WRD FinMan 13e - SM 26 (11) - Final PDF

CHAPTER 26 (FIN MAN); CHAPTER 11 (MAN)
COST ALLOCATION AND ACTIVITY-BASED COSTING
DISCUSSION QUESTIONS
1. Management desires accurate product costs so that its decisions regarding products are correct.
Managers are concerned about the accuracy of product costs, which are used for decisions such
as determining product mix, establishing product price, and determining whether to discontinue a
product line.
2. A single plantwide overhead rate will provide accurate product costing if products use
production department activity-base quantities in nearly the same ratio across departments.
For example, if Product X used 2 hours of Department A and 4 hours of Department B
activity-base quantities and Product Y used 1 hour of Department A and 2 hours of
Department B activity-base quantities, then a single rate approach would not cause distortion.
This is true because the ratio of activity-base usage quantity is 1:2 for both products across the
two departments. Additionally, if the production departments have nearly the same factory
overhead rate, then there would be no need to use the multiple production department rate
method.
3. Under the multiple production department rate method, factory overhead rates are determined
for each production department. Factory overhead is allocated to products depending on the
amount of allocation base used in each department. Under the single plantwide rate method,
one factory overhead rate is determined for the whole factory and is allocated to products
depending on the amount of allocation base used in the factory.
4. The multiple production department factory overhead rate method would provide more accurate
product costs than the single plantwide factory overhead method when there are significant
differences in the factory overhead rates across different production departments, and when the
products require different proportions of allocation-base usage in each production department.
5. Under activity-based costing, factory overhead costs are assigned to activity cost pools rather
than production departments. The budgeted factory overhead in the activity pools is allocated
to products based upon their own unique activity rates.
6. These activities are part of selling and administrative expenses, which must be treated as
period expenses under generally accepted accounting principles (GAAP). Thus, they cannot
be included as product costs under GAAP.
7. If the costs listed in Discussion Question 6 were included as product costs, then they would be
part of the cost of inventory. If inventory increased, then the net income would be more than it
would be under GAAP, since these selling and administrative expenses would be capitalized
in inventory rather than being expensed as required.
8. Calculating product costs using activity rates may result in greater accuracy than using
multiple production department overhead rates when products consume activities in
proportions that are unrelated to departmental allocation bases.
9. Activity-based costing would be preferred over the relative sales value method when the
products use selling and administrative activities in proportions that are unrelated to their sales
volumes.
10. Service companies can use activity-based costing to determine the cost of service offerings.
This information can be used to determine customer service profitability, which in turn can be
used to guide service pricing and strategy.
26-1
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CHAPTER 26 Cost Allocation and Activity-Based Costing
PRACTICE EXERCISES
PE 26–1A (FIN MAN); PE 11–1A (MAN)
a. Jeans: 20,000 units × 0.10 direct labor hour = 2,000 direct labor hours
Khakis: 20,000 units × 0.10 direct labor hour = 2,000
4,000 direct labor hours
b. Single plantwide factory overhead rate:

$180,000 ÷ 4,000 dlh = $45 per dlh
c. Jeans: $45 per direct labor hour × 0.10 dlh per unit = $4.50/unit
Khakis: $45 per direct labor hour × 0.10 dlh per unit = $4.50/unit
PE 26–1B (FIN MAN); PE 11–1B (MAN)

a. Speedboat: 250 units × 12 direct labor hours = 3,000 direct labor hours
Bass boat: 250 units × 12 direct labor hours = 3,000
b. Single plantwide factory overhead rate:

$600,000 ÷ 6,000 dlh = $100 per dlh
c. Speedboat: $100 per direct labor hour × 12 dlh per unit = $1,200/unit
Bass boat: $100 per direct labor hour × 12 dlh per unit = $1,200/unit

a. Cutting: (20,000 jeans × 0.04 dlh) + (20,000 khakis × 0.06 dlh)
= 2,000 direct labor hours
Sewing: (20,000 jeans × 0.06 dlh) + (20,000 khakis × 0.04 dlh)

b. Cutting Department rate: $60,000 ÷ 2,000 dlh = $30 per dlh

Sewing Department rate: $120,000 ÷ 2,000 dlh = $60 per dlh
c. Jeans: Cutting Department 0.04 dlh × $30 = $1.20

Sewing Department 0.06 dlh × $60 = 3.60
Total factory overhead per pair of jeans $4.80
Khakis: Cutting Department 0.06 dlh × $30 = $1.80

Sewing Department 0.04 dlh × $60 = 2.40
Total factory overhead per pair of khakis $4.20
26-2

a. Fabrication: (250 speedboats × 8 dlh) + (250 bass boats × 4 dlh)
Assembly: (250 speedboats × 4 dlh) + (250 bass boats × 8 dlh)
b. Fabrication Department rate: $420,000 ÷ 3,000 dlh = $140 per dlh

Assembly Department rate: $180,000 ÷ 3,000 dlh = $60 per dlh
c. Speedboat: Fabrication Department 8 dlh × $140 = $1,120

Assembly Department 4 dlh × $60 = 240
Total factory overhead per speedboat $1,360
Bass boat: Fabrication Department 4 dlh × $140 = $ 560

Assembly Department 8 dlh × $60 = 480
Total factory overhead per bass boat $1,040
26-3

a. Cutting: $18,000 ÷ 2,000 direct labor hours = $9.00 per dlh
Sewing: $36,000 ÷ 2,000 direct labor hours = $18.00 per dlh
Setup: $96,000 ÷ 2,400 setups = $40.00 per setup
Inspection: $30,000 ÷ 5,000 inspections = $6.00 per inspection
b. Jeans Khakis
Activity- Activity-
Base Activity Activity Base Activity Activity
Activity Usage × Rate = Cost Usage × Rate = Cost
Cutting 800 dlh $9.00 /dlh $ 7,200 1,200 dlh $9.00 /dlh $10,800
Sewing 1,200 dlh $18.00 /dlh 21,600 800 dlh $18.00 /dlh 14,400
Setup 1,400 setups $40.00 /setup 56,000 1,000 setups $40.00 /setup 40,000
Inspections 3,000 insp. $6.00 /insp. 18,000 2,000 insp. $6.00 /insp. 12,000
Total $102,800 $77,200
÷ Budgeted items ÷ 20,000 ÷ 20,000
Factory overhead per unit $ 5.14 $ 3.86
26-4

a. Fabrication: $204,000 ÷ 3,000 direct labor hours = $68 per dlh
Assembly: $105,000 ÷ 3,000 direct labor hours = $35 per dlh
Setup: $156,000 ÷ 400 setups = $390 per setup
Inspection: $135,000 ÷ 1,500 inspections = $90 per inspection
b. Speed Boat Bass Boat

Activity- Activity-
Fabrication 2,000 dlh $68 /dlh $136,000 1,000 dlh $68 /dlh $ 68,000
Assembly 1,000 dlh $35 /dlh 35,000 2,000 dlh $35 /dlh 70,000
Setup 300 setups $390 /setup 117,000 100 setups $390 /setup 39,000
Inspections 1,100 insp. $90 /insp. 99,000 400 insp. $90 /insp. 36,000
Total $387,000 $213,000
÷ Budgeted items ÷ 250 ÷ 250
Factory overhead per unit $ 1,548 $ 852
26-5

a. Sales order processing activity: 5,000 orders × $12 per order = $60,000
Shipping activity: 1,400 shipments × $20 per shipment = 28,000
Total activity cost $88,000
b. $3.20 per unit ($88,000 ÷ 27,500 units)

a. Sales order processing activity: 750 orders × $20 per order = $15,000
Customer return activity: 80 returns × $100 per return = 8,000
b. $9.20 per unit ($23,000 ÷ 2,500 units)

Teller transaction processing………………………… $42.00 (12 transactions × $3.50)
Check processing………………………………………… 12.00 (100 checks × $0.12)
ATM transaction processing…………………………… 2.00 (20 transactions × $0.10)
Total activity cost………………………………………… $56.00

Guest check-in…………………………………………… $ 8.00 (1 check-in × $8.00)
Room cleaning…………………………………………… 75.00 (3 nights × $25.00)
Meal service……………………………………………… 12.00 (3 meals × $4.00)
Total activity cost………………………………………… $95.00
26-6
EXERCISES
Ex. 26–1 (FIN MAN); Ex. 11–1 (MAN)
($560,000 ÷ 8,000) × 5,150 = $360,500
Ex. 26–2 (FIN MAN); Ex. 11–2 (MAN)

$188,000
a. Single Plantwide Factory Overhead Rate =
4,700 direct labor hours*
= $40 per direct labor hour

* Total direct labor hours:
Budgeted
Production Direct Labor Direct Labor
Volume × Hours per Unit = Hours
Trumpets…………………… 2,100 units × 0.8 = 1,680

Tubas………………………… 750 × 1.6 = 1,200
Trombones………………… 1,300 × 1.4 = 1,820
Total………………………… 4,700
b. Single Plant-
Direct wide Rate Factory Overhead per Unit
Labor per Direct Factory (Factory Overhead ÷
Hours × Labor Hour = Overhead Budgeted Production Volume)
Trumpets…… 1,680 × $40 = $ 67,200 $67,200 ÷ 2,100 units = $32
Tubas……… 1,200 × 40 = 48,000 $48,000 ÷ 750 units = $64
Trombones… 1,820 × 40 = 72,800 $72,800 ÷ 1,300 units = $56
Total………… 4,700 $188,000
26-7
Ex. 26–3 (FIN MAN); Ex. 11–3 (MAN)

$153,000*
a. Single Plantwide Factory Overhead Rate =
2,550 processing hours**
= $60 per direct processing hour

* $196,000 – $18,000 – $25,000
The selling and administrative expenses are not factory overhead.
** Total processing hours:

Budgeted
Production
Volume Processing Processing
(Cases) × Hours per Case = Hours
Tortilla chips………………… 4,000 × 0.20 = 800

Potato chips………………… 5,000 × 0.15 = 750
Pretzels……………………… 2,500 × 0.40 = 1,000
Total…………………………… 2,550
b. Single Plantwide
Factory Over-
head Rate per Factory Overhead per Case
Processing Processing Factory (Factory Overhead ÷
Hours × Hour = Overhead Budgeted Production Volume)
Tortilla chips…… 800 × $60 = $ 48,000 $48,000 ÷ 4,000 cases = $12.00
Potato chips…… 750 × 60 = 45,000 $45,000 ÷ 5,000 cases = $9.00
Pretzels…………… 1,000 × 60 = 60,000 $60,000 ÷ 2,500 cases = $24.00
Total……………… 2,550 $153,000
26-8
Ex. 26–4 (FIN MAN); Ex. 11–4 (MAN)

a. First, determine the total estimated labor hours consumed by the three products:
Direct Labor Total
Hours per Labor
Volume × Unit = Hours
Pistons…………………………………… 7,200 × 0.20 = 1,440
Valves…………………………………… 28,800 × 0.15 = 4,320
Cams……………………………………… 1,200 × 0.32 = 384
Total estimated direct labor hours………………………………………………… 6,144
Next, determine the plantwide overhead rate:
Budgeted Factory Overhead $184,320

= = $30.00 per dlh
Plantwide Allocation Base 6,144 direct labor hours
b. Factory Overhead Direct Labor

Direct Labor Cost per Unit Cost per Unit
Hours per ($30.00 × Direct ($20.00 × Direct
Unit Labor Hours per Unit) Labor Hours per Unit)
Pistons………………… 0.20 $6.00 $4.00
Valves………………… 0.15 4.50 3.00
Cams…………………… 0.32 9.60 6.40
c. ORANGE COUNTY ENGINE PARTS INC.

Product Line Budgeted Gross Profit Reports
For the Year Ended December 31, 2016
Pistons Valves Cams
1 2
Revenues (price × unit volume) $360,000 $288,000 $84,0003
Direct materials (direct materials
cost per unit × unit volume) $180,000 4 $115,200 5 $34,8006
Direct labor [direct labor cost per
unit (b) × unit volume] 28,800 7 86,400 8 7,680 9
Factory overhead [factory overhead
cost per unit (b) × unit volume] 43,20010 129,60011 11,52012
$252,000 $331,200 $54,000
Gross profit $108,000 $ (43,200) $30,000
Gross profit percentage of sales 30.0% –15.0% 35.7%
1 5 9
7,200 × $50.00 28,800 × $4.00 1,200 × $6.40
2 6 10
28,800 × $10.00 1,200 × $29.00 7,200 × $6.00
3 7 11
1,200 × $70.00 7,200 × $4.00 28,800 × $4.50
4 8 12
7,200 × $25.00 28,800 × $3.00 1,200 × $9.60
d. Valves have the lowest (and negative) gross profit as a percent of sales. Valves may
require a higher price or lower cost to manufacture in order to achieve the same
profitability as the other two products.
26-9
Ex. 26–5 (FIN MAN); Ex. 11–5 (MAN)

a. Production department factory overhead rates:
Pattern Cut and Sew
Department Department
Total factory overhead………………………… $288,000 $412,500
÷ Direct labor hours…………………………… 2,880 dlh 3,300 dlh
Departmental overhead rate………………… $ 100.00 /dlh $ 125.00 /dlh
b. Product cost allocation:

Small Glove
Pattern Department…………………………0.10 dir. labor hr. × $100/dlh = $10.00
Cut and Sew Department………………… 0.12 dir. labor hr. × $125/dlh = 15.00
Total factory overhead per small glove……………………………………………… $25.00
Medium Glove
Total factory overhead per medium glove………………………………………… $29.50
Large Glove
Total factory overhead per large glove……………………………………………… $34.00
26-10
Ex. 26–6 (FIN MAN); Ex. 11–6 (MAN)

a. Plantwide overhead rate:
= = $110.00 per dmh
Plantwide Allocation Base 9,000 direct machine hours
Product costs:
Commercial………… $110 per dir. mach. hr. × 4.5 dmh = $495
Residential……………$110 per dir. mach. hr. × 3.0 dmh = $330
b. Department factory overhead rates:

Assembly Testing
Production department overhead………………… $240,000 $750,000
÷ Direct machine hours…………………………… 3,000 dmh 6,000 dmh
Production department overhead rate………… $ 80.00 /dmh $ 125.00 /dmh
Product cost allocation:
Commercial Motor
Assembly Department………… 1.5 dir. mach. hr. × $80/dmh = $120
Testing Department…………… 3.0 dir. mach. hrs. × $125/dmh = 375
Total factory overhead per commercial motor………………………… $495
Residential Motor
Assembly Department………… 1.0 dir. mach. hrs. × $80/dmh = $ 80
Testing Department…………… 2.0 dir. mach. hrs. × $125/dmh = 250
Total factory overhead per residential motor…………………………… $330
c. The factory overhead determined under the single plantwide factory overhead
rate and multiple production department factory overhead rate methods are
the same. This is because the ratio of direct machine hours used by each
product from the two departments is the same. The commercial motor uses
1.5 direct machine hour in the Assembly Department and 3.0 hours in the
Testing Department, or a ratio of 1:2. The residential motor uses 1.0 direct
machine hours in the Assembly Department and 2.0 hours in the Testing
Department, also for a ratio of 1:2. Thus, even though the two production
department overhead rates are different, this is not sufficient for the plantwide
rate to cause product cost distortion. Thus, Pineapple should consider remaining
with the easier single plantwide rate method in this situation.
26-11
Ex. 26–7 (FIN MAN); Ex. 11–7 (MAN)

a. Plantwide factory overhead rate:
= = $80 per dlh
Product costs:
Gasoline engine…… $80 per dir. labor hr. × 5.0 dlh = $400
Diesel engine…………$80 per dir. labor hr. × 5.0 dlh = $400
b. Department factory overhead rates:

Fabrication Assembly
Total production department
factory overhead…………………………………… $550,000 $250,000
÷ Direct labor hours………………………………… 5,000 dlh 5,000 dlh
Production department overhead rate…………… $ 110 /dlh $ 50 /dlh
Product cost allocation:

Gasoline engine
Fabrication Department……… 3.0 dir. labor hr. × $110/dlh = $330
Assembly Department………… 2.0 dir. labor hrs. × $50/dlh = 100
Total factory overhead per
gasoline engine……………………………………………………………… $430
Diesel engine
Fabrication Department……… 2.0 dir. labor hrs. × $110/dlh = $220
Assembly Department………… 3.0 dir. labor hr. × $50/dlh = 150
Total factory overhead per
diesel engine………………………………………………………………… $370
c. Management should select the multiple department factory overhead rate method
of allocating overhead costs. The single plantwide factory overhead rate method
indicates that both products have the same factory overhead of $400 per unit.
This is because each product uses a total of 5.0 direct labor hours per unit.
However, each product uses these 5.0 direct labor hours much differently. The
gasoline engine consumes 3.0 hours in the expensive Fabrication Department and
2.0 hours in the less expensive Assembly Department. The opposite is the case
for diesel engines. Thus, the multiple production department rate method avoids
the cost distortions of the single plantwide rate method by accounting for the
overhead in each production department separately. In this case, there are both
production department rate differences across the departments and differences
in the ratios of allocation-base usage of the products across the departments
(3.0:2.0 vs. 2.0:3.0). These conditions will cause the single plantwide rate method
to distort product costs.
26-12
Ex. 26–8 (FIN MAN); Ex. 11–8 (MAN)

Activity Activity Base
Accounting reports Number of accounting reports
Customer return processing Number of customer returns
Electric power Kilowatt hours used
Human resources Number of employees
Inventory control Number of inventory transactions
Invoice and collecting Number of customer orders
Machine depreciation Number of machine hours
Materials handling Number of material moves
Order shipping Number of customer orders
Payroll Number of payroll checks processed
Production control Number of production orders
Production setup Number of setups
Purchasing Number of purchase orders
Quality control Number of inspections
Sales order processes Number of sales orders
Ex. 26–9 (FIN MAN); Ex. 11–9 (MAN)

a. Sales order processing activity rate:
$540,000 ÷ 60,000 sales orders = $9 per sales order
b. Sales order processing cost:

$9 × 45,000 sales orders = $405,000
26-13
Ex. 26–10 (FIN MAN); Ex. 11–10 (MAN)

Elliptical Machines Treadmills
Activity- Activity-
Fabrication 800 mh $30 /mh $24,000 500 mh $30 /mh $15,000
Assembly 210 dlh $15 /dlh 3,150 90 dlh $15 /dlh 1,350
Setup 24 setups $50 /setup 1,200 10 setups $50 /setup 500
Inspecting 140 insp. $25 /insp. 3,500 160 insp. $25 /insp. 4,000
Production scheduling 20 prod. ord. $15 /prod. ord. 300 10 prod. ord. $15 /prod. ord. 150
Purchasing 85 purch. ord. $10 /purch. ord. 850 60 purch. ord. $10 /purch. ord. 600
Total activity cost $33,000 $21,600
÷ Number of units ÷ 300 ÷ 160
Activity cost per unit $ 110 $ 135
26-14
Ex. 26–11 (FIN MAN); Ex. 11–11 (MAN)
a. Budgeted Total
Activity Activity Activity
Activity Cost ÷ Base = Rate
Casting $127,750 3,650 mh $35 /mh
Assembly 63,200 3,160 dlh $20 /dlh
Inspecting 21,330 1,185 insp. $18 /insp.
Setup 28,750 230 setups $125 /setup
Materials handling 31,600 790 loads $40 /load
b. Entry Lighting Fixtures Dining Room Lighting Fixtures

Activity- Activity-
Casting 2,500 mh $35 /mh $ 87,500 1,150 mh $35 /mh $ 40,250
Assembly 960 dlh $20 /dlh 19,200 2,200 dlh $20 /dlh 44,000
Inspecting 860 insp. $18 /insp. 15,480 325 insp. $18 /insp. 5,850
Materials handling 570 loads $40 /load 22,800 220 loads $40 /load 8,800
÷ Number of units ÷ 5,541 ÷ 2,128
Activity cost per unit $ 30.00 $ 50.00
26-15
Ex. 26–12 (FIN MAN); Ex. 11–12 (MAN)
a. Product
Procurement Scheduling Materials Handling Development
Factory overhead $66,000 $4,120 $13,280 $8,100
÷ Activity base ÷ 660 purch. ords. ÷ 206 prod. ords. ÷ 415 moves ÷ 108 ECOs*
Activity rate $ 100 /purch. ord. $ 20 /prod. ord. $ 32 /move $ 75 /ECOs
* Engineering Change Order
b. Ovens Refrigerators
Activity- Activity-
Procurement 400 purch. ords. $100 /purch. ord. $ 40,000 260 purch. ords. $100 /purch. ord. $26,000
Scheduling 136 prod. ords. $20 /prod. ord. 2,720 70 prod. ords. $20 /prod. ord. 1,400
Materials handling 240 moves $32 /move 7,680 175 moves $32 /move 5,600
Product development 68 ECOs $75 /ECO 5,100 40 ECOs $75 /ECO 3,000
Total $55,500 $36,000
÷ Unit volume ÷ 740 ÷ 600
26-16
Ex. 26–13 (FIN MAN); Ex. 11–13 (MAN)

a. Single plantwide rate:
Indirect Labor $375,000
=

Direct Indirect
Labor Plantwide Indirect Labor Cost
Hours × Rate = Labor Cost ÷ Units = per Unit
Cell phones… 1,875 × $100 /dlh = $187,500 ÷ 93,750 = $2.00
Tablets……… 1,875 × $100 /dlh = $187,500 ÷ 93,750 = $2.00
b. Activity-based rates:
Production
Setup Support
Budgeted activity cost*……………… $150,000 $225,000
Activity base…………………………… ÷ 2,000 setups ÷ 3,750 dlh
Activity rate…………………………… $ 75.00 /setup $ 60.00 /dlh
* Setup activity cost = $375,000 × 40% = $150,000

Production support activity cost = $375,000 × 60% = $225,000
26-17
Ex. 26–13 (FIN MAN); Ex. 11–13 (MAN) (Concluded)

c. Cell Phones Tablets
Activity- Activity-
Setup 600 setups $75.00 /setup $ 45,000 1,400 setups $75.00 /setup $105,000
Production support 1,875 dlh $60.00 /dlh 112,500 1,875 dlh $60.00 /dlh 112,500
Total $157,500 $217,500
÷ Units ÷ 93,750 ÷ 93,750
d. The per-unit indirect labor costs in (a) are distorted because setup activity is consumed by the products in a different ratio from the direct
labor. Cell phones required 600 setups over a volume of 93,750 units (or 156 units per production run), while tablets required 1,400 setups
over the same volume (approximately 67 units per production run). The activity-based costing method properly allocates the setup-related
activity so that the tablets, the setup-intensive product, receive a larger portion of the setup activity cost, while the cell phones receive a
smaller portion. The single rate system allocates overhead only on the basis of direct labor hours. Since the direct labor hours are equal
for each product, the allocated indirect labor will also be equal. Again, this is clearly a distortion, since the setup activity (40% of the
indirect labor) is not consumed equally by each product.
26-18
Ex. 26–14 (FIN MAN); Ex. 11–14 (MAN)

a. Production department factory overhead rates:
Assembly Test and Pack
Factory overhead………………………………………… $186,000 $120,000
Direct labor hours……………………………………… ÷ 3,000 ÷ 3,000
Production department factory overhead rate……… $ 62 /dlh $ 40 /dlh
b. Blender Toaster Oven

Allocation- Allocation-
Assembly Department 750 dlh $62 /dlh $ 46,500 2,250 dlh $62 /dlh $139,500
Test and Pack Department 2,250 dlh $40 /dlh 90,000 750 dlh $40 /dlh 30,000
Total $136,500 $169,500
÷ Units ÷ 7,500 ÷ 7,500
Factory overhead cost per unit $ 18.20 $ 22.60
26-19
Ex. 26–15 (FIN MAN); Ex. 11–15 (MAN)

a. Activity rates:
Assembly Test and Pack Setup
Activity Activity Activity
Budgeted activity cost…………………………………… $105,000 1 $39,000 2 $162,000
Activity base……………………………………………… ÷ 3,000 dlh ÷ 3,000 dlh ÷ 180 setups
Activity rate………………………………………………… $ 35 /dlh $ 13 /dlh $ 900 /setup
1
$186,000 – $81,000
2
$120,000 – $81,000
b. Blender Toaster Oven

Activity- Activity-
Assembly activity 750 dlh $35 /dlh $ 26,250 2,250 dlh $35 /dlh $ 78,750
Test and pack activity 2,250 dlh $13 /dlh 29,250 750 dlh $13 /dlh 9,750
Setup activity 135 setups $900 /setup 121,500 45 setups $900 /setup 40,500
Total $177,000 $129,000
÷ Units ÷ 7,500 ÷ 7,500
Factory overhead cost per unit $ 23.60 $ 17.20
26-20

Note to Instructors: If you assigned both Ex. 26–14 and Ex. 26–15, then you can make
the following observations:
The activity-based costing approach provides unit factory overhead cost information
that is opposite to that of the multiple production department factory overhead rate
method. The reason is that the multiple production department factory overhead rate
method allocates all factory overhead to the products on the basis of direct labor hours.
However, factory overhead includes the setup activity. Setup activity is consumed by the
products in ratios that are not equal to their direct labor consumption. Indeed, the blender
uses three times as much setup activity as the toaster oven. The activity-based costing
method correctly accounts for this difference, while the multiple production department
factory overhead rate method incorrectly assumes that this activity is equal to both
products (proportional to the direct labor hours or volume of production). Thus, the
management of Four Finger Appliance should be encouraged to use activity-based
costing information for product-based decisions.
26-21
Ex. 26–16 (FIN MAN); Ex. 11–16 (MAN)
a. Column A Column B Column C

Single Rate
Overhead ABC Overhead Percent Change
Allocation Allocation in Allocation
Product Volume Class per Unit per Unit (Col. B – Col. A) ÷ Col. A
1 2
Low $30.00 $58.06 93.5%
Medium 30.00 3 29.31 4 -2.3%
High 30.00 5 25.46 6 -15.1%
1
(24 hours × $200/hour) ÷ 160 units
2
[(24 hours × $160/hour) + (14 setups × $240/setup) +
(38 sales orders × $55/sales order)] ÷ 160 units
3
(225 hours × $200/hour) ÷ 1,500 units
4
(88 sales orders × $55/sales order)] ÷ 1,500 units
5
(900 hours × $200/hour) ÷ 6,000 units
6
(120 sales orders × $55/sales order)] ÷ 6,000 units
b. The machine hour rate is greater under the single rate method than under the activity-
based method because all the factory overhead is allocated by machine hours under
the single rate method. However, only a portion of the factory overhead is allocated
under the machine rate method using activity-based costing. The remaining factory
overhead is allocated using the other two activity rates. Thus, the numerator for
determining the machine hour rate under activity-based costing must be less than
the numerator under the single machine hour rate method.
c. Column C indicates that under activity-based costing the low-volume product has a
higher per-unit cost than calculated under the single rate method. In contrast, under
activity-based costing the high-volume product has a lower per-unit cost than
calculated under the single rate method. This result will occur when there are activities
that occur in proportions different from their volumes. In this case, lower-volume
products have setups and sales orders occurring in higher proportions of total setups
and sales orders than their proportion of machine hours to total machine hours. The
opposite is the case for the high-volume product. Thus, the lower-volume products
are produced and ordered in smaller batch sizes compared to the higher-volume
product. This implies that Whirlpool may wish to simplify its product line by
eliminating some of the low-volume products or by attempting to reduce the overall
cost of setup and sales order processing activities.
Note: The sum of the total overhead from Columns A and B is not equal because there
are only three representative products, not all of the products.
26-22
Ex. 26–17 (FIN MAN); Ex. 11–17 (MAN)

The selling and administrative expenses should not be allocated on the basis of relative
sales dollars. The two product lines have very different attributes. The commercial
product is relatively inexpensive to sell, while the home product has a number of
additional costs associated with it. As a result, the relative sales dollar method of
allocation will distribute too much selling and administrative cost to the commercial
product and too little to the home product. The commercial product receives twice as
much selling and administrative expense as the home product because it has twice
the sales. An activity-based approach would trace the selling and administrative costs
to the products based upon their actual consumption of activities. Such an allocation
would show the commercial product to be more profitable than indicated and the home
product to be less profitable than indicated.
Ex. 26–18 (FIN MAN); Ex. 11–18 (MAN)

a. Sales order processing activities:
Number of Activity Activity
Sales Orders × Rate = Cost
Generators………………………… 980 × $80 $ 78,400
Air compressors………………… 1,160 × 80 92,800
Total………………………………… $171,200
Post-sale customer service activities:

Number of Activity Activity
Service Requests × Rate = Cost
Generators………………………… 150 × $300 $ 45,000
Air compressors………………… 456 × 300 136,800
Total………………………………… $181,800
Note to Instructor: $171,200 + $181,800 = $353,000, which is the total selling and
administrative expense reported in the exercise.
26-23

b. VOLT-GEAR INC.
Product Profitability Report
For the Year Ended December 31
Air
Generators Compressors Total
Revenues $2,000,000 $1,400,000 $3,400,000
Cost of goods sold 1,400,000 980,000 2,380,000
Gross profit $ 600,000 $ 420,000 $1,020,000
Sales order processing $ 78,400 1 $ 92,800 3 $ 171,200
Post-sale customer service 45,000 2 136,800 4 181,800
Total selling and
administrative expense $ 123,400 $ 229,600 $ 353,000
Income from operations $ 476,600 $ 190,400 $ 667,000
Gross profit as a percentage
of sales 30.00%5 30.00% 7
Income from operations as
a percentage of sales 23.83%6 13.60%8
1
$78,400 = 980 sales orders × $80/sales order
2
$45,000 = 150 service requests × $300/service request
3
$92,800 = 1,160 sales orders × $80/sales order
4
$136,800 = 456 service requests × $300/service request
5
$600,000 ÷ $2,000,000
6
$476,600 ÷ $2,000,000
7
$420,000 ÷ $1,400,000
8
$190,400 ÷ $1,400,000
c. The complete product profitability report provides much greater insight than did the
original report. The air compressors have the lower income from operations to sales
percentage because the product is a heavy user of Volt-Gear’s sales and service
activities. The air compressors are ordered in small quantities (hence a high number
of sales orders) and have a high amount of post-sale service. All of these factors
cause the air compressors to have less income from operations as a percent of
sales than generators. In contrast, relative to the sales volume, the generators have
much less activity and thus have the higher income from operations as a percent of
sales. Volt-Gear can respond to this situation by rationing the amount of service to
the air compressor product line, charging air compressor customers for some of the
services, reducing the number of service requests by improving the product, or
raising the price on the air compressors.
26-24
Ex. 26–19 (FIN MAN); Ex. 11–19 (MAN)

a. SCHNEIDER ELECTRIC
Customer Profitability Report
For the Year Ended December 31, 2016
(assumed data)
Customer 1 Customer 2 Customer 3
Revenue $39,000 $26,000 $31,200
Cost of goods sold 24,180 13,520 15,600
Gross profit $14,820 $12,480 $15,600
Customer service activities:
Bid preparation $ 2,4001 $ 1,6005 $ 5,0009
10
Shipment 2562 3846 720
Support standard items 9603 7607 1,12011
Support nonstandard items 1,3504 2,2508 4,05012
Total customer service activities $ 4,966 $ 4,994 $10,890
Income from operations after
customer service activities $ 9,854 $ 7,486 $ 4,710
Gross profit as a percent of sales 38% 48% 50%
Income from operations after
customer service activities as
a percent of sales 25% 29% 15%
1
$200 × 12 bid requests
2
$16 × 16 shipments
3
$20 × 48 standard items
4
$75 × 18 nonstandard items
5
6
$16 × 24 shipments
7
8
9
10
$16 × 45 shipments
11
12
b. The gross profit as a percent of sales indicated that Customer 1 was the least
profitable, while Customer 3 was the most profitable. After deducting the activity
costs associated with customer service activities, Customer 3 became the least
profitable, while Customer 1 became nearly as profitable as Customer 2. The reason
is because Customer 3 consumed much more customer service activities than did
either Customer 1 or Customer 2. Apparently, Customer 3 ordered nonstandard
products that required specialized bid requests. In addition, Customer 3 required
more shipments, indicating smaller shipments to a customer’s location, rather than
a few large shipments.
26-25
Ex. 26–20 (FIN MAN); Ex. 11–20 (MAN)

a. Patient Putin Patient Umit
Activity Activity Activity Activity Activity Activity
Room and meals 6 days $240 /day $ 1,440 4 days $240 /day $ 960
Radiology 4 images $215 /image 860 3 images $215 /image 645
Pharmacy 6 orders $50 /order 300 2 orders $50 /order 100
Chemistry lab 5 tests $80 /test 400 4 tests $80 /test 320
Operating room 8 hrs. $1,000 /hr. 8,000 4 hrs. $1,000 /hr. 4,000
Total cost $11,000 $6,025
b. Patient Putin apparently had a different condition that required more extensive treatment than did Patient Umit. Patient Putin
required more operating room hours, more tests and images, and more days to recover than did Patient Umit. Thus, the activity
cost to Patient Putin is more than two times that of Patient Umit.
26-26
Ex. 26–21 (FIN MAN); Ex. 11–21 (MAN)

a. SAFETY FIRST INSURANCE COMPANY
Product Profitability Report
Workers’
Auto Comp. Homeowners
Premium revenue $5,750,000 $6,240,000 $8,160,000
Less estimated claims 4,312,500 4,680,000 6,120,000
Underwriting income $1,437,500 $1,560,000 $2,040,000
Administrative activities:*
New policy processing $ 158,400 $ 180,000 $ 489,600
Cancellation processing 84,000 42,000 378,000
Claim audits 123,200 38,400 307,200
Claim disbursements processing 49,920 22,464 87,360
Premium collection processing 201,600 43,200 360,000
Total administrative expenses $ 617,120 $ 326,064 $1,622,160
Income from operations $ 820,380 $1,233,936 $ 417,840
a percent of premium revenue 14% 20% 5%
* The activity costs are determined by multiplying the activity rate by the activity-based usage quantity.
For example, the administrative activity costs for the Auto line is as follows:
$158,400 = $1,320 new policies × $120 per new policy

$84,000 = $480 cancellations × $175 per cancellation
$123,200 = $385 audits × $320 per claim audit
$49,920 = $480 disbursements × $104 per disbursement
$201,600 = $8,400 premiums collected × $24 per collection
b. All three insurance lines have the same percentage of underwriting income to
premium revenue (25%). The differences among the insurance lines are in the
way they consume administrative activities. For example, the Homeowners
insurance line has the least profitability due to its high use of administrative
activities. Specifically, the Homeowners line has smaller and more frequent
claims that require more auditing and disbursement processing than do the
other two lines. In addition, the Homeowners line has a much higher rate
of cancellation relative to the other two lines (over 50% of new policies). Lastly,
the Homeowners line has more premium collections compared to the other two
lines. Possibly, the Homeowners line is collected in smaller amounts from more
customers than the other two lines. In contrast, the Workers’ Compensation line
consumes the fewest administrative activities, causing it to be very profitable.
The Auto line is in between these two.
26-27
PROBLEMS
Prob. 26–1A (FIN MAN); Prob. 11–1A (MAN)
1. a. Direct labor overhead rate:
$220,800
b. Machine hour overhead rate:

$220,800
= $48 per machine hour
4,600 machine hours
2. Automobile Valve
Bumpers Covers Wheels
a. Direct labor hours:
Stamping Department…………… 560 dlh 300 dlh 340 dlh
Plating Department………………… 170 180 175
Total direct labor hours…………… 730 dlh 480 dlh 515 dlh
× Direct labor overhead rate……… $128 /dlh $128 /dlh $128 /dlh
Allocated factory overhead……… $93,440 $61,440 $65,920
b. Machine hours:
Stamping Department…………… 800 mh 560 mh 600 mh
Plating Department………………… 1,170 710 760
Total machine hours……………… 1,970 mh 1,270 mh 1,360 mh
× Machine hour overhead rate…… $48 /mh $48 /mh $48 /mh
Instructor’s Note: The allocated factory overhead is the same for both allocation
bases because their usage is proportional across product.
26-28

1. Stamping Plating
Dept. Dept.
Production department factory
overhead totals………………………………………………… $115,200 $105,600
÷ Activity rate……………………………………………………… 1,200 dlh 2,640 mh
Production department rate…………………………………… $ 96 /dlh $ 40 /mh
2. Automobile bumpers
Stamping Department…………………… 560 dir. labor hrs. × $96/dlh = $ 53,760
Plating Department……………………… 1,170 dir. mach. hrs. × $40/dmh = 46,800
Total factory overhead for bumpers………………………………………………… $100,560
Valve covers
Plating Department……………………… 710 dir. mach. hrs. × $40/dmh = 28,400
Total factory overhead for valve covers…………………………………………… $ 57,200
Wheels
Plating Department……………………… 760 dir. mach. hrs. × $40/dmh = 30,400
Total factory overhead for wheels…………………………………………………… $ 63,040
26-29

1. Production department rates:
Cutting Finishing
Factory overhead……………………………………… $315,000 $540,000
÷ Direct labor hours…………………………………… 6,000 6,000
Production department rate………………………… $ 52.5 /dlh $ 90.0 /dlh
2. Production
Direct Department Factory
Labor Hours × Rate = Overhead
Snowboards:
Cutting Department……………… 4,000 × $52.5 /dlh = $210,000
Finishing Department…………… 2,000 × $90.0 /dlh = 180,000
Total factory overhead…………… $390,000
÷ Number of units………………… 6,000
Factory overhead per unit……… $ 65.00
Skis:
Cutting Department……………… 2,000 × $52.5 /dlh = $105,000
Finishing Department…………… 4,000 × $90.0 /dlh = 360,000
3. Activity-based rates:
Production Materials Cutting Finishing
Control Handling Department Department
Factory
overhead……… $237,000 $270,000 $156,000 $192,000
÷ Activity base… 500 prod. runs 7,500 moves 6,000 dlh 6,000 dlh
Activity rate…… $ 474.0 /prod. run $ 36.0 /move $ 26.0 /dlh $ 32.0 /dlh
26-30
Prob. 26–3A (FIN MAN); Prob. 11–3A (MAN) (Concluded)

4. Snowboards Skis
Production control 430 prod. runs $474 /prod. run $203,820 70 prod. runs $474 /prod. run $ 33,180
Materials handling 5,000 moves $36 /move 180,000 2,500 moves $36 /move 90,000
Cutting Department 4,000 dlh $26 /dlh 104,000 2,000 dlh $26 /dlh 52,000
Finishing Department 2,000 dlh $32 /dlh 64,000 4,000 dlh $32 /dlh 128,000
Total $551,820 $303,180
÷ Number of units 6,000 6,000
5. The activity-based overhead allocation reveals that snowboards consume more factory overhead on a per-unit basis than do skis. The
multiple production department factory overhead rate method does not show this because all factory overhead is assumed to be
proportional to direct labor hours. The activity-based method separately accounts for the production control and materials handling
activity costs. Snowboards have more production control and materials handling activities than do skis. This is because snowboards are
made in smaller lots, representing a wide variety of styles. Thus, snowboards have higher activity costs per unit than skis.
26-31

Materials
1. Production Setup Handling Inspection Engineering
Total activity cost…………… $264,000 $96,000 $9,600 $50,000 $150,000
÷ Total activity base………… 2,200 mh 400 setups 480 no. parts 1,000 insp. hours 500 eng. hours
Activity rate………………… $ 120 /mh $ 240 /setup $ 20 /part $ 50 /hour $ 300 /hour
2. M5 Z4
Activity- Activity-
Production 1,000 mh $120 /mh $120,000 800 mh $120 /mh $ 96,000
Setup 60 setups $240 /setup 14,400 120 setups $240 /setups 28,800
Material handling 80 parts $20 /part 1,600 150 no parts $20 /part 3,000
Inspection 450 insp. hours $50 /hour 22,500 300 insp. hours $50 /hour 15,000
Engineering 125 eng. hours $300 /hour 37,500 175 eng. hours $300 /hour 52,500
I8
Activity-
Base Activity Activity
Activity Usage × Rate = Cost
Production 400 mh $120 /mh $ 48,000
Setup 220 setups $240 /setups 52,800
Material handling 250 parts $20 /part 5,000
Inspection 250 insp. hours $50 /hour 12,500
Engineering 200 eng. hours $300 /hour 60,000
÷ Number of units 500
Activity cost per unit $ 356.60
26-32

3. The unit costs are different even though each product requires 0.8 machine hour
because the products consume many activities in ratios different from the volume.
For example, the I8 consumes setup, moving, shipping, and product engineering
activities proportionately greater than its volume, while the M5 consumes the same
activities proportionately less than its volume.
26-33

1. Customer Project Engineering
Service Bidding Support
Activity cost……………………………… $83,720 $61,360 $86,800
÷ Activity base…………………………… 322 sr* 104 bids 217 dc*
Activity rate……………………………… $ 260 /sr $ 590 /bid $ 400 /dc
2. Good Knowledge University

Customer service………………………… 60 sr × $260/sr = $15,600
Project bidding…………………………… 36 bids × $590/bid = 21,240
Engineering support…………………… 45 dc × $400/dc = 18,000
Total nonmanufacturing activity costs………………………………………… $54,840
Hot Shotz Arena

Customer service………………………… 52 sr × $260/sr = $13,520
Break-a-Leg Hospital
Customer service………………………… 210 sr × $260/sr = $ 54,600
* “sr” stands for service request; “dc” stands for design change.
26-34

3. COLD ZONE MECHANICAL INC.
Good
Knowledge Hot Shotz Break-a-Leg
University Arena Hospital
Revenues $1,650,000 1 $1,050,000 2 $450,0003
Less cost of goods sold 1,320,000 4 840,000 5 360,000 6
Gross profit $ 330,000 $ 210,000 $90,000
Less selling and administrative
activities:
Customer service $ 15,600 $ 13,520 $ 54,600
Project bidding 21,240 10,620 29,500
Engineering support 18,000 12,000 56,800
$ 54,840 $ 36,140 $140,900
Income from operations $ 275,160 $ 173,860 $ (50,900)
1 4
$75,000 × 22 units $60,000 × 22 units
2 5
$75,000 × 14 units $60,000 × 14 units
3 6
$75,000 × 6 units $60,000 × 6 units
4. Break-a-Leg Hospital is unprofitable, while the other two customers have acceptable
margins. This is because Break-a-Leg Hospital requires many customer service,
project bidding, and design change activities. For example, Break-a-Leg Hospital
awards contracts on only 12% of the bid efforts (6 contracts ÷ 50 bids); it requests
a large amount of service; and it requires extensive design change effort. The
company's options include:
a. Stop bidding Break-a-Leg Hospital projects. This does not necessarily mean that
all the costs can be avoided. The costs only will be eliminated if the reduced
activity translates into lower headcount (dismissals). Thus, the company should
evaluate the contribution margin of this customer relationship before making this
decision.
b. Reprice Break-a-Leg Hospital work. Charge Break-a-Leg Hospital a higher price to
compensate for the higher activities required to serve it. However, the customer
may not accept the price increase required to move it to a profitable relationship.
c. Encourage Break-a-Leg Hospital to reduce the amount of design changes and
customer service requests. The design changes are probably driving the customer
service requests. This may be appealing, but there may be no incentive for Break-
a-Leg Hospital to change its behavior.
d. Charge a price for customer service and design change separately. That is,
unbundle the pricing of goods from the support services. This is a good long-
term solution. In addition, improve the bidding process in order to improve the
“hit rate” or the percentage of awarded contracts to bids.
26-35

1. Activity Activity Cost ÷ Activity Base = Activity Rate
Scheduling and admitting……… $ 432,000 ÷ 6,000 patients = $72 /patient
Housekeeping…………………… 4,212,000 ÷ 27,000 pds* = $156 /pd
Nursing…………………………… 5,376,000 ÷ 192,000 wcus* = $28 /wcu
Total………………………………… $10,020,000
* "pd" stands for patient day; "wcu" stands for weighted care unit
2. Total Activity
Activity Activity Cost by
Activity Usage × Rate = Procedure
Procedure A
Scheduling and admitting 280 patients $72 /patient $ 20,160
Housekeeping 1,680 pds $156 /pd 262,080
Nursing 19,200 wcus $28 /wcu 537,600
$819,840
Procedure B
Scheduling and admitting 650 patients $72 /patient $ 46,800
Nursing 6,000 wcus $28 /wcu 168,000
$721,800
Procedure C
Scheduling and admitting 1,200 patients $72 /patient $ 86,400
Nursing 24,000 wcus $28 /wcu 672,000
$1,507,200
26-36

3. Procedure A Procedure B Procedure C
Reimbursement (patient days ×
reimbursement rate)* $ 682,080 $1,319,500 $1,948,800
Total activity cost (from 2.) 819,840 721,800 1,507,200
Excess (deficiency) of
reimbursement over activity cost $(137,760) $ 597,700 $ 441,600
* 1,680 patient days × $406/patient day = $682,080

3,250 patient days × $406/patient day = $1,319,500
4,800 patient days × $406/patient day = $1,948,800
4. Procedure A requires more activity cost than is being reimbursed by the insurance
company. As a result, the hospital may wish to determine if the costs of providing
Procedure A are too high. Hospital management may wish to investigate the
nursing effort, because the weighted average care units are averaging nearly 11.4
(19,200 ÷ 1,680) wcus per patient day for Procedure A, which compares to 1.8
(6,000 ÷ 3,250) and 5 (24,000 ÷ 4,800) wcus per patient day for Procedures B and
C, respectively. Alternatively, the hospital may wish to negotiate for a higher
reimbursement from the insurance company for Procedure A.
Note to Instructors: The total activity costs and activity-base quantities for the
three procedures are less than the totals because these are only three “selected”
procedures out of a larger population.
26-37
Prob. 26–1B (FIN MAN); Prob. 11–1B (MAN)

1. a. Direct labor overhead rate:
$299,700
b. Machine hour overhead rate:

$299,700
= $111 per machine hour
2,700 machine hours
2.
Whole Milk Skim Milk Cream
a. Direct labor hours:
Blending Department…………… 260 dlh 245 dlh 215 dlh
Packing Department……………… 470 300 130
Total direct labor hours………… 730 dlh 545 dlh 345 dlh
× Direct labor overhead rate…… $185 /dlh $185 /dlh $185 /dlh
b. Machine hours:
Blending Department…………… 650 mh 710 mh 260 mh
Packing Department……………… 500 415 165
Total machine hours……………… 1,150 mh 1,125 mh 425 mh
× Machine hour overhead rate… $111 /mh $111 /mh $111 /mh
26-38

1. Blending Packing
Dept. Dept.
Production department factory
overhead totals…………………………………………………… $178,200 $121,500
÷ Activity base……………………………………………………… 1,620 mh 900 dlh
Production department rate……………………………………… $ 110 /mh $ 135 /dlh
2. Whole milk
Blending Department…………………… 650 dir. mach. hrs. × $110/dmh = $ 71,500
Packing Department…………………… 470 dir. labor hrs. × $135/dlh = 63,450
Total factory overhead for whole milk………………………………………………… $134,950
Skim milk
Packing Department…………………… 300 dir. labor hrs. × $135/dlh 40,500 =
Total factory overhead for skim milk…………………………………………………… $118,600
Cream
Packing Department…………………… 130 dir. labor hrs. × $135/dlh = 17,550
Total factory overhead for cream……………………………………………………… $ 46,150
26-39

1. Production department rates:
Subassembly Final Assembly
Factory overhead……………………………………… $420,000 $294,000
÷ Direct labor hours………………………………… 1,400 1,400
Production department rate………………………… $ 300 /dlh $ 210 /dlh
2. Production
Direct Department Factory
Labor Hours × Rate = Overhead
Receivers:
Subassembly Department……… 875 × $300 /dlh = $262,500
Final Assembly Department……… 525 × $210 /dlh = 110,250
Loudspeakers:
Subassembly Department……… 525 × $300 /dlh = $157,500
Final Assembly Department……… 875 × $210 /dlh = 183,750
3. Activity-based rates:
Quality Subassembly Final Assembly
Setup Control Department Department
Factory
overhead……… $138,600 $261,800 $198,800 $114,800
÷ Activity base… 400 setups 2,200 insp. 1,400 dlh 1,400 dlh
Activity rate…… $ 346.50 /setup $ 119 /insp. $ 142 /dlh $ 82 /dlh
26-40
Prob. 26–3B (FIN MAN); Prob. 11–3B (MAN) (Concluded)

4. Receivers Loudspeakers
Setup 80 setups $346.50 /setup $ 27,720 320 setups $346.50 /setup $110,880
Quality control 450 insp. $119 /insp. 53,550 1,750 insp. $119 /insp. 208,250
Subassembly Dept. 875 dlh $142 /dlh 124,250 525 dlh $142 /dlh 74,550
Final Assembly Dept. 525 dlh $82 /dlh 43,050 875 dlh $82 /dlh 71,750
Total $248,570 $465,430
5. The activity-based overhead allocation reveals that loudspeakers are more costly on a per-unit basis than are the receivers. The multiple
production department rate method determines that the per-unit factory overhead is nearly the same for the two products. The multiple
production department factory overhead rate method distorts the unit costs because all factory overhead is assumed to be proportional to direct
labor hours. Since each product consumes the same total direct labor hours, the factory overhead allocation is nearly equal. The activity-based
method separately accounts for the setup and quality-control activity costs. Loudspeakers have more setups and inspection activities than do
receivers. Thus, loudspeakers have higher activity costs per unit than do receivers.
26-41

1. Production Setup Inspection Shipping Customer Service
Total activity cost……………$500,000 $144,000 $44,000 $115,000 $84,000
÷ Total activity base………… 10,000 mh 450 setups 1,100 insp. 5,750 cust. ord. 600 req.
Activity rate………………… $ 50 /mh $ 320 /setup $ 40 /insp. $ 20 /cust. ord. $ 140 /req.
2. White Sugar Brown Sugar

Activity- Activity-
Production 5,000 mh $50 /mh $250,000 2,500 mh $50 /mh $125,000
Inspection 220 insp. $40 /insp. 8,800 330 insp. $40 /insp. 13,200
Shipping 1,150 cust. ord. $20 /cust. ord. 23,000 2,600 cust. ord. $20 /cust. ord. 52,000
Customer service 60 requests $140 /request 8,400 350 requests $140 /request 49,000
÷ Units ÷ 10,000 ÷ 5,000
Powdered Sugar
Activity-
Base Activity Activity
Activity Usage × Rate = Cost
Production 2,500 mh $50 /mh $125,000
Setup 195 setups $320 /setup 62,400
Inspection 550 insp. $40 /insp. 22,000
Shipping 2,000 cust. ord. $20 /cust. ord. 40,000
Customer service 190 requests $140 /request 26,600
÷ Units ÷ 5,000
Activity cost per unit $ 55.20
26-42

3. The unit costs are different even though each product requires 0.5 machine
hour because the products consume many activities in ratios different from the
volume. For example, the brown sugar consumes setup, inspection, shipping,
and customer service activities proportionately greater than its volume, while
white sugar consumes the same activities proportionately less than its volume.
26-43

1. Customer Sales Order Advertising
Service Processing Support
Activity cost pool……………………… $76,860 $25,920 $311,250
÷ Activity base…………………………… 427 sr* 1,080 so* 249 ads
Activity rate……………………………… $ 180 /sr $ 24 /so $ 1,250 /ad
2. The Warehouse
Customer service……………………… 62 srs × $180/sr = $ 11,160
Sales order processing………………… 300 sos × $24/so = 7,200
Advertising support…………………… 25 ads × $1,250/ad = 31,250
Total nonmanufacturing activity costs…………………………………………… $ 49,610
Kosmo Co.
Total nonmanufacturing activity costs…………………………………………… $301,560
Supply Universe
Total nonmanufacturing activity costs…………………………………………… $ 62,860
* “sr” stands for service request; “so” stands for sales order
26-44

3. SHRUTE INC.
The Supply
Warehouse Kosmo Co. Universe
Revenues $899,100 1 $899,100 $899,100
Less cost of goods sold 552,420 2 552,420 552,420
Gross profit $346,680 $346,680 $346,680
Less selling and administrative
activities:
Customer service cost $ 11,160 $ 61,200 $ 4,500
Sales order processing cost 7,200 15,360 3,360
Advertising support cost 31,250 225,000 55,000
$ 49,610 $301,560 $ 62,860
Income from operations $297,070 $ 45,120 $283,820
1
$1,110 × 810 units
2
$682 × 810 units
4. Kosmo Co. has low profitability, while the other two customers have acceptable
margins. This is because Kosmo Co. requires many customer services, sales
order processing, and advertising support activities. For example, Kosmo Co.
orders frequently in small order sizes, which increases the sales order processing
costs; it requests a large amount of service; and it requires extensive promotional
support. The company's options include:
a. Drop Kosmo Co. This does not necessarily mean that all the costs can be
avoided. The costs will only be eliminated if the reduced activity translates
into lower spending. Thus, the company should evaluate the contribution
margin of this customer relationship before making this decision.
b. Reprice Kosmo Co. Charge Kosmo Co. a higher price to compensate for
the higher activities required to serve it. The customer may not accept the
price increase required to move this to a profitable relationship.
c. Encourage Kosmo Co. to order in larger quantities. This may be appealing.
However, if Kosmo Co. wishes to keep its inventories low, it will avoid
making large infrequent orders but instead will prefer smaller frequent orders.
d. Improve the internal operations of Shrute Inc. to reduce the impact of the sales
order-related activities. Reduce the cost of sales order processing.
e. Unbundle pricing. Price customer service and advertising support as
separate services. That is, unbundle the pricing of goods from the support
services. This is a good long-term solution.
26-45

1. The depreciation and maintenance cost per mile is calculated as follows:*
Monthly Fuel, Crew, and Depreciation $2,120,000 + $850,000 + $430,000
=
Monthly Number of Miles Flown 170,000 miles
= $20/mile
*Ground personnel costs are not included. They are allocated separately below.
2. Monthly
Ground
Personnel Number of Arrival/Departure
Terminal City Cost per City ÷ Arrivals/Departures = Rate per City
Charlotte……………… $256,000 ÷ 320 = $800
Pittsburgh…………… 97,500 ÷ 130 = 750
Detroit………………… 129,000 ÷ 150 = 860
San Francisco……… 306,000 ÷ 340 = 900
Total…………………… $788,500 940
3. BLUE STAR AIRLINE

Flight Profitability Report
For Three Representative Flights
Flight 101 Flight 102 Flight 103
Passenger revenue
(passengers × ticket price) $55,600 $22,075 $ 7,640
Fuel, crew, and depreciation
costs (miles × $20 per mile) $40,000 $16,000 $ 8,000
Ground personnel (sum of
departure plus arrival charges) 1,7001 1,660 2 1,550 3
$41,700 $17,660 $ 9,550
Flight income from operations $13,900 $ 4,415 $(1,910)
1
$800 + $900 (Charlotte + San Francisco)
2
$860 + $800 (Detroit + Charlotte)
3
$800 + $750 (Charlotte + Pittsburgh)
26-46

4. The break-even formula is:
Break-Even Number of Fixed Costs of a Flight
=
Passengers per Flight Ticket Price – Variable Cost per Seat
None of the costs in a flight are variable to the number of seats. Essentially, the
costs will be incurred regardless of the number of passengers on the flight.
Thus, the costs of the flight are all fixed. Given this assumption, the break-even
number of passengers is a straightforward division of the costs by the fare. The
results are (rounded to the nearest whole number):
Flight Approximate Break-Even

101 $41,700 ÷ $695 = 60 passengers
102 $17,660 ÷ $441.50 = 40 passengers
103 $9,550 ÷ $382 = 25 passengers
Note that Flight 103 is losing money because only 20 seats were sold, which is
below the break-even point. Thus, this flight must have a higher proportion of
seats sold in order to earn a profit. This is a key feature of service companies.
They must manage the revenue earned from a fixed capacity. The technique for
doing this is termed “yield management.” For example, when a hotel offers a
weekend discount to attract volume during slower weekends, it is practicing
yield management.
26-47
CASES & PROJECTS

CP 26–1 (FIN MAN); CP 11–1 (MAN)
The net income is larger because the controller took period costs and treated them
as product costs for financial reporting purposes. All of the post-manufacturing
costs should be treated as an expense in the period incurred according to generally
accepted accounting principles (GAAP). If treated as product costs for financial
reporting purposes, some of these period costs were included in inventory while the
rest were included in the cost of goods sold. As a result, the net income would be
higher by the amount of period cost included (capitalized) in inventory.
Unfortunately, the controller has prepared financial statements that do not present
fairly the results of operations, according to GAAP. The new activity-based costing
information may have been very useful for internal decision making, but the post-
manufacturing period costs cannot be included as a product cost. These costs must
be treated as a period cost, according to GAAP. This is a situation where GAAP
requires a method that provides less decision relevance for managers inside the
firm. However, GAAP is concerned more about decision relevance to external users.
Thus, one could argue that expensing product costs is prohibited in financial
reporting (but not management reporting) in order to provide useful information to
external users.
The controller should have known that period costs cannot be treated as product
costs on the financial statements. Supporting such treatment would be considered
a breach of professional ethics.

The product profitability report indicates that the two products are equal in terms of
profitability (on a per-case basis). However, the additional information indicates that
there will be more activities required for Fizz Whiz than for Storm Soda. Apparently,
the factory overhead costs are being allocated on the basis of a single activity base
that does not capture these product differences. Since the direct labor costs are equal
for producing a case of each product, the factory overhead allocated to each case
would also be the same under the single plantwide factory overhead rate method.
Thus, they would appear to have similar cost and profitability. An activity-based
costing approach would likely demonstrate that the Fizz Whiz is less profitable and
the Storm Soda more profitable than indicated by the single plantwide factory overhead
rate method.
26-48

Wells Fargo Insurance Service’s (WFIS) activity-based costing model provides more
accurate product costs than does the revenue-based allocation scheme. This is
because WFIS has a large amount of processing and service expenses that are
unrelated to revenue volume but are instead related to products being “easy” and
“difficult.” WFIS’s actual activities associated with processing and service expenses
included phone inquiries, written inquiries, electronic processing, claim processing,
account enrollment and billing, and underwriting. The activity-based costing approach
distinguishes between the “easy” and “difficult” products by tracing activity costs
according to the product's use of these processing- and service-related activities. The
difficult products will consume relatively more of these activities per unit than will the
easy products.
The revenue-based allocation scheme allocates cost based only on the volume of
business. The activities associated with complexity (being easy or difficult) are not
likely to be associated with volume. In fact, the smaller-volume products are likely to
be the most complex (per unit of volume), since they are new and the "bugs" have
not yet been worked out. Thus, it is not surprising that the volume-based allocation
scheme causes inaccurate product cost calculations.
26-49

1. Floor Bookshelf Ribbon
Loudspeakers Loudspeakers Loudspeakers
Gross profit as percentage
of sales…………………………………… 30% 40% 10%
percentage of sales……………………… –10% 30% 2%
2. To: Management of Boom Box Sounds Inc.

From: Controller
The enclosed product profitability report indicates that our product lines provide
varying degrees of profitability. By far, our most profitable product line is the
bookshelf loudspeakers. The floor loudspeakers provide a healthy gross profit.
However, our marketing costs associated with this product line exceed our
gross profit. As a result, the product line is unprofitable as a whole. The ribbon
loudspeakers, on the other hand, have a very weak gross profit. As a result, the
product line is just barely profitable. As a result of this analysis, I offer the
following recommendations:
Bookshelf Loudspeakers
Bookshelf loudspeakers provide both a healthy gross profit and operating return
on sales.
Floor Loudspeakers
We should retain the floor loudspeakers in our product portfolio. The product
provides us a healthy gross profit. Unfortunately, we spend too much on
marketing this high-volume line of product. The vice president of marketing
assures me that the product has strong recognition in the marketplace. As such,
I recommend that we reduce our marketing effort for this product and manage
our profit for this product more carefully.
Ribbon Loudspeakers
Ribbon loudspeakers are one of our “up and comers.” No other competitor has
a similar product. Thus, we have the market to ourselves. Yet, this product does
not meet our profitability objectives. We are unable to spend much on marketing
because our gross profit is too low. This suggests that either we have priced the
ribbon loudspeakers too low or that the costs associated with making the product
are too high. Upon review of the cost information, the costs do not appear to be
out of line. Thus, I recommend a significant price increase and an increase in the
marketing budget for this important product. I believe the market will not reject the
price increase, since there are no similar products in the marketplace, and customers
have been pleased with the product.
26-50

Adlin’s concern appears valid. Teldar Tech Inc. is presently using direct labor as an
allocation base. This method, either as a single plantwide factory overhead rate or
as multiple production department factory overhead rates, will distort the product
costs when activities are consumed by products in different proportions than their
consumption of direct labor hours. The high-volume T-100 calculators appear easy
to make and consume relatively little factory support overhead, while the T-900
series consumes a small amount of direct labor (they are low-volume) but larger
amounts of factory support activity. This all suggests that Francie should consider
adopting an activity-based costing method. The activity-based costing method
would associate activities to the products based on their actual consumption of
those activities. Therefore, the T-900 series would consume relatively more of the
engineering, testing, and materials management activity than would the T-100,
using activity bases such as number of engineering changes, number of tests,
or number of materials requisitions. In addition, Francie may wish to consider
allocating some of the post-manufacturing selling and administrative activities to
the products. Activities such as warehousing, distribution, promotion, invoicing,
collecting, and selling could be identified to specific products, using activity-based
costing. However, the post-manufacturing costs only can be allocated to products for
internal reporting. Francie is correct in stating that they must be accounted for as
period costs under generally accepted accounting principles.

Students may arrive at a variety of possible activities and activity bases. Below is a
representative list.
Activity Activity Base

Opening an account Number of accounts opened
Teller deposit transaction Number of teller deposits
Teller withdrawal transaction Number of teller withdrawals
ATM withdrawal transaction Number of ATM withdrawals
ATM deposit transaction Number of ATM deposits
Online bill pay Number of online bill pay transactions
Providing a monthly statement Number of statements
Direct deposit transaction Number of direct deposits
Making a correction Number of corrections
Providing a balance Number of balance inquiries
Electronic funds transfer (EFT) Number of EFT transactions
Closing an account Number of accounts closed
26-51

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CHAPTER 26 (FIN MAN); CHAPTER 11 (MAN)

COST ALLOCATION AND ACTIVITY-BASED COSTING

b. Single plantwide factory overhead rate:

PE 26–1B (FIN MAN); PE 11–1B (MAN)

b. Single plantwide factory overhead rate:

PE 26–2A (FIN MAN); PE 11–2A (MAN)

Sewing: (20,000 jeans × 0.06 dlh) + (20,000 khakis × 0.04 dlh)

b. Cutting Department rate: $60,000 ÷ 2,000 dlh = $30 per dlh

c. Jeans: Cutting Department 0.04 dlh × $30 = $1.20

Khakis: Cutting Department 0.06 dlh × $30 = $1.80

PE 26–2B (FIN MAN); PE 11–2B (MAN)

b. Fabrication Department rate: $420,000 ÷ 3,000 dlh = $140 per dlh

c. Speedboat: Fabrication Department 8 dlh × $140 = $1,120

Bass boat: Fabrication Department 4 dlh × $140 = $ 560

PE 26–3A (FIN MAN); PE 11–3A (MAN)

PE 26–3B (FIN MAN); PE 11–3B (MAN)

b. Speed Boat Bass Boat

PE 26–4A (FIN MAN); PE 11–4A (MAN)

b. $3.20 per unit ($88,000 ÷ 27,500 units)

PE 26–4B (FIN MAN); PE 11–4B (MAN)

b. $9.20 per unit ($23,000 ÷ 2,500 units)

PE 26–5A (FIN MAN); PE 11–5A (MAN)

PE 26–5B (FIN MAN); PE 11–5B (MAN)

Ex. 26–2 (FIN MAN); Ex. 11–2 (MAN)

= $40 per direct labor hour

Trumpets…………………… 2,100 units × 0.8 = 1,680

Ex. 26–3 (FIN MAN); Ex. 11–3 (MAN)

= $60 per direct processing hour

** Total processing hours:

Tortilla chips………………… 4,000 × 0.20 = 800

Ex. 26–4 (FIN MAN); Ex. 11–4 (MAN)

Next, determine the plantwide overhead rate:

Budgeted Factory Overhead $184,320

b. Factory Overhead Direct Labor

c. ORANGE COUNTY ENGINE PARTS INC.

Ex. 26–5 (FIN MAN); Ex. 11–5 (MAN)

b. Product cost allocation:

Ex. 26–6 (FIN MAN); Ex. 11–6 (MAN)

b. Department factory overhead rates:

Ex. 26–7 (FIN MAN); Ex. 11–7 (MAN)

b. Department factory overhead rates:

Product cost allocation:

Ex. 26–8 (FIN MAN); Ex. 11–8 (MAN)

Ex. 26–9 (FIN MAN); Ex. 11–9 (MAN)

b. Sales order processing cost:

Ex. 26–10 (FIN MAN); Ex. 11–10 (MAN)

Ex. 26–11 (FIN MAN); Ex. 11–11 (MAN)

b. Entry Lighting Fixtures Dining Room Lighting Fixtures

Ex. 26–12 (FIN MAN); Ex. 11–12 (MAN)

* Engineering Change Order

Ex. 26–13 (FIN MAN); Ex. 11–13 (MAN)

= $100 per direct labor hour

* Setup activity cost = $375,000 × 40% = $150,000

Ex. 26–13 (FIN MAN); Ex. 11–13 (MAN) (Concluded)

Ex. 26–14 (FIN MAN); Ex. 11–14 (MAN)

b. Blender Toaster Oven

Ex. 26–15 (FIN MAN); Ex. 11–15 (MAN)

b. Blender Toaster Oven

Ex. 26–15 (FIN MAN); Ex. 11–15 (MAN) (Concluded)

Ex. 26–16 (FIN MAN); Ex. 11–16 (MAN)

a. Column A Column B Column C

Ex. 26–17 (FIN MAN); Ex. 11–17 (MAN)

Ex. 26–18 (FIN MAN); Ex. 11–18 (MAN)