$0.40 2,000,000 800,000$0.40 200,000 $ 80,000$0.40 300,000 120,000

Issuing statements:$1.60 350,000 560,000$1.60 50,000 80,000$1.60 150,000 240,000

Customer inquiries:$0.60 350,000 210,000$0.60 90,000 54,000$0.60 160,000 96,000

Total cost $1,660,000 $214,000 $466,000Units of product ÷ 30,000 ÷ 5,000 ÷ 10,000 Unit cost $ 55.33 * $ 42.80 $ 46.60 *Rounded

12–16 Concluded

3. The revenues received are the interest earned plus the service charges (4% average balance + $60 per year, where appropriate). The expenses are the interest paid plus the activity charges computed in Requirement 2 [2% average balance (where appropriate) plus $55.33]. The profitability of each category is computed below for the average balance of each category:

Account Categories Average balance $ 400 $ 750 $ 2,000 $ 5,000 Revenues $76.00 $90.00 $ 80.00 $200.00Expenses 55.33 70.33 95.33 155.33

Profit per account $20.67 $19.67 $(15.33) $ 44.67

Breakeven point: Revenue = Cost0.04X = 0.02X + $55.33

X = $55.33/0.02= $2,767*

*Rounded

Accounts with a balance between $1,000 and $2,767 are not profitable. Since the increase in dollar volume came from this category, the decision to modify the product apparently reduced the bank’s profitability. The bank should consider restoring the service charge for accounts over $1,000. The effect may be to drive off some customers—customers that are unprofitable—who are in the $2,000 category. Unfortunately, it could also drive off customers in the $5,000 category. Furthermore, the effect on other products has not been analyzed. It may be that many of these customers are also buying other banking products because they have their checking accounts in this bank. Perhaps a gradual restoration of the charge for the higher balances would be the best solution.

12–17

1. Overhead rate = $6,990,000/272,500 = $25.65* per DLH

Overhead assignment:

Part #127: $25.65 250,000/500,000 = $12.83* per unitPart #234: $25.65 22,500/100,000 = $5.77* per unit

*Rounded to the nearest cent.

Unit gross margin: #127 #234

Selling price $31.86 $24.00Cost 21 .36 a 12 .03 b

Gross margin $10 .50 $11 .97 aPrime costs + Overhead = ($8.53 + $12.83) = $21.36bPrime costs + Overhead = ($6.26 + $5.77) = $12.03

12–17 Continued

2. Pools Cost Driver Pool Rate Setup Runs $240,000/300 = $800/runMachine Machine hours $1,750,000/185,000 = $9.46*/MHr.Receiving Receiving orders $2,100,000/1,400 = $1,500/orderEngineering Engineering hours $2,000,000/10,000 = $200/eng. hr.Material handling Material moves $900,000/900 = $1,000/move

Overhead assignment: #127 #234

Setup costs:$800 100 $ 80,000$800 200 $ 160,000

Machine costs:$9.46 125,000 1,182,500$9.46 60,000 567,600

Receiving costs:$1,500 400 600,000$1,500 1,000 1,500,000

Engineering costs:$200 5,000 1,000,000$200 5,000 1,000,000

Material-handling costs:$1,000 500 500,000$1,000 400 400,000

Total overhead costs $3,362,500 $3,627,600Units produced ÷ 500,000 ÷ 100,000 Overhead per unit $ 6.72* $ 36.28*Prime cost per unit 8.53 6.26 Unit cost $ 15.25 $ 42.54 Selling price $ 31.86 $ 24.00Cost 15.25 42.54 Gross margin (loss) $ 16.61 $ (18.54 )*Rounded

12–17 Concluded

3. No. The cost of making Part #127 is $15.25, much less than the amount indi-cated by functional-based costing. The company can compete with foreign producers by lowering its price on the high-volume product. The $20 price offered by foreign competitors is not out of line, and thus the concern about selling below cost is unfounded.

4. Part #234 is apparently quite expensive to make; thus, no competitor is will -ing to sell it for $24, a price well below its cost of production. This explains why Autotech has no competition. It also explains why customers would be willing to pay $30, a price that is probably still way below quotes from other manufacturers.

5. The price of Part #127 should be lowered so that the product is competitive and the price of #234 increased so that its costs are covered and a reason-able return is being earned.

12–18

1. Plantwide rate = ($1,725,000 + $945,000 + $735,000)/7,500= $454 per machine hour

Cylinder A: Unit cost = ($454 2,250)/1,500 = $681.00Cylinder B: Unit cost = ($454 5,250)/3,000 = $794.50

2. Cutting and Welding (C&W):

Pool 1 (Batch level):Setups $225,000Inspecting 150,000Material handling 600,000

Total $975,000Number of moves ÷ 12,000 Pool rate $ 81.25 per move

Note: The three activities are all batch-level activities and have the same con-sumption ratios.

12–18 Continued

Pool 2 (Unit level):Machining $300,000Welding 450,000

Total $750,000Machine hours ÷ 7,500 Pool rate $ 100 per machine hour

Assembly:

Pool 3 (Batch level):Changeover $180,000Rework 60,000Inspecting 225,000

Total $465,000No. of batches ÷ 750 Pool rate $ 620 per batch

Pool 4 (Product level):Engineering support $120,000Material handling 360,000

Total $480,000Engineering hours ÷ 2,000 Pool rate $ 240 per hour

Note: Material handling is a product-level activity because in assembly it is a function of product-level characteristics.

Procurement:

Pool 5 (Product level):Purchasing $135,000Receiving 270,000Paying suppliers 225,000

Total $630,000Receiving orders ÷ 900 Pool rate $ 700 per receiving order

12–18 Continued

Sustaining:

Pool 6 (Facility level):Providing space $ 45,000Providing utilities 60,000

Total $105,000Machine hours ÷ 7,500 Pool rate $ 14 per machine hour

There are potentially 15 rates, one for each activity. Thus, pool formation re-duced the rates by nine.

3. Overhead assignment:Cylinder A Cylinder B

Pool 1:$81.25 6,000 moves $ 487,500$81.25 6,000 moves $ 487,500

Pool 2:$100 2,250 MHrs. 225,000$100 5,250 MHrs. 525,000

Pool 3:$620 375 batches 232,500$620 375 batches 232,500

Pool 4:$240 1,200 eng. hours 288,000$240 800 eng. hours 192,000

Pool 5:$700 600 orders (rec.) 420,000$700 300 orders (rec.) 210,000

Pool 6:$14 2,250 MHrs. 31,500$14 5,250 MHrs. 73,500

Total overhead costs $1,684,500 $1,720,500Units produced ÷ 1,500 ÷ 3,000 Overhead per unit $ 1,123 $ 573.50

12–18 Concluded

Using plantwide rate assignments, Cylinder A is undercosted, and Cylinder B is overcosted. The activity assignments reflect the overhead consumption patterns better than the machine hour pattern of the plantwide rate. Accord-ing to the machine hour pattern, Cylinder B consumes 2.33 times as much overhead as Cylinder A. Yet, the activity drivers show that in many cases consumption is equal; in other cases, Cylinder A consumes more overhead resources.

12–19

1. Activity Relational Table

Act.No.

ActivityName

Process Level ActivityDriver

ActivityCapacity

Cost

1 Setups Cutting & Welding

Batch Moves 12,000 $225,000

2 Inspecting Cutting & Welding

Batch Moves 12,000 150,000

3 Material handling

Cutting & Welding

Batch Moves 12,000 600,000

4 Welding Cutting & Welding

Unit Machine hours

7,500 450,000

5 Machining Cutting & Welding

Unit Machine hours

7,500 300,000

6 Changeover Assembly Batch Batches 750 180,000

7 Inspecting Assembly Batch Batches 750 225,000

8 Rework Assembly Batch Batches 750 60,000

9 Material handling

Assembly Product Engineering hours

2,000 360,000

10 Engineering support

Assembly Product Engineering hours

2,000 120,000

11 Purchasing Procurement Product Receiving orders

900 135,000

12 Receiving Procurement Product Receiving orders

900 270,000

13 Paying sup-pliers

Procurement Product Receiving orders

900 225,000

14 Providing space

Sustaining Facility Machine hours

7,500 45,000

15 Providing utilities

Sustaining Facility Machine hours

7,500 60,000

12–19 Continued

Product Relational Table

ProductNo.

ProductName

ActivityDriver No.

ActivityDriver Name

ActivityUsage

1 Cylinder A 1 Units 1,500

1 Cylinder A 2 Moves 6,000

1 Cylinder A 3 Machine hours 2,250

1 Cylinder A 4 Batches 375

1 Cylinder A 5 Engineering hours 1,200

1 Cylinder A 6 Receiving orders 600

1 Cylinder A 7 Machine hours 2,250

2 Cylinder B 1 Units 3,000

2 Cylinder B 2 Moves 6,000

2 Cylinder B 3 Machine hours 5,250

2 Cylinder B 4 Batches 375

2 Cylinder B 5 Engineering hours 800

2 Cylinder B 6 Receivingorders

300

2 Cylinder B 7 Machine hours 5,250

2. A general ledger database focuses on accounts and shows what is spent, while an activity relational database traces costs to activities and shows how costs are spent.

12–20

1. To build a relational database, entities and attributes must first be defined. The entity defines the row, and the attributes define the column. For an activ-ity relational table, activity is the entity, and important activity attributes such as process, level, driver, capacity, and cost define the columns. For a prod-uct relational table, the entity is the product, and the attributes are things like driver number, driver name, and activity usage. A relational structure re-quires fixed row lengths, unique rows, and attributes for each row related to a single entity.

2. a. Primary key: Activity number and activity nameb. Concatenated key: Product name and activity driver numberc. Record: Any row of either tabled. Activity attribute: Name of any column of either tablee. Product attribute: Name of any column of a product relational tablef. Entity: Activity or product—the name of either table

3. Pool rates, molding process (taken from the activity relational table):

Pool 1:Designing molds $600,000Making molds 320,000

Total $920,000Number of products ÷ 20 Pool rate $ 46,000 per product

Pool 2:Inspecting molds $120,000Setting up batches 120,000

Total $240,000Number of setups ÷ 400 Pool rate $ 600 per setup

4. Molding overhead cost assignment (using pool rates and product relational table):

Component A:$46,000 1 $46,000$600 10 6,000 Total $52,000Units ÷ 1,000 Unit cost $ 52

12–21

1. Homogeneous Set Activities Level Driver Batch set 1 Setup Batch Setups

Inspecting Batch Setups

Batch set 2 Material handling Batch Moves

Conversion Power Unit Machine hoursMachine depreciation Unit Machine hours

Sustaining set 1 Scheduling Product No. of products

Sustaining set 2 Maintenance Product Machine hours

Sustaining set 3 Providing space Facility Value-added*Plant supervision Facility Value-added*

*This is simply the way facility costs are allocated to products. It may not measure the product’s demands for the facility activities.

2. Homogeneous cost pools and pool rates:

Batch process:Pool 1 (Setups + Inspection): $650,000/1,000 = $650 per setupPool 2 (Material handling): $200,000/10,000 = $20 per move

Conversion process:Pool 3 (Conversion): $400,000/5,000 = $80 per machine hour

Sustaining process:Pool 4 (Scheduling): $60,000/2 = $30,000 per product typePool 5 (Maintenance): $150,000/5,000 = $30 per machine hourPool 6 (Facility): $169,000/$1,690,000 = $0.10 per value-added dollar

Note: Value-added = Nonfacility overhead + Direct labor= $1,460,000 + $230,000= $1,690,000

12–21 Concluded

3. Product cost assignment:Small Frame Large Frame

Pool 1:$650 300 setups $195,000$650 700 setups $ 455,000

Pool 2:$20 3,500 moves 70,000$20 6,500 moves 130,000

Pool 3:$80 2,000 MHrs. 160,000$80 3,000 MHrs. 240,000

Pool 4:$30,000 1 (product type) 30,000$30,000 1 (product type) 30,000

Pool 5:$30 2,000 MHr 60,000$30 3,000 MHr 90,000

Pool 6:$0.10 $600,000a 60,000$0.10 $1,090,000b 109,000

Total $575,000 $1,054,000Units produced ÷ 10,000 ÷ 15,000 Unit overhead cost $ 57.50 $ 70.27 *a(Nonfacility-level overhead + Direct labor = $515,000 + $85,000).b(Nonfacility-level overhead + Direct labor = $945,000 + $145,000).

*Rounded

Facility-level costs are difficult to trace to individual products. Because there is no theoretical way to identify how individual products consume facility-level activities, some have recommended treating them as period costs. In practice, companies tend to follow a full costing approach and usually as-sign these costs to products. Either approach may be satisfactory since they are not typically a large percentage of total product cost. (They are about 10 percent of total overhead cost for this example and so would likely be less than half, or 5 percent, of total product cost when direct materials and direct labor are added.)

12–22

1. Plantwide rate = $660,000/440,000 DLH = $1.50 per DLH

Overhead cost per unit:

Scientific: $1.50 40,000/30,000 = $2Business: $1.50 400,000/300,000 = $2

2. Departmental rates:

Department 1: $340,000/170,000 = $2.00 per MHrDepartment 2: $320,000/365,000 = $0.88* per DLH

Overhead cost per unit:

Scientific: [($2.00 10,000) + ($0.88 10,000)]/30,000 = $0.96Business: [($2.00 160,000) + ($0.88 355,000)]/300,000 = $2.11*

Departmental rates:

Department 1: 340,000/75,000 = $4.53* per DLHDepartment 2: 320,000/50,000 = $6.40 per MHr

Overhead cost per unit:

Scientific: [($4.53 30,000) + ($6.40 10,000)]/30,000 = $6.66*Business: [($4.53 45,000) + ($6.40 40,000)]/300,000 = $1.53*

*Rounded to the nearest cent.

12–22 Concluded

3. Calculation of pool rates:

Cost Pool Cost Driver Pool Rate Batch-level pool:

Setup and Productioninspection runs $320,000/100 = $3,200/run

Unit-level pool:Power and Machine

maintenance hours $340,000/220,000 = $1.55*/MHr.*Rounded

Note: Direct labor hours could be used as a driver instead of machine hours. Inspection hours could be used instead of production runs.

Overhead assignment:Scientific Business

Batch-level:Setups:

$3,200 40 $128,000$3,200 60 $ 192,000

Unit-level:Power and maintenance:

$1.55 20,000 31,000$1.55 200,000 310,000

Total overhead $159,000 $ 502,000Units produced ÷ 30,000 ÷ 300,000 Overhead per unit $ 5.30 * $ 1.67 **Rounded to the nearest cent.

4. Using activity-based costs as the standard, the first set of departmental rates decreased the accuracy of the overhead cost assignment (over the plantwide rate) for both products. The opposite is true for the second set of departmen-tal rates. Thus, in one case it is possible to conclude that departmental rate assignments are better than the plantwide rate assignment.

COLLABORATIVE LEARNING EXERCISE

12–23

1. Shipping and warehousing costs are currently assigned using tons of paper produced, a unit-based measure. Many of these costs, however, are not driven by quantity produced. Many products have special handling and ship-ping requirements involving extra costs. These costs should not be assigned to those products that are shipped directly to customers.

2. The new method proposes assigning the costs of shipping and warehousing separately for the low-volume products. To do so requires three cost assign-ments: receiving goods, shipping goods, and carrying goods. The drivers for each activity are tons processed, items shipped, and tons sold.

I. Pool rate, receiving costs:Receiving cost/ton processed = $4,400,000/112,000 tons

= $39.29* per ton processedII. Pool rate, shipping costs:

Shipping cost per shipping item = $9,200,000/380,000= $24.21* per shipping item

III. Pool rate, carrying cost (an opportunity cost):Carrying cost per year (LLHC) = 3 $1,998 0.14

= $839.16Carrying cost per ton sold = $839.16/10 = $83.92* per ton

IV. Shipping and warehousing cost per ton sold:Receiving $ 39.29Shipping ($24.21 7) 169.47Carrying 83.92

Total $ 292.68

*Rounded

12–23 Concluded

3. Profit analysis:

Revised profit per ton (LLHC):Selling price $2,500.00Less manufacturing cost 1,998.00 Gross profit $ 502.00Less shipping and warehousing 292.68 Profit $ 209.32

Original profit per ton:Selling price $2,500.00Less manufacturing costs 1,998.00 Gross profit $ 502.00Less shipping and warehousing 36.00 Profit $ 466.00

The revised profit, reflecting a more accurate assignment of shipping and warehousing costs, presents a much different picture of LLHC. The product is, in reality, showing less than half the profit indicated initially. Its earlier ap-parent high profitability was attributable to subsidization by the high-volume products (by spreading the special shipping and handling costs over all products, using tons produced as the cost driver). The same is also true for the other low-volume products. Essentially, the system is understating the handling costs for low-volume products and overstating the cost for high-volume products.

4. The decision to drop some high-volume products and emphasize low-volume products could clearly be erroneous. As LLHC has demonstrated, its appar-ent high profitability is attributable to distorted cost assignments. A signifi-cant change in the image of LLHC was achieved by simply improving the ac-curacy of shipping and handling costs. Further improvements in accuracy in the overhead assignments may cause the view of LLHC to deteriorate even more. Conversely, the profitability of high-volume products may improve sig-nificantly with increased costing accuracy. This example underscores the im-portance of having accurate and reliable accounting information. The ac-counting system must bear the responsibility of providing reliable informa-tion.

5. Emily’s strategy changed because her information concerning the individual products changed. Apparently, the accounting system was undercosting the low-volume products and overcosting the high-volume products. Once more accurate information was available, Emily was able to respond more strategi-cally to competitive conditions.

CYBER RESEARCH CASES

12–24

Answers will vary.