22806855 Activity Based Costing

ACTIVITY-BASED COSTING

TRUE-FALSE STATEMENTS

1. Traditional costing systems use multiple predetermined overhead rates.

2. Traditionally, overhead is allocated based on direct labor cost or direct labor hours.

3. Current trends in manufacturing include less direct labor and more overhead.

4. Activity-based costing allocates overhead to multiple cost pools and assigns the cost pools to products using cost drivers.

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

6. The first step in activity-based costing is to assign overhead costs to products, using cost drivers.

7. To achieve accurate costing, a high degree of correlation must exist between the cost driver and the actual consumption of the activity cost pool.

8. Low-volume products often require more special handling than high-volume products.

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

10. ABC leads to enhanced control over overhead costs.

11. ABC usually results in less appropriate management decisions.

12. ABC is generally more costly to implement than traditional costing.

13. ABC eliminates all arbitrary cost allocations.

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

15. ABC is particularly useful when overhead costs are an insignificant portion of total costs.

16. Activity-based management focuses on reducing costs and improving processes.

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

18. Engineering design is a value-added activity.

19. Nonvalue-added activities increase the cost of a product but not its market value.

20. Machining is a nonvalue-added activity.

21. Not all activities labeled nonvalue-added are totally wasteful, nor can they be totally

Test Bank for Managerial Accounting, Second Edition

eliminated.

22. The overall objective of installing ABC in service firms is no different than it is in a manufacturing company.

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

24. The general approach to identifying activities, activity cost pools, and cost drivers is used by a service company in the same manner as a manufacturing company.

25. Inventory storage costs are reduced in just-in-time processing.

26. Rework costs typically increase in just-in-time processing.

27. Just-in-time strives to eliminate inventories by using a pull approach.

28. Quality control is less important in just-in-time than in traditional manufacturing philosophies.

*29. Plant management is a batch-level activity.

*30. Painting is a product-level activity.

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.1. F 6. F 11. F 16. T 21. T 26. F2. T 7. T 12. T 17. F 22. T 27. T3. T 8. T 13. F 18. T 23. F 28. F4. T 9. F 14. T 19. T 24. T *29. F5. F 10. T 15. F 20. F 25. T *30. F

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Activity-Based Costing

MULTIPLE CHOICE QUESTIONS

31. Which of the following is not typical of traditional costing systems?a. Use of a single predetermined overhead rate.b. Use of direct labor hours or direct labor cost to assign overhead.c. Assumption of correlation between direct labor and incurrence of overhead cost.d. Use of multiple cost drivers to allocate overhead.

32. In traditional costing systems, overhead is generally applied based ona. direct labor.b. machine hours.c. direct material dollars.d. units of production.

33. An activity that has a direct cause-effect relationship with the resources consumed is a(n)a. cost driver.b. overhead rate.c. cost pool.d. product activity.

34. Which best describes the flow of overhead costs in an activity-based costing system?a. Overhead costs direct labor cost or hours productsb. Overhead costs productsc. Overhead costs activity cost pools cost drivers productsd. Overhead costs machine hours products

35. The first step in activity-based costing is toa. assign manufacturing overhead costs for each activity cost pool to products.b. compute 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.

36. A well-designed activity-based costing system starts witha. 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.

37. One of Lara Dole Company's activity cost pools is machine setups, with estimated overhead of $300,000. Dole produces flares (400 setups) and health packs (600 setups). How much of the machine setup cost pool should be assigned to flares?a. $0.b. $120,000.c. $150,000.d. $180,000.

38. Which would be an appropriate cost driver for the ordering and receiving activity cost pool?a. Machine setupsb. Purchase ordersc. Machine hoursd. Inspections

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39. As compared to a high-volume product, a low-volume producta. usually requires less special handling.b. is usually responsible for more overhead costs per unit.c. requires relatively fewer machine setups.d. requires use of direct labor hours as the primary cost driver to ensure proper allocation

of overhead.

40. In Japan,a. activity-based costing is used more than in the U.S.b. companies prefer volume measures such as direct labor hours to assign overhead costs.c. labor cost reduction is less of a priority.

d. developing more accurate product costs is more of a priority.

Use the following information to answer questions 41–44.

Robot Toy Company manufactures two products, X-O-Tron and Mechoman. Robot's overhead costs consist of setting up machines, $400,000; machining, $900,000; and inspecting, $300,000. Information on the two products is:

X-O-Tron MechomanDirect labor hours 15,000 25,000Machine setups 600 400Machine hours 24,000 26,000Inspections 800 700

41. Overhead applied to X-O-Tron using traditional costing isa. $600,000.b. $768,000.c. $832,000.d. $960,000.

42. Overhead applied to Mechoman using traditional costing isa. $640,000.b. $768,000.c. $832,000.d. $1,000,000.

43. Overhead applied to X-O-Tron using activity-based costing isa. $600,000.b. $768,000.c. $832,000.d. $960,000.

44. Overhead applied to Mechoman using activity-based costing isa. $640,000.b. $768,000.c. $832,000.d. $1,000,000.

45. Which of the following is a limitation of activity-based costing?a. More cost poolsb. Less control over overhead costsc. Poorer management decisionsd. Some arbitrary allocations continue

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46. 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.

47. Which of the following is true of activity-based costing?a. More cost poolsb. Same base as traditional costingc. Less costly to used. Eliminates arbitrary allocations

48. The primary benefit of ABC is it provides a. better management decisions.b. enhanced control over overhead costs.c. more cost pools.d. more accurate product costing.

49. Which of the following is not a benefit of activity-based costing?a. More accurate product costingb. Enhanced control over overhead costsc. Better management decisionsd. Less costly to use

50. Each of the following is a limitation of activity-based costing except thata. 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.

51. The presence of any of the following factors would suggest a switch to ABC except whena. 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.

52. Which of the following is a value-added activity?a. Engineering designb. Machinery repairc. Inventory storaged. Inspections

53. Which of the following is a nonvalue-added activity?a. Engineering designb. Machiningc. Inspectiond. Packaging

54. A nonvalue-added activity in a service enterprise isa. taking appointments.b. traveling.c. advertising.d. all of these.

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55. Value-added activitiesa. 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 nonvalue-added activities.

56. All of the following are examples of a value-added activity in a service company excepta. delivering packages by a delivery service.b. ordering supplies.c. performing surgery.d. providing legal research for legal services.

57. Activity-based costing has been found to be useful in each of the following service industries excepta. banks.b. hospitals.c. telephone companies.d. ABC has been useful in any of these industries.

58. What sometimes makes implementation of activity-based costing difficult in service industries isa. the labeling 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 nonvalue-added activities.

59. All of the following statements are correct except thata. 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.

60. The use of activity-based costing in service industriesa. 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.

61. Just-in-time processinga. is based on a just-in-case philosophy.b. results in a push approach.c. minimizes inventory storage and waiting time.d. all of these.

62. An element of just-in-time processing isa. dependable suppliers who are willing to deliver on short notice.b. a multi-skilled workforce.c. a total quality control system.d. all of these.

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63. Which of the following is not a benefit of just-in-time processing?a. Control of significant inventory balancesb. Enhanced product qualityc. Reduction of rework costsd. Production cost savings

64. Which account is used in just-in-time processing?a. Raw materials inventoryb. Work-in-process inventoryc. Merchandise inventoryd. Raw and In-Process inventory

65. Under just-in-time processing, all of the following are received or completed “just in time” excepta. finished goods.b. raw materials.c. subassembly parts.d. supplies.

*66. Which of the following is not a facility-level activity?a. Plant managementb. Product designc. Personnel administrationd. Training

*67. Which of the following is not a product-level activity?a. Product designb. Engineering changesc. Inventory managementd. Equipment setups

*68. Which of the following is not a batch-level activity?a. Engineering changesb. Equipment setupsc. Inspectiond. Materials handling

*69. Which of the following is not a unit-level activity?a. Purchase orderingb. Assemblingc. Paintingd. Sewing

*70. Which of the following is a batch-level activity?a. Plant managementb. Product designc. Equipment setupsd. Assembling

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Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.31. d 37. b 43. c 49. d 55. b 61. c *67. d32. a 38. b 44. b 50. c 56. b 62. d *68. a33. a 39. b 45. d 51. b 57. d 63. a *69. a34. c 40. b 46. b 52. a 58. c 64. d *70. c35. c 41. a 47. a 53. c 59. b 65. d36. d 42. d 48. d 54. d 60. d *66. b

EXERCISES

Ex. 71

Reese Corporation manufactures easy chairs and recliners. The following information is available:

Easy Chairs Recliners Total CostMachine setups 200 600 $16,000Inspections 250 500 $27,000Labor hours 2,600 2,400

Reese is considering switching from one overhead rate based on labor hours to activity-based costing.

InstructionsPerform the following analyses for these two components of overhead:1. Compute total machine setups and inspection costs assigned to each product, using a single

overhead rate.2. Compute total machine setups and inspection costs assigned to each product, using activity-

based costing.3. Comment on your findings.

Solution 71 (8–12 min.)

1. Single overhead rate($16,000 + $27,000) ÷ 5,000 = $8.60 per labor hour

Easy chairs: 2,600 × $8.60 = $22,360Recliners: 2,400 x $8.60 = 20,640

$43,000

2. Activity-based costingMachine setups: $16,000 ÷ 800 = $20 per setup

Inspections: $27,000 ÷ 750 = $36 per inspection

Easy chairs: (200 × $20) + (250 × $36) = $13,000Recliners: (600 × $20) + (500 × $36) = 30,000

$43,000

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Solution 71 (cont.)

3. The use of activity-based costing resulted in the allocation of less cost to easy chairs and more cost to recliners. The change in cost allocation reflects a more accurate allocation based on cause and effect.

Ex. 72

Vid-saver, Inc. has five activity cost pools and two products (a budget tape rewinder and a deluxe tape rewinder). Information is presented below:

Cost Drivers by ProductActivity Cost Pool Cost Driver Est. Overhead Budget Deluxe Ordering and Receiving Orders $ 120,000 600 400Machine Setup Setups 297,000 500 400Machining Machine hours 1,500,000 150,000 100,000Assembly Parts 1,200,000 1,200,000 800,000Inspection Inspections 300,000 550 450

InstructionsCompute the overhead cost per unit for each product. Production is 700,000 units of Budget and 200,000 units of Deluxe.


Activity Cost Pool Est. Overhead ÷ Total Est. Activity = Overhead RateOrdering & Receiving $ 120,000 1,000 orders $120/orderMachine Setup 297,000 900 setups $330/setupMachining 1,500,000 250,000 mach. hours $6/machine hourAssembly 1,200,000 2,000,000 parts $.60/partInspection 300,000 1,000 inspections $300/inspection

Budget Deluxe Cost Cost Cost Cost

Activity Cost Pool Driver × Rate = Assigned Driver × Rate = AssignedOrdering & Receiving 600 $120 $ 72,000 400 $120 $ 48,000Machine Setup 500 330 165,000 400 330 132,000Machining 150,000 6 900,000 100,000 6 600,000Assembly 1,200,000 .60 720,000 800,000 .60 480,000Inspection 550 300 165,000 450 300 135,000

$2,022,000 $1,395,000 ÷ 700,000 ÷ 200,000$2.89 per unit $6.98 per unit

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Ex. 73

Ms. Bentley owns a small department store in a metropolitan area. For twenty years, the accountant has applied overhead to the various departments—Women's Apparel, Men's Apparel, Cosmetics, Housewares, Shoes, and Electronics—based on the basis of employee hours worked. Ms. Bentley's daughter, who is an accounting student at a local university, has suggested her mother should consider using activity-based costing (ABC). In an attempt to implement ABC, Ms. Bentley and her daughter have identified the following activities.

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

Cost Pool Cost Driver

a. Placing orders ______________________________

b. Stocking merchandise ______________________________

c. Waiting on customers ______________________________

d. Janitorial and Maintenance ______________________________

e. Training employees ______________________________

f. Administrative ______________________________

g. Advertising and Marketing ______________________________

h. Accounting and Legal Services ______________________________

i. Wrapping packages ______________________________


Cost Pool Cost Driver

a. Placing orders number of orders; volume of individual orders

b. Stocking merchandise number of orders; dollar volume of orders

c. Waiting on customers number of customers; dollar volume of sales

d. Janitorial and Maintenance square feet occupied; traffic through area

e. Training employees total number of employees; number of new employees

f. Administrative number of employees; dollar volume of business

g. Advertising and Marketing number of ad campaigns

h. Accounting and Legal Services dollar volume of sales

i. Wrapping packages number of packages

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Ex. 74

A list of possible cost drivers is presented below:

Code CodeA Engineering hours D Number of subassembliesB Setups E BoxesC Machine hours F Orders

InstructionsFor 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


1. B 4. A2. F 5. C3. E 6. D

Ex. 75

Identify appropriate cost drivers for the following activity cost pools:1. Human resources2. Security3. Receiving4. Data processing


1. Number of employees, number of hires2. Square footage3. Shipments received4. Lines printed, CPU minutes, storage units

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Ex. 76

Two of the activity cost pools for Sabrina Company are (a) machining ($800,000) and (b) inspections ($84,000). Possible cost drivers are direct labor hours (5,000), machine hours (25,000), square footage (4,000), and number of inspections (300).

InstructionsCompute the overhead rate for each activity.


$800,000(a) Machining: —————————— = $32 per machine hour

25,000 machine hours

$84,000(b) Inspections: ———————- = $280 per inspection

300 inspections

Ex. 77

Tanner, Inc. produces two models of cameras, Standard and Luxury. They sell 100,000 Standard cameras and 15,000 Luxury cameras annually. Tanner switched from traditional costing to activity-based costing and discovered that the cost allocated to Luxury cameras increased so dramatically that the Luxury was now only marginally profitable.

InstructionsGive a probable explanation for this shift.


Low-volume products often require more special handling, such as more machine setups and inspections, than high-volume products. Also, the overhead costs incurred by the low-volume product are often disproportionate to a traditional allocation base such as direct labor hours.

Ex. 78

Compute activity-based costing rates from the following budgeted data for Freddy's Fashions:

Activity Cost Pool Budgeted Cost Budgeted Cost Driver Cutting and stitching $5,100,000 150,000 machine hoursTrimming and packing 1,050,000 42,000 operator hoursDesigning 930,000 62,000 designer hours

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Cutting and stitching ($5,100,000 ÷ 150,000) = $34Trimming and packing ($1,050,000 ÷ 42,000) = $25Designing ($930,000 ÷ 62,000) = $15

Ex. 79

Cool Designs manufactures metal trim used for a variety of projects. Cool Designs' activity-based costing overhead rates are:

Purchasing $170 per orderStoring $1 per square foot/daysMachining $50 per machine hourSupervision $2 per direct labor hour

Job 319 involved three purchase orders, 4,000 square feet/days, 60 machine hours, and 30 direct labor hours. The cost of direct materials on the job was $8,500 and the direct labor rate is $15 per hour.

InstructionsDetermine the total cost of Job 319.


Direct materials $ 8,500Direct labor (30 × $15) 450Factory overhead

Purchasing (3 × $170) $ 510Storing (4,000 × $1) 4,000Machining (60 × $50) 3,000Supervision (30 × $2) 60 7,570

Total cost $16,520

Ex. 80

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

____ 1. Engineering design

____ 2. Machine repair

____ 3. Inventory storage

____ 4. Machining

____ 5. Assembly

____ 6. Painting

____ 7. Inspections

____ 8. Packaging

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1. VA 5. VA2. NVA 6. VA3. NVA 7. NVA4. VA 8. VA

Ex. 81

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

_______________ 1. Taking appointments

_______________ 2. Reception

_______________ 3. Meeting with clients

_______________ 4. Bookkeeping

_______________ 5. Court time

_______________ 6. Meeting with opposing attorneys

_______________ 7. Billing

_______________ 8. Advertising


1. Nonvalue-added 5. Value-added2. Nonvalue-added 6. Value-added3. Value-added 7. Nonvalue-added4. Nonvalue-added 8. Nonvalue-added

Ex. 82

Brewer & Carr, PSC 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 $360,000Travel expense 80,000Plan reproduction expense 120,000Total $560,000

Activity Cost Pools Project Business

Assignment Development OtherSalaries and wages 60% 30% 10%Travel expense 40% 40% 20%Plan reproduction expense 30% 40% 30%

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Ex. 82 (cont.)

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


Activity Cost Pools (a) (b) (c)

Project Business Assignment Development Other Total Salaries and wages $216,000 $108,000 $36,000 $360,000Travel expense 32,000 32,000 16,000 80,000Plan reproduction expense 36,000 48,000 36,000 120,000Total $284,000 $188,000 $88,000 $560,000

Ex. *83

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 *83 (4–6 min.)

1. Facility 5. Product2. Unit 6. Unit3. Unit 7. Batch4. Batch 8. Product

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COMPLETION STATEMENTS

84. In traditional costing systems, direct labor cost is often used for the assignment of all ____________________.

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

86. In activity-based costing, overhead costs are allocated to ____________________, then assigned to products.

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

88. The primary benefit of activity-based costing is ___________________ product costing.

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

90. ______________________ increase the worth of a product or service to customers.

91. A primary objective of __________________ processing is to eliminate all manufacturing inventories.

92. Dependable suppliers, a multi-skilled workforce, and a __________________________ are necessary elements of just-in-time processing.

*93. In the hierarchy of activity levels, the four levels are __________, ___________, ____________, and _____________.

*94. Equipment setups are a ______________-level activity.

Answers to Completion Statements

84. overhead costs85. cost driver86. activity cost pools87. purchase orders88. more accurate89. activity-based costing90. value-added activities91. just-in-time92. total quality control system

*93. unit, batch, product, facility*94. batch

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MATCHING

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

A. Pull approach F. Just-in-time processingB. Cost driver G. Batch-level activityC. Facility-level activity H. Product-level activityD. Unit-level activity I. Nonvalue-added activityE. Activity-based costing J. 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.

_____ 9. Primary objective is to eliminate all manufacturing inventories.

_____ 10. Used to initiate manufacturing under JIT processing.

Answers to Matching

1. E 6. H2. B 7. G3. J 8. D4. I 9. F5. C 10. A

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SHORT-ANSWER ESSAY QUESTIONS

S-A E 96

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 96

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 compute 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.

S-A E 97

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 97

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.

S-A E 98

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 98

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.

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22806855 Activity Based Costing

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