Ch7 Activity-Based Costing And Activity Based Test Bank

Chapter 7

Activity-Based Costing and Activity Based Management

CHAPTER LEARNING OBJECTIVES

1. Classify activities as unit-level, batch-level, product-level, customer-level, or organization level.

Unit-level activities are performed for each individual unit. Since each unit of a particular product requires the same level of activity, each unit consumes the same amount of resources that provide for that activity. The total level of activity performed varies proportionately with the number of units produced.

Batch-level activities are performed on groups, or batches, of products at one time. Since the activity is based on the existence of the batch rather than on the number of units in the batch, a batch consumes the same quantity of resources whether it includes 20 units or 2,000 units.

Product-level activities, also referred to as product-sustaining activities, support the products or services provided by the company. These activities are performed for the entire product line, regardless of how many units or batches are produced.

Customer-level activities are performed for specific customers. These activities, and the resources consumed to perform them, do not affect product costs. Rather, the resources are consumed in the delivery of customer support services, and the associated costs are then used to determine the cost to serve a particular customer.

Organization-level activities are required to provide productive capacity and to keep the business in operation. Although these activities do not provide identifiable benefits to specific products or services, without them there would be no business.

1. Calculate activity-based product costs.

Step 1: Identify activities.

Step 2: Develop activity cost pools.

Step 3: Calculate activity cost pool rates.

Step 4: Allocate costs to products or services.

Step 5: Calculate unit product costs.

1. Explain the difference between traditional product costs and activity-based product

costs.

The difference between traditional product costs and activity-based product costs lies in the way manufacturing overhead is allocated and in the inclusion of selling and administrative costs as a component of product cost. (Direct materials and direct labor costs do not differ between the two methods.) Activity-based product costs are based on the consumption of activities by each product rather than on consumption of the overhead base as in the traditional method.

1. Distinguish between value-added and non-value-added activities.

Value-added activities are those activities that create the product or service the customer wants to buy. Non-value-added activities are those activities that consume resources but do not contribute to the product’s value.

1. Explain how information about activities can be used to make decisions.

Activity-based management uses activity-based costing information to manage business activities. Decisions regarding pricing, customer profitability, distribution channel profitability, and process improvement can all benefit from the use of activity-based costing information.

TRUE-FALSE STATEMENTS

1. Calculating the direct materials and direct labor cost that have been incurred to produce a product or deliver a service is a relatively complex process.
2. Even when direct materials and direct labor comprise the majority of product costs, manufacturing overhead allocation is still a major issue.
3. Activity-based costing is a costing technique that assigns costs to cost objects such as products or customers, based on the activities those cost objects require.
4. A simple ABC model can have fewer than 20 activities; a complex model may include up to 100 activities, but no more.
5. With activity-based costing, the goal is to develop a product cost that captures the amount of each resource consumed by the activities performed to produce a specific product.
6. An activity-based analysis that focuses only on manufacturing overhead improves GAAP-based financial statements.
7. For unit-level activities, the total level of activity performed varies proportionately with the number of units produced.
8. Product-level activities are also referred to as product-sustaining activities.
9. Customer-level activities are also referred to as customer-sustaining activities.
10. Customer-level activities and the resources consumed to perform them do not affect product costs.
11. Organizational-level activities provide identifiable benefits to specific products or services.
12. Under activity-based costing, selling and administrative costs should be allocated to products if they are incurred to provide resources that are consumed by unit-level, batch-level, or product-level activities.
13. The first step in developing activity-based product costs is to develop activity cost pools.
14. Identifying the activities performed in the organization is the most time-consuming part of implementing an activity-based costing system.
15. In an activity-based costing system, a critical question to ask during activity identification is, “How important is this activity to the overall strategy of the organization?”

LO: 2, Bloom: AN, Unit: 7-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting

1. In an activity-based costing system, the greater the level of detail the company wants to collect, the greater the chance of misclassifying some costs and activities.
2. In an activity-based costing system, the benefits of defining more detailed activities will always outweigh the effort needed to monitor activity performance, and the resulting potential for error.
3. In an activity-based costing system, after all the activities have been identified and the appropriate level of detail selected, the activities are combined into activity cost pools based on their cost drivers.
4. First-stage allocation is the process of assigning manufacturing overhead costs to activity pools.
5. In an activity-based costing system, after the manufacturing overhead costs have been assigned to activity cost pools, the next step is to calculate the unit product cost.
6. The calculation to allocate costs to products or services is to divide the activity driver consumption by the activity rate.
7. The total amount of manufacturing overhead allocated to a particular product will always be the same for both the traditional overhead allocation method based on direct labor hours and the activity-based costing overhead allocation.
8. Although the total amount of allocated overhead differs between a traditional overhead allocation method and activity-based overhead allocations, we can still compare the percentage of overhead allocated to each product.
9. Activity-based management focuses on using the costs of performing the activities required to produce and sell products to identify activities that are non-value added.
10. Non-value-added costs cannot be eliminated without affecting the quality of products.
11. The two categories – valued-added and non-value added – are defined from the organization’s management perspective.

LO: 4, Bloom: K, Unit: 7-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: None, IMA: Strategy

1. Process improvement is the examination of business processes to identify incremental changes that may reduce operating costs.
2. The process of using activity-based costing information to manage a business’s activities, and thus its costs, is called total quality management.
3. The greatest use of activity-based costing information is for product costing and cost control.
4. Activity-based costing information can be used to make decisions regarding pricing, customer profitability, distribution channel profitability, and process improvement.

Answers to True-False Questions

MULTIPLE-CHOICE QUESTIONS

1. A costing technique that assigns costs to cost objects such as products or customers, based on the activities those cost objects require is referred to as
   1. activity-job costing.
   2. activity-based costing.
   3. activity-pool costing.
   4. activity-trace costing.
2. Frederick Taylor was the first to understand the importance of a business’s activities. He examined workers’ jobs as a set of tasks, each of which had a standard completion time in the
   1. early 1800s.
   2. late 1800s.
   3. early 1900s.
   4. late 1900s.
3. Activity-based costing did not gain widespread popularity until
   1. 1882.
   2. 1907.
   3. 2000.
   4. 1987.
4. With activity-based costing, the goal is to
   1. develop a product cost that captures the amount of each resource consumed by the activities performed to produce a specific product.
   2. develop a product cost that allocates manufacturing overhead to each resource consumed by the activities performed to a group of similar products.
   3. develop a product cost that eliminates all waste such as machine down time and defective products.
   4. develop a product cost that maximizes the number of units sold.
5. Which of the following is not an indicator that an activity-based costing analysis may be appropriate?
   1. Bids for complex products are accepted, while bids for simple products are rejected.
   2. Products are similar and consume resources in the same way.
   3. High-volume jobs show losses or minimal profits, while low-volume jobs show healthy profits.
   4. Bids for jobs that require “special” processing are always accepted.
6. An activity-based analysis that focused only on manufacturing overhead will
   1. not improve GAAP-based financial statements.
   2. improve GAAP-based financial statements.
   3. improve statement sent to the SEC by publicly traded companies.
   4. both improve GAAP-based financial statements and statement sent to the SEC by publicly traded companies.
7. The main reason for generating new information provided by activity-based costing is to
   1. help managers make better decisions.
   2. reduce product costs.
   3. calculate variances.
   4. reduce total overhead costs.
8. In an activity-based costing system, which of the following is not a category in which activities are classified?
   1. Unit-level
   2. Batch-level
   3. Product-level
   4. Factory-level
9. In an activity-based costing system, which of the following is not a category in which activities are classified?
   1. Product-level
   2. Operations-level
   3. Customer-level
   4. Organization-level
10. In an activity-based costing system, which of the following is not a category in which activities are classified?
    1. Unit-level
    2. Product-level
    3. Industry-level
    4. Customer-level
11. In an activity-based costing system, which of the following is not a category in which activities are classified?
    1. Variable-level
    2. Batch-level
    3. Product-level
    4. Organization-level
12. In an activity-based costing system, which of the following is not a category in which activities are classified?
    1. Unit-level
    2. Batch-level
    3. Product-level
    4. Delivery-level
13. An activity that is performed for each individual unit of product is classified as a
    1. variable cost-level activity.
    2. unit-level activity.
    3. batch-level activity.
    4. operations-level activity.
14. For a unit-level activity, the total level of activity performed varies
    1. proportionately with the number of units produced.
    2. inversely with the number of units produced.
    3. like a step-function.
    4. It does not change with a change in activity.
15. Activities that are performed all at once on groups of products are classified as a(n)
    1. unit-level activity.
    2. group-level activity.
    3. batch-level activity.
    4. operations-level activity.
16. Since a batch-level activity is based on the existence of the batch, a batch consumes resources
    1. proportionately with the number of units in the batch.
    2. inversely with the number of units in the batch.
    3. that cause total overhead costs to decrease.
    4. as a fixed amount whether it contains 20 units or 2,000 units.
17. Product-level activities are also referred to as
    1. product-sustaining activities.
    2. product resource activities.
    3. batch-level activities.
    4. group-level activities.
18. Activities that support the products or services a company provides are classified as a(n)
    1. unit-level activity.
    2. batch-level activity.
    3. product-level activity.
    4. organization-level activity.
19. Activities that are performed for specific customers are classified as a(n)
    1. delivery-level activity.
    2. customer-level activity.
    3. accounts receivable-level activity.
    4. organization-level activity.
20. Processing a sales order is an example of a
    1. product-level activity.
    2. unit-level activity.
    3. customer-level activity.
    4. group-level activity.
21. Activities that are required to provide productive capacity and to keep the business in operation are
    1. batch-level activities.
    2. product-level activities.
    3. customer-level activities.
    4. organization-level activities.
22. An example of an organization-level activity is
    1. providing electricity to the factory to run the sewing machines.
    2. creating a pattern for a new line of dresses.
    3. renting factory space.
    4. processing a sales order.
23. Which of the following is not a product- or service-related activity?
    1. Unit-level
    2. Product-level
    3. Batch-level
    4. Customer-level
24. Which of the following is a product- or service-related activity?
    1. Making sales calls
    2. Performing machine maintenance
    3. Running a production machine
    4. Moving materials
25. A difference in GAAP-based product costing and activity-based costing is that under activity-based costing
    1. all costs are classified as product and period costs, whereas under GAAP they are classified by behavior.
    2. sales less cost of goods sold is classified as gross profit, whereas under GAAP this subtotal is titled contribution margin.
    3. selling and administrative costs are allocated to products if they are incurred to provide resources that are consumed by unit-level, batch-level, or product-level activities.
    4. all costs are traceable, whereas in GAAP-based costing some costs are allocated.
26. Which of the following is considered a unit-level activity?
    1. Ordering direct materials
    2. Direct labor
    3. Preparing the annual budget
    4. Performing quality tests
27. Which of the following is considered a unit-level activity?
    1. Preparing purchase orders
    2. Machine set-up
    3. Quality tests
    4. Running a production machine
28. Which of the following is considered a batch-level activity?
    1. Machine set-up
    2. Preparing the annual budget
    3. Direct labor
    4. Warehouse costs
29. Which of the following is considered a batch-level activity?
    1. Engineering changes made on the assembly line
    2. Quality tests
    3. Warehouse costs
    4. Preparing the annual budget
30. Which of the following is considered a product-level activity?
    1. Product design changes
    2. Quality tests
    3. Preparing purchase orders
    4. Direct labor
31. Which of the following is considered a product-level activity?
    1. Quality tests
    2. Engineering changes made in the assembly line
    3. Machine set-up
    4. Preparing purchase orders
32. Which of the following is not considered a customer-level activity?
    1. Making a sales call
    2. Processing a sales order
    3. Delivery costs
    4. Preparing purchase orders
33. Which of the following is considered a customer-level activity?
    1. Ordering direct materials used in all products
    2. Engineering changes made that will affect all products
    3. Cleaning the machines before beginning production
    4. Processing a sales order
34. Estimated costs for activity cost pools and other item(s) are as follows:

Machining $800,000

Assembling 200,000

Advertising 450,000

Inspecting and testing 175,000

Total estimated overhead is

• 1. $1,000,000.
  2. $1,175,000.
  3. $1,450,000.
  4. $1,625,000.

1. The first step in implementing an activity-based costing system begins with
   1. developing activity cost pools.
   2. identifying activities.
   3. calculating activity cost pool rates.
   4. calculate the unit product cost.
2. Which of the following is not a step in implementing an activity-based costing system?
   1. Developing activity cost pools
   2. Identifying activities
   3. Calculating predetermined overhead rates
   4. Calculate the unit product cost
3. Identifying activities performed in the organization is the first step in developing activity-based product costs. Which of the following is a way to identify these activities?
   1. Asking employees what they do
   2. Analyzing industry averages
   3. Investigating variances
   4. Determining cost pools
4. Identifying activities performed in the organization is the first step in developing activity-based product costs. Which of the following is a way to identify these activities?
   1. Asking managers about product profitability
   2. Observe what employees do
   3. Separate costs into cost pools
   4. Perform first-stage allocation
5. Which of the following is the most time-consuming part of implementing an activity-based costing system?
   1. Identifying activities
   2. Developing activity cost pools
   3. Calculating activity cost pool rates
   4. Calculate the unit product cost
6. Which of the following is the step in implementing an activity-based costing system that can generate the greatest error?
   1. Identifying activities
   2. Developing activity cost pools
   3. Calculating activity cost pool rates
   4. Calculate the unit product cost
7. Which of the following is a reason that employees must estimate how much time they spend performing each activity?
   1. So that the budget committee can estimate labor costs
   2. So that the resources consumed by the activities can be calculated
   3. So that the cost pools can be identified
   4. So that the activity rates are used correctly
8. In the activity identification stage of implementing an activity-based costing system, the greater the level of detail
   1. the less likely the company will be to have a net loss.
   2. the greater chance of misclassifying some costs and activities.
   3. the less likely to misclassify some costs and activities.
   4. the more likely the company will identify cost pools.
9. In the activity identification stage of implementing an activity-based costing system, defining activities in greater detail will
   1. require more monitoring.
   2. increase the effect of misclassifying some costs and activities.
   3. cause fewer variances.
   4. enable all costs to be unit-costs.
10. In implementing an activity-based costing system, after all the activities have been identified and the appropriate level of detail selected, the activities are combined into activity cost pools based on their
    1. behavior.
    2. function.
    3. cost drivers.
    4. cost levels.
11. Which of the following is a likely activity driver for warehousing/packaging?
    1. Direct labor hours
    2. Number of machine set-ups
    3. Number of product lines
    4. Number of batches
12. Which of the following is a likely activity driver for product design?
    1. Number of product lines
    2. Number of direct labor hours
    3. Number of machine hours
    4. Number of batches
13. In implementing an activity-based costing system, once the activity pools have been determined, manufacturing overhead costs can be assigned to them. This is referred to as
    1. predetermined overhead allocation.
    2. overhead application.
    3. first-stage allocation.
    4. activity allocation.
14. Assigning manufacturing overhead cost to activity pools is referred to as first-stage allocation because costs are assigned first to the activity pools before being assigned to
    1. cost objects.
    2. cost drivers.
    3. activity drivers.
    4. activity objects.
15. Calculating the activity rate is similar to the calculation of the
    1. activity pools.
    2. predetermined overhead rate.
    3. overhead leverage rate.
    4. contribution margin rate.
16. Which of the following is the formula for calculating the activity rate in an activity-based costing system?
    1. Activity cost pool resources divided by total activity driver volume
    2. Activity driver divided by activity cost pool resources
    3. Activity cost pool resources divided by estimated total cost pool volume
    4. Estimated cost pool driver volume divided by activity cost pool resources
17. Assume that activity cost is $93,000, predetermined total overhead is $120,000, actual overhead is $98,000, and the company has three product lines, the activity rate is
    1. $32,667 per product line.
    2. $31,000 per product line.
    3. $40,000 per product line.
    4. $50,000 per product line.
18. Assume that activity cost totals $180,000. The company produced an average of 40 units per batch and the number of batches produced is 9,000. Calculate the activity rate.
    1. $20 per batch
    2. $4,500 per batch
    3. 225 per batch
    4. .005 per batch
19. A&W Manufacturing uses an activity-based costing system for its cutting department. The activity cost totals $148,000. The number of cuts is the cost driver. The cutting department processed a total of 9,000 batches with an average cuts per batch of 6 and total cuts of 46,250. What is the activity rate for the cutting department?
    1. $1,500 per cut
    2. $247 per cut
    3. $16.45 per batch
    4. $3.20 per cut
20. When using an activity-based costing system, which of the following is the formula for allocating costs to products or services?
    1. Activity rate × activity driver consumption
    2. Activity rate × amount in activity pool
    3. Predetermined manufacturing overhead rate × actual activity
    4. Predetermined manufacturing overhead rate × planned activity
21. When using an activity-based costing system, which of the following is the formula for allocating costs to products or services?
    1. Activity cost pool resources divided by activity driver
    2. Activity cost pool resources times activity driver
    3. Activity rate divided by activity driver consumption
    4. Activity rate times activity driver consumption
22. The last step in the preparation of activity-based costing data is to
    1. determine the cost pool resources.
    2. determine the activity driver.
    3. allocate cost to products.
    4. calculate the unit product cost.
23. The second step in the preparation of activity-based costing data is to
    1. calculate activity cost pool rates.
    2. develop activity cost pools.
    3. allocate costs to products.
    4. calculate the unit product cost.
24. The activity rate for each cost pool is
    1. computed as Total activity driver volume ÷ Total activity cost pool resources.
    2. similar to the predetermined overhead rate calculation under traditional job order costing.
    3. computed as part of the last step in the preparation of activity-based costing data.
    4. similar to process costing.
25. The easiest part of calculating the total product cost is
    1. separating direct material and indirect material.
    2. allocating costs to products.
    3. adding the direct materials and direct labor costs to overhead.
    4. only adding direct materials to overhead.
26. Which of the following is probably not included in the allocation of overhead costs to products, but is included in the “general” category?
    1. Depreciation on factory equipment
    2. Maintenance of factory equipment
    3. Indirect material
    4. Advertising
27. Which of the following is the most appropriate cost driver for the purchasing department?
    1. Number of orders placed
    2. Direct labor hours
    3. Machine hours
    4. Direct labor cost
28. Which of the following is the most appropriate cost driver for delivery of goods?
    1. Wages of the delivery drivers
    2. Number of deliveries made
    3. Depreciation on delivery trucks
    4. Insurance on delivery trucks
29. Patel Catering Service uses an activity-based costing system. What is the most appropriate cost driver for the activity of preparing meals?
    1. Number of meals prepared
    2. Number of orders taken
    3. Number of rolls used
    4. Rent on building
30. A firm produces and sells two products, Standard and Deluxe. The following information relates to setup costs of $180,000 (a part of factory overhead).

Activity-based costing will allocate which of the following amounts of setup cost to each unit (rounded to the nearest dollar)?

$180,000 ÷ (100 + 125) = $800 per setup;

Standard setup cost per unit = $800 ÷ 16 = $50;

Deluxe setup cost per unit = $800 ÷ 12.8 = $62.50 (rounded to nearest dollar is $63.00)

1. Brandon Consulting Company is headquartered in Atlanta and has branch offices in Nashville and Birmingham. Brandon uses an activity-based costing system. The Atlanta office has its costs for Administration and Legal allocated to the two branch offices. Brandon has provided the following information:

How much of Atlanta’s cost will be allocated to Nashville?

• 1. $628,500
  2. $663,500
  3. $670,400
  4. $665,300

Legal: $138,000 × [18,000 ÷ (18,000 + 6,000)] = $103,500;

$560,000 + $103,500 = $663,500

1. Brandon Consulting Company is headquartered in Atlanta and has branch offices in Nashville and Birmingham. Brandon uses an activity-based costing system. The Atlanta office has its costs for Administration and Legal allocated to the two branch offices. Brandon has provided the following information:

How much of Atlanta’s cost will be allocated to Birmingham?

• 1. $174,500
  2. $167,600
  3. $209,500
  4. $175,400

Legal: $138,000 × [6,000 ÷ (18,000 + 6,000)] = $34,500;

$140,000 + $34,500 = $174,500

1. Murphy Company produces two products: Standard and Deluxe. The company uses an activity-based costing system. Murphy produced 8,000 units of Standard and 2,000 units of Deluxe. The company uses two activity cost pools, with estimated total cost and activity as follows:

What is the cost per unit of Standard under activity-based costing?

• 1. $1.75
  2. $9.00
  3. $15.00
  4. $16.00

Activity #2: $24,000 × [400 ÷ (400 + 1,200)] = $6,000;

($8,000 + $6,000) ÷ 8,000 units of Standard = $1.75 per unit of Standard

1. Murphy Company produces two products: Standard and Deluxe. The company uses an activity-based costing system. Murphy produces 8,000 units of Standard and 2,000 units of Deluxe. The company uses two activity cost pools, with estimated total cost and activity as follows:

What is the cost per unit of Deluxe under activity-based costing?

• 1. $1.75
  2. $11.00
  3. $15.00
  4. $16.00

Activity #1: $12,000 × [250 ÷ (500 + 250)] = $4,000;

Activity #2: $24,000 × [1,200 ÷ (400 + 1,200)] = $18,000;

1. Sampson Company manufactures two products, plain and complex. The company has estimated its overhead in the order-processing department to be $480,000. The company produces 50,000 plain and 80,000 complex each year. Plain production requires 25,000 machine hours, complex production requires 50,000 machine hours. The company places raw materials orders 10 times per month, 2 times for raw materials for plain and the remainder for raw materials for complex. How much of the order processing overhead should be allocated to complex?
   1. $240,000
   2. $320,000
   3. $295,386
   4. $384,000
2. Morrow Co. produces 3 products: Beta, Delta, and Gamma. Beta requires 400 purchase orders, Delta requires 600 purchase orders, and Gamma requires 1,000 purchase orders. Morrow has identified an ordering and receiving activity cost pool with allocated overhead of $180,000 for which the cost driver is purchase orders. Direct labor hours used on each product are 50,000 for Beta, 40,000 for Delta, and 110,000 for Gamma. How much ordering and receiving overhead is assigned to each product?

   Beta      Delta    Gamma

• 1. $60,000 $60,000 $60,000
  2. $45,000 $36,000 $99,000
  3. $36,000 $54,000 $90,000
  4. $40,500 $45,000 $94,500

Delta = $180,000 × [600 ÷ (400 + 600 + 1,000 purchase orders) = $54,000

Gamma = $180,000 × [1,000 ÷ (400 + 600 + 1,000 purchase orders) = $90,000

1. Ayala Inc. computed an overhead rate for machining costs ($1,500,000) of $15 per machine hour. Machining costs are driven by machine hours. If computed based on direct labor hours, the overhead rate for machining costs would be $30 per direct labor hour. The company produces two products, Hammer and Tong. Hammer requires 60,000 machine hours and 20,000 direct labor hours, while Tong requires 40,000 machine hours and 30,000 direct labor hours. Using activity-based costing, machining costs assigned to each product is

Hammer    Tong   

• 1. $600,000 $900,000
  2. $750,000 $750,000
  3. $800,000 $700,000
  4. $900,000 $600,000

Tong: $1,500,000 × [40,000 MH ÷ (60,000 + 40,000)] = $600,000, or $15 × 40,000 = $600,000

1. Gooding Company manufactures two models of its skillet, the Kitchen and the Campfire. The Kitchen model requires 10,000 direct labor hours and the Campfire requires 30,000 direct labor hours. The company produces 3,400 units of the Kitchen model and 600 units of the Campfire model each year. The company inspects one Kitchen for every 100 produced and inspects one Campfire for every 10 produced. The company expects to incur $84,600 of total inspecting costs this year. How much of the inspecting costs should be allocated to the Kitchen model using ABC costing?
   1. $21,150
   2. $30,600
   3. $42,300
   4. $71,910

Total inspections = 34 + 60 = 94;

$84,600 × (34 ÷ 94) = $30,600;

1. Mantle Co. manufactures baseball bats. The company’s total overhead consists of assembly costs and inspection costs. The following data is available:

Cost Pool Wood Aluminum Total Cost

Assembly 500 machine hrs. 500 machine hrs. $ 45,000

Inspections 350 inspections 150 inspections 75,000

2,100 labor hrs. 1,900 labor hrs.

Total overhead assigned to wood bats assuming a single overhead rate and using activity-based costing, respectively, are

• 1. $63,000 and $75,000.
  2. $63,000 and $57,000.
  3. $57,000 and $45,000.
  4. $57,000 and $75,000.

$30/DLH × 2,100 DLH = $63,000;

Inspections: $75,000 ÷ (350 + 150 inspections) = $150 per inspection;

ABC: ($45 × 500) + ($150 × 350) = $75,000

1. Mantle Co. manufactures baseball bats. The company’s total overhead consists of assembly costs and inspection costs. The following data is available:

Cost Pool Wood Aluminum Total Cost

Assembly 500 machine hrs. 500 machine hrs. $ 45,000

Inspections 350 inspections 150 inspections 75,000

2,100 labor hrs. 1,900 labor hrs.

Total overhead assigned to aluminum bats assuming a single overhead rate and using activity-based costing, respectively, are

• 1. $63,000 and $75,000.
  2. $57,000 and $45,000.
  3. $63,000 and $57,000.
  4. $57,000 and $75,000.

$30/DLH × 1,900 DLH = $57,000;

Inspections: $75,000 ÷ (350 + 150 inspections) = $150 per inspection;

ABC: ($45 × 500) + ($150 x 150) = $45,000

1. Dawson Company manufactures two products, Regular and Deluxe. Overhead costs consist of machining, $2,500,000; and assembly, $1,250,000. Recent data are provided below:

Regular Deluxe

Direct labor hours 10,000 15,000

Machine hours 10,000 30,000

Number of parts 90,000 160,000

Overhead allocated to Regular using a single overhead rate (based on number of parts) and using activity-based costing, respectively, are

• 1. $2,400,000 and $2,625,000.
  2. $937,500 and $2,812,500.
  3. $1,350,000 and $1,125,000.
  4. $1,075,000 and $2,675,000.

Regular: $15/part x 90,000 DLH = $1,350,000;

Assembly: $1,250,000 ÷ (10,000 + 15,000 DLH) = $50/DLH;

ABC for Regular: ($62.50 x 10,000) + ($50 x 10,000) = $1,125,000

1. Dawson Company manufactures two products, Regular and Deluxe. Overhead costs consist of machining, $2,500,000; and assembly, $1,250,000. Recent data are provided below:

Regular Deluxe

Direct labor hours 10,000 15,000

Machine hours 10,000 30,000

Number of parts 90,000 160,000

Overhead allocated to Deluxe using a single overhead rate (based on number of parts) and using activity-based costing, respectively, are

• 1. $2,400,000 and $2,625,000.
  2. $937,500 and $2,812,500.
  3. $1,350,000 and $1,125,000.
  4. $1,075,000 and $2,675,000.

Deluxe: $15/part × 160,000 DLH = $2,400,000;

Assembly: $1,250,000 ÷ (10,000 + 15,000 DLH) = $50 per DLH;

ABC for Deluxe: ($62.50 × 30,000) + ($50 × 15,000) = $2,625,000

1. Auburn, Inc.‘s overhead costs of $700,000 consist of machining $400,000; inspecting $200,000; and packaging $100,000. Machining works 4,000 hours a year, 500 inspections occur each year, and 1,000 packing order occur each year. Information on the company’s two products are as follows:

Alpha Omega

Machining hours 1,000 3,000

Inspections 100 400

Packing orders 350 650

Direct labor hours 1,700 1,800

How much overhead is allocated to Alpha using a single overhead rate (based on direct labor hours) and assuming ABC, respectively?

• 1. $340,000 and $360,000
  2. $340,000 and $175,000
  3. $360,000 and $175,000
  4. $360,000 and $525,000

Alpha: $200 per DLH × 1,700 DLH = $340,000;

Inspection: $200,000 ÷ 500 inspections = $400/inspection;

Packaging: $100,000 ÷ 1,000 orders = $100/order;

ABC for Alpha: ($100 × 1,000) + ($400 × 100) + ($100 × 350) = $175,000

1. Auburn, Inc.‘s overhead costs of $700,000 consist of machining $400,000; inspecting $200,000; and packaging $100,000. Machining works 4,000 hours a year, 500 inspections occur each year, and 1,000 packing order occur each year. Information on the company’s two products are as follows:

Alpha Omega

Machining hours 1,000 3,000

Inspections 100 400

Packing orders 350 650

Direct labor hours 1,700 1,800

How much overhead is allocated to Omega using a single overhead rate (based on direct labor hours) and using ABC, respectively?

• 1. $340,000 and $360,000
  2. $340,000 and $175,000
  3. $360,000 and $175,000
  4. $360,000 and $525,000

Omega: $200/DLH × 1,800 DLH = $360,000;

Inspection: $200,000 ÷ 500 inspections = $400/inspection;

Packaging: $100,000 ÷ 1,000 orders = $100/order;

ABC for Omega: ($100 × 3,000) + ($400 × 400) + ($100 × 650) = $525,000

1. Austin Company manufactures 2 products, Flacca and Gordo. Overhead costs are comprised of machine set-ups $1,600,000; machining $3,600,000; and inspecting $1,200,000. Recent data are shown below:

Flacca Gordo

Direct labor hours 15,000 25,000

Machine setups 600 400

Machine hours 24,000 26,000

Inspections 800 700

Overhead assigned to Flacca using a single overhead rate based on direct labor hours and using ABC, respectively, will be

• 1. $4,000,000 and $2,400,000.
  2. $4,000,000 and $3,072,000.
  3. $2,400,000 and $3,328,000.
  4. $2,400,000 and $3,072,000.

Flacca: $160 per DLH × 15,000 DLH = $2,400,000;

Machining: $3,600,000 ÷ (24,000 + 26,000 MH) = $72 per MH;

Inspections: $1,200,000 ÷ (800 + 700 inspections) = $800 per inspection;

ABC for Flacca: ($1,600 × 600) + ($72 × 24,000) + ($800 × 800) = $3,328,000

1. Austin Company manufactures 2 products, Flacca and Gordo. Overhead costs are comprised of machine set-ups $1,600,000; machining $3,600,000; and inspecting $1,200,000. Recent data are shown below:

Flacca Gordo

Direct labor hours 15,000 25,000

Machine setups 600 400

Machine hours 24,000 26,000

Inspections 800 700

Overhead assigned to Gordo using a single overhead rate based on direct labor hours and using ABC, respectively, will be

• 1. $4,000,000 and $2,400,000.
  2. $4,000,000 and $3,072,000.
  3. $2,400,000 and $3,328,000.
  4. $2,400,000 and $3,072,000.

Gordo: $160/DLH × 25,000 DLH = $4,000,000;

Machining: $3,600,000 ÷ (24,000 + 26,000 MH) = $72 per MH;

Inspections: $1,200,000 ÷ (800 + 700 inspections) = $800 per inspection;

ABC for Gordo: ($1,600 × 400) + ($72 × 26,000) + ($800 × 700) = $3,072,000

1. Turnbull Company produces two products and their overhead consists of setups $20,000; machining $2,220,000; and packing $80,000. Data for the current year follow:

Beta Delta

Number of setups 20 20

Machine hours 1,000 4,000

Packing orders 150 350

Number of units produced 600 400

The overhead allocated to Beta assuming a single overhead rate based on machine hours and assuming ABC, respectively, are

• 1. $256,000 and $478,000.
  2. $464,000 and $456,000.
  3. $256,000 and $242,000.
  4. $464,000 and $478,000.

Single OH Rate Allocation Beta: $2,320,000 × [1,000 ÷ (1,000 + 4,000)] = $464,000;

Setups: $20,000 ÷ (20 + 20 setups) = $500 per setup;

Machining: $2,220,000 ÷ (1,000 + 4,000 MH) = $444 per MH;

Packing: $80,000 ÷ (150 + 350 orders) = $160 per order;

1. Turnbull Company produces two products and their overhead consists of setups $20,000; machining $2,220,000; and packing $80,000. Data for the current year follow:

Beta Delta

Number of setups 20 20

Machine hours 1,000 4,000

Packing orders 150 350

Number of units produced 600 400

The overhead allocated to Delta assuming a single overhead rate based on machine hours and assuming ABC, respectively, are

• 1. $1,856,000 and $1,878,000.
  2. $1,864,000 and $2,056,000.
  3. $1,856,000 and $1,842,000.
  4. $1,864,000 and $1,878,000.

Single OH Rate Allocation Beta: $2,320,000 × [4,000 ÷ (1,000 + 4,000)] = $1,856,000;

Setups: $20,000 ÷ (20 + 20 setups) = $500 per setup;

Machining: $2,220,000 ÷ (1,000 + 4,000 MH) = $444 per MH;

Packing: $80,000 ÷ (150 + 350 orders) = $160 per order;

1. In changing from a traditional costing system to an activity-based costing system, overhead costs tend to shift from high-volume standard products to low-volume premium products because
   1. all overhead costs are indirect.
   2. premium products usually consume more activities per unit than standard products.
   3. standard products use more total activities than premium products.
   4. all overhead costs are direct.
2. Which of the following might be a reason that allocating overhead under an activity-based approach might have less manufacturing overhead allocated to the products?
   1. The general overhead cost pool is not allocated to products under activity-based costing.
   2. The product mix includes products that are not similar in material and labor.
   3. The product mix has all products that are similar in makeup of materials and labor.
   4. The general overhead cost pool is allocated to products under activity-based costing.
3. Those activities that consume resources but do not contribute to the value of the product are referred as
   1. contribution activities.
   2. non-value-added activities.
   3. negative activities.
   4. period costs.
4. Those activities that create the product the customer wants to buy are referred to as
   1. profitability activities.
   2. manufacturing burden.
   3. value-added activities.
   4. period costs.
5. The categories of activities that are required to produce and sell products, non-value-added and value-added, are defined from which of the following perspectives?
   1. Industry
   2. Management
   3. Customer
   4. Organization
6. Which of the following activities is classified as non-value added in the manufacture of wooden bird houses?
   1. Moving paint to production
   2. Nailing the oak roof
   3. Painting the sides
   4. Sanding the corners
7. Which of the following activities is classified as non-value-added in the manufacture of dresses?
   1. Cutting
   2. Sewing
   3. Hemming
   4. Inspecting
8. Which of the following activities is classified as non-value-added in the manufacture of decorative pillows?
   1. Cutting
   2. Sewing
   3. Storing
   4. Stuffing
9. Which of the following activities is classified as non-value-added in the manufacture of sports jackets?
   1. Machine setup
   2. Cutting
   3. Sewing
   4. Lettering
10. As non-value-added activities and their associated resources are eliminated, a company’s
    1. costs will decrease.
    2. fixed costs will be eliminated.
    3. variable costs will increase.
    4. fixed costs will increase.
11. The key to reducing costs through activity management is
    1. reducing the number of activities.
    2. eliminating the resources associated with the reduced activities.
    3. reducing the work force.
    4. reducing the commissions of sales force.
12. The key to reducing costs through activity management is
    1. eliminating high-cost executive positions.
    2. eliminating activities such as inspections.
    3. eliminating the resources associated with the reduced activities.
    4. eliminating high-cost executive positions, activities such as inspections, and the resources associated with the reduced activities.
13. A characteristic of non-value-added activities is that they
    1. can always be eliminated.
    2. can never be eliminated.
    3. can sometimes be eliminated.
    4. are always related to fixed costs.
14. A characteristic of non-value-added activities is that they
    1. can always be eliminated.
    2. can never be eliminated.
    3. are always related to fixed costs.
    4. are sometimes essential to production or business operations.
15. Which of the following characteristics relate to non-value-added activities?
    1. They are not essential to production.
    2. They can sometimes be decreased without affecting the quality of operations.
    3. They rarely consume resources in the production process.
    4. They improve the production process.
16. Which of the following is not a characteristic of a non-value-added activity?
    1. An activity may be non-value-added in one scenario but value-added in another.
    2. Non-value-added activities may be decreased without affecting the quality of the product.
    3. Non-valued-added activities cannot be eliminated entirely.
    4. Non-value-added activities always relate to fixed costs.
17. Inspection is classified as value-added in which of the following scenarios?
    1. Production of motorcycles
    2. Manufacture of baseball jerseys
    3. Processing meat for compliance with FDA regulations
    4. Production of cereal
18. The examination of business processes to identify incremental changes that may reduce operating costs is referred to as
    1. process improvement.
    2. incremental analysis.
    3. business process analysis.
    4. activity-based management.
19. The examination of business processes to identify incremental changes that may reduce operating costs is referred to as
    1. variance analysis.
    2. incremental analysis.
    3. process improvement.
    4. total quality management.
20. A management tool that focuses on improving the efficiency and effectiveness of an organization’s business processes through radical change is referred to as
    1. business process reengineering.
    2. process improvement.
    3. radical analysis.
    4. activity-based management.
21. A company that is interested in maximizing profits will instruct its sales force to emphasize its
    1. products with the least non-value-added activities.
    2. oldest products.
    3. most profitable products.
    4. least profitable products.
22. In order to increase a company’s bottom line, it can
    1. increase sales and expenses.
    2. decrease non-value-added costs and increase value-added costs.
    3. assign the same profit margin to each product.
    4. increase sales and decrease costs.
23. Which of the following is a way a company can use information about activities to manage its operations?
    1. Activity-based costing and activity-based budgeting
    2. Activity-based management and activity-based budgeting
    3. Activity-based budgeting and activity-based engineering
    4. Activity-based costing, activity-based management, and activity-based budgeting
24. Which of the following is a way a company can use information about activities to manage its operations?
    1. Activity-based budgeting
    2. Activity-based engineering
    3. Activity-based costing
    4. Activity-based management
25. At a Dole pineapple processing plant, which of the following is not a value-added activity?
    1. Washing the pineapples
    2. Coring the pineapples
    3. Slicing the pineapples
    4. Labeling the packages
26. The process of using activity-based costing information to manage a business’s activities, and thus its costs, is called
    1. activities’ management.
    2. product management.
    3. activity-based management.
    4. neither activities’ management, product management, or activity-based management.
27. The greatest use of activity-based costing information for managers is for
    1. costing and cost control.
    2. pricing decisions.
    3. product profitability decisions.
    4. process improvement.
28. Activity-based costing information may be used by managers for
    1. process improvement and CVP analysis.
    2. vendor selection decisions and customer profitability.
    3. pricing decisions and variance analysis.
    4. process improvement and product cost control.
29. Which of the following is not a reason that managers use activity-based costing information?
    1. Pricing decisions
    2. Distribution channel profitability decisions
    3. Product costing
    4. Variance analysis
30. Which of the following is not a consequence of poor management of an organization’s activities?
    1. The company may see an increase in costs.
    2. Employees may experience a decrease in job satisfaction.
    3. Non-value-added activities are generally eliminated.
    4. The number of customer complaints increases.
31. When managers reduce the workforce without considering the activities that employees perform, which of the following is not a likely consequence?
    1. The amount of work will be reduced.
    2. There will be a decrease in job satisfaction.
    3. The company will have to pay overtime.
    4. The amount of work will increase.

Answers to Multiple-Choice Questions

Matching

1. Match the following terms to the appropriate statements by placing the letter to the left of each statement.

1. f– Customer-level activity
2. b – Activity-based management
3. k – Unit-level activity
4. g – Non-value-added activity
5. e – Business process reengineering
6. a – Activity-based costing
7. c – Activity rate
8. j – Product-level activity
9. i – Process improvement
10. l – Value-added activity
11. h – Organizational-level activity
12. d – Batch-level activity

BRIEF EXERCISES

1. Place an “X” in the column that corresponds to the type of activity-level referred to in each scenario.

1. Place an “X” in the column that corresponds to the type of activity-level referred to in each scenario.

1. Place an “X” in the column that corresponds to the type of activity level referred to in the following hospital setting.

1. Place an “X” in the column that corresponds to the type of activity level referred to in the following hospital setting.

1. A&W Manufacturing has implemented an activity-based costing system. For warehousing/ packaging, the activity cost totals $140,400. The number of batches produced is the cost driver for this activity pool. A&W has the following information relating to its warehousing/packaging department:

Required:

Calculate the activity cost rate per batch for the warehousing/packaging department.

$140,400 ÷ 450 batches = $312 per batch

1. Graham’s Wholesale Supply is a distributor of electrical supplies. The company has recently hired a controller who used activity-based costing at her last job. At her suggestion, Graham’s is in the beginning stages of implementing activity-based costing for its operations. The following activity pools have been identified:
2. Filling sales orders
3. Maintenance of warehouse equipment
4. Warehousing of electrical supplies
5. Electricity to heat and cool warehouse
6. Delivery of goods to customer job sites

Required:

Identify at least one possible cost driver for each activity cost pool.

1. Number of orders filled
2. Time equipment is in use
3. Square footage
4. Square footage or cubic footage
5. Number of orders filled, or number of orders delivered
6. Readers Room Bookstore has a chain of stores that sell used and new books. The company has recently hired a controller who used activity-based costing at her last job. At her suggestion, the store is in the beginning stages of implementing activity-based costing for its operations. The following activity pools have been identified:
7. Inspection of used books before shelving
8. Costs of human resources department
9. Costs of computer department
10. Salaries of salesclerks
11. Costs of cleaning service

Required:

Identify at least one possible cost driver for each activity cost pool.

1. Number of inspections
2. Number of employees, number of new hires
3. Number of computer reports generated; number of computer hours used
4. Number of customers, number of items sold, total sales volume
5. Square footage
6. Identify the following activities in a medical equipment plant as value-added or non-value-added.

1. Place and “X” in the column that corresponds to the type of activity referred to in each scenario.

1. Place an “X” in the column that corresponds to the type of activity referred to in each scenario.

EXERCISES

1. Place an “x” in the column that corresponds to the type of activity level referred to in a hospital setting.

1. Place an “X” in the column that corresponds to the type of activity referred to in a hospital setting.

*Depends upon if cost is assigned to each patient for the department

1. Place and “X” in the column that corresponds to the type of activity referred to in each scenario.

1. Place and “X” in the column that corresponds to the type of activity referred to in each scenario.

1. Place an “X” in the column that corresponds to the type of activity level referred to in each scenario.

1. Bayline, Inc. manufactures two types of surf boards, Beginner and Longboard. Manufacturing overhead has been applied on the basis of direct labor hours. Bayline gathers some activity information and is interested in implementing an activity-based costing system. The company wants all overhead costs to be allocated to products. The overhead cost pools and activity drivers are as follows:

Other product information follows:

Required:

• 1. Using the traditional method, determine the overhead rate per direct labor hour.
  2. Using the activity-based costing approach, determine the two activity rates.
  3. Using the activity-based costing approach, determine the unit product cost for the Beginner board.

1. $98,000 ÷ (6,000 + 8,000) = $7 per direct labor hour
2. Setup activity rate = $36,000 ÷ 1,000 = $36 per setup

Cutting/Assembly activity rate = $62,000 ÷ 31,000 = $2 per machine hour

1. Direct material ($10 × 40,000) $400,000

Direct labor ($8 × 40,000) 320,000

Overhead ($36 × 750) + ($2 x 20,000) 67,000

Total costs $787,000

$787,000 ÷ 40,000 = $19.675 per unit

1. Camping Suppliers, Inc. manufactures two types of safety strobe lights, one that is visible for one mile and one that is visible for two miles. Manufacturing overhead has been applied on the basis of direct labor costs. Camping Suppliers has gathered some activity information and is interested in implementing an activity-based costing system. The company wants all overhead costs to be allocated to products. The overhead cost pools and activity drivers are as follows:

Other product information is as follows:

Required:

• 1. Using the traditional method, calculate the predetermined overhead rate as a percentage of direct labor cost.
  2. Using the activity-based costing approach, determine the two activity rates.
  3. Using the activity-based costing approach, determine the unit product cost for the one-mile light.

1. $68,000 ÷ $34,000 = $2 per direct labor dollar
2. Setup activity rate = $32,000 ÷ 500 = $64 per setup

Assembly activity rate = $36,000 ÷ 12,000 = $3 per machine hour

1. Direct material ($6 × 20,000) $120,000

Direct labor ($8 × 20,000) 160,000

Overhead ($64 × 150) + ($3 x 4,000) 21,600

Total costs $301,600

$301,600 ÷ 20,000 = $15.08 per unit

1. Jones Manufacturing Company makes two products. In the past, the company allocated overhead based on estimated total direct labor hours of 20,000. Jones recently implemented an activity-based costing system and had determined that overhead can be broken into three overhead pools: processed purchase orders, machine setups, and good shipped. The following is a summary of company information:

Required:

• 1. Calculate the company’s overhead rate using a single cost pool.
  2. Calculate the company’s overhead rates using the activity-based costing pools.

1. $117,000 ÷ 20,000 = $5.85 per direct labor hour
2. Orders $75,000 ÷ 5,000 = $15 per order processed

Setups $12,000 ÷ 500 = $24 per machine hour

Shipping $30,000 ÷ 60,000 = $0.50 per shipment

1. Clover Manufacturing Company makes two products. Using the traditional allocation method, the company has allocated overhead based on estimated total direct labor cost of $125,000. Clover recently implemented an activity-based costing system and had determined that overhead can be broken into three overhead pools: cutting, machine setups, and shipping. The following is a summary of company information:

Required:

• 1. Calculate the company’s overhead rate as a percentage of direct labor cost.
  2. Calculate the company’s overhead rates using the activity-based costing pools.

1. $52,000 ÷ $125,000 = $0.416 per direct labor dollar
2. Cutting $24,000 ÷ 500 = $48 per cut

Setups $8,000 ÷ 200 = $40 per machine hour

Shipping $20,000 ÷ 40,000 = $0.50 per shipment

1. Angora, Inc. uses activity-based costing to cost its two products: Standard and Deluxe. The company has provided the following data relating to its activities:

Required:

• 1. What is the activity rate for the cutting cost pool?
  2. If actual activity is the same as that estimated, what is the total amount of overhead cost allocated to the Standard product?

1. $536,000 ÷ 8,000 = $67 per cut
2. Machine $144,000 ÷ 8,000 = $18 per machine hour

Cutting $536,000 ÷ 8,000 = $67 per cut

Sales $108,000 ÷ 9,000 = $12 per sales order

($18 × 1,000) + ($67 × 3,000) + ($12 × 7,000) = $303,000

1. Camilla, Inc. uses activity-based costing to cost its two products: Standard and Deluxe. The company has provided the following data relating to its activities:

Required:

• 1. What is the activity rate for the sales cost pool?
  2. If actual activity is the same as that estimated, what is the total amount of overhead cost allocated to the Deluxe product?

1. $108,000 ÷ 9,000 = $12 per order
2. Machine $144,000 ÷ 8,000 = $18 per machine hour

Cutting $536,000 ÷ 8,000 = $67 per cut

Sales $108,000 ÷ 9,000 = $12 per sales order

($18 × 7,000) + ($67 × 5,000) + ($12 × 2,000) = $485,000

1. The following list includes activities that are performed in a manufacturing company. Classify each activity as value-added or non-value added.

1. The following list includes activities that are performed in a women’s retail store. Classify each activity as value-added or non-value added.

1. The following list includes activities that are performed in a CPA firm. Classify each activity as value-added or non-value added.

1. The following list includes activities that are performed in a manufacturing company that produces children’s toys. Classify each activity as value-added or non-value added.

PROBLEMS

1. Megan Industries manufactures several products including a basic case for a popular smart phone. The company is considering adopting an activity-based costing approach to set its budget. The company’s production activities, budgeted activity costs, and cost drivers for the coming year are as follows.

The budgeted data for smart phone case production are as follows.

Required:

a. Calculate the activity rate for each cost pool.

b. Calculate the activity-based unit cost of the smart phone case.

a. Machine setup $192,000 ÷ 800 setups = $240/setup

Inspection $175,000 ÷ 500 tests = $350/test

Materials receiving $198,000 ÷ 1,800 POs = $110/PO

b.

Machine setups $ 21,600 ($240 × 90 setups)

+ Inspections 140,000 ($350 × 400 inspections)

+ Materials receiving 6,600 ($110 × 60 POs)

= Total overhead cost 168,200

÷ Units produced 20,000

= OH cost/unit $8.41

+ Direct material 2.60

+ Direct labor 0.59

= Activity-based unit cost $11.60

1. Stockin Company produces tablets and books. Total overhead costs traditionally have been allocated on the basis of direct labor hours. As part of the process of implementing activity-based costing, managers determined the following cost pools and cost drivers.

The company determined it will not allocate general costs. Other information is as follows:

Required:

a. Determine the unit product cost for Tablets using the traditional costing system.

b. Determine the unit product cost for Tablets using the activity-based costing system.

1. ($1,845,000 − $608,250) ÷ (30,000 + 15,000) = $27.483

Binding:

Printing:67

$798,000 = $3.04/machine hour

(150,000 + 112,500) machine hours

Product Design:

Tablets

Binding 75,000 tablets × $2.64/unit $198,000

Printing 150,000 MH × $3.04/MH 456,000

Product design 1,875 change orders × $34/change order 63,750

Total overhead 717,750

Units produced ÷ 75,000

Overhead per unit $ 9.57

Tablets

Direct materials $ 4.00

Direct labor 5.00

Overhead 9.57

Total unit cost $18.57

1. Schwynn Inc. manufactures street bicycle tires and mountain bicycle tires. To determine the amount of overhead to assign to each product line, the controller, Chu has developed the following information.

Street Mountain

Estimated tires produced 25,000 15,000

Direct labor hours per tire 2 4

Total estimated overhead costs for the two product lines are $990,000.

Required:

1. Compute the overhead cost assigned to the street tires and mountain tires, assuming the company uses a single cost pool and direct labor hours to allocate overhead costs.
2. Chu is not satisfied with the traditional method of allocating overhead because he believes that most of the overhead costs relate to the mountain tire product line because of its complexity. He therefore develops the following three activity cost pools and related cost drivers to better understand these costs.

Compute the activity-based overhead rates for these three cost pools.

1. Compute the cost that is assigned to the street tires and mountain tires product lines using an activity-based costing system, given the following information.

Expected Use of Cost Drivers per Product

Street Mountain

Number of setups 150 350

Direct labor hours 25,000 15,000

Number of inspections 180 320

1. What do you believe Chu should do?
2. Direct labor hours for street tires (25,000 × 2) = 50,000

Direct labor hours for mountain tires (15,000 × 4) = 60,000

Total direct labor hours 110,000

Overhead assigned

Street tires (50,000 × $9) = $450,000

Mountain tires (60,000 × $9) = 540,000

1. Assuming that the cost drivers are a reasonable representation of what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocation of resources and pricing decisions in the future.
2. Paula’s Payroll Services provides weekly payroll processing for a number of small businesses. Paula Peraz, the company’s owner, has been using an activity-based costing system for several years. She used the following information in preparing this year’s budget.

Required:

a. Calculate the cost rates for each activity cost pool.

b. Paula is preparing a proposal for a prospective client, Barney’s Bistro. The client has 25 employees. What is the estimated cost of providing weekly payroll services to this client for the first year?

c. How can Paula use the estimated cost information you have calculated to price the service it will provide to Barney’s Bistro.

a.

b.

1. With this estimate of the cost to provide payroll services to Barney’s Bistro, Paula knows the lowest price she can bid on the job, $6,527.50. However, that price will not provide any profit or room for misestimates, so Paula will need to price the job at a higher price. Also, this estimate assumes that there is no employee turnover at Barney’s Bistro. Any turnover that adds additional employees will cause Paula to incur additional costs to provide her service. Therefore, she should increase her proposed price to cover such contingencies.
2. In an activity- based costing system, all activities are not created equal. List the five categories for which activities are classified and give one example of each for a company that produces t-shirts.
3. Unit-level activities – providing electricity to run sewing machines
4. Batch-level activities – moving raw materials to the production floor
5. Product-level activities – creating a pattern for a new style of a product
6. Customer-level activities – processing a sales order
7. Organization-level activities – managing the corporate office
8. A company may use GAAP-based product costing or activity-based costing. List two differences between these two methods.
9. Under GAAP-based product costing, selling and administrative costs are not allocated to products. However, under activity-based costing, these costs should be allocated to products if they are incurred to provide resources that are consumed by unit-level, batch-level or product-level activities.
10. Under GAAP-based product costing, a company generally uses a two-step approach to applying overhead, with first calculating a pre-determined overhead rate and second, applying all overhead to products using the single rate. Under activity-based costing, overhead is applied using a five-step approach, where costs in various cost pools are assigned to cost objects using a rate for each cost pool.
11. List the five steps in implementing an activity-based costing system.
12. Identify the activities performed in the organization.
13. Develop activity cost pools based on their cost drivers.
14. Calculate activity cost pool rates for each pool.
15. Allocate costs to products or services.
16. Calculate unit product costs.
17. What is an activity cost pool and how are activity cost pool rates calculated?

In an activity-based costing environment, after all the activities have been identified and the appropriate level of detail selected, the costs of each activity is sorted into activity cost pools based on their cost drivers. Once the activity pools have been determined, manufacturing overhead can be assigned to them before being allocated to cost objects.

The activity cost pool rate is calculated by dividing activity cost pool resources by the activity driver.

1. The process of using activity-based costing information to manage a business’s activities, and its costs, is called activity-based management. How do managers use the information provided by an activity-based costing system?

By far, the greatest use of activity-based information is for product costing and cost control. In addition, it is used to make decisions regarding pricing, customer profitability, distribution channel product profitability, and process improvement.

ESSAY

1. In an activity-based costing system, activities are classified into five categories. List and define the five categories and give one example of each type of activity.
2. Unit-level activity – performed for each individual unit of product. Each unit consumes the same amount of resources for each unit of activity. An example is the amount of electricity used to run sewing machines used in making the product.
3. Batch-level activity – performed all at once on groups, or batches, of products. A batch consumes the same amount of resources whether it contains 20 units or 2,000 units. The cost of moving fabric to the production floor is an example of a batch-level activity.
4. Product-level activity – those activities that support the products or services of a company. Also referred to as product-sustaining activities. An example is creating a pattern for a new style of a company’s product.
5. Customer-level activities – performed for specific customers. An example is making a sales call.
6. Organization-level activities – required to provide productive capacity and to keep the business in operation. These activities do not provide identifiable benefits to specific products or services. An example is managing the corporate office.
7. Assume you have been hired by a company that is considering implementing an activity-based costing system. One of your co-workers is not eager to change and believes the benefits of moving to activity-based costing will not be worth the time and effort of implementing the new system. Explain to your co-worker the characteristics of an organization that make it a good candidate to implement activity-based costing and how activity-based costing might benefit the company.

A problem with traditional product costing is that it does not reflect the way costs are actually incurred during the production process. Some jobs might look profitable when they are actually losing money. Activity-based costing works for companies that produce products or delivers services that differ in complexity or in their consumption of common (overhead) resources. Indicators that an activity-based costing analysis may be appropriate include:

1. Bids for complex products are accepted, while bids for simple products are rejected.
2. High-volume jobs show losses or minimal profits, while low-volume jobs show healthy profits.
3. Bids for jobs that require “special” processing are always accepted.
4. Some manufacturing departments run at capacity, while others have minimal operations.
5. One way to implement activity-based management is to take a fresh look at the activities performed in an organization to see if a business process can be changed so it can reduce costs. As part of a team responsible for implementing an activity-based costing system, you are to investigate business processes for your company and specifically investigate processes in products that are not profitable. You have been introduced to the terms, Process Improvement and Business Process Reengineering.

Required:

Define activity-based management and list four ways managers use activity-based costing information and define process improvement and business process engineering.

The process of using activity-based costing information to manage a business’s activities, and thus its costs, is called activity-based management. Managers use activity-based costing information for product costing and cost control and to make decisions regarding pricing, customer profitability, distribution channel profitability, and process improvement.

Process improvement is the examination of business processes to identify incremental changes that may reduce operating costs. For example, if the process of moving material to the production floor has been done in an inefficient manner, if the managers can find a less expensive way to move raw materials into the factory, the result will be a process improvement and less cost.

Business process reengineering (BPR) is a managerial tool that focuses on improving the efficiency and effectiveness of an organization’s business processes through radical change.

1. You are part of a team responsible for implementing an activity-based costing system. Some of the members do not understand the steps involved in implementing such a system. Prepare a summary showing your team members the steps involved and a brief description of each step that are completed in the process.

By completing the following five steps, our company can implement an activity-based costing system. To be successful, these efforts must have the full support of our team and top management.

Step 1: Identify activities. The first step in developing activity-based product costs is to identify the activities performed in the organization. To gather this information the team may ask questions of employees to determine the activities they perform or observe what they do. This is the most time-consuming part of implementing the system.

Step 2: Develop activity cost pools. After the activities are identified and the appropriate level of detail selected, the activities are combined into activity cost pools based on their cost drivers. Once the activity pools have been determined, manufacturing overhead can be assigned to them.

Step 3: Calculate activity cost pool rates. After the overhead costs have been assigned to activity cost pools, the next step is to calculate an activity rate for each pool. This calculation is similar to the pre-determined overhead rate calculation under traditional job order costing.

Step 4: Allocate costs to products or services. This calculation is similar to the calculation for applying overhead costs to products or services under traditional job order.

Step 5: Calculate unit product costs. For decision-making purposes, we need to convert the total allocated overhead of each product to a unit cost. To calculate the total product cost per unit, add the direct material, direct labor and overhead cost per unit.

1. You have been hired by a company that is transitioning from a traditional method of product costing to an activity-based costing method. You are assigned to a team that has the responsibility of classifying activities as value-added or non-value-added. One of the team members does not understand the purpose of classifying activities. Define valued-added and non-value-added costs for your team member, give an example of each, and explain how non-value added activities affect product costs.

Non-valued added activities are those activities that consume resources but do not contribute to the value of the product. They create the product the customer wants to buy. An example of a value-added activity is the assembly of the product. An example of a non-value-added activity is the storage and moving of material.

Although non-value-added activities do not contribute to the value of the product, they may be a necessary activity. For example, quality inspections may not add value to the product, but if defective products were shipped to customers, they would not be happy. As non-value-added activities and their associated resources are eliminated, a company’s cost will decrease, thus adding to profit.