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Chapter 9

Activity-Based Costing

True/False Questions

T F 1. Traditional product costing systems (e.g., job and process costing) are designed primarily
to accumulate cost information for financial reporting.

Answer: True Difficulty: Simple Learning Objective: 1


AACSB: Analytic

T F 2. Applied manufacturing overhead for product costing purposes may lead to inappropriate
managerial decisions because a single cost driver is used as the allocation base.

Answer: True Difficulty: Simple Learning Objective: 1


AACSB: Analytic

T F 3. The death spiral concept refers to the process of continually decreasing selling prices to
meet foreign competition.

Answer: False Difficulty: Simple Learning Objective: 1


AACSB: Analytic

T F 4. The usual cost objects used in a first-stage product cost allocation are the manufacturing
overhead accounts themselves.

Answer: True Difficulty: Moderate Learning Objective: 2


AACSB: Analytic

T F 5. The basic difference between a first-stage cost allocation and a second-stage cost
allocation is that cost pools are not used in first-stage cost allocations.

Answer: False Difficulty: Moderate Learning Objective: 2


AACSB: Analytic

T F 6. Predetermined overhead rates are used in first-stage cost allocations but not in second-
stage cost allocations.

Answer: False Difficulty: Simple Learning Objective: 2


AACSB: Analytic

210 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


T F 7. In general, variable costs are allocated using a first-stage cost allocation system and fixed
costs are allocated using a second-stage cost allocation system.

Answer: False Difficulty: Simple Learning Objective: 2


AACSB: Analytic

T F 8. A company that uses a second-stage cost allocation system will have one unique
allocation base for each cost pool.

Answer: True Difficulty: Moderate Learning Objective: 2


AACSB: Analytic

T F 9. The single-stage cost allocation system uses a plant wide rate because the cost pool is the
entire plant.

Answer: True Difficulty: Simple Learning Objective: 3


AACSB: Analytic

T F 10. The department cost allocation method provides more accurate product cost information
for managerial decision-making that the plant wide cost allocation method.

Answer: True Difficulty: Simple Learning Objective: 3


AACSB: Analytic

T F 11. The plant wide cost allocation method can be used by either a manufacturer or a
merchandiser.

Answer: True Difficulty: Simple Learning Objective: 3


AACSB: Analytic

T F 12. The plant wide cost allocation method should be used by companies that manufacture
products that are similar and use the same resources.

Answer: True Difficulty: Moderate Learning Objective: 3


AACSB: Analytic

T F 13. Activity-based costing (ABC) is a second-stage cost allocation system that (1) allocates
costs to activities and (2) then to products based on their use of the activities.

Answer: True Difficulty: Simple Learning Objective: 4


AACSB: Analytic

Test Bank, Chapter 9 211


T F 14. The basic difference between the department cost allocation method and activity-based
costing (ABC) is the number of stages involved in allocating costs to products.

Answer: False Difficulty: Moderate Learning Objective: 4


AACSB: Analytic

T F 15. In general, the cost drivers used in activity-based costing (ABC) cause an activity's costs
to change.

Answer: True Difficulty: Simple Learning Objective: 4


AACSB: Analytic

T F 16. The best cost drivers are activities that are causally related to the costs being allocated.

Answer: True Difficulty: Simple Learning Objective: 4


AACSB: Analytic

T F 17. The first-stage allocation in activity-based costing (ABC) allocates costs to departments
using appropriate cost drivers.

Answer: False Difficulty: Moderate Learning Objective: 4


AACSB: Analytic

T F 18. Direct labor cost (DLC) and direct labor hours (DLH) are examples of volume-related
cost drivers in the cost hierarchy.

Answer: True Difficulty: Moderate Learning Objective: 4


AACSB: Analytic

T F 19. The number of products produced is an example of a facility-related cost driver in the
cost hierarchy.

Answer: False Difficulty: Simple Learning Objective: 4


AACSB: Analytic

T F 20. Activity-based costing (ABC) provides more detailed measures of costs than do plant
wide or department allocation methods.

Answer: True Difficulty: Simple Learning Objective: 6


AACSB: Analytic

212 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


T F 21. Before using activity-based costing (ABC), managers must apply the cost-benefit
principle to the additional recordkeeping costs associated with ABC.

Answer: True Difficulty: Simple Learning Objective: 6


AACSB: Analytic

T F 22. In general, traditional product costing methods allocate less cost to low-volume products
and more costs to high-volume products than activity-based costing (ABC).

Answer: True Difficulty: Complex Learning Objective: 6


AACSB: Analytic

T F 23. Activity-based costing (ABC) uses more overhead accounts than traditional product
costing systems.

Answer: True Difficulty: Simple Learning Objective: 7


AACSB: Analytic

T F 24. Using direct labor costs to allocate overhead costs in an activity-based costing (ABC)
system will encourage management to reduce labor costs.

Answer: True Difficulty: Moderate Learning Objective: 7


AACSB: Analytic

T F 25. In general, low-volume products (and services) have a lower degree of complexity
associated with them.

Answer: False Difficulty: Moderate Learning Objective: 7


AACSB: Analytic

T F 26. In general, traditional product costing methods have resulted in lower gross margins for
high-volume products and higher gross margins for low-volume products than activity-
based costing (ABC).

Answer: False Difficulty: Complex Learning Objective: 6


AACSB: Analytic

T F 27. When overhead is applied based on the volume of output, high-volume products tend to
"subsidize" low-volume products.

Answer: True Difficulty: Moderate Learning Objective: 7


AACSB: Analytic

Test Bank, Chapter 9 213


T F 28. Activity-based costing (ABC) can be applied to administrative activities (e.g.,
purchasing) but not to marketing activities.

Answer: False Difficulty: Simple Learning Objective: 8


AACSB: Analytic

T F 29. It is possible to apply activity-based costing (ABC) to segments of an organization


without applying it to the entire organization.

Answer: True Difficulty: Simple Learning Objective: 8


AACSB: Analytic

T F 30. In general, activity-based costing methods result in higher product costs per unit than
plant wide cost allocation methods.

Answer: False Difficulty: Moderate Learning Objective: 8


AACSB: Analytic

Multiple Choice Questions

Part A: Conceptual Questions

31. Which of the following statements is (are) true regarding the potential effects of using reported
product costs for decision making?

(A) Traditional product costing systems (e.g., job and process costing) are designed primarily to
accumulate cost information for financial reporting.
(B) Applied manufacturing overhead for product costing purposes may lead to inappropriate
managerial decisions because a single cost driver is used as the allocation base.

A) Only A is true
B) Only B is true.
C) Both A and B are true.
D) Neither A nor B is true.

Answer: C Difficulty: Simple Learning Objective: 1


AACSB: Analytic

32. Which of the following statements is (are) false regarding first-stage and second-stage cost
allocation methods?

(A) The basic difference between a first-stage cost allocation and a second-stage cost allocation
is that cost pools are not used in first-stage cost allocations.

214 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


(B) Predetermined overhead rates are used in first-stage cost allocations but not in second-stage
cost allocations.

A) Only A is false
B) Only B is false.
C) Neither A and B nor false.
D) Both A and B are false.

Answer: D Difficulty: Simple Learning Objective: 2


AACSB: Analytic

33. Activity-based costing (ABC) is a costing technique that uses a two stage allocation process.
Which of the following statements best describes these two stages?
A) The costs are assigned to activities, and then to the products based upon their use of the
activities.
B) The costs are assigned to departments, and then to the products based upon their use of
activity resources.
C) Service department costs are allocated to the production departments, and then to the
products based upon their use of the activities.
D) Indirect costs are assigned to activities, and then to the products based upon the direct cost
resources used by the activities.

Answer: A Difficulty: Simple Learning Objective: 2


AACSB: Analytic

34. Which of the following statements is true?


A) One of the lessons learned from activity-based costing (ABC) is that all costs are really a
function of volume.
B) The primary purpose of the plant wide and department allocation methods is allocating direct
costs to specific products.
C) A problem with activity-based costing (ABC) is that it requires more recordkeeping than
other methods.
D) Service department allocations are required for the plant wide and department allocation
methods.

Answer: C Difficulty: Simple Learning Objective: 3


AACSB: Analytic

35. Cost pools are used with

Plant wide Rates Department Rates


A) Yes No
B) No Yes
C) No No
D) Yes Yes

Test Bank, Chapter 9 215


Answer: D Difficulty: Simple Learning Objective: 3
AACSB: Analytic

36. A company is considering the use of a single plant wide rate. Under what conditions would this
choice be justified?
A) The company has many service departments but only one production department.
B) The company produces a few products with similar characteristics in a few departments.
C) The company has no service departments but many production departments.
D) The company produces a wide selection of products in a single production department.

Answer: B Difficulty: Moderate Learning Objective: 3


AACSB: Analytic

37. Which of the following should not be used as the allocation base in a company that appropriately
uses a single plant wide rate?
A) sales volume
B) machine hours
C) material costs
D) direct labor cost
E) direct labor hours

Answer: A Difficulty: Simple Learning Objective: 3


AACSB: Analytic

38. The electricity used for computerized machinery would be classified as a(n)
A) volume-related activity.
B) batch-related activity.
C) product-related activity.
D) facility-related activity.

Answer: A Difficulty: Simple Learning Objective: 4


AACSB: Analytic

39. The number of services provided by an accounting firm would be classified as a(n)
A) volume-related activity.
B) batch-related activity.
C) product-related activity.
D) facility-related activity.

Answer: C Difficulty: Moderate Learning Objective: 4


AACSB: Analytic

40. Activity analysis is one of the first stages in implementing an activity-based costing system.
Which of the following steps in "activity analysis" is usually performed first?

216 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


A) Classify all activities as value added or nonvalue added.
B) Record, from start to finish, the activities used to complete the product or service.
C) Identify the process objectives that are defined by what the customer wants from the process.
D) Improve the efficiency of all activities and develop plans to eliminate any nonvalued-added
activities.

Answer: B Difficulty: Moderate Learning Objective: 4


AACSB: Analytic

41. Which of the following costs is not related to a batch-related activity?


A) Material handling
B) Machine setups
C) Shipping costs
D) Compliance costs

Answer: D Difficulty: Moderate Learning Objective: 4


AACSB: Analytic

42. Which of the following measures is used by traditional costing systems as an allocation base for
allocating overhead costs to the units produced?
A) volume-related activities
B) batch-related activities
C) product-related activities
D) facility-related activities

Answer: A Difficulty: Simple Learning Objective: 4


AACSB: Analytic

43. Which of the following measures is used by activity-based costing (ABC) systems as an
allocation base for allocating overhead costs to the units produced
A) volume-related activities
B) batch-related activities
C) product-related activities
D) facility-related activities
E) all of the above are used by ABC systems

Answer: E Difficulty: Simple Learning Objective: 4


AACSB: Analytic

44. Which of the following statements is (are) true?

(1) Activity-based costs per unit are greater than volume-based costs per unit.
(2) Volume-based costing has typically resulted in lower gross margins for high volume products
and higher gross margins for low volume products.

Test Bank, Chapter 9 217


A) Only (1) is true.
B) Only (2) is true.
C) Both (1) and (2) are true.
D) Neither (1) nor (2) are true.

Answer: B Difficulty: Moderate Learning Objective: 6


AACSB: Analytic

45. Volume-based costing allocates indirect product costs based on the volume of output, using such
allocation bases as direct labor hours, machine hours, and the amount of direct material used in
the production process. Activity-based costing (ABC) has consistently shown that Volume-based
costing
A) overstates high volume products.
B) overstates low volume products.
C) understates high volume products.
D) understates low volume products.
E) More than one of the above is true_____________.

Answer: E Difficulty: Moderate Learning Objective: 6


AACSB: Analytic

46. Which of the following statements regarding traditional costing and activity-based costing is
false?
A) There are more overhead cost pools in ABC systems.
B) There are more cost allocation bases in ABC systems.
C) ABC cost pools are more homogeneous than the cost pools in traditional costing.
D) ABC systems use more first-stage cost allocations than traditional costing.

Answer: D Difficulty: Simple Learning Objective: 6


AACSB: Analytic

47. Which one of the following accounts is not used in an activity-based costing (ABC) system?
A) Materials Inventory
B) Work-in-Process Inventory
C) Finished Goods Inventory
D) Overhead Applied
E) Allocations Incurred

Answer: E Difficulty: Simple Learning Objective: 7


AACSB: Analytic

48. Companies using activity-based costing (ABC) have learned that costs are a function of
A) volume and activities.
B) time and complexity.

218 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


C) volume and time.
D) resources and time.
E) volume and resources.

Answer: A Difficulty: Simple Learning Objective: 7


AACSB: Analytic

Part B: Computational Questions

Use the following to answer questions 49-50:

Smelly Perfume Company manufactures and distributes several different products. They currently use a
plantwide allocation method for allocating overhead at a rate of $7 per direct labor hour. Cindy is the
department manager of Department C which produces Products J and P. Diane is the department
manager of Department D which manufactures Product X. The product costs (per case of 24 bottles) and
other information are as follows:

Products
J P X

Direct materials $100.00 $ 72.00 $48.00


Direct labor 42.00 31.50 12.00
Overhead 28.00 21.00 14.00
$170.00 $124.50 $74.00

Machine hours 4 2 3
Number of cases (per year) 300 500 600

49. If Smelly changes its allocation basis to machine hours, what is the total product cost per case for
Product P?
A) $163.50
B) $144.00
C) $138.15
D) $117.15
E) Some other answer _______________.

Answer: D Difficulty: Moderate Learning Objective: 5

Response:
Total overhead = $28(300) + $21(500) + $14(600) = $27,300
Total machine hours = 4(300) + 2(500) + 3(600) = 4,000
Overhead rate = $27,300/4,000 = $6.825/MH
Product cost for P $72.00 + $31.50 + $6.825(2) = $117.15
AACSB: Analytic

50. Department D has recently purchased and installed new computerized equipment for Product X.
This equipment will increase the overhead costs by $2,700 and decrease labor costs in

Test Bank, Chapter 9 219


Department D by $3.00 per case. Cindy believes that her department will be allocated some of
Department D's overhead if Smelly uses machine hours to allocate overhead. If Smelly uses
departmental rates, what are the product costs per case for Product X assuming Departments C
and D use direct labor hours and machine hours as their respective allocation bases?
A) $81.98
B) $79.50
C) $77.48
D) $75.00
E) Some other answer ________________.

Answer: A Difficulty: Simple Learning Objective: 5

Response: $48.00 (materials) + $9.00 (labor) +[(3 x $6.825) + ($2,700/600)] = $81.98


AACSB: Analytic

Use the following to answer questions 51-52:

RS Company manufactures and distributes two products, R and S. Overhead costs are currently allocated
using the number of units produced as the allocation base. The controller has recommended changing to
an activity-based costing (ABC) system. She has collected the following information:

Activity Cost Driver Amount R S

Production setups Number of setups $ 82,000 8 12


Material handling Number of parts 48,000 56 24
Packaging costs Number of units 130,000 80,000 50,000
$260,000
AACSB: Analytic

51. What is the total overhead allocated to Product R using the current system?
A) $113,600
B) $130,000
C) $146,400
D) $160,000
E) Some other answer _______________.

Answer: D Difficulty: Simple Learning Objective: 5

Response: $260,000/130,000 = $2.00 per unit


$2(80,000) = $160,000
AACSB: Analytic

52. What is the total overhead per unit allocated to Product R using activity-based costing (ABC)?
A) $2.60
B) $2.27

220 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


C) $2.00
D) $1.83
E) Some other answer _______________.

Answer: D Difficulty: Moderate Learning Objective: 5

Response: ($82,000/20)8 + ($48,000/80)56 + ($130,000/130,000)80,000 = $146,400


$146,400/80,000 = $1.83
AACSB: Analytic

Use the following to answer questions 53-56:

Terri Martin Nerdmeister, CPA provides bookkeeping and tax services to her clients. She charges a fee of
$60 per hour for bookkeeping and $90 per hour for tax services. Martin estimates the following costs for
the upcoming year:

Office supplies $16,000


Computer fees 24,000
Secretary's salary 30,000
Rent 18,000
$88,000

Operating profits declined last year and Ms. Martin has decided to use activity-based costing (ABC)
procedures to evaluate her hourly fees. She gathered the following information from last year's records:

Activity Levels
Activity Cost Driver Bookkeeping Tax services
Office supplies Hours billed 1,200 800
Computer fees Computer hours used 400 600
Secretary's salary Number of clients 16 84
Rent Types of services offered 1 1

53. What is the total cost allocated to the bookkeeping services using activity-based costing?
A) $24,000
B) $33,000
C) $35,000
D) $44,000
E) Some other answer _______________.

Answer: B Difficulty: Moderate Learning Objective: 5

Response: (16,000/2,000)1,200 + (24,000/1,000)400 + (30,000/100)16 + (18,000/2)1 = $33,000


AACSB: Analytic

54. Martin wants her hourly fees for the tax services to be 160% of their activity-based costs. What
is the fee per hour for tax services in the upcoming year?
A) $ 70.40

Test Bank, Chapter 9 221


B) $ 88.00
C) $110.00
D) $118.40
E) Some other answer _______________.

Answer: C Difficulty: Moderate Learning Objective: 5

Response:
($88,000 - $33,000)/800 = $68.75
(1.60)($68.75) = $110.00
AACSB: Analytic

55. Martin cannot change the hourly fee for the bookkeeping services because of the number of
competing firms in the area. If Martin wants to earn $60,000 in the upcoming year, how much
will she charge per hour for tax services?
A) $ 74
B) $ 90
C) $ 95
D) $106
E) Some other answer _______________.

Answer: C Difficulty: Complex Learning Objective: 5

Response:
[($60)(1,200) + x(800)] - $88,000 = $60,000; x = $95.00
AACSB: Analytic

56. A major client has requested bookkeeping service. However, Martin is already billing 100% of
her capacity (i.e., 2,000 hours per year) and is reluctant to shift 100 hours from her tax services to
meet this client's request. What is the minimum fee per hour that Martin could charge this client
for bookkeeping services and be no worse off than last year? Assume that activity-based costing
(ABC) is used.
A) $48.75
B) $60.00
C) $81.25
D) $90.00
E) Some other answer _______________.

Answer: D Difficulty: Complex Learning Objective: 5

Response:
[($60)(1,200) + $90(800) - $88,000 = $56,000
[($60)(1,200) + x(100) + $90(700) - $88,000 = $56,000; x = $90.00
AACSB: Analytic

Use the following to answer questions 57-59:

Zela Company is preparing its annual profit plan. As part of its analysis of the profitability of individual

222 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


products, the controller estimates the amount of overhead that should be allocated to the individual
product lines from the information provided below. (CMA based)

Wall Mirrors Specialty Windows


Units produced 40 20
Material moves per product line 5 15
Direct labor hours per unit 200 300

Budgeted material handling costs $50,000

57. Under a traditional costing system that allocates overhead on the basis of direct labor hours, the
materials handling costs allocated to one unit of wall mirrors would be
A) $1,000
B) $ 500
C) $2,000
D) $5,000
E) some other answer _______________.

Answer: B Difficulty: Moderate Learning Objective: 6

Response:
$50,000/(200 + 300) = $100
[($100(200)]/40 = $500
AACSB: Analytic

58. Under an activity-based costing (ABC) system, the materials handling costs allocated to one unit
of wall mirrors would be
A) $ 625.00
B) $ 312.50
C) $ 833.33
D) $1,000.00
E) some other answer _______________.

Answer: B Difficulty: Moderate Learning Objective: 6

Response:
$50,000/(5 + 15) = $2,500
[$2,500(5)]/40 = $312.50
AACSB: Analytic

59. Under an activity-based costing (ABC) system, the materials handling costs allocated to one unit
of specialty windows would be
A) $1875.00
B) $ 937.50
C) $ 312.50
D) $1,500.00
E) some other answer _______________.

Test Bank, Chapter 9 223


Answer: B Difficulty: Moderate Learning Objective: 6

Response:
$50,000/(5 + 15) = $2,500
[$2,500(15)]/20 = $1,875.00
AACSB: Analytic

Use the following to answer questions 60-61:

The LMN Company recently switched to activity-based costing (ABC) from the department allocation
method. The department method allocated overhead costs at a rate of $60 per machine hour. The cost
accountant for Department XZ has gathered the following data:

Activity Cost Drivers Rate


Material handling Tons of material handled $ 80
Machine setups Number of production runs $3,750
Utilities Machine hours $ 25
Quality control Number of inspections $ 500

During April, LMN purchased and used $100,000 of direct materials at $20 per ton. There were eight (8)
production runs using a total of 12,000 machine hours in April. The manager of Department XZ needed
12 inspections. Actual overhead costs totaled $820,000 for the month.

60. How much overhead costs were applied to the Work-in-Process Inventory during April?
A) $536,000
B) $720,000
C) $736,000
D) $820,000
E) some other answer _______________.

Answer: C Difficulty: Moderate Learning Objective: 5

Response: ($100,000/$20)80 + 8($3,750) + $25(12,000) + $500(12) = $736,000


AACSB: Analytic

61. What account would be credited for $400,000 during April?


A) Material Inventory
B) Work-in-Process Inventory
C) Overhead Incurred
D) Overhead Applied

Answer: A Difficulty: Simple Learning Objective: 7


AACSB: Analytic

Use the following to answer questions 62-65:

224 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


The Muskego National Bank is considering either a bankwide overhead rate or department overhead rates
to allocate $250,000 of indirect costs. The bankwide rate could be based on either direct labor hours
(DLH) or the number of loans processed. The departmental rates would be based on direct labor hours for
Consumer Loans and a dual rate based on direct labor hours and the number of loans processed for
Commercial Loans. The following information was gathered for the upcoming period:

Department DLH Loans Processed Direct Costs


Consumer 9,000 400 $200,000
Commercial 6,000 100 $150,000

62. If Muskego uses a bankwide rate based on direct labor hours, what would be the indirect costs
allocated to the Consumer Department?
A) $100,000
B) $150,000
C) $250,000
D) $350,000
E) some other answer _______________.

Answer: B Difficulty: Moderate Learning Objective: 3

Response:
$250,000/(9,000 + 6,000) = $16.6667/DLH
9,000(16.6667) = $150,000
AACSB: Analytic

63. If Muskego uses a bankwide rate based on the number of loans processed, what would be the total
costs for the Commercial Department?
A) $ 50,000
B) $150,000
C) $200,000
D) $250,000
E) some other answer _______________.

Answer: C Difficulty: Moderate Learning Objective: 3

Response:
$250,000 (400 + 100) = $500 per loan
100($500) = $50,000
$50,000 + $150,000 = $200,000
AACSB: Analytic

64. Management estimates that it costs $500 to analyze and close a commercial loan. This amount
has been included in the $250,000 of indirect costs. How much of the indirect costs should be
allocated to the Commercial Department?
A) $ 40,000
B) $ 50,000
C) $ 90,000

Test Bank, Chapter 9 225


D) $120,000
E) some other answer _______________.

Answer: C Difficulty: Moderate Learning Objective: 3


Response:
$250,000 - $500(100) = $200,000
$200,000/(400 + 100) = $400 per loan
$400(100) + $500(100) = $90,000
AACSB: Analytic

65. Management estimates that it costs $400 to analyze and close a commercial loan. What is the
overhead rate for the Commercial Loan Department, if Muskego allocates the remaining indirect
costs using direct labor hours?
A) $14.00 per hour plus $400 per loan
B) $16.67 per hour plus $400 per loan
C) $1,000 per loan
D) $ 500 per loan
E) some other answer _______________.

Answer: A Difficulty: Complex Learning Objective: 3

Response:
$250,000 - $400(100) = $210,000
$210,000/(9,000 + 6,000) = $14.00 per hour
AACSB: Analytic

Part C: Professional Examination Questions

66. Multiple (departmental) manufacturing overhead rates are considered preferable to a single (plant
wide) overhead rate when (CMA adapted)
A) manufacturing is limited to a single product flowing through identical departments in a fixed
sequence.
B) various products are manufactured that do not pass through the same departments or use the
same manufacturing techniques.
C) individual cost drivers cannot accurately be determined with respect to cause-and-effect
relationships.
D) the single or plant wide rate is related to several identified cost drivers.

Answer: B Difficulty: Simple Learning Objective: 3


AACSB: Analytic

67. What is the normal effect on the numbers of cost pools and cost assignment bases when an
activity-based costing (ABC) system replaces a traditional costing system? (CPA adapted)

Cost Pools Cost Assignment Bases


A) No effect No effect
B) Increase No effect

226 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


C) No effect Increase
D) Increase Increase

Answer: D Difficulty: Simple Learning Objective: 4


AACSB: Analytic

68. Which of the following would be a reasonable basis for assigning the materials handling costs to
the units produced in an activity-based costing (ABC) system?
A) number of production runs per year
B) number of components per completed unit
C) amount of time required to produce one unit
D) amount of overhead applied to each completed unit

Answer: B Difficulty: Moderate Learning Objective: 7


AACSB: Analytic

Use the following to answer questions 69-71:

A company has identified the following overhead costs and cost drivers for the coming year: (CIA
adapted)

Overhead Item Cost Driver Budgeted Cost Bud. Activity Level


Machine setup Number of setups $ 20,000 200
Inspection Number of inspections $130,000 6,500
Material handling Number of material moves $ 80,000 8,000
Engineering Engineering hours $ 50,000 1,000

Budgeted direct labor cost was $100,000 and budgeted direct material cost was $280,000. The following
information was collected on three jobs that were completed during the year:

Job 101 Job 102 Job 103


Direct materials $5,000 $12,000 $8,000
Direct labor $2,000 $2,000 $4,000
Units completed 100 50 200
Number of setups 1 2 4
Number of inspections 20 10 30
Number of mat’l moves 30 10 50
Engineering hours 10 50 10

69. If the company uses activity-based costing (ABC), how much overhead cost should be assigned
to Job 101?
A) $1,300
B) $2,000
C) $5,000
D) $5,600
E) some other answer _______________.

Test Bank, Chapter 9 227


Answer: A Difficulty: Moderate Learning Objective: 5

Response:
[($20,000/200) x 1] + [($130,000/6,500) x 20] + [($80,000/8,000) x 30] +
[($50,000/1,000) x 10] = $1,300
AACSB: Analytic

70. If the company uses activity-based costing (ABC), what is the cost of each unit of Job 102?
A) $340
B) $392
C) $440
D) $520
E) some other answer ______________.

Answer: A Difficulty: Complex Learning Objective: 5

Response:
[($20,000/200) x 2] + [($130,000/6,500) x 10] + [($80,000/8,000) x 10] +
[($50,000/1,000) x 50] = $3,000
$12,000 + 2,000 + 3,000 = $17,000
$17,000/50 = $340
AACSB: Analytic

71. The company prices its products at 140% of cost. If the company uses activity-based costing
(ABC), the price of each unit of Job 103 would be
A) $ 98
B) $100
C) $116
D) $140
E) some other answer _______________.

Answer: A Difficulty: Complex Learning Objective: 5

Response:
[($20,000/200) x 4] + [($130,000/6,500) x 30] + [($80,000/8,000) x 50] +
[($50,000/1,000) x 10] = $2,000
$8,000 + 4,000 + 2,000 = $14,000
[$14,000(1.40)]/20= $98
AACSB: Analytic

Essay Questions

72. Wayne Shen established Windy City Placement Service (WCPS) to provide executive counseling
and job placement services to its clients. Wayne charges a fee of $450.00 per hour for each
service. The revenues and costs for the year are shown in the following income statement:

Executive Placement Total

228 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


Counseling Service
Revenue $99,000 $202,500 $301,500
Expenses:
Administrative Support 60,000
Transportation, etc. 54,000
Equipment 30,000
Profit $157,500

Wendy has kept good records of the following data for cost allocation purposes:

Activity Level
Activity Cost Driver Executive Counseling Placement Service
Administrative support Number of clients 9 6
Transportation, etc. Number of visits 150 225
Equipment Computer hours 1,350 1,050

Required:
(a) Complete the income statement using activity-based costing and WCPSs three cost drivers.
(b) Recompute the income statement using direct labor-hours as the only allocation base (220
hours for teen counseling; 450 hours for executive coaching).
(c) How might Wayne's decisions be altered if he were to allocate all overhead costs using direct
labor-hours?
(d) Under what circumstances would the labor-based allocation and activity-based costing (using
Wayne's three cost drivers) result in similar profit results?

Answer:

Executive Placement
a. Account Rate Counseling Service Total
Revenue $99,000 $202,500 $301,500
Expenses:
a d
Administrative support $4,000 36,000 24,000 60,000
b e
Transportation 144 21,600 32,400 54,000
c f
Equipment. 12.50 16,875 13,125 30,000
Profit $ 24,525 $132,975 $157,500

a$4,000 per client = $60,000/15 clients


b$144 per visit = $54,000/375 visits
c$12.50 per computer hour = $30,000/2,400 hours
d$36,000 = $4,000 per client x 9 clients
e$21,600 = $144 per hour x 150 visits
f$16,875 = $12.50 per computer hour x 1,350 hours

Executive Placement
b. Account Rate Counseling Service Total
Revenue $ 99,000 $202,500 $301,500
a b
Expenses $214.925 47,282 96,718 144,000
Profit $ 51,718 $105,782 $157,500

Test Bank, Chapter 9 229


a$301,500 revenue/$450 per hour = 670 hours of labor
$214.925 per labor hour = $144,000 of expenses/670 hours
b$47,284 = $214.925 per labor hour x 220 hours of labor

C) Under labor-based costing, teen counseling and executive coaching appear equally profitable
(relative to revenues), so Wayne will not emphasize one or the other. However, using ABC,
Windy City Placement Service appears to be much more profitable.
D) ABC and traditional costing systems generally yield comparable product-line profits when
overhead is a small portion of costs, or when cost drivers are highly correlated with the volume-
related allocation base. In this case, labor hours were distributed 32.8% to Executive Counseling
and 67.2% to Placement Service. If Wayne's three cost drivers were each also distributed 32.8%
to Executive Counseling and 67.5% to Placement Service, the labor-hour allocation and ABC
would have been identical.
AACSB: Analytic

73. Delta Parts, Inc., recently switched to activity-based costing from the department allocation
method. The Fabrication Department manager has estimated the following cost drivers and rates:

Activity Centers Cost Drivers Rate per Cost Driver Unit


Materials handling Pounds of material handled $25.20 per pound
Quality inspections Number of inspections $315 per inspection
Machine setups Number of machine setups $3,780 per setup
Running machines Number of machine-hours $31.50 per hour

Direct materials costs were $420,000, and direct labor costs were $210,000 during July, when the
Fabrication Department handled 5,250 pounds of materials, made 1,050 inspections, had 56
setups, and ran the machines for 21,000 hours.
Required
Use T-accounts to show the flow of materials, labor, and overhead costs from the four overhead
activity centers through work-in-process inventory and out to finished goods inventory. Use the
accounts materials inventory, wages payable, work-in-process inventory, finished goods
inventory, and four overhead applied accounts.

Answer:

Materials Inventory
$420,000
Wages Payable
$210,000

Overhead Applied:
Materials Handling
5,250 pounds x $25.20
per pound = $132,300 to
WIP

Overhead Applied:
Quality Inspections

230 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


1,050 inspections x $315
per inspection =
$330,750 to WIP

Overhead Applied:
Machine Setups
56 setups x $3,780 per
setup = $211,680 to WIP

Overhead Applied:
Running Machines
21,000 hours x $31.50
per hour = $661,500 to
WIP
AACSB: Analytic

74. Platt Sports Products manufactures and distributes three types of golf clubs: beginners,
intermediate, and advanced. The materials used in these clubs increases in each level and allows
for more precise balancing and longer wear. Production is highly automated for the beginners'
clubs, whereas the intermediate and advanced clubs require a varying degree of labor, depending
on the intricacy of the balancing process. Platt applies all indirect costs according to a
predetermined rate based on direct labor hours. A consultant recently suggested that Platt switch
to an activity-based costing (ABC) system, and identified the following cost breakdown for the
upcoming year:

Estimated
Activity Recommended Cost Drivers Costs Cost Driver
Order processing Number of orders $ 52,500 125 orders
Production setup Number of production runs $210,000 75 runs
Materials handling Pounds of materials used $375,000 125,000 lbs.
Machine depr. and maintenance Machine hours $322,000 20,000 hours
Quality control Number of inspections $ 80,000 40 inspections
Packing Number of units $ 14,000 280,000 units

In addition, management estimates 50,000 direct labor hours will be used in the upcoming year at
a rate of $14 per hour.

Assume that the following activity took place in the first month of the upcoming year:

Beginners Intermediate Advanced

Number of units produced 20,000 8,000 3,000


Direct material costs $20,800 $13,000 $8,000
Direct labor hours 500 1,000 2,000
Number of orders 6 4 3
Number of production runs 2 2 3
Pounds of material 8,000 3,200 1,500
Machine hours 1,200 300 200

Test Bank, Chapter 9 231


Number of inspections 3 3 2
Number of units shipped 18,000 7,500 2,500

Required:
A) Compute the production costs for each product in the first month of the upcoming year using
direct labor hours as the allocation base.
B) Compute the production costs for each product in the first month of the upcoming year using
machine hours as the allocation base.
C) Compute the production costs for each product in the first month of the upcoming year using
activity-based costing.

Answer:
(A) Total estimated costs = $1,053,500
$1,053,500/50,000 = $21.07/DLH

Beginning Intermediate Advanced


Direct materials $20,800 $13,000 $8,000
Direct labor 7,000 14,000 28,000
Overhead 10,535 21,070 42,140
Total $38,335 $48,070 $7
78,140

(B) $1,053,500/20,000 - $52.675/MH

Beginning Intermediate Advanced


Direct materials $20,800 $13,000 $8,000
Direct labor 7,000 14,000 28,000
Overhead 63,210 15,802.50 10,535
Total $91,010 $42,802.50 $4
46,535

Activity-based rate:

Activity Rate
Order processing $420/order
Production setup $2,800/run
Materials handling $3.00/pound
Machine depr. and maintenance $16.10/hour
Quality control $2,000/inspection
Packing $.05/unit

Beginning Intermediate Advanced


Direct materials $20,800 $13,000 $8,000
Direct labor 7,000 14,000 28,000
Overhead 58,340 28,085 21,505
Total $86,140 $55,085 $5
57,505

AACSB: Analytic

232 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e


75. ABC Enterprises manufactures and distributes three products; A, B, and C. Over the past few
years, ABC has gradually automated its operations. As a result, total direct labor hours have
substantially declined, while total manufacturing overhead costs have significantly increased.
Because of these changes, ABC wants to evaluate its product costs using activity-based costing
procedures. The following information has been gathered from the company's internal records
and budgetary system:

Exhibit #1
A B C
Units produced and sold 5,000 2,000 1,000
Total direct material cost $90,000 $50,000 $ 40,000
Total direct labor hours 3,600 2,000 800
Direct labor rate per hour $ 9.00
Total manufacturing overhead $360,000
Total operating expenses $225,000

Exhibit #2
Overhead: Number of Events
Activity Cost Driver Total Cost A B C
Production No. of parts per unit $150,000 20 32 68
Set-up No. of production runs 90,000 8 5 3
Quality control No. of inspection pts. 50,000 3 6 11

Expenses: Number of Events


Activity Cost Driver Total Cost A B C
Marketing No. of sales calls $125,000 100 75 25
Customer Service No. of units shipped 60,000 5,000 2,000 1,000

ABC Enterprises determines its selling price per unit using a 40% markup on traditional product
cost.

Required:
(A) Use traditional costing procedures and complete the segmented income statement provided
below, using direct labor hours to assign overhead costs to products.

Product
A B C Total
Sales
Cost of sales
Gross margin
Operating expenses
Operating income

(B) Use activity-based costing procedures and complete the segmented income statement
provided below.

Test Bank, Chapter 9 233


Product
A B C Total
Sales

Cost of sales

Gross margin

Unassignable costs

Operating income

Answer:
(A) Use traditional costing procedures and complete the segmented income statement provided
below.

Overhead rate = $360,000/6,400 = $56.25/DLH

Product
A B C Total
Sales $454,860 $252,700 $129,080 $836,640

Cost of sales 324,900 180,500 92,200 597,600

Gross margin 129,960 72,200 36,880 239,040

Operating expenses 225,000

Operating income 14,040

(B) Use activity-based costing procedures complete the segmented income statement provided
below. Use the sales figures from part A.
Activity-based rates = $1,250/part; $5,625/run; $2,500/inspection; $625/sales call; $7.50/unit

Product
A B C Total
Sales $454,860 $252,700 $129,080 $836,640

Cost of sales 299,900 213,000 199,700 712,600

Gross margin 154,960 39,700 ( 70,620 ) 124,040

Unassignable costs 110,000

Operating income $ 14,040

AACSB: Analytic

234 Lanen, Anderson, Maher Fundamentals of Cost Accounting, 2e

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