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5-2
5-3
5-4
5-5
(b)
(c)
McGraw-Hill/Irwin
Managerial Accounting, 8/e
(d)
5-6
5-7
5-8
In traditional, volume-based costing systems, only direct material and direct labor
are considered direct costs. In contrast, under an activity-based costing system, an
effort is made to account for as many costs as possible as direct costs of
production. Any cost that can possibly be traced to a particular product line is
treated as a direct cost of that product.
5-9
The pool rate is calculated by dividing the budgeted amount of an activity cost pool
by the budgeted total quantity of the associated cost driver. The pool rate is the cost
of a particular activity that is expected per unit of the associated cost driver.
5-10
Two factors that tend to result in product cost distortion under traditional, volumebased product-costing systems are as follows:
(a) Non-unit level overhead costs: Many overhead costs vary with cost drivers that
are not unit-level activities. Use of a unit-level cost driver to assign such costs
tends to result in cost distortion.
(b) Product diversity: When a manufacturer produces a diverse set of products,
which exhibit different consumption ratios for overhead activities, use of a single
cost driver to assign costs results in cost distortion.
5-11
Three important factors in selecting cost drivers for an ABC system are as follows:
(a) Degree of correlation between consumption of an activity and consumption of
the cost driver.
(b) Cost of measurement of the cost driver.
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5-2
(c) Behavioral effects, that is, how the cost driver selected will affect the behavior of
the individuals involved in the activity related to the cost driver.
5-12
An activity dictionary lists all of the activities identified and used in an activity-based
costing analysis. The activity dictionary provides for consistency in the terminology
and level of complexity in the ABC analysis in the organizations various subunits.
5-13
Line managers are close to the production process and may realize that a complex
product, which is difficult to manufacture, is undercosted by a traditional, volumebased costing system. Because of the cost distortion that is common in such
systems, the undercosted product may appear to be profitable when it is really
losing money. Line managers may have a "gut feeling" for this situation, even if the
cost-accounting system suggests otherwise.
5-14
5-15
5-16
5-17
Management could use the ABC information about the cost of various types of
patient appointments for determining charges for appointments, making
appointment staffing decisions (e.g., physician versus nurse practitioner), and
justifying reimbursements from insurance companies or government agencies.
McGraw-Hill/Irwin
Managerial Accounting, 8/e
5-18
At Patio Grill Company, every unit of each product line manufactured requires all
eight of the support activities covered by the ABC system. In contrast, at Delaware
Medical Center, each patient sees a physician, or a nurse practitioner, or an intern, or
a resident. Moreover, each patient is either a new patient or a continuing patient, but
not both. Therefore, in determining the cost a patient appointment, the cost analyst
would include only the relevant activity costs in the cost of a patient appointment.
5-19
The two-dimensional activity-based costing model provides one way of picturing the
relationship between ABC and ABM. The vertical dimension of the model depicts the
cost assignment view of an ABC system. From the cost assignment viewpoint, the
ABC system uses two-stage cost allocation to assign the costs of resources to the
firm's cost objects. These cost objects could be products manufactured, services
produced, or customers served.
Depicted in the horizontal dimension of the model that follows is the process
view of an ABC system. The emphasis now is on the activities themselves, the
processes by which work is accomplished in the organization. The left-hand side of
the model depicts activity analysis, which is the detailed identification and
description of the activities conducted in the enterprise. Activity analysis entails the
identification not only of the activities, but also of their root causes, the events that
trigger activities, and the linkages among activities. The right-hand side of the model
depicts the evaluation of activities through performance measures. These processes
of activity analysis and evaluation constitute activity-based management.
The two-dimensional ABC model is depicted in the diagram on the next page.
5-20
McGraw-Hill/Irwin
5-4
Diagram of two-dimensional ABC model (from review question 5-19 on preceding page):
Cost Assignment View
RESOURCE COSTS
Process View
Activity analysis
ROOT
ACTIVITY
CAUSES
TRIGGERS
ACTIVITIES
PERFORMANCE
MEASURES
Assignment of activity
costs to cost objects
using second-stage
cost drivers
COST OBJECTS
(products or services
produced; customers)
McGraw-Hill/Irwin
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5-21
An activity's trigger is the preceding event that indicates that the activity should be
performed. The activity's root cause is the event or activity that, if it had not
occurred, would have prevented the activity in question from happening. For
example, the event that triggers the activity of rework is the identification of a
defective part during inspection. However, the inspection is not the root cause of the
rework activity. The root cause of the defective part, and hence the need for rework,
could lie in erroneous part specifications, in an unreliable vendor, or in faulty
production.
5-22
5-23
5-24
5-25
In a just-in-time (JIT) production system, raw materials and parts are purchased or
produced just in time to be used at each stage of the production process. This
approach to inventory and production management brings considerable cost
savings from reduced inventory levels.
The key to the JIT system is the "pull" approach to controlling manufacturing.
The diagram on the next page displays a simple multistage production process. The
flow of manufacturing activity is depicted by the solid arrows running down the
diagram from one stage of production to the next. However, the signal that triggers
more production activity in each stage comes from the next stage of production.
These signals, depicted by the dashed-line arrows, run up the diagram. We begin
with sales at the bottom of the exhibit. When sales activity warrants more production
of finished goods, the goods are "pulled" from production stage III by a signal that
more goods are needed. Similarly, when production employees in stage III need more
inputs, they send a signal back to stage II. This signal triggers production activity in
McGraw-Hill/Irwin
5-6
stage II. Working our way back up to the beginning of the process, purchases of raw
materials and parts are triggered by a signal that they are needed in stage I.
Sales
Denotes flow of materials, parts, partially finished goods, and finished goods.
Denotes a signal that more goods are needed at the next stage of production.
McGraw-Hill/Irwin
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Solutions to exercises
EXERCISE 5-26 (15 MINUTES)
1.
Material-handling cost per lens = $1,500. The analysis is identical to that given for
requirement (1).
3.
$90,000
4
(4 16) *
$600
30
*The total number of material moves.
McGraw-Hill/Irwin
5-8
52,000 yen
52,000 yen
793,000 yen
793,000 yen
McGraw-Hill/Irwin
Managerial Accounting, 8/e
a.
Quality-control costs assigned to the enamel paint line under the traditional
system:
Quality-control costs = 16% direct-labor cost
Quality-control
costs assigned to
enamel paint line = 16% $98,000
= $15,680
McGraw-Hill/Irwin
5-10
2.
Assigned
Cost
$ 552
9,800
7,200
$17,552
The traditional product-costing system undercosts the enamel paint product line, with
respect to quality-control costs, by $1,872 ($17,552 $15,680).
McGraw-Hill/Irwin
Managerial Accounting, 8/e
(b)
(c)
Stage two: Select cost drivers for each activity-cost pool. Then assign the costs
in each cost pool to the company's product lines in proportion to the amount of
the related cost driver used by each product line.
2.
As described in the answer to the preceding exercise, the new system probably will
reveal distortion in the firm's reported product costs. In all likelihood, the high-volume
products are overcosted and the low-volume specialty products are undercosted.
3.
Strategic options:
(a)
Lower the prices on the firm's high-volume products to compete more effectively.
(b)
(c)
Consider eliminating the specialty product lines. This option may not be desirable
if there is a marketing need to produce a full product line. Also, the specialty
wheels may give Wheelco prestige.
McGraw-Hill/Irwin
5-12
Classification
P
P
P
P
P
P
P
B
B
B
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Managerial Accounting, 8/e
Activity
(11)
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
Classification
B
B
U
U
U
U
B
F
F
Order Size
Medium
Large
Total
Sales commissions
(Unit cost: $675,000/225,000
= $3.00 per box)....................................................
$ 6,000
$135,000
box)...........................................................................
$534,000
$ 675,000
62,600
295,400
26,400
105,000
31,000
60,000
$654,000
$1,135,400
2,180,000
Catalogsb
(Unit cost: $295,400/590,800
= $.50 per catalog)................................................
127,150
105,650
catalog)....................................................................
Costs of catalog salesc
(Unit cost: $105,000/175,000
= $.60 per motor)..................................................
47,400
31,200
skein)........................................................................
Credit and collectiond
(Unit cost: $60,000/6,000
= $10.00 per order)...............................................
4,850
24,150
order)........................................................................
$.30
The analysis of selling costs shows that small orders cost more than large orders.
This fact could persuade management to market large orders more aggressively
and/or offer discounts for them.
McGraw-Hill/Irwin
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For example, moving materials is a batch-level activity because a raw material must be
moved to the product area when a production run or batch is started. Depreciation is a
facility-level account because depreciation on plant and equipment represents the cost of
providing production facilities in which manufacturing can take place.
McGraw-Hill/Irwin
5-16
Airline:
(a)
(b)
Preparing excess food for a flight, which is not consumed, because the flight
occupancy was misforecast.
(c)
(d) Canceling a flight because of an aircraft maintenance problem that should have
been prevented by routine maintenance.
2.
Bank:
(a)
(b)
(c)
(d)
(e)
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3.
Hotel:
(a)
(b)
(c)
(d)
Performance Measure
Tagging luggage
Handling luggage
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5-18
Enplaning passengers
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Managerial Accounting, 8/e
Activity Description
Value-Added
or Non-ValueAdded
Taking reservations
VA
Customer calls on
phone
Customer desires
reservation
Customers waiting
for a table
NVA
Seating customers
VA
Table becomes
available
Taking orders
VA
Customers indicate
readiness to order
Serving meals to
customers
VA
Returning meal to
kitchen for revised
preparation
NVA
Customer complains
about meal
Customers eating
meal
VA
VA
Customers are
finished
McGraw-Hill/Irwin
5-20
Activity Trigger
Root Cause
VA
Customers are
finished ordering and
eating
Collecting payment
VA
Customers have
produced cash or
credit card
108
114
112
116
110
124
121
127
125
128
(11)
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
(20)
113
135
106
111
133
107
134
119
136
137
Yes, the ranking by sales revenue is different from that based on operating income.
2.
No, the least profitable customers are not the ones with the lowest sales revenue.
The least profitable customers are numbers 119 and 134.
3.
Yes, the profile would be different, because the ordering of the customers along the
horizontal axis would match the order in requirement (1) instead of the ordering in
Exhibit 5-15.
McGraw-Hill/Irwin
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A customer characterized by high sales revenue would not necessarily be the most
profitable, because the customer may demand costly services such as special
handling or packaging, frequent small shipments, or unique design features.
Today
To:
From:
Subject:
Customer-Profitability Analysis
McGraw-Hill/Irwin
5-22
airline:
(a)
(b)
(c)
(d)
(e)
(2)
restaurant
(a)
(b)
(c)
(d)
(e)
(3)
fitness club:
(a)
(b)
(c)
(d)
(e)
(4)
bank:
(a)
(b)
(c)
(d)
(e)
(5) hotel:
(a)
(b)
(c)
(d)
(e)
(6)
(a)
(b)
(c)
(d)
(e)
hospital:
McGraw-Hill/Irwin
Managerial Accounting, 8/e
solutions to Problems
PROBLEM 5-45 (35 MINUTES)
1.
Activity-based costing results in improved costing accuracy for two reasons. First,
companies that use ABC are not limited to a single driver when allocating costs to
products and activities. Not all costs vary with units, and ABC allows users to select
a host of nonunit-level cost drivers. Second, consumption ratios often differ greatly
among activities. No single cost driver will accurately assign costs for all activities
in this situation.
2.
McGraw-Hill/Irwin
5-24
Information
Systems
Services
Billings:
3,600 hours x $140
2,400 hours x $140
Less: Professional staff cost:
3,600 hours x $50
2,400 hours x $50
Administrative cost.
Income
(120,000)
(152,704)
$ 63,296
( 229,056)
$ 94,944
Income billings.
18.84%
18.84%
$504,000
$336,000
(180,000)
Activity
Driver
Cost
Staff support
In-house
computing
$207,000
145,000
Miscellaneous
office charges
29,760
Application
Rate
300 clients
5,000 computer
hours (CH)
$29 per CH
1,200 client
transactions (CT)
$24.80 per CT
Activity
Staff support:
240 clients x $690...
60 clients x $690.
In-house computing:
2,900 CH x $29.
2,100 CH x $29.
Miscellaneous office charges:
480 CT x $24.80...
720 CT x $24.80...
Total .
McGraw-Hill/Irwin
Managerial Accounting, 8/e
E-Commerce
Consulting
Information
Systems
Services
$165,600
$ 41,400
84,100
60,900
11,904
17,856
$120,156
$261,604
Information
Systems
Services
$504,000
$336,000
(180,000)
(120,000)
(120,156)
$ 95,844
28.53%
( 261,604)
$ 62,396
12.38%
4.
Yes, his attitude should change. Even though both services are needed and
professionals are paid the same rate, the income percentages show that e-commerce
consulting provides a higher return per sales dollar than information systems
services (28.53% vs. 12.38%). Thus, all other things being equal, professionals
should spend more time with e-commerce.
5.
Probably not. Although both services produce an attractive return for Clark and
Shiffer, the firm is experiencing a very tight labor market and will likely have trouble
finding qualified help. In addition, the professional staff is currently overworked,
which would probably limit the services available to new clients.
McGraw-Hill/Irwin
5-26
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45,000 hours
44,000 hours
13,000 hours
102,000 hours
Activity
Activity
Cost Pool
Cost
Driver
Pool
Rate
$
115,000 2.70
Machine
Related
$310,500
Material
Hand.
52,500
Prod.
Runs
100 525.00
Purch.
75,000
Purch.
Orders
300 250.00
Setup
85,000
Prod.
Runs
100 850.00
Inspect.
27,500
Inspect.
Hours
1,100
25.00
Ship.
66,000
Ship.
1,100
60.00
Eng.
32,500
Eng.
Hours
650
50.00
Fac.
575,000
115,000
5.00
Grand
Total
$1,224,000
McGraw-Hill/Irwin
5-28
Machine
Hours
Cost
Driver
Quantity
Machine
Hours
Product
Line
REG
ADV
GMT
Total
REG
ADV
GMT
Total
REG
ADV
GMT
Total
REG
ADV
GMT
Total
REG
ADV
GMT
Total
REG
ADV
GMT
Total
REG
ADV
GMT
Total
REG
ADV
GMT
Total
Grand
Total
Cost
Driver
Quantity
for
Product
Line
50,000
48,000
17,000
115,000
40
40
20
100
100
96
104
300
40
40
20
100
400
400
300
1,100
500
400
200
1,100
250
200
200
650
50,000
48,000
17,000
115,000
Activity
Cost for
Product
Line
$135,000
129,600
45,900
$310,500
$ 21,000
21,000
10,500
$ 52,500
$ 25,000
24,000
26,000
$ 75,000
$ 34,000
34,000
17,000
$ 85,000
$ 10,000
10,000
7,500
$ 27,500
$ 30,000
24,000
12,000
$ 66,000
$ 12,500
10,000
10,000
$ 32,500
$250,000
240,000
85,000
$575,000
Product
Line
Prod.
Volume
5,000
4,000
1,000
Activity
Cost per
Unit of
Product
$27.00
32.40
45.90
5,000
4,000
1,000
4.20
5.25
10.50
5,000
4,000
1,000
5.00
6.00
26.00
5,000
4,000
1,000
6.80
8.50
17.00
5,000
4,000
1,000
2.00
2.50
7.50
5,000
4,000
1,000
6.00
6.00
12.00
5,000
4,000
1,000
2.50
2.50
10.00
5,000
4,000
1,000
50.00
60.00
85.00
$1,224,000
Direct material.................................
Direct labor (not including
set-up time).................................
Total direct costs per unit...............
REG
$129.00
ADV
$151.00
GMT
$203.00
$ 32.40
5.25
6.00
8.50
2.50
6.00
2.50
60.00
$ 45.90
10.50
26.00
17.00
7.50
12.00
10.00
85.00
$123.15
$483.15
$213.90
$663.90
McGraw-Hill/Irwin
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Managerial Accounting, 8/e
REG
ADV
GMT
$108.00
$132.00
$156.00
103.50
123.15
213.90
408.00
492.00
606.00
403.50
483.15
663.90
530.40
639.60
787.80
524.55
628.10
863.07
525.00
628.00
800.00
The REG and ADV products were overcosted by the traditional system, and the GMT
product was undercosted by the traditional system
McGraw-Hill/Irwin
Inc.
5-30
$408.00
$492.00
$606.00
403.50
483.15
663.90
$ 4.50
$ 8.85
($ 57.90)
6.
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Activity
Activity
Cost
Pool
Cost
Driver
Cost
Driver
Quantity
100
Product
Line
Cost
Driver
Quantity
for
Product
Line
$525.00 REG
ADV
GMT
Total
40
40
20
100
Pool
Rate
Activity
Cost for
Product
Line
$21,000
21,000
10,500
$52,500
Product
Line
Production
Volume
Activity
Cost
per Unit
of
Product
5,000
4,000
1,000
$ 4.20
5.25
10.50
The results of the ABC calculations are in columns E, H and J. The ABC calculations are as
follows:
(1) Compute pool rate for material-handling activity:
Activity cost pool cost driver quantity = pool rate
$52,500
100
= $525.00
Pool Rate
Cost Driver
Quantity for
x Product Line
$525.00 x
525.00 x
525.00 x
40
40
20
=
=
=
$21,000
21,000
10,500
(3) Compute product cost per unit for each product line:
Activity Cost
for Each
Product
Product
Line
Line
REG
ADV
GMT
$21,000
21,000
10,500
McGraw-Hill/Irwin
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5-32
Product Line
Production Volume
5,000
4,000
1,000
=
=
=
=
Activity Cost
per Unit
of Product
$ 4.20
5.25
10.50
2009 The McGraw-Hill Companies,
Solutions Manual
Executive
$ 40
25
160
$225
$ 65
25
120
$210
Direct material.
Direct labor..
Manufacturing overhead.
Unit cost
2. Activity-based application rates:
Activity
Driver
Application
Rate
Activity
Cost
Manufacturing
setups
$1,344,000
= $8,400 per SU
Machine
processing
3,696,000
77,000 machine
hours (MH)
= $48 per MH
Product
shipping
1,120,000
350 outgoing
= $3,200 per OS
shipments (OS)
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Deluxe
Executive
$ 840,000
$ 504,000
1,536,000
2,160,000
640,000
$3,016,000
480,000
$3,144,000
16,000
30,000
$188.50*
$104.80**
Direct material
Direct labor.
Manufacturing setup, machine
processing, and outgoing shipments..
Total cost.
Deluxe
Executive
$ 40.00
25.00
$ 65.00
25.00
188.50
$253.50
104.80
$194.80
3. The Deluxe storage cabinet is undercosted. The use of machine hours produced a
unit cost of $225; in contrast, the more accurate activity-based-costing approach
shows a unit cost of $253.50. The difference between these two amounts is $28.50.
McGraw-Hill/Irwin
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5-34
5.
Executive
*$253.50 $225.00
$194.80 $210.00
No, the discount is not advisable. The regular selling price of $270, when compared
against the more accurate ABC cost figure, shows that each sale provides a profit to
the firm of $16.50 ($270.00 - $253.50). However, a $30 discount will actually produce
a loss of $13.50 ($253.50 - $240.00), and the more units that are sold, the larger the
loss. Notice that with the less-accurate, machine-hour-based figure ($225), the
marketing manager will be misled, believing that each discounted unit sold would
boost income by $15 ($240 - $225).
McGraw-Hill/Irwin
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a.
Indirect material.
Other indirect manufacturing costs (e.g., building maintenance, machine and
tool maintenance, property taxes, insurance, depreciation on plant and
equipment, rent, and utilities).
b.
2.
The increase in the overhead rate should not have a negative impact on the
company, because the increase in indirect costs was offset by a decrease in direct
labor.
3.
Rather than using a plantwide overhead rate, Digital Light could implement
separate activity cost pools. Examples are as follows:
Separate costs into departmental overhead accounts (or other relevant pools),
with one account for each production and service department. Each
department would allocate its overhead to products on the basis that best
reflects the use of these overhead services.
Treat individual machines as separate cost centers, with the machine costs
collected and charged to the products using machine hours.
4.
McGraw-Hill/Irwin
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5-36
Direct material.................................
Direct labor:
3 hours x $15.............................
4 hours x $15.............................
Manufacturing overhead:
3 hours x $35.50........................
4 hours x $35.50........................
Total cost.........................................
2.
Medform
Procel
$ 30.00
$ 45.00
45.00
60.00
106.50
$181.50
142.00
$247.00
Cost
Activity Cost
Driver
Application
Rate
Order
processing
$120,000
600 orders
processed (OP)
= $200 per OP
Machine
processing
500,000
50,000 machine
hrs. (MH)
= $10 per MH
Product
inspection
90,000
15,000 inspection
hrs. (IH)
= $6 per IH
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Medform
Procel
$ 70,000
$ 50,000
230,000
270,000
24,000
$324,000
66,000
$386,000
2,500
$129.60*
3,125
$123.52**
Direct material.
Direct labor:
3 hours x $15
4 hours x $15
Order processing, machine processing,
and product inspection..
Total cost.
McGraw-Hill/Irwin
Inc.
5-38
Medform
Procel
$ 30.00
$ 45.00
45.00
60.00
129.60
$204.60
123.52
$228.52
a.
b.
4.
Yes, especially since Meditechs selling prices are based heavily on cost. An
overcosted product will result in an inflated selling price, which could prove
detrimental in a highly competitive marketplace. Customers will be turned off
and will go elsewhere, which hurts profitability. With undercosted products,
selling prices may be too low to adequately cover a products more accurate
(higher) cost. This situation is also troublesome and will result in lower
income reported for the company.
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Valdosta Vinyl Company (VVC) is currently using a plantwide overhead rate that is
applied on the basis of direct-labor dollars. In general, a plantwide manufacturingoverhead rate is acceptable only if a similar relationship between overhead and direct
labor exists in all departments or the company manufactures products that receive the
same proportional services from each department
In most cases, departmental overhead rates are preferable to plantwide
overhead rates because plantwide overhead rates do not provide the following:
Because the company uses a plantwide overhead rate applied on the basis of directlabor dollars, the elimination of direct labor in the Molding Department through the
introduction of robots may appear to reduce the overhead cost of the Molding
Department to zero. However, this change will not reduce fixed manufacturing costs
such as depreciation and plant supervision. In reality, the use of robots is likely to
increase fixed costs because of increased depreciation. Under the current method of
allocating overhead costs, these costs merely will be absorbed by the remaining
departments.
McGraw-Hill/Irwin
Inc.
5-40
a.
In order to improve the allocation of overhead costs in the Cutting and Finishing
departments, management should move toward an activity-based costing system.
The firm should:
b.
Establish a separate overhead pool and rate for the Molding Department.
Identify fixed and variable overhead costs and establish fixed and variable
overhead rates.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
Pool
Rate
$4,000 per setup
$4 per pound
$10 per pound
$150 per inspection
$20 per machine
hour
Level of
Cost Driver
6 setups
9,000 pounds
2,100 pounds
8 inspections
550 machine hours
Total
Assigned
Overhead
Cost
$24,000
36,000
21,000
1,200
11,000
$93,200
2.
$93,200
$93.20 per box
1,000 boxes
3.
Predetermined
overhead rate
$2,500,000
total budgeted overhead cost
b.
5.
$34,375
$34.375 per box
1,000 boxes
McGraw-Hill/Irwin
Inc.
5-42
6.
(b)
Level of
Cost Driver
4 setups
800 pounds
400 pounds
4 inspections
60 machine hours
Assigned
Overhead
Cost
$16,000
3,200
4,000
600
1,200
$25,000
$25,000
$250
100 plates
$210
60
250
$520
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
2.
Type of Activity
Unit-level
Batch-level
Product-sustaining-level
Facility-level
I: Machine-related costs:
$1,800,000
18,000 machine hrs.
III. Engineering:
$360,000
200 change orders
McGraw-Hill/Irwin
Inc.
5-44
III: Engineering:
Odds:
$270,000
= $270 per unit
1,000 units
$1,800 per change order 200 change orders 25%
5,000 units
=
Ends:
$90,000
= $18 per unit
5,000 units
$307,200
= $307.20 per unit
1,000 units
$100 per sq. ft. 3,840 sq. ft. 20%
5,000 units
=
Ends:
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
$76,800
= $15.36 per unit
5,000 units
5.
200.00
72.00
18.00
15.36
$725.36
6.
Ends
$240.00
180.00
Ends
$725.36
120%
$870.43 (rounded)
Ends
McGraw-Hill/Irwin
Inc.
5-46
Cost distortion:
Odds
Traditional volume-based costing system:
reported product cost...................................................
Activity-based costing system:
reported product cost...................................................
Amount of cost distortion per unit......................................
Ends
664.00
$996.00
2,017.20
$(1,353.20)
725.36
$270.64
Traditional
system
undercosts
odds by
$1,353.20
per unit
Production volume............................................................... 1,000
Total amount of cost distortion for entire
product line.................................................................... $(1,353,200)
Traditional
system
overcosts
ends by
$270.64
per unit
5,000
$1,353,200
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
a.
GSCC's predetermined overhead rate, using direct-labor cost as the single cost
driver, is $10 per direct labor dollar, calculated as follows:
Overhead rate
= $12,000,000/$1,200,000
= $10 per direct-labor dollar
b.
The full product costs and selling prices of one pound of Jamaican and one
pound of Colombian coffee are calculated as follows:
Jamaican
Direct material........................................
Direct labor.............................................
Overhead (.40$10).............................
Full product cost...................................
Markup (30%).........................................
Selling price...........................................
2.
$2.90
.40
4.00
$7.30
2.19
$9.49
Colombian
$ 3.90
.40
4.00
$8.30
2.49
$10.79
The new product cost, under an activity-based costing approach, is $11.06 per pound
of Jamaican and $4.62 per pound of Columbian coffee, calculated as follows:
Activity
Purchasing
Material handling
Quality control
Roasting
Blending
Packaging
McGraw-Hill/Irwin
Inc.
5-48
Cost Driver
Purchase orders
Setups
Batches
Roasting hours
Blending hours
Packaging hours
Budgeted
Activity
2,316
3,600
1,440
192,200
67,200
52,000
Budgeted
Cost
$2,316,000
2,880,000
576,000
3,844,000
1,344,000
1,040,000
Unit Cost
$1,000
800
400
20
20
20
$2.90
.40
2.00
4.80
.80
.10
.05
.01
$11.06
$3.90
.40
.02
.12
.02
.10
.05
.01
$4.62
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
a.
The ABC analysis indicates that several activities other than direct labor drive
overhead. The cost computations show that the current system significantly
undercosted Jamaican coffee, the low-volume product, and significantly
overcosted the high-volume product, Colombian coffee.
b.
The implication of the ABC analysis is that the low-volume products are using
resources but are not covering their share of the cost of those resources. The
Jamaican blend is currently priced at $9.49 [see requirement 1(b)], which is
significantly below its activity-based cost of $11.06. The company should set
long-run prices above cost. If there is excess capacity and many of the costs are
fixed, it may be acceptable to price some products below full activity-based cost
temporarily in order to build demand for the product. Otherwise, the high-volume,
high-margin products are subsidizing the low-volume, low-margin products.
McGraw-Hill/Irwin
Inc.
5-50
Kara Lindley's predecessor at Pensacola Air Industries (PAI) would have used a 10
percent material-handling rate, calculated as follows:
Payroll...................................................................................
Employee benefits................................................................
Telephone..............................................................................
Other utilities........................................................................
Materials and supplies.........................................................
Depreciation..........................................................................
Total Material-Handling Department costs.........................
Material-handling rate
$432,000
$3,009,000 $1,311,000
$270,000
54,000
57,000
33,000
9,000
9,000
$432,000
= 10%
2.
a.
b.
$432,000
69,000
$363,000
363,000
$ 1.00
Purchase orders might be a more reliable cost driver than is the dollar amount of
direct material, because resources are consumed in processing a purchase
order. The size of the order does not necessarily have an impact on the
consumption of resources.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
$ 3,009,000
10%
$300,900
New method:
Directly traceable material-handling costs
[$54,000 + (20% $54,000) + $4,200]...........................
Purchase orders (120,000 $1.00).....................................
Total (new method)...............................................................
$69,000
120,000
$189,000
Net reduction........................................................................
$111,900
McGraw-Hill/Irwin
Inc.
5-52
A forecast of the cumulative dollar impact over a three-year period from 20x4 through
20x6 of Kara Lindley's recommended change for allocating Material-Handling
Department costs to the Government Contracts Unit is $351,519, calculated as
follows:
20x5
20x6
$4,538,700
$ 453,870
69,000a
$384,870
400,208 (rounded)
132,069(rounded)
$ 384,870
400,208
$ .96
132,069
$ 126,786
69,000a
$ 195,786
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
$ 3,177,090 c
$ 317,709e
195,786
$121,923
a.
$111,900
117,696
121,923
$351,519
Refrain from engaging in any activity that would prejudice Lindley's ability to
carry out her duties ethically.
McGraw-Hill/Irwin
Inc.
5-54
The steps Kara Lindley could take to resolve this ethical conflict are as follows:
She should also discuss the situation with an objective advisor to clarify the
issues involved and obtain an understanding of possible courses of action.
If the ethical conflict still exists after exhausting all levels of internal review,
then she may have no other course of action than to resign from the
company and submit an informative memorandum to an appropriate
representative of the company.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
2.
Queensland Electronics should not continue with its plans to emphasize the Zodiac
model and phase out the Novelle model. As shown in the following activity-based
costing analysis, the Zodiac model has a gross margin of less than 1 percent, while
the Novelle model generates a gross margin of nearly 42 percent.
Cost per event for each cost driver:
Soldering....................
Shipments...................
Quality control............
Purchase orders.........
Machine power...........
Machine setups..........
$880,000
836,000
1,170,000
1,110,000
47,500
948,500
1,600,000 =
19,000 =
78,000 =
185,000 =
190,000 =
9,485 =
$.55
44.00
15.00
6.00
.25
100.00
Zodiac
Novelle
$2,316,000
196,000
304,000
$2,816,000
$ 4,642,000
462,000
3,344,000
$ 8,448,000
Assigned costs:
Solderingd.......................................................................
Shipmentse.....................................................................
Quality controlf...............................................................
Purchase ordersg...........................................................
Machine powerh.............................................................
Machine setupsi.............................................................
Total assigned costs.............................................................
Total cost...............................................................................
$ 220,000
167,200
315,900
632,700
3,800
450,000
$1,789,600
$4,605,600
$ 660,000
668,800
854,100
477,300
43,700
498,500
$ 3,202,400
$11,650,400
McGraw-Hill/Irwin
Inc.
5-56
Material.........................................
Direct labor...................................
c
Machine hours..............................
d
Soldering......................................
e
Shipments.....................................
f
Quality control..............................
g
Purchase orders...........................
h
Machine power.............................
i
Machine setups.............................
b
Novelle
4,000 $579
4,000 $49
4,000 $76
400,000 $.55
3,800 $44
21,060 $15
105,450 $6
15,200 $.25
4,500 $100
22,000 $211
22,000 $21
22,000 $152
1,200,000 $.55
15,200 $44
56,940 $15
79,550 $6
174,800 $.25
4,985 $100
Profitability analysis:
Sales..............................................................
Less: Cost of goods sold.............................
Gross margin................................................
Units sold......................................................
Per-unit calculations:
Selling price...........................................
Less: Cost of goods sold......................
Gross margin.........................................
Gross margin percentage.....................
Zodiac
Novelle
$4,640,000 $20,020,000
4,605,600 11,650,400
$ 34,400 $8,369,600
4,000
22,000
$1,160.00
1,151.40
$ 8.60
0.7%a
Total
$24,660,000
16,256,000
$ 8,404,000
$910.00
529.56
$380.44
41.8%b
$8.60/$1,160.00 = 0.7%
$380.44/$910.00 = 41.8%
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
McGraw-Hill/Irwin
Inc.
5-58
Using Ultratechs unit cost data, the total contribution margin expected from the PC
board is $4,720,000, calculated as follows:
Revenue................................................................................
Direct material......................................................................
Material-handling charge (10% of material).......................
Direct labor ($28 per hr.4 hr.)..........................................
Variable overhead ($8 per hr.4 hr.)*................................
Machine time ($20 per hr.1.5 hr.)....................................
Total cost.......................................................................
Unit contribution margin.....................................................
Total contribution margin (40,000$118).........................
Per Unit
$600
$280
28
112
32
30
$482
$118
Total for
40,000
Units
$24,000,000
$11,200,000
1,120,000
4,480,000
1,280,000
1,200,000
$19,280,000
$4,720,000
Revenue................................................................................
Direct material......................................................................
Material-handling charge (10% of material).......................
Direct labor ($28 per hr.1.5 hr.).......................................
Variable overhead ($8 per hr.1.5 hr.)*.............................
Machine time ($20 per hr..5 hr.)......................................
Total cost.......................................................................
Unit contribution margin.....................................................
Total contribution margin (65,000$60)...........................
Per Unit
$300
$160
16
42
12
10
$240
$60
Total for
65,000
Units
$19,500,000
$10,400,000
1,040,000
2,730,000
780,000
650,000
$15,600,000
$ 3,900,000
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
The pool rates, which apply to both the PC board and the TV board, are calculated as
follows:
Procurement............................
$800,000/4,000,000 = $.20 per part
Production scheduling...........
$440,000/110,000 = $4.00 per board
Packaging and shipping.........
$880,000/110,000 = $8.00 per board
Machine setup.........................
$892,000/278,750 = $3.20 per setup
Hazardous waste disposal.....
$96,000/16,000 = $6.00 per lb.
Quality control.........................
$1,120,000/160,000 = $7.00 per inspection
General supplies.....................
$132,000/110,000 = $1.20 per board
Machine insertion.................... $2,400,000/3,000,000 = $.80 per part
Manual insertion...................... $8,000,000/1,000,000 = $8.00 per part
Wave soldering........................
$264,000/110,000 = $2.40 per board
Using activity-based costing, the total contribution margin expected from the PC
board is $3,464,000, calculated as follows:
Revenue..................................................................................
Direct material........................................................................
Procurement ($.20 per part55 parts)...............................
Production scheduling..........................................................
Packaging and shipping........................................................
Machine setup ($3.20 per setup3 setups).......................
Hazardous waste disposal ($6 per lb..40 lb.)..................
Quality control
($7.00 per inspection2 inspections).........................
General supplies....................................................................
Machine insertion ($.80 per part36 parts).......................
Manual insertion ($8 per part19 parts)............................
Wave soldering......................................................................
Total cost
Unit contribution margin
Total contribution margin
McGraw-Hill/Irwin
Inc.
5-60
Per Unit
$600.00
$280.00
11.00
4.00
8.00
9.60
2.40
14.00
1.20
28.80
152.00
2.40
$513.40
$86.60
Total for
40,000
Units
$24,000,000
$11,200,000
440,000
160,000
320,000
384,000
96,000
560,000
48,000
1,152,000
6,080,000
96,000
$20,536,000
$3,464,000
Revenue................................................................................
Direct material......................................................................
Procurement ($.20 per part26 parts)..............................
Production scheduling........................................................
Packaging and shipping......................................................
Machine setups ($3.20 per setup2 setups)....................
Hazardous waste disposal ($6 per lb..03 lb.)................
Quality control ($7.00 per inspection x 1 inspection)........
General supplies..................................................................
Machine insertion ($.80 per part25 parts).....................
Manual insertion ($8.00 per part x 1 part)...........................
Wave soldering.....................................................................
Total cost.........................................................................
Unit contribution margin.....................................................
Total contribution margin....................................................
4.
Per Unit
$ 300.00
$160.00
5.20
4.00
8.00
6.40
.18
7.00
1.20
20.00
8.00
2.40
$222.38
$77.62
Total for
65,000
Units
$19,500,000
$10,400,000
338,000
260,000
520,000
416,000
11,700
455,000
78,000
1,300,000
520,000
156,000
$14,454,700
$ 5,045,300
The analysis using the previously reported costs indicates that the unit contribution of
the PC board is almost double that of the TV board. On this basis, 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 costing does not support this
decision. This analysis shows that the unit dollar contribution from each of the boards
is not as different as previously believed, and the total contribution from the TV board
exceeds that of the PC board by almost $1.6 million. As a percentage of selling price,
the contribution from the TV board is almost double that of the PC board (26 percent
versus 14 percent).
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
a.
b.
$300,000
180,000
$ 480,000
2,400,000
$ 72,000
15,000
93,000
540,000
225,000
30,000
30,000
45,000
1,050,000
$3,930,000
The unit costs of Tuff Stuff and Ruff Stuff, with overhead assigned on the basis
of direct-labor hours, are calculated as follows:
Tuff Stuff:
Direct material........................................................
Direct labor ($24.00 per hour2 hours)*............
Overhead ($10.50 per hour2 hours)*...............
Tuff Stuff unit cost...........................................
$15.00
48.00
21.00
$84.00
40,000
60,000
100,000
McGraw-Hill/Irwin
Inc.
5-62
$ 9.00
72.00
31.50
$112.50
40,000
60,000
100,000
The total budgeted cost of the Fabricating and Assembly Departments, after
separation of costs into the activity cost pools, is calculated as follows:
Total
Direct material...........
Direct labor...............
Overhead:
Indirect labor
Fringe benefits
Indirect material
Power
Setup
Quality assurance
Other utilities
Depreciation
Total overhead
Total cost
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
$480,000
2,400,000
$ 72,000
15,000
93,000
540,000
225,000
30,000
30,000
45,000
$1,050,000
$3,930,000
Fabricating
Percent
Dollars
100%
$ 480,000
74%
1,776,000
76%
80%
80%
50%
78%
54,720
12,000
60,000
480,000
15,000
24,000
15,000
35,100
$ 695,820
$2,951,820
Assembly
Percent
Dollars
26%
$624,000
24%
20%
$ 17,280
3,000
33,000
60,000
210,000
6,000
15,000
9,900
$354,180
$978,180
20%
50%
22%
The unit costs of the products using activity-based costing are calculated as follows:
Fabricating:
Total cost..............................................................................................................
$2,951,820
Less: Direct material............................................................................................
480,000
Less: Direct labor................................................................................................
1,776,000
Pool overhead cost..............................................................................................
$ 695,820
Hours:
88,000 hours
Tuff Stuff (4.4 hours 20,000 units).................................................
120,000 hours
Ruff Stuff (6.0 hours 20,000 units).................................................
Total machine hours................................................................
208,000 hours
Tuff Stuff..........................................................................................
1,000
Ruff Stuff..........................................................................................
272
Total setups............................................................................
1,272
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
2.
Again, based on the product costs reported by the firm's traditional, volume-based
product-costing system, product W appears to be very profitable. As in requirement
(1), however, the validity of this assessment depends on the accuracy of the reported
product costs.
3.
Gigabyte's competitors have moved aggressively into the market for gismos (product
G), but they have abandoned the whatchamacallit (product W) market to Gigabyte.
These competing firms apparently believe they can sell gismos at a much
lower price than Gigabyte's management feels is feasible. This evidence suggests that
Gigabyte's competitors may believe their product cost for gismos is below Gigabyte's
reported product cost. In contrast, Gigabyte's competitors apparently believe that
they cannot afford to sell whatchamacallits at Gigabyte's current price of $600.
Perhaps the competing firms' reported production costs for product W are higher than
the cost reported by Gigabyte's product-costing system.
The danger to Gigabyte is that the company will be forced out of the market for
its second largest selling product. This could be disastrous to Gigabyte, Inc.
4.
Product
G
T
W
Total
Raw-Material
Cost per Unit
$105.00
157.50
52.50
Annual
Volume
8,000
15,000
4,000
Annual
Raw-Material
Cost
$ 840,000
2,362,500
210,000
$3,412,500
Percentage
of Total
Raw-Material
Cost*
25%
69%
6%
100%
McGraw-Hill/Irwin
Inc.
5-66
$105.00
48.00
110.25
.43
31.50
82.03
45.25
$422.46
Product
T
Product
W
$157.50
36.00
122.50
.32
46.20
120.75
6.90
$490.17
$52.50
24.00
238.88
1.89
157.50
39.38
142.21
$656.36
Machinery:
Product G: ($3,675,000 24%)
Product T:
($3,675,000 50%)
Product W: ($3,675,000 26%)
b
Machine setup:
Product G: ($15,750 22%)
Product T:
($15,750 30%)
Product W: ($15,750 48%)
c
Inspection:
Product G: ($1,575,000 16%)
Product T:
($1,575,000 44%)
Product W: ($1,575,000 40%)
d
Material handling:
Product G: ($2,625,000 25%)
Product T:
($2,625,000 69%)
Product W: ($2,625,000 6%)
e
Engineering:
Product G: ($1,034,250 35%)
Product T:
($1,034,250 10%)
Product W: ($1,034,250 55%)
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
8,000 units =
15,000 units =
4,000 units =
$110.25
$122.50
$238.88
8,000 units =
15,000 units =
4,000 units =
$.43
$.32
$1.89
8,000 units =
15,000 units =
4,000 units =
$ 31.50
$ 46.20
$157.50
8,000 units =
15,000 units =
4,000 units =
$ 82.03
$120.75
$ 39.38
8,000 units =
15,000 units =
4,000 units =
$ 45.25
$ 6.90
$142.21
Comparison of reported product costs, new target prices, and actual selling prices:
Product
G
Reported product costs:
Traditional, volume-based costing system
Activity-based costing system
Target price based on new product costs
(150%new product cost)
Current actual selling price
Product
T
Product
W
$573.00
422.46
$508.50
490.17
$286.50
656.36
633.69
639.00
735.26
762.75
984.54
600.00
McGraw-Hill/Irwin
Inc.
5-68
Today
To:
From:
I.M. Student
Subject:
Implement the new activity-based costing system and revise its database frequently.
2.
Lower the target price of gismos to $639, the current actual selling price. This price is
slightly over our usual 50 percent markup over product cost.
3.
Consider lowering the price of thingamajigs to $736 in order to increase demand. The
lower price still yields Gigabyte a 50 percent markup over product cost.
4.
Raise the price of whatchamacallits to $985. If the product does not sell at that price,
consider discontinuing the product line.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 8/e
Product
T
$573.00
$508.50
$286.50
422.46
$150.54
490.17
$ 18.33
656.36
$(369.86)
Traditional
system
overcosts
product
G by
$150.54
per unit
Product volume......................................................
Total amount of cost distortion for entire
product line......................................................
Product
W
Traditonal
system
overcosts
product
T by
$18.33
per unit
Traditional
system
undercosts
product
W by
$369.86
per unit
8,000
15,000
4,000
$1,204,320
$(1,479,440)
274,950
McGraw-Hill/Irwin
Inc.
5-70
Step 1:
(b)
Step 2:
(c)
Step 4:
Storing dough until bagel machine is free. (Could move toward a JIT
system for dough mixing.)
(d)
Step 5:
(e)
Step 5:
Keeping cut-out bagels until boiling vat is free. (Could move toward
a JIT system.)
(f)
Step 6:
(g)
Step 7:
(h)
Step 7:
(i)
Step 7:
(j)
Step 9:
(k)
Step 10:
(l)
Step 11:
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Ingredients, such as flour and raisins, are received and inspected in the morning
or afternoon they are to be used. Then they are placed on a conveyor belt that
transports the ingredients to the mixing room next door.
(b)
(c)
The board is tipped automatically and the dough slides into the hopper of a
bagel machine. This machine pulls off a piece of dough, rolls it into a cylindrical
shape, and then squeezes it into a doughnut shape. The bagel machines can be
adjusted in a setup procedure to accommodate different sizes and styles of
bagels. Workers remove the uncooked bagels and place them on a tray. The
trays are set on the conveyor, which carries the uncooked bagels into an
adjoining room.
(d)
This room houses three 50-gallon vats of boiling water. The bagels are boiled for
approximately one minute.
(e)
Bagels are removed from the vats with a long-handled strainer and placed on a
wooden board. The boards full of bagels are placed on the conveyor, which
transports them to the oven room.
(f)
The two ovens contain eight racks that rotate but remain upright, much like the
seats on a Ferris wheel. A rack full of bagels is finished baking after one
complete revolution in the oven. When a rack full of bagels is removed from the
oven, a fresh rack replaces it. The oven door automatically opens and closes as
each rack completes a revolution in the oven.
(g)
After the bagels are removed from the oven, they are placed in baskets for
cooling.
(h)
While the bagels are cooling, they are inspected. Misshapen bagels are removed
and set aside for sale at a reduced price.
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(2)
(i)
After the bagels are cool, the wire baskets are placed on the conveyor and
transported to the packaging room next door.
(j)
Here the bagels are dumped automatically into the hopper on a bagging
machine. This machine packages a half dozen bagels in each bag and seals the
bag with a twist tie.
(k)
Then the packaged bagels are placed in cardboard boxes, each holding 24 bags.
(l)
The boxes are placed in the freezer, where the bagels are frozen and stored for
shipment. The freezer has a door in the packaging room, and another door in the
shipping/receiving room.
(3)
New equipment:
Bodacious Bagels, Inc. would need to purchase a new conveyor system that would
transport partially completed bagels between production steps. The conveyor would
tip the bagels automatically into appropriate production machines at various points in
the process. Also needed would be an efficient oven that would open and close
automatically (and quickly) to minimize heat loss.
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Process View
1
7
11
Activity analysis
2
8
3
9
12
13
ROOT
CAUSES
4
10
14
15
16
ACTIVITY
TRIGGERS
Activity evaluation
ACTIVITIES
PERFORMANCE
MEASURES
(see req. (4) for examples)
Assignment of activity
costs to cost objects
using second-stage
cost drivers
COST OBJECTS
(Product lines: cooking
utensils, tableware,
flatware)
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3.
(9)
Realization by purchasing personnel that the ordered part will be (or may
be) late in arriving
(11)
Receipt of order
(12)
(13)
Vendor delay
Delay in placing order
Failure by purchasing personnel to make deadline clear
(11)
Use of vendor that has not been fully certified as a reliable supplier
Critical importance of parts
(12)
Misspecification of parts
Error by purchasing personnel in placing order
Vendor error
Inspector error
(13)
Misspecification of parts
Incomplete specifications
Poor product design
Error by purchasing personnel in placing order
Vendor error
*This list is not necessarily complete. Other root causes may exist.
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Number of vendors
Number of vendors that are precertified as dependable
(10)
(12)
(16)
Customer-profitability analysis:
Sales revenue......................................................................
Cost of goods sold..............................................................
Gross margin.......................................................................
Selling and administrative costs:
General selling costs....................................................
General administrative costs.......................................
Customer-related costs:
Sales activity...........................................................
Order taking.............................................................
Special handling......................................................
Special shipping......................................................
Total selling and administrative costs...............................
Operating income................................................................
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Caltex
Computer
Trace
Telecom
$380,000
160,000
$220,000
$247,600
124,000
$123,600
$ 48,000
38,000
$ 36,000
32,000
16,000
6,000
80,000
18,000
$206,000
$ 14,000
12,000
8,000
60,000
20,000
$168,000
$ (44,400)
Customers*
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Customer
Numbera
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Customer
Network-All, Inc.
Golden Gate Service Associates
Graydon Computer Company
Mid-State Computing Company
Caltex Computerb
The California Group
Tele-Install, Inc.
Trace Telecomc
Operating
Income
Cumulative
Operating
Income
$186,000
142,000
120,000
84,000
14,000
12,000
(36,000)
(44,400)
$186,000
328,000
448,000
532,000
546,000
558,000
522,000
477,600
Cumulative
Operating
Income as a
Percentage of
Total
Operating
Income
39%
69%
94%
111%
114%
117%
109%
100%
2.
Memorandum
Date:
Today
To:
From:
I. M. Student
Subject:
Customer-profitability profile
The attached customer-profitability profile shows that two of our customer relationships are
unprofitable (Tele-Install, Inc. and Trace Telecom). As the profile shows, over half of our
operating income is generated by our two most profitable customer relationships, and 94
percent of our operating profit is generated by our three most profitable customers.
An activity-based costing analysis of customer-related costs provided the data for the
customer-profitability analysis portrayed in the profile.
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SOLUTIONS TO CASES
CASE 5-68 (45 MINUTES)
1.
Activity-based costing (ABC) differs from traditional costing in that it focuses on activities
that consume resources as the fundamental cost drivers. ABC is a two-stage cost
assignment process focused on causality and the determination of cost drivers. It usually
uses several different activities to assign costs to products or services. Therefore, it is
more detailed and more accurate than traditional costing. It also helps managers
distinguish between value added and non-value added activities.
2.
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JY-63
Estimated
20x5
Product
Cost
Direct material:
No cost increase.........................
Direct labor:
Direct labor
$370,370
1.08 cost increase*...............
Material handling:
Number of parts
5
units produced.....................
5,000
25,000
$1.60 per unit........................
Inspection:
Inspection hours
5,000
$20 per hour.........................
Machining:
Machining activity in
15,000
hours
$20 per hour.........................
Assembly:
Assembly activity in
6,000
hours
$40 per hour.........................
Total cost......................................
RX-67
20x4
Cost
Data
$2,000,000
RX-67
Estimated
20x5
Product
Cost
$3,500,000
$185,186
400,000
200,000
10
5,000
50,000
40,000
80,000
7,500
100,000
150,000
30,000
300,000
600,000
5,500
240,000
220,000
$3,080,000
$4,750,000
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JY-63
$3,621,000
RX-67
$4,459,000
Total
$8,080,000
$ 480,000
2,000,000
400,000
40,000
100,000
300,000
240,000
$3,560,000
431,200
$3,128,800
$ 492,200
$ 600,000
3,500,000
200,000
80,000
150,000
600,000
220,000
$5,350,000
665,000
$4,685,000
$ (226,000)
$1,080,000
5,500,000
600,000
120,000
250,000
900,000
460,000
$8,910,000
1,096,200
$7,813,800
$ 266,200
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2.
Regular
Model
Advanced
Model
Deluxe
Model
$210.00
110%
$231.00
$430.00
110%
$473.00
$464.00
110%
$510.40
Advanced
Model
$50.00
40.00
416.00
Deluxe
Model
$84.00
40.00
153.60
Direct material..................................................
Direct labor......................................................
Machinery depreciation and maintenancea. . .
Engineering, inspection and
repair of defectsb........................................
Purchasing, receiving, shipping, and
material handlingc......................................
Factory depreciation, taxes, insurance,
and miscellaneous overhead costsd........
Total..................................................................
Regular
Model
$ 20.00
20.00
62.40
34.08
87.00
68.15
30.55
104.00
58.50
24.99
$192.02
178.50
$875.50
51.17
$455.42
Pool I:
Depreciation, machinery...............................................................
Maintenance, machinery...............................................................
Total................................................................................................
Regular:
Advanced:
Deluxe:
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($3,200,00039%) 20,000 =
($3,200,00013%) 1,000 =
($3,200,00048%) 10,000 =
$2,960,000
240,000
$3,200,000
$ 62.40
$416.00
$153.60
Pool II:
Engineering....................................................................................
Inspection and repair of defects..................................................
Total................................................................................................
Regular:
Advanced:
Deluxe:
$ 700,000
750,000
$1,450,000
$ 34.08
$ 87.00
$ 68.15
Pool III:
Purchasing, receiving, and shipping...........................................
Material handling...........................................................................
Total................................................................................................
Regular:
Advanced:
Deluxe:
$ 30.55
$104.00
$ 58.50
Pool IV:
Depreciation, taxes, and insurance for factory...........................
Miscellaneous manufacturing overhead.....................................
Total................................................................................................
Regular:
Advanced:
Deluxe:
($1,190,000 42%)
($1,190,000 15%)
($1,190,000 43%)
$ 500,000
800,000
$1,300,000
20,000 =
1,000 =
10,000 =
$ 600,000
590,000
$1,190,000
$ 24.99
$178.50
$51.17
3.
Regular
Model
Product costs based on activity-based
costing system..................................................
110%........................................................................
New target price........................................................
$192.02
110%
$211.22
Advanced
Model
$875.50
110%
$963.05
Deluxe
Model
$455.42
110%
$500.96
The new target price of the regular model, $211.22, is lower than the current actual
selling price, $220.
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MEMORANDUM
Date:
Today
To:
From:
I.M. Student
Subject:
Product costing
Based on the cost data from our traditional, volume-based product-costing system,
our regular model is not very profitable. Its reported actual contribution margin is only
$10 ($220 $210). However, the validity of this conclusion depends on the accuracy of
the product costs reported by our product-costing system. Our competitors are
selling motors like our standard model for $212. This price suggests that their product
cost is substantially below our previously reported cost of $210.
Our new, activity-based costing system reveals serious product cost
distortions stemming from our old costing system. The new costing system shows
that the regular model costs only $192.02, which implies a target price of $211.22. This
price is lower than our current actual selling price and roughly consistent with the
price our competitors are charging.
In contrast, our new product-costing system reveals that the advanced model's
product cost is $875.50 instead of the previously reported cost of $430. The new
product cost suggests a target price of $963.05 for the advanced model, rather than
$473, which was our previous target price for the advanced model.
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The company should adopt and maintain the activity-based costing system. The price
of the regular model should be lowered to the $212. Lowering the price should enable
the firm to regain its competitive position in the market for the regular model. Further
price cuts should be considered if marketing studies indicate such a move will
increase demand.
The price of the advanced model should be set near the target price of $963.05.
If the advanced model does not sell at this price, management should consider
discontinuing the product line. Input from the marketing staff should be sought before
such an action is taken. An important consideration is the extent to which sales in the
regular model and deluxe model markets depend on the firm's offering a complete
product line.
A slight price reduction should be considered for the deluxe model (from
$510.40 down to $500.96). However, the product cost distortion from the old costing
system did not affect this model as seriously as it did the other two.
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Deluxe
Model
$210.00
$ 430.00
$464.00
192.02
$ 17.98
875.50
$(445.50)
455.42
$ 8.58
Traditional
system
overcosts
Regular
model by
$17.98
per unit
Product volume......................................................
Total amount of cost distortion for entire
product line........................................................
Advanced
Model
Traditonal
system
undercosts
Advanced
model by
$445.50
per unit
Traditional
system
overcosts
Deluxe
model by
$8.58
per unit
20,000
1,000
10,000
$359,600
$(445,500)
$85,800
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5-86
The controller, Erin Jackson, has acted ethically up to this point. She correctly
pointed out to the president that the firm's traditional, volume-based product-costing
system was distorting the reported product cost for the company's three products.
She designed an activity-based costing system to provide more accurate productcosting data.
2.
The production manager, Alan Tyler, is not acting ethically. Although we can
sympathize with his plight, we cannot condone his pressuring the controller to
suppress or alter the new product-costing data she has compiled.
What can Tyler do that is ethical and has the potential for positive results?
First, he could take a hard look at the deluxe model's production process. Are there
non-value-added activities that could be reduced or eliminated? Second, he could
argue to the president that the company should carry a full product line, if he has
reason to believe that is the firm's best strategy.
3.
Jackson has an ethical obligation to the president, to the company, to her profession,
and to herself to report accurate product-costing data to the president. There is
nothing wrong with her offer to her friend to go over her analysis again to verify its
accuracy. However, she must report what she finds with no suppression or alteration
of the data. Several of the ethical standards for managerial accounting apply in this
case. (See Chapter 1 for a listing of these standards.) The standards that are most
clearly relevant include the following:
Integrity:
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