CHAPTER 25 (FIN MAN); CHAPTER 10 (MAN)
COST ALLOCATION AND ACTIVITY-BASED COSTING
CLASS DISCUSSION QUESTIONS
1. Product costs are used to determine the
profitability of individual products. This is
useful information in setting prices, determining promotional strategies, or in deciding
whether to stop making the product.
2. A company building aircraft carriers builds
them one at a time. There is no opportunity
for product cost distortion by incorrectly allocating overhead across products by using a
single overhead rate. Thus, a single overhead rate can be supported on the basis of
its simplicity and lack of distortion.
3. Management desires accurate product costs
so that its decisions regarding products are
correct. For example, the wrong product cost
could lead to incorrect pricing or promotional
strategies.
4. The same total cost is allocated under the
three different approaches. The different
cost assignment methods do not change the
total to be assigned.
5. 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.
6. 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.
7. The production department factory overhead
rates are determined by dividing the budgeted production department factory overhead by the budgeted allocation base for
each department.
8. An allocation base should measure the consumption of production department factory
overhead cost. For example, direct labor
hours or machine hours would be a good allocation base for a Fabrication Department,
because as products consume these hours,
they are likely consuming a proportionate
share of factory overhead from the department.
9. When there are significant differences in the
factory overhead rates across different production departments, and when the products
require different proportions of allocationbase usage in each production department
10. 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.
11. 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.
12. If the costs listed in Question 11 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.
13. 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.
14. Activity-based costing would be preferred
over the relative sales value method when
the products use selling and administrative
441
15.
activities in proportions that are unrelated to
their sales volumes.
Service companies can use activity-based
costing to determine the cost of service offerings. This information can be used to determine customer service profitability,
16.
442
which in turn can be used to guide service
pricing and strategy.
A telecommunications company could use
activity-based costing to determine the profitability of customer classes, such as residential customers and different types of
commercial customers.
EXERCISES
Ex. 25–1 (Fin Man); Ex. 10–1 (Man)
($125,000/4,000) × 1,800 = $56,250
Ex. 25–2 (Fin Man); Ex. 10–2 (Man)
a. Single plantwide factory overhead rate =
$140,840
5,030 direct labor hours *
= $28 per direct labor hour
*Total direct labor hours:
Budgeted Production
Volume
Trumpets .........
Tubas ...............
Trombones ......
Total .................
2,400 units
900
1,600
×
Direct Labor
Hours per Unit
=
×
×
×
0.8
1.5
1.1
=
=
=
Direct Labor
Hours
1,920
1,350
1,760
5,030
b.
Direct
Labor
Hours
Trumpets .......
Tubas.............
Trombones ....
Total...............
Single Plantwide Rate
per Direct
× Labor Hour =
1,920 ×
1,350 ×
1,760 ×
5,030
$28
28
28
Factory
Overhead
= $ 53,760
=
37,800
=
49,280
$140,840
443
Factory Overhead per Unit
(Factory Overhead ÷ Budgeted Production Volume)
$ 53,760 ÷ 2,400 units = $22.40
$ 37,800 ÷ 900 units = $42.00
$ 49,280 ÷ 1,600 units = $30.80
Ex. 25–3 (Fin Man); Ex. 10–3 (Man)
a. Single plantwide factory overhead rate =
$529,300
7,900 processing hours *
= $67 per processing hour
The selling and administrative expenses are not factory overhead.
*Total processing hours:
Budgeted Production
Volume
(Cases)
×
Tortilla chips ...
Potato chips ....
Pretzels ............
Total .................
15,000
32,000
13,000
60,000
Processing
Hours per Case
=
0.12
0.15
0.10
=
=
=
×
×
×
Processing
Hours
1,800
4,800
1,300
7,900
b.
Single Plantwide
Factory OverProcessing
head Rate per
Hours
× Processing Hour =
Tortilla chips .
Potato chips ..
Pretzels ..........
Total ...............
1,800
4,800
1,300
7,900
×
×
×
$67
67
67
=
=
=
444
Factory
Overhead
Factory Overhead per Case
(Factory Overhead ÷ Budgeted Production Volume
$120,600 $120,600/15,000 cases = $8.04
321,600 $321,600/32,000 cases = $10.05
87,100 $ 87,100/13,000 cases = $6.70
$529,300
Ex. 25–4 (Fin Man); Ex. 10–4 (Man)
a. First, determine the total estimated labor hours consumed by the three products:
Volume
Direct Labor
× Hours per Unit
=
Pistons ........................................ 4,000
×
0.20
Valves ......................................... 16,000
×
0.14
Cams ........................................... 1,000
×
0.12
Total estimated direct labor hours ..............................................
Total Labor
Hours
=
=
=
800
2,240
120
3,160
Next, determine the plantwide overhead rate:
Budgeted factory overhead
$96,380
=
= $30.50 per dlh
Plantwide allocation base
3,160 direct labor hours
b.
Direct
Labor Hours
per Unit
Pistons .............
Valves ..............
Cams ................
c.
Factory Overhead Cost
per Unit ($30.50 × Direct
Labor Hours per Unit)
0.20
0.14
0.12
Direct Labor Cost
per Unit ($24 × Direct
Labor Hours per Unit)
$6.10
4.27
3.66
$4.80
3.36
2.88
MERRIMACK VALLEY ENGINE PARTS, INC.
Product Line Estimated Gross Profit Reports
For the Year Ended December 31, 2006
Pistons
Valves
Cams
Revenues (price × unit volume) .....................
Direct materials (direct materials cost
per unit × unit volume) ..............................
Direct labor (direct labor cost per
unit (b) × unit volume) ...............................
Factory overhead (factory overhead
cost per unit (b) × unit volume) ................
$192,000
$252,800
$38,750
$ 98,000
$ 92,800
$16,400
19,200
53,760
2,880
24,400
$141,600
68,320
$214,880
3,660
$22,940
Gross profit .....................................................
$ 50,400
$ 37,920
$15,810
Gross profit percentage of sales ...................
26.3%
15.0%
40.8%
d. Valves have the lowest 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.
445
Ex. 25–5 (Fin Man); Ex. 10–5 (Man)
a. Production department factory overhead rates:
Total factory overhead...............................
Direct labor hours ......................................
Departmental overhead rate .....................
Pattern
Department
Cut and Sew
Department
$ 80,000
÷ 2,500 dlh
$ 32.00/dlh
$320,000
÷ 4,000 dlh
$ 80.00/dlh
b. Product cost allocation:
Small
Glove
Medium
Glove
Large
Glove
Direct labor hours per unit—
Pattern Dept. .............................
0.02
0.04
0.08
Pattern Dept. factory overhead
rate ............................................ × $32.00
× $32.00
× $32.00
Pattern Department factory
overhead ...................................
$0.64
$1.28
$2.56
Direct labor hours per unit—
Cut and Sew Dept. ....................
0.05
0.06
0.08
Cut and Sew Dept. factory
overhead rate ............................ × $80.00
× $80.00
× $80.00
Cut and Sew Dept. factory
overhead ...................................
4.00
4.80
6.40
Total factory overhead per glove ..
$4.64
$6.08
$8.96
Ex. 25–6 (Fin Man); Ex. 10–6 (Man)
a. Plantwide factory overhead rate:
Budgeted factory overhead
Plantwide allocation base
=
$1,050,000
5,000 direct machine hours
= $210.00 per dmh
Product costs:
Total direct machine hours per unit ....................
Plantwide factory overhead rate ..........................
Factory overhead per unit ....................................
446
Desktop
1.25
× $210.00
$262.50
Portable
2.0
× $210.00
$420.00
Ex. 25–6 (Fin Man); Ex. 10–6 (Man)
Concluded
b. Department factory overhead rates:
Production department overhead.............
Direct machine hours ................................
Production department overhead rate .....
Assembly
Department
Testing
Department
$360,000
÷ 3,000 dmh
$ 120.00/dmh
$690,000
÷ 2,000 dmh
$ 345.00/dmh
Product cost allocation:
Desktop
Portable
Direct machine hours per unit—
Assembly Department ...................
0.75
1.20
Assembly Department factory
overhead rate.................................. × $120.00
× $120.00
Assembly Department factory
overhead .........................................
$ 90.00
$144.00
Direct machine hours per unit—
Testing Department .......................
0.50
0.80
Testing Department factory
overhead rate.................................. × $345.00
× $345.00
Testing Department factory
overhead .........................................
172.50
276.00
Total factory overhead per unit ...........
$262.50
$420.00
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 desktop machine uses
0.75 direct machine hours in the Assembly Department and 0.50 hours in the
Testing Department, or a ratio of 3:2. The portable computer uses 1.20 direct
machine hours in the Assembly Department and 0.80 hours in the Testing Department, also for a ratio of 3:2. 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, Peach should consider remaining
with the easier single plantwide rate method in this circumstance.
447
Ex. 25–7 (Fin Man); Ex. 10–7 (Man)
a. Plantwide factory overhead rate:
Budgeted factory overhead
Plantwide allocation base
=
$819,000
6,000 direct labor hours
= $136.50 per dlh
Product costs:
Total direct labor hours per unit ...............
Plantwide factory overhead rate ...............
Factory overhead per unit .........................
Gasoline
Engine
Diesel
Engine
4
× $136.50
$546.00
4
× $136.50
$546.00
Fabrication
Department
Assembly
Department
$570,000
÷ 3,000 dlh
$ 190.00/dlh
$249,000
÷ 3,000 dlh
$ 83.00/dlh
b. Department factory overhead rates:
Total production department factory
overhead .................................................
Direct labor hours .........................................
Production department overhead rate ........
Product cost allocation:
Gasoline Engine
Diesel Engine
Direct labor hours per unit—
Fabrication Department .................
1
3
Fabrication Department factory
overhead rate.................................. × $190.00
× $190.00
Fabrication Department factory
overhead .........................................
$190.00
$570.00
Direct labor hours per unit—
Assembly Department ...................
3
1
Assembly Department factory
overhead rate.................................. × $ 83.00
× $ 83.00
Assembly Department factory
overhead .........................................
249.00
83.00
Total factory overhead per unit ...........
$439.00
$653.00
448
Ex. 25–7 (Fin Man); Ex. 10–7 (Man)
Concluded
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
$546 per unit. This is because each product uses a total of 4 direct labor hours
per unit. However, each product uses these 4 direct labor hours much differently. The gasoline engine consumes 1 hour in the expensive Fabrication Department and 3 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 (1:3 vs. 3:1). These conditions will cause the single plantwide rate method to distort product costs.
Ex. 25–8 (Fin Man); Ex. 10–8 (Man)
Activity
Customer return processing
Electric power
Human resources
Invoice and collecting
Machine depreciation
Materials handling
Order shipping
Payroll
Production control
Production setup
Purchasing
Quality control
Activity Base
Number of customer returns
Kilowatt-hours used
Number of direct labor hours
Number of customer orders
Number of machine hours
Number of material moves
Number of customer orders
Number of payroll checks processed
Number of production orders
Number of setups
Number of purchase orders
Number of inspections
Ex. 25–9 (Fin Man); Ex. 10–9 (Man)
a. Sales order processing activity rate: $99,400 ÷ 14,200 sales orders = $7 per
sales order
b. China sales order processing cost: $7 × 6,500 sales orders = $45,500
449
Ex. 25–10 (Fin Man); Ex. 10–10 (Man)
Activity-Base Usage
×
Activity
Rate
Activity
=
Cost
Stationary bicycle:
Fabrication .......................
1,796 machine hours × $25/mach. hr.
Assembly .........................
448 direct labor hrs.
× $8/dlh
Setup ................................
45 setups
× $50/setup
Inspecting ........................
700 inspections
× $24/inspection
Production scheduling ...
70 production orders × $15/prod. order
Purchasing.......................
180 purchase orders × $10/purch. order
Total.............................................................................................................
Number of units ..........................................................................................
Activity cost per unit ..................................................................................
= $44,900
=
3,584
=
2,250
= 16,800
=
1,050
=
1,800
$70,384
÷
800
$ 87.98
Rowing machine:
Fabrication .......................
988 machine hours
× $25/mach. hr.
Assembly .........................
176 direct labor hrs.
× $8/dlh
Setup ................................
16 setups
× $50/setup
Inspecting ........................
400 inspections
× $24/inspection
Production scheduling ...
12 production orders × $15/prod. order
Purchasing.......................
120 purchase orders × $10/purch. order
Total.............................................................................................................
Number of units ..........................................................................................
Activity cost per unit ..................................................................................
450
= $24,700
=
1,408
=
800
=
9,600
=
180
=
1,200
$37,888
÷
800
$ 47.36
Ex. 25–11 (Fin Man); Ex. 10–11 (Man)
a.
Activity Cost
Activity
Pool
÷ Total Activity Base
Casting ..................... $261,000 ÷ 9,000 machine
hours
Assembly ................. 112,200 ÷ 10,200 direct labor
hours
Inspecting ................ 35,000 ÷ 2,500 inspections
Setup ........................ 75,000 ÷ 300 setups
Materials handling ... 34,000 ÷ 1,000 loads
=
Activity Rate
= $29.00/machine hour
= $11.00/direct labor hour
= $14.00/inspection
= $250.00/setup
= $34.00/load
b.
Activity
Activity-Base Usage
×
Activity
Rate
=
Activity
Cost
Entry Lighting
Fixtures:
Casting ..................... 5,000 machine hrs.
× $29.00/machine hr.
Assembly ................. 4,100 direct labor hrs. × $11.00/direct labor hr.
Inspecting ................ 1,800 inspections
× $14.00/inspection
Setup ........................ 220 setups
× $250.00/setup
Materials handling ... 750 loads
× $34.00/load
Total activity cost .......................................................................................
Number of units ..........................................................................................
Activity cost per unit ..................................................................................
= $145,000
=
45,100
=
25,200
=
55,000
=
25,500
$295,800
÷ 5,916
$ 50.00
Dining Room Lighting
Fixtures:
Casting ..................... 4,000 machine hrs.
× $29.00/machine hour
Assembly ................. 6,100 direct labor hrs. × $11.00/direct labor hr.
Inspecting ................ 700 inspections
× $14.00/inspection
Setup ........................ 80 setups
× $250.00/setup
Materials handling ... 250 loads
× $34.00/load
Total activity cost .......................................................................................
Number of units ..........................................................................................
Activity cost per unit ..................................................................................
451
= $116,000
=
67,100
=
9,800
=
20,000
=
8,500
$221,400
÷ 3,280
$ 67.50
Ex. 25–12 (Fin Man); Ex. 10–12 (Man)
a.
Procurement
Scheduling
Materials
Handling
Product
Development
Factory overhead $150,000
$8,400
$37,500
$24,650
Activity base
÷ 1,200 purch. orders ÷ 350 prod. orders ÷ 750 moves ÷ 170 ECOs
Activity rate
$
125/purch. order $ 24/prod. order $
50/move $ 145/ECO
b.
Activity
Activity-Base Usage
×
Activity
Rate
=
Activity
Cost
Ovens:
Procurement ....................
700 purch. orders
× $125/purch. order
Scheduling .......................
220 prod. orders
× $24/prod. order
Materials handling ...........
450 moves
× $50/move
Product development......
130 ECOs
× $145/ECO
Total.............................................................................................................
Unit volume .................................................................................................
Activity cost per unit ..................................................................................
= $ 87,500
=
5,280
= 22,500
= 18,850
$134,130
÷ 1,500
$ 89.42
Refrigerators:
Procurement ....................
500 purch. orders
× $125/purch. order
Scheduling .......................
130 prod. orders
× $24/prod. order
Materials handling ...........
300 moves
× $50/move
Product development......
40 ECOs
× $145/ECO
Total.............................................................................................................
Unit volume .................................................................................................
Activity cost per unit ..................................................................................
452
= $62,500
=
3,120
= 15,000
=
5,800
$86,420
÷ 2,000
$ 43.21
Ex. 25–13 (Fin Man); Ex. 10–13 (Man)
a. Single plantwide rate:
Indirect labor
$480,000
=
= $120 per direct labor
Plantwide allocation base
4,000 direct labor hours hour
hour
Direct Labor
Plantwide
Hours
×
Rate
=
CDs
2,000
Data cartridges 2,000
× $120/dlh
× $120/dlh
Indirect
Labor cost
=
=
÷ Units
$240,000
$240,000
=
Indirect Labor
Cost per Unit
÷ 50,000 =
÷ 50,000 =
$4.80
$4.80
b. Activity-based rates:
Activity cost pool1 .................
Activity base ..........................
Activity rate............................
Setup
Production Support
$ 168,000
÷ 1,600 setups
$ 105.00/setup
$ 312,000
÷
4,000 dlh
$
78.00/dlh
1 Setup
activity cost = $480,000 × 35% = $168,000
Production support activity cost = $480,000 × 65% = $312,000
c.
Activity
Activity-Base Usage
×
Activity
Rate
=
Activity
Cost
CDs:
Setup ............................
Production support .....
Total..............................
Units .............................
Activity cost per unit ...
400 setups
× $105.00/setup
= $ 42,000
2,000 direct labor hrs. × $78/direct labor hr. = 156,000
$198,000
÷ 50,000
$
3.96
Data cartridges:
Setup ............................
Production support .....
Total..............................
Units .............................
Activity cost per unit ...
1,200 setups
× $105.00/setup
= $126,000
2,000 direct labor hrs. × $78/direct labor hr. = 156,000
$282,000
÷ 50,000
$
5.64
453
Ex. 25–13 (Fin Man); Ex. 10–13 (Man)
Concluded
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. CDs required 400 setups over a volume of 50,000 units (or 125 units per production
run), while data cartridges required 1,200 setups over the same volume (approximately 42 units per production run). The activity-based costing method
properly allocates the setup-related activity so that the data cartridges, the
setup-intensive product, receive a larger portion of the setup activity cost,
while the CDs 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 (35% of the indirect
labor) is not consumed equally by each product.
Ex. 25–14 (Fin Man); Ex. 10–14 (Man)
a. Production department factory overhead rates:
Assembly
Department
Factory overhead .................................................
Direct labor hours ................................................
Production department factory overhead rate...
$205,000
÷ 1,250
$ 164.00/dlh
Test and Pack
Department
$135,000
÷ 1,250
$ 108.00/dlh
b.
Activity
Allocation-Base Usage
×
Activity
Rate
=
Activity
Cost
Blender:
Assembly Department................
450 dlh
× $164/dlh
Test and Pack Department ........
800 dlh
× $108/dlh
Total.......................................................................................................
Units ......................................................................................................
Factory overhead cost/unit..................................................................
= $ 73,800
=
86,400
$160,200
÷ 10,000
$ 16.02
Toaster oven:
Assembly Department................
800 dlh
× $164/dlh
Test and Pack Department ........
450 dlh
× $108/dlh
Total.......................................................................................................
Units ......................................................................................................
Factory overhead cost/unit..................................................................
454
= $131,200
=
48,600
$179,800
÷ 10,000
$ 17.98
Ex. 25–15 (Fin Man); Ex. 10–15 (Man)
a. Activity rates:
Assembly
Activity
Activity cost pool.............
Activity base ....................
Activity rate ......................
Test and Pack
Activity
Setup
Activity
$75,000
÷ 1,250 dlh
$
60/dlh
$ 120,000
÷
400 setups
$
300/setup
$145,000
÷ 1,250 dlh
$
116/dlh
b. Product factory overhead costs:
Activity
Activity-Base Usage
× Activity Rate
=
Activity
Cost
Blender:
Assembly activity ....................
Test and Pack activity .............
Setup activity ...........................
Total..........................................
Units .........................................
Factory overhead cost/unit.....
800 dlh
450 dlh
275 setups
× $116/dlh
× $60/dlh
× $300/setup
= $ 52,200
=
48,000
=
82,500
$182,700
÷ 10,000
$ 18.27
800 dlh
450 dlh
125 setups
× $116/dlh
× $60/dlh
× $300/setup
= $ 92,800
=
27,000
=
37,500
$157,300
÷ 10,000
$ 15.73
Toaster oven:
Assembly activity ....................
Test and Pack activity .............
Setup activity ...........................
Total..........................................
Units .........................................
Factory overhead cost/unit.....
Note to Instructors: If you assigned both Ex. 25–14 and Ex. 25–15, then you can
make the following observations:
The activity-based costing approach provides unit factory overhead cost information that is nearly 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 2.2 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 Handy Kitchen should be encouraged to use activity-based costing information for product-based decisions.
455
Ex. 25–16 (Fin Man); Ex. 10–16 (Man)
a.
Column A
Product Volume Class
Single Rate
Overhead
Allocation
per Unit
Column B
Column C
ABC Overhead
Allocation per
Unit
Percent Change in
Allocation (Col. B –
Col. A)/Col. A
$58.331
$118.502
103.15%
Medium
59.403
50.334
–15.27%
High
56.005
38.606
–31.07%
Low
1
(25 hours × $280/hour)/120 units
[(25 hours × $180/hour) + (18 setups × $400/setup) + (42 sales orders ×
$60/sales order)]/120 units
3 (297 hours × $280/hour)/1,400 units
4 [(297 hours × $180/hour) + (20 setups × $400/setup) + (150 sales orders ×
$60/sales order)]/1,400 units
5 (860 hours × $280/hour)/4,300 units
6 [(860 hours × $180/hour) + (10 setups × $400/setup + (120 sales orders ×
$60/sales order)]/4,300 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 medium and higher volume products. 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.
2
Note: The sum of Column C is not equal to zero because there are only three representative products, not all of the products.
456
Ex. 25–17 (Fin Man); Ex. 10–17 (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. 25–18 (Fin Man); Ex. 10–18 (Man)
a. Sales order processing activities:
Generators .......................
Air compressors ..............
Total..................................
Number of
Sales Orders
×
Activity Rate
=
Activity Cost
300
800
×
×
$90
90
=
=
$27,000
72,000
$99,000
Activity Rate
=
Activity Cost
=
=
$ 27,000
127,500
$154,500
Post-sale customer service activities:
Number of
Service Requests ×
Generators .......................
Air compressors ..............
Total..................................
90
425
×
×
$300
300
Note: $154,500 + $99,000 = $253,500 which is the total selling and administrative
expense reported in the exercise.
457
Ex. 25–18 (Fin Man); Ex. 10–18 (Man)
Concluded
b.
POWER SERVE EQUIPMENT COMPANY
Product Profitability Report
For the Year Ended December 31, 20—
Generators
Revenues ................................................. $ 1,800,000
Cost of goods sold ..................................
1,350,000
Gross profit.............................................. $ 450,000
Sales order processing .......................... $
27,000
Post-sale customer service ....................
27,000
$
54,000
Income from operations ......................... $ 396,000
Gross profit as a percentage of sales ...
Income from operations as a
percentage of sales ...........................
Air
Compressors
$950,000
712,500
$237,500
$ 72,000
127,500
$199,500
$ 38,000
25.00%
25.00%
22.00%
4.00%
Total
$ 2,750,000
2,062,500
$ 687,500
$
99,000
154,500
$ 253,500
$ 434,000
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 Power
Serve’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. Power Serve
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.
458
Ex. 25–19 (Fin Man); Ex. 10–19 (Man)
a.
SQUARE D CORPORATION
Customer Profitability Report
For the Year Ended December 31, 20—
(assumed data)
Customer 1 Customer 2
Revenue ........................................................
$18,500
$27,750
Cost of goods sold .......................................
10,175
14,430
Gross profit...................................................
$ 8,325
$13,320
Customer service activities:
Bid preparation .......................................
Shipment .................................................
Support standard items ..........................
Support nonstandard items ...................
Total customer service activities ................
Income from operations after customer
service activities .....................................
Income from operations after customer
service activities as a percent of sales ..
Customer 3
$40,000
24,000
$16,000
$ 1,1601
5602
1,3503
2,6404
$ 5,710
$ 2,610
1,008
2,025
6,050
$ 11,693
$
$ 2,615
$ 1,627
$11,201
14.1%
5.9%
28%
725
504
2,250
1,320
$ 4,799
1
$145 × 8 bid requests
$28 × 20 shipments
3 $45 × 30 standard items
4 $110 × 24 nonstandard items
2
b. The gross profit as a percent of sales indicated that Customer 3 was the least
profitable, while Customer 2 was the most profitable. After deducting the activity costs associated with customer service activities, these positions reversed. Customer 3 became the most profitable, while Customer 2 became the
least profitable. The reason is because Customer 3 consumed much fewer
customer service activities than did Customer 2. Apparently, Customer 3 ordered standard products that required few specialized bid requests. In addition, Customer 3 required fewer shipments, indicating larger loads to a single
location, rather than many smaller shipments to different locations.
459
Ex. 25–20 (Fin Man); Ex. 10–20 (Man)
a.
Patient M
Activity
Room and meals ..
Radiology .............
Pharmacy..............
Chemistry lab .......
Operating room ....
Total cost ..............
Activity Usage
× Activity Rate
Patient T
Patient M
Activity
= Cost
7 days × $175/day
= $1,225
4 images × $280/image = 1,120
5 order × $35/order
=
175
6 tests × $90/test
=
540
4.5 OR hrs. × $700/hr. = 3,150
$6,210
Activity Usage
× Activity Rate
Patient T
Activity
= Cost
3 days × $175/day
= $ 525
2 images × $280/image =
560
1 orders × $35/order
=
35
2 tests × $90/test
=
180
1 OR hrs. × $700/hr.
=
700
$2,000
b. Patient M apparently had a more serious condition than did Patient T. Patient
M required more operating room hours, more tests and images, and more
days to recover than did Patient T. Thus, the activity cost to Patient M is over
three times that of Patient T.
460
Ex. 25–21 (Fin Man); Ex. 10–21 (Man)
a.
SAFE HANDS INSURANCE COMPANY
Product Profitability Report
For the Year Ended December 31, 2007
Premium revenue .................................
Less estimated claims .........................
Underwriting income ...........................
Administrative activities:
New policy processing ...................
Cancellation processing ................
Claim audits ....................................
Claim disbursements processing .
Premium collection processing .....
Total administrative expenses .......
Income from operations ......................
Income from operations
as a percent of premium revenue ..
Auto
Workers’
Comp.
Homeowners
$5,000,000
3,250,000
$1,750,000
$4,000,000
2,600,000
$1,400,000
$6,000,000
3,900,000
$2,100,000
$ 198,000
130,500
188,500
43,750
296,000
$ 856,750
$ 893,250
$ 216,000
43,500
63,800
17,500
48,000
$ 388,800
$1,011,200
$ 468,000
391,500
417,600
93,750
480,000
$1,850,850
$ 249,150
17.9%
25.3%
4.2%
b. All three insurance lines have the same percentage of underwriting income to
premium revenue (35%). 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 is having 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’ comp. line
consumes the fewest administrative activities, causing it to be very profitable.
The auto line is in between these two.
461
PROBLEMS
Prob. 25–1A (Fin Man); Prob. 10–1A (Man)
1.
a. Direct labor overhead rate:
$672,000
$420 per direct labor
=
1,600 direct labor hours
hour
b. Machine hour overhead rate:
$672,000
= $240 per machine hour
2,800 machine hours
2.
Whole Milk
Skim Milk
Cream
200 dlh
460
660 dlh
× $420/dlh
$277,200
240 dlh
520
760 dlh
× $420/dlh
$319,200
60 dlh
120
180 dlh
× $420/dlh
$75,600
800 mh
400
1,200 mh
× $240/mh
$288,000
750 mh
450
1,200 mh
× $240/mh
$288,000
250 mh
150
400 mh
× $240/mh
$96,000
a. Direct labor hours:
Blending Department.................
Packing Department ..................
Total direct labor hours .............
Direct labor overhead rate ........
Allocated factory overhead .......
b. Direct machine hours:
Blending Department.................
Packing Department ..................
Total machine hours ..................
Machine hour overhead rate .....
Allocated factory overhead .......
462
Prob. 25–2A (Fin Man); Prob. 10–2A (Man)
1.
Blending Dept.
Packing Dept.
$540,000
÷ 1,800 mh
$
300/mh
$132,000
÷ 1,100 dlh
$
120/dlh
Production department factory overhead
totals .......................................................
Activity base ...............................................
Production department rate ......................
2.
Machine hours—Blending
Department ............................
Blending Dept. factory overhead rate per mach. hr. .........
Blending Department factory
overhead ................................
Direct labor hours—
Packing Department .............
Packing Dept. factory overhead rate per labor hr. ..........
Packing Dept. factory
overhead ................................
Total factory overhead ................
Whole Milk
Skim Milk
800
750
250
× $300
× $300
× $300
$240,000
Cream
$225,000
$75,000
460
520
120
× $120
× $120
× $120
55,200
$295,200
463
62,400
$287,400
14,400
$89,400
Prob. 25–3A (Fin Man); Prob. 10–3A (Man)
1. Production department rates:
Factory overhead .......................................
Direct labor hours ......................................
Production department rate ......................
Subassembly
Department
Final Assembly
Department
$720,000
÷ 1,000
$
720/dlh
$620,000
÷ 1,000
$
620/dlh
2.
Direct Labor
Production
Hours
× Department Rate =
Factory
Overhead
Receivers:
Subassembly Department ......
Final Assembly Department ..
Total factory overhead ............
Number of units .......................
Factory overhead per unit ......
700
300
×
×
$720/dlh
$620/dlh
=
=
$504,000
186,000
$690,000
÷ 8,000
$ 86.25
300
700
×
×
$720/dlh
$620/dlh
=
=
$216,000
434,000
$650,000
÷ 8,000
$ 81.25
CD Players:
Subassembly Department ......
Final Assembly Department ...
Total factory overhead ............
Number of units .......................
Factory overhead per unit ......
3. Activity-based rates:
Setup
Factory overhead .... $380,000
Activity base ............ ÷
250 setups
Activity rate ............. $ 1,520/setup
Quality
Control
$180,000
÷ 1,250 insp.
$
144/insp.
464
Subassembly
Department
Final Assembly
Department
$440,000
÷ 1,000 dlh
$
440/dlh
$340,000
÷ 1,000 dlh
$
340/dlh
Prob. 25–3A (Fin Man); Prob. 10–3A (Man)
Concluded
4.
Activity
Activity Usage
× Activity Rate
=
Activity Cost
190 setups
1,045 inspections
700 dlh
300 dlh
×
×
×
×
$1,520/setup
$144/insp.
$440/dlh
$340/dlh
=
=
=
=
$288,800
150,480
308,000
102,000
$849,280
÷ 8,000
$ 106.16
60 setups
205 inspections
300 dlh
700 dlh
×
×
×
×
$1,520/setup
$144/insp.
$440/dlh
$340/dlh
=
=
=
=
$ 91,200
29,520
132,000
238,000
$490,720
÷ 8,000
$ 61.34
Receivers:
Setup.......................................
Quality control .......................
Subassembly Department .....
Final Assembly Department ..
Total ........................................
Number of units .....................
Activity cost per unit ..............
CD Players:
Setup.......................................
Quality control .......................
Subassembly Department .....
Final Assembly Department .
Total ........................................
Number of units .....................
Activity cost per unit ..............
5. The activity-based overhead allocation reveals that receivers are more costly
on a per-unit basis than are the CD players. The multiple production department rate method determined that the per-unit factory overhead was 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. Receivers have more setups and inspection activities
than do CD players. Thus, receivers have higher activity costs per unit than do
CD players.
465
Prob. 25–4A (Fin Man); Prob. 10–4A (Man)
1.
Production
Total activity
cost .......
Total activity
base .......
Activity rate .
Setup
Inspection
Shipping
Customer
Service
$580,000
$400,000
$168,000
$270,000
$72,000
÷
$
÷
$
÷
$
÷
$
÷
$
8,000 mh
72.50/mh
400 setups
1,000/setup
1,200 insp.
140/insp.
4,500 cust. ord.
60/cust. ord.
400 req.
180/req.
2.
Activity
Activity-Base Usage ×
Activity Rate
= Activity Cost
White sugar:
Production .................
Setup ..........................
Inspection ..................
Shipping .....................
Customer service ......
Total activity cost ......
Units ..........................
Activity cost per unit
3,840 mach. hrs.
100 setups
200 inspections
800 cust. orders
60 requests
×
×
×
×
×
$72.50/mh
$1,000/setup
$140/inspection
$60/cust. order
$180/request
= $278,400
= 100,000
= 28,000
= 48,000
= 10,800
$465,200
÷ 9,600 units
$ 48.46/unit
1,600 mach. hrs.
150 setups
400 inspections
2,700 cust. orders
240 requests
×
×
×
×
×
$72.50/mh
$1,000/setup
$140/inspection
$60/cust. order
$180/request
= $116,000
= 150,000
= 56,000
= 162,000
= 43,200
$527,200
÷ 4,000 units
$ 131.80/unit
2,560 mach. hrs.
150 setups
600 inspections
1,000 cust. orders
100 requests
×
×
×
×
×
$72.50/mh
$1,000/setup
$140/inspection
$60/cust. order
$180/request
= $185,600
= 150,000
= 84,000
= 60,000
= 18,000
$497,600
÷ 6,400 units
$ 77.75/unit
Brown sugar:
Production .................
Setup ..........................
Inspection ..................
Shipping .....................
Customer service ......
Total activity cost ......
Units ...........................
Activity cost per unit
Powdered sugar:
Production .................
Setup ..........................
Inspection ..................
Shipping .....................
Customer service ......
Total activity cost ......
Units ...........................
Activity cost per unit
466
Prob. 25–4A (Fin Man); Prob. 10–4A (Man)
Concluded
3. The unit costs are different even though each product requires 0.4 machine
hours 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.
467
Prob. 25–5A (Fin Man); Prob. 10–5A (Man)
1.
Customer
Service
Activity cost pool ..........
Activity base ..................
Activity rate ...................
Sales Order
Processing
$56,350
$42,240
÷ 230 serv. reqs. ÷ 880 sls. orders
$ 245/serv. req. $
48/sls. order
Advertising
Support
$110,400
÷
120 ads placed
$
920/ad
2.
Office-to-Go
General
Office Supply
Office Warehouse
Number of customer
service requests ..................
35
5
190
Activity rate ............................... × $245/sr*
× $245/sr*
× $245/sr*
Customer service
activity cost .........................
$ 8,575
$ 1,225
$ 46,550
Number of sales orders ............
250
110
520
Activity rate ............................... × $48/ord.
× $48/ord.
× $48/ord.
Sales order
processing cost...................
12,000
5,280
24,960
Number of ads placed ..............
25
10
85
Activity rate ............................... × $920/ad
× $920/ad
× $920/ad
Advertising support
cost ......................................
23,000
9,200
78,200
Total nonmanufacturing
activity costs .......................
$43,575
$15,705
$149,710
* “sr” stands for service request.
468
Prob. 25–5A (Fin Man); Prob. 10–5A (Man)
3.
Concluded
Z-ROX, INC.
Customer Profitability Report
For the Year Ended December 31, 20—
Office-to-Go
Revenues .............................................. $ 792,0001
Less cost of goods sold ......................
675,0002
Gross profit........................................... $ 117,000
Less selling and administrative
activities:
Customer service cost ................... $ 8,575
Sales order processing cost ..........
12,000
Advertising support cost................
23,000
$ 43,575
Income from operations ...................... $ 73,425
1
$440 × 1,800 units
2
General
Office Supply
$ 792,000
675,000
$ 117,000
$
1,225
5,280
9,200
$ 15,705
$ 101,295
Office
Warehouse
$ 792,000
675,000
$ 117,000
$ 46,550
24,960
78,200
$ 149,710
$ (32,710)
$375 × 1,800 units
4. Office Warehouse is unprofitable, while the other two customers have acceptable margins. This is because Office Warehouse requires many customer
services, sales order processing, and advertising support activities. For example, Office Warehouse 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 Office Warehouse. This does not necessarily mean that all the costs
can be avoided. The costs will only go away 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 Office Warehouse. Charge Office Warehouse 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.
Try to get Office Warehouse to order in larger quantities. This may be appealing. However, if Office Warehouse 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 Z-Rox 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. In other words, unbundle the pricing of goods from the
support services. This is a good long-term solution.
469
470
Prob. 25–6A (Fin Man); Prob. 10–6A (Man)
1. The depreciation and maintenance cost per mile is calculated as follows:
Monthly fuel, crew, and depreciation
Monthly number of miles flown
$1,020,000 + $644,000 + $352,000
= $16.80/mile
120,000 miles
2.
Terminal City
Atlanta ...................
Cincinnati ..............
Chicago .................
Los Angeles ..........
Total.......................
Monthly
Ground Personnel
Cost per City
$256,000
105,000
140,800
263,200
$765,000
÷
Number of
Arrivals/Departures
÷
÷
÷
÷
320
140
160
280
900
Arrival/Departure
=
Rate per City
=
=
=
=
$800
750
880
940
3.
FRIENDLY SKIES AIRLINE
Flight Profitability Report
For Three Representative Flights
Flight 101 Flight 102
Passenger revenue (passengers × fare) .......
Fuel, crew, and depreciation costs (miles
× $16.80 per mile) .......................................
Ground personnel (sum of departure
plus arrival charges) ..................................
Flight income from operations .......................
1
$800 + $940
$880 + $800
3 $800 + $750
2
471
Flight 103
$36,000
$ 17,940
$ 6,790
$ 32,760
$ 10,080
$ 6,216
1,7401
$34,500
$ 1,500
1,6802
$ 11,760
$ 6,180
1,5503
$ 7,766
$ (976)
Prob. 25–6A (Fin Man); Prob. 10–6A (Man)
Concluded
4. The break-even formula is:
Fixed costs of a flight
Break-even number of
=
passengers per flight
Seat fare  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
101
102
103
Approximate Break-Even
34,500/$1,800 = 19 passengers
$11,760/$690 = 17 passengers
$7,766/$485 = 16 passengers
Note that Flight 103 is losing money because only 14 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 the slower weekend, it is practicing yield management.
472
Prob. 25–1B (Fin Man); Prob. 10–1B (Man)
1. a.
b.
Direct labor overhead rate:
$1,053,000
= $405 per direct labor hour
2,600 direct labor hours
Machine hour overhead rate:
$1,053,000
= $225 per machine hour
4,680 machine hours
2.
Automobile
Bumpers
Valve Covers
Stamping Department ..............................
490 dlh
Plating Department ..................................
260
Total direct labor hours ...........................
750 dlh
Direct labor factory overhead rate .......... × $405/dlh
Allocated factory overhead ..................... $303,750
450 dlh
290
740 dlh
× $405/dlh
$299,700
760 dlh
350
1,110 dlh
× $405/dlh
$449,550
420 mh
810
1,230 mh
× $225/mh
$276,750
710 mh
1,370
2,080 mh
× $225/mh
$468,000
Wheels
a. Direct labor hours:
b. Direct machine hours:
Stamping Department ..............................
450 mh
Plating Department ..................................
920
Total machine hours ................................
1,370 mh
Machine hour factory overhead rate ....... × $225/mh
Allocated factory overhead ..................... $308,250
473
Prob. 25–2B (Fin Man); Prob. 10–2B (Man)
1.
Stamping Dept.
Production department factory
overhead totals .....................................
Activity base ...............................................
Production department rate ......................
$669,375
÷ 1,700 dlh
$ 393.75/dlh
Plating Dept.
$383,625
÷ 3,100 mh
$ 123.75/mh
2.
Automobile
Bumpers
Labor hours—Stamping
Department ...........................
490
Stamping Dept. factory
overhead rate per labor hr. .. × $393.75
Stamping Department factory
overhead ...............................
$192,938
Machine hours—Plating
Department ...........................
920
Plating Department factory
overhead rate per mach. hr. × $123.75
Plating Department factory
overhead ...............................
113,850
Total factory overhead ..............
$306,788
474
Valve Covers
Wheels
450
760
× $393.75
×$393.75
$177,188
810
$299,250
1,370
× $123.75
× $123.75
100,238
$277,426
169,538
$468,788
Prob. 25–3B (Fin Man); Prob. 10–3B (Man)
1. Production department rates:
Factory overhead ............................
Direct labor hours ...........................
Production department rate ...........
Cutting
Department
Finishing
Department
$630,000
÷ 5,000
$ 126.00/dlh
$420,000
÷ 5,000
$ 84.00/dlh
2.
Direct Labor
Production
Hours
× Department Rate =
Factory
Overhead
Snowboards:
Cutting Department ...........
Finishing Department ........
Total factory overhead.......
Number of units .................
Factory overhead per unit .
4,000
1,000
×
×
$126.00/dlh
$84.00/dlh
=
=
$504,000
84,000
$588,000
÷ 20,000
$ 29.40
1,000
4,000
×
×
$126.00/dlh
$84.00/dlh
=
=
$126,000
336,000
$462,000
÷ 20,000
$ 23.10
Skis:
Cutting Department ...........
Finishing Department ........
Total factory overhead.......
Number of units .................
Factory overhead per unit .
3. Activity-based rates:
Production
Control
Factory overhead .... $150,000
Activity base ............ ÷
400 prod.runs
Activity rate ............. $
375/prod.run
Materials
Handling
Cutting
Department
Finishing
Department
$300,000
$330,000
÷ 6,000 moves ÷ 5,000 dlh
$
50/move
$
66/dlh
$270,000
÷ 5,000 dlh
$
54/dlh
475
Prob. 25–3B (Fin Man); Prob. 10–3B (Man)
Concluded
4.
Activity
Activity Usage
×
Activity Rate
=
Activity Cost
80 prod. runs
1,000 moves
4,000 dlh
1,000 dlh
×
×
×
×
$375/prod. run
$50/move
$66/dlh
$54/dlh
=
=
=
=
$ 30,000
50,000
264,000
54,000
$398,000
÷ 20,000
$ 19.90
320 prod. runs
5,000 moves
1,000 dlh
4,000 dlh
×
×
×
×
$375/prod. run
$50/move
$66/dlh
$54/dlh
=
=
=
=
$120,000
250,000
66,000
216,000
$652,000
÷ 20,000
$ 32.60
Snowboards:
Production control ..........
Materials handling ...........
Cutting Department .........
Finishing Department .....
Total..................................
Number of units ...............
Activity cost per unit .......
Skis:
Production control ..........
Materials handling ...........
Cutting Department .........
Finishing Department .....
Total..................................
Number of units ...............
Activity cost per unit .......
5. The activity-based overhead allocation reveals that skis consume more factory
overhead on a per-unit basis than do snowboards. 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 snowboard cost per unit is higher, since the Cutting Department has the highest
factory overhead rate, and snowboards use more Cutting Department labor
hours relative to the skis. The activity-based method separately accounts for
the production control and materials handling activity costs. Skis have more
production control and materials handling activities than do snowboards. This
is because skis are made in smaller lots, representing a wide variety of
lengths and styles. Thus, skis have higher activity costs per unit than snowboards.
476
Prob. 25–4B (Fin Man); Prob. 10–4B (Man)
1.
Production
Total activity
cost .......
Total activity
base .......
Activity rate .
$739,440
÷
$
Setup
$256,000
2,340 mh ÷
316/mh $
500 setups
512/setup
Moving
$30,600
÷
$
Product
Engineering
Shipping
$ 88,400
850 moves ÷
36/move $
$40,000
1,300 cust. ord. ÷
68/cust. ord. $
200 test runs
200/test run
2.
Activity
Activity-Base Usage ×
Activity Rate
=
Activity Cost
Computer paper:
Production .................
Setup ..........................
Moving ........................
Shipping .....................
Product engineering .
Total activity cost ......
Units ...........................
Activity cost per unit
810 mach. hrs.
120 setups
280 moves
470 cust. orders
70 test runs
×
×
×
×
×
$316/mh
$512/setup
$36/move
$68/cust. order
$200/test run
=
=
=
=
=
$ 255,960
61,440
10,080
31,960
14,000
$ 373,440
÷
900 units
$ 414.93/unit
1,080 mach. hrs.
50 setups
120 moves
145 cust. orders
10 test runs
×
×
×
×
×
$316/mh
$512/setup
$36/move
$68/cust. order
$200/test run
=
=
=
=
=
$341,280
25,600
4,320
9,860
2,000
$383,060
÷ 1,200 units
$ 319.22/unit
450 mach. hrs.
330 setups
450 moves
685 cust. orders
120 test runs
×
×
×
×
×
$316/mh
$512/setup
$36/move
$68/cust. order
$200/test run
=
=
=
=
=
$ 142,200
168,960
16,200
46,580
24,000
$ 397,940
÷
500 units
$ 795.88/unit
Newsprint:
Production .................
Setup ..........................
Moving ........................
Shipping .....................
Product engineering .
Total activity cost ......
Units ...........................
Activity cost per unit
Specialty Paper:
Production .................
Setup ..........................
Moving ........................
Shipping .....................
Product engineering .
Total activity cost ......
Units ...........................
Activity cost per unit
477
Prob. 25–4B (Fin Man); Prob. 10–4B (Man)
Concluded
3. The unit costs are different even though each product requires 0.9 machine
hours because the products consume many activities in ratios different from
the volume. For example, the specialty paper consumes setup, moving, shipping, and product engineering activities proportionately greater than its volume, while the newsprint consumes the same activities proportionately less
than its volume.
478
Prob. 25–5B (Fin Man); Prob. 10–5B (Man)
1.
Activity cost .......
Activity base ......
Activity rate ........
Customer Service
Project Bidding
Engineering Support
$203,500
÷
185 serv. reqs.
$ 1,100/serv. req.
$128,000
÷
40 bids
$ 3,200/bid
$94,500
÷ 105 des. changes
$
900/change
Atlantic University
Star Arena
2.
Number of customer
service requests ...
120
Activity rate .................. × $1,100/sr*
Customer service
activity cost ...........
$132,000
Number of bids ............
12
Activity rate .................. × $3,200/bid
Project bidding
activity cost ...........
38,400
Number of customer
design changes.....
65
Activity rate .................. × $900/dc*
Engineering support
activity cost ...........
58,500
Total nonmanufacturing
activity costs .........
$228,900
25
× $1,100/sr*
Covenant Hospital
40
× $1,100/sr*
$ 27,500
10
× $3,200/bid
$ 44,000
18
× $3,200/bid
32,000
×
15
$900/dc*
×
25
$900/dc*
13,500
22,500
$ 73,000
$124,100
* “sr” stands for service request; “dc” stands for design change.
479
57,600
Prob. 25–5B (Fin Man); Prob. 10–5B (Man)
3.
Concluded
ARCTIC AIR, INC.
Customer Profitability Report
For the Year Ended December 31, 2006
Revenues ......................................
Less cost of goods sold ..............
Gross profit...................................
Less selling and administrative
activities:
Customer service ....................
Project bidding ........................
Engineering support ...............
Income from operations ..............
1
$126,000 × 5 units
4 $87,000 × 5 units
Atlantic
University
$ 630,0001
435,0004
$ 195,000
$ 132,000
38,400
58,500
$ 228,900
$ 33,900)
2
$126,000 × 10 units
5 $87,000 × 10 units
Star Arena
$1,260,0002
870,0005
$ 390,000
Covenant
Hospital
$ 1,890,0003
1,305,0006
$ 585,000
$
$
27,500
32,000
13,500
$ 73,000
$ 317,000
3
6
$
$
44,000
57,600
22,500
124,100
460,900
$126,000 × 15 units
$87,000 × 15 units
4. Atlantic University is unprofitable, while the other two customers have acceptable margins. This is because Atlantic University requires many customer
service, project bidding, and design change activities. For example, Atlantic
University awards contracts on only 42% of the bid efforts (5 contracts/12
bids); it requests a large amount of service; and it requires extensive design
change effort. The company's options include:
a.
Stop bidding Atlantic University projects: This does not necessarily mean
that all the costs can be avoided. The costs will only go away 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 Atlantic University work. Charge Atlantic University 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. Try to get Atlantic University 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 Atlantic University to change its behavior.
d. Charge a price for customer service and design change separately. In other words, 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.
480
Prob. 25–6B (Fin Man); Prob. 10–6B (Man)
1.
Activity
Activity Cost ÷
Scheduling and
admitting ............ $ 193,200
Housekeeping ......... 1,932,000
Nursing .................... 2,175,000
Total ......................... $4,300,200
÷
÷
÷
Activity Base
=
Activity Rate
4,200 patients
= $46/patient
16,800 patient days
= $115/patient day
150,000 weighted care units = $14.50/wcu
2.
Activity
Activity Usage
×
Activity Rate
Total Activity
Cost by
=
Procedure
Procedure A:
Scheduling and admitting .....
Housekeeping ........................
Nursing ...................................
200 patients
× $46/patient
=
1,200 patient days × $115/patient day =
16,000 wcus
× $14.50/wcu
=
$ 9,200
138,000
232,000
$379,200
400 patients
800 patient days
4,200 wcus
× $46/patient
=
× $115/patient day =
× $14.50/wcu
=
$ 18,400
92,000
60,900
$171,300
800 patients
× $46/patient
=
2,400 patient days × $115/patient day =
25,000 wcus
× $14.50/wcu
=
$ 36,800
276,000
362,500
$675,300
Procedure B:
Scheduling and admitting .....
Housekeeping ........................
Nursing ...................................
Procedure C:
Scheduling and admitting .....
Housekeeping ........................
Nursing ...................................
481
Prob. 25–6B (Fin Man); Prob. 10–6B (Man)
Concluded
3.
Procedure A Procedure B
Reimbursement (patient days ×
reimbursement rate)* ...................
Total activity cost ...............................
Excess (deficiency) of reimbursement over activity cost .................
Procedure C
$360,000
379,200
$240,000
171,300
$720,000
675,300
$ (19,200)
$ 68,700
$ 44,700
*1,200 patient days × $300/patient day = $160,000
800 patient days × $300/patient day = $240,000
2,400 patient days × $300/patient day = $480,000
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 13.33 wcus per patient day for Procedure A, which compares to
5.25 and 10.4 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 of procedures.
482
SPECIAL ACTIVITIES
Activity 25–1 (Fin Man); Activity 10–1 (Man)
The net income is larger because the controller took period costs and treated
them as product costs for financial reporting purposes. Instead of all the postmanufacturing costs being treated as an expense in the period incurred, which is
the correct treatment according to generally accepted accounting principles,
some of these period costs were included as 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 generally accepted accounting
principles. 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.
Activity 25–2 (Fin Man); Activity 10–2 (Man)
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 Jamaican Punch than for King
Kola. 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
Jamaican Punch is less profitable and the King Kola more profitable than indicated by the single plantwide factory overhead rate method.
483
Activity 25–3 (Fin Man); Activity 10–3 (Man)
Acordia's activity-based costing model provides more accurate product costs
than does the revenue-based allocation scheme. This is because Acordia 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.” Acordia’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 volumebased allocation scheme causes inaccurate product cost calculations.
Activity 25–4 (Fin Man); Activity 10–4 (Man)
1.
Floor
Loudspeaker
Gross profit as percentage of
sales .........................................
Income from operations as
percentage of sales ................
Bookshelf
Loudspeaker
Ribbon
Loudspeaker
32.50%
40.00%
4.00%
(2.50)%
32.00%
1.60%
484
Activity 25–4 (Fin Man); Activity 10–4 (Man) Concluded
2.
To: Management of Audio Escape 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 low-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 is 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.
485
Activity 25–5 (Fin Man); Activity 10–5 (Man)
Lopez’s concern appears valid. Digital Assistant 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 Greene 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,
Greene 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 activities could be identified to specific products, using activity-based costing. However, the postmanufacturing costs can only be allocated to products for internal reporting.
Greene is correct in stating that they must be accounted for as period costs under generally accepted accounting principles.
Activity 25–6 (Fin Man); Activity 10–6 (Man)
Students may arrive at a variety of possible activities and activity bases. Below is
a representative list:
Activity
Activity Base
Opening an account
Teller deposit transaction
Teller withdrawal transaction
ATM withdrawal transaction
ATM deposit transaction
Providing a monthly statement
Direct deposit transaction
Making a correction
Providing a balance
Wire transfer
Closing an account
Number of accounts opened
Number of teller deposits
Number of teller withdrawals
Number of ATM withdrawals
Number of ATM deposits
Number of statements
Number of direct deposits
Number of corrections
Number of balance inquiries
Number of wire transfers
Number of accounts closed
486