CHAPTER 5
Q5-1
A cost accounting system collects and classifies costs and assigns them to
cost objects in order to measure the cost of designing, developing, producing (or
purchasing), selling, distributing, and servicing particular products or services.
Q5-2
No. The costs in a cost pool are not physically traced to cost objects. They
are allocated to cost objects using a single cost driver as a base.
Q5-3
Reallocate, trace, assign, distribute, redistribute, load, apportion, reapportion.
Q5-4
The three purposes of cost allocation are: 1) to obtain desired employee
motivation, 2) to compute income and asset valuations, and 3) to justify costs or obtain
reimbursement.
Q5-5
The three types of allocation are: 1) allocation of joint costs to the appropriate
organizational unit, 2) reallocation of costs from one organizational unit to another, and
3) allocation of the costs of a particular organizational unit to products or services.
Q5-6
The preferred guides for allocating service department costs are:
a. Evaluate performance using budgets for each service (staff) department, just
as they are used for each production or operating (line) department. When
feasible, maintain distinctions between variable-cost pools and fixed-cost
pools.
b. Allocate variable- and fixed-cost pools separately. This is sometimes called
the dual method of allocation. Note that one service department (such as a
computer department) can contain a variable-cost pool and a fixed-cost pool.
That is, costs may be pooled within and among departments if desired.
c. Establish the details regarding cost allocation in advance of rendering the
service rather than after the fact.
Q5-7
Using budgeted rather than actual cost rates protects the using departments
from inefficiencies in the service departments and from intervening price fluctuations. It
also provides timely information for decision making.
Q5-8
Fixed costs are often allocated separately from variable costs because they
are caused by different activities. Fixed costs are affected primarily by long-range
decisions about the overall level of service. In contrast, variable costs depend on shortrun fluctuations in actual usage.
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Q5-9
The motivation to underestimate long-run usage is a common problem with
allocation methods using lump-sums based on long-range plans. To counteract this
tendency, management can evaluate predictions of long-run usage and provide rewards
for accurate predictions, and also penalize for underpredictions.
Q5-10
Sales dollars are often a poor basis for allocation of costs because they
reflect efficiency of sales effort and variations in pricing margins, neither of which is
related to costs.
Q5-11
National advertising costs could be allocated to territories on the basis of
expected sales in each territory, computed by some formula combining population,
income, appeal, competition, and supply capability.
Q5-12
Three methods of allocating service department costs are the direct method,
the step-down method, and the reciprocal allocation method. The direct method ignores
other service departments when any given service department's costs are allocated. No
costs are allocated from one service department to another. The step-down method
recognizes that some service departments provide services to other service
departments as well as to producing departments. The costs of the first service
department are allocated to all other service departments. Then the second service
department's costs are allocated to the remaining service departments (i.e., all service
departments except those whose costs have already been allocated) and the producing
departments. Once a service department's costs have been allocated, no subsequent
service department's costs are allocated back to it. This procedure continues until all
service department costs have been allocated. The reciprocal allocation method
recognizes that service departments provide services to each other. It uses a set of
simultaneous equations to determine the total amount of costs for each service
department. These total costs are then allocated to the production departments and the
service departments that use each individual service department services.
Q5-13
No. Both the direct and step-down methods allocate the same total amount
of costs to the producing departments.
Q5-14
Application tends to have the narrower meaning of costs traced to products
(or services) rather than to departments.
Q5-15
Non-volume-related cost drivers are causes of costs that are not proportional
to the volume of output. For example, number of hours of engineering design services is
a non-volume-related cost driver that can be used to allocate engineering costs.
Another non-volume-related cost driver is product complexity — more specifically,
possibly number of components in a final product.
Q5-16
First, managers identify the key activities in the organization and collect
overhead costs for each activity. Cost drivers are then selected for each activity, and
those cost drivers are used to allocate the costs to the cost objects.
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Q5-17
The physical units method allocates joint costs in proportion to some physical
property of the products (e.g., weight or volume) at the split-off point. The relative sales
value method allocates joint costs in proportion to the amounts for which the products
can be sold at the split-off point. The net realizable value method allocates joint costs on
the basis of the relative net realizable value, defined as expected final sales value less
the expected separable production and marketing costs.
Q5-18
Byproducts, like joint products, are not separately identifiable before the splitoff point. However, byproducts have relatively insignificant sales values compared to
main products. Only separable costs are applied to byproducts; no joint costs are
allocated to them. Revenues from byproducts, less separable costs, are deducted from
the cost of the main product.
Q5-19
Some possible activities and cost drivers are:
Activity
Group of machines
Set-up costs
Quality inspection
Personnel department
Cost driver
Machine hours
Number of set-ups
Units passing inspection point
Number of employees
Q5-20
No. The main reasons that activity-based costing is becoming so popular
relate to planning and control, not product costing: 1) decisions about product mix,
prices, and other product-related decisions, and 2) control of costs focused on
managing activities instead of products.
Q5-21 The simplest answer is to recommend a traditional costing system for the
Youngstown plant and an ABC costing system for the Salem plant. Why? Because the
purpose of any costing system is to provide as accurate cost information as possible
subject to the benefit-cost criterion. There is always a tradeoff between the accuracy of
a system and the costs to implement and maintain it. Generally, as the operations of a
company become more complex, the diversity of demands upon resources increases
across products (services). In order to accurately track resource costs in such a diverse
operating environment, many cost pools are used—that is, an ABC system. Because
the Youngstown plant operations are not complex, a simple (traditional) costing system
probably provides sufficiently accurate cost information. Due to the complexity and
diversity of the Salem plant operations, an ABC costing system should be considered.
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Q5-22 The four steps are:
Step 1. Determine cost objects, key activity centres, resources, and related cost drivers.
Step 2. Develop a process-based map representing the flow of activities, resources,
and their interrelationships.
Step 3. Collect relevant data concerning costs and physical flow of cost-driver units
among resources and activities.
Step 4. Calculate and interpret the new activity-based information.
Q5-23 A variable-cost resource is a resource with costs that change in direct
proportion to changes in the amount of the cost-driver units. In Exhibit 5-7, paper,
telecommunications, account inquiry and billing labour, and computer resources are
probably variable-cost resources.
Q5-24 Five factors that explain why more and more organizations are adopting activitybased costing systems are:
1. Fierce competitive pressure has resulted in shrinking margins making accurate
cost determinations essential. While companies may know their overall (annual
basis) margin is shrinking, they often do not have faith in the accuracy of the
margins for individual products or services. Some are winners and some are
losers—but which ones?
2. Business complexity has increased, resulting in greater diversity in the types of
products and services as well as customer classes. This means that the
consumption of a company’s shared resources also varies substantially across
products and customers.
3. New production techniques have increased the proportion of indirect costs—that
is, indirect costs are far more important in today’s world-class manufacturing
environment. In many industries direct labour is being replaced by automated
equipment. It is not unusual for indirect cost to be over 50% of total cost.
4. The rapid pace of technological change has shortened product life cycles. This
means that companies do not have time to make price or cost adjustments once
costing errors are discovered.
5. Computer technology has reduced the costs of developing and operating cost
systems that track many activities.
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Q5-25 Managers seek to eliminate, or at least reduce as much as possible, non-valueadded activities. Separating these from value-added activities helps focus attention on
the costs that should be examined for potential reductions.
Q5-26 Just-in-time production systems require 1) short production cycle times, 2)
smooth flow of production, 3) focus on quality, and 4) flexible production operations.
Q5-27 The goal of ABC and JIT is the same—improve competitiveness. However, the
means used to achieve competitive improvements are very different. JIT focuses on
operational improvements such as reduction in inventories, reduced cycle times, cellular
manufacturing, focus on quality, flexible production operations, and a customer
orientation.
Activity-based costing systems focus on identifying opportunities for improvement by
providing more accurate costs of activities, products, customers, and other cost objects.
In many cases, JIT systems reduce the total amount of indirect costs because of the
use of dedicated work cells. This reduces the need for ABC. However, many companies
use both JIT and ABC since indirect cost is still an important component of total costs.
In addition, nonmanufacturing costs are largely indirect and often significant in amount.
For the same reasons mentioned above, ABC applied to all indirect costs enables many
companies to gain and maintain the competitive edge.
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P5-1
(10-15 min.)
1.
Rate =
$2,500 + ($0.02 + $0.03) x 100,000
= $0.075 per copy
(100,000)
Cost allocated to City Planning in August = $0.075 x 42,000 = $3,150.
2.
Fixed cost pool allocated as a lump sum depending on predicted usage:
To City Planning: (36,000 ÷ 100,000) x $2,500 = $900 per month
Variable cost pool allocated on the basis of actual usage:
$0.05 x number of copies
Cost allocated to City Planning in August: $900 + $0.05 x 42,000 = $3,000.
3.
The second method, the one that allocates fixed- and variable-cost pools
separately, is preferable. It better recognizes the causes of the costs. The fixed
cost depends on the size of the photocopy machine, which is based on
predicted usage and is independent of actual usage. Variable costs, in contrast,
are caused by actual usage.
P5-2
(10-15 min.)
Sunnyville
Yorkville
Discountville
1. Allocation based on budgeted sales* $60,000
$100,000
$40,000
2. Allocation based on actual sales**
66,667
77,778
55,555
*$200,000 x 600/2,000; $200,000 x 1,000/2,000; $200,000 x 400/2,000
** $200,000 x 600/1,800; $200,000 x 700/1,800; $200,000 x 500/1,800
3.
The major argument against using actual sales as a cost driver for cost
allocation is that a department's allocation depends on the success of other
departments. Here, Sunnyville is allocated an extra $6,667 because sales in the
Yorkville store are below budget, even though Sunnyville's sales came in right
on target. Further, stores with poor sales results probably do not cause reduced
central office costs. If anything, a department with poor performance requires
more central attention. Also, using budgeted sales reduces surprises;
managers know what amount of allocated cost to expect. Often managers are
more upset by unexpected changes in allocated amounts than by the size of the
allocation itself.
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P5-3 (15-30 min.)
1.
Direct method:
Personnel
Custodial
Machining
Assembly
$32,000
(32,000)
$70,000
(70,000)
$0
$600,000
14,222
20,000
$634,222
$800,000
17,778
50,000
$867,778
Personnel
Custodial
Machining
Assembly
$32,000
(32,000)
$70,000
2,000
(72,000)
$0
$600,000
13,333
20,571
$633,904
$800,000
16,667
51,429
$868,096
Direct department costs
before allocation
Personnel*
Custodial**
Total cost after allocation
$0
*(200/450) x $32,000; (250/450) x $32,000
**(10/35) x $70,000; (25/35) x $70,000
2.
Step-down method:
Direct department costs
before allocation
Personnel*
Custodial**
Total cost after allocation
$0
*(30/480) x $32,000; (200/480) x $32,000; (250/480) x $32,000
**(10/35) x $72,000; (25/35) x $72,000
P5-4
(10 min.)
1.
Solvent A
Solvent B
2.
Litres
20,000
10,000
30,000
Weighting
20/30 x $400,000
10/30 x $400,000
Relative Sales
Value at Split-off*
Weighting
Solvent A
$200,000
200/500 x $400,000
Solvent B
300,000
300/500 x $400,000
$500,000
* $20 x 10,000 and $60 x 5,000
Copyright © 2007 Pearson Education Canada
Allocation of
Joint Costs
$266,667
133,333
$400,000
Allocation of
Joint Costs
$160,000
240,000
$400,000
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P5-5
(15 min.)
The joint costs include the purchase cost of $600,000 and the processing cost before
the split-off point of $0.30 x 1,000,000 = $300,000, a total of $900,000.
1.
2.
3.
Allocation of
Kilograms
Weighting
Joint Costs
Oat flour
800,000
800/1,000 x $900,000
$720,000
Oat bran
200,000
200/1,000 x $900,000
180,000
1,000,000
$900,000
Relative Sales
Allocation of
Value at Split-off*
Weighting
Joint Costs
Oat flour
$1,200,000
1,200/1,600 x $900,000
$675,000
Oat bran
400,000
400/1,600 x $900,000
225,000
$1,600,000
$900,000
* $1.50 x 800,000 and $2.00 x 200,000
Estimated value of oat flour at split-off:
Sales value of oat flakes, $2.90 x 800,000 kilograms
- Processing cost after split-off point, $0.60 x 800,000
kilograms + $240,000
Relative Sales
Value at Split-off
Oat flakes $1,600,000
Oat bran
400,000
$2,000,000
P5-6
1.
Weighting
1,600/2,000 x $900,000
400/2,000 x $900,000
$2,320,000
720,000
$1,600,000
Allocation of
Joint Costs
$720,000
180,000
$900,000
(10-15 min.)
None. The entire joint cost is allocated to the main product.
2.
$35,000. The total inventory cost of the pulp is the separable cost, that is, the
cost incurred after the split-off point.
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3.
Inventory cost of apples:
Direct materials (apples)
Pressing cost
Filter, pasteurize, and pack cost
Total
Less: Revenue less separable
costs of byproduct
($50,000 - $35,000)
Net cost of apple juice
P5-7
$1,000,000
130,000
150,000
$1,280,000
(15,000)
$1,265,000
(15-20 min.)
1. Value-Added Activities
Rear-wheel assembly
Assemble handlebars
Install speedometers
Non-Value-Added Activities
Materials receiving and inspection
Production scheduling
Production set-up
Move engine from fabrication to assembly
building
Paint inspection
Rework defective brake assemblies
Put completed motorcycle in finished goods
storage
2. • Materials receiving and inspection. Inspection costs can be reduced by forming
good relations with suppliers so that they guarantee quality. Receiving costs can
be reduced by setting up the receiving area so that minimal handling is necessary.
If materials are received just when they are needed, time to place them in
inventory storage and then retrieve them is eliminated.
• Production scheduling. Scheduling time is reduced by simplifying the production
process and letting the receipt of orders drive the production schedule.
• Production set-up. Simplifying products and processes may reduce the number of
set-ups required. Changing the production process and training production
employees to perform set-ups can reduce the time and cost of the set-ups.
• Move engine from fabrication to assembly building. Changing the production flow
to minimize move times and waiting times and automating production flow can
reduce these costs.
• Paint inspection. An emphasis on quality in the painting operation may make
inspection unnecessary, or at least less costly.
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• Rework defective brake assemblies. Again, emphasis on quality may make much
of this rework unnecessary. Rework can often be done more cheaply directly on
the production line if employees are trained to spot defects and know how to fix
them.
• Put completed motorcycle in finished goods storage. A JIT system is driven by
customer orders. If an order is received for a motorcycle before it is produced, it
will be shipped immediately upon completion instead of being put into storage,
saving costs of handling and storing finished goods.
P5-8
(20-30 min.)
This problem provides an overview of cost accumulation and allocation without getting
bogged down in the intricacies of bookkeeping.
1.
Figures are in dollars.
Accounting
96,000
12,000
36,000
144,000
Consulting
24,000
48,000
42,000
114,000
Total
120,000
60,000
78,000
258,000
Accounting
Consulting
Totals
Direct
Material
48,000
8,000
56,000
X-1
Direct
Labour
4,000
19,200
23,200
Mfg.
Overhead
12,000
16,800
28,800
Accounting
Consulting
Totals
Direct
Material
24,000
8,000
32,000
Y-1
Direct
Labour
4,000
19,200
23,200
Mfg.
Overhead
12,000
16,800
28,800
Direct
Material
24,000
8,000
32,000
Z-1
Direct
Labour
4,000
9,600
13,600
Mfg.
Overhead
12,000
8,400
20,400
Direct material
Direct labour
Manufacturing overhead
Total
2.
Accounting
Consulting
Totals
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Total Costs:
X-1 (56,000 + 23,200 + 28,800)
Y-1 (32,000 + 23,200 + 28,800)
Z-1 (32,000 + 13,600 + 20,400)
Accounted for
108,000
84,000
66,000
258,000
P5-9
(20-30 min.)
1.
The first step is to determine the cost per cost-driver unit for each activity:
Activity Centre [Cost Driver]
Materials Handling [Direct materials
cost]
Engineering [Engineering change
orders]
Power [Kilowatt hours]
Total Manufacturing Overhead
Monthly
Manufacturing
Overhead
$ 8,000
Cost-Driver
Activity
$200,000
Cost per
Driver Unit
$
0.04
20,000
20
1,000.00
16,000
$44,000
400,000
0.04
Next, the costs of each activity can be allocated to each of the three products:
Material Handling
Engineering
Power
$0.04 x 25,000
= $ 1,000
$0.04 x 50,000
$1,000 x 13
= 13,000
$1,000 x 5
=
5,000
2,000 $0.04 x 200,000
=
8,000
$0.04 x 50,000
Total
2.
PHYSICAL FLOW/ALLOCATED COST
SA5
SA2
Cost
=
$16,000
= $ 2,000
SA9
$0.04 x 125,000
$1,000 x 2
$0.04 x 150,000
$15,000
= $ 5,000
=
2,000
=
6,000
$13,000
Overhead rate based on direct labour costs:
Rate =
Total manufacturing overhead $44,000
=
= $5.50/DL$
Total direct labour cost
$8,000
Overhead allocated to each product is:
SA2: $5.50 x 4,000 = $22,000
SA5: $5.50 x 1,000 = 5,500
SA9: $5.50 x 3,000 = 26,500
Total
$44,000
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Notice that much less manufacturing overhead cost is allocated to SA5 using
direct labour as a cost drive. Why? Because SA5 uses only a small amount of
labour but large amounts of other resources, especially power.
3.
The product costs in requirement 1 are more accurate if the cost drivers are
good indicators of the causes of the costs—they are both plausible and reliable.
For example, kilowatt hours is certainly a better measure of the cost of power
costs than is direct labour hours. Therefore, the allocation of power costs in
requirement 1 is certainly better than in requirement 2. Materials handling and
engineering are likewise more accurate in requirement 1.
A manager would be much more confident in the manufacturing overhead
allocated to products in requirement 1. Remember, however, that there are
incremental costs of data collection associated with the more accurate ABC
system. The benefit/cost criteria must be applied in deciding which costing
system is “better.”
P5-10 (20 min.)
The cost driver would be "weighted number of kilograms processed" instead of
"number of kilograms processed." The new computations are:
Laundry department costs
Weighted number of kilograms processed:
Radiology, (7,500 x 5) and (7,500 x 1)
Other centres, 600,000 - 15,000
Divided by
Cost per weighted kilogram
Total costs to radiology:
Using unweighted base, 15,000 x $0.30
Using weighted base, 45,000 x $0.285
$180,000
45,000
585,000
630,000
$ 0.285
$ 4,500
$12,825
One basis for the allocation of laundry costs is kilograms of soiled laundry.
This is a good basis provided it is possible for the hospital to identify the
source of soiled linens by department. However, because of the use of
linen chutes, or for other reasons, many hospitals cannot identify the source
of laundry by department. In smaller hospitals the use of an outside
commercial laundry service also is common, and some hospitals do not
have weighing facilities.
In every hospital there must be a linen distribution function, and a study of
the amount and type of linen distributed to the various departments of the
hospital will produce a reliable basis for allocation. As a minimum, the
number of pieces, adjusted for weight differentials, should be tallied for a
period of perhaps two weeks, two or three times a year. The weight factor,
however, needs to be established only once. Reliable weight factors can be
developed by simply weighing the various pieces and establishing standard
piece weights for each type of laundry. The average of the several two-
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week tests can be used as the basis for distributing laundry costs for costfinding purposes.
Another method is to use commercial laundry prices as a weighting factor
for the different types of pieces. This method has the advantage of allowing
for the relative difficulty of different processing functions, such as pressed
versus mangle finishing.
Hospitals can conduct very refined studies if they so desire. It may be
appropriate, especially in larger institutions, to give special consideration to
refinements. For example, where the laundry processes a large volume of
uniforms for student nurses and doctors, and for dietary, housekeeping, and
other service personnel, it may be desirable to separate washing and
pressing costs and to develop separate allocation bases for each of these
functions based on the production statistics. Furthermore, it may be
desirable to consider the effect of different processing cycles, such as the
special rinse cycles for operating room linens or the special cold wash
cycles for woolen blankets. Through discussions with the laundry manager,
it is possible to determine whether further analysis is justified. Another
example of possible refinements is the personal laundry done for medical
interns, residents, student nurses, and others; if the volume is large, it might
have to be recognized in the departmental operations.
P5-11 (15 min.)
1.
What is the purpose of this cost allocation? Primarily, it is to help set a "fair"
price. (Note the NP representative's reference to "it is not fair.") Regulatory
authorities set prices based on cost allocations in many industries, including
utilities, natural gas, and railroads, where free markets are allowed to reign only
to a limited degree. The most troublesome problems usually arise when there is
a significant amount of common costs.
Obviously, this specific illustration will not lead to any clear-cut answers. Those
commissioners who favour "full costing" will be sympathetic to the NP position,
while those commissioners who favour "incremental costing" will be sympathetic
to the PUC staff.
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Those who favour full costing should nevertheless be cautious in applying
"system-wide" overhead rates to a small operation. The problem is akin to using
plant-wide overhead rates for a particular factory department's operations;
sometimes the final results are not affected significantly, but big potential
differences lead toward developing departmental rates.
Those who favour incremental costing should be concerned about more costs
than just "above-the-rail" costs like fuel, labour, and equipment maintenance.
The NP representative cited two examples of "common" costs that would indeed
be affected if commuter service were discontinued. In addition, if regulatory
commissions allowed only incremental costs to be covered by prices, companies
would eventually go out of business. In the long run all costs must be covered.
2.
This question was raised to demonstrate the dangers of having a cost allocation
to one segment be heavily dependent on what is happening in another segment.
Commuter passenger traffic is unlikely to be as sensitive to changes in business
conditions as is freight traffic. Therefore, a sudden decline in freight traffic would
result in passenger traffic's bearing a higher fraction of common costs.
P5-12 (20-25 min.)
1.
Annual costs for 24,000 kilometres: Fixed
Variable ($0.10 x 24,000)
$3,600
2,400
$6,000
Cost per kilometre = $6,000 ÷ 24,000 kilometres = $0.25 per kilometre
2.
Two factors caused the April allocation of $0.48 per kilometre to exceed the
average of $0.25 per kilometre:
(1) The motor pool's operating inefficiencies are passed on to the user
departments. The cost of 50,000 kilometres in April should have been
($3,600 ÷ 12 months) x 50 autos + $.10 x 50,000 kilometres = $15,000 +
$5,000 = $20,000. Therefore, $4,000 of "unnecessary" cost was assigned
to user departments, which is $4,000 ÷ 50,000 kilometres = $.08 per
kilometre.
(2) April was a month of low general usage. In an average month, 100,000
kilometres are driven (2,000 kilometres per auto), and the fixed cost per
kilometre is ($3,600 ÷ 12 months) ÷ 2,000 kilometres = $300 ÷ 2,000
kilometres = $0.15 per kilometre. In April the $300 fixed cost of each auto
was spread over only 1,000 kilometres , so fixed cost per kilometre was
$300 ÷ 1,000 = $0.30 per kilometre. This factor accounts for an extra $0.15
per kilometre .
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3.
Undesirable behavioural effects include:
(a) The total actual motor pool cost is allocated. The manager is not
motivated to control these costs.
(b) Allocated costs are affected by auto usage in other departments. A
department is better off if its auto usage happens to fall in a month when other
departments have high mileage.
(c) Decisions about whether driving another kilometre is worth its cost are not
appropriately made. The city incurs only $0.10 more expense for an additional
kilometre, but departments are charged more.
(d) The cost allocation is affected only by kilometres driven, not number of
autos assigned to a department. A department with two autos each being
driven 15,000 kilometres per year is allocated the same cost as one with one
auto driven 30,000 kilometres per year. But each auto causes the same
average fixed costs, so fixed costs should be allocated on the basis of number
of autos rather than kilometres driven. This may be the reason the city planner
was continually concerned with her auto costs. Her department's autos were
driven an average of 3,000 kilometres per month but the city's average was
only 2,000 kilometres. Because both fixed and variable costs are allocated on
a per-kilometre basis, her department's autos are allocated more fixed cost
than the average auto in the city. If fixed costs were allocated on the basis of
number of autos, each auto would be charged $300 per month. This becomes
$0.10 per kilometre for the city planner's autos compared to $0.15 for the
average auto in the city.
4.
Two basic principles should be applied:
(a) Allocate budgeted, not actual, costs. Inefficiencies of the motor pool
should not be passed on to user departments.
(b) Separate costs into fixed and variable cost pools. The fixed costs should
be allocated on the basis of number of autos assigned to a department or longrun predicted use of autos. Variable costs are appropriately assigned on a perkilometre-driven basis.
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This cost-allocation method illustrates why the city planner has a legitimate
complaint. In April she paid $0.08 per kilometre extra because of motor pool
inefficiency, $0.10 per kilometre extra because other departments had light
usage in April, and $0.05 per kilometre extra because fixed costs are charged
on a per-kilometre basis rather than a per-auto basis.
P5-13 (20-30 min.)
1.
Actual costs
Rate per tonne-km*
To East
To West
$750,000 + $0.80(500,000) =
$1,150,000 ÷ 500,000
=
250,000 x $2.30
=
250,000 x $2.30
=
$1,150,000
$2.30
$575,000
$575,000
*Rate is per thousand tonne-kilometres
2.
Actual costs
Rate per tonne-km
To East
To West
$750,000 + $0.80(400,000)
$1,070,000 ÷ 400,000
150,000 x $2.675
250,000 x $2.675
=
=
=
=
$1,070,000
$2.675
$401,250
$668,750
Note that West's costs increased from $575,000 to $668,750 or 16.3%, solely
because East's volume declined.
3.
Rate per tonne-km
To East
To West
$1,275,000 ÷ 500,000
250,000 x $2.55
250,000 x $2.55
= $2.55
= $637,500
= $637,500
Such allocation seems unjustified because the operating departments have to
bear another department's cost of inefficiency. Note that the use of a
predetermined or budgeted total amount geared to the various levels of activity
of the operating departments would eliminate this difficulty. For example, the
$2.30 rate of part (1) would be used here despite the excess of actual costs over
budgeted costs.
Copyright © 2007 Pearson Education Canada
132
4.
Basic maximum capacity: 360,000 + 240,000 = 600,000 tonne-kilometres.
Fixed costs:
To East, 36/60 x $750,000
To West, 24/60 x $750,000
Variable costs:
To East, $0.80 x 150,000
To West, $0.80 x 250,000
Total costs
East
$450,000
-
West
$
300,000
120,000
$570,000
200,000
$500,000
Note that East's costs are $570,000 rather than the $401,250 in part (2).
This method has the following advantages:
a.
The use of a predetermined unit rate for variable costs prevents the total
charges from being affected by the efficiency of price changes of the service
department.
b.
The use of a predetermined lump-sum for fixed costs prevents the total
charges from being affected by the consumption of service or the activity
levels of other operating departments or the activity level of the service
department.
P5-14 (20-30 min.)
1.
Basic long-run usage:
75 + 50 = 125 X-rays per month
Total costs incurred:
$12,000 + 100 X-rays ($30) = $15,000
Premier
Hospital
Fixed costs:
75/125 x $12,000
50/125 x $12,000
Variable costs:
50 x $30
50 x $30
Total allocated costs
Copyright © 2007 Pearson Education Canada
St. Mary’s
Hospital
$7,200
$4,800
1,500
$8,700
1,500
$6,300
133
2.
For budgetary control and motivation purposes, it is best not to allocate the
$1,500 efficiency variance ($16,500 minus the $15,000 computed above). For
cost recovery purposes, if reimbursement is based on actual costs, it should be
allocated.
3.
Premier
Hospital
Total costs incurred, $15,000:
50/100 x $15,000
50/100 x $15,000
St. Mary’s
Hospital
$7,500
$7,500
St. Mary’s Hospital bears $1,200 more costs than in part (1) despite the fact that
its volume was exactly in accordance with its long-run average usage. In short,
St. Mary’s Hospital's costs have increased solely because of a fellow
consumer's actions, not its own actions. Premier Hospital's failure to reach its
predicted usage results in shifting $1,200 more fixed costs to St. Mary’s
Hospital.
A behavioural effect of this method would be toward more erratic scheduling (to
the extent this discretion exists). For instance, if Premier Hospital had a
relatively light month, it would be motivated toward not scheduling procedures
during the final week and bunching them in the first week of the second month.
In this way, its unit costs of the second month would be lowered.
4.
Both Premier and St. Mary’s Hospitals would be induced to underestimate
usage. Of course, if both play the same game, the final fraction borne by each
would be little changed. One way to counteract these tendencies is to exert
higher arbitrary (and unreimburseable) cost allocations to both Premier and St.
Mary’s Hospitals if they consistently exceed their predicted usage. Also, first
priority on scarce resources can be extended to those consumers who are
committed to the higher fractions.
P5-15 (20-30 min.)
1.
Building
Services
Direct department costs
before allocation
$150,000
Building services (sq. metres) (150,000)
Materials receiving
and handling (components
handled)
Total costs after allocation
0
Copyright © 2007 Pearson Education Canada
Materials
Receiving
and
Handling
Mechanical
Instruments
Electronic
Instruments
$120,000
$680,000
100,000
$548,000
50,000
(120,000)
0
40,000
$820,000
80,000
$678,000
134
Calculations:
50,000 + 25,000 = 75,000
(50,000 ÷ 75,000) x $150,000 = $100,000
(25,000 ÷ 75,000) x $150,000 = $50,000
No. of components: 10 x 8,000 = 80,000; 16 x 10,000 = 160,000
80,000 + 160,000 = 240,000
(80,000 ÷ 240,000) x $120,000 = $40,000
(160,000 ÷ 240,000) x $120,000 = $80,000
2.
Mechanical instruments: $820,000 ÷ 30,000 hours = $27.33 per direct-labour
hour
Electronic instruments: $678,000 ÷ 160,000 components = $4.24 per
component
3.
Total cost = direct materials cost + manufacturing cost:
M1:
M2:
E1:
E2:
$74 + ($27.33 x 4)
$86 + ($27.33 x 8)
$63 + ($ 4.24 x 10)
$91 + ($ 4.24 x 15)
=
=
=
=
$74 + $109.32
$86 + 218.64
$63 + 42.40
$91 + 63.60
=
=
=
=
$183.32
$304.64
$105.40
$154.60
P5-16 (20-30 min.)
1.
Building
Services
Direct department costs
before allocation
Building services
Materials receiving and
handling
Total costs after allocation
Materials
Receiving
and
Handling
Mechanical
Instruments
Electronic
Instruments
$150,000
(150,000)
$ 120,000
9,375
$680,000
93,750
$548,000
46,875
0
$(129,375)
0
43,125
$816,875
86,250
$681,125
Calculations:
5,000 + 50,000 + 25,000 = 80,000
(5 ÷ 80) x $150,000 = $9,375
(50 ÷ 80) x $150,000 = $93,750
(25 ÷ 80) x $150,000 = $46,875
No. of components: 10 x 8,000 = 80,000; 16 x 10,000 = 160,000
80,000 + 160,000 = 240,000
(80 ÷ 240) x $129,375 = $43,125
(160 ÷ 240) x $129,375 = $86,250
Copyright © 2007 Pearson Education Canada
135
2.
Mechanical instruments: $816,875 ÷ 30,000 hours = $27.23 per direct-labour hour
Electronic instruments: $681,125 ÷ 160,000 components = $4.26 per component
3.
Total cost = direct materials cost + manufacturing cost
M1:
M2:
E1:
E2:
$74 + ($27.23 x 4)
$86 + ($27.23 x 8)
$63 + ($ 4.26 x 10)
$91 + ($ 4.26 x 15)
=
=
=
=
$74 + $108.92
$86 + $217.84
$63 + $ 42.60
$91 + $ 63.90
=
=
=
=
$182.92
$303.84
$105.60
$154.90
P5-17 (30-35 min.)
1.
Cost/Activity Centre:
Cost Drivers
Quality: Pieces scrapped
Production scheduling:
Setups
Setup: Setups
Shipping: Containers
shipped
Shipping admin.:
Shipments
Production: Machine
hours
Total indirect cost
Direct materials
Direct labour
Total Cost of Part T151A
Number of units produced
Cost per unit
Selling price
Gross margin
Gross margin percentage
A
B
C
(A ÷ B)
Annual
Traceable
Cost
$ 800,000
Annual
Cost
Driver
Activity
10,000
Cost
per
Driver
Unit
$ 80
D
Cost
Driver
Consumption,
Part
T151A
1,000
50,000
600,000
500
500
100
1,200
12
12
1,200
14,400
300,000
60,000
5
500
2,500
50,000
1,000
50
100
5,000
1,500,000
$3,300,000
10,000
150
500
75,000
$178,100
150,000
86,000
$414,100
100,000
$4.141
6.000
$1.859
31.0%
Copyright © 2007 Pearson Education Canada
E
(C x D)
Total
Cost,
Part
T151A
$ 80,000
136
2.
Assuming that the results of the activity analysis are accurate, Product T151A is
much more profitable than RMP’s existing costing system estimates. The
existing system is overcosting product T151A by $1.659 or 40%! Chrysler’s
proposal can be accepted as long as the reduction in price is not significant.
RMP should be aware, however, that the existing costing system is also
undercosting some products, since all indirect costs are allocated. The activitybased costing system should be used to cost all product lines in order to identify
RMP’s “winners” as well as “losers.”
Benefits of activity-based implementation include:
•
•
•
More accurate costing of activities, product, customers, and other cost
objects
A solid foundation for activity-based management—using ABC information
as a management tool for budgeting, planning, and control purposes
An effective communication tool, since successful ABC implementation
should involve all functional areas of the company
Costs of implementing ABC include:
•
•
•
•
The cost of a pilot study includes salaries of managers who are dedicated to
the study;
Consultants are often necessary;
Data collection is extensive since operational and financial data are often not
available as required to support the new ABC system;
It may be necessary to purchase, install, and maintain an ABC system
separate from the accounting system used for external reporting.
Copyright © 2007 Pearson Education Canada
137
P5-18 (40 min.)
1 & 2. The solution to requirements 1 and 2 is in Table P5-18 on page 140.
3.
Single plantwide rate: $145,000 ÷ 20,000 = $7.25 per direct-labour hour.
4.
Comparison of methods:
Step-down method:
Job K10,
19 x $11 + 2 x $6 = $209 + $ 12 =
Job K12,
3 x $11 + 18 x $6 = $ 33 + $108 =
Total
Direct method:
Job K10, 19 x $10.855 + 2 x $6.048 = $206.25 + $ 12.10 =
Job K12, 3 x $10.855 + 18 x $6.048 = $ 32.57 + $108.86 =
Total =
Blanket rate:
Job K10, 21 x $7.25 =
Job K12, 21 x $7.25 =
Total
$221.00
141.00
$362.00
$218.35
141.43
$359.78
$152.25
152.25
$304.50
P5-19 (20-40 min.)
1.
(a) The allocation of joint costs would be in a 1:5 ratio:
Product
Product
A
B
Sales value
$1,000
$1,000
Joint costs
$200
$1,000
Separable costs
350
200
Total costs
$550
$1,200
Operating profit
$450
$ (200)
Total
$2,000
$1,200
550
$1,750
$ 250
(b) No. Joint costs are not relevant for this decision because you cannot stop
incurring that part allocated to one product and still continue to incur only
the other part. If the total process is profitable, you should process any
product that shows a positive contribution after the split-off point. Although
Product B shows a book loss of $200, it has a contribution after the split-off
point of $1,000 - $200, or $800.
Copyright © 2007 Pearson Education Canada
138
2.
(a) The net realizable value method deducts separable costs to arrive at an
imputed sales value at split-off point:
A
B
Total
Sales value
$1,000
$1,000
$2,000
Separable costs
350
200
550
Sales value imputed at
split-off point
$ 650
$ 800
$1,450
Allocation of joint costs,
650/1,450 and 800/1,450,
respectively
538
662
1,200
Operating profit
$ 112
$ 138
$ 250
(b) No. Product B does have the greater book profit and contribution after the
split-off point, but Product A has the greatest contribution per kilogram, which
is the scarce resource in this case. If, for example, the engineer changes the
process by 40 kilograms, so that we end up with 440 kilograms of B and 40
kilograms of A, separable costs would become $175 for A and $220 for B,
totalling $395. Sales values would become $500 for A and $1,100 for B, and
total $1,600. Total contribution after the split-off would drop from $1,450 to
$1,205 and total profit would drop from $250 to $5.
Kilograms
Sales value
Separable costs
Contribution to joint
costs
Joint costs
Operating profit
Copyright © 2007 Pearson Education Canada
A
40
B
440
Total
480
$500
175
$1,100
225
$1,600
400
$325
$ 880
$1,205
1,200
$
5
139
Copyright © 2007 Pearson Education Canada
140
P5-20 (25-30 min.)
1.
$1,080,000 ÷ 45,000 hours
= $24 per direct-labour hour
2. (a)
(b)
$630,000
$450,000
÷ 15,000 hours
÷ 30,000 hours
= $42 per direct-labour hour
= $15 per direct-labour hour
3. (a)
(b)
$630,000
$450,000
÷ 105,000 hours
÷ 30,000 hours
= $6 per machine hour
= $15 per direct-labour hour
4. (a)
$24 x (1.0 + 14.0) = $360.00
$24 x (1.5 + 3.0) = $108.00
$24 x (1.3 + 8.0) = $223.20
(b)
($42 x 1.0) + ($15 x 14.0) = $42.00 + $210.00 = $252.00
($42 x 1.5) + ($15 x 3.0) = $63.00 + $ 45.00 = $108.00
($42 x 1.3) + ($15 x 8.0) = $54.60 + $120.00 = $174.60
(c)
($6 x 10.0) + ($15 x 14.0) = $ 60.00 + $210.00 = $270.00
($6 x 17.0) + ($15 x 3.0) = $102.00 + $ 45.00 = $147.00
($6 x 14.0) + ($15 x 8.0) = $ 84.00 + $120.00 = $204.00
(d)
A major change in costs results from using departmental instead of firm-wide
rates. Departmental rates decrease the cost applied to units of A and C, which
use relatively more assembly time. The cost of B remains the same because of
the relative combination of assembly and machining time. Changing from a
firm-wide rate to a base of machine hours in machining causes smaller
changes in unit costs. Product B is the only one with an increase in cost.
Why? Because B's proportion of the machine hours in machining exceeds its
proportion of direct-labour hours in machining. Therefore, it receives more
costs with a base of machine hours than with a base of direct-labour hours.
Both A and C have a higher proportion of the direct-labour hours than of the
machine hours in the machining department.
Copyright © 2007 Pearson Education Canada
141
P5-21 (30-45 min.)
1.
Cost pool*
Board L**
0. Direct-material cost
£ 660,000
1. Direct-labour hours
560,000
2. Machine hours
560,000
3. Kilograms of materials
90,000
4. Number of production setups
80,000
5. Number of production orders
13,500
6. Number of orders shipped
30,000
Total budgeted cost
£1,993,500
Board M
£ 70,400
201,600
96,000
9,600
40,000
9,000
24,000
£450,600
Number of units
Unit cost
÷ 800
£ 563.25
÷ 10,000
£ 199.35
Board N
Total
£ 225,000 £ 955,400
630,000
1,391,600
280,000
936,000
30,000
129,600
40,000
160,000
3,150
25,650
60,000
114,000
£1,268,150 £3,712,250
£
÷ 5,000
253.63
*Identified by the cost driver used
**Calculations for Product L (Products M and N are similar):
0. 10,000 x £66 = £660,000
1. [(4 x 10,000) ÷ (4 x 10,000 + 18 x 800 + 9 x 5,000)] x £1,391,600 = £560,000
2. [(7 x 10,000)÷(7 x 10,000 + 15 x 800 + 7 x 5,000)] x £936,000=£560,000
3. [(3 x 10,000) ÷ (3 x 10,000 + 4 x 800 + 2 x 5,000)] x £129,600 = £90,000
4. [100 ÷ (100 + 50 + 50)] x £160,000 = £80,000
5. [300 ÷ (300 + 200 + 70)] x £25,650 = £13,500
6. [1,000 ÷ (1,000 + 800 + 2,000)] x £114,000 = £30,000
2.
Total cost (except direct materials) per direct-labour hour:
£2,756,850 ÷ (4 x 10,000 + 18 x 800 + 9 x 5,000)
= £2,756,850 ÷ 99,400 = £27.735 per direct-labour hour
Board L
Direct material cost per unit
£ 66.00
Other manufacturing cost per unit
110.94
Total manufacturing cost per unit
£176.94
Number of units
x 10,000
Total budgeted cost*
£1,769,400
Board M
£ 88.00
499.23
£587.23
x 800
£469,784
Board N
£ 45.00
249.62
£294.62
x 5,000
£1,473,100
*Total = £1,769,400 + £469,784 + £1,473,100 = £3,712,284, which differs from
£3,712,250 due to rounding error in the £27.735 rate.
Copyright © 2007 Pearson Education Canada
142
3.
The new system is more complex and more costly. The added expense would be
justified if the added value of better decisions made using the new system exceeds
the added cost of the system. Examples of pertinent questions include: Are
product prices or product choices directly affected by product costs? Or does the
market set prices?
P5-22 (15-20 min.)
1.
Allocations are in millions:
Actual
Revenue
Divisions:
Northern
Central
Southern
Total
2.
$120
200
280
$600
%
Total
Revenue
20.0%
33.3
47.7
100%
Allocated
Costs
$ 7.0
11.7
16.3
$35.0
Northern's manager would probably be indifferent, Central’s would be pleased,
and Southern’s would be displeased.
The major weakness of using revenue as a basis for cost allocation is that it
often fails to portray underlying cause-and-effect relationships. The major point
of this problem is to show how strange results occur when the costs being
allocated to a given segment are dependent on the activity of some other
segment. The Southern Division has done the most to reduce the unit cost of
central services, but it is being charged with a heavier dose of common costs.
Indeed, Central may have received more rather than less attention because of
its current competitive troubles.
Most of the central costs are discretionary. Pinpointing cause-and-effect
relationships is hard. Such costs are usually predetermined by management fiat
or by budgeted revenue.
Serious consideration should be given to one or more of the following:
a. No allocation, because no convincing allocation base is available.
b. Dividing the services into sub-categories and allocating by the use of
several different cost drivers.
c. Using budgeted revenues rather than actual revenues as a cost driver for
allocation. Of course, the use of budgeted revenues may induce more
"gamesmanship" than is typically encountered during the budgetary
process. There is a tendency to "under-budget" whenever a lower cost
allocation will result.
Copyright © 2007 Pearson Education Canada
143
3.
Allocations are in millions:
Divisions:
Northern
Central
Southern
Total
Budgeted
Revenue
%
Total
Revenue
Allocated
Costs
$120
240
280
$640
18.75%
37.50%
43.75%
100.00%
$ 6.6
13.1
15.3
$35.0
Many managers prefer this method because it portrays causes and effects
somewhat better than in requirement (1). That is, at least the overall level of
costs tend to be planned rather than just happen after the fact.
In requirement (1), the allocated costs were a straight 5.8% of actual revenue.
However, in requirement (3), the allocation is predetermined, and therefore the
percentages of actual revenue vary:
(1)
Actual
Revenue
Divisions:
Northern
Central
Southern
Total
$120
200
280
$600
(2)
Allocated
Costs
$ 6.6
13.1
15.3
$35.0
(3)
Percentage
(2) ÷ (1)
5.5%
6.6%
5.5%
Note that Central’s budgeted percentage would have been $13.1 ÷ $240 = 5.5%.
The resultant deviation of the actual percentage (6.6%) from the budgeted
percentage (5.5%) would highlight the effects of Central’s troubles.
4.
Many accountants and managers oppose allocating any central costs when no
convincing causes and effects can be established in any economically feasible
way. The opponents of cost allocation feel that the managers of subunits will
have better attitudes and will make better decisions if no allocation occurs.
Copyright © 2007 Pearson Education Canada
144
P5-23 (30-40 min.)
1.
Direct method:
Personnel
Direct departmental
costs before allocation
$ 70,000
Personnel
(70,000)
Administrative
Total costs after allocation
0
Administrative
Residential
$ 90,000
$240,000
28,000
33,750
$301,750
(90,000)
0
Commercial
$400,000
42,000
56,250
$498,250
Calculations:
12 + 18 = 30
(12 ÷ 30) x $70,000 = $28,000
(18 ÷ 30) x $70,000 = $42,000
240,000 + 400,000 = 640,000
(240,000 ÷ 640,000) x $90,000 = $33,750
(400,000 ÷ 640,000) x $90,000 = $56,250
2.
Step-down method:
Personnel
Direct departmental
cost before allocation
$ 70,000
Personnel
(70,000)
Administrative
Total cost after allocation
0
Administrative
Residential
$ 90,000
10,000
$(100,000)
0
$240,000
24,000
37,500
$301,500
Commercial
$400,000
36,000
62,500
$498,500
Calculations:
5 + 12 + 18 = 35
(5 ÷ 35) x $70,000 = $10,000
(12 ÷ 35) x $70,000 = $24,000
(18 ÷ 35) x $70,000 = $36,000
240,000 + 400,000 = 640,000
(240,000 ÷ 640,000) x $100,000 = $37,500
(400,000 ÷ 640,000) x $100,000 = $62,500
3.
(a) Residential:
(b) Commercial:
$301,500 ÷ 24,000 hours = $12.56 per direct-labour hour
$498,500 ÷ 9,970,000 m2 = $0.05 per m2
Copyright © 2007 Pearson Education Canada
145
P5-24 (15-25 min.)
1.
Direct materials
Materials handling
Assembly
Soldering
Quality assurance
Total for 100 circuit boards
Cost per circuit board
2.
Model A
Model B
Model C
¥ 400,000 ¥ 600,000 ¥ 800,000
20,000
30,000
40,000
300,000
200,000
100,000
150,000
150,000
150,000
200,000
120,000
80,000
¥1,070,000 ¥1,100,000 ¥1,170,000
¥ 10,700 ¥ 11,000 ¥ 11,700
The cost is ¥840,000 for 100 Model A circuit boards:
Model A
Direct materials
¥400,000
Materials handling
20,000
Assembly (30 x ¥50 x 100)
150,000
Soldering (3 x ¥400 x 100)
150,000
Quality assurance
120,000
Total for 100 circuit boards
¥840,000
Cost per circuit board (840,000 ÷ 100)
¥ 8,400
Copyright © 2007 Pearson Education Canada
146
P5-25 (20-30 min.)
1.
Unit costs:
Direct materials
Materials receiving and handling
($1.20 x 0.2; $1.20 x 0.4)
Production setup (60/600, 60/240)
Cutting, sewing, and assembly
Total unit cost
x Number of units
Cost before packing and shipping
Packing and shipping
Total cost
Standard
Kiwis
$1.30
0.24
0.10
0.40
$2.04
100
$204.00
10.00
$214.00
Giant
Kiwis
$2.20
0.48
0.25
0.40
$3.33
50
$166.50
10.00
$176.50
2.
This requirement calls for an understanding of cost drivers. Instead of setup
costs being added as an average unit cost, they are added as a total cost for
each product in this order. In essence, setup costs are driven by the order
because the new requirement calls for one setup for each product in each order:
Standard
Giant
Unit costs:
Kiwis
Kiwis
Direct materials
$1.30
$2.20
Materials receiving and handling
($1.20 x 0.2; $1.20 x 0.4)
0.24
0.48
Cutting, sewing, and assembly
0.40
0.40
Total unit cost
$1.94
$3.08
x Number of units
100
50
Cost before setup and packing and shipping $194.00
$154.00
Setup
60.00
60.00
Packing and shipping
10.00
10.00
Total cost
$264.00
$224.00
3.
The activity-based costing system recognizes the behaviour of the costs.
Because Maori Novelty has no category for direct labour, it apparently is not a
significant cost. Therefore, it is unlikely to cause the other costs. The activitybased costing system allocates costs based on their causes. Therefore, Maori
can better assess the costs of individual products. In addition, special situations
such as the setups needed in requirement 2 can be costed more easily and
accurately.
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147
P5-26 (25 min.)
1.
Recording and record-keeping cost: $16.50 x 550 =
Labour cost: ($23,000 / 460,000) x 80,000 =
Inspection cost: $2.75 x 4,000 =
Total cost
$ 9,075
4,000
11,000
$24,075
2.
Record and record-keeping cost: $16.50 x 220 =
Labour cost: ($23,000 / 460,000) x 60,000 =
Inspection cost: $2.75 x 2,500 =
Total cost
$ 3,630
3,000
6,875
$13,505
Cost saved = $24,075 - $13,505 = $10,570
3.
Receiving cost per kilogram: $24,075/80,000 = $0.30
Estimated cost saved from 20,000 kilograms = $0.30 x 20,000 = $6,000
The company would have underestimated the savings by $10,570 - $6,000 =
$4,570, and they may have continued to purchase and stock small-sales-level
brands that are actually unprofitable.
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