Hansen Aise Sm_ch04

8/2/2019 Hansen Aise Sm_ch04

1/36

CHAPTER 4ACTIVITY-BASED PRODUCT COSTING

QUESTIONS FOR WRITING AND DISCUSSION

1. Unit costs provide essential informationneeded for inventory valuation and prepara-tion of income statements. Knowingunit costs is also critical for many decisionssuch as bidding decisions and accept-or-reject special order decisions.

2. Cost measurement is determining the dollaramounts associated with resources used inproduction. Cost assignment is associatingthe dollar amounts, once measured, withunits produced.

3. An actual overhead rate is rarely usedbe- cause of problems with accuracy andtimeli- ness. Waiting until the end of the yearto en- sure accuracy is rejected becauseof the need to have timely information.Timeliness of information based on actualoverhead costs runs into difficulty (accuracyproblems) because overhead is incurrednonuniformly and because production alsomay be nonuniform.

4. For plantwide rates, overhead is first col-lected in a plantwide pool, using direct trac-ing. Next, an overhead rate is computed and

used to assign overhead to products.5. First stage: Overhead is assigned to produc-

tion department pools using direct tracing,driver tracing, and allocation. Second stage:Individual departmental rates are used toassign overhead to products as they passthrough the departments.

6. Departmental rates would be chosen overplantwide rates whenever some depart-ments are more overhead intensive thanothers and if certain products spend moretime in some departments than they doin others.

7. Plantwide overhead rates assign overheadto products in proportion to the amount ofthe unit-level cost driver used. If the prod-ucts consume some overhead activities indifferent proportions than those assigned

by the unit-level cost driver, then cost dis-tortions can occur (the product diversity

factor). These distortions can be significant ifthe nonunit-level overhead costs repre-

sent a significant proportion of total over-head costs.

8. Low-volume products may consume non-unit-level overhead activities in muchgreater proportions than indicated by a unit-level cost driver and vice versa for high-volume products. If so, then the low-volumeproducts will receive too little overhead andthe high-volume products too much.

9. If some products are undercosted andoth- ers are overcosted, a firm can make a

number of competitively bad decisions.For example, the firm might selectthe wrong product mix or submit distortedbids.

10. Nonunit-level overhead activities are thoseoverhead activities that are not highly corre-lated with production volume measures. Ex-amples include setups, material handling,and inspection. Nonunit-level cost driversare causal factors factors that explain theconsumption of nonunit-level overhead. Ex-amples include setup hours, number ofmoves, and hours of inspection.

11. Product diversity is present whenever prod-ucts have different consumption ratios fordifferent overhead activities.

12. An overhead consumption ratio measuresthe proportion of an overhead activitycon- sumed by a product.

13. Departmental rates typically use unit-levelcost drivers. If products consume nonunit-level overhead activities in different propor-tions than those of unit-level measures, thenit is possible for departmental rates to moveeven further away from the true consump-

tion ratios, since the departmental unit-levelratios usually differ from the one used at theplant level.

14. Agree. Prime costs can be assignedusing direct tracing and so do not causecost distortions. Overhead costs,however, are not directly attributable andcan cause distortions. For example,using unit-level activity drivers to tracenonunit-level overhead costs would causedistortions.

6969ThiseditionisintendedforuseoutsideoftheU.S.only,withcontentthatmaybedifferentfromtheU.S.Edition.Thismaynotbe

resold,copied,ordistributedwithoutthepriorconsentofthepublisher.


2/36


3/36

EXERCISES

41

1. $27,000,000/90,000 = $300 per direct labor hour (DLH)

2. $300 91,000 = $27,300,0003. Applied overhead $ 27,300,000

Actual overhead 27,200,000Overrapplied overhead $ 100,000

4. Predetermined rates allow the calculation of unit costs and avoid theprob-

lems of nonuniform overhead incurrence and nonuniform production associ-

ated with actual overhead rates. Unit cost information is needed throughoutthe year for a variety of managerial purposes.

42

1. Predetermined overhead rate = $4,500,000/600,000 = $7.50 per DLH

2. Applied overhead = $7.50 585,000 = $4,387,500

3. Applied overhead $ 4,387,500Actual overhead 4,466,250Underapplied overhead $ (78,750)

4. Unit cost:

Prime costs $ 6,750,000Overhead costs 4,387,500Total $ 11,137,500Units 750,000Unit cost $ 14.85

43

1. Predetermined overhead rate = $4,500,000/187,500 = $24 per machine hour(MHr)

2. Applied overhead = $24 187,875 = $4,509,000




4/36

Prime $20 $20 $20Overhead 8 15 45Total $28 $35 $65

43 Concluded

3. Applied overhead $ 4,509,000Actual overhead 4,466,250Overapplied overhead $ 42,750

4. Unit cost:

Prime costs $ 6,750,000Overhead costs 4,509,000Total $ 11,259,000Units 750,000Unit cost $ 15.01*

*Rounded

5. Gandars needs to determine what causes its overhead. Is it primarily

labor driven (e.g., composed predominantly of fringe benefits, indirectlabor, and personnel costs), or is it machine oriented (e.g., composed ofdepreciation on machinery, utilities, and maintenance)? It is impossible fora decision to be made on the basis of the information given in this exercise.

44

1.

Quarter 1 Quarter 2 Quarter 3 Quarter 4 TotalUnits produced 400,000 160,000 80,000 560,000 1,200,000

Prime costs $8,000,000 $3,200,000 $1,600,000 $11,200,000 $24,000,000Overhead costs $3,200,000 $2,400,000 $3,600,000 $2,800,000 $12,000,000Unit cost:

$20 $205 10

$25 $30

2. Actual costing can produce wide swings in the overhead cost per unit. Thecause appears to be nonuniform incurrence of overhead and nonuniformproduction (seasonal production is a possibility).

3. First, calculate a predetermined rate:

OH rate = $11,640,000/1,200,000= $9.70 per unit

This rate is used to assign overhead to the product throughout the year.Since the driver is units produced, $9.70 would be assigned to each unit.




5/36

Adding this to the actual prime costs produces a unit cost under normal cost-ing:

Unit cost = $9.70 + $20.00 = $29.70

This cost is close to the actual annual cost of $30.00.

45

1.Scented Cards Regular Cards

Inspection hours 0.20a

0.80a

Setup hours 0.50b

0.50b

Machine hours 0.25c 0.75cNumber of moves 0.75d 0.25da. Totalinspectionhours=200(40+160);40/200forScentedand160/200forRegular

b. TotalSetuphours=100(50+50);50/100forScentedand50/100forRegularc. TotalMachinehours=800(200+600);200/800forScentedand600/800forRegular d.

TotalNumberofmoves=300(225+75);225/300forScentedand75/300forRegular

2. The consumption ratios vary significantly from driver to driver. Using, for ex-ample, only machine hours to assign the overhead may create accuracy prob-lems. Both setup hours and number of moves have markedly differentcon- sumption ratios.

46

1. Rates:

Inspecting products: $2,000/200 = $10 per inspection hourSetting up equipment: $2,500/100 = $25 per setup hourMachining: $4,000/800 = $5 per machine hourMoving materials: $900/300 = $3.00 per move

Note: The denominator is the total driver amount (sum of the demand of the twoproducts).

2.

Rate = Cost/hoursInspection hours = Cost/Rate = $2,000/$20 = 100 inspection hours




6/36

47

1. Predetermined rates:

Drilling Department: Rate = $600,000/280,000 = $2.14* per MHrAssembly Department: Rate = $392,000/200,000

= $1.96 per DLH*Rounded

2. Applied overhead:

Drilling Department: $2.14 288,000 = $616,320Assembly Department: $1.96 196,000 = $384,160Overhead variances:

Drilling Assembly TotalActual overhead $602,000 $ 412,000 $ 1,014,000

Applied overhead 616,320 384,160 1,000,480Overhead variance $ (14,320 ) over $ 27,840 under $13,520 under

3. Unit overhead cost = [($2.14 4,000) + ($1.96 1,600)]/8,000= $11,696/8,000= $1.46*

*Rounded

48

1. Activity rates:

Machining = $632,000/300,000= $2.11* per MHr

Inspection = $360,000/12,000= $30 per inspection hour

*Rounded

2. Unit overhead cost = [($2.11 4,000) + ($30 800)]/8,000= $32,440/8,000= $4.055




7/36

49

1. Yes. Because direct materials and direct labor are directly traceable toeach

product, their cost assignment should be accurate.

2. The consumption ratios for each (using machine hours and setup hours as theactivity drivers) are as follows:

Elegant Fina

Machining 0.10 0.90 (500/5,000 and 4,500/5,000)Setups 0.50 0.50 (100/200 and 100/200)

3. Elegant: (1.75 $9,000)/3,000 = $5.25 per briefcaseFina: (1.75 $3,000)/3,000 = $1.75 per briefcase

Note: Overhead rate = $21,000/$12,000 = $1.75 per direct labor dollar (or 175percent of direct labor cost).

There are more machine and setup costs assigned to Elegant than Fina. Thisis clearly a distortion because the production of Fina is automated and usesthe machine resources much more than the handcrafted Elegant. In fact, theconsumption ratio for machining is 0.10 and 0.90 (using machine hours as themeasure of usage). Thus, Fina uses 9 times the machining resources as Ele-gant. Setup costs are similarly distorted. The products use an equal number ofsetup hours. Yet if direct labor dollars are used, then the Elegant briefcase re-ceives three times more machining costs than the Fina briefcase.

4. Products tend to make different demands on overhead activities and thisshould be reflected in overhead cost assignments. Usually this means the useof both unit and nonunit-level activity drivers. In this example, there is a unit-level activity (machining) and a nonunit-level activity (setting up equipment).

Machine rate: $18,000/5,000 = $3.60 per machine hourSetup rate: $3,000/200 = $15 per setup hour

Costs assigned to each product:

Machining: Elegant Fina

$3.60 500 $ 1,800$3.60 4,500 $16,200

Setups:

$15 100 1,500 1,500Total $ 3,300 $17,700Units 3,000 3,000Unit overhead cost $ 1.10 $ 5.90




8/36

410

1.

Treating patients:Normal Intensive

$4.00 5,000 $ 20,000$4.00 20,000 $ 80,000

Providing hygienic care:$5.00 5,000 25,000$5.00 11,000 55,000

Responding to requests:$2.00 30,000 60,000$2.00 50,000 100,000

Monitoring patients:$0.75 20,000 15,000

$0.75 180,000 135,000Cost Assigned $120,000 $370,000

2. Nursing cost per patient day:

Normal Intensive$120,000/10,000 $12.00$370,000/8,000 $46.25

7676

ThiseditionisintendedforuseoutsideoftheU.S.only,withcontentthatmaybedifferentfromtheU.S.Edition.Thismaynotberesold,copied,ordistributedwithoutthepriorconsentofthepublisher.


9/36

Equipment $ 12,000Fuel 2,400Operating 1,000Labor* 48,000 30,000

411

Activity dictionary:

Activity Activity Primary/ Activity

Name Description Secondary DriverProviding nursing Satisfying patient Primary Nursing hours

care needs

Supervising Coordinating Secondary Number of nursesnurses nursing activities

Feeding patients Providing meals Primary Number of mealsto patients

Laundering Cleaning and Primary Pounds of laundry

bedding and delivering clothesclothes and bedding

Providing Therapy treatments Primary Hours of therapyphysical directed bytherapy physician

Monitoring Using equipment to Primary Monitoring hourspatients monitor patient

conditions

4-12

1.Resource Unloading Counting Inspecting

$ 800

50042,000

Total $ 63,400 $ 30,000 $ 43,300

*(0.40 $120,000; 0.25 $120,000; 0.35 $120,000)

2. Direct tracing and driver tracing are used. When the resource is used only byone activity, then direct tracing is possible. When the activities are shared,as in the case of labor, then resource drivers must be used.




10/36

Activity 1: $2 20,000 = $ 40,000Activity 2: $80 300 = 24,000

413

1. Unit-level activities: Machining

Batch-level activities: Setups and packing

Product-level activities: Receiving

Facility-level activities: None

2. Activity rates:

(1) Machining: $80,000/40,000 = $2 per MHr(2) Setups: $32,000/400 = $80 per setup(3) Receiving: $18,000/600 = $30 per receiving order(4) Packing: $48,000/3,200 = $15 per packing order

Overhead assignment:

Infantry

Activity 3: $30 200 = 6,000Activity 4: $15 2,400 = 36,000

Total $106,000

Special forcesActivity 1: $2 20,000 = $ 40,000Activity 2: $80 100 = 8,000Activity 3: $30 400 = 12,000Activity 4: $15 800 = 12,000

Total $ 72,000

Combining Activities 2 and 4 produces a new pooled rate:

($32,000 + $48,000)/400 = $ 200 per setup


Infantry

Activity 1: $2 20,000 = $ 40,000Activity 2*: $200 300 = 60,000Activity 3: $30 200 = 6,000

Total $106,000

*Combined activities 2 and 4




11/36

Special forces

Activity 1: $2 20,000 = $ 40,000Activity 2: $200 100 = 20,000Activity 3: $30 400 = 12,000

Total $ 72,000

The assignments are the same and this happens because the consumption ra-tios of activities 2 and 4 are identical. Thus, rate reduction can occur by com-bining all activities with identical rates.

3. The two most expensive activities are the first and the combined 2 and 4 activi-ties. Each has $80,000 of cost. Thus if the cost of activity 3 is allocated in pro-portion to the cost, each of the expensive activities would receive 50% of the$18,000 or $9,000. This yields the following pool rates:

Activity (pool 1) 1: ($80,000 + $9,000)/40,000 = $2.225 per machine hour

Activities 2 and 4 (pool 2): ($80,000 + $9,000)/400 = $222.50 per setup


Infantry

Pool 1: $2.225 20,000 = $ 44,500Pool 2: $222.50 300 = 66,750

Total $111,250

Special forces

Pool 1: $2.225 20,000 = $ 44,500Pool 2: $222.5 100 = 22,250Total $ 66,750

4. Infantry: ($111,250 - $106,000)/$106,000 = .05 (rounded)

Special forces = ($66,750 - $72,000)/$72,000 = -.07 (rounded)

The error is less than 10% for both products. Using machine hours would haveproduce a rate of $178,000/40,000 = $4.45 per Mhr and an assignment of$89,000 to each product ($4.45 20,000). The error for the plantwide ratewould be

Infantry: ($89,000 - $106,000)/106,000 = 0.16 (rounded)

Special forces = ($89,000 - $72,000)/$72,000 = 0.24 (rounded)

Thus, the plantwide rate produces product costing errors that are more thanthree times the magnitude of the approximately relevant ABCassignments. Clearly, the approximation produces a more reasonable anduseful outcome and is less complex than the full ABC system.




12/36

414

1. Cost of labor (0.40 $50,000) $20,000Forklift (direct tracing) 10,000

Total cost of receiving $30,000

2.

Activity rates:

Receiving: $30,000/60,000 = $0.50 per partSetup: $60,000/300 = $200 per setup

Grinding: $90,000/18,000 = $5 per MHrInspecting: $20,000/2,000 = $10 per inspection

Overhead:

Setup:

Subassembly A Subassembly B

$200 150 $ 30,000$200 150 $ 30,000

Inspecting:

$10 1,500 15,000$10 500 5,000

Grinding:

$5 7,200 36,000$5 10,800 54,000

Receiving:

$0.50 20,000 10,000$0.50 40,000 20,000

Total costs assigned $ 91,000 $ 109,000

3. Setup pool: $60,000 + [($60,000/$150,000) $50,000] = $80,000Grinding pool: $90,000 + [($90,000/$150,000) $50,000] = $120,000Pool rates:

Setup = $80,000/300= $266.67/setup

Grinding = $120,000/18,000= $6.67/ Mhr




13/36

Approximating assignment:

Setup:

Subassembly A Subassembly B

$266.67 150 $40,000$266.67 150 $ 40,000Grinding:

$6.67 7,200 48,024$6.67 10,800 72,036

Total costs assigned $88,024 $ 112,036

4. Error (Subassembly A) = ($91,000 - $88,024)/$91,000 = 0.033Error (Subassembly B) = ($109,000 - $112,036)/$109,000 = - 0.028

The error is small and so the approach may be desirable as it reduces thecomplexity and size of the system, making it more likely to be accepted bymanagement.

415

1. Unit-level: Testing products, inserting dies

2. Batch-level: Setting up batches, handling wafer lots, purchasing

materials, receiving materials

3. Product-level: Developing test programs, making probe cards,

engineering design, paying suppliers

4. Facility-level: Providing utilities, providing space




14/36

PROBLEMS

416

1. Plantwide rate = $1,320,000/440,000 = $3.00 per DLH

Overhead cost per unit:

Model A: $3.00 140,000/30,000 = $14.00

Model B: $3.00 300,000/300,000 = $3.00

2. Calculation of activity rates:

Activity Driver Activity RateSetup Prod. runs $360,000/100 = $3,600 per run

Inspection Insp. hours $280,000/2,000 = $140 per hour Machining Mach. Hours $320,000/220,000 = $1.454 per hr

Maintenance Maint. hours $360,000/100,000 =$3.60 per hr


Setups

Model A Model B

$3,600 40 $ 144,000

$3,600 60 $ 216,000

Inspections$140 800 112,000$140 1,200 168,000

Machining

$1.454 20,000 29,080$1.454 200,000 290,800

Maintenance$3.60 10,000 36,000

$3.60 90,000 ----- 324,000

Total overhead $ 321,080 $ 998,800

Units produced 30,000 300,000Overhead per unit $ 10.70 $ 3.33

3. Departmental rates:

Overhead cost per unit:

Model A: [($4.66 10,000) + ($1.20 130,000)]/30,000 = $6.76

Model B: [($4.66 170,000) + ($1.20 270,000)]/300,000 = $3.72




15/36

4. A common justification is that of using machine hours for machine-intensivedepartments and labor hours for labor-intensive departments. Using activity-based costs as the standard, we can say that departmental rates decreasedthe accuracy of the overhead cost assignment (over the plantwide rate)for both products. Looking at Department 1, this departments costs are

assigned at a 17:1 ratio which overcosts B and undercosts A in a big way.This raises some doubt about the conventional wisdom regardingdepartmental rates.

417

1. Cost before addition of duffel bags:

$60,000/100,000 = $0.60 per unit

The assignment is accurate because all costs belong to one product.

2. Activity-based cost assignment:

Stage 1 :

Activity rate = $120,000/80,000 = $1.50 per transaction

Stage 2 :

Overhead applied:

Backpacks: $1.50 40,000* = $60,000

Duffel bags: $1.50 40,000 = $60,000

*80,000 transactions/2 = 40,000 (number of transactions had doubled)

Unit cost:

Backpacks: $60,000/100,000 = $0.60 per unit

Duffel bags: $60,000/25,000 = $2.40 per unit

3. Product cost assignment:

Overhead rates:

Patterns: $48,000/10,000 = $4.80 per direct labor hour

Finishing: $72,000/20,000 = $3.60 per direct labor hour




16/36

417 Concluded

Unit cost computation:

Patterns:

Backpacks Duffel Bags

$4.80 0.1 $0.48

$4.80 0.4 $1.92

Finishing:

$3.60 0.2 0.72

$3.60 0.8 2.88Total per unit $1.20 $4.80

4. This problem allows us to see what the accounting cost per unit should be byproviding the ability to calculate the cost with and without the duffelbags. With this perspective, it becomes easy to see the benefits of the activity-based approach over those of the functional-based approach. The activity-based approach provides the same cost per unit as the single-productsetting. The functional-based approach used transactions to allocateaccounting costs to each producing department, and this allocation probablyreflects quite well the consumption of accounting costs by each producingdepartment. The problemis the second-stage allocation. Direct labor hours do not capture theconsumption pattern of the individual products as they pass through thedepart- ments. The distortion occurs, not in using transactions to assign

accounting costs to departments, but in using direct labor hours to assignthese costs to the two products.

In a single-product environment, ABC offers no improvement in product-costing accuracy. However, even in a single-product environment, it maybe possible to increase the accuracy of cost assignments to other costobjects such as customers.

418

1. Unit-level costs ($120 20,000) $ 2,400,000Batch-level costs ($80,000 20) 1,600,000Product-level costs ($80,000 10) 800,000Facility-level ($20 20,000) 400,000

Total cost $ 5,200,000



17/36



18/36

2. Unit-level costs ($120 30,000) $ 3,600,000Batch-level costs ($80,000 20) 1,600,000Product-level costs ($80,000 10) 800,000Facility-level costs 400,000

Total cost $ 6,400,000

The unit-based costs increase because these costs vary with the number ofunits produced. Because the batches and engineering orders did not change,the batch-level costs and product-level costs remain the same, behaving asfixed costs with respect to the unit-based driver. The facility-level costs arefixed costs and do not vary with any driver.

3. Unit-level costs ($120 30,000) $ 3,600,000Batch-level costs ($80,000 30) 2,400,000Product-level costs ($80,000 12) 960,000Facility-level costs 400,000

Total cost $ 7,360,000Batch-level costs increase as the number of batches changes, and the costsof engineering support change as the number of orders change. Thus,batches and orders increased, increasing the total cost of the model.

4. Classifying costs by category allows their behavior to be better understood.This, in turn, creates the ability to better manage costs and make decisions.

419

1. Labor and gasoline are driver tracing.

Labor (0.75 $180,000) $ 135,000 Time = Resource driver

Gasoline ($4.50 6,000 moves) 27,000 Moves = Resource driver

Depreciation 18,000 Direct tracing

Total cost $180,000

2. Plantwide rate = $660,000/20,000

= $33 per DLH

Unit cost:

Basic DeluxePrime costs $160.00 $320.00

Overhead:

$33 10,000/40,000 8.25

$33 10,000/20,000 16.50

$168.25 $336.50




19/36

419 Continued

3. Activity rates:

Maintenance $114,000/4,000 = $28.50 per maint. hour

Engineering $120,000/6,000 = $20 per eng.

hour Material handling $180,000/6,000 = $30 per move

Setting up $ 96,000/80 = $1,200 per move

Purchasing $ 60,000/300 = $200 per

requisition Receiving $ 40,000/750 = $53.33 per order

Paying suppliers $ 30,000/750 = $40 per invoiceProviding space $ 20,000/10,000 = $2.00 per machine hour




20/36

419 Continued

Unit cost:

Basic Deluxe

Prime costs $6,400,000 $6,400,000

Overhead:

Maintenance

$28.50 1,000 28,500

$28.50 3,000 85,500

Engineering

$20 1,500 30,000

$20 4,500 90,000

Material Handling

$30 1,200 36,000

$30 4,800 144,000Setting up

$1,200 16 19,200

$1,200 64 76,800

Purchasing

$200 100 20,000

$200 200 40,000

Receiving

$53.33 250 13,333

$53.33 500 26,665

Paying Suppliers

$40 250 10,000

$40 500 20,000

Providing space

$2 5,000 10,000

$2 5,000 10,000

Total $ 6,567,033 $6,892,965Units produced 40,000 20,000

Unit cost (ABC) $ 164.18 $ 344.65

Unit cost (traditional) $ 168.25 $ 336.50

The ABC costs are more accurate (better tracing closer representationofactual resource consumption). This shows that the basic model wasover- costed and the deluxe model undercosted when the plantwideoverhead rate was used.




21/36

419 Continued

4. Consumption ratios:

Maint. Eng. Mat. H. Setups Purch. Receiving Pa y . Sup Space

Basic 0.25 0.25 0.20 0.20 0.33 0.33 0.33 0.50

Delux 0.75 0.75 0.80 0.80 0.67 0.67 0.67 0.50

5. When products consume activities in the same proportion, the activities withthe same proportions can be combined into one pool. This is so because thepooled costs will be assigned in the same proportion as the individual activ-ity costs. Using these consumption ratios as a guide, we create four pools,reducing the number of rates from 8 to 4.

Pool 1:

Maintenance $114,000

Engineering 120,000

Total $234,000

Maintenance hours 4,000

Pool rate $ 58.50

Note: Engineering hours could also be used as a driver. The activitiesare grouped together because they have the same consumption ratios:

(0.25, 0.75).

Pool 2: Material handling $180,000

Setting up 96,000

Total $276,000

Number of moves 6,000

Pool rate $ 46

Note: Material handling and setups have the same consumption ratios: (0.20,0.80). The number of setups could also be used as the pool driver.




22/36

Activity driver 100,000 MHr Pool rate $ 0.90 per MHr

419 Concluded

Pool 4: Purchasing $ 60,000

Receiving 40,000

Paying suppliers 30,000

Total $130,000Orders processed 750

Pool rate $ 173.33

Note: The three activities are all product-level activities and have the sameconsumption ratios: (0.33, 0.67)

Pool 5: Providing space $ 20,000

Machine hours 10,000

Pool rate $ 2

Note: This is the only facility-level activity.

420

1. Activity classification:

Unit-level: Machining

Batch-level: Material handling, setups, inspection, and receiving

Product-level: Maintenance and engineering

Facility-level: None

2. Pool 1, consumption ratios: (0.5, 0.5):

Machining $ 90,000

Pool 2, consumption ratios: (0.75, 0.25):

Setups $ 96,000

Inspection 60,000Total $ 156,000Activity driver 80 setups*Pool rate $ 1,950 per setup

*Inspection hours could also be used.




23/36

420 Concluded

Pool 3, consumption ratios: (0.33, 0.67):

Material handling $ 120,000

Receiving 30,000Total $ 150,000Activity driver 6,000 material movesPool rate $ 25 per move

Pool 4, consumption ratios: (0.67, 0.33):Engineering $ 100,000Maintenance 80,000Total $ 180,000Activity driver 6,000 maintenance hours*Pool rate $ 30 per maintenance hour

*Number of engineering hours could also be used.

3. Computation of unit overhead costs:

Small Clock Large ClockUnit-level activities:

Pool 1:$0.90 50,000 $ 45,000$0.90 50,000 $ 45,000Batch-level activities:

Pool 2:$1,950 60 117,000$1,950 20 39,000Pool 3:$25 2,000 50,000$25 4,000 100,000Product-level activities:

Pool 4:

$30

4,000 120,000$30 2,000 60,000Total overhead costs $ 332,000 $ 244,000Units produced 100,000 200,000Overhead cost per unit $ 3.32 $ 1.22




24/36

421

1. The total cost of care is $1,950,000 plus a $50,000 share of the cost of super-vision [(25/150) $300,000]. The cost of supervision is computed as follows:Salary of supervisor (direct) $ 70,000

Salary of secretary (direct) 22,000Capital costs (direct) 100,000

Assistants (3 0.75 $48,000) 108,000Total $ 300,000

Thus, the cost per patient day is computed as follows:

$2,000,000/10,000 = $200 per patient day

(The total cost of care divided by patient days.) Notice that everymaternity patient regardless of type would pay the daily rate of $200.

2. First, the cost of the secondary activity (supervision) must be assigned to theprimary activities (various nursing care activities) that consume it (the driveris the number of nurses):

Maternity nursing care assignment:

(25/150) $300,000 = $50,000Thus, the total cost of nursing care is $950,000 + $50,000 = $1,000,000.

Next, calculate the activity rates for the two primary activities:Occupancy and feeding: $1,000,000/10,000 = $100 per patient dayNursing care: $1,000,000/50,000 = $20 per nursing hour

Finally, the cost per patient day type can be computed:

Patient Daily Rat e *Normal $150Cesarean 225Complications 500

*($100 7,000) + ($20 17,500)/7,000($100 2,000) + ($20 12,500)/2,000($100 1,000) + ($20 20,000)/1,000

This example illustrates that activity-based costing can producesignificant product costing improvements in service organizations thatexperience product diversity.




25/36

421 Concluded

3. The Laundry Department cost would increase the total cost of the MaternityDepartment by $100,000 [(200,000/1,000,000) $500,000]. This wouldincrease the cost per patient day by $10 ($100,000/10,000). The activity

approach would need more detailed information specifically, the amountof pounds of laundry caused by each patient type. The activity approachwill increase the accuracy of the cost assignment if patient types produce adisproportionate shareof laundry. For example, if patients with complications produce 40 percent ofthe pounds with only 10 percent of the patient days, then the $10 charge perday is not a fair assignment.

422

1. Activity rates:

Testing products = $252,000/300 = $840 per setupPurchasing materials = $36,000/1,800 = $20 per orderMachining = $252,000/21,000 = $12 per machine hour Receiving = $60,000/2,500 = $24 per receiving hour

Overhead cost assignment:

Testing products:Model A Model B

$840 200 $168,000$840 100 $ 84,000Purchasing materials:

$20 600 12,000$20 1,200 24,000

Machining:

$12 12,000 144,000$12 9,000 108,000

Receiving:

$24 750 18,000$24 1,750 42,000

Total OH assigned $342,000 $258,000



26/36



27/36

2. New cost pools:

Testing products: $252,000 + [($252,000/$504,000) $96,000] = $300,000Machining: $252,000 + [($252,000/$504,000) $96,000] = $300,000New activity rates:

Testing products: $300,000/300 = $1,000 per setupMachining: $300,000/21,000 = $14.29 per hour

Testing products:Model A Model B

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

Machining:

$14.29 12,000 171,480$14.29 9,000 128,610

Total OH assigned $371,480 $228,610

3. Percentage error:

Model A: ($371,480 $342,000)/$342,000 = 0.086 (8.6%)Model B: ($228,610 $258,000)/$258,000 = 0.114 (11.4%)

The error is not bad and is certainly not in the range that is often seen whencomparing a plantwide rate assignment with the ABC costs. For example, if

Model A is expected to use 30% of the direct labor hours, then it would re-ceive a plantwide assignment of $180,000, producing an error of morethan47%an error almost six times greater than the approximately relevantas- signment. In this type of situation, it may be better to go with twodrivers to gain acceptance and get reasonably close to the more accurateABC cost. It also avoids the data collection costs of the bigger system.



28/36



29/36

423

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


X-12: $25.65 250,000/1,000,000 = $6.41*S-15: $25.65 22,500/200,000 = $2.89**Rounded numbers used throughout

Unit gross margin:

X-12 S-15Price $ 15.93 $ 12.00Cost 10.68 * 6.02 **Gross margin $ 5.25 $ 5.98

*Prime costs + Overhead = ($4.27 + $6.41)

**Prime costs + Overhead = ($3.13 + $2.89)

2. Pools Driver Pool Rate

Setup Runs $240,000/300 = $800 per run

Machine Machine hrs. $1,750,000/185,000 = $9.46/per MHr

Receiving Orders $2,100,000/1,400 = $1,500/per order

Engineering Engineering hrs. $2,000,000/10,000 = $200/per eng. hour

Material handling Moves $900,000/900 = $1,000/per move




30/36

423 Continued


Setup costs:

X-12 S-15

$800 100 $ 80,000$800 200 $ 160,000Machine costs:$9.46 125,000 1,182,500$9.46 60,000 567,600Receiving costs:$1,500 400 600,000$1,500 1,000 1,500,000Engineering costs:$200 5,000 1,000,000$200 5,000 1,000,000Material-handling costs:$1,000 500 500,000$1,000 400 400,000Total overhead costs $ 3,362,500 $ 3,627,600Units produced 1,000,000 200,000Overhead cost per kg $ 3.36 $ 18.14Prime cost per kg 4.27 3.13

Unit cost $ 7.63 $ 21.27Selling price $ 15.93 $ 12.00Less unit cost 7.63 21.27Unit gross margin $ 8.30 $ (9.27)

9595

ThiseditionisintendedforuseoutsideoftheU.S.only,withcontentthatmaybedifferentfromtheU.S.Edition.Thismaynotberesold,copied,ordistributedwithoutthepriorconsentofthepublisher.


31/36

423 Concluded

3. No. The cost of making X-12 is $7.63, much less than the amount indicated byfunctional-based costing. The company can compete by lowering its price onthe high-volume product. The $10 price offered by competitors is not out of

line. The concern about selling below cost is unfounded.

4. The $12 price of compound S-15 is well below its cost of production. This ex-plains why Pearson has no competition and why customers are willing to pay$15, a price that is probably still way below competitors quotes.

5. The price of X-12 should be lowered to a competitive level and the price ofS-15 increased so that a reasonable return is being earned.

424

1.

Welding $2,000,000Machining 1,000,000Setups 400,000

Total $3,400,000

Percentage of total activity costs = $3,400,000/$4,000,000= 85%.

2.

Allocation:

($2,000,000/$3,400,000) $600,000 = $352,941($1,000,000/$3,400,000) $600,000 = $176,471($400,000/$3,400,000) $600,000 = $70,588Cost pools:

Welding = $2,000,000 + $352,941 = $2,352,941

Machining = $1,000,000 + $176,471 = $1,176,471Setups = $400,000 + $70,588 = $470,588

Activity rates:

Rate 1: Welding = $2,352,941/4,000 = $588 per welding hourRate 2: Machining = $1,176,471/10,000 = $118 per machine hourRate 3: Setups = $470,588/100 = $4,706 per batch




32/36

Total overhead costs $1,506,570 $2,496,030Units produced 1,500 3,000

Overhead assignment:Subassembly A Subassembly B

Rate 1:

$588 1,600 welding hours $ 940,800$588 2,400 welding hours $1,411,200Rate 2:$118 3,000 machine hours 354,000$118 7,000 machine hours 826,000

Rate 3:

$4,706 45 batches 211,770$4,706 55 batches 258,830

Overhead per unit $ 1,004 $ 832

3. Percentage error:

Error (Subassembly A) = ($1,004 $1,108)/$1,108 = 0.094 (9.4%)Error (Subassembly B) = ($832 $779)/$779 = 0.068 (6.8%)

The error is at most 10%. The simplification is simple and easy to implement.Most of the costs (85%) are assigned accurately. Only three rates are used toassign the costs, representing a significant reduction in complexity.




33/36

MANAGERIAL DECISION CASES

425

1. Shipping and warehousing costs are currently assigned using tons of paper

produced, a unit-based measure. Many of these costs, however, are notdriven by quantity produced. Many products have special handling and ship-ping requirements involving extra costs. These costs should not be assignedto those products that are shipped directly to customers.

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

Pool rate, receiving costs:

Receiving cost/Tons processed = $1,100,000/56,000 tons= $19.64 per ton processed*

Pool rate, shipping costs:

Shipping cost per shipping item = $2,300,000/190,000= $12.11 per shipping item*

Pool rate, carrying cost (an opportunity cost):

Carrying cost per year (LLHC) = 25 $1,665 0.16= $6,660

Carrying cost per ton sold = $6,660/10 = $666

Shipping and warehousing cost per ton sold:Receiving $ 19.64Shipping ($12.11 7) 84.77Carrying 666.00

Total $770.41

*Rounded




34/36

3. Profit analysis:

Revised profit per ton (LLHC):

Selling price $2,400.00Less manufacturing cost 1,665.00

Gross profit $ 735.00Less shipping and warehousing 770.41Loss $ (35.41)

Original profit per ton:

Selling price $2,400.00Less manufacturing costs 1,665.00Gross profit $ 735.00Less shipping and warehousing 30.00Profit $ 705.00

The revised profit, reflecting a more accurate assignment of shipping andwarehousing costs, presents a much different picture of LLHC. The productis, in reality, losing money for the company. Its earlier apparent profitabilitywas attributable to a subsidy being received from the high-volume products(by spreading the special shipping and handling costs over all products, us-ing tons produced as the cost driver). The same effect is also true forthe other low-volume products. Essentially, the system is understating thehan- dling costs for low-volume products and overstating the cost for high-volume products.

4. The decision to drop some high-volume products and emphasize low-volumeproducts could clearly be erroneous. As LLHC has demonstrated, its appar-ent profitability is attributable to distorted cost assignments. Asignificant change in the image of LLHC was achieved by simply improvingthe accuracyof shipping and handling costs. Further improvements in accuracy inthe overhead assignments may cause the view of LLHC to deteriorate evenmore. Conversely, the profitability of high-volume products may improvesignifi- cantly with increased costing accuracy. This example underscoresthe impor- tance of having accurate and reliable accounting information. Theaccounting system must bear the responsibility of providing reliable

information.

5. Ryans strategy changed because his information concerning theindividual products changed. Apparently, the accounting system wasundercosting the low-volume products and overcosting the high-volumeproducts. Once better information was available, Ryan was able torespond better to competitive conditions.



35/36



36/36

426

1. Disagree. Chuck is expressing an uninformed opinion. He has not spent theeffort to find out exactly what activity-based management and costing are at-tempting to do; therefore, he has no real ability to offer any constructive criti-

cism of the possible benefits of these two approaches.

2. and 3.

At first glance, it may seem strange to even ask if Chucks behavior is unethi-cal. After all, what is unethical about expressing an opinion, albeit unin-formed? While offering uninformed opinions or recommendations may be oflittle consequence in many settings, a serious issue arises when a personsexpertise is relied upon by others to make decisions or take actionsthat could be wrong or harmful to themselves or their organizations.This very well may be the case for Chucks setting, and his behaviormay be labeled professionally unethical.

Chucks lack of knowledge about activity-based systems is a signal ofhis failure to maintain his professional competence. Standard I-1 of theIMA Statement of Ethical Professional Practice indicates thatmanagement ac- countants have a responsibility to continually developtheir knowledge and skills. Failure to do so is unethical.

RESEARCH ASSIGNMENT

427

Answers will vary.

Hansen Aise Sm_ch04

Documents

Transcript of Hansen Aise Sm_ch04