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CHAPTER 7 SOLUTIONS

CHAPTER 7

Activity-Based Costing and Activity-Based Management

Learning Objectives

1. Classify activities as unit-level, batch-level, product-level, customer-level, or organization-level. (Unit 7.1)

2. Calculate activity-based product costs. (Unit 7.2)3. Explain the difference between traditional product costs and activity-based product costs. (Unit

7.2)4. Distinguish between value-added and non-value-added activities. (Unit 7.3)5. Explain how information about activities can be used to make decisions. (Unit 7.3)

Summary of End of Chapter Material by Learning Objective and Bloom’s Taxonomy

Puzzle Clues Exercises Problems CasesItem L.O. Bloom Item L.O. Bloom Item L.O. Bloom Item L.O. Bloom

Unit 7.1 1 1 C 14 2 AP 23 2 AP,AN,E

1 1 K 2 1 AP,AN 15 2 AP,AN2 1 K,C 3 2 AP,AN 16 2,3 AP,AN3 1 C 4 2 AP,AN 17 2,5 AP,AN

,E5 2 AP 18 2,5 AP,AN

Unit 7.2 6 2 AP,AN 19 2,5 AP,AN,E

1 2 K 7 3 AP,AN 20 2,5 AP,AN,E

2 2 K 8 3 E,AN 21 2,3,5 AP,AN,E

3 2 C 9 2,3 AP,AN 22 2,3,5 AP,AN,E

4 2 C 10 4 C5 2 C 11 4 C6 3 C 12 5 AN7 3 C 13 5 AN

Unit 7.31 4 K,C2 4 K,C3 4 C4 5 C5 5 AN

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DAVIS & DAVIS MANAGERIAL ACCOUNTING

SOLUTIONS TO PUZZLE CLUES

Unit 7.1

1. An activity is an event that consumes resources. Examples include purchasing inventory, hiring employees, setting up machines for production, making sales calls, and answering customer inquiries.

LO: 1, Bloom: K, Unit: 7-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA: Cost Management

2. a. Unit-level activities are performed for each individual unit produced. Putting a zipper in a pair of C&C’s baseball pants is an example of a unit-level activity.

b. Batch-level activities are performed for a group, or batch, of units. The activity is performed all at once, regardless of the number of individual units in the batch. Cutting fabric for baseball jerseys (in batches of 35) is an example of a batch-level activity.

c. Product-level activities are performed to support an entire product line, regardless of how many individual units or batches are produced. Preparing a catalog of award jacket options would be an example of a product-level activity.

d. Customer-level activities are performed to provide service to a customer. Creating and mailing a monthly statement to customers is an example of a customer-level activity.

e. Organization-level activities are performed to provide productive capacity and general management. Renting the factory building would be an example of an organization-level activity.

LO: 1, Bloom: K, C, Unit: 7-1, Difficulty: Moderate, Min: 10, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA: Cost Management

3. If a company produces different products that have different production requirements yet share production resources (e.g., machines), activity-based costing may provide better product costing information. The same is true for service organizations that provide different kinds of services (e.g., hospitals). In addition, if bids for complex, “expensive,” low-volume jobs are always accepted, while bids for simple, “low cost,” high-volume jobs are rejected, competitors

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CHAPTER 7 SOLUTIONS

must be doing something differently. These results signal a need to investigate whether management is receiving bad costing information.

If a company produces a single product, or multiple products that are very similar in their consumption of resources, activity-based costing will not likely provide benefits over traditional costing methods. If a company with multiple products has dedicated manufacturing facilities for each product, there likely will be no benefit to implementing activity-based costing.

LO: 1, Bloom: C, Unit: 7-1, Difficulty: Difficult, Min: 10, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA: Cost Management

Unit 7.2

1. An activity cost pool is a collection of activities that share a common cost driver. The costs of the individual resources provided to accomplish the activities are added together to form the cost pool.

LO: 2, Bloom: K, Unit: 7-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

2. Once costs have been assigned to an activity cost pool through a first-stage allocation, the total cost is divided by the activity driver volume to yield the activity cost pool rate.

LO: 2, Bloom: K, Unit: 7-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

3. A cost object will have one overhead charge for each activity cost pool in which it consumes resources.

LO: 2, Bloom: C, Unit: 7-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

4. Manufacturing overhead and selling and administrative costs are allocated in total to products based on their consumption of the resources. This total is divided by the number of units produced/sold to determine the overhead cost per unit. Direct material cost per unit and direct labor cost per unit are added to this amount to determine total product unit cost.


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5. Organization-level costs are not allocated to products under activity-based costing because there is no reasonable activity driver to complete the allocation. These resources benefit the entire organization rather than a specific product or customer.


6. A traditional costing system allocates manufacturing overhead costs based on resources consumed by a product rather than the activities consumed by a product. If all overhead costs were unit-level costs, that might be OK. However, traditional costing systems treat batch-level, product-level and organization-level costs as unit-level costs, resulting in distorted product cost information.


7. Low-volume/high complexity products use just as many, if not more, batch-level and product-level activities as high-volume/low complexity products. Therefore, when activity-based costing is implemented and resources are allocated based on activity consumption, the low-volume/high complexity products carry their “fair share” of these costs, which were traditionally allocated across all units.


Unit 7.3

1. Value-added activities are those activities that create the product the customer wants to buy. In other words, the activity’s results are valued by the customer and the customer is willing to pay for that activity to be performed. Sewing buttons on a baseball jersey is value-added, since a customer would not want a jersey without buttons.

LO: 4, Bloom: K,C, Unit: 7-3, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning

2. A non-value-added activity is one that doesn’t contribute directly to the creation of the product the customer wants. Hence, the customer does not value that activity and does not want to pay for it. Storing partially completed goods between production stages does not add value to a product.

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CHAPTER 7 SOLUTIONS

LO: 4, Bloom: K,C, Unit: 7-3, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning

3. Non-value-added activities increase the cost to produce and deliver a good or service to customers. While it is desirable to reduce non-value-added activities, it is not possible to eliminate all non-value-added activities.

LO: 4, Bloom: C, Unit: 7-3, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning

4. By examining the company’s activities, managers may identify non-value-added activities that can be eliminated without compromising the final product or service. They may also discover that factory layouts can be altered to reduce the amount of non-value-added activities. Once the activities have been eliminated, managers can work to eliminate the accompanying resources, thereby reducing product costs.

LO: 5, Bloom: C, Unit: 7-3, Difficulty: Difficult, Min: 4, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning, Decision Analysis

5. Raising the selling price of a product may lower the number of units sold. The end result may be lower operating income than before the price increase. The first thing managers need to do is manage the activities and reduce cost. Managers also need to gather data about competitors’ prices and what customers are willing to pay for products/services before changing the price structure.

LO: 5, Bloom: AN, Unit: 7-3, Difficulty: Difficult, Min: 4, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning, Decision Analysis

5


SOLUTIONS TO EXERCISES

Exercise 7-1

Unit Batch Product Customer Organizational

a. Setting up a machine for a production run of 500 units

X

b. Conducting a seminar for local doctors on the benefits of a new drug

X

c. Embossing a company logo on every product made

X

d. Seating a party of 11 at a restaurant

X

e. Providing technical support for two years following a sale

X

f. Managing a corporation’s accounting department

X

g. Attaching a price tag to each product

X

h. Issuing an invoice X

i. Developing a corporate advertising campaign

X

j. Recalling a defective product X

LO: 1, Bloom: C, Unit: 7-1, Difficulty: Moderate, Min: 10-15, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA: Cost Management

Exercise 7-2

a. Since the single warehouse provides services for all products, customers, and regions, it would be considered an organization-level cost.

b. Since each new regional warehouse will provide service for a single product line, warehouse costs will be a product-level cost.

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CHAPTER 7 SOLUTIONS

c. Changing to the regional warehouses will likely change the product costs under an activity-based costing system. With a single warehouse, total warehouse costs were allocated across all products, regardless of how the warehousing services were consumed by the products. Under the regional warehouse system, warehouse costs will be allocated to the units consuming those resources. The revised products costs will likely reflect a more accurate allocation of warehouse costs.

LO: 1, Bloom: AP,AN, Unit: 7-1, Difficulty: Moderate, Min: 12, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA: Cost Management

Exercise 7-3

There are several activity cost drivers that could be used for each cost pool. The following are representative choices.

Stocking shelves: number of units shelved, number of products carried, square inches of shelf space occupied

Managing stockroom inventory: number of products stored, square feet of storage space occupied, number of units stored, number of cases stored, number of pallets stored

Maintaining refrigeration units: number of maintenance hours worked, number of service calls, number of motors maintained, number of hours units are in operation

Processing lottery tickets: number of tickets sold, number of customers purchasing lottery tickets

Maintaining employee records: number of employees, number of labor hours worked, amount of time spent maintaining employee records

LO: 2, Bloom: AP, AN, Unit: 7-2, Difficulty: Difficult, Min: 10, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA: Cost Management

Exercise 7-4

7


a. Depreciation of phone and computer equipment, telephone company line charges, help desk personnel salaries and benefits, help desk employee training, software, computer maintenance, office supplies

b. Length of call would be the best choice of cost driver for this cost pool. A longer support call consumes more of the resources (think help desk employee time) than a shorter call. Therefore, the longer call should be allocated more cost than the shorter call. If number of calls was used as the cost driver, a 30-minute call would receive the same cost allocation as a 30-second call. This clearly would not capture the relative cost incurred to deliver the support service.

LO: 2, Bloom: AP, AN, Unit: 7-2, Difficulty: Difficult, Min: 8-10, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA: Cost Management

Exercise 7-5

a. = $25/DLH

b.

Order processing$175,00010,000 orders

= $17.50 per order

Setups = $40 per setup

Milling = $20 per machine hour

Shipping = $10.20 per shipment

LO: 2, Bloom: AP, Unit: 7-2, Difficulty: Easy, Min: 10-12, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

Exercise 7-6

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CHAPTER 7 SOLUTIONS

a. = $1.25 per tape mount

Customer Calculation Allocated

Storage Cost Perkins 69,388 mounts × $1.25/mount $86,735Alderson 142,392 mounts × $1.25/mount 177,990McEwen 5,072 mounts × $1.25/mount 6,340Hodges 1,972 mounts × $1.25/mount 2,465Jenkins 8,388 mounts × $1.25/mount 10,485 Total $284,015

b. = $2.15 per gigabyte

Customer CalculationAllocated

Storage Cost Perkins 36,254 gigabytes × $2.15/gigabyte $77,946.10Alderson 75,236 gigabytes × $2.15/gigabyte 161,757.40McEwen 830 gigabytes × $2.15/gigabyte 1,784.50Hodges 18 gigabytes × $2.15/gigabyte 38.70Jenkins 19,762 gigabytes × $2.15/gigabyte 42,488.30 Total $284,015.00

c. With a goal of minimizing their cost, Perkins, Alderson, and McEwen would prefer an allocation based on gigabytes of storage, while Hodges and Johnson would prefer an allocation based on number of tape mounts. However, customer preference should not be the basis for selecting the appropriate allocation base. If Lewis believes that the department’s costs are driven by the storage space required, then she should use that driver as the basis for cost allocation.

d. If the cost of the system is due primarily to the amount of storage space provided, number of tape mounts will not be a good cost driver. The storage space has to be provided regardless of how many times the tape is mounted.

LO: 2, Bloom: AP, AN, Unit: 7-2, Difficulty: Difficult, Min: 15-20, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

9


Exercise 7-7

a. Standard edition Deluxe edition

Direct labor hours/unit 500 ,000500 ,000

=1 DLH/unit 30 ,00010 ,000

=3 DLH/unit

Printing press hours/unit 80 ,000500 ,000

=.16 PPH/unit 1,60010,000

=. 16 PPH/unit

Sales orders/unit 10 ,000500 ,000

=.0 2 orders/unit 10 ,00010 ,000

=1 order/unit

b. The deluxe editions use more direct labor hours per unit and more sales orders per unit. Both books use the same amount of printing press time.

c. With the current system, a deluxe edition gets three times the overhead allocation as a standard edition because it requires three times as many direct labor hours as the standard edition. An ABC system that creates a cost pool for printing press costs will shift some overhead costs to the standard edition since both books consume the same amount of printing press activities. However, a deluxe edition uses 50 times more sales activities than the standard edition, so these costs will shift to the deluxe edition. The effect on the costs of the books will depend on how large the printing press cost pool is relative to the sales order cost pool.

LO: 3, Bloom: AP, AN, Unit: 7-2, Difficulty: Moderate, Min: 15, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

Exercise 7-8

The cost to produce the product didn’t change; the costs have been allocated differently. When an activity-based costing system is introduced, the cost assigned to premium products generally increases. This is because premium products are usually lower volume products but still consume a high level of resources. The original $125 cost was low because overhead costs had been incorrectly assigned to other products. The conversion to activity-based costing correctly assigns batch-level and product-level costs to the products. Under the original costing system, these costs were

10

CHAPTER 7 SOLUTIONS

treated as unit-level costs. Machine setups are an example of costs that are mistreated under traditional costing.

LO: 3, Bloom: E, AN, Unit: 7-2, Difficulty: Difficult, Min: 10, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

11


Exercise 7-9

a. Overhead rate =

$1,599 ,000(50,000 MH + 32,000 MH ) = $19.50/MH

Simple ComplexMachine hours 50,000 32,000

× Overhead rate $19.50 $19.50= Total overhead to product $975,000 $624,000

Total assigned overhead = $975,000 + $624,000 = $1,599,000

Simple ComplexTotal overhead to product $975,000 $624,000

÷ Number of units produced 125,000 40,000= Overhead per unit $7.80 $15.60

b. Simple

Assembly 250,000 DLH × $1.25/DLH $312,500Fabrication 50,000 MH × $9.75/MH 487,500Setups 2,500 batches × $18.00/batch 45,000Bonding 0Total overhead $845,000

Complex

Assembly 160,000 DLH × $1.25/DLH $200,000Fabrication 32,000 MH × $9.75/MH 312,000Set ups 4,000 batches × $18.00/batch 72,000Bonding 170,000Total overhead $754,000

Total assigned overhead = $845,000 + $754,000 = $1,599,000

Simple ComplexTotal overhead to product $845,00

0$754,000

÷ Number of units produced 125,000 40,000

12

CHAPTER 7 SOLUTIONS

= Overhead per unit $6.76 $18.85

c. Complex uses twice the direct labor and machine hours per unit as Simple. Complex also requires more setups than Simple. Activity-based product costs reflect this higher relative use of these overhead resources by the Complex product. Additionally, under a traditional overhead allocation based on machine hours, Simple units were allocated a portion of the bonding costs, a resource that the units did not consume. Activity-based costing corrects this costing error, since all bonding costs are allocated to the Complex product.

LO: 2,3, Bloom: AP, AN, Unit: 7-2, Difficulty: Moderate, Min: 15-20, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

Exercise 7-10

Value-Added Non-Value-Added Can be Eliminateda. Xb. Xc. X Xd. Xe. X Xf. Xg. Xh. Xi. X

LO: 4, Bloom: C, Unit: 7-3, Difficulty: Moderate, Min: 10-15, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning

Exercise 7-11

Value-Added Non-Value-Added Can be Eliminateda. Xb. Xc. Xd. Xe. Xf. Xg. Xh. X

13


i. Xj. X

LO: 4, Bloom: C, Unit: 7-3, Difficulty: Moderate, Min: 10-15, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning

14

CHAPTER 7 SOLUTIONS

Exercise 7-12

a. If Clive retains all the resources currently used to provide the setups, reducing the number of batches to 25,000 will have no effect on total setup costs. However, if Clive is able to release unused resources, the total cost will fall.

b. Again, the effect on the cost of a tube of paint depends on whether Clive reduces the resources committed to setups. If he retains all the resources, there will be no effect on the cost to produce a tube of

paint ( = $0.05 per tube). If he reduces the level of resources, then the cost to produce a tube of paint will decrease.

c. The effect of the increased batch size on total costs incurred by the company will depend on the presence of other batch activities. If there are other batch activities, and if the resources committed to those activities are reduced with the decreased number of batches produced, then other costs incurred by the company will decrease.

d. Clive needs to consider the effect that the increased batch size will have on the quality of the paint. Additionally, if these larger batch sizes create excess inventory in one color and long delays between the time colors are produced, he may not be able to meet demand on a timely basis.

LO: 5, Bloom: AN, Unit: 7-3, Difficulty: Difficult, Min: 15-18, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning, Decision Analysis

Exercise 7-13

a. The U.S. Postal Service assumes that customers will change their behavior to take advantage of the price decrease. However, customers may decide that the time and financial investment they have to make to produce computer-readable labels and to increase the number of drop-offs is not worth the rate savings. Alternatively, customers may look for other delivery options besides the U.S. Postal Service.

15


Organizations that can benefit from this strategy are those that can clearly identify activities that customers can control. Additionally, competition should be such that customers can’t easily switch to another vendor.

b. It is unlikely that the U.S. Postal Service would experience immediate savings if all customers adopted the new behaviors. A major cost of human sorting and magazine delivery is personnel, and these people are unlikely to be terminated. Rather, they will likely be reassigned to other roles within the organization. To save money on this change, the Postal Service would have to reduce the number of employees. Alternatively, the U.S. Postal Service could create additional revenue-generating work for these workers.

LO: 5, Bloom: AN, Unit: 7-3, Difficulty: Difficult, Min: 10-15, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Strategic Planning, Decision Analysis

SOLUTIONS TO PROBLEMS

Problem 7-14

a. Basic: = 7.5 hours per account

Premier: = 15 hours per account

b. Basic: = 3 transactions per account

Premier:14 ,000 transactions

1,000 accounts = 14 transactions per account

c. Cost per hour = $2,880,000(15,000 hours+15,000 hours) = $96 per hour

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CHAPTER 7 SOLUTIONS

BasicTotal allocated cost 15,000 hours × $96/hour = $1,440,000÷ number of accounts ÷ 2,000Cost per account $720

PremierTotal allocated cost 15,000 hours × $96/hour = $1,440,000÷ number of accounts ÷ 1,000Cost per account $1,440

d. ABC Rates

Maintenance: = $192/account

Transaction Processing: = $64.80/transaction

Account Analysis: = $33.60/hour

Basic

Maintenance 2,000 accounts × $192/account $384,000Transaction processing 6,000 transactions × $64.80/transaction 388,800Account analysis 15,000 hours × $33.60/hour 504,000 Total cost $1,276,800÷ # of accounts ÷ 2,000Cost per account $638.40

Premier

Maintenance 1,000 accounts × $192/account $192,000Transaction processing 14,000 transactions × $64.80/transaction 907,200Account analysis 15,000 hours × $33.60/hour 504,000 Total cost $1,603,200÷ # of accounts ÷ 1,000Cost per account $1,603.20

17


LO: 2, Bloom: AP, Unit: 7-2, Difficulty: Moderate, Min: 20-25, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

18

CHAPTER 7 SOLUTIONS

Problem 7-15

a. Predetermined OH rate = = $45/DLH

Tablets BooksDirect Materials $3.00 $10.00Direct Labor 4.00 8.00Overhead

× $45/DLH = 18 .00

× $45/DLH = 36 .00

Total Unit Cost $25 .00 $54 .00

b. ABC Rates

Binding:$247,500

(62 ,500 tablets+ 20,000 books ) = $3.00/unit

Printing:$796,250

(125,000 + 120,000 ) machine hours = $3.25/machine hour

Product Design:$195,000

(1,250 + 2,000 ) change orders = $60/change order

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ABC overhead allocation

Tablets Binding 62,500 tablets × $3.00/unit $187,500 Printing 125,000 MH × $3.25/MH 406,250 Product Design 1,250 change orders × $60/change order 75,000 Total Overhead 668,750Units produced ÷ 62,500 Overhead per unit $10 .70

Books Binding 20,000 books × $3.00/unit $60,000 Printing 120,000 MH × $3.25/MH 390,000 Product Design 2,000 change orders × $60/change order 120,000 Total Overhead 570,000Units produced ÷ 20,000 Overhead per unit $28 .50

ABC unit cost

Tablets BooksDirect Materials $3.00 $10.00Direct Labor 4.00 8.00Overhead 10 .70 28 .50 Total Unit Cost $17 .70 $46 .50

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CHAPTER 7 SOLUTIONS

Problem 7-15 continued

c.OH allocated to tablets using traditional POR (25,000 DLH × $45/DLH)

$1,125,000

OH allocated to books using traditional POR (16,000 DLH × $45/DLH)

720,000

Totaled allocated OH using traditional POR $1,845,000

OH allocated to tablets using ABC $668,750OH allocated to books using ABC 570,000Totaled allocated OH using ABC 1,238,750

Difference in allocated overhead $606,250

LO: 2, Bloom: AP,AN, Unit: 7-2, Difficulty: Moderate, Min: 20-25, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

Problem 7-16

a. Overhead rate =

$899,000(15,000 DLH+14,000 DLH ) = $31.00/DLH

AM-2 FM-9 Total overhead to product $31 15,000 DLH $465,000 $31 14,000 DLH $434,000

÷ Number of units produced 15,000 2,000= Overhead per unit $31 $217

b.

Assembly:$638,000

15,000+14,000= $22/DLH

Setupa:$121,500

5+40= $2,700/setup

Packagingb:$139,500

7,500+8,000= $9/pound

aSetups equals units produced units per batch

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AM-2: 15,000 units 3,000 units per batch = 5 batches (setups) FM-9: 2,000 units 50 units per batch = 40 batches (setups)bPounds equals units produced weight per unit AM-2: 15,000 units .5 pounds per unit = 7,500 pounds FM-9: 2,000 units 4 pounds per unit = 8,000 pounds

AM-2

Assembly 15,000 DLH × $22/DLH $330,000Setup 5 setups × $2,700/setup 13,500Packaging: 7,500 pounds × $9/pound 67,500Total overhead $411,000Number of units produced 15,000 Overhead per unit $27.40

FM-9

Assembly 14,000 DLH × $22/DLH $308,000Setup 40 setups × $2,700/setup 108,000Packaging: 8,000 pounds × $9/pound 72,000Total overhead $488,000Number of units produced 2,000 Overhead per unit $244.00

c. Under traditional costing, the cost of these resources was spread across all units produced based on the direct labor hours consumed. Each FM-9 was charged seven times the overhead charged to each AM-2 because each FM-9 requires 7 DLH, whereas each AM-2 requires only one DLH. Using ABC, each FM-9 received seven times the assembly cost, 60 times the setup cost, and eight times the packaging cost that was charged to AM-2. Properly allocating these resources to the low-volume FM-9 product significantly increases its per unit cost.

LO: 2,3, Bloom: AP, AN, Unit: 7-2, Difficulty: Difficult, Min: 15-20, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management

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CHAPTER 7 SOLUTIONS

Problem 7-17

a.Tablets Books

Sales price $33.00 $65.00Product costs 25 .00 54 .00 Product margin $ 8 .00 $11 .00

b.Tablets Books

Sales price $33.00 $65.00Product costs

25 .00 54 .00

Product margin

$ 8.00 $11.00

× Unit sales 62,500 20,000 = Total margin

$500,000 $220,000

% of total margin

$500,000($500,000+$220,000 )

= 69.4% $220,000($500,000+$220,000 )

= 30.6%

c. S&A Cost ABC Rates

Shipping: = $4.50/lb.

Advertising: = $0.80/mailing

23


ABC selling & administrative cost allocation

Tablets Shipping 31,250 lbs. × $4.50/lb. $140,625 Advertising 125,000 mailings × $0.80/mailing 100,000 Commissions $33 × 62,500 tablets × 5% 103,125 Total S&A cost 343,750Units produced ÷ 62,500 S&A cost per unit $5 .50

Books Shipping 40,000 lbs. × $4.50/lb. $180,000 Advertising 100,000 mailings × $0.80/mailing 80,000 Commissions $65 × 20,000 books × 5% 65,000 Total S&A cost 325,000Units produced ÷ 20,000 S&A cost per unit $16 .25

Tablets BooksSales Price $33.00 $65.00Product Costs 17.70 46.50Selling & Administrative 5 .50 16 .25 Product Margin $ 9 .80 $2 .25

d.Tablets Books

Sales Price $33.00 $65.00Product Costs 17.70 46.50Selling & Administrative 5 .50 16 .25 Product Margin $ 9.80 $2.25× Unit sales 62,500 $20,000= Total margin $612,500 $45,000

% of total margin $612,500($612,500+$45,000 )

=

93.2%

$45,000($612,500+$45,000 )

=

6.8%

e. The company sends out 100,000 mailings to generate sales of only 20,000 books. Managers should consider a more targeted mailing

24

CHAPTER 7 SOLUTIONS

approach that reduces the number of mailings while reaching the most likely purchasers. Such a move would reduce the overall cost of books. Since tablets have a lower sales price and a higher product margin than books, managers may want to redirect some of the sales efforts currently used on books to increase the sales of tablets.

LO: 2,5, Bloom: AP, AN, E, Unit: 7-2,7-3, Difficulty: Difficult, Min: 25-30, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management, Strategic Planning

Problem 7-18

a.Cost Pool Calculation Activity Rate

Setting up new employees = $150/new employee

Processing weekly payroll = $0.312/check

Weekly reporting = $3,000/client

Annual tax reporting $240,00060,000 W-2s = $4/W-2

b.

Cost Pool CalculationExpected

Annual CostSetting up new employees 20 new employees × $150 $3,000.00Processing weekly payroll 20 employees × 52 weeks × $0.312 324.48Weekly reporting 1 client × $3,000 3,000.00Annual tax reporting 20 employees × $4 80 .00 Total $6,404 .48

c. With this estimate of the cost to provide payroll services to Nelly’s Nectar Bar, Patrick knows the lowest price he can bid on the job - $6,404.48. However, that price will not provide any profit or room for misestimates, so Patrick will need to price the job at a higher price. Also, this estimate assumes that there is no employee turnover at Nelly’s Nectar Bar. Any turnover that adds additional employees will cause Patrick to incur additional costs to provide his service. Therefore, he should increase his proposed price to cover such contingencies.

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LO: 2,5, Bloom: AP, AN, Unit: 7-2,7-3, Difficulty: Moderate, Min: 15-20, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management, Strategic Planning

26

CHAPTER 7 SOLUTIONS

Problem 7-19

a. Predetermined overhead rate = = 500% of direct labor cost

Cashews ChestnutsDirect material $4.20 $3.20Direct labor .30 .30Overhead 1 .50 1 .50 Cost/lb. 6.00 5.0040% markup 2 .40 a 2 .00 bSelling price $8 .40 $7 .00

a$6.00 × 40% = $2.40b$5.00 × 40% = $2.00

b.Cost Pool Calculation Activity Rate

Purchasing = $1,000/purchase order

Material handling = $800/setup

Quality control $300,000600 batches = $500/batch

Roasting = $20/roasting hour

Seasoning = $20/seasoning hour

Packaging = $20/packaging hour

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Cashews Purchasing

× $1,000 $4,000

Material handling

× 3 setups × $800 24,000

Quality control

× $500 5,000

Roasting

× 1 hour × $20 20,000

Seasoning

× .5 hour × $20 10,000

Packaging

× .1 hour × $20 2,000

Total overhead 65,000Pounds produced ÷ 100,000 Overhead per pound $0 .65

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CHAPTER 7 SOLUTIONS

Chestnuts Purchasing

× $1,000 $4,000

Material handling

× 3 setups × $800 9,600

Quality control

× $500 2,000

Roasting

× 1 hour × $20 400

Seasoning

× .5 hour × $20 200

Packaging

× .1 hour × $20 40

Total overhead 16,240Pounds produced ÷ 2,000 Overhead per pound $8 .12

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Cashews ChestnutsDirect material $4.20 $3.20Direct labor .30 .30Overhead .65 8 .12 Cost/lb. 5.15 11.6240% markup 2 .06 a 4 .65 bSelling price $7 .21 $16 .27

a$5.15 × 40% = $2.06b$11.62 × 40% = $4.65 (rounded from $4.648)

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CHAPTER 7 SOLUTIONS

c. As a result of the activity-based costing analysis, Nancy’s managers must recognize that they cannot continue to sell chestnuts at the $7.00 per pound. At that price, the company is not even covering the manufacturing overhead consumed by the chestnuts. If the company cannot sell the chestnuts at $16.27 per pound, it will have to accept a lower markup or consider dropping chestnuts from its product offerings. The company could also investigate the feasibility of roasting chestnuts in larger batches, which would reduce the amount of setup and quality control costs.

The company does have an opportunity with cashews. If the market is currently paying $8.40 per pound, there is no need to reduce the price to $7.21 per pound just to stay at the 40% markup. However, the company will want to conduct C-V-P analysis to see if a price cut would generate a large enough volume increase to generate additional contribution margin above the current amount.

LO: 2,5, Bloom: AP, AN, E, Unit: 7-2,7-3, Difficulty: Moderate, Min: 25-30, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management, Strategic Planning

Problem 7-20

a. Common pool hourly cost = = $12/test hour

Hourly billing rate = $12 + .45($12) = $17.40

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b. HTT ATT SST ACT AQT

Test pool labora $126,000 $84,000 $84,000 $42,000 $84,000Supervision 28,800 10,800 10,800 10,800 10,800Depreciation 48,000 22,000 39,000 32,000 37,000Heat 85,000 8,500 8,500 51,000 17,000Electricity 37,200 12,400 12,400 49,600 12,400Water 0 0 14,800 14,800 44,400Setup 11,600 8,700 17,400 8,700 11,600Indirect materials 16,500 15,600 31,200 20,600 20,100Supplies 6,000 6,000 15,000 12,000 21,000 Total costs $359,100 $168,000 $233,100 $241,500 $258,300Test hours 31,500 10,500 26,250 21,000 15,750 Cost per hour $11.40 $16.00 $8.88 $11.50 $16.40

afor HTT: $420,000 total labor cost10 employees × 3 HTT employees

c. HTT ATT SST ACT AQT

Cost per hour $11.40 $16.00 $8.88 $11.50 $16.4045% markup (rounded) 5.13 7.20 4.00 5.18 7.38Hourly billing rate $16.53 $23.20 $12.88 $16.68 $23.78

32

CHAPTER 7 SOLUTIONS

d. The newly calculated billing rates for ATT, ACT and AQT are all higher than competitor rates, though the price charged for ACT at $17.40 was already higher than the competitors’ rates. If Rick Shaw was to change prices and charge more than his competitors’ do, he may lose sales.

Before changing prices, Rick needs to determine what customers are willing to pay for the tests. The 45% markup has no meaning regarding the value of the tests to customers. For example, why lower the price of SST to $12.88 when competitors charge $15.50? Rick needs to consider the pricing of the 5 tests as a whole, considering competitors’ rates and the number of tests demanded, so as to maximize income.

LO: 2,5, Bloom: AP, AN, E, Unit: 7-2,7-3, Difficulty: Difficult, Min: 30-35, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management, Strategic Planning

Problem 7-21

a.Cost Pool Calculation Activity Rate

Soldering = $0.60/joint

Shipping = $43/shipment

Quality control$1,248,000

78,000 inspections= $16/inspection

Purchasing$950,000

190,000 purchase orders= $5/purchase order

Machining$70,400

176,000 machine hours= $0.40/machine hour

Setups = $25/setup

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b.Cost Pool 32” LCD 42” Plasma

Soldering 1,185,000 joints × $0.60 $711,000 385,000 joints × $0.60 $231,000Shipping 16,000 shipments × $43 688,000 4,000 shipments × $43 172,000Quality control 56,250 inspections × $16 900,000 21,750 inspections × $16 348,000Purchasing 80,000 purchase orders × $5 400,000 110,000 purchase orders × $5 550,000Machining 160,000 MH × $0.40 64,000 16,000 MH × $0.40 6,400Setups 16,000 setups × $25 400,000 14,000 setups × $25 350,000

3,163,000 1,657,400÷ units produced 20,000 4,000OH per unit $158.15 $414.35

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CHAPTER 7 SOLUTIONS

c.32” LCD 42” Plasma

Direct material $352.00 $656.00Direct labor 18.00 42.00Overhead 158 .15 414 .35 Cost per unit $528 .15 $1,112 .35

d. No. Selling and administrative costs are not included.

e.32” LCD 42” Plasma

Sales pricea $900.00 $1,140.00ABC cost 528 .15 1,112 .35 Profit $371 .85 $27 .65

afor 32” LCD:

The plan to focus on the 42” and phase out the 32” is not a profitable strategy. Because of the activities required to produce the 42” TV, the company will only have $27.65 per TV sold to cover selling and administrative costs and contribute to profit. On the other hand, the 32” nets $371.85 per TV to cover selling and administrative costs and contribute to profit.

f. Efferson could identify the activities that are used to produce the 42” TV to see what non-value-added activities could be eliminated. For example, 110,000 purchase orders are used to acquire the raw materials needed to make 4,000 42” TVs. That’s 27.5 orders per TV produced (110,000 4,000). On the other hand, 80,000 purchase orders are needed to acquire the raw materials needed to make 20,000 32” TVs. That’s only 4 orders per TV produced (80,000 20,000). While it could be that the 42” TV has many more parts than the 32” TV, seven times the number of orders per TV seems excessive. Likewise, the 42” TV requires 3.5 setups per TV (14,000 4,000), whereas the 32” TV requires .8 setups per TV (16,000 20,000). Increasing the batch size for the 42” TV would decrease the number of setups, though the production manager would need to ensure that quality wasn’t sacrificed with this change.

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Once Efferson has identified non-value-added activities to eliminate, the resources consumed by those activities must be eliminated or the company will not reduce production costs.

LO: 2,3,5, Bloom: AP, AN, E, Unit: 7-2,7-3, Difficulty: Difficult, Min: 50-60, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management, Strategic Planning

Problem 7-22

a. Predetermined OH rate =

$350,000(20,000 units × 2 DLH/unit )+(20,000 units × 3 DLH/unit ) = $3.50/DLH

Balzene GalveneDirect material $ 5.00 $ 3.00Direct labor 16.00a 24.00Overhead 7 .00 b 10 .50 cCost per unit $28 .00 $37 .50

aDL rate = = $8/DLHb2 DLH × $3.50/DLHc3 DLH × $3.50/DLH

b.Fabricating Assembly

Indirect labor 24,000 × .75 = $18,000 24,000 × .25 = $6,000Fringe benefits 5,000 × .60 = 3,000 5,000 × .40 = 2,000Indirect materials 20,000 11,000Power 160,000 20,000Setup 5,000 70,000Quality assurance 10,000 × .70 = 7,000 10,000 × .30 = 3,000Other utilities 10,000 × .50 = 5,000 10,000 × .50 = 5,000Depreciation 15,000 × .80 = 12,000 15,000 × .20 = 3,000 Total $230,000 $120,000

36

CHAPTER 7 SOLUTIONS

Cost Pool Calculation Activity Rate

Fabricating = $1.15/MH

Assembly = $96.00/setup

a(20,000 units of balzene × 4MH/unit) + (20,000 units of galvene × 6MH/unit)b1,000 setups for balzene + 250 setups for galvene

c. Balzene

Cost Pool Calculation Overhead Fabricating (20,000 units × 4 MH/unit) × $1.15 $92,000Assembly 1,000 setups × $96 96,000 Total allocated OH 188,000÷ units produced 20,000 OH per unit $9 .40

Galvene

Cost Pool Calculation Overhead Fabricating (20,000 units × 6 MH/unit) × $1.15 $138,000Assembly 250 setups × $96 24,000 Total allocated OH 162,000÷ units produced 20,000 OH per unit $8 .10

Balzene GalveneDirect material $5.00 $3.00Direct labor 16.00 24.00Overhead 9 .40 8 .10 ABC cost per unit $30 .40 $35 .10

d. The switch to ABC did not change the actual cost to produce Galvene. Switching costing systems does nothing to change the resources actually consumed in production. However, the switch will

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change the reported cost of resources consumed to produce the product.

e. The $35.10 activity-based cost of galvene provides Highland’s managers with better information for making pricing and production decisions. Given this cost, managers can consider lowering the price of galvene to meet or beat the new competitor’s price.

LO: 2,3,5, Bloom: AP, AN, E, Unit: 7-2,7-3, Difficulty: Difficult, Min: 50-60, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and Decision Making, IMA: Cost Management, Strategic Planning

SOLUTIONS TO CASE

Case 7-23

a. Allocation based on materials cost 2011 2012 2013 Total

Government contracts unit $195,840.00 $228,749.50 $262,094.00 $686,683.50

Commercial unit 92,160.00 98,035.50 112,326.00 302,521.50 Total direct

materials cost $288,000.00 $326,785.00 $374,420.00 $989,205.00

Allocation based on purchase orders 2011 2012 2013 Total

Government contracts unit $95,040.00 $104,571.20 $112,326.00 $311,937.20

Commercial unit 184,320.00 202,606.70 217,163.60 604,090.30 Total direct

materials cost $279,360.00 $307,177.90 $329,489.60 $916,027.50

b. There is no reason to think that the amount of resources consumed to process a $1,000 purchase order and a $10,000 purchase order is very different. Yet, allocating materials handling costs based on the cost of materials assumes that very thing. If indeed it costs the same amount to process a $1,000 purchase order and a $10,000 purchase order, then the number of purchase orders better reflects how costs are incurred, and it is a better allocation base.

38

CHAPTER 7 SOLUTIONS

c. Since a purchasing agent (plus phone) is assigned specifically to purchase materials for government contracts, these costs should be traced directly to the government contract unit. Additionally, you can tell by the difference between the total materials handling costs and the costs allocated based on purchase orders that other units are starting to cause more of the costs. Therefore, a portion of the costs should be assigned to these other units.

d. No, I don’t agree with Mason. There is no accounting pronouncement that requires companies to prepare information for internal decision making, yet we know it is important to have such information for companies to operate efficiently and effectively. Accountants have to use their best judgment regarding what information will provide managers with information that will result in the best decisions for the company.

e. The IMA Statement of Ethical Professional Practice requires that members act with competence and “provide decision support information and recommendations that are accurate, clear, concise, and timely.” Additionally, the Statement requires the use of credibility and communicating information “fairly and objectively.” Thus, Lindley should not comply with Mason’s directive to hide part of the commercial unit’s purchase order volume in other units. To do so would be to generate information that is inaccurate and that was presented unfairly and unobjectively. Following Mason’s directive will compromise Lindley’s integrity and set her up for additional ultimatums in the future.

Lindley should discuss the situation with her superior, likely the CFO. Should she not receive support from her superior, she should take the matter to the audit committee or board of directors.

Lindley will need to review the contracting requirements of the government agencies involved to ensure that no laws are being violated by the choice of allocation method. If there appears to be a question of legality, she should consult her attorney as to a possible course of action.

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If Lindley does not receive support and is told to do what she feels is unethical, she should consider if continued employment at Thomas-Britt is in her best interest.

LO: 2, Bloom: AP, AN, E, Unit: 7-2, Difficulty: Difficult, Min: 45-50, AACSB: Analytic, Ethics, AICPA FN: Measurement AICPA PC: Problem Solving and Decision Making IMA: Cost Management, Business Applications

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