Kimmel.sm.Cp17.Vpdf

CHAPTER 17

Activity-Based Costing

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives QuestionsBrief

Exercises ExercisesA

ProblemsB

Problems

*1. Recognize the difference between traditional costing and activity-based costing.

1, 2, 3,4, 5

1, 2 1, 2, 3, 4, 5, 6, 12, 13

1A, 3A,4A, 5A

1B, 3B,4B, 5B

*2. Identify the steps in thedevelopment of an activity- based costing system.

7

*3. Know how companiesidentify the activitycost pools used inactivity-based costing.

9 7, 8

*4. Know how companiesidentify and use costdrivers in activity-based costing.

6, 10, 11, 12

3, 4, 5, 6, 7, 12

1, 3, 4, 5, 6, 8, 9, 10, 11, 12, 13

1A, 2A, 3A,4A, 5A

1B, 2B, 3B,4B, 5B

*5. Understand the bene-fits and limitations ofactivity-based costing.

13, 14, 15 11

*6. Differentiate between value-added and non-value-added activities.

8, 16, 17 8, 9 12, 13, 14,15, 16

1A, 5A 1B, 5B

*7. Understand the value of us-ing activity levels inactivity-based costing.

19 10, 11, 12 17, 18

*8. Apply activity-based cost-ing to service industries.

18 9, 10 16 5A 5B

*9. Explain just-in-time(JIT) processing.

20

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in theappendix*to the chapter.

17-1

ASSIGNMENT CHARACTERISTICS TABLE

ProblemNumber Description

DifficultyLevel

TimeAllotted (min.)

1A Assign overhead using traditional costing and ABC;compute unit costs; classify activities as value- ornon-value-added.

Moderate 3545

2A Assign overhead to products using ABC and evaluatedecision.

Moderate 2535

3A Assign overhead costs using traditional costing and ABC; compare results.

Moderate 3545

4A Assign overhead costs using traditional costing and ABC; compare results.

Moderate 4050

5A Assign overhead costs to services using traditionalcosting and ABC; compute overhead rates and unit costs; compare results.

Moderate 3545

1B Assign overhead using traditional costing and ABC;compute unit costs; classify activities as value- ornon-value-added.

Moderate 3545

2B Assign overhead to products using ABC and evaluatedecision.

Moderate 2535

3B Assign overhead costs using traditional costing and ABC; compare results.

Moderate 3545

4B Assign overhead costs using traditional costing and ABC; compare results.

Moderate 4050

5B Assign overhead costs to services using traditionalcosting and ABC; compute overhead rates and unit costs; compare results.

Moderate 3545

17-2

BLOOM’S TAXONOMY TABLE

17-3

ANSWERS TO QUESTIONS

1. Direct labor is a valid basis for allocating overhead when: (a) direct labor constitutes a significant part of total product cost, and (b) there is a high correlation between direct labor and changes in the amount of overhead costs.

2. The amount of direct labor in many industries has greatly decreased, due to advances in comput-erized systems, technological innovation, global competition and automation.Total overhead costs resulting from depreciation on expensive equipment and machinery, utilities, repairs, and maintenance have significantly increased. Many companies now use machine hours as the basis on which to allocate overhead in an automated manufacturing environment.

3. In many automated manufacturing environments, machine hours is a more relevant basis on which to allocate overhead.

4. Under a traditional volume-based costing system where overhead cost is allocated on the basis of units of output, the high-volume product will undoubtedly absorb more overhead than the low-volume product.

5. (a) The principal differences are:

Activity-Based Costing Traditional Costing

(1)

(2)(3)

Primary focus

Bases of allocationTotal product costs

Activities performed in making products

Multiple cost driversSum of costs of activities con-

sumed in making product

Units of production

Single unit-level baseDirect materials plus direct labor

plus manufacturing overhead

(b) There are two assumptions that must be met in using ABC:(1) All overhead costs related to the activity must be driven by the cost driver used to assign

costs to products.(2) All overhead costs related to the activity should respond proportionally to changes in

the activity level of the cost driver.

6. Activity-based overhead rates are computed using the following formula:

Estimated Overhead per ActivityExpected Use of Cost Drivers per Activity

7. The four steps involved in developing an ABC system are:(1) Identify and classify the major activities involved in the manufacture of specific products, and

allocate manufacturing overhead costs to appropriate cost pools.(2) Identify the cost driver that has a strong correlation to the costs accumulated in the cost

pool.(3) Compute the overhead rate per cost driver.(4) Assign manufacturing overhead costs for each cost pool to products, using the overhead

rates (cost per driver).

17-4

Questions Chapter 17 (Continued)

8. A value-added/non-value-added activity flowchart is based on a systematic analysis of all the activities (resource-consuming actions and transactions) performed to manufacture a product or render a service. The flowchart documents each activity and the time involved in each activity. The flow chart also documents management’s proposed reengineering of the manufacturing process.

9. An activity cost pool is the accumulated overhead cost attributed to a distinct type of activity.

10. A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed. A cost driver should be an accurate and appropriate measure of an activity consumed or performed in manufacturing a product or rendering a service.

11. A cost driver is accurate and appropriate if it measures the actual consumption of specific activities in manufacturing a product or rendering a service and the data relating to the cost driver is avail-able and easily obtained.

12. The formula for assigning activity cost pools to products is:

Activity-based overhead rate X Number of cost drivers expected to be used per product

13. The primary benefit of ABC is more accurate product costing. This results from using more cost pools and enhanced control over overhead costs, and leads to better management decisions.

14. The limitations of ABC are: (a) higher analysis and measurement costs that accompany multiple-activity cost pools and cost drivers and (b) the necessity still to allocate some costs arbitrarily.

15. ABC is the superior costing system when: (1) product lines differ greatly in volume and manufac-turing complexity; (2) product lines are numerous, diverse, and require differing degrees of sup-port services; (3) overhead costs constitute a significant portion of total costs; (4) the manufactur-ing process or the number of products has changed significantly; and (5) data from the existing system is being ignored.

16. Basic ABC has been enhanced by identifying activities as value-added and non-value-added.

17. Identifying non-value-added activities highlights for managers the activities that should bereduced or eliminated because they add no value to the product.

18. The overall objective of using ABC in service industries is no different than for manufacturingindustries; that is, improved costing of services rendered (by job, service, contract, or customer). The general approach to costing is the same—analyze operations, identify activities, assign over-head costs to activity cost pools, and identify and use cost drivers to assign the cost pools to the services.

17-5

Questions Chapter 17 (Continued)

19. Greater accuracy in cost allocation is achieved by recognizing the four levels of activity. Some activities are affected (driven) by changes in the number of units produced, while other activities are affected only by changes in the number of batches or the number of products, and some, facility-level activities, are unaffected by changes in either units, batches, or products produced.

*20. (a) Just-in-time processing has a just-in-time philosophy and a demand-pull approach to eliminate inventory. It is dedicated to having the right amount of materials, parts, or products at the time they are needed.

(b) There are three important elements in JIT processing:(1) A company must have dependable suppliers who are willing to deliver on short notice

exact quantities of raw materials according to precise quality specifications.(2) A multiskilled workforce must be developed.(3) A total quality control system must be established.

17-6

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 17-1

(a) Estimated annual overhead costs = Predetermined overhead rate

Expected annual operating activity

$1,000,000 = $10 per direct labor hour

100,000

(b) 90,000 direct labor hours $10 = $900,000 overhead applied

(c) If the manufacturing process is complex, then multiple allocation bases can result in more accurate product-cost computations. In such situations, managers need to consider a new overhead cost allocation method that uses multiple bases. That method is activity- based costing.

BRIEF EXERCISE 17-2

Under ABC, overhead costs are shifted from the high-volume products to the low-volume products. This shift results in more accurate costing for two reasons:

1. Low-volume products often require more special handling, such as more machine setups and inspections, than high-volume products. Thus, the low-volume product frequently is responsible for more overhead costs per unit than is a high-volume product.

2. Assigning overhead using ABC will usually increase the cost per unit for low-volume products. Therefore, a traditional overhead allocation such as direct labor hours is usually a poor cost driver for assigning overhead costs to low-volume products.

As a result, for Sassafras, one of the products (Product RX3) may have been low volume and therefore may have more overhead costs assigned to it un-der an ABC system.

17-7

BRIEF EXERCISE 17-3

An appropriate cost driver for each activity is:

Activity Cost Driver

Materials handlingMachine setupsFactory machine maintenanceFactory supervisionQuality control

Number of requisitionsNumber of setupsMachine hours usedNumber of employeesNumber of inspections

BRIEF EXERCISE 17-4

(a) Number of parts or assemblies(b) Number of setups(c) Number of employees(d) Number of inspections(e) Number of purchase orders(f) Machine hours(g) Square footage occupied

BRIEF EXERCISE 17-5

Machine setupsMachiningInspections

$180,000 ÷ 2,500 = $72 per setup$325,000 ÷ 25,000 = $13 per machine hour$ 87,500 ÷ 1,750 = $50 per inspection

BRIEF EXERCISE 17-6

Activity Cost PoolEstimatedOverhead ÷

Expected Use ofCost Drivers per Activity =

Activity-BasedOverhead Rates

DesigningSizing and cuttingStitching and trimmingWrapping and packing

$ 450,000 4,000,000 1,440,000 336,000

12,000 Designer hours160,000 Machine hours 80,000 Labor hours 32,000 Finished units

$37.50 per designer hour$25.00 per machine hour$18.00 per labor hour$10.50 per finished unit

17-8

BRIEF EXERCISE 17-7




Ordering and receivingEtchingSoldering

$ 90,000 480,000 1,760,000

15,000 Orders 60,000 Machine hours440,000 Labor hours

$6.00 per order$8.00 per machine hour$4.00 per labor hour

Cost Drivers XOverhead

Rates =Total overhead

applied11,000 orders50,000 machine hours500,000 labor hours

$6$8$4

$ 66,000 400,000 2,000,000 $2,466,000

BRIEF EXERCISE 17-8

(a)(b)(c)(d)(e)(f)(g)(h)

Non-value-addedNon-value-addedValue-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedValue-added

BRIEF EXERCISE 17-9

Value-added Activities Hours

(1)(3)(5)

Designing and draftingOn-site supervisionConsultation with client

3.02.01.56.5

Non-value-added Activities Hours

(2)(4)(6)

Staff meetingsLunchEntertaining a prospective client

1 1 2 4

17-9

BRIEF EXERCISE 17-10

(a) Batch- or unit-level(b) Unit-level(c) Unit-level(d) Batch- or unit-level(e) Facility-level(f) Batch- or product-level(g) Batch- or product-level(h) Unit-level(i) Facility-level(j) Batch-level


(a) Facility-level(b) Unit-level(c) Product-level(d) Unit-level(e) Batch-level(f) Batch-level(g) Product-level(h) Facility-level


(a) Product design $50,000 = $5,000 per product change

10

Machining $300,000 = $2 per machine hour

150,000

Material handling $100,000 = $1,000 per set up

100

(b) Product design—product levelMachining—unit levelMaterial handling—batch level

17-10

SOLUTIONS TO EXERCISES

EXERCISE 17-1

(a) Estimated overhead = Predetermined overhead rate

Direct labor costs

$300,000 = 200% of direct labor cost

$50,000 + $100,000

(b) Activity cost pools Cost drivers Estimated overhead

Machining Machine hours $200,000

Machine setup Set up hours 100,000

Activity-based overhead rates

Machining: Machine setup:

$200,000 = $100 per machine hour

$100,000 = $200 per setup hour

1,000 + 1,000 500

(c) Traditional costing Standard Custom

$50,000 X 200% $100,000

$100,000 X 200% $200,000

$100,000 $200,000

Activity-based costing

Machining:

1,000 X $100 $100,000

1,000 X $100 $100,000

Machine setup:

100 X $200 20,000

400 X $200 80,000

$120,000 $180,000

17-11

EXERCISE 17-2

(a) Traditional costing system

Product 540X Product 137Y Product 249S

Sales $200,000 $160,000 $80,000

Costs 55,000 50,000 15,000

Operating income $145,000 $110,000 $65,000

(b) Activity-based costing system

Product 540X Product 137Y Product 249S

Sales $200,000 $160,000 $80,000

Costs 50,000 35,000 35,000

Operating income $150,000 $125,000 $45,000

(c) Product 540X: ($150,000 – $145,000) ÷ $145,000 = 3.45%

Product 137Y ($125,000 – $110,000) ÷ $110,000 = 13.64%

Product 249S ($45,000 – $65,000) ÷ $65,000 = (30.77%)

(d) These costs are similar probably because the cost drivers areessentially the same; that is, they are based on a unit volumeconcept.

17-12

EXERCISE 17-3

(a) Activity cost pools Cost drivers Estimated overhead

Cutting Machine hours $300,000

Design Number of setups 600,000

Activity-based overhead rates

Cutting Design$300,000

= $1.50 per machine hour$600,000

= $400 per setup 200,000 1,500

Wool CottonActivity-based costing

Cutting100,000 X $1.50 $150,000100,000 X $1.50 $150,000

Design1,000 X $400 400,000

500 X $400 200,000Total cost allocated $550,000 $350,000

(b)Estimated overhead

= $900,000

= $2 per direct labor hourDirect labors hours 450,000

Wool CottonTraditional costing

225,000 X $2 $450,000225,000 X $2 $450,000

The wool product line is allocated $100,000 ($550,000 – $450,000) more overhead cost when an activity-based costing system is used. As a result, the cotton product line is allocated $100,000 ($450,000 – $350,000) less.

17-13

EXERCISE 17-4

(a) Direct labor hours for car wheels (40,000 X 1) = 40,000

Direct labor hours for truck wheels (10,000 X 3) = 30,000Total direct labor hours 70,000

$700,000 ( total estimated overhead) = $10 per direct labor hour.

70,000 (total direct labor hours)

Overhead assigned

Car wheels (40,000 X $10) = $400,000Truck wheels (30,000 X $10) = 300,000Total overhead $700,000

(b)

Activity Cost PoolEstimated Overhead

ExpectedUse of

Cost Drivers

ABCOverhead

Rate

Setting up machines $180,000 1,000 $180Assembling 280,000 70,000 $4Inspection 240,000 1,200 $200

(c) Car Wheels

Activity Cost Pools

Expected Use of Cost Driver per Product

Activity-BasedOverhead

RatesCost

Assigned

Setting up machines 200 $180 $ 36,000Assembling 40,000 $ 4 $160,000Inspection 100 $200 $ 20,000 Total cost assigned $216,000

17-14

EXERCISE 17-4 (Continued)

(c) Truck Wheels

Activity Cost Pools

Expected use of Cost Driver per Product

Activity-BasedOverhead

RatesCost

Assigned

Setting up machines 800 $180 $144,000Assembling 30,000 $ 4 $120,000Inspection 1,100 $200 $220,000 Total cost assigned $484,000

(d) Assuming that the cost drivers are a reasonable representation of what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocation of resources and pricing decisions in the future.

17-15

EXERCISE 17-5

(a) Activity Cost Pools

Estimated Overhead

Expected use

of Cost Drivers ABC Overhead Rates

Scheduling and travel $90,000 1,500 $ 60.00

Setup time $70,000 700 $100.00

Supervision $40,000 $400,000* $ .10

*$100,000 + $300,000

Commercial

Activity Cost Pools

Expected use of Cost

Drivers per Product ABC Overhead Rates Cost Assigned

Scheduling and travel 1,000 $ 60.00 $ 60,000

Setup time 450 $100.00 45,000

Supervision $100,000 $ .10 10,000

Total assigned costs $115,000

Residential

Activity Cost Pools

Expected use of Cost

Drivers per Product ABC Overhead Rates Cost Assigned

Scheduling and travel 500 $ 60.00 $30,000

Setup time 250 $100.00 25,000

Supervision $300,000 $ .10 30,000

Total assigned costs $85,000

(b) Commercial Residential

Revenues $300,000 $480,000

Direct material costs $ 30,000 $ 50,000

Direct labor costs 100,000 300,000

Overhead costs 115,000 245,000 85,000 435,000

Operating income (loss) $ 55,000 $ 45,000

(c) Assuming that the cost drivers are a reasonable representation of what is occurring in the

two product lines, it seems appropriate to switch to activity-based costing. By using this

system, more accurate cost information is developed which should lead to better alloca-

tions of resources and more informative pricing decisions in the future.

17-16

EXERCISE 17-6

(a) Traditional costing:

$235,000 ÷ 2,500 (800 + 1,700) hours= $94 per direct labor hour

(1) One mobile safe:800 hours X $94 = $75,200$75,200 ÷ 200 = $376 each

(2) One walk-in safe:1,700 hours X $94 = $159,800$159,800 ÷ 50 = $3,196 each

(b) Activity-based costing:

(1) Material handling costs$150,000 ÷ 500 (300 + 200) moves = $300 per move

(a) One mobile safe:300 moves X $300 = $90,000$90,000 ÷ 200 = $450 each

(b) One walk-in safe:200 moves X $300 = $60,000$60,000 ÷ 50 = $1,200 each

(2) Purchasing activity costs$85,000 ÷ 800 (450 + 350) orders = $106.25 per order

(a) One mobile safe:450 orders X $106.25 = $47,812.50$47,812.50 ÷ 200 = $239.0625 each

(b) One walk-in safe:350 orders X $106.25 = $37,187.50$37,187.50 ÷ 50 = $743.75 each

17-17


(c) The total amount of overhead allocated to each unit of the two products under the two allocation approaches is:

TraditionalCosting

Activity-BasedCosting

Mobile safeWalk-in safe

$ 376$3,196

**$689.0625** $ 1,943.75**

**$450 + $239.0625**$1,200 + $743.75

EXERCISE 17-7

The following activities might be identified at Quik Prints Company from your analysis of its operations and a discussion with the owner-manager, Damon Hastings.

1. Hiring and training personnel 11. Maintenance and repairs 2. Purchasing supplies and materials 12. Delivery 3. Selling, promoting, and marketing 13. Accounting 4. Billing and collecting 5. Designing 6. Offset printing 7. Copying 8. Faxing 9. Collating10. Cutting and folding

17-18

EXERCISE 17-8

Budgeted Costs Activity Cost Pool Cost Driver

Engineering designEngineering prototypes

Engineering Engineering hours

Depreciation, machineryElectricity, machinery

Machinery Machine hours

Machine setup, indirect laborMachine setup, indirect materials

Machine setup Number of setups

InspectionsTests

Quality controlNumber of tests or inspections

Depreciation, plantInsurance, plantProperty taxesOil, heatingElectricity, plant lighting

Factory utilitiesSquare feetMachine hours

Custodial wages MaintenanceNumber of machinesMachine hours

EXERCISE 17-9

The following cost drivers might be used to assign overhead:

1.2.3.4.5.

6.7.8.

Labor hoursLabor hoursLabor hoursGallons of chemicalsNumber of cartfuls or labor hoursNumber of cartfulsGallons of juiceGallons of juice

9.10.11.12.13.14.15.

Gallons of wine or months of agingNumber of bottlesNumber of bottlesNumber of boxesNumber of shipmentsNumber of gallons processedNumber of gallons processed

17-19

EXERCISE 17-10

1. Number of engineering change orders; hours of designing 2. Number of orders processed 3. Number of parts in stock 4. Weight of material; number of boxes or cartons 5. Employee turnover; number of employees hired 6. Machine hours; direct labor hours 7. Number of employees; number of parts; direct labor 8. Number of employees 9. Book or market value of assets10. Cost of goods manufactured, direct labor hours; number of

employees11. Machine hours; number of machines12. Gallons of paint; number of appliances

EXERCISE 17-11

(a) The overhead rates are:

Activity Cost PoolsEstimatedOverhead ÷

Expected Useof Cost Drivers

per Activity =Activity-Based

Overhead Rates

Materials handlingMachine setupsQuality inspections

$35,000 27,500 27,000

1,000 500 600

$35 55 45

(b) The assignment of the overhead costs to products is as follows:

Instruments Gauges CostAssignedCost Driver Number Cost Number Cost

Materials handling ($35)Machine setups ($55)Quality inspections ($45)

Total costsassigned (a)

Units produced (b)

400200

200

$14,000 11,000

9,000

$34,000

50

600300

400

$21,000 16,500

18,000

$55,500

300

$35,000 27,500

27,000

$89,500

Overhead cost perunit (a) ÷ (b) $680 $185

17-20


(c) MEMO

To: President, Fontillas Instrument, Inc.

From: Student

Re: Benefits of activity-based costing (ABC)

ABC focuses on the activities performed in producing a product. Over-head costs are assigned to products based on cost drivers that mea-sure the activities performed on the product.

The primary benefit of ABC is more accurate and meaningful product costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced.

The improved cost data should also lead to better management deci-sions. More accurate product costing should contribute to setting selling prices which will help achieve desired profitability levels. In addition, it should be helpful in deciding whether to make or buy a product part or component, and sometimes even whether to eliminate a product.

17-21

EXERCISE 17-12

(a) (1) Traditional product costing system:

$400,000 X .70 = $280,000 Selling costs assigned in March to the “high intensity” product line.

(2) Activity-based costing system:

Activity Cost PoolsCost Drivers

Used X

Activity-Based

OverheadRates =

Overhead CostAssigned

Sales commissionsAdvertising—TV/RadioAdvertising—NewspaperCatalogsCost of catalog salesCredit and collection

Total assigned cost for March

$930,000 250 2,000 60,000 9,000$930,000

$.05$300$10

$2.50$1.00$.03

$ 46,500 75,000 20,000 150,000 9,000 27,900$328,400

(b) As compared to ABC, traditional costing grossly undercosts the selling costs assigned to the “high intensity” product line. The difference of $48,400 ($328,400 – $280,000) in the month of March is a 14.7%understatement.

(c) All six activities, as selling activities, are non-value-added activities.

17-22

EXERCISE 17-13

(a) (1) Traditional product costing system:

$55,000 X .17 = $9,350 Quality-control overhead costs assigned in June to the low-calorie dessert line are $9,350 ($55,000 X .17).

(2) Activity-based costing system:

Activity Cost PoolsCost Drivers

Used X

Activity-Based

OverheadRate =

Overhead CostAssigned

Inspections of material receivedIn-process inspectionsFDA certification

Total assigned cost for June

6,00010,000 420

$.60$.33

$12.00

$ 3,600 3,300 5,040$11,940

(b) As compared to ABC, the traditional costing system undercosts the quality-control overhead cost assigned to the low-calorie dessert prod-uct line by $2,590 ($11,940 – $9,350) in the month of June. That is a 21.7% understatement.

(c) All three activities, as quality-control related activities, are non-value-added activities.

EXERCISE 17-14

1. Value-added. It is assumed that any activity which directly enhances or improves the quality or quantity of the vines, grapes, or wine is a value-added activity.

2.3.4.5.6.7.8.

Non-value-addedValue-addedValue-addedNon-value-addedValue-addedValue-addedValue-added

9.10.11.12.13.14.15.

Value-addedValue-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedNon-value-added

17-23

EXERCISE 17-15

1. 2. 3. 4. 5. 6. 7. 8. 9.10.11.12.

Value-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedValue-addedValue-addedNon-value-addedNon-value-addedNon-value-addedNon-value-addedValue-added

EXERCISE 17-16

Value-Added Activities Hours

Writing contracts and lettersTaking depositionsContemplating legal strategyLitigating a case in court

1.01.01.02.55.5

Non-value-Added Activities Hours

Attending staff meetingsDoing researchTraveling to/from courtEating lunchEntertaining a prospective client

0.51.01.01.02.05.5

Questionable Classifications

Writing contracts is value-added; writing letters may be value-added if re-lated to a specific case or it may be non-value-added if it is billing a client or collecting receivables. Research may be value-added if it is unique,related to a specific case, and is billable. Research may be nonvalue-added if it is something the attorney should already have known and is not bill-able to the client.

17-24

EXERCISE 17-17

Activity Cost Pools Activity Level

EngineeringMachineryMachine setupQuality controlFactory utilitiesMaintenance

Product-levelUnit-levelBatch-levelDepends on frequency. Could be unit batch or product-levelFacility-levelFacility-level

EXERCISE 17-18

1. Facility-level activity 2. Product-level activity 3. Batch-level activity 4. Product-level activity 5. Product-level activity 6. Batch-level activity 7. Facility-level activity 8. Batch-level or unit-level activity 9. Unit-level activity10. Unit-level activity

17-25

SOLUTIONS TO PROBLEMS

PROBLEM 17-1A

(a) Computation of unit costs—traditional costing.

Products

Manufacturing Costs Home Model Commercial Model

Direct materialsDirect laborOverhead

Total unit cost

$18.50 19.00

* 23.40*$60.90

$26.50 19.00

* 23.40*$68.90

*$15.60 X 1.5 = $23.40

(b)


ExpectedUse of Cost Drivers =

Activity-BasedOverhead Rate

ReceivingFormingAssemblingTestingPaintingPacking and shipping

$ 70,350 150,500 390,600 51,000 52,580 787,250 $1,502,280

335,000 Pounds 35,000 Machine hours217,000 Parts 25,500 Tests 5,258 Gallons335,000 Pounds

$ .21 per pound$ 4.30 per machine hour$ 1.80 per part$ 2.00 per test$10.00 per gallon$ 2.35 per pound

(c)

Home Model Commercial Model

Activity Cost Pool

ExpectedUse ofDrivers X

Activity-Based

OverheadRates =

CostAssigned


Activity-Based

OverheadRates =

CostAssigned


Total costs assigned

Units produced

(a)

(b)

215,000 27,000165,000 15,500 3,680215,000

$ .21$ 4.30$ 1.80$ 2.00$10.00$ 2.35

$ 45,150 116,100 297,000 31,000 36,800 505,250 $1,031,300

54,000

120,000 8,000 52,000 10,000 1,578120,000

$ .21$ 4.30$ 1.80$ 2.00$10.00$ 2.35

$ 25,200 34,400 93,600 20,000 15,780 282,000$470,980

10,200

Overhead cost per unit [(a) ÷ (b)] $19.10 $46.17

17-26

PROBLEM 17-1A (Continued)

(d)

ABC Manufacturing Costs Home Model Commercial Model


Total cost per unit

$18.50 19.00 19.10$56.60

$26.50 19.00 46.17$91.67

(e) Activity Value- vs. Non-value-Added


Non-value-addedValue addedValue-addedNon-value-addedValue-addedValue-added

(f) (1) Activity-based costing shows the commercial model absorbs nearly 21/2 ($46.17 ÷ $19.10) times as much overhead per unit as the home model.

(2) The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal at $23.40 but rather $19.10 for the home model and $46.17 for the commercial model. Under traditional costing, the margin of error on the commercial model was almost 100%, an understate-ment of $22.77 on an assignment of $23.40. These distorted over-head assignments have likely led to overpricing the home model and underpricing the commercial model.

17-27

PROBLEM 17-2A

(a) The allocation of total manufacturing overhead using activity-based costing is as follows:

Royale Majestic

Overhead RateDriversUsed

CostAssigned

DriversUsed

CostAssigned

TotalOverhead

Purchase orders @ $30Machine setups @ $50Machine hours @ $40Inspections @ $25

Total assigned costs (a)

Units produced (b)

Cost per unit (a) ÷ (b)

15,000 5,00075,000 9,000

$ 450,000 250,000 3,000,000 225,000 $3,925,000

25,000

$157

25,00013,00045,00019,000

$ 750,000 650,000 1,800,000 475,000 $3,675,000

10,000

$367.50

$1,200,000 900,000 4,800,000 700,000 $7,600,000

(b) The cost per unit and gross profit of each model under ABC costing were:

Royale Majestic

Direct materialsDirect laborManufacturing overhead

Total cost per unit

Sales price per unitCost per unitGross profit

$ 700 120 157 $ 977

$1,600 977 $ 623

$ 420.00 100.00 367.50 $ 887.50

$1,300.00 887.50 $ 412.50

(c) Management’s future plans for the two television models are not sound. Under ABC costing, the Royale model is $210.50 ($623.00 – $412.50) per unit more profitable than the Majestic model. If any product should be phased out, it is the Majestic. But, by applying ABC and activity-based management analysis, Jacobson may determine how to reduce the costs of producing the Majestic model.

17-28

PROBLEM 17-3A

(a) Predetermined overhead rate using machine hours:

$830,000 ÷ 100,000 hrs. = $8.30 per machine hour

(b) Manufacturing cost per stair under traditional costing:

Direct materials................................................................ $103,600Direct labor....................................................................... 112,000Overhead (14,500 X $8.30)............................................... 120,350

Total cost of 280 stairs............................................ $335,950

Cost per stair ($335,950 ÷ 280)........................................ $1,199.82

(c) Manufacturing cost per stair under activity-based costing:

Computation of Activity-Based Overhead Rate


Expected Use of Cost Drivers per Activity =


PurchasingHandling materialsProductionSetting up machinesInspectingInventory controlUtilities

$ 57,000 82,000 210,000 85,000 90,000 126,000 180,000$830,000

600 Orders 8,000 Moves100,000 D/L Hours 1,250 Setups 6,000 Inspections168,000 Components 90,000 Sq. ft.

$95 per order$10.25 per move$2.10 per D/L hour$68 per setup$15 per inspection$.75 per component$2.00 per sq. ft.

Assignment of Overhead to Order of 280 Stairs

Activity Cost PoolsExpected Use of

Cost Drivers XActivity-Based

Overhead Rates = Cost Assigned


60 Orders 800 Moves 5,000 D/L Hours 100 Setups 450 Inspections16,000 Components 8,000 Sq. ft.

$95$10.25$2.10$68$15$.75

$2.00

$ 5,700 8,200 10,500 6,800 6,750 12,000 16,000

Total overhead assigned $65,950

17-29


Total manufacturing cost per stair under ABC:

Direct materials....................................................................... $ 103,600Direct labor.............................................................................. 112,000Overhead.................................................................................. 65,950

Total cost of 280 stairs.................................................... $ 281,550

Total cost per stair ($281,550 ÷ 280)...................................... $1,005.54

(d) The difference between the traditional cost and the activity-based cost per unit, $1,199.82 versus $1,005.54, is not great in amount but $194.28 or ($1,199.82 – $1,005.54) is 19.3% of the more correct ABC cost per unit. Activity-based costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity cost drivers under ABC than the single cost driver used with the traditional volume-based system.

17-30

PROBLEM 17-4A

(a) Computation of unit costs—traditional costing

Overhead cost per labor hour is $1,241,660 ÷ (120,000 + 25,000) =$8.563

ProductsManufacturing Costs CoolDay LiteMist


$0.400 0.250 0.428*$1.078

$1.200 0.500 0.771**$2.471

*$8.563 X .05 **$8.563 X .09

(b)Activity Cost Pools

EstimatedOverhead



Grape processingAgingBottling and corkingLabeling and boxingMaintain and inspect equipment

$ 145,860 396,000 270,000 189,000

240,800 $1,241,660

6,6006,600,000 900,000 900,000

800

$22.10 per cart$0.06 per month$0.30 per bottle$0.21 per bottle

$301 per inspection

(c) CoolDay LiteMist

Activity Cost Pools

ExpectedUse ofCost

Drivers X

Activity-Based

OverheadRates =

CostAssigned

ExpectedUse ofCost

Drivers X

Activity-Based

OverheadRates

= CostAssigned

Grape processingAgingBottling and corkingLabeling and boxingMaintain and inspect equipmentTotal costs assigned (a)

Liters produced (b)

Overhead cost per liter [(a) ÷ (b)]

6,0003,000,000 600,000 600,000

350

$22.10 $0.06 $0.30 $0.21

$301

$132,600 180,000 180,000 126,000

105,350 $723,950

3,000,000

$0.241

6003,600,000 300,000 300,000

450

$22.10$0.06$0.30$0.21

$301

$ 13,260 216,000 90,000 63,000

135,450$517,710

300,000

$1.726

17-31


(d) ProductsManufacturing Costs CoolDay LiteMist


$0.400 0.250 0.241$0.891

$1.200 0.500 1.726$3.426

(e) To: Mr. Tyler Silva

From: Student

Subject: Product costs using traditional approach versus ABC

The memorandum covers the following points:

a. ABC allocates overhead costs as a function of each product’s use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each product’s generation of overhead costs.

b. Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labor costs.

c. In the case of the Mendocino Wine Company, the LiteMist product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When over-head costs were allocated using labor rates, too much overhead was allocated to the high volume CoolDay product. This reduced the apparent profitability of this product.

d. The total cost of the two products under the two approaches was as follows:

17-32


CoolDay LiteMist

Traditional approach

ABC

$1.078

$0.891

$2.471

$3.426

Therefore, the relative profitability of the two products should bedetermined using ABC costing.

17-33

PROBLEM 17-5A

(a) Computation of assigned overhead under traditional costing (“direct labor dollars” appears in the first line of the schedule of overhead data):

Predetermined overhead rate X direct labor dollars

Overhead assigned to audit: .40 X $1,000,000 = $400,000Overhead assigned to tax: .40 X $800,000 = $320,000

(b) (1) Computation of activity-based overhead rate:




Employee trainingTyping and secretarialComputingFacility rentalTravel

$216,000 76,200 204,000 142,500 81,300 $720,000

$1,800,000 Direct labor dollars 2,500 Reports/forms 60,000 Minutes 40 Employees Direct

$.12 per DL dollar$30.48 per report/form$3.40 per minute$3,562.50 per employeeDirect

(2) Assignment of overhead to audit and tax services:

Audit Tax

Activity Cost Pools

ExpectedUse ofCost

Driver

Activity-Based

OverheadRate

CostAssigned

ExpectedUse ofCost

Driver

Activity-Based

OverheadRate

CostAssigned


$1,000,000 600 25,000 22 56,000

$.12$30.48$3.40

$3,562.50Direct

$120,000 18,288 85,000 78,375 56,000

$800,000 1,900 35,000 18 25,300

$.12$30.48$3.40

$3,562.50Direct

$ 96,000 57,912 119,000 64,125 25,300

Overhead costsassigned $357,663 $362,337

17-34


(c) Activity Value-Added vs. Nonvalue-Added


Nonvalue-addedValue-addedValue-addedNonvalue-addedNonvalue-added

(d) Overhead is assigned to the two service lines as follows:

Audit Tax

Traditional costingABC

Difference

$400,000 357,663$ 42,337

$320,000 362,337$ 42,337

The $42,337 difference for audits is 10.6% lower under ABC costing, while the $42,337 difference for tax is 13.2% higher under ABC costing. Clearly, ABC costing should be used to determine the relative prof-itability of each service.

17-35

PROBLEM 17-1B

(a) Computation of unit costs—traditional costing.

Products

Manufacturing Costs Curler Dryer

Direct materialsDirect laborOverhead ($438,000 ÷ 120,000 hours)

Total unit cost

$ 5.25 8.00 3.65$16.90

$ 9.75 8.00 3.65$21.40

*

(b)


Total ExpectedUse of Cost Drivers =


PurchasingReceivingAssemblingTestingFinishingPacking and shipping

$ 57,500 42,000 166,000 52,000 60,000 60,500$438,000

500 Orders140,000 Pounds830,000 Parts130,000 Tests120,000 Units 12,100 Cartons

$ 115 per order$ .30 per pound$ .20 per part$ .40 per test$ .50 per unit$5.00 per carton

(c)

Curler Dryer

Activity Cost Pools


Activity-Based

OverheadRates =

CostAssigned


Activity-Based

OverheadRates =

CostAssigned


Total costs assigned (a)

Units produced (b)

170 58,000415,000 82,000 80,000 8,040

$115.00$.30$.20$.40$.50

$5.00

$ 19,550 17,400 83,000 32,800 40,000 40,200$232,950

80,000

330 82,000415,000 48,000 40,000 4,060

$115.00$.30$.20$.40$.50

$5.00

$ 37,950 24,600 83,000 19,200 20,000 20,300$205,050

40,000

Overhead cost per unit [(a) ÷ (b)] $2.91 $5.13

17-36

PROBLEM 17-1B (Continued)

(d)

ABC Manufacturing Costs Curler Dryer


Total cost per unit

$ 5.25 8.00 2.91$16.16

$ 9.75 8.00 5.13$22.88

(e) Activity Value- vs. Nonvalue-Added


Nonvalue-addedNonvalue-addedValue-addedNonvalue-addedValue-addedValue-added

(f) (1) Activity-based costing shows the blow dryer will absorb 76 percent more overhead per unit, $5.13 versus $2.91, than the hair curler.

(2) A comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal as under traditional costing at $3.65 per unit; rather it is $2.91 per curler unit and $5.13 per blower unit. Under traditional costing, the margin of error on the curlers is 74 cents per unit, an over-statement of 25%, and on the blowers it is $1.48 per unit, an un-derstatement of 29%. These distorted overhead assignments have likely led to overpricing the curlers and underpricing the blowers.

17-37

PROBLEM 17-2B

(a) The allocation of total manufacturing overhead using activity-based costing is as follows:

Ice House Cool Chest

Activity-Based Overhead RateDriversUsed

CostAssigned

DriversUsed

CostAssigned

TotalOverhead

Purchase orders @ $40Machine setups @ $250Machine hours @ $4Tests and inspections @ $20

Total costs assigned (a)

Units produced (b)

Cost per unit (a) ÷ (b)

2,500 48060,000 5,000

$100,000 120,000 240,000 100,000$560,000

50,000

$11.20

1,975 30020,000 3,000

$ 79,000 75,000 80,000 60,000$294,000

20,000

$14.70

$179,000 195,000 320,000 160,000$854,000

(b) The cost per unit and the gross profit of each product under ABC cost-ing were:

Ice House Cool Chest

Direct materialsDirect laborManufacturing overhead

Total cost per unit

Sales price per unitCost per unitGross profit (loss)

$ 9.50 8.00 11.20$28.70

$35.00 28.70$ 6.30

$ 6.00 5.00 14.70$25.80

$24.00 25.70

($ (1.70 )

(c) Activity-based costing reveals a very different situation than traditional costing. Management must be stunned to learn that the “Cool Chest” is unprofitable, losing $1.70 per unit while its other product, “Ice House,” earns gross profit of $6.30 per unit. Obviously, management must revise its marketing and selling efforts as well as its pricing, and maybe its production, of the “Cool Chest.”

17-38

PROBLEM 17-3B

(a) Predetermined overhead rate using machine hours:

$1,750,000 ÷ 100,000 hrs. = $17.50 per machine hour

(b) Manufacturing cost per kitchen under traditional costing:

Direct materials..................................................................... $180,000Direct labor............................................................................ 200,000Overhead (15,000 X $17.50)................................................. 262,500

Total cost of 50 kitchens.............................................. $642,500

Cost per kitchen ($642,500 ÷ 50)......................................... $12,850

(c) Manufacturing cost per kitchen under activity-based costing:

Computation of Activity-Based Overhead Rates


Expected Use of Cost Drivers per

Activity =Activity-Based

Overhead Rates


$ 114,400 164,320 500,000 174,480 184,800 252,000 360,000 $1,750,000

650 Orders 8,000 Moves100,000 D/L Hours 1,200 Setups 6,000 Inspections 36,000 Components 90,000 Sq. ft.

$176 per order$20.54 per move$5 per D/L hour$145.40 per setup$30.80 per inspection$7 per component$4 per sq. ft.

Assignment of Overhead to Order of 50 Kitchens

Activity Cost PoolsExpected Use of

Cost Drivers XActivity-Based

Overhead Rates = Cost Assigned


50 Orders 800 Moves12,000 D/L Hours 100 Setups 450 Inspections 3,000 Components 8,000 Sq. ft.

$176$20.54

$5$145.40$30.80

$7$4

$ 8,800 16,432 60,000 14,540 13,860 21,000 32,000


17-39


Total manufacturing cost per kitchen under ABC:

Direct materials..................................................................... $ 180,000Direct labor............................................................................ 200,000Overhead............................................................................... 166,632

Total cost of 50 kitchens.............................................. $ 546,632

Total cost per kitchen ($546,632 ÷ 50)................................. $10,932.64

(d) The difference between the traditional cost and the activity-based cost per unit of $1,917.36 ($12,850 vs. $10,932.64) is significant—17.5% ($1,917.36 ÷ $10,932.64). The traditional costing did not take intoaccount the mass production of 50 identical kitchens rather than build-ing custom-made, one-of-a-kind, kitchens. ABC allowed for the savings in fewer orders, fewer material moves, fewer setups, fewer labor hours, and fewer inspections when producing 50 identical units. The greater accuracy of ABC over traditional costing, which used only one cost driver (machine hours), results from the identification of multiple activities and their relevant cost drivers.

17-40

PROBLEM 17-4B

(a) Computation of unit costs—traditional costing

Overhead cost per labor hour is $1,485,000 ÷ (60,000 + 30,000) = $16.50

ProductsManufacturing Costs StarDew VineRose


$1.100 .500 1.238*$2.838

$2.400 1.000 2.475**$5.875

*$16.50 X .075 **$16.50 X .15

(b)

Activity Cost PoolsEstimatedOverhead


per ActivityActivity-Based

Overhead Rates

Grape processingAgingBottling and corkingLabeling and boxingMaintain and inspect equipment

$189,000 416,000 360,000 240,000

280,000 $1,485,000

10,00010,400,000 1,600,000 1,600,000

560

$18.90 per cart$0.040 per month$0.225 per bottle$0.15 per bottle

$500 per inspection

(c) StarDew VineRose

Activity Cost Pools

ExpectedUse ofCost

Drivers X

Activity-Based

OverheadRates =

CostAssigned

ExpectedUse ofCost

Drivers X

Activity-Based

OverheadRates =

CostAssigned

Grape processingAgingBottling and corkingLabeling and boxingMaintain and inspect EquipmentTotal cost assigned (a)

Gallons produced (b)

Overhead cost per Gallon [(a) ÷ (b)]

8,000800,000800,000800,000

160

$18.90$0.04$0.225$0.15

$500

$151,200 32,000 180,000 120,000

80,000$563,200

800,000

$0.704

2,0009,600,000 800,000 800,000

400

$18.90$0.040$0.225$0.15

$500

$ 37,800 384,000 180,000 120,000

200,000$921,800

200,000

$4.609

17-41


(d) ProductsManufacturing Costs StarDew VineRose


$1.100 .500 0.704$2.304

$2.400 1.000

4.609 $8.009

(e) To: Mr. Jorge Rojo

From: Student

Subject: Product costs using traditional approach versus ABC

The student’s memorandum should cover the following points:

(1) ABC allocates overhead costs as a function of each product’s use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each product’s generation of overhead costs.

(2) Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labor costs.

(3) In the case of the Vino Verite Corporation, the VineRose product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When over-head costs were allocated using labor rates, too much overhead was allocated to the high volume StarDew product. This reduced the apparent profitability of this product.

(4) The total cost of the two products under the two approaches was as follows:

17-42


StarDew VineRose

Traditional approach

ABC

$2.838 0

$2.304

$5.875

$8.009

Therefore, the relative profitability of the two products should bedetermined using ABC costing.

17-43

PROBLEM 17-5B

(a) Computation of total overhead cost using direct labor hours:

Total overhead=

$265,000= $53 per D/L hour

Total direct labor hours 5,000

Overhead assigned to farm animals: $53 X 2,000 = $106,000Overhead assigned to pets: $53 X 3,000 = $159,000

(b) (1) Computation of activity-based overhead rates:

Farm and Home Veterinary Clinic


Expected Use ofCost Driversper Activity =


Drug treatmentSurgeryTravelConsultationAccounting/OfficeBoarding/Grooming

$ 64,000 70,000 28,000 33,000 30,000 40,000$265,000

4,000 treatments 800 operations28,000 miles 3,000 appointments 5,000 D/L hours

(Pets only)

$16 per treatment$87.50 per operation$1 per mile$11 per appointment$6 per D/L hour

—

(2) Assignment of activity cost pools to services:

Farm and Home Veterinary Clinic

Farm Animals Pets

Activity Cost Pools

ExpectedUse ofCost

Drivers

Activity-Based

OverheadRates

CostAssigned

ExpectedUse ofDrivers

Activity-Based

OverheadRate

CostAssigned

Drug treatmentSurgeryTravelConsultationAccounting/OfficeBoarding/Grooming

1,700 20026,000 600 2,000

—

$16$87.50

$1$11$6

$27,200 17,500 26,000 6,600 12,000000,000

2,300 6002,0002,4003,000

(Direct)

$16$87.50

$1$11$6

$ 36,800 52,500 2,000 26,400 18,000 40,000

Total overhead assigned $89,300 $175,700

(c) Value-added activities: Drug treatment, surgery, consultation, boarding/grooming. Non-value-added activities: Travel, accounting/ of-fice.

17-44


(d) Comparison of overhead assigned:

Traditional costing:

Farm animalsPets

Total

$106,000 159,000$265,000

40%60%

ABC:

Farm animalsPets

Total

$ 89,300 175,700$265,000

34%66%

The difference in the overhead assigned is significant.

17-45

BYP 17-1 GROUP DECISION CASE

The following activities and cost drivers might be submitted:

(a) Activities (b) Cost Drivers

LaunderingHousekeepingDietaryComputing information technologyNursing careSurgeryClinical labImaging (X-ray, etc.)PharmacyEmergency roomMaintenanceBilling and collecting

Pounds of linenSquare footage; number of bedsNumber of mealsMinutes of computer usage; or number of work stationsNumber of patientsNumber of procedures or operationsNumber of testsNumber of imagesNumber of prescriptionsNumber of cases or patientsSquare footageNumber of invoices

17-46

BYP 17-2 MANAGERIAL ANALYSIS

(a) Computation of activity-based overhead rate:

Activity Cost Pools

TotalEstimatedOverhead ÷

Expected Use ofCost DriversPer Activity =


Market analysisProduct designProduct developmentPrototype testing

$1,050,000 2,280,000 3,600,000 1,400,000

15,000 Hours 2,500 Designs 90 Products 700 Tests

$70 per hour$912 per design$40,000 per product$2,000 per test

(b) Charges to in-house manufacturing department:

In-House Manufacturing Department

Activity Cost Pools Cost Drivers UsedActivity-Based

Overhead Rates Cost Assigned


1,800 Hours 280 Designs 10 Products 92 Tests

$70$912

$40,000$2,000

$126,000 255,360 400,000 184,000


(c) Charges to outside R & D contractor:

Outside Contract Costs

Activity Cost Pools Cost Drivers UsedActivity-Based

Overhead Rates Cost Assigned


800 Hours178 Designs 3 Products 70 Tests

$70$912

$40,000$2,000

$ 56,000 162,336 120,000 140,000


17-47

BYP 17-2 (Continued)

(d) Activity-based costing permits the company to identify its R & D costs by the activities that cause the costs; that is, ABC allows closer scru-tiny of the causes for cost incurrences; hence, greater control. By charging in-house manufacturing departments for their fair share of the company’s R & D costs, these departments may exert their own control over such costs. Activity-based costing allows Ideal to compile realistic costs for bidding and charging outside users of its R & D de-partment’s services.

17-48

BYP 17-3 REAL-WORLD FOCUS

(a) 1. Too many drivers. At the Colorado Springs Division, participants attempted to select a cost driver for just about every activity in a process rather than picking drivers for just the top two or three critical activities of a particular process. Extending 20+ cost drivers over numerous processes created too large of an information matrix.

2. No proper administration. The Division tracked, documented, and explained all the driver differences just like material usage variance, purchase part price variance, and all other variances. It drove an overhead structure in the administrative area that it could not and should not have supported. Explaining driver variances over a short period of time does not provide value-added benefits to a cost structure that is relatively fixed over that period of time.

3. No follow-through. The Division had become so engulfed in identi-fying and explaining monthly variances that it never quite followed through with delivering a cost reduction.

4. Too much emphasis on consensus . The Colorado Springs Divi-sion spent too much time trying to achieve cost pool consensus with other divisions within the Test Measurement Group in order to provide comparable measurements across the Group’s divisions. Decentralized divisions should focus their ABC implementation efforts internally. Too much time was spent micro-managing the drivers versus analyzing the impact at the manufacturing overhead level, or better yet, the gross margin level.

(b) At Colorado Springs, ABC and its resultant development of cost drivers constituted an excellent tool for understanding manufacturing proc-esses, overhead consumption and manufacturing efficiency—but it did not ascertain the real value of its product in the form of inventory.

Successful ABC implementation requires clear goals, simple tracking methods, close internal and external collaboration, and consistent, as well as persistent, follow-through.

17-49

BYP 17-4 EXPLORING THE WEB

(a) The definition provided by Cost Technology is: Activity-based costing is a method of describing, measuring, analyzing, and communicating business performance. The textbook defines activity based costing as follows: An overhead cost allocation system that allocates overhead to multiple activity cost pools and assigns the activity cost pools to prod-ucts or services by means of cost drivers that represent theactivities used. The definition used by Cost Technology is much broader than the one provided in the textbook. The textbook definition is much more specific about what is involved with activity based costing. The Cost Technology definition is less technical and may be a good way of attracting companies to use activity based costing.

(b) “The ABC Assessment: Obtaining the Highest Value from Your Imple-mentation” is described as follows:

In this seminar, Dr. Turney focuses on what you need prior to ABC implementation to ensure success. He explains how to define suc-cess before you begin, and to systematically plan for results from your ABC implementation. Drawing on more than 16 years of expe-rience implementing ABC, Dr Turney uses actual examples to illus-trate the assessment process.

The Drivers of Successful ABC implementation is described as follows:

In this presentation, Dr. Turney identifies the drivers of successful ABC implementation. He provides guidelines for action that will help ensure management buy-in, establish proper leadership, lead to project success, encourage management use of ABC information, sustain the ABC initiative beyond the implementation phase, and in other ways create results from the ABC implementation effort.

17-50

BYP 17-5 COMMUNICATION ACTIVITY

(a) The following unique strategies and tactics prompted sales to take off:

1. Super Bakery targeted the school system segment of the institu-tional food market.

2. Super Bakery avoided the local market restrictions of most fresh-baked goods by refrigerating the product, vacuum-sealing it, and distributing it nationally.

3. Super Bakery developed numerous ways of serving and supporting its customers. They included: helping customers obtain lower prices by acquiring government-supported commodities, cooperating with noncompeting suppliers by providing complete prepackaged meals to schools, and helping distributors reduce inventory carrying costs and avoiding stockouts through reliable, just-in-time delivery.

4. Super Bakery reduced capital investment and overhead expenses by contracting out major functions of the business—it became a virtual corporation.

(b) Super Bakery’s management decided to install a detailed ABC system, first, because it would allow management to track the profitability of each customer’s account and, second, because it would allow man-agement to track the performance of outside contractors more closely.

(c) One of the main differences between Super Bakery’s ABC system and other manufacturers’ ABC systems is that the main focus is placed on capturing costs by customer order rather than by product.

17-51

BYP 17-6 RESEARCH ASSIGNMENT

(a) The 1996 survey conducted by The Cost Management Group of the IMA found that 49% of all responding firms have adopted ABC (up from 41% a year earlier), that 25% of the nonadopting companies were con-sidering it, that 21% had not considered it, and that only 5% seriously considered ABC and rejected it. The survey also showed that for those companies that adopted ABC, 54% used ABC for decision making not only for accounting purposes but used it for decision making outside the accounting function.

(b) Krumwiede’s survey attempted to determine if adoption of ABC isassociated with kinds of products and processes, quality and lean pro-duction practices, and information technologies.

(c) The factors that appeared to separate those who adopted ABC from those who didn’t were: (1) potential for cost distortions, (2) decision usefulness of cost information, (3) lack of system initiatives, and (4) the size of organization.

(d) Professor Krumwiede recommends the following “basic ABCimplementation tips”:

1. Focus on critical needs. Before implementing an expensive inte-grated information system or a more sophisticated costing sys-tem, decide what are the organization’s most important issues or decisions and what types of information would help address those issues.

2. Get top management support. If you think ABC might be a useful tool in your organization, be sure to get top management’s support first. With its help, identify critical information needs, and show how an activity cost approach could provide valuable information. Seek approval for small, relatively quick projects, such as a single process or a pilot plant. If these are successful, management will drive further implementation and help make it a priority for other areas.

17-52

BYP 17-6 (Continued)

3. The main cost system. If pilot projects are successful, try to incor-porate ABC methods into your organization’s financial reporting process. Successful implementers of ABC systems were more than six times as likely to have integrated ABC into their primary financial system and almost twice as likely to use ABC for budgeting.

4. Consider a separate model. If integrating ABC into the main cost re-porting system is not feasible, consider developing a separate PC-based ABC system that can be used on an infrequent basis for strategic decision making. The model should be relatively simple and can be updated with data that already are available or easily col-lected. But even a relatively simple model can be far more accurate than many traditional cost allocation methods.

5. The existing information system. If you implement an ABC costing system, make sure that the input requirements can be easily sup-ported by the existing information system. If not, either change the model or install a more sophisticated integrated system.

6. Smaller companies. Smaller companies need to be especiallycreative to find reasonable activity cost drivers from their often more limited data. Like one company using material cost as a proxy for its weight, look for available drivers that have some correlation with how resources are spent.

7. The implementation team. Make sure the people who will be actual users of the ABC information are represented on the implementation team. A common mistake is putting managers on the team and not getting enough input from the cost accountants or other analysts.

8. The right software. Several respondents reported purchasing ex-pensive ABC software and having a fairly successful initial study, but then having to use spreadsheets to generate the specificreports that are needed. Complaints about maintaining ABC also were common. It’s wise to start simple. Early studies should be high-level in order to get concepts across. Once you have created interest, there will be a “demand-pull” for more information. Use spreadsheets until you identify exactly what your needs are, and then buy the software that meets your needs.

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BYP 17-7 ETHICS CASE

(a) The stakeholders (parties affected by Marcus’s and Ray’s actions) in this case are:

Marcus as cost accountant.

Ray and all personnel employed in the production of the Supercut Model of lawn tractor.

Hi-Power Mower management.

Hi-Power Mower owners (stockholders).

The stakeholder group may be expanded to include Hi-Power Mower’s suppliers and customers.

(b) The objective of cost accounting is to provide useful, accurate infor-mation for decision making by managers. Ray is coercing Marcus to massage the data to save the product line and, thus, Ray’s job. Ray is advocating knowingly providing false data, deceiving management, and jeopardizing Marcus’s job.

(c) Marcus is a management accountant employed by Hi-Power Mower Company. His first job responsibility is to his employer to: (1) communi-cate information fairly and objectively and (2) disclose fully all relevant in-formation that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented (see Appendix D, “Standards of Ethical Conduct for Manage-ment Accountants—Objectivity”). Marcus’s obligation is to provide management with timely, truthful information.

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Kimmel.sm.Cp17.Vpdf

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