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Exercise 2 – Activity Based Costing

Problem 1
Saludable Company produces two types of get well cards: scented and regular. Drivers for the
four activities are as follows:

Scented Regular
Cards Cards
Inspection hours 1,080 720
Setup hours 420 180
Machine hours 960 2,880
No. of moves 2,880 720

The following activity data have been collected:

Inspecting products P45,000
Setting up equipment 28,500
Machining 30,720
Moving materials 16,200
1. Compute the consumption ratios for the four drivers (round to two decimal places).
2. Is there evidence of product diversity? Explain the significance of product diversity for
decision makng if the company chooses to use machine hours to assign all overhead.
3. Compute the activity rates that would be used to assign costs to each product (round to
two decimal places).
4. Suppose that the activity rate for inspecting products is P20 per inspection hour. How
many hours of inspection are expected for the coming year?

Problem 2
ToySRUs Company uses activity-based costing (ABC). The company manufactures toy cars using
two activities: plastic inspection molding and decal application. ToySURs 20x1 total budgeted
overhead costs for these two activities are P675,000 (80% for inspection molding and 20% for
decal application). Molding overhead costs are driven by the number of pounds of plastic that
are moulded together. Decal application overhead costs are driven by the number of decals
applied to toys. The budgeted activity data for 20x1 are as follows:
Pounds of plastic moulded 3,000,000
Number of decals applied 375,000
1. Compute the activity rate for the plastic injection moulding activity (round to two
decimal places).
2. Compute for the activity rate for the decal application activity (round to two decimal

Problem 3
Weelington Chocolate Company uses activity-based costing. The controller identified two
activities and their budgeted costs:
Setting up equipment P432,000
Other overhead P1,440,000
Setting up equipment is based on setup hours, and other overhead is based on oven hours.
Wellington produces two products, Fudge and Cookies. Information on each product is as
Fudge Cookies
Units produced 8,000 445,000
Setup hours 6,400 1,600
Oven hours 1,600 8,000
1. Compute the activity rate for (a) setting up equipment and (b) other overhead.
2. How much total overhead is assigned to Fudge using ABC?
3. What is the unit overhead assigned to Fudge using ABC?
4. Now, ignoring ABC results, compute the plantwide overhead rate, based on oven hours.
5. How much total overhead is assigned to Fudge using the plantwide overhead rate?
6. Explain why the total overhead assigned to Fudge is different under ABC system. (i.e.
using the activity rates) than under non-ABC system (using plantwide rate).

Problem 4
Suppose that a surgical ward has gathered the following information for four nursing activities
and two types of patients:
Patient Category Activity
Driver Normal Intensive Rate
Treating patients Treatments 6,400 8,000 P200.00
Providing hygienic care Hygienic hours 4,800 17,600 P250.00
Responding to requests Requests 32,000 80,000 P100.00
Monitoring patients Monitoring hours 6,000 72,000 P150.00

1. Determine the total nursing costs assigned to each patient category.
2. Output is measured in patient days. Assuming that the normal patient category uses
8,000 patient days and the intensive patient category uses 6,400 patient days, compute
the nursing cost per patient day for each type of patient. (round to two decimal places).
3. The supervisor of the surgical ward has suggested the patient day is the only driver
needed to assign nursing costs to each type of patient. Compute the charge per patient
day (rounded to the nearest centavo) using this approach and then explain to the
supervisor why this would be a bad decision.

Problem 5
The receiving department has three activities: unloading, counting goods, and inspecting.
Unloading uses a forklift that is leased for P750,000 per year. The forklift is used for unloading.
The fuel for the forklift is P180,000 per year. Other operating costs (maintenance) for the
forklift total P75,000 per year. Inspection uses some special testing equipments that has
depreciatio of P60,000 per year and an operating cost of P37,500. Receiving has three
employees who have an average salary of P2,500,000 per year. The work distribution matrix for
the receiving personnel is as follows:

% of Time on Each
Unloading 40%
Counting 25%
Inspecting 35%

1. Compute the cost of each activity.
2. Explain the two methods used to assign costs to activity.

Problem 6
Suppose that Stillwater Designs has two classes of distributors, JIT distributors and non-JIT
distributors. The JIT distributors place small, frequent orders and the non-JIT distributors tend
to place larger, less frequent orders. Both types of distributors are buying the same product.
Stillwater Designs provides the following information about customer-related activities and
costs for the most recent quarter:
JIT Distributor Non-JIT Distributor
Sales orders 700 70
Sales calls 70 70
Service calls 350 175
Average order size 750 7,500
Manufacturing cost/unit P125 P125
Customer Costs:
Processing sales orders P3,080,000
Selling goods 1,120,000
Servicing goods 1,050,000
1. Compute the total revenues per distribution category and assign the customer costs to
each distributor type by using revenues as the allocation base. Selling prices for one
unit is P150.
2. Compute the customer cost per distributor type using activity-based costing
assignments. Discuss the merits of offering the non-JIT distributors a P2 price decrease
(assume that they are agitating for a price concession).
3. Assume that the JIT dsitributors are simply imposing the frequent orders on Stillwaters
Designs. No formal discussion has taken place between JIT customers and Stillwaters
Designs regarding the supply of goods on JIT basis. The sales pattern has evolved over
time. As an independent consultant, what would you suggest to Stillwaters Design

Problem 7
Bowman Company manufactures cooling systems. Bowman produces all the parts necessary for
its product except for one electronic component, which is purchased from two local suppliers:
Manzer Inc. and Buckner Company. Both suppliers are reliable and seldom deliver late,
however, Manzer sells the component for P89 per unit while Buckner sells the same component
for P86. Bowman purchases 80% of its components from Buckner because of its lower price.
The total annual demand is 4,000,000 components.

To help assess the cost effect of the two components, the following data were collected for
supplier-related activities and suppliers:
I. Activity Data
Activity Costs
Inspecting components (sampling only) P 480,000
Reworking products (due to failed components) 6,084,000
Warranty work (due to failed component) 9,600,000

II. Supplier Data

Manzer Inc. Buckner Company
Units purchase price P89 P86
Units purchased 800,000 3,200,000
Sampling hours 80 3,920
Rework hours 360 5,640
Warranty hours 800 15,200
Sampling inspection for Manzer’s products has been reduced because the reject
rate is so low.

1. Compute the cost per component for each supplier, taking into considerationthe costs
of the supplier-related activities and using the current prices and sales volume. (round
the unit cost to two decimal places).
2. Suppose that Bowman loses P4,000,000 in sales per year because it develops a poor
reputation due to defective units attributable to failed components. Using warranty
hours, assign the cost of lost sales to each supplier. By how much would this change the
cost of each supplier’s component? (round to two decimal places).
3. Based on the analysis on Requirement 1 and 2, discuss the importance of activity-based
supplier costing for internal decision making.