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QUESTIONS
5-1
Product costs are likely being distorted when a firm uses a plantwide or
departmental overhead rate if the plant or department engages in more than one
activity in its operations and not all activities consume overhead in the same
proportion. The more diverse the product mixes of the plant or department are in
volume, sizes, manufacturing processes, or product complexities the plant or
department, the worse cost distortions are likely to be in using a plantwide or
departmental overhead rate to assign overhead costs to cost objects.
5-2
Undercosting a product may appear to have increased the reported profit the
product earned (assuming the firm did not lower its selling price because of the
reported lower product cost). However, the increased profit is, at best, a twist in
truth. Costs of the product not charged to the product itself are borne by other
products of the firm.
Worse, undercosting a product may result in managers erroneously believing the
product to be more profitable than other products and shifting the limited
resource the firm has into manufacturing, promotion, and sales of the product
when, in fact, other products are more profitable to the firm. Severe cost
distortions may lead firms not to drop unprofitable products because the cost data
show these products are profitable.
5-3
Overcosting does not increase revenues. A firm can increase the selling price of
a product, thereby increaseing the total revenue from the product only if the
market allows. Increases in the selling price of a product without experiencing
noticeable decrease in the sales quantity of the product is likely an indication
that the product was not priced properly, which might be a result of undercosting
of the product.
Furthermore, overcosting a product is likely accompanied by undercosting of
the firms other products and, as a result, underpricing of one or more of the
firms other products.
When a firm sets a high selling price that is a result of overcosting, competitors
also are likely to enter the market and take away the firms market share. A firm
also may drop or de-emphasize an erroneously overcosted product when it
erroneously believe the product is either unprofitable or having a low-margin.
Solutions Manual
5- 1
5-4
Activity-based costing recognizes that resources are spent on activities and the
cost of a product or service is the sum of the costs of activities performed in
manufacturing the product or providing the service.
Activity-based costing system traces costs to the activity that consume resources.
Costs are determined based on the activities performed for cost objects and their
underlying cost drivers that consume resources. Product or service costs
determined using an activity-based costing reflect costs of resources consumed
for activities performed in manufacturing products or providing services. In
contrast, a volume-based costing system uses cost allocations to channel indirect
costs to products or services. As a result, the cost of a product or service often
bears little or no relationship to activities performed in the manufacturing of the
product or service.
5-5
Based on the activities of most manufacturing firms, the general levels of cost
hierarchy of an activity-based costing system are:
Unit-level cost;
Batch-level cost;
Product-sustaining cost; and
Facility-sustaining cost.
5-6
5-7
All firms should use ABC system when the benefits of such a system exceed the
costs of implementing it. It is especially beneficial to firms with product diversity
and/or process complexity.
5-8
5-9
5-2
5-10
5-11
include
product
design, parts
5-12 A product-costing system that uses a single volume-based cost driver is likely to
overcost high-volume products because high-volume products do not consume
support resources in proportion to their production volumes. As a result, a
product-costing system that uses a single volume-based cost driver often
overcosts high-volume products or services and undercosts low-volume products
or services.
The subsidizations low-volume products by high-volume products is likely to lead
the firm not to price its products properly and poor management planning and
control of the firms resources. This may also decrease the profits of the firm and
reduce managements confidence in the product cost predictions. Poor pricing
can lead a firm to promote less profitable products while not spending sufficient
resources on more profitable items.
5-13 Activity-based management is the uses of an activity-based costing database to
improve operations, increase customer values, and enhance profitability.
5.14
5.15
5.16
5.17
Solutions Manual
5- 3
5-4
EXERCISES
5-20 Activity Levels (5 min)
1. Cost Hierarchy
f.
Product-sustaining
a.
Unit-level
g.
Facility-sustaining
b.
Unit-level
h.
Facility-sustaining
c.
Facility-sustaining
i.
Batch-level
d.
Unit-level
j.
e.
Unit-level
customer).
2. Cost Driver
a.
Number of hamburgers
b.
Number of hours
c.
Square feet
d.
e.
Number of hamburgers
f.
g.
h.
Square feet
i.
j.
Number of customers
Solutions Manual
5- 5
f. Facility-sustaining
b. Batch-level
g. Product-sustaining
c. Batch-level
h. Product-sustaining
d. Batch-level; Product-
i. Unit-level; Batch-level
sustaining
j. Batch-level
e. Product-sustaining
2. Cost Drivers
a. Machine hours
b. Number of setups or setup hours
c. Number of production orders
d. Number of material receipts; Number of purchase orders
e. Number of products
f. Number of machine hours
g. Number of engineering change notices; number of modifications;
Number of products
h. Number of parts; Number of products; Number of purchase orders
i. Number of inspection hours; Number of units; Number of batches
j. Number of loads; Number of material moves; Material weights
f.
Batch-level
b. Product-sustaining
g. Unit-level
c. Product-sustaining
h. Facility-sustaining
d. Product-sustaining
i.
Product-sustaining
e. Batch-level
j.
Facility-sustaining
2. Cost Drivers
a. Number of products
b. Number of products
c. Number of products
d. Number of products
e. Number of batches or setups
f. Number of batches
g. Number of units
h. Purchase costs; Replacement costs; Book values
i. Number of purchase orders; Number of products; Number of suppliers
j. Square feet
5-6
5-23 Activity Levels and Cost Drivers - Service Company (15 min)
1. Output unit-level costs:
a. Salaries and wages of lab technicians
b. Equipment-related costs
$1,200,000
$ 300,000
These costs are likely to vary with the number of test-hours, which are
functions of the output units (test).
Batch-level costs:
c. Setup costs
$240,000
Setup costs are incurred each time a batch of tests is setup for either ST or
PRT, regardless of the number of hours of the tests.
Product-sustaining costs: d. Costs of test designs
$360,000
These costs are incurred in designing ST and PRT tests, regardless of the
number of test-hours or number of batches tested.
2. As shown in the calculation below, the current costing system of charging
$70 per test-hour for overhead undercosts soil test (ST) and overcosts
pesticide residues test (PRT). One reason is that ST uses more setup costs
and test design costs than PRT does, while ST has lower test hours than
PRT. On average, ST tests take longer to setup (0.85 versus 0.575 setup
hour per test hour) and it is more difficult to design the test (0.58 versus
0.21 setup hour per test hour)
ST
PRT
Test-Hour
10,000
20,000
Setup Hour
Total
Per Test-Hour
8,500
0.850
11,500
0.575
0.21
5-23 (Continued)
3.
Test hour
Salaries and Wages
Equipment-related
costs*
ST
PRT
Setup costs#
ST
PRT
Test design costs&
ST
PRT
TOTAL
*Equipment-related
costs
Test hours
Per test hour
Total
#
Setup costs:
Setup hours
Per hour
Total
&
Test design costs:
Test design hours
Per hour
Total
ST
Total Per Hour
10,000
$540,000 $54.00
100,000
102,000
208,800
________
$950,800
PRT
Total
Per Hour TOTAL
20,000
30,000
$660,000 $33.00 $1,200,000
$10.00
200,000
$10.00
138,000
$6.90
$20.88
______
151,200
$95.08 $1,149,200
7.56
$57.46
$10.20
10,000
20,000
100,000
200,000
8,500
11,500
102,000
138,000
5,800
4,200
208,800
151,200
5-6
$300,000
30,000
$10
$240,000
20,000
$12.00
$360,000
10,000
$36.00
5-23 (Continued-2)
4.
ST
Total
Per Hour
2,500
$135,000 $54.00
PRT
Total
Per Hour TOTAL
5,000
7,500
$165,000
$33.00 $300,000
Test hour
Salaries and Wages
Equipment-related costs*
ST
100,000 $40.00
PRT
200,000
#
Setup costs
ST
255,000 $102.00
PRT
$345,000
&
Test design costs
ST
522,000 $208.80
PRT
_________ _______
378,000
TOTAL
$1,012,000 $404.80 $1,088,000
*Equipment-related costs:
Test hours
Per test hour
Total
#
Setup costs:
Setup hours
Per hour
Total
&
Test design costs:
Test design hours
Per hour
Total
2,500
5,000
100,000
$240,000 $360,000
8,500
200,000
255,000
$360,000 $540,000
5,800
345,000
522,000
11,500
4,200
$40.00
$69.00
$75.60
$217.60
$300,000
7,500
$40
$600,000
20,000
$30.00
$900,000
10,000
$90.00
378,000
The cost per test-hour increased from $95.08 to $404.80 for ST and from $57.46
to $217.60 for PRT. Platte Valley needs to reexamine the appropriateness for
using test-hour as the basis for costing. The bulk of the cost is for setup and testdesign and the direct cost related to test-hour is only a fraction of the setup and
test-design costs. A costing system based on the direct test-hour is likely to
distort the true cost of testing.
5-6
5-24 (Continued)
3. The benefits that management can expect from activity-based costing
include these:
a. Leads to a more competitive position by evaluating cost drivers, i.e.,
costs associated with the complexity of the transaction rather than the
production volume.
b. Streamlines production processes by reducing low-value-added
activities, e.g., reduced set-up times, optional plant layout, and
improved quality.
c. Provides management with a more thorough understanding of product
costs and product profitability for strategies and pricing decisions.
4. The steps that a company, using a volume-based cost system, would take
to implement activity-based costing include:
a. evaluation of the existing system to assess how well the system
supports the objective of an activity-based cost system.
b. identification of the activities for which cost information is needed with
differentiation between value added and low-value-added activities.
(CMA 6/90, Part IV No. 5)
Activity Costs
Machine setup
$360,000
Cost Drivers
Overhead Rate
$120
25,000 pounds
Electric power
40,000
A
Direct materials
$40,000
Direct labor
Factory overhead:
Machine setup
$50,000
24,000
$120 x 200 =
24,000
.
40,000
$120 x 240 =
28,800
Materials handling
$4 x 1,000= 4,000
$4 x 3,000 =
12,000
Electric power
$1 x 2,000 =
$1 x 4,000 =
4,000
2,000
$94,000
$134,800
Production units
20,000
4,000
$23.50
5-6
$6.74
$69,120,000 /1,152,000 =
$60 x 5,900 =
$60
$354,000
$2,000
Budgeted
Cost
$810,000
Activity
900
Budgeted
OH Rate
$900.00
Total
Applied
Activity Overhead
900
$810,000
Equipment
422,500
845
500.00
870
435,000
Personnel
457,500
6,000
76.25
5,900
449,875
$1,694,875
2. The first method uses a hospital-wide overhead rate, which likely bears
no relationship with the overhead activities performed in the intensive
care unit (ICU). The second method uses the patient-day overhead rate
for the ICU department. This is an improvement over the first method.
But a single patient-day cost driver may not have direct relationships with
some of the activities performed in the ICU department. The third method
is the preferred method because it uses a cost driver for each of the cost
pools that reflects the resources consumed by activities of the cost pool.
5-6
f. High-value-added
b. High-value-added
g. High-value-added
c. High-value-added
h. Low-value-added
d. Low-value-added
i. High-value-added
e. Low-value-added
e. Low-value-added
b. Low-value-added
f. High-value -added
c. Low-value-added
g. Low-value-added
d. Low-value-added
h. High-value -added
5-6
$800
$400
$200
$40,000
12,000
4,000
$56,000
22,400
$78,400
10
30
60
100
$800
$400
$200
$8,000
12,000
12,000
$32,000
12,800
$44,800
5-31 (Continued)
Requirement 2
Client
# of Hours Hourly Rate Total Amount Billed
B&J Cream
Partner
50
$800
$40,000
Senior Consultant
30
$400
12,000
Consultant
20
$200
4,000
Total for professional time
100
$56,000
Support activities ($60 per hour)
6,000
Total billed
$62,000
Mini Mart
Partner
10
Senior Consultant
30
Consultant
60
Total for professional time
100
Support activities ($60 per hour)
Total billed
$800
$400
$200
$8,000
12,000
12,000
$32,000
6,000
$38,000
5-6
Department
Engineering
Precision tooling
30,000
1,800,000
120,000
2,400,000
Total
160,000
$7,800,000
Answer for 3
Machine
Total
Number
Hour
Overhead
of Unit
4,000 $ 195,000 500,000
8,000
390,000
40,000
148,000
7,215,000 200,000
160,000 $7,800,000
Overhead
Per Unit
$ 0.390
9.750
36.075
Department Rates
Department
Budgeted
Activity
Cost
Cost Driver
Overhead
2.
Rate
Engineering
Engineering hours
30,000 $ 3,600,000
$120.00
Precision Tooling
96,000 $ 1,800,000
$18.75
120,000 $ 2,400,000
$20.00
$7,800,000
Total manufacturing overhead for each of the three customers:
Customer
Engineering
Dellway
24,000 x $120 =
Computer
$2,880,000
Leland
2,400 x $120 =
Motors
$288,000
PH
3,600 x $120 =
Company
$432,000
Total
Activity Hours
Total
Direct Labor
Machine
Overhead
2,000 x $18.75 =
3,000 x $20 =
$37,500
$60,000 $2,977,500
84,000 x $18.75 =
6,000 x $20 =
$1,575,000
$120,000 $1,983,000
10,000 x $18.75 = 111,000 x $20 =
$187,500
$2,220,000 $2,839,500
$3,600,000
$1,800,000
$2,400,000 $7,800,000
Total Overhead
Number of Unit
$2,977,500
500,000
$ 5.9550
Leland Motors
1,983,000
40,000
49.5750
PH Company
2,839,500
200,000
14.1975
Total
$7,800,000
5-6
5-33 (Continued)
4. Summary of results:
Customer
Dellway Computer
Leland Motors
PH Company
Plantwide Rate
Total
Per Unit
$195,000
$0.3900
$390,000
9.7500
$7,215,000
36.0750
$7,800,000
Department Rates
Total
Per Unit
$2,977,500
$5.9550
1,983,000
49.5750
2,839,500
14.1975
$7,800,000
$0.15 x 30 =
$ 4.50
B:
$37 1.85 =
$20.00
C:
$35.50 5 =
$ 7.10
D:
$0.08 x 100 =
$ 8.00
$240.00
Rejection rate
50%
$120.00
Direct materials
$25.00
Direct labor
5.00
$ 4.50
Hardware insertion37.00
Hand load
35.50
Masking
8.00
85.00
115.00
$5.00
5-6
10
$0.50
$120,000
$90,000
$158,125
105,000
67,000
110,000
$ 15,000
$23,000
$ 48,125
24,000
18,000
31,625
($ 9,000)
$ 5,000
$ 16,500
-7.50%
5.56%
10.43%
$120,000
$90,000
$158,125
105,000
67,000
110,000
$ 15,000
$23,000
$ 48,125
800
4,400
7,200
1,100
7,700
13,200
300
525
7,200
6,000
8,000
17,200
8,200
20,625
44,800
$ 6,800
$ 2,375
5.67%
2.64%
Fresh Produce
Store support:
Order processing
Receiving
Shelf-stocking
Customer support
Total store support cost
Operating income
Operating margin (OI/S)
3,325
2.10%
3. Both baked goods and fresh produces drop in profitability when ABC is used.
The decrease in profitability of fresh produce is most noticeable. The
profitability of fresh produce decreases from 10.43 percent of the sales
revenues under the current system, the highest of the three products, to 2.10
percent under ABC, the lowest of the three. This is because fresh produce
requires more support activities than the other two products.
5-6
TS
CS
$800,000.00
$880,000
96,000.00
132,000
$704,000.00
$748,000
3,520.00
5,610
$700,480.00
$742,390
7,004.80
$693,475.20
5,201.06*
$698,676.26
$742,390
87.33%
84.36%
Requirement 1
Jerry Inc.
Donald Co.
$200
$875
$1,500
200
2,500
$9,000
500
15,000
12,000
4,000
$16,400
$29,375
Jerry Inc.
$1,000,000
8,000
$992,000
744,000
$248,000
16,400
$231,600
Donald Co.
$1,200,000
35,000
$1,165,000
873,750
$291,250
29,375
$261,875
23.35%
22.48%
TOTAL
Requirement 2
Sales
Sales return
Net Sales
Cost of goods sold
Gross margin
Sales support cost
Operating income
Operating margin %
5-6
60
670
x $60,000
$ 40,200,000
40,200
x $1,500
+
60,300,000
$100,500,000
1,000,000
$100.50
5-39 (Contd)
2. Order filling cost per unit sold to PC:
Total number of orders
Number of orders per block
Total number of blocks
Cost per block
Total block cost
Total number of orders
Order-filling cost per order
Total cost per order
Total order-filling cost
Total units sold
Order-filling cost per unit
2
60
1/30
x $60,000
$2,000
2
x $1,500
+ 3,000
$5,000
5,000
$1.00
Net profit per unit at $700 selling price per unit to preferred customers:
Selling price per unit
Manufacturing cost
Order-filling cost/unit
Total cost per unit
Net Profit per unit
Preferred Customer
$700.00
$600.00
+
1.00
601.00
$ 99.00
14.14%
5-6
5-39 (Contd-2)
3. Order filling cost per order by SC:
Cost per block
Number of orders per block
$60,000
60
$1,000
10
$10,000
$1,500
x
10
+ 15,000
$25,000
125
Order-filling cost/unit
$200
$800.00
Manufacturing cost
Order-filling cost/unit
Total cost per unit
Net profit or loss per unit
Profit margin
$600.00
+
200.00
800.00
$
0
0
PROBLEMS
5-40 Cost Pools and Cost Drivers (15 min)
Note to instructor: The answer below is but one possible solution.
1.
Cost pool 1: Cost driver: Number of purchase orders
Receiving
$10,000
Inspection of direct materials
3,000
Purchasing
20,000
Total
$33,000
Cost pool 2: Cost driver: Number of production runs
Setup wages
$20,000
$40,000
30,000
11,000
9,000
$90,000
$ 50,000
6,000
20,000
15,000
8,000
51,000
$150,000
Note: However, the problem indicated that the firm uses machine hours as
the base for assigning facility-sustaining costs. An alternative
solution is to combine cost pools 3 and 4.
Cost pool 5: Cost driver: production (in units)
Inspection of finished goods
Cost pool 6: Cost driver: engineering hours
Engineering design
Total
5-6
$7,000
$600,000
$600,000
5-40 (Contd)
2.
Overhead Rates:
Cost pool 1:
Total cost
Number of purchase orders
Cost per purchase order
Total cost
Number of production runs
Cost per production run
$33,000
6
$5,500
Cost pool 2:
$20,000
40
$500
Cost pool 3:
$ 90,000
100,000
$0.90
Cost pool 4:
$150,000
100,000
$1.50
Cost pool 5:
$ 7,000
100,000
Cost pool 6:
$600,000
20,000
$30.00
Total cost
Number of machine hours
Cost per machine hour
Total cost
Number of machine hours
Cost per machine hour
Total cost
Number of units
Cost per unit $0.07
Total cost
Total engineering hours
Cost per engineering hour
5-40 (Contd-2)
Manufacturing overheads:
Unit level:
Cost pool 3 Cost per machine hour
Number of machine hours
$ 0.90
x 4,250
$ 3,825
1,000
Product-sustaining level:
Cost pool 1 Cost per purchase order
Number of purchase orders
$5,500
x
1
5,500
$ 30
100
3,000
5-6
$ 1.50
x 4,250
280
6,375
$19,980
4,000
$4.995
5-40 (Contd-3)
* There are at least two alternative activity consumption drivers for
assigning facility-sustaining cost:
Based on machine hours:
Total facility-sustaining cost (Cost pool 4)
Number of machine hours
Cost per machine hour
$150,000
100,000
$1.50
$ 3,825
280
Batch level:
Cost pool 2
1,000
Product-sustaining level:
Cost pool 1
Cost pool 6
5,500
3,000
Facility-sustaining level:
Cost pool 4 Cost per unit
Number of units
x 4,000
Total manufacturing overhead
Number of units
Manufacturing overhead per unit
$ 1.50
6,000
$ 19,605
4,000
$4.90125
5,000
$36.65
400
$14,660
2. Activity-based costing
Overhead Rates:
Quality control
$50,000
$3,250
$2.50 per MH
25 = $130.00 per PO
$30,000 5,000 =
$500.00 x
5=
$2,500
$2.50 x 1,400 =
3,500
$130.00 x
1=
130
$6.00 x
400 =
2,400
$8,530
Number of boxes
Overhead per box
500
$17.06
3. Using a single application rate for a firm with product diversity is likely to
distort product costs. Using a costing system with multiple rates based on
cost drivers that reflect the underlying activities can provide a better cost
determination.
5-6
80 x $1,200 =
$ 96,000
80 x 105 x $0.45 =
80 x
3x
$51 =
80 x 105 x $2.85 =
80 x $30 =
3,780
12,240
23,940
2,400
$138,360
80
$1,729.50
$180.00
1,729.50
250.00
$2,159.50
8.33%
80.09%
11.58%
100%
Strategic implications:
(1) Knowing the full cost of a product including upstream and downstream
costs allows the firm to be aware of all costs attributable to the product.
(2)
(3)
3. The total value chain cost provides the firm a long-term perspective of the
product cost, in addition to the short term manufacturing cost. Different
industries have different cost structures. For example, firms in the
computer software industry are likely to have high upstream costs while
firms in the retailing industry tend to have high downstream costs.
Barrel
OH per Barrel
P5
500
$96.00
G23
500
$96.00
2. Overhead Rates:
Overhead
Cost Pool
Budgeted
Overhead
Level of
Cost Driver
Predetermined
Overhead Rate
Machine set-ups
$100,000
100 setups
Material handling
80,000
8,000 barrels
Quality control
200,000
Other overheads
Rate
1,000 inspections
Quality control
Other overheads
$10 per MH
Manufacturing Overhead
P5
G23
Activity Overhead
Activity Overhead
$ 1,000
50
$50,000
$10
500
5,000
500
5,000
$200
400
20
4,000
$10
1,000
10,000
1,000
10,000
Total overhead
$16,400
Number of barrels
Cost per barrel
500
$ 32.80
$69,000
500
$138.00
5-6
1.
Product A
(1) Target price
$279.00
(2) Manufacturing cost (1) 150% $186.00
Prime cost
- 70.00
Overhead cost per unit
$116.00
Number of units
x 1,000
Total overhead
$116,000
Product B
$294.00
$196.00
- 126.40
$ 69.60
x 5,000
$348,000
Product A Product B
Actual selling price
$280
$250
Product manufacturing cost
186
196
Gross margin
$ 94
$ 54
Gross margin ratio
33.57%
21.6%
Product C
$199.50
$133.00
- 75.00
$ 58.00
x
500
$29,000
Product C
$300
133
$167
55.67%
Based on the current cost data, it is true that product B is the least profitable
product with a gross margin per unit of $54.00 (21.6%) and product C is the
most profitable product with a gross margin per unit of $167.00 (55.67%).
However, the validity of this conclusion is based on the accuracy of the
reported product costs.
Product costs based on the activity-based costing system
Direct materials
Direct labor
Factory overhead:
Setups (a)
Materials handling (b)
Hazardous control (c)
Quality control (d)
Utilities (e)
Total
Product A
$ 50.00
20.00
1.60
40.00
62.50
22.50
12.00
$208.60
Product B
$114.40
12.00
Product C
$ 65.00
10.00
0.80
5.00
22.50
5.25
8.40
$168.35
4.80
70.00
150.00
52.50
12.00
$364.30
$250.00
168.35
$ 81.65
32.66%
$300.00
364.30
($64.30)
(21.43)%
5-44 (Continued)
Notes:
(a) Setups:
Cost per setup: $8,000 (2 + 5 + 3) =
$800 per setup
Product A = 2 x $800 = $1,600;
$1,600 1,000 = $1.60 per unit
Product B = 5 x $800 = $4,000;
$4,000 5,000 = $0.80 per unit
Product C = 3 x $800 = $2,400;
$2,400 500 = $4.80 per unit
(b) Materials handling:
Cost per pound = $100,000 (400 + 250 + 350) = $100 per pound
Product A = 400 x $100 = $40,000;
$40,000 1,000 = $40.00 per unit
Product B = 250 x $100 = $25,000; $25,000 5,000 = $ 5.00 per unit
Product C = 350 x $100 = $35,000; $35,000 500 = $70.00 per unit
(c) Waste and hazardous disposals:
Cost per disposal: $250,000 (25 + 45 + 30) = $2,500 per disposal
Product A = 25 x $2,500 = $ 62,500; $ 62,500 1,000 = $ 62.50/unit
Product B = 45 x $2,500 = $112,500; $112,500 5,000 = $ 22.50/unit
Product C = 30 x $2,500 = $ 75,000; $ 75,000 500 = $150.00/unit
(d) Quality inspections:
Cost per inspection = $75,000 (30 + 35 + 35) = $750 per inspection
Product A = 30 x $750 = $22,500; $22,500 1,000 = $22.50 per unit
Product B = 35 x $750 = $26,250; $26,250 5,000 = $ 5.25 per unit Product
C = 35 x $750 = $26,250;
$26,250 500 = $52.50 per unit
(e) Utilities:
Cost per MH = $60,000 (2,000 + 7,000 + 1,000) = $6.00 per MH
Product A = 2,000 x $6 = $12,000; $12,000 1,000 = $12.00 per unit
Product B = 7,000 x $6 = $42,000; $42,000 5,000 = $ 8.40 per unit
Product C = 1,000 x $6 = $ 6,000; $ 6,000 500 = $12.00 per unit
5-6
5-44 (Continued-2)
3. Comparison of reported product costs, new target price, actual selling price,
and gross margin (loss):
Product A Product B Product C
Product costs:
1. Direct-labor based system
$186.00
$196.00
$133.00
2. Activity-based system
$208.60
$168.35
$364.30
ABC-based product costs:
Target price (150%)
Actual selling price
Difference in price
$312.90
$252.53
$280.00
$250.00
<$32.90> <$2.52>
33.57%
$71.40
25.50%
$ 54
21.6%
$81.65
32.66%
$546.45
$300.00
<$246.45>
$167
55.67%
$(64.30)
<21.43%>
4. Comment
1. Emphasizing Product C as suggested by the current direct-laborcost based overhead costing system is likely to lead to the demise
of the firm. The activity-based costing system shows that the
manufacturing cost of Product C is $364.30 per unit and, at the
current selling price, the firm suffers a $64.30 loss for each unit it
manufactures and sells.
2. If the actual selling prices of products A & B are fair market prices
for these products and a markup of 150% is a common industry
practice, the firm needs to examine the manufacturing cost of
product A. The fact that the firms target price, determined using
150% of the manufacturing cost, is more than 10 percent over the
fair market price of the product suggests possible wastes and
inefficiencies in the manufacturing of product A.
Elite
5,000
Standard
20,000
Junior
50,000
$180.00
97.50
$ 82.50
$150.00
75.00
$ 75.00
$110.00
47.50
$ 62.50
45.83%
50%
56.82%
$412,500
$1,500,000
$3,125,000
Sales units
Based on the gross margin per unit determined using the current
volume-based product costing system, Elite Box Radio is the most
profitable product ($82.50 per unit), followed by Standard model ($75
per unit). Junior model is the least profitable of the three ($62.50 per
unit).
2. Multiple drivers costing system
Elite
Selling price (actual)
Standard
Junior
$180.00
$150.00
$110.00
Direct materials
22.50
15.00
7.50
Direct labor
15.00
12.00
8.00
100.80
10.50
2.52
b) Quality control
31.70
15.85
9.51
c) Machinery
12.80
10.50
5.40
d) Materials handling
15.00
10.00
5.00
$197.80
$ 73.85
$ 37.93
-$ 17.80
$ 76.15
$ 72.07
-9.89%
50.77%
65.52%
Factory overhead*
a) Engineering
Total cost
Gross margin
Gross margin ratio
5-45 (Continued)
Blocher, Chen, Corkin, Lin: Cost Management
5-6
*Note:
a) Engineering
Factory overhead per engineering hour:
$840,000 (900 + 375 +2 25) =
$560.00
Elite:
(900 x $560) 5,000 =
$100.80
Standard:
(375 x $560) 20,000 =
$ 10.50
Junior:
(225 x $560) 50,000 =
$ 2.52
b) Quality Control
Factory overhead per quality inspection hour:
$951,000 (5,000 + 10,000 +15,000) =
$31.70
Elite:
( 5,000 x $31.70) 5,000 =
Standard:
(10,000 x $31.70) 20,000 =
Junior:
(15,000 x $31.70) 50,000 =
$31.70
$15.85
$ 9.51
c) Machinery
Factory overhead per machine hour:
$544,000 (640 +2,100 + 2,700) =
Elite:
( 640 x $100) 5,000 =
Standard:
(2,100 x $100) 20,000 =
Junior:
(2,700 x $100) 50,000 =
$12.80
$10.50
$ 5.40
$100
d) Materials handling
Total direct materials cost:
Elite
$22.50 per unit x 5,000 units =
Standard
$15.00 per unit x 20,000 units =
Junior
$ 7.50 per unit x 50,000 units =
Total direct materials cost
Factory overhead per dollar of direct materials:
$525,000 787,500 =
$0.6667
Elite:
$112,500 x $0.6667 5,000 =
Standard:
$300,000 x $0.6667 20,000 =
Junior:
$375,000 x $0.6667 50,000 =
$112,500
300,000
375,000
$787,500
$15.00
$10.00
$ 5.00
5-45 (Continued-2)
3. Comparison of reported product costs:
Costing System
Elite
Standard Junior
Volume-based (direct labor cost)
$ 97.50
$75.00 $47.50
Activity-based costing
197.80
73.85
37.93
Difference in cost
-$100.30
$ 1.15 $ 9.57
Elite consumes more of engineering hours and Quality Control
activities. These two activities are not directly related to direct
labor hours. Therefore, under the activity-based costing system,
Elite has a much higher unit cost than the volume-based direct
labor costing system for factory overhead.
Costing System
Target price
Actual price
Gross margin (Volume-based)
Gross margin (ABC)
Elite
$195.00
$180.00
$82.50
-$17.80
Standard
Junior
$150.00 $95.00
$150.00 $110.00
$75.00 $62.50
$76.15 $72.07
5-6
5-47
$2,800 x
100 =
$100 x 400,000 =
$40 x 120,000 =
$20 x 200,000 =
Deluxe
$ 560,000
10,000,000
1,800,000
1,000,000
$13,360,000
50,000
$267.20
Speedy
$ 280,000
40,000,000
4,800,000
4,000,000
$49,080,000
400,000
$122.70
Deluxe %
$475.00100
Price
Cost
Prime cost
$180.00
Overhead
267.20
447.20 94
Unit gross profit
$27.80
6
5-6
$110.00
122.70
Speedy
$300.00
%
100
232.70
$67.30
78
22
5-47 (Contd)
3. Using the activity-based costing, a much different picture on profitability of the
Deluxe and Speedy models emerges. The Speedy model is actually more
profitable than the Deluxe model. The revised cost data suggests that shifting
the emphasis to the Deluxe model may very well be a mistake. The Deluxe
printer is a much heavier user of overhead resources as can be seen in the
table below that compares uses of overhead.
Overhead
Activity
Activity Consumption
Deluxe
Speedy
Setups
Machine costs
Engineering
Packing
2 MH per unit
1 MH per unit
Supporting calculations
Activity Consumption
Total
Units
Setups
Machine
costs
Deluxe
Per Activity Measure
50,000
400,000
2 MH per unit
50,000
Total
Speedy
Per Activity Measure
Cost Pool
Overhead Rate
Machine depr./maint.
$135,000
27,000
$5.00 per MH
Factory depr./util./insur.
$120,000
30,000
$4.00 per MH
Product design
$504,000
Materials purch./stor.
$147,000
Total overhead
$906,000
Men Shavers
$30,000 x 15% =$4,500
Product design
Women Shavers
$26,000 x 15% = $3,900
$12 x 15 =180
$12 x 37.5 =
450
Machine depreciation
$5.00 x 50 =
250
$5.00 x 40 =
200
Factory depreciation
$4.00 x 50 =
200
$4.00 x 40 =
160
$5,130
$4,710
15,000
20,000
$ 0.342
$ 0.2355
$300 x 24 =
$7,200
Women Shavers:
$300 x 12 =
$3,600
5. Men Shavers:
Women Shavers:
$7,200 / 15,000 =
$ 0.48
$3,600 / 20,000 =
$ 0.18
5-6
Job 101
$ 45,300
16,800
Job 102
$ 5,700
1,400
50,400 35 x $120 =
4,200
$112,500
Number of units
$11,300
450
20
$ 250
$ 565
Job 101
$ 45,300
Job 102
$5,700
16,800
1,400
1,500 x $.70 =
1,050
600 x $.70 =
420
80,000 x $.35 =
28,000
15,000 x $.35 =
5,250
750 x $15 =
11,250
70 x $15 =
1,050
Grinding
1,500 x $.60 =
900
600 x $.60 =
360
Shipping
1 x $2,180 =
2,180
1 x $2,180 =
2,180
Lathe work
Milling
Total overhead
43,380
9,260
$105,480
$16,360
450
20
$234.40
Number of units
$ 818
Job 101
450
Job 102
20
$565
$818
$234.40
5-49 (Continued)
The cost per unit of Job 102 increased 44.8% [($818 - $565) / $565 ] while
the cost per unit of Job 101 decreased 6.24% [($234.40 - 250) / $250 ],
when using ABC instead of a single cost pool with a single allocation base.
A common finding after implementing an activity-based accounting system
is that the costs of low-volume products increased and the costs of highvolume products decreased. Similar results are found in requirements 1
and 2 for Auer Corporation.
4. Among factors that contribute to the differences in the product cost figures
computed in requirements 1 and 2 are:
(a) the jobs differ in the way they use each of five activity areas, and
(b) the activities differ in their indirect cost application base (the direct labor
hour is not the only cost allocation base).
5. Adopting the ABC method is strategically important for the Auer
Corporation. The ABC method provides the Auer Corporation a more
accurate product cost picture, and directs the managements attention to
the high-volume more profitable jobs. If management can find ways to
continuously improve the high-volume jobs product design or
manufacturing process, the company will sustain its competitive advantage.
5-6
Ceiling Fixture
Per Unit
Total
Per Unit
$ 80,000
$70.00
20.00
$ 400,000
$40.00
10.00
Direct Labor
32,000
8.00
200,000
5.00
Overhead*
64,000
16.00
400,000
10.00
$176,000
44.00
$1,000,000
25.00
Manufacturing Cost
Gross Margin
$26.00
$15.00
Overhead Rate
$160,000
81,200
10,000
232,000
$16.00
0.35
Machine Setup
68,000
2,500
27.20
Assembly
88,550
402,500
0.22
Inspection
66,250
4,000
16.5625
Total
$464,000
5-50 (Continued-1)
Applied overheads
Luxury Pendants
Machine Operation
Support labor
Machine Setup
Ceiling Fixtures
1,000
27,200
1,500
40,800
Assembly
0.22
192,500
42,350
210,000
46,200
Inspection
16.5625
1,600
26,500
2,400
39,750
Total Overhead
$131,250
$332,750
Ceiling Fixtures
Total
Per Unit
40,000
$1,600,000
$40.00
$400,000
$10.00
$200,000
$ 5.00
136,000
70,000
40,800
46,200
39,750
$332,750 $ 8.3188
$932,750 $23.3188
$667,250 $16.6813
41.7%
3. The above profitability analysis indicates that the Luxury Pendant is not as
profitable as the vice president of marketing thinks it is.
5-6
5-50 (Continued-2)
4. Unit Cost Comparison between the current and ABC costing systems
Reported Overhead Costs
Current
ABC
Difference
Luxury Pendants
$16.00
$32.8125
+$16.8125
Ceiling Fixtures
$10.00
$ 8.3188
- $ 1.6822
According to the ABC cost data, a shift to more Luxury Pendant units
and fewer Ceiling Fixture units would be ill advised. The apparent
higher unit gross margin of the Luxury Pendants relative to the Ceiling
Fixtures that the current costing system reports was a result of
inaccurate overhead applications, which distorted relative unit
profitability.
5. Among the reasons for the different costs reported between the
current direct labor based and the ABC systems are:
a. The current direct labor based costing system focused on only one
manufacturing activity of the entire production process. It measures
only one attribute of the individual product: the number of direct labor
hours consumed. By contrast, the ABC system considered all
activities of the manufacturing processes. Costs were traced from
activities to products based on the products demand for these
activities during the production process. The allocation bases used in
ABC were thus measures of the activities performed. For Modern
Lighting Inc., the ABC systems listed not only the unit-level activities
(machine operation, support labor overhead) but also the batch-level
ones (setup, assembly, and inspection.)
b. Under the volume-based costing system, the high-volume ceiling
fixtures were overcosted and the low-volume luxury pendants were
undercosted. The source of this distortion is the choice of a single
volume-related allocation base, direct labor hours, for tracing of costs
from manufacturing to products. Using a volume-related allocation
base alone to trace costs to products distorted reported product costs
if some of the product-related activities were not related to volume,
such as the setup hours.
c. Differences in the complexity of the products also contribute to cost
distortion. Using a volume-based costing system, overhead costs
differ only when different number of units are manufactured. Although
the luxury pendants were low-volume products, they actually consume
more resources a result not related to volume.
Homycin
6,800
Addolin
2,000
Overhead rate
$12.50
$12.50
$12.50
Total overhead
$90,000
$85,000
$25,000
Diomycin
$205,000
Homycin
$265,000
Addolin
$258,000
250,000
234,000
263,000
Overhead:
90,000
85,000
25,000
Total Cost
$545,000
$584,000
$546,000
Packets produced
1,000,000
500,000
300,000
$0.545
$1.168
$1.820
Direct labor-hours
5-6
5-51 (Continued-1)
2. Overhead rates for Activity-Based Costing:
Activity
Machine setup
Cost Driver
Setup hours
Budgeted
Budgeted
Overhead Cost Driver Overhead
Cost
Volume
Rate
$ 16,000
1,600 $10.00
36,000
Supervision of
Direct labordirect labor
hours
Quality inspection Inspectionhours
Expediting orders Customers
serviced
Total overhead
1,200
$30.00
1,150
$40.00
50,400
1,050
$48.00
51,600
645
$80.00
46,000
$200,000
$30
200
$6,000
400
$12,000
600
$18,000
$40
200
$8,000
300
$12,000
650
$26,000
$48
150
$7,200
200
$9,600
700
$33,600
$80
45
$3,600
100
$8,000
500
$40,000
$26,800
$47,600
$125,600
5-51 (Continued-2)
Cost per capsule under Activity-Based Costing:
Direct Materials
Direct Labor
Overhead
Total Cost
Packets produced
Cost per capsule
Diomycin
Homycin
Addolin
$205,000.00 $265,000.00 $258,000.00
250,000.00
234,000.00
263,000.00
26,800.00
47,600.00
125,600.00
$481,800.00 $546,600.00 $646,600.00
1,000,000
500,000
300,000
$0.4818
$1.0932
$2.1553
Diomycin
Homycin
Addolin
$90,000
$0.5450
$85,000
$1.1680
$25,000
$1.8200
$26,800
$0.4818
$47,600
$1.0932
$125,600
$2.1553
5-51 (Continued-3)
Activity-based costing provides ADA with more detailed and better
estimates of product costs. For example by using ABC, ADA becomes
aware that the cost of Diomycin is lower ($0.4818 per capsule compared to
$0.545 under current costing), meaning that it can set the price of Diomycin
lower and be more competitive. Also, ABC revealed how costly Addolin is
Blocher, Chen, Corkin, Lin: Cost Management
5-6
($2.1553 per capsule compared to $1.82 under the current costing). Thus,
this opportunity would allow ADA to properly price Addolin or if it is not
profitable, stop producing.
From the schedule, activity-based costing assigns more overheads to
the lower-volume Addolin because the production of Addolin requires more
setups, inspection, supervision, formulation and management. The current
direct-labor-hours based costing system failed to assign costs of all
activities. As a result, Diomycin and Homycin subsidized Addolin.
The production department at ADA also benefits under ABC. ABC
provides better costing information on the cost of each of the activities and
identifies cost drivers and the activities that consume resources and raise
cost. The additional information enables production mangers to manage
cost by managing activities and cost drivers.
Adopting the ABC method is strategically important for ADA. Because
the ABC method provides ADA with a more accurate product cost picture
and directs managements attention to the high-volume, more profitable
products, the firm can gain competitive advantages and profits by focusing
on the high-volume products.
5-51 (Continued-4)
4. Among major uses of ABC in the Pharmaceutical Industry are:
a. Strategic Use of ABC to Reduce Costs
One of the important ways companies develop competitive advantages is
to become a low-cost producer. Many companies in the pharmaceutical
industry have learned to use the information they have gained from their
costing systems to make substantial price cuts to increase market share.
b. Use of ABC to Eliminate Low-Value-Added Costs
ABC can be used to identify and eliminate activities that add costs but
not value to the products in the pharmaceutical industry. A company can
eliminate low-value added activities and costs without reducing quality or
value. In the pharmaceutical industry, the following activities typically do
not add value to a product: storage, moving items, and waiting for work.
Analyses of activities facilitate firms to identify low-value-added activities.
c. Use of ABC in Marketing and Distribution
In the pharmaceutical industry, ABC can be applied to marketing or
administrative activities. The cost of performing marketing services such
as distributing products through different distribution channels can be
computed and the information used in making informed decisions. For
example, some of the different channels of distribution in the
pharmaceutical industry are: grocery stores, convenience stores,
pharmacy shops, each having different activities. The cost of alternative
channels of distribution is useful to marketing managers who make
decisions about which channel to use.
d. Use of ABC to Make Better Pricing Decisions
ABC enables managers to make better pricing decisions by providing
managers with more accurate product cost data for pricing decisions.
e. Use of ABC to Make Better Product Mix Decisions
ABC provides a firm more detailed and better estimation of product costs.
Thus, it allows a company the opportunity to decide which products to
make and which ones to eliminate.
5-6
$150
$ 9,750,000
Direct materials
80
5,200,000
21
1,365,000
520,000
390,000
325,000
$120
$7,800,000
$ 30
$1,950,000
Total cost
Contribution margin
5-52 (Continued-1)
2. b. Using traditional volume-based standard costs, the total contribution
expected in 2007 by Alaire Corporation from the PC Board is $2,360,000,
calculated as follows.
Per Unit Totals for 40,000 units
Revenue
$300
$ 12,000,000
140
5,600,000
56
2,240,000
14
560,000
16
640,000
15
600,000
Total cost
241
9,640,000
Contribution margin
$ 59
$ 2,360,000
Direct materials
Production scheduling:
Machine setups:
Machine insertion:
Manual insertion:
Wave soldering:
5-52 (Continued-2)
Blocher, Chen, Corkin, Lin: Cost Management
5-6
$150.00
$ 9,750,000
80.00
5,200,000
2.50
162,500
Production scheduling
2.00
130,000
4.00
260,000
3.20
208,000
Materials overhead:
Variable overhead:
Machine set-ups ($1.60 x 2)
Waste disposal ($3 x .02)
Quality control
.06
3,900
3.50
227,500
.60
39,000
9.60
624,000
Manual insertion
4.00
260,000
Wave soldering
1.20
78,000
$110.66
$7,192,900
$ 39.34
$2,557,100
General supplies
Manufacturing overhead:
Total cost
Contribution margin
Note that the only cost that remains the same for both cost methods is the
cost of direct materials. Under the ABC method, direct labor cost becomes
part of the manufacturing manual insertion overhead cost.
5-52 (Continued-3)
b. Using activity-based costing, the total contribution expected in 2007 by Alaire
Corporation from the PC Board is $1,594,000 calculated as follows.
Per Unit Totals for 40,000 units
Revenue
$300.00
$ 12,000,000
140.00
5,600,000
5.50
220,000
Production scheduling
2.00
80,000
4.00
160,000
4.80
192,000
1.05
42,000
7.00
280,000
.60
24,000
14.00
560,000
80.00
3,200,000
1.20
48,000
`Total cost
$260.15
$10,406,000
Contribution margin
$ 39.85
$ 1,594,000
Direct materials
Materials overhead:
Variable overhead:
General supplies
Manufacturing:
Wave soldering
5-6
5-52 (Continued-4)
4. The analysis using volume-based standard costs shows that the unit
contribution of the PC Board is almost double that of the TV Board. On
this basis, Alaires management is likely to accept the suggestion of the
production manager and concentrate promotional efforts on expanding
the market for the PC Boards.
However, the analysis using activity-based costs does not support
this decision. This analysis shows that the unit dollar contribution from
each of the boards is almost equal, and the total contribution from the
TV Board exceeds that of the PC Board by almost $1,000,000. As a
percentage of selling price, the contribution from the TV Board is double
that of the PC Board, 26 percent versus 13 percent. Therefore, it may
not be advisable to concentrate promotional efforts only on expanding
the market for the PC Board.
= $3,000,000 / $600,000
Product Costs
Mona Loa
Malaysian
Direct costs:
Direct materials
$4.20
$3.20
Direct labor
.30
$4.50
.30
$3.50
1.50
1.50
Indirect costs:
Factory overhead (0.30 x $5.00)
Total costs
Mark-up
Budgeted selling prices per pound
2. The cost per driver unit is:
Activity
Purchasing
Budgeted
Cost Driver
Cost
Purchase orders $579,000
$6.00
$5.00
30%
30%
$7.80
$6.50
Budgeted
Activity
1,158
Cost per
Unit
$500
Material handling
Setups
720,000
1,800
400
Quality control
Batches
144,000
720
200
Roasting
Roasting hours
961,000
96,100
10
Blending
Blending hours
336,000
33,600
10
Packaging
Packaging hours
260,000
26,000
10
5-6
5-53 (Continued-1)
The budgeted unit costs per pound are:
Mona Loa Coffee
Malaysian Coffee
Direct unit costs:
Direct materials
$4.20
$3.20
Direct labor
0.30 $4.50
0.30 $3.50
Indirect unit costs:
Purchasing
0.02
1.00
(4 orders x $500 /100,000 lbs.)
(4 orders x $500/2,000 lbs.)
Material handling
0.12
2.40
(30 setups x $400/100,000 lbs.)
(12 setups x $400/2,000 lbs.)
Quality control
0.02
0.40
(10 batches x $200/100,000 lbs.)
(4 batches x $200/2,000 lbs.)
Roasting
0.10
0.10
(1,000 hours x $10/100,000 lbs.)
(20 hours x $10/2,000 lbs.)
Blending
0.05
0.05
(500 hrs. x $10/100,000 lbs.)
(10 hrs. x $10/2,000 lbs.)
Packaging
0.01
0.01
(100 hrs. x $10/100,000 lbs.)
(2 hrs. x$10/2,000 lbs.)
Total unit cost
$4.82
$7.46
The comparative cost numbers are:
Mona Loa
Malaysian
Requirement 1
$6.00
$5.00
Requirement 2
4.82
7.46
The ABC system in requirement 2 reports a decreased cost for the highvolume Mona Loa and an increased cost for the low-volume Malaysian.
The current costing system leads to cross-subsidization between the two
products.
5-53 (Continued-2)
3. Three of the indirect cost items can be classified as output-unit driven:
Mona Loa Coffee
Malaysian Coffee
Roasting
$0.10
$0.10
Blending
0.05
0.05
Packaging
0.01
0.01
Total output-unit overhead
$0.16
$0.16
The other three indirect cost items are batch-level driven:
Mona Loa Coffee
Malaysian Coffee
Purchasing
$0.02
$1.00
Material handling
0.12
2.40
Quality control
0.02
0.40
Total batch-level overhead
$0.16
$3.80
Malaysian coffee has a greater number of setups per output unit than
does Mona Loa coffee. The result is that the unit cost of the lowervolume Malaysian coffee is much higher than that of the higher-volume
coffee, even though its cost of direct materials is lower.
With the current costing system, the high-volume Mona Loa is
overcosted, while the low-volume Malaysian is undercosted. Pricing of
Mona Loa can be reduced to make it more competitive. In contrast,
Malaysian should be priced at a much higher level if the strategy is to
cover the current periods cost. CBI may wish to have lower margins with
its low-volume products such as Malaysian in an attempt to build up
volume. The company can use the ABC cost information to compare its
two product costs with competitors, and decide which product has a low
cost competitive advantage. Then the company can change its pricing
and product mix strategies by using the ABC cost information.
ABC cost data also point out that the reason for the Malaysian
Coffee to have a higher unit cost is not because of high-priced
ingredients. In fact, Malaysian Coffee has a lower cost of direct materials
than that of Mona Loa Coffee. The costs of roasting, blending, and
packaging are $0.16 per pound for both coffees. The higher cost of
Malaysian is because of the way in which it is processed. The batch-level
cost per pound is $0.16 for Mona Loa and $3.80 for Malaysian. CBI can
increase its profit margin or lower its price on Malaysian Coffee if it can
change the way in which it handles purchasing, material handling, and
quality control functions of Malaysian coffee.
5-6
Omega International
City of Albion
Requisition Handling
$3,000
$ 7,000
(300 requisitions x $10/requisition)
(700 requisitions x $10/requisition)
Warehouse Activity
750
7,500
(50 cartons x $15.00 per carton)
(500 cartons x $15.00 per carton)
Pick-Packing
1,350
3,150
(900 pick-pack lines x $1.50)
(2,100 pick-pack lines x $1.50)
Data Entry
900
2,100
(900 lines x $1.00/line)
(2,100 lines x $1.00/line)
Freight Out
3,450
8,260
($10 x 300) + ($0.30 x 5 x 300)
($10 x 700) + ($0.30 x 6 x 700)
Total Service Costs
$9,450
$28,010
3. Customer Profitability Analysis-Activity Based
Omega International
Sales
$ 80,000
City of Albion
$80,000
Product Cost
(50,000)
(48,000)
Service costs
( 9,450)
(28,010)
Gross Margin
Gross Margin %
$20,550
25.69%
$ 3,990
4.99%
5-54 (Continued-1)
The above profitability analysis indicates that, under activity-based
costing, Omega International, not City of Albion, is more profitable to
Boston Depot. The apparent higher gross margin percentage of the
City of Albion relative to the Omega International was the result of not
recognizing differences in the service activities requested by different
customers under the firms existing costing system.
City of Albion is a much heavier user of services provided by
Boston Depot. Although both customers had the same total sales, City
of Albion made more desktop delivery requests in smaller quantities
and maintained more inventory by Boston Depot.
4.
The answer depends on the competitive strategy of the firm. The gross
profit margin ratios show that Omega is the better customer of the two.
Omega does not use much of the desktop delivery service Boston
offers. Most likely Omega is a buyer of commodity items and does not
need the convenience of desktop delivery. However, Bostons pricing is
likely to have incorporated the average cost of desktop deliveries. If
Omega realizes that it is paying for services not used, it may buy the
commodity it needs elsewhere, unless Boston lowers the price to
Omega.
All custom-printed business forms by different suppliers are likely
to be the same. Delayne wanted to differentiate its forms from those
of competitors by offering desktop delivery services. In the long-run,
Omega is not likely to be a customer staying with Boston Depot.
Boston Depot needs to be prepared to lower the price to Omega.
If the firm desires to compete on a differentiation strategy it needs
to price accordingly. Boston Depot needs to raise prices to City of
Albion. If City of Albion is willing to pay a higher price for the
convenience of desktop delivery, it is the kind of customer that Delayne
wants.
5-6
5-55 (Continued-1)
Calculation for general administration allocated to branches:
Total direct labor dollar: $382,413 + $317,086 + $317,188 = $1,016,687
Allocation of general administration based on direct labor dollar:
Proportion
Allocated Amount
Columbus
Cincinnati
Dayton
Cincinnati
Dayton
Total
$1,500
$1,419
$1,067
$3,986
382
317
317
1,016
281
421
185
887
180
270
177
627
$657
$411
$388
$1,456
Dayton
Total
$1,500
$1,419
$1,067
$3,986
382
317
317
1,016
Direct materials
281
421
185
887
180
270
177
627
$657
$411
$388
$1,456
529
$128
453
($42)
278
$110
1,261
$195
Direct overhead
Contribution margin
Activity-based overhead
Operating income
5-55 (Continued-2)
Blocher, Chen, Corkin, Lin: Cost Management
5-6
Baldwin
$600,000
$750,000
$900,000
12,000
22,500
18,000
$588,000
$727,500
$882,000
11,760
7,275
26,460
$576,240
$720,225
$855,540
11,525
Finance charge
(7,530)
Net proceeds
$572,245
21,606
$698,619
$855,540
200
$ 125
$ 450
Order taking
500
250
2,500
Order processing
750
375
3,750
Sales return
600
800
2,000
Delivery
1,500
15,000
Expediting order
1,000
2,500
800
800
1,600
$2,850
$4,850
$27,800
$569,395
$693,769
$827,740
5-6
5-56 (Continued)
1
Net proceeds:
$576,240 - $11,525 =
$564,715
$7,530
$720,225 2 = $360,112.50
$360,112.50 x 2% =
$720,225 2 = $360,112.50
$360,112.50 x 2% x 2 =
Restocking cost:
$ 7,202
14,404
$21,606
HS Inc:
10 x 100 x 2% x $10 =
$200
Adventix:
5 x 250 x 1% x $10 =
$125
Baldwin:
50 x 30 x 3% x $10 =
$450
5-6