Chapter 4
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DO IT!
Costing Systems
Indicate whether the following statements are true or false.
1. A traditional costing system allocates overhead by means of multiple overhead rates.
Action Plan
2. Activity-based costing allocates overhead costs in a two-stage process.
✔ Understand that a
3. Direct material and direct labor costs are easier to trace to products than overhead.
traditional costing
system allocates overhead on the basis of a
single predetermined
overhead rate.
✔ Understand that an
ABC system allocates
overhead to identified
activity cost pools,
and then assigns costs
to products using
related cost drivers
that measure the
resources consumed.
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4. As manufacturing processes have become more automated, more companies have
chosen to allocate overhead on the basis of direct labor costs.
5. In activity-based costing, an activity is any event, action, transaction, or work sequence
that incurs cost when producing a product.
Solution
1. false.
2. true.
3. true.
4. false.
5. true.
Related exercise material: BE4-1, BE4-2, E4-1, and
DO IT!
4-1.
DO IT!
Apply ABC
Casey Company has five activity cost pools and two products. It expects to produce 200,000
units of its automobile scissors jack and 80,000 units of its truck hydraulic jack. Having
identified its activity cost pools and the cost drivers for each cost pool, Casey Company
accumulated the following data relative to those activity cost pools and cost drivers.
Expected Use of
Cost Drivers per Product
Annual Overhead Data
Activity Cost Pools
Cost Drivers
Estimated
Overhead
Expected Use of Cost
Drivers per Activity
Scissors
Jacks
Hydraulic
Jacks
Ordering and receiving
Machine setup
Machining
Assembling
Inspecting and testing
Purchase orders
Setups
Machine hours
Parts
Tests
$ 200,000
600,000
2,000,000
1,800,000
700,000
2,500 orders
1,200 setups
800,000 hours
3,000,000 parts
35,000 tests
1,000
500
300,000
1,800,000
20,000
1,500
700
500,000
1,200,000
15,000
$5,300,000
Using the above data, do the following.
(a) Prepare a schedule showing the computations of the activity-based overhead rates per
cost driver.
(b) Prepare a schedule assigning each activity’s overhead cost to the two products.
(c) Compute the overhead cost per unit for each product.
(d) Comment on the comparative overhead cost per unit.
D-1
D-2
DO IT!
Solution
Action Plan
✔ Determine the activitybased overhead rate by
dividing the estimated
overhead per activity
by the expected use of
cost drivers per activity.
✔ Assign the overhead
of each activity cost
pool to the individual
products by multiplying
the expected use of
cost driver per product
times the activity-based
overhead rate.
✔ Determine overhead
cost per unit by dividing
the overhead assigned
to each product by the
number of units of that
product.
(a) Computations of activity-based overhead rates per cost driver:
Activity Cost Pools
Estimated
Overhead
Ordering and receiving
Machine setup
Machining
Assembling
Inspecting and testing
$ 200,000
600,000
2,000,000
1,800,000
700,000
Expected Use of Cost
Drivers per Activity
4
Activity-Based
Overhead Rates
5
2,500 purchase orders
1,200 setups
800,000 machine hours
3,000,000 parts
35,000 tests
$80 per order
$500 per setup
$2.50 per machine hour
$0.60 per part
$20 per test
$5,300,000
(b) Assignment of each activity’s overhead cost to products using ABC:
Scissors Jacks
Activity Cost
Pools
Ordering and
receiving
Machine setup
Machining
Assembling
Inspecting and
testing
Total assigned
costs
Hydraulic Jacks
Expected
ActivityUse of
Based
Cost Drivers
Overhead
Cost
per Product 3
Rates
5 Assigned
1,000
500
300,000
1,800,000
$80
$500
$2.50
$0.60
20,000
$20
$
Expected
ActivityUse of
Based
Cost Drivers
Overhead
per Product 3
Rates
5
Cost
Assigned
80,000
250,000
750,000
1,080,000
1,500
700
500,000
1,200,000
$80
$500
$2.50
$0.60
$ 120,000
350,000
1,250,000
720,000
400,000
15,000
$20
300,000
$2,560,000
$2,740,000
(c) Computation of overhead cost per unit:
Total costs assigned
Total units produced
Overhead cost per unit
Scissors Jack
Hydraulic Jack
$2,560,000
$2,740,000
200,000
80,000
$12.80
$34.25
(d) These data show that the total overhead assigned to 80,000 hydraulic jacks exceeds the overhead assigned to
200,000 scissors jacks. The overhead cost per hydraulic jack is $34.25, but it is only $12.80 per scissors jack.
Related exercise material: BE4-5, BE4-6, BE4-7, E4-1, E4-2, E4-3, E4-4, E4-5, E4-6, E4-11,
and DO IT! 4-2.
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DO IT!
Value-Added
Activities
Action Plan
✔ Recognize that
value-added activities
increase the worth of
a product or service to
customers.
✔ Understand that non–
value-added activities
simply add cost to or
increase the time spent
on a product or service
without increasing its
market value.
Classify each of the following activities within a water-ski manufacturer as value-added (VA)
or non–value-added (NVA).
1. Inspecting completed skis.
2. Storing raw materials.
3. Machine setups.
4. Installing bindings on skis.
5. Packaging skis for shipment.
6. Reworking defective skis.
Solution
1. NVA.
2. NVA.
3. NVA.
4. VA.
5. VA.
6. NVA.
Related exercise material: BE4-8, BE4-9, E4-13, E4-14, E4-15, E4-16, and
DO IT!
4-3.
DO IT!
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DO IT!
Classify Activity
Levels
Action Plan
✔ You should use: unitlevel activities for
each unit of product;
batch-level activities
for each batch of
product; product-level
activities for an entire
product line; and
facility-level activities
for across the entire
range of products.
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D-3
Morgan Toy Company manufactures six primary product lines of toys in its Morganville
plant. As a result of an activity analysis, the accounting department has identified eight
activity cost pools. Each of the toy products is produced in large batches, with the whole
plant devoted to one product at a time. Classify each of the following activities as either
unit-level, batch-level, product-level, or facility-level: (a) engineering design, (b) machine
setup, (c) toy design, (d) interviews of prospective employees, (e) inspections after each
setup, (f) polishing parts, (g) assembling parts, and (h) health and safety.
Solution
(a) product-level. (b) batch-level. (c) product-level. (d) facility-level. (e) batch-level.
(f) unit-level. (g) unit-level. (h) facility-level.
Related exercise material: BE4-10, BE4-11, BE4-12, E4-17, E4-18, and
Comprehensive
DO IT!
4-4.
DO IT!
Spreadwell Paint Company manufactures two high-quality base paints: an oil-based paint
and a latex paint. Both are housepaints and are manufactured in neutral white color only.
Spreadwell sells the white base paints to franchised retail paint and decorating stores
where pigments are added to tint (color) the paint as the customer desires. The oil-based
paint is made with organic solvents (petroleum products) such as mineral spirits or turpentine. The latex paint is made with water; synthetic resin particles are suspended in the
water, and dry and harden when exposed to the air.
Spreadwell uses the same processing equipment to produce both paints in different production runs. Between batches, the vats and other processing equipment must be
washed and cleaned.
After analyzing the company’s entire operations, Spreadwell’s accountants and production managers have identified activity cost pools and accumulated annual budgeted
overhead costs by pool as follows.
Estimated
Activity Cost Pools
Overhead
Purchasing
Processing (weighing and mixing,
grinding, thinning and drying, straining)
Packaging (quarts, gallons, and 5-gallons)
Testing
Storage and inventory control
Washing and cleaning equipment
$ 240,000
Total annual budgeted overhead
$3,200,000
1,400,000
580,000
240,000
180,000
560,000
Following further analysis, activity cost drivers were identified and their expected use by
product and activity were scheduled as follows.
Expected Use of
Expected Cost
Drivers
per Product
Activity Cost
Drivers per
Pools
Purchasing
Processing
Packaging
Testing
Storing
Washing
Cost Drivers
Activity
Oil-Based
Latex
Purchase orders
Gallons processed
Containers filled
Number of tests
Avg. gals. on hand
Number of batches
1,500 orders
1,000,000 gallons
400,000 containers
4,000 tests
18,000 gallons
800 batches
800
400,000
180,000
2,100
10,400
350
700
600,000
220,000
1,900
7,600
450
D-4
DO IT!
Spreadwell has budgeted 400,000 gallons of oil-based paint and 600,000 gallons of latex
paint for processing during the year.
Instructions
(a) Prepare a schedule showing the computations of the activity-based overhead rates.
(b) Prepare a schedule assigning each activity’s overhead cost pool to each product.
(c) Compute the overhead cost per unit for each product.
Solution to Comprehensive DO IT!
Action Plan
✔ Identify the major
activities that pertain
to the manufacture
of specific products
and allocate manufacturing overhead costs
to activity cost pools.
✔ Identify the cost
drivers that accurately
measure each activity’s
contribution to the
finished product.
✔ Compute the activitybased overhead rates.
✔ Assign manufacturing
overhead costs for
each activity cost pool
to products, using the
activity-based overhead rates.
(a) Computations of activity-based overhead rates:
Activity Cost
Pools
Estimated
Overhead
Purchasing
Processing
Packaging
Testing
Storing
Washing
$ 240,000
1,400,000
580,000
240,000
180,000
560,000
Expected Use of
Cost Drivers
4
5
1,500 orders
1,000,000 gallons
400,000 containers
4,000 tests
18,000 gallons
800 batches
Activity-Based
Overhead Rates
$160 per order
$1.40 per gallon
$1.45 per container
$60 per test
$10 per gallon
$700 per batch
$3,200,000
(b) Assignment of activity cost pools to products:
Oil-Based Paint
Latex Paint
Activity
Cost
Pools
Expected
Use of
Drivers
Overhead
Rates
Cost
Assigned
Purchasing
Processing
Packaging
Testing
Storing
Washing
800
400,000
180,000
2,100
10,400
350
$160
$1.40
$1.45
$60
$10
$700
$ 128,000
560,000
261,000
126,000
104,000
245,000
Total overhead assigned
Expected
Use of
Overhead
Drivers
Rates
700
600,000
220,000
1,900
7,600
450
$1,424,000
$160
$1.40
$1.45
$60
$10
$700
Cost
Assigned
$ 112,000
840,000
319,000
114,000
76,000
315,000
$1,776,000
(c) Computation of overhead cost assigned per unit:
Total overhead cost assigned
Total gallons produced
Overhead cost per gallon
Oil-Based Paint
Latex Paint
$1,424,000
$1,776,000
400,000
600,000
$3.56
$2.96
DO IT!
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DO IT!
D-5
REVIEW
DO IT! 4-1 Indicate whether the following statements are true or false.
(a) The reasoning behind ABC cost allocation is that products consume activities and
activities consume resources.
(b) Activity-based costing is an approach for allocating direct labor to products.
(c) In today’s increasingly automated environment, direct labor is never an appropriate
basis for allocating costs to products.
(d) A cost driver is any factor or activity that has a direct cause-effect relationship with
resources consumed.
(e) Activity-based costing segregates overhead into various cost pools in an effort to provide more accurate cost information.
DO IT! 4-2 Flynn Industries has three activity cost pools and two products. It expects to
produce 3,000 units of Product BC113 and 1,500 of Product AD908. Having identified its
activity cost pools and the cost drivers for each pool, Flynn accumulated the following
data relative to those activity cost pools and cost drivers.
Machine setup
Machining
Packing
(LO 1, 2), K
Compute activity-based
overhead rates and assign
overhead using ABC.
(LO 4), AP
Expected Use of
Cost Drivers per Product
Annual Overhead Data
Activity Cost Pool
Identify characteristics of
traditional and ABC costing
systems.
Cost Drivers
Estimated
Overhead
Expected Use of Cost
Drivers per Activity
Product
BC113
Product
AD908
Setups
Machine hours
Orders
$ 16,000
110,000
30,000
40
5,000
500
25
1,000
150
15
4,000
350
Using the above data, do the following:
(a) Prepare a schedule showing the computations of the activity-based overhead rates per
cost driver.
(b) Prepare a schedule assigning each activity’s overhead cost to the two products.
(c) Compute the overhead cost per unit for each product. (Round to nearest cent.)
(d) Comment on the comparative overhead cost per product.
DO IT! 4-3 Classify each of the following activities within a tax-preparation business as
value-added (VA) or non–value-added (NVA).
Classify activities as value- or
non–value-added.
(a)
(b)
(c)
(d)
(e)
(LO 6, 8), AP
Advertising.
Completing tax returns.
Billing clients.
Answering client questions.
Accompanying clients to audit proceedings.
DO IT! 4-4 Adamson Company manufactures four lines of garden tools. As a result of
an activity analysis, the accounting department has identified eight activity cost pools.
Each of the product lines is produced in large batches, with the whole plant devoted to
one product at a time. Classify each of the following activities or costs as either unit-level,
batch level, product-level, or facility-level.
(a)
(b)
(c)
(d)
Machining parts.
Product design.
Plant maintenance.
Machine setup.
(e)
(f)
(g)
(h)
Assembling parts.
Purchasing raw materials.
Property taxes.
Painting.
Classify activities according
to level.
(LO 7), C