CHAPTER 5

Activity-Based COSTING

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES

Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge

E = Evaluation

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: F = Financial Reporting MA = Management Accounting

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES (CONT’D)

Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge

E = Evaluation

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: F = Financial Reporting MA = Management Accounting

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note: TF = True-False C = Completion BE = Brief Exercise

MC = Multiple Choice Ex = Exercise SAE = Short Answer Essay

Ma = Matching MP = Multi-Part Question

CHAPTER LEARNING OBJECTIVES

1. Recognize the difference between traditional costing and activity-based costing (ABC) and understand the nature of ABC.

A traditional costing system allocates overhead to products based on a predetermined plant-wide or department-wide volume of unit-based output rates, such as direct labour or machine hours. An ABC system allocates overhead to identify activity cost pools, and then assigns costs to products using related cost drivers that measure the activities (resources) consumed.

2. Apply activity-based costing to a manufacturer.

The development of an activity-based costing system for a manufacturer involves four steps: (1) Identify and classify the major activities that pertain to the manufacture of specific products, and allocate manufacturing overhead costs to the appropriate cost pools. To identify activity cost pools, a company must perform an analysis of each operation or process, documenting and timing every task, action, or transaction. (2) Identify the cost driver that has a strong correlation to the costs accumulated in each activity cost pool. Cost drivers that companies identify for activity cost pools must (a) accurately measure the actual consumption of the activity by the various products, and (b) have data on them that are easily available. (3) Calculate the activity-based overhead rate per cost driver. (4) Use the cost drivers to assign overhead costs for each activity cost pool to products or services.

3. Understand the benefits and limitations of activity-based costing.

What makes ABC a more accurate product costing system is (1) the increased number of cost pools used to assign overhead, (2) the enhanced control over overhead costs, and (3) the better management decisions it makes possible. The limitations of ABC are (1) the higher analysis and measurement costs that accompany multiple activity centres and cost drivers, and (2) the need to still allocate some costs arbitrarily.

Value-added activities increase the worth of a product or service. Non–value-added activities simply add cost to, or increase the time spent on, a product or service without increasing its market value. Being aware of these classifications helps managers reduce or eliminate the time spent on the non–value-added activities.

Activities may be classified as unit level, batch level, product level, and facility level. A company controls overhead costs at unit, batch, product, and facility levels by modifying unit-, batch-, product-, and facility-level activities, respectively. Failure to recognize this classification of levels can result in distorted product costing.

4. Apply activity-based costing to service industries.

The overall objective of using ABC in service industries is the same as in manufacturing industries; that is, improved costing of the services provided (by job, service, contract, or customer). The general approach to costing is the same: analyze operations, identify activities, accumulate overhead costs by activity cost pools, and identify and use cost drivers to assign the cost pools to the services.

TRUE-FALSE STATEMENTS

1. A cost driver does not generally have a direct cause-effect relationship with the resources consumed.

2. When overhead is properly assigned in ABC, it will usually decrease the unit cost of high-volume products.

3. ABC is particularly useful when product lines differ greatly in volume and manufacturing complexity.

4. Non-value-added activities increase the cost of a product but not its market value.

5. What sometimes makes implementation of activity-based costing difficult in service industries is that a smaller proportion of overhead costs are company-wide costs.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

6. Which of the following is typical of traditional costing systems?

a) Uses multiple cost drivers to allocate overhead.

b) Is more complicated than Activity-Based Costing systems.

c) Is still the best way to allocate direct labour costs.

d) Uses a single cost driver to allocate overhead.

7. In traditional costing systems, overhead is generally applied based on

a) direct labour for job-order costing, and machine hours for process costing.

b) direct material for job-order costing, and direct labour for process costing.

c) factory usage for both job-order costing and process costing.

d) units of production.

8. A cost driver is

a) any factor or activity that has a direct cause-effect relationship with the resources consumed.

b) always based on time consumed by the activity.

c) another name for cost pool.

d) a term used only in traditional costing systems.

9. Which best describes the flow of overhead costs in an activity-based costing system?

a) overhead costs – direct labour cost or hours – products

b) overhead costs – products

c) overhead costs – activity cost pools – cost drivers – products

d) overhead costs – machine hours – products

10. Sleep-Tight manufactures mattresses for the hotel industry. It has two products, Downy and Firm, and total overhead of $504,000. The company plans to manufacture 200 Downy mattresses and 300 Firm mattresses this year. In manufacturing the mattresses, the company must perform 700 material moves for the Downy and 300 for the Firm; it processes 114 purchase orders for the Downy and 90 for the Firm; and the company’s employees work 2,800 direct labour hours on the Downy product and 3,500 on the Firm. Sleep-Tight’s total material handling costs are $300,000 and its total purchasing costs are $204,000.

Under a traditional costing approach based on direct labour hours, how much overhead would be assigned to the Downy product?

a) $224,000

b) $252,000

c) $280,000

d) $336,000

11. In companies where there is good reason to change from a traditionally based costing system to an activity-based costing system, management might expect

a) products or services with high volumes to have higher overhead costs.

b) products or services with high volumes to have lowered overhead costs.

c) products or services with low volumes to have lowered overhead costs.

d) products or services with high volumes are generally costed accurately.

12. The first step in activity-based costing is to

a) assign manufacturing overhead costs for each activity cost pool to products.

b) calculate the activity-based overhead rate per cost driver.

c) identify and classify the major activities involved in the manufacture of specific products.

d) identify the cost driver that has a strong correlation to the activity cost pool.

13. A well designed activity-based costing system starts with

a) identifying the activity-cost pools.

b) computing the activity-based overhead rate.

c) assigning manufacturing overhead costs for each activity cost pool to products.

d) analyzing the activities performed to manufacture a product.

14. One of Astro Fireworks Company's activity cost pools is machine setups, with estimated overhead of $200,000. Astro produces sparklers (75 setups) and lighters (25 setups). How much of the machine setup cost pool should be assigned to sparklers?

a) $50,000

b) $150,000

c) $166,666

d) $200,000

15. Activity-based costing normally allocates overhead costs

a) to products only.

b) more accurately than traditional costing systems.

c) to services, whereas traditional costing systems normally allocate overhead costs to products.

d) based on no more than three cost drivers.

16. When using a single cost driver to allocate overhead costs, the amount of overhead costs that are applied is

a) usually greater for low-volume products than for high-volume products.

b) usually greater for high-volume products than for low-volume products.

c) usually equal for both low and high-volume products.

d) sometimes greater for higher-volume products, and sometimes greater for low-volume products.

17. A good cost driver should have a high correlation with

a) the actual number of units produced.

b) the actual consumption of overhead costs.

c) the actual number of products produced.

d) the actual consumption of direct costs.

Use the following information to answer questions 18–21.

Poodle Company manufactures two products, Mini A and Maxi B. Poodle's overhead costs consist of setting up machines- $800,000; machining- $2,000,000; and inspecting- $600,000. Information on the two products is:

Mini A Maxi B

Direct labour hours 15,000 25,000

Machine setups 600 400

Machine hours 24,000 26,000

Inspections 800 700

18. Overhead applied to Mini A using traditional costing and direct labour hours is

a) $1,275,000.

b) $1,536,000.

c) $1,670,000.

d) $1,700,000.

19. Overhead applied to Maxi B using traditional costing and direct labour hours is

a) $1,280,000.

b) $1,664,000.

c) $1,700,000.

d) $2,125,000.

20. Overhead applied to Mini A using activity-based costing is

a) $1,275,000.

b) $1,536,000.

c) $1,760,000.

d) $1,920,000.

21. Overhead applied to Maxi B using activity-based costing is

a) $1,280,000.

b) $1,640,000.

c) $1,664,000.

d) $2,125,000.

22. Veronica Co. produces three products: Rain, Snow, and Wind. Product Rain requires 15 machine setups, Product Snow requires 20 setups, and Product Wind requires 35 setups. Veronica has identified an activity cost pool with allocated overhead of $420,000 for machine setups as the cost driver. How much overhead is assigned to each product?

Rain Snow Wind

a) $140,000 $140,000 $140,000

b) $28,000 $21,000 $12,000

c) $90,000 $120,000 $210,000

d) $12,000 $21,000 $28,000

23. GoFish Inc. has an overhead rate for machine setups of $200 per machine setup, with a total of $56,000 of overhead. The company produces two products, Product Salamander and Product Gold, which require 120 and 160 setups each, respectively. The overhead assigned to each product is

Salamander Gold

a) $28,000 $28,000

b) $32,000 $24,000

c) $26,000 $30,000

d) $24,000 $32,000

24. Hammock Company manufactures two models of its hammock, the Superior and the Deluxe. The Superior model requires 10,000 direct labour hours and the Deluxe requires 40,000 direct labour hours. The company produces 4,000 units of the Superior model and 1,000 units of the Deluxe model each year. The company produces the Superior model in batch sizes of 200, while it produces the Deluxe model in batch sizes of 100. The company expects to incur $120,000 of total setup costs this year. How much of the setup costs are allocated to the Superior model using ABC costing?

a) $80,000

b) $60,000

c) $24,000

d) $100,000

25. Jaime Inc. manufactures two products, sweaters and jackets. The company has estimated its overhead in the order-processing department to be $180,000. The company produces 50,000 sweaters and 80,000 jackets each year. Sweater production requires 25,000 machine hours, jacket production requires 50,000 machine hours. The company places raw materials orders 10 times per month, 2 times for raw materials for sweaters and the remainder for raw materials for jackets. How much of the order-processing overhead should be allocated to jackets?

a) $90,000

b) $120,000

c) $110,770

d) $144,000

26. Canterra Co. incurs $160,000 of overhead costs each year in its three main departments, setup ($10,000), machining ($110,000), and packing ($40,000). The setup department performs 40 setups per year, the machining department works 5,000 hours per year, and the packing department packs 500 orders per year. Information about Canterra’s 2 products is as follows:

Product One Product Two

Number of setups 20 20

Machining hours 1,000 4,000

Orders packed 150 350

If machining hours are used as a base, how much overhead is assigned to Product One each year?

a) $32,000

b) $80,000

c) $55,000

d) $48,000

27. Canterra Co. incurs $540,000 of overhead costs each year in its three main departments, setup ($40,000), machining ($400,000), and packing ($100,000). The setup department performs 50 setups per year, the machining department works 8,000 hours per year, and the packing department packs 200 orders per year. Information about Canterra’s 2 products is as follows:

Product One Product Two

Number of setups 10 40

Machining hours 3,000 5,000

Orders packed 110 90

Using ABC, how much overhead is assigned to Product One each year?

a) $540,000

b) $327,000

c) $270,000

d) $213,000

28. Canterra Co. incurs $160,000 of overhead costs each year in its three main departments, setup ($10,000), machining ($110,000), and packing ($40,000). The setup department performs 40 setups per year, the machining department works 5,000 hours per year, and the packing department packs 500 orders per year. Information about Canterra’s 2 products is as follows:

Product One Product Two

Number of setups 20 20

Machining hours 1,000 4,000

Orders packed 150 350

Number of product

Manufactured 600 400

Using ABC, how much overhead is assigned to Product Two each year?

a) $80,000

b) $64,000

c) $121,000

d) $128,000

29. A company incurs $1,200,000 of overhead each year in three departments, Processing, Packaging, and Testing. The company performs 800 processing transactions, 200,000 packaging transactions, and 2,000 tests per year in producing 400,000 drums of oil and 600,000 drums of sludge. The following data are available:

Department Use of Cost Driver Cost

Processing 800 $500,000

Packaging 200,000 500,000

Testing 2,000 200,000

Production information for oil is as follows:

Department Use of Cost Driver

Processing 300

Packaging 120,000

Testing 1,600

Calculate the amount of overhead assigned to oil.

a) $600,000

b) $647,500

c) $552,500

d) $460,000

30. A company incurs $1,200,000 of overhead each year in three departments, Processing, Packaging, and Testing. The company performs 800 processing transactions, 200,000 packaging transactions, and 2,000 tests per year in producing 400,000 drums of oil and 600,000 drums of sludge. The following data are available:

Department Use of Cost Driver Cost

Processing 800 $500,000

Packaging 200,000 500,000

Testing 2,000 200,000

Production information for sludge is as follows:

Department Use of Cost Driver

Processing 500

Packaging 80,000

Testing 400

Calculate the amount of overhead assigned to sludge.

a) $600,000

b) $552,500

c) $647,500

d) $460,000

31. Sleep-Tight manufactures mattresses for the hotel industry. It has two products, Downy and Firm and total overhead of $504,000. The company plans to manufacture 200 Downy mattresses and 300 Firm mattresses this year. In manufacturing the mattresses, the company must perform 700 material moves for the Downy and 300 for the Firm; it processes 114 purchase orders for the Downy and 90 for the Firm; and the company’s employees work 2,800 direct labour hours on the Downy product and 3,500 on the Firm. Sleep-Tight’s total material handling costs are $300,000 and its total purchasing costs are $204,000.

Using ABC, how much overhead would be assigned to the Downy product?

a) $504,000

b) $324,000

c) $252,000

d) $180,000

32. A relevant unit-level cost driver for a spa is

a) advertising the offerings in the spa.

b) products used for facial care.

c) training of new staff.

d) hours patrons spend in the whirlpool.

33. A critical component of an activity-based accounting system is

a) the ability to accurately measure activities that consume cost.

b) few areas in the facility that capture costs.

c) the ability to eliminate non-value-added activities.

d) flexible job-order costing information.

34. Which of the following is true?

a) Any activity that increases the cost of producing a product is a value-added activity.

b) Engineering design is a non-value-added activity.

c) Machining is a non-value-added activity.

d) Not all activities labelled non-value-added are totally wasteful, nor can they be totally eliminated.

35. Which of the following is a limitation of activity-based costing?

a) more cost pools

b) less control over overhead costs

c) poorer management decisions

d) some arbitrary allocations continue

36. Which of the following factors would suggest a switch to activity-based costing?

a) product lines similar in volume and manufacturing complexity

b) overhead costs constitute a significant portion of total costs

c) the manufacturing process has been stable

d) production managers use data provided by the existing system

37. Which of the following is true of activity-based costing?

a) more cost pools

b) same base as traditional costing

c) less costly to use

d) eliminates arbitrary allocations

38. The primary benefit of ABC is it provides

a) faster management decisions.

b) enhanced control over overhead costs.

c) more cost pools.

d) more accurate product costing.

39. Which of the following is not a benefit of activity-based costing?

a) more accurate product costing

b) enhanced control over overhead costs

c) better management decisions

d) less costly to use

40. Each of the following is a limitation of activity-based costing except that

a) it can be expensive to use.

b) it is more complex than traditional costing.

c) more cost pools are used.

d) some arbitrary allocations continue.

41. The presence of any of the following factors would suggest a switch to ABC except when

a) product lines differ greatly in volume.

b) overhead costs constitute a minor portion of total costs.

c) the manufacturing process has changed significantly.

d) production managers are ignoring data provided by the existing system.

42. What might be an impediment in changing from a traditionally based costing system to an activity-based costing system?

a) Management may not be in favour of a change.

b) Excessive costs may be incurred to assist in capturing costs.

c) Some costs would still have to be allocated arbitrarily after the changeover.

d) All of the above are impediments.

43. What might be a reason to not change from a traditionally based costing system to an activity-based costing system?

a) Products or services are similar in volume and activity.

b) Support services are spread evenly throughout the company’s activities.

c) Overhead is a low component of the overall cost.

d) All of the above are valid reasons.

44. A major advantage in changing from a traditionally based costing system to an activity-based costing system is

a) a company’s customers can benefit from any reduction in costs.

b) management will be able to identify the true cost of non-value-added or nonessential activities.

c) direct labour and material costs will be reduced.

d) supplier costs will be reduced after the changeover.

45. Which of the following is a value-added or essential activity?

a) engineering design

b) machinery repair

c) inventory storage

d) inspections

46. Which of the following is a non-value-added or nonessential activity?

a) engineering design

b) machining

c) inspection

d) packaging

47. Essential activities

a) should be reduced or eliminated.

b) involve resource usage customers are willing to pay for.

c) add cost to a product without affecting selling price.

d) cannot be differentiated from non-essential activities.

48. Which of the following is a unit-level activity?

a) cleaning the paint sprayer when switching from one colour of paint to another

b) paint used in the manufacturing process

c) test marketing to see which colour of paint customers prefer

d) painting the executive offices

49. Which of the following is a batch-level activity?

a) sandpaper used to smooth the wood used in the manufacture of a chair

b) the design of a chair

c) the chairs in the staff cafeteria

d) shipment of chairs to a customer

50. Which of the following is a product-level activity?

a) regulatory approval of a new prescription drug

b) an advertisement campaign that focuses on the large number of products the company produces

c) equipment cleaning between batches

d) material handling

51. Which of the following is a facility-level activity?

a) the Human Resources Department

b) the Product Manager’s salary

c) insurance on the factory that is used exclusively to manufacture one of the company’s seven products

d) inspections

52. Which of the following is a batch-level activity?

a) plant management

b) product design

c) equipment setups

d) assembling

53. Which of the following is an example of a product-level activity in a refinery?

a) transportation of fuel to gas stations

b) product testing for quality control

c) advertising the benefits of the company’s products

d) maintenance activities in the refinery

54. Which of the following is an example of unit-level activity in a major automotive parts distribution company?

a) preparing cheques for suppliers

b) promotional materials

c) packing parts for shipment

d) shipping costs of parts to dealers

55. Which of the following is an example of batch-level activity in a company marketing cell phones?

a) internet advertising

b) preparing monthly customer invoices

c) rent for kiosks in shopping malls

d) offering discounts on monthly payment plans

56. Which of the following is an example of a facility-level activity in an airport?

a) wages for security screening personnel

b) parking lot revenue and expenses

c) airline landing fees

d) salaries of air traffic controllers

57. A non-value-added activity in a service enterprise is

a) taking appointments.

b) travelling.

c) advertising.

d) all of these

58. All the following are examples of a value-added activity in a service company except

a) delivering packages by a delivery service.

b) ordering supplies.

c) performing surgery.

d) providing legal research for legal services.

59. Activity-based costing is used in

Service industries Manufacturing industries

a) Yes No

b) Yes Yes

c) No Yes

d) No No

60. Activity-based costing has been found to be useful in each of the following service industries except

a) banks.

b) hospitals.

c) telephone companies.

d) ABC has been useful in any of these industries.

61. What sometimes makes implementation of activity-based costing difficult in service industries is

a) the labelling of activities as value-added.

b) identifying activities, activity cost plus, and cost drivers.

c) that a larger proportion of overhead costs are company-wide costs.

d) attempting to reduce or eliminate non-value-added activities.

62. All the following statements are correct except that

a) activity-based costing has been widely adopted in service industries.

b) the objective of installing ABC in service firms is different than it is in a manufacturing firm.

c) a larger proportion of overhead costs are company-wide costs in service industries.

d) the general approach to identifying activities and activity cost pools is the same in a service company as in a manufacturing company.

63. The use of activity-based costing in service industries

a) has the same objective as in manufacturing.

b) results in improved costing of services provided.

c) uses cost pools to assign overhead.

d) all of these

64. Which of the following is false when using ABC in a service industry?

a) identify activities

b) identify and use cost drivers to assign the cost pools to products

c) accumulated overhead costs by activity cost pools

d) analyze operations

65. Port Accounting performs two types of services, audit and tax. Port’s overhead costs consist of computer support, $240,000; and legal support, $120,000. Information on the two services is:

Audit Tax

Direct labour cost $50,000 $100,000

CPU minutes 40,000 10,000

Legal hours used 200 800

Overhead applied to audit services using ABC is

a) $120,000.

b) $144,000.

c) $216,000.

d) $240,000.

66. Port Accounting performs two types of services, audit and tax. Port’s overhead costs consist of computer support, $240,000; and legal support, $120,000. Information on the two services is:

Audit Tax

Direct labour cost $50,000 $100,000

CPU minutes 40,000 10,000

Legal hours used 200 800

Overhead applied to audit services using traditional costing is

a) $120,000.

b) $144,000.

c) $216,000.

d) $240,000.

67. Jackal Security Inc. provides security guard services to shopping malls. Data related to Jackal’s overhead costs for the current year are as follows:

Head Office Activity Total Overhead Cost Driver

Cost Activity

Supervision $128,000 # of employees 80

Technology fees 58,000 computer hours 2,000

Rent/Utilities/Taxes 42,000 direct labour hours 160,000

Total $228,000

During the year, Jackal provided security services to the Apple Creek Mall including 5 employees, 150 computer hours and 10,800 labour hours. Overhead applied to the Apple Creek Mall job for the year using ABC is

a) $1,629.26.

b) $15,185.00.

c) $15,390.00.

d) $17,100.00.

BRIEF Exercises

Brief Exercise 68

Speedy Access Services Inc. leases high-speed computers to small businesses. It provides the following information for the year:

Budgeted Actual

Overhead cost $2,200,000 $2,100,000

Computer hours 100,000 90,000

Direct labour hours 200,000 180,000

Overhead is applied on the basis of computer hours.

Instructions

a) Compute the predetermined overhead rate.

b) Calculate the amount of overhead applied for the year.

Solution 68 (5 min.)

a) $2,200,000 ÷ 100,000 = $22 per computer hour.

b) 90,000 computer hours X $22 per computer hour = $1,980,000 overhead applied

AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem Solving, IMA: Cost Mgmt

Brief Exercise 69

Sanchez Co. has three activities in its manufacturing process: machine setups, machining, and inspections. Estimated annual overhead cost for each activity is $75,000, $132,000, and $22,000, respectively. The estimated annual use in each department is 500 setups, 4,000 machine hours, and 2,750 inspections.

Instructions

Calculate the overhead rate for each activity.

Solution 69 (5 min.)

Machine setups $75,000 ÷ 500 = $150 per setup

Machining $132,000 ÷ 4,000 = $33 per machine hour

Inspections $22,000 ÷ 2,750 = $8 per inspection

Brief Exercise 70

Boots and More, Inc. uses activity-based costing to assist management in setting prices for the company’s three major product lines. The following information is available:

Activity Cost Pool Estimated Overhead Use of Cost Driver

Per Activity

Cutting $1,200,000 60,000 labour hours

Stitching 7,000,000 50,000 machine hours

Inspections 750,000 10,000 labour hours

Packing 900,000 3,600 finished goods units

Instructions

Calculate the activity-based overhead rates.

Solution 70 (5 min.)

Brief Exercise 71

Stereo City Co. manufactures speakers and receivers and uses activity-based costing. The following information is available:

Activity Cost Pool Estimated Overhead Use of Cost Driver

Per Activity

Ordering $72,000 12,000 orders

Soldering 390,000 52,000 machine hours

Inspecting 805,100 97,000 labour hours

Packing 226,800 63,000 boxes

Instructions

Calculate the activity-based overhead rates.

Solution 71 (5 min.)

Brief Exercise 72

Plum Tired manufactures tires for dune buggies and has two different products, Nubby Tires and Smooth Tires. The company produces 8,750 Nubby Tires and 12,600 Smooth Tires each year and incurs $65,050 of overhead costs. The following information is available:

Activity Total Cost Cost Driver

Materials handling $37,500 Number of requisitions

Machine setups 4,750 Number of setups

Quality inspections 22,800 Number of inspections

For the Nubby Tires, the company has 700 requisitions, 80 setups, and 225 inspections. The Smooth Tires requires 800 requisitions, 45 setups, and 175 inspections.

Instructions

Determine the overhead rate for each activity.

Solution 72 (5–10 min.)

The overhead rates are:

Brief Exercise 73

Myrna’s Mowing provides lawn service in her town. Myrna has identified the following activities:

1. Advertising

2. Scheduling

3. Equipment inspection and maintenance

4. Travel

5. Lawn cutting

6. Trimming

7. Billing

8. Bill collecting

Instructions

Classify each activity as value-added or non-value-added.

Solution 73 (5 min.)

Activity Classification

1. Advertising Non-value-added

2. Scheduling Non-value-added

3. Equipment inspection and maintenance Non-value-added

4. Travel Non-value-added

5. Lawn cutting Value-added

6. Trimming Value-added

7. Billing Non-value-added

8. Bill collecting Non-value-added

Brief Exercise 74

Rong Number Cell Phones repairs broken phone systems in large office buildings. It has a number of repair technicians who travel to a customer and work on the phone systems. Sometimes a phone has to be brought back to Rong Number’s office and repaired there. The company has identified a number of activities that their repair staff performs each day. These activities include the following:

a) The repair technicians must get a list of clients to visit from the dispatcher.

b) They must drive to each client’s office.

c) Time is needed to discuss the problem with the client.

d) Time is needed to diagnose and then fix the problem.

e) Broken parts must be removed and replaced as needed.

f) The client must sign for the work done.

Instructions

Classify each of the above into value-added or non-value-added activities.

Solution 74 (5 min.)

a) NVA

b) NVA

c) VA

d) VA

e) VA

f) NVA

Brief Exercise 75

Mike’s Motors manufactures small gas motors. Mike has identified the following activities:

a) design

b) regulatory approval

c) machine set up

d) staff annual picnic

e) electricity

f) sales commission, (percent of sale price)

Instructions

Classify each of the above activities with regard to activity level.

Solution 75 (5 min.)

Activity Activity Level

a) design Product level

b) regulatory approval Product level

c) machine setup Batch level

d) staff annual picnic Facility level

e) electricity Unit level

f) sales commission, (percent of sale price) Unit level

Brief Exercise 76

Spooners Spa is setting its holiday spa package prices and needs to allocate its overhead. It gathers the following data on its main services:

Usage of Cost

Estimated Overhead Driver per Service

Massage $20,000 800 massage hours

Whirlpool $80,000 10,000 whirlpool hours

Mud baths $15,000 1,000 mud baths

Facials $100,000 5,000 facials

Spooners Spa uses ABC as the basis to help set its prices for its pricing packages. Package A includes a two hour massage, three hours in the whirlpool, a mud bath and a facial.

Instructions

Determine the amount of overhead that should be applied to Package A.

Solution 76 (5–10 min.)

Estimated Usage of Cost Activity-Based

Overhead Driver per Service OH Rates

Massage $20,000 800 massage hours $25 per hour

Whirlpool $80,000 10,000 whirlpool hours $8 per hour

Mud baths $15,000 1,000 mud baths $15 per bath

Facials $100,000 5,000 facials $20 per facial

Package A: ($25 x 2) + ($8 x 3) + $15 + $20 = $109

Brief Exercise 77

Explorit Travel Services arranges group tours in the Vancouver area. Explorit has four employees in its downtown office who research and develop various tours for its customers. It advertises upcoming tours in travel magazines and on travel websites. The cost associated with the three overhead activities at Explorit are as follows:

Estimated

Overhead

Advertising $82,560

Information Technology Costs 42,000

Office Wages 92,000

In their implementation of ABC costing, Explorit identified a number of potential cost drivers for these overhead activities including:

Usage

# of tours 500

Hours spent by office staff working on tours 8,000

# of ads placed per tour 320

# of customers 14,000

Computer hours (can be tracked by tour) 5,000

Instructions

Identify the cost driver most correlated to each of the three activity costs incurred by Explorit. Calculate the overhead cost rate for each activity cost.

Solution 77 (10–15 min.)

Overhead Cost Best Cost Driver

Advertising # of ads placed per tour

Information Technology computer hours

Office Wages hours spent by office staff working on tours

Estimated

Overhead Driver OH Rates

Advertising $82,560 320 $258 ad placed

IT $42,000 5,000 $8.4 per computer hour

Office Wages $92,000 8,000 $11.5 per hour spent on tour

Exercises

Exercise 78

Hayward Industries manufactures dining chairs and tables. The following information is available:

Dining Chairs Tables Total Cost

Machine setups 200 600 $48,000

Inspections 250 470 $72,000

Labour hours 2,600 2,400

Hayward is considering switching from using one overhead rate based on labour hours to activity-based costing.

Instructions

Perform the following analyses for these two components of overhead:

a) Compute total machine setups and inspection costs assigned to each product, using a single overhead rate.

b) Compute total machine setups and inspection costs assigned to each product, using activity-based costing.

c) Comment on your findings.

Solution 78 (8–12 min.)

a) Single overhead rate

($48,000 + $72,000) ÷ 5,000 = $24 per labour hour

Dining chairs: 2,600 × $24 = $62,400

Tables: 2,400 × $24 = 57,600

$120,000

b) Activity-based costing

Machine setups: $48,000 ÷ 800 = $60 per setup

Inspections: $72,000 ÷ 720 = $100 per inspection

Dining chairs: (200 × $60) + (250 × $100) = $37,000

Tables: (600 × $60) + (470 × $100) = 83,000

$120,000

c) The use of activity-based costing resulted in the allocation of less cost to dining chairs and more cost to tables. The change in cost allocation reflects a more accurate allocation based on cause and effect.

Exercise 79

Randel Manufacturing has five activity cost pools and two products (a budget vacuum and a deluxe vacuum). Information is presented below:

Cost Drivers by Product

Activity Cost Pool Cost Driver Est. Overhead Budget Deluxe

Ordering and Receiving Orders $ 130,000 600 400

Machine Setup Setups 297,000 500 400

Machining Machine hours 1,000,000 150,000 100,000

Assembly Parts 1,600,000 1,200,000 800,000

Inspection Inspections 300,000 550 450

Instructions

Compute the overhead cost per unit for each product. Production is 700,000 units of Budget and 200,000 units of Deluxe. Round your answer to the nearest cent.

Solution 79 (15–20 min.)

Activity Cost Pool Est. Overhead ÷ Total Activity = Overhead Rate

Ordering & Receiving $ 130,000 1,000 orders $130/order

Machine Setup 297,000 900 setups $330/setup

Machining 1,000,000 250,000 mach. hours $4/machine hour

Assembly 1,600,000 2,000,000 parts $.80/part

Inspection 300,000 1,000 inspections $300/inspection

Budget Deluxe

Cost Cost Cost Cost

Activity Cost Pool Driver × Rate = Assigned Driver × Rate = Assigned

Ordering & Receiving 600 $130 $ 78,000 400 $130 $ 52,000

Machine Setup 500 330 165,000 400 330 132,000

Machining 150,000 4 600,000 100,000 4 400,000

Assembly 1,200,000 .80 960,000 800,000 .80 640,000

Inspection 550 300 165,000 450 300 135,000

$1,968,000 $1,359,000

÷ 700,000 ÷ 200,000

$2.81 per unit $6.80 per unit

Exercise 80

All Wood Corporation manufactures dining chairs and tables. The following information is available:

Activity Volume Total Activity

Dining Chairs Tables Cost

Machine setups 50 75 $9,000

Inspections 300 190 $7,590

Labour hours 700 300

All Wood is considering switching from using one overhead rate based on labour hours to activity-based costing.

Instructions

Perform the following analyses of overhead for these two products:

a) Calculate total machine setups and inspection costs assigned to each product, using a single overhead rate.

b) Calculate total machine setups and inspection costs assigned to each product, using activity-based costing.

c) Comment on your findings.

Solution 80 (8–12 min.)

a) Single overhead rate

($9,000 + $7,595) ÷ 1,000 = $16.59 per labour hour

Dining chairs: 700 × $16.59 = $11,613

Tables: 300 x $16.59 = 4,977

$16,590

b) Activity-based costing

Machine setups: $9,000 ÷ 125 = $72 per setup

Inspections: $7,590 ÷ 490 = $15.49 per inspection

Dining chairs: (50 × $72) + (300 × $15.49) = $8,247

Tables: (75 × $72) + (190 × $15.49) = 8,343

$ 16,590

c) The use of activity-based costing resulted in the allocation of less cost to dining chairs and more cost to tables. The change in cost allocation reflects a more accurate allocation based on cause and effect.

Exercise 81

Holiday Favourites manufactures a wide variety of holiday and seasonal decorative items. Holiday's activity-based costing overhead rates are:

Purchasing $450 per order

Storing $5 per square metre

Machining $30 per machine hour

Supervision $10 per direct labour hour

The Haunted House Project involved five purchase orders, 2,000 square metres, 45 machine hours, and 25 direct labour hours. The cost of direct materials on the job was $35,000 and the direct labour rate is $15 per hour.

Instructions

a) Calculate the total cost of the Haunted House Project using activity-based costing.

b) Calculate the total cost of the Haunted House Project using traditional costing, when manufacturing overhead is applied at 250% of direct labour cost.

Solution 81 (5–7 min.)

a) Direct materials $35,000

Direct labour (25 × $15) 375

Factory overhead

Purchasing (5 × $450) $ 2,250

Storing (2,000 × $5) 10,000

Machining (45 × $30) 1,350

Supervision (25 × $10) 250 13,850

Total cost $49,225

b) Direct materials $35,000

Direct labour (25 x $15) 375

Factory overhead: $375 x 250% 938

$36,313

Exercise 82

Seats On Chairs (SOC) manufactures funky chairs. SOC has identified various activity centres to which overhead costs are assigned. The cost pools for these centres and their selected cost drivers for 2022 are as follows:

Activity Centres Cost Pools

Utilities $278,000

Scheduling and setup $260,000

Materials handling $640,000

Total overhead $1,178,000

SOC’s products and other operating statistics follow:

Metaz Chair Yak Chair Latko Chair

Direct costs $80,000 $80,000 $90,000

Machine hours 30,000 10,000 20,000

Number of setups 130 380 270

Pounds of materials 500,000 300,000 800,000

Number of units produced 40,000 20,000 60,000

Direct labour hours 40,000 20,000 60,000

Instructions

a) Determine unit product costs using traditional costing and direct labour hours as the driver.

b) Determine unit product costs using the ABC method and appropriate cost drivers for each product.

Solution 82 (20–25 min.)

Metaz Chair Yak Chair Latko Chair Totals

Direct costs $80,000 $80,000 $90,000 250,000

Machine hours 30,000 10,000 20,000 60,000 hrs

Number of setups 130 380 270 780 Setups

Pounds of materials 500,000 300,000 800,000 1,600,000 lbs

Number of units produced 40,000 20,000 60,000 120,000 units

Direct labour hours 40,000 20,000 60,000 120,000 hrs

a) Traditional Costing:

Predetermined overhead rate: Total overhead: $1,178,000 = $9.82 per DLH

Total direct labour hours 120,000

Unit Costs: Metaz Chair Yak Chair Latko Chair

Direct costs (given) $80,000 $80,000 $90,000

Overhead ($9.82 x

individual DLH per chair type) $392,800 $196,400 $589,200

Total Product Costs (A): $472,800 $276,400 $679,200

# units produced (B): 40,000 20,000 60,000

Cost per unit (A) / (B): $11.82 $13.82 $11.32

b) Activity-Based Costing:

Activity Centres Cost Pools Selected Cost Drivers Activity Rate__

Utilities $278,000 60,000 machine hours $4.63/mach hr

Scheduling and setup $260,000 780 setups $333.33/setup

Materials handling $640,000 1,600,000 lbs of materials $0.40/lb

Total overhead $1,178,000

Unit Costs: Metaz Chair Yak Chair Latko Chair

Direct costs (given) $80,000 $80,000 $90,000

Overhead

Utilities: ($4.63 x # machine

hours used per chair type) $138,900 $46,300 $92,600

Scheduling and setup

($333.33 x # setups) $43,333 $126,666 $90,000

Materials handling ($0.40/lb

x # lbs moved per chair type) $200,000 $120,000 $320,000

Total Product Costs (A): $462,233 $372,966 $592,600

# units produced (B): 40,000 20,000 60,000

Cost per unit (A) / (B): $11.55 $18.65 $9.88

Exercise 83

Prior to installing an ABC system, Bags Galore (BG) had been pricing its products on the basis of traditional costing using direct labour hours to allocate total overhead. Because the firm operates in a competitive environment, it sets prices at only a 25% mark-up on cost.

Under a traditional costing system, handbags, shoulder bags, and wallets are allocated total costs of $12, $16, and $8 respectively.

Under ABC, handbags, shoulder bags, and wallets are allocated total costs of $10, $18, and $6 respectively.

Instructions

a) Determine selling prices using traditional costing and ABC costing.

b) Comment on the results.

Solution 83 (5–10 min.)

a) Prices Using Traditional Costing:

Unit Costs: Handbag Shoulder Bag Wallet

Cost per unit $12.00 $16.00 $ 8.00

Mark-up on cost (25%) $ 3.00 $ 4.00 $ 2.00

Selling price $15.00 $ 20.00 $10.00

Prices Using ABC:

Unit Costs: Handbag Shoulder Bag Wallet

Cost per unit $10.00 $18.00 $6.00

Mark-up on cost (25%) $ 2.50 $ 4.50 $1.50

Selling price $12.50 $22.50 $7.50

b) BG produces 60,000 wallets.. A change from traditional costing to ABC reduces the selling price of a wallet, making it even more attractive to customers. In contrast, the least popular bag, the shoulder bag, increases in price as a result of the switch to ABC. Since ABC allocates the overhead costs of resources used per item, it might signal management that the shoulder bag is more expensive to produce and may not be as popular with customers. The company may wish to reconsider offering this item.

Exercise 84

FlyOver Airlines is a cargo air freight company and plans to add two new routes: Victoria to Los Angeles (Route 105) and Calgary to San Francisco (Route 106). The company is setting its rate charges for the two routes and expects to have 300 flights per year on Route 105 and 400 flights per year on Route 106.

The company must load 500 containers onto each flight for Route 105 and 300 containers for each flight of Route 106. In addition, 30 regulatory forms must be filled out for Route 105 and 70 forms for Route 106 every time a plane flies. In preparing the flights, it takes FlyOver 100 hours to load containers for Route 105 and 140 hours for Route 106.

The company’s total container handling costs for the year are expected to be $600,000 and total costs for receiving regulatory approval is $250,000.

Instructions

Under a traditionally based accounting system, using container loads as basis for allocating overhead:

a) Determine the amount of overhead that will be assigned to Route 105.

b) Determine the amount of overhead that will be assigned to Route 106.

If the company switches to an ABC accounting system:

c) Determine the amount of overhead that will be assigned to Route 105.

d) Determine the amount of overhead that will be assigned to Route 106.

Solution 84 (5–10 min.)

a) $531,250 ($600,000 + $250,000 / 500 + 300 = $1,062.50 x 500 = $531,250)

b) $318,750 ($600,000 + $250,000 / 500 + 300 = $1,062.50 x 300 = $318,750)

Use Activity-Based

Activity Cost Pool Cost Driver of Driver OH Rates

Container handling costs $600,000 ÷240 hours =$2,500

Regulatory costs 250,000 ÷100 forms =$2,500

Total $850,000

c) d)

Allocation: Route 105 Route 106

Containers $2,500 x 100 = $250,000

$2,500 x 140 $350,000

Regulatory fees $2,500 x 30 = 75,000

$2,500 x 70 = _______ 175,000

Total Overhead allocated $325,000 $525,000

Exercise 85

Jack Bauer Co. has decided to use a predetermined overhead rate to assign factory overhead to production. The following predictions have been made for 2022:

Total Factory Overhead Costs: $150,000

Direct Labour Hours: 40,000 hrs

Direct Labour Costs: $200,000

Machine Hours: 60,000 hrs

Instructions

a) Compute the predetermined factory overhead rate under three different scenarios: 1) direct labour hours, 2) direct labour costs and 3) machine hours.

b) Assume that actual factory overhead was $152,500 and that Jack Bauer Co. elected to apply factory overhead to WIP inventory based on direct labour hours. If actual direct labour hours were 42,000 for 2022, was factory overhead over-applied or under-applied? By how much?

c) Jack Bauer Co. typically writes off any under- or over-applied factory overhead to Cost of Goods Sold at year end. Show the necessary journal entry at the end of 2022 to dispose of the balance you calculated in part b.

Solution 85 (13–17 min.)

a) 1. Direct Labour Hours: ($150,000/40,000 hrs) = $3.75/DLH

2. Direct Labour Costs: ($150,000/$200,000) = 75% of Direct Labour Cost

3. Machine Hours: ($150,000/60,000 hrs) = $2.50 per MH

b) Overhead applied is based on DLH, and calculated at 42,000 hours x $3.75

Overhead applied: $157,500

Actual overhead incurred: $152,500

Over-applied by: $5,000

c) Write off over-applied overhead as follows:

Factory Overhead Clearing Account $5,000

Cost of Goods Sold $5,000

Exercise 86

Flash, Inc. has five activity cost pools and two products (a budget flash drive and a deluxe flash drive). Information is presented below:

Cost Drivers by Product

Activity Cost Pool Cost Driver Est. Overhead Budget Deluxe

Ordering and Receiving Orders $ 140,000 500 200

Machine Setup Setups 90,000 100 200

Machining Machine hours 2,500,000 25,000 25,000

Assembly Parts 750,000 150,000 250,000

Inspection Inspections 480,000 700 500

Instructions

Calculate the overhead cost per unit for each product. Production is 1,000,000 units of Budget and 600,000 units of Deluxe. Round your answer to the nearest dollar.

Solution 86 (15–20 min.)

Activity Cost Pool Est. Overhead ÷ Total Activity = Overhead Rate

Ordering & Receiving $ 140,000 700 orders $200/order

Machine Setup 90,000 300 setups $300/setup

Machining 2,500,000 50,000 mach. hours $50/machine hour

Assembly 750,000 400,000 parts $1.875/part

Inspection 480,000 1,200 inspections $400/inspection

Budget Deluxe

Cost Cost Cost Cost

Activity Cost Pool Driver × Rate = Assigned Driver × Rate = Assigned

Ordering & Receiving 500 $200 $ 100,000 200 $200 $ 40,000

Machine Setup 100 300 30,000 200 300 60,000

Machining 25,000 50 1,250,000 25,000 50 1,250,000

Assembly 150,000 1.875 281,250 250,000 1.875 468,750

Inspection 700 400 280,000 500 400 200,000

$1,941,250 $2,018,750

÷ 1,000,000 ÷ 600,000

$1.94 per unit $3.36 per unit

Exercise 87

Woody’s Furniture manufactures wooden tables and chairs. The company has divided the manufacturing process employees into two teams: one making tables, and one making chairs. Woody has decided that it should adopt an activity-based costing system (ABC).

Instructions

Determine a cost driver for each of the activities listed below.

Cost Pool Cost Driver

a) Product design ______________________________

b) Sawing ______________________________

c. Sanding ______________________________

d) Supervisor salary ______________________________

e) Depreciation on finishing equipment ______________________________

f) Administrative ______________________________

g) Advertising and Marketing ______________________________

h) Storage ______________________________

i) Shipping ______________________________

Solution 87 (6–9 min.)

Cost Pool Cost Driver

a) Product design Designer hours

b) Sawing Machine hours

c) Sanding Direct labour hours

d) Supervisor salary Direct labour hours

e) Depreciation on finishing equipment Machine hours

f) Administrative Number of employees

g) Advertising and Marketing Sales revenue

h) Storage Square footage occupied

i) Shipping Number of shipments

Exercise 88

A list of possible cost drivers is presented below:

Code

A Engineering hours

B Setups

C Machine hours

D Kg of materials handled

E Number of boxes

F Number of sales orders taken

G Number of subassemblies

H Number of purchase orders placed

Instructions

For each of the following activity cost pools, select the most appropriate cost driver:

Code Cost Pool

_____ 1. Machine setup

_____ 2. Ordering and receiving

_____ 3. Packaging and shipping

_____ 4. Engineering design

_____ 5. Machining

_____ 6. Assembly

Solution 88 (4–6 min.)

1. B

2. H

3. E

4. A

5. C

6. G

Exercise 89

Identify appropriate cost drivers for the following activity cost pools:

1. Human resources

2. Security

3. Receiving

4. Data processing

Solution 89 (3–5 min.)

1. Number of employees, number of hires

2. Square metres

3. Shipments received; kilograms received

4. Lines printed, CPU minutes, storage units

Exercise 90

Two of the activity cost pools for Calgary Company are

a) machining ($150,000) and

b) inspections ($80,000).

Possible cost drivers are direct labour hours (7,000), machine hours (7,500), square footage (10,000), and number of inspections (80).

Instructions

Calculate the overhead rate for each activity.

Solution 90 (4–6 min.)

$150,000

a) Machining: —————————— = $20 per machine hour

7,500 machine hours

$80,000

b) Inspections: ———————- = $1,000 per inspection

80 inspections

Exercise 91

Calculate activity-based costing rates from the following budgeted data for Tatum's Tools:

Activity Cost Pool Budgeted Cost Budgeted Cost Driver

Designing $7,500,000 50,000 design hours

Machining 625,000 100,000 machine hours

Packing 540,000 9,000 labour hours

Solution 91 (3–5 min.)

Designing ($7,500,000 ÷50,000) = $150 per design hour

Machining ($625,000 ÷ 100,000) = $6.25 per machine hour

Packing ($540,000 ÷ 9,000) = $60 per labour hour

Exercise 92

EKP Inc. produces two products. Its main product is simple to produce, but only marginally profitable on a per unit basis. Nonetheless, EKP makes most of its operating income on this product due to high volume of sales even though it only has a small portion of the market. The second product is complex to produce but is very profitable on a per unit basis. Sales volume of the second product is low despite EKP’s dominance of the market. EKP uses a traditional costing system with all overhead allocated based on direct labour hours.

Instructions

a) Identify which factors would suggest that EKP should consider switching to an activity-based costing system.

b) What outcomes can be expected if EKP switched to an activity-based costing system?

Solution 92 (4–6 min.)

a) EKP’s high-volume product is only marginally profitable on a per unit basis and it has only a small portion of the market share. The high volume, low profit per unit and low market share suggests that this product may have been assigned a large portion of the overhead costs; probably more than the competition has assigned to its products.

EKP’s low-volume product is very profitable on a per unit basis and it has a large portion of the market share. The low volume, high profit per unit and high market share suggests that this product may have been assigned a small portion of the overhead costs; probably less than the competition has assigned to its products.

A further factor that suggests that EKP should consider switching to an activity-based costing system is that the high-volume product is simple to produce, whereas the low-volume product is complex.

b) If EKP switches to an activity-based costing system, it is apt to find that less of the overhead costs will be allocated to the high-volume product, and more will be allocated to the low-volume product. That may lead EKP to lower its selling price for the high-volume product—making it more competitive, and raise its selling price for the low-volume product.

Exercise 93

Label the following costs as value-adding (VA) or non-value-adding (NVA):

____ 1. Engineering design

____ 2. Machine repair

____ 3. Inventory storage

____ 4. Machining

____ 5. Assembly

____ 6. Painting

____ 7. Inspections

____ 8. Packaging

Solution 93 (3–5 min.)

1. VA

2. NVA

3. NVA

4. VA

5. VA

6. VA

7. NVA

8. VA

Exercise 94

Bjork and Falvery is a law firm that uses activity-based costing. Classify these activities as value-added or non-value-added:

1. Taking appointments

2. Reception

3. Meeting with clients

4. Bookkeeping

5. Court time

6. Meeting with opposing lawyers

7. Billing

8. Advertising

Solution 94 (3–5 min.)

1. Non-value-added

2. Non-value-added

3. Value-added

4. Non-value-added

5. Value-added

6. Value-added

7. Non-value-added

8. Non-value-added

Exercise 95

Tim Taylor Tool Company manufactures small tools. Classify each of the following activity costs of the tool company as either unit level, batch level, product level, or facility level:

1. Plant management

2. Drilling

3. Painting

4. Machine setups

5. Product design

6. Cutting

7. Inspection

8. Inventory management

Solution 95 (4–6 min.)

1. Facility

2. Unit

3. Unit

4. Batch

5. Product

6. Unit

7. Unit

8. Product

Exercise 96

Pipes-R-Us Inc. is considering replacing its traditional costing system with an activity-based costing system using three activity cost pools: Wages, Disposal, and Supplies. The company has provided the following information concerning the activity and costs:

Wages $250,000

Disposal 140,000

Supplies 60,000

Total $450,000

Activity Cost Pools

Remove Job

Galvanized Pipe Setup Other

Wages 65% 25% 10%

Disposal 75% 25% 0%

Supplies 60% 20% 20%

Instructions

Calculate the total cost to be allocated to the (a) Removing Galvanized Pipe (b) Job Setup, and (c) Other activity cost pools.

Solution 96 (6–9 min.)

Activity Cost Pools

a) b) c)

Remove Job

Galvanized Pipe Setup Other Total

Wages $162,500 $62,500 $25,000 $250,000

Disposal 105,000 35,000 0 140,000

Supplies 36,000 12,000 12,000 60,000

Total $303,500 $109,500 $37,000 $450,000

Exercise 97

Franklin & Associates, a small accounting firm, employs an ABC costing system. The following budgeted data for each of the activity cost pools is provided for the year 2022:

Estimated Use of

Activity Cost Pools Overhead Cost Drivers per Activity

Scheduling $ 45,000 30 clients

Meeting with clients 125,000 250 professional hours

Preparing working papers 36,000 320 staff hours

During 2022 the firm scheduled 20 clients, spent 100 professional hours meeting with clients and 140 staff hours in preparing working papers.

Instructions

Compute the total overhead applied during 2022.

Solution 97 (5 min.)

Estimated Use of Activity-Based

Activity Cost Pool Overhead Cost Drivers per Activity Overhead Rates

Scheduling $ 45,000 30 clients $1,500 per client

Meeting with clients 125,000 250 prof. hours $500 per prof. hour

Preparing working papers 36,000 320 staff hours $112.50 per staff hour

Overhead Total Overhead

Cost Drivers Rates Applied

20 clients $1,500/client $ 30,000

100 professional hours $500/professional hour 50,000

140 staff hours $112.50/staff hour 15,750

$95,750

Exercise 98

Jayson Woods, PSC is an architectural firm that uses activity-based costing. The three activity cost pools used by Jayson Woods are: Salaries and Wages, Travel Expense, and Plan Reproduction Expense. The firm has provided the following information concerning activity and costs:

Salaries and wages $430,000

Travel expense 100,000

Plan reproduction expense 120,000

Total $650,000

Activity Cost Pools

Project Business

Assignment Development Other

Salaries and wages 60% 30% 10%

Travel expense 40% 40% 20%

Plan reproduction expense 35% 40% 25%

Instructions

Calculate the total cost to be allocated to the (a) Project Assignment, (b) Business Development, and (c) Other activity cost pools.

Solution 98 (6–9 min.)

Activity Cost Pools

a) b) c)

Project Business

Assignment Development Other Total

Salaries and wages $258,000 $129,000 $43,000 $430,000

Travel expense 40,000 40,000 20,000 100,000

Plan reproduction expense 42,000 48,000 30,000 120,000

Total $340,000 $217,000 $93,000 $650,000

Exercise 99

Brewer & Carr, Ltd. is an architectural firm that uses activity-based costing. The three activity cost pools used by Brewer & Carr are: Salaries and Wages, Travel Expense, and Plan Reproduction Expense. The firm has provided the following information concerning activity and costs:

Salaries and wages $360,000

Travel expense 80,000

Plan reproduction expense 120,000

Total $560,000

Activity Cost Pools

Project Business

Assignment Development Other

Salaries and wages 60% 30% 10%

Travel expense 40% 40% 20%

Plan reproduction expense 30% 40% 30%

Instructions

Calculate the total cost to be allocated to the

a) Project Assignment,

b) Business Development, and

c) Other activity cost pools.

Solution 99 (6–9 min.)

Activity Cost Pools

a) b) c)

Project Business

Assignment Development Other Total

Salaries and wages $216,000 $108,000 $36,000 $360,000

Travel expense 32,000 32,000 16,000 80,000

Plan reproduction expense 36,000 48,000 36,000 120,000

Total $284,000 $188,000 $88,000 $560,000

Exercise 100

Ahmet, McGuire, and Able, a law firm, employs ABC. The following budgeted data for each of the activity cost pools is provided for the year 2022:

Estimated Use of

Activity Cost Pools Overhead Cost Drivers per Activity

Researching legal issues $ 31,500 900 research hours

Meeting with clients 1,760,000 8,800 professional hours

Preparing legal documents 480,000 30,000 pages

During 2022 the firm experienced 660 research hours, prepared 25,000 document pages, and 10,000 professional hours.

Instructions

Compute the total overhead applied during 2022.

Solution 100 (5 min.)

Estimated Use of Activity-Based

Activity Cost Pool Overhead Cost Drivers per Activity Overhead Rates

Researching legal issues $ 31,500 900 research hours $35 per res. hour

Preparing legal documents 480,000 30,000 pages $16 per page

Meeting with clients 1,760,000 8,800 prof. hours $200 per prof. hour

Overhead Total Overhead

Cost Drivers Rates Applied

660 research hours $35/research hour $ 23,100

25,000 document pages $16/page 400,000

10,000 professional hours $200/professional hour 2,000,000

$2,423,100

COMPLETION STATEMENTS

101. In traditional costing systems, direct labour cost is often used for the assignment of all ___.

102. A ___ is any activity that has a direct cause-effect relationship with the resources consumed.

103. In activity-based costing, overhead costs are allocated to ___, then assigned to products.

104. The number of ___ is an appropriate cost driver for the ordering and receiving activity cost pool.

105. The primary benefit of activity-based costing is ___ product costing.

106. When product lines differ greatly in volume and manufacturing complexity, a switch from traditional costing to ___ is indicated.

107. ___ increase the worth of a product or service to customers.

108. In the hierarchy of activity levels, the four levels are ___, ___, ___, and ___.

109. Equipment setups are a ___-level activity.

110. In a service industry, a large proportion of the overhead costs are ___.

ANSWERS TO COMPLETION STATEMENTS

101. overhead costs

102. cost driver

103. activity cost pools

104. purchase orders

105. more accurate

106. activity-based costing

107. Value-added activities

108. unit, batch, product, facility

109. batch

110. company-wide costs

MATCHING

111. Match the items in the two columns below by entering the appropriate code letter in the space provided.

A. Cost driver E. Batch-level activity

B. Facility-level activity F. Product-level activity

C. Unit-level activity G. Non-value-added activity

D. Activity-based costing H. Value-added activity

____ 1. Allocates overhead to multiple activity cost pools, then assigns the activity cost pools to products

____ 2. An activity that has a direct cause-effect relationship with the resources consumed

____ 3. Increases the worth of a product or service to customers

____ 4. Should be eliminated or reduced

____ 5. Plant management

____ 6. Engineering changes

____ 7. Equipment setups

____ 8. Assembling

ANSWERS TO MATCHING

1. D

2. A

3. H

4. G

5. B

6. F

7. E

8. C

SHORT-ANSWER ESSAY QUESTIONS

SAE 112

Is it always appropriate to use plant-wide, predetermined overhead rates that are based on direct labour? Explain.

Solution 112

When there is no correlation between direct labour and overhead, it is inappropriate to use plant-wide, predetermined overhead rates that are based on direct labour. When this correlation does not exist, companies that use overhead rates based on direct labour have significant product cost distortions. Companies that have complex processes need to use multiple allocation bases to calculate accurate product costs. An overhead cost allocation method that uses multiple bases is activity-based costing.

SAE 113

How do data collection efforts at every stage of the value chain benefit a company in achieving accurate costing?

Solution 113

To achieve accurate costing, a high degree of correlation must exist between the cost driver and the actual consumption of the overhead costs in the cost pool. This is an area that has benefited greatly from company data collection efforts at nearly every stage of the value chain. By applying analytics to this data, the company can increase the likelihood that cost drivers are closely related to resource consumption. Availability and ease of obtaining data relating to the cost driver is an important fact that must be considered in its selection.

SAE 114

Borg Corporation uses a traditional costing system. Management is considering switching to an activity-based costing system. What steps must Borg take in initiating an activity-based costing system?

Solution 114

Borg Corporation must first identify the major activities that pertain to the manufacture of specific products, then allocate manufacturing overhead to activity cost pools. Next, Borg must identify the cost drivers that accurately measure each activity's contribution to the finished product and calculate activity-level overhead rates for each pool. Finally, the manufacturing overhead costs for each activity pool must be allocated to products, using the activity-based overhead rates.

SAE 115

What are the conditions that would indicate to the management of a firm that they should switch from traditional costing to activity-based costing?

Solution 115

The presence of one or more of the following conditions indicates ABC as the superior costing system:

1) Product lines differ greatly in volume and manufacturing complexity.

2) Product lines are numerous, diverse, and require differing degrees of support services.

3) Overhead costs constitute a significant portion of total costs.

4) The manufacturing process or the number of products has changed significantly.

5) Production or marketing managers are ignoring data provided by the existing system and are, instead, using alternative data in decision-making.

SAE 116

How can an activity-based costing system be modified to be compliant with external reporting and IFRS?

Solution 116

A modified form of activity-based costing can be used to develop product costs for external financial reports compliant with IFRS if:

• fixed manufacturing costs are allocated to inventory based on normal capacity,

• variable production overheads are allocated based on the use of the production facilities, and

• all non-manufacturing costs are excluded.

SAE 117

Seven Company produces phasers (sales of 200,000 units per year) and force field enhancers (sales of 25,000 units per year). If Seven switches from traditional costing to activity-based costing, what is the likely effect on overhead assigned to the two products?

Solution 117

When overhead is properly assigned in ABC, it will usually increase the unit cost of low-volume products like the force field enhancers. This is because low-volume products often require more special handling, such as machine setups and inspections, than high-volume products. Also, overhead costs incurred by low-volume products often are disproportionate to a traditional allocation base.

SAE 118

How have automated systems helped companies with the high cost of data collection to

determine cost pools, cost drivers, and activity usage?

Solution 118 (5 min.)

In the past, one of the main barriers to implementing ABC was the high cost of data collection needed to determine cost pools, cost drivers, and activity usage. But today’s automated systems collect data on virtually every aspect of a company’s operations, thus helping a company to more easily implement ABC and employ ABM. This data can also help companies employ ABM by reducing non–value-added activities

SAE 119

In a service company, a large percentage of overhead costs are company-wide costs. Why does this present a unique challenge for an ABC implementation in a service company, as compared to a manufacturing company?

Solution 119

Company-wide costs are costs that are necessary in order to run a company but are not explicitly related to producing a distinct product or providing a specific service. Company-wide costs are difficult to accurately attribute to a specific product or service provided by either a manufacturing or service company. In service industries, however, company-wide costs often represent a significant proportion of overhead costs as compared to a manufacturing company. This presents a challenge in an ABC implementation in a service company as the inability to tie overhead costs to specific services may lead to arbitrary allocations which can, in essence, negate the purpose of an ABC implementation (which is to improve the accuracy of service costing).

SAE 120

Describe how the application of ABC to service companies is the same as its application to manufacturing companies.

Solution 120

The overall objective of ABC in service companies is the same as that for manufacturing companies—improved costing of services provided. The general approach to costing is the same: analyze operations, identify activities, assign overhead costs to activity cost pools, and identify and use cost drivers to assign the cost pools to the services.

MULTI-PART QUESTION

121. Randy’s Roofing is a city wide company specializing in replacing shingle roofs. Lately, Randy has been puzzled by the fact that though some of his jobs appear to make good money, he doesn’t seem to come out as profitable at the end of each month as he thinks he should.

In exchange for some work on your own roof, Randy asks you to help him better understand his costs and how he can price his jobs better. He tells you his total costs are $220,000 every month and that number never changes. You ask him what are the different components of his costs and he lists them as shown below, together with what Randy says is a breakdown of where the costs are incurred.

Replacing Travelling Office Promotion Total Cost per

Activity Shingles to Jobs Work for New Jobs Allocation Month

Wages 80% 20% 0 0 100% $160,000

Shingles 100% 0 0 0 100% 20,000

Shingle Disposal 100% 0 0 0 100% 5,000

Truck Expenses 0 100% 0 0 100% 5,000

Randy`s Car 0 0 30% 70% 100% 3,000

Randy`s Salary 0 0 20% 80% 100% 10,000

Office Expenses 0 0 70% 30% 100% 17,000

Total $220,000

Randy then tells you that he does 5,000 square metres of shingle roofs every month and his crews travel about 2,000 kilometres to get to and from the jobs. Last month his crews did 200 roofs. He also shows that he did a job for Leaky Eaves last month for $7,000 and he allocated $6,000 in costs, based on his usual method of allocating costs (which was an estimate of what he thought the job should cost.)

Randy said that the Leaky Eaves roof was 200 square metres and to get to the job and back to his yard was 150 kilometres.

Instructions

See if there is a way that ABC can help Randy understand whether the Leaky Eaves job actually made a profit or not.

Solution 121 (20–30 min.)

(requires the student to allocate costs in three steps to arrive at the answer to the Leaky Eaves job)

Step 1 Allocation of costs to activities

Replacing Travelling Office Promotion Total

Activity Shingles to Jobs Work for New Jobs Allocation

Wages 128,000 32,000 0 0 $160,000

Shingles 20,000 0 0 0 20,000

Shingle Disposal 5,000 0 0 0 5,000

Truck Expenses 0 5,000 0 0 5,000

Randy`s Car 0 0 900 2,100 3,000

Randy`s Salary 0 0 2,000 8,000 10,000

Office Expenses 0 0 11,900 5,100 17,000

Totals $153,000 $37,000 $14,800 $15,200 $220,000

Step 2 Allocate rates for each activity

Replacing Travelling Office Promotion

Activity Shingles to Jobs Work for New Jobs

(per 5,000 (per 2,000 (200 jobs) (200 jobs)

square metres) kilometres)

Wages $25.60 $16.00 0 0

Shingles 4.00 0 0 0

Shingle Disposal 1.00 0 0 0

Truck Expenses 0 2.50 0 0

Randy`s Car 0 0 4.50 10.50

Randy`s Salary 0 0 10.00 40.00

Office Expenses 0 0 59.50 25.50

Totals $30.60 $18.50 $74.00 $76.00

Step 3 Determine cost for Leaky Eaves job by using rates above

Replacing Travelling Office Promotion Total Job

Activity Shingles to Jobs Work for New Jobs Cost

(for a 200 (for 150 km (for 1 job) (200 jobs)

sq. m. roof) to job)

Wages $5,120 $2,400 0 0 $7,520.00

Shingles 800 0 0 0 800.00

Shingle Disposal 200 0 0 0 200.00

Truck Expenses 0 375 0 0 375.00

Randy`s Car 0 0 4.50 10.50 15.00

Randy`s Salary 0 0 10.00 40.00 50.00

Office Expenses 0 0 59.50 25.50 85.00

Totals $6,120 $2,770 $74.00 $76.00 $9,045.00

Comments:

Randy lost money on the Leaky Eaves job when he thought he had made a profit. His original cost allocation of $6,000 to the job did not cover his wages and the overall charge to the customer of $7,000 did not cover his additional costs.

Worse, he has not considered his own salary and car expenses that are needed to help promote any new jobs.

If Randy wants to use ABC to help him build up his expected costs of repairing a roof, he will most likely have to raise his prices for any future jobs that he bids on.

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