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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.
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.
T F 3. The death spiral concept refers to the process of continually decreasing selling prices to
meet foreign competition.
T F 4. The usual cost objects used in a first-stage product cost allocation are the manufacturing
overhead accounts themselves.
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.
T F 6. Predetermined overhead rates are used in first-stage cost allocations but not in second-
stage cost allocations.
T F 8. A company that uses a second-stage cost allocation system will have one unique
allocation base for each cost pool.
T F 9. The single-stage cost allocation system uses a plant wide rate because the cost pool is the
entire plant.
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.
T F 11. The plant wide cost allocation method can be used by either a manufacturer or a
merchandiser.
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.
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.
T F 15. In general, the cost drivers used in activity-based costing (ABC) cause an activity's costs
to change.
T F 16. The best cost drivers are activities that are causally related to the costs being allocated.
T F 17. The first-stage allocation in activity-based costing (ABC) allocates costs to departments
using appropriate cost drivers.
T F 18. Direct labor cost (DLC) and direct labor hours (DLH) are examples of volume-related
cost drivers in the cost hierarchy.
T F 19. The number of products produced is an example of a facility-related cost driver in the
cost hierarchy.
T F 20. Activity-based costing (ABC) provides more detailed measures of costs than do plant
wide or department allocation methods.
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).
T F 23. Activity-based costing (ABC) uses more overhead accounts than traditional product
costing systems.
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.
T F 25. In general, low-volume products (and services) have a lower degree of complexity
associated with them.
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).
T F 27. When overhead is applied based on the volume of output, high-volume products tend to
"subsidize" low-volume products.
T F 30. In general, activity-based costing methods result in higher product costs per unit than
plant wide cost allocation methods.
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.
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.
A) Only A is false
B) Only B is false.
C) Neither A and B nor false.
D) Both A and B are false.
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.
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.
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
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.
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.
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?
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
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
(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.
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_____________.
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.
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
48. Companies using activity-based costing (ABC) have learned that costs are a function of
A) volume and activities.
B) time and complexity.
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
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 _______________.
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
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:
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 _______________.
52. What is the total overhead per unit allocated to Product R using activity-based costing (ABC)?
A) $2.60
B) $2.27
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:
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 _______________.
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
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 _______________.
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 _______________.
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
Zela Company is preparing its annual profit plan. As part of its analysis of the profitability of individual
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 _______________.
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 _______________.
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 _______________.
Response:
$50,000/(5 + 15) = $2,500
[$2,500(15)]/20 = $1,875.00
AACSB: Analytic
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:
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 _______________.
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 _______________.
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 _______________.
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
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 _______________.
Response:
$250,000 - $400(100) = $210,000
$210,000/(9,000 + 6,000) = $14.00 per hour
AACSB: Analytic
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.
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)
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
A company has identified the following overhead costs and cost drivers for the coming year: (CIA
adapted)
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:
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 _______________.
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 ______________.
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 _______________.
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:
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
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
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:
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
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:
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
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
AACSB: Analytic
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
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.
Cost of sales
Gross margin
Unassignable costs
Operating income
Answer:
(A) Use traditional costing procedures and complete the segmented income statement provided
below.
Product
A B C Total
Sales $454,860 $252,700 $129,080 $836,640
(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
AACSB: Analytic