Cost Accounting Ch. 4

CHAPTER 4
ACTIVITY-BASED MANAGEMENT AND

ACTIVITY-BASED COSTING
QUESTIONS
1. Activitybasedmanagementisamanagementmodelthatassociatesanorganizations
activities with the value customers derive from the organizations products.
Efficiencyandeffectivenessareachievedbyreducingthelevelofactivitiesthatdo
notcreatevalueforthecustomerandbyimprovingexecutionofactivitiesthatdo
createcustomervalue.
SpecifictoolsusedinABMincludeactivityanalysis,costdriveranalysis,activity
basedcosting,continuousimprovement,operationalcontrol,performanceevaluation,
andbusinessprocessreengineering.
2. Activityanalysis is usedtoseparateactivities intotwogroups:thosethatadd
valuetotheproductorserviceandthosethatdonotaddvalue.Oncethenon
valueaddedactivities areidentified,managersseektoreduceoreliminatethe
levelofthedriversofthoseactivities.Ifsucheffortsaresuccessful,NVAcosts
will be reduced without impairing the value of products or services to the
consumer.Theresultshouldbeanincreaseinprofits.
3. Valueaddedactivitiesaredefinedfromthecustomersperspectivebecauseitis
thecustomerwhoisthefinalevaluatorofaproductsorservicesworthand,
therefore,theactivitiesinvolvedincreatingthatproductorservice.Thecustomer
isalsothepersonwhoshould,inthefinalanalysis,betheonewhodetermines
whether he or she actually wants to pay the price for engaging in all of the
activitiesthatareincurredintheproductionofaproductortheperformanceofa
service.
4. Inadditiontoapproximatelyonehourofcommercials,theremainingtimeisspent
showingplayersstandingaround,networkannouncers,replays,cheerleaders,head
coaches,andreferees.Inatelevisedfootballgame,thevalueaddedactivitiesare
theactualgameplays.Nonvalueaddedactivitiesconsistofcommercialsandthe
time between plays. Activities such as moving the chains, measuring to
determineifafirstdownwasmade,andmovingtheballfromtheendofoneplay
tothepointwhereitwillbeputinplaynextareallnonvalueaddedactivities.
Peoplewhobelievethatthecommercialsareinformativeandinterestingandthat
thetimebetweenplaysallowsthemanopportunitytoexaminethestrategiesof
the teams and project what each team is likely to do may disagree with this
assessment. Advertisers may also disagree that commercials are NVA:
HomeAwayestimatedthat60to70percentofitsfirstSuperBowladcostwas
recoupedinnewbusinessandGoDaddysaysitobtainedfivepercentagepointsof
marketsharewithinthefirst48hoursafteraSuperBowlad(R.Nakashima,At
$3 Million per 30 Seconds, an Ad Often Is Still Worth the Gamble, Austin
AmericanStatesman,2/3/11,p.B5).
67
2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Chapter 4
Thecycleefficiencyofthegamewouldbe11180=6%.
5. The five people would probably not calculate the same MCE. First, times of
processeswilldifferandavaluechartwilltypicallycontainbothminimumand
maximumtimesforanactivity;thus,theindividualsmaychoosedifferenttimes
withintherangetodeterminetotalcycletime.Additionally,somepeoplemaybelieve
that certain activities (such as packaging and inspection) are valueadded, while
others maybelieve thesame activities tobenonvalueadded. However,allfive
wouldprobablyagreethatasignificantportionoftotalcycletimeisNVAtime
fromacustomersperspective.
6. Servicecycleefficiencyisgenerallyhigherthanmanufacturingcycleefficiency
becauseservicesareprimarilyacquiredatthetimetheyareneeded,meaningthat
there is little storage time. Additionally, transfer time is commonly small in
service businesses, with the exception of having to go from one location to
another.
7. Yes, cost drivers exist in traditional accounting systems, although they are
generallycalledoverheadallocationbases.
Intraditionalsystems,asinglecostpooliscommonlyusedforoverheadcostsand
asinglecostdriversuchasdirectlaborhoursormachinehoursisusedratherthan
multiplecostdrivers.Alsointraditionalsystems,volumebasedcostdriversare
morethenormthannonvolumebased(e.g.,squarefootageordistancemoved)
costdrivers.Finally,traditionalaccountingstressesfindinganallocationbasethat
demonstrates strong statistical correlation to the cost, but ABC emphasizes
searchingformultiplecostdriversthatbearcauseandeffectrelationshipstothe
cost.
However, regardless of how the drivers are titled or on what bases they are
calculated,theuseofthedriversisthesameinbothsystems.Costdriversareused
tocomputeapredeterminedoverheadratetoassignoverheadcoststoproducts
andservices.
8. Byusingasinglecostpoolandasinglecostdrivertoallocateoverhead,themore
traditional methods of overhead assignment ignore the influence on cost of the
differentactivitiesthatoccurtomakeaproduct.Inthismanner,lowvolumespecialty
products,whichcauseadisproportionateamountofoverheadcosts,areonlyassigned
anaveragechargeforoverhead,therebyshiftingcoststothestandardproductlines.
ABCdoesabetterjoboftracingcoststotheproductsthatcausedthevariouscostsby
usingmultiplecostpoolsandmultiplecostdrivers.
Additionally,mostcostsinatraditionalcostingsystemareviewedasbeingeither
variableonaperunitofactivitybasisorfixed.Activitybasedcostingrecognizes
thattheunitcausingachangeinvariablecostsmayalsobeabatchlevelora
processlevelunit.Thus,ratherthanspreadingcostsoverallunitsproduced,
ABCspreadscostsoverallunitsproducedwithintheappropriatelevelofactivity.
Chapter 4
9.
Asistruewithanymanagementorcostingsystem,anABCsystemwillnotlast
forever. The system must be updated periodically to reflect changes in the
companys human and physical resources, products/services, and business
environment.Additionally,theoriginalsystemmaynothavebeenthebestit
could have been. For a discussion of changing the ABC system, see B. E.
Waldrup,J.B.MacArthur,andJ.E.Michelman,DoesYourCostingSystem
NeedaTuneUp?StrategicFinance(June2009),pp.4751.
10. AllcompaniesarenotlikelytobenefitequallyfromadoptingABC.Thegreatest
benefitsarelikelytobegainedbyfirmswithcomplexproductionprocesses;firms
thatmakeproductsthathavesubstantialdiversityrelativetocost,complexity,and
volume;andfirmsthathaveahighlevelofoverheadcoststhatarefixedrelative
toproductionvolume.
11. Someoftheadditionalcoststhatwillbeincurredwillrelatetopurchasingand
storagetohavetheoptionsavailableascustomersmakerequests.(Interestingly,
Chryslerhasaskeditssupplierstokeepmorepartsonhandratherthanincurring
manyofthosecosts.)Setupcostswillincreasewhentheproductionlinehasto
change paint colors. Also, Chrysler incurred significant retooling costs for its
plantinMexicothatmanufacturestheFiat500.However,oneofthelargestcosts
mayoccuronproductionforcarstobesenttodealers:ifthecompanymakes
configurationsnotdesiredbythecustomers,thecarsmaynotbesoldandthe
customers will go elsewhere. Many customers are not willing to wait for the
modeltheywanttobedeliveredfromanotherlocation.
Customersmaybewillingtopaymodestpricevariationsfordifferentoptions,but
withabasepriceof$15,500,customersmaylikelybepricesensitiveespecially
inurbanmarketswheresmallcarssuchastheFiat500maybedrivenlessand
garagedmore.ManycustomerssimplywouldnotunderstandwhypaintcolorA
shouldcost$XmorethanpaintcolorB.TheParetoprincipleislikelytoholdtrue
asshownbythefollowingquote.[C]armakershavetriedhardtobundlefeatures
sotheycanproduceadozenorsoversionsofavehiclethatwillsatisfymost
buyers.Thatlimitsthecomplexityonthefactoryflooranddealershiplots.(J.
Bennett,OptionsOverloadforFiats500,WSJ,11/22/10,p.B1.)
12. ImplementationofABCrequiresasignificantcommitmentoftimeandresources.
Significanttimeisconsumedbypreparingprocessandvaluecharts,identifying
costdrivers,anddetermininghowtosplitproductioncostsintopoolsthatare
relativelyhomogeneousrelativetoaparticularcostdriver.Identifyingcostdrivers
typically requires internal surveys and interviews with company personnel.
Additional time is consumed evaluating, selecting, and implementing any
softwarethatisusedtomanagetheABCdatacollectionandcostassignments.
70
Chapter 4
EXERCISES
13. Eachstudentwillhaveadifferentanswer.Nosolutionprovided.
14. Eachstudentwillhaveadifferentanswer.Nosolutionprovided.However,itis
likelythatstudentswilldeterminethatqualityinspectionisnonvalueaddedfor
theclothingmanufacturerandvalueaddedforthepharmaceuticalcompany.
15. Eachstudentwillhaveadifferentanswer.Nosolutionprovided.
16.a.(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
BVA(customersmightviewthisasVA)
BVA
BVA
NVA
NVA
BVA
BVA
BVA
VA
BVA
VA
VA
b. Pisanasmightwanttohavebetterrelationshipswithsupplierssothattheywill
provide the store with the most uptodate merchandise possible (given
parameters established by Pisanas) that have both barcodes and customer
readabletags,andwithanodefectclause.
17. a. Noneoftheitemsisavalueaddedactivity.Productsshouldbedesignedsothat
schedulechangesshouldnotbeneeded.
b.
c.
Numberoffactoryschedulechangesisthedriver.
Eliminatefactoryschedulechangesexceptforthoseaskedfor
byacustomer(inwhichcasethecustomershouldbechargedforthecostofthe
change) or for critical changes necessary to realize significant quality
improvementsandcostreductions.
18. a. Cycletime=9+264+3.5+6.5+3+5=291hours
Valueaddedprocessingtime=6.5hoursofmixingandcooking+3hoursof
bottling
MCE=(6.5+3.0)291.0=9.5291.0=3.3%
Chapter 4
19.a. Valueaddedactivities:
Removesodandlevelsite
Buildforms
Mixandpourconcrete
Levelconcreteandsmooth
Removeforms
Total
b. Nonvalueaddedactivities:
Purchasematerials
Obtainrentalequipment
Dryingtime
Returnrentaltools
Cleanup
Total
Time
20
10
5
6
2
43hours
Time
5
2
24
1
4
36hours
c. Totalcycletime=43+36=79hours
MCE=4379=54.4%
20.a. Valueaddedactivities:
Measuringandcuttingmaterials
Assemblingmaterials
Buildingfireplace
Pegginglogs
Cuttingandframingdoors/windows
Sealingjoints
Totalvalueaddedtime
b. Nonvalueaddedactivities
Receivingmaterials
Storingmaterials
Handlingmaterials
Settingupandmovingscaffolding
Waitingforinspectors
Countyinspections
Totalnonvalueaddedtime
Time
9
3
12
8
5
4
41days
Time
2
10
7
6
6
1
32days
c. Totalcycletime=41+32=73days
MCE=4173=56.2%
d. Valueadded activities are those that increase the worth of the product or
serviceintheeyesofthecustomerandforwhichthecustomeriswillingto
pay.Nonvalueaddedactivitiesarethosethatdonotincreaseaproductsvalue
inthecustomersperspective.
72
Chapter 4
21.a. Receivingingredients
Movingingredientstostockroom
Storingingredientsinstockroom
Movingingredientsfromstockroom
Measuringingredients
Mixingingredients
Packagingingredients
Movingpackagedseasoningtowarehouse
Storingpackagedseasoninginwarehouse
Movingpackagedseasoningfromwarehouseto
trucks
Totalminutesofcycletime
60
80
8,200
8
30
60
50
100
20,000
120
28,708
b. Thevalueaddedfunctionsare(1)measuringingredients,(2)mixingingredients,
and(3)packagingingredients.(30min.+60min.+50min.=140min.)
c. MCE=14028,780=0.5%
d. ThecompanycoulddomanythingstoimproveitsMCE.Theprimaryareason
whichtoconcentratearethetimesspentstoringingredientsinthestockroomand
storing packaged seasoning in the warehouse. Probably the most significant
improvementinMCEwouldcomefromadoptingJIT(justintime)management
ofallinventories,whichwouldallowthefirmtoconcentrateonreducingtotal
cycletimebynotpurchasingmaterialsuntiltheyareneededandnotproducing
finishedgoodsuntiltheyaredemandedbycustomers.
22. EachstudentwillhaveadifferentanswerbecausedeterminationofVAandNVA
timeinthissituationdependsonReliancesperspectiveofthevariousactivities.
Anauditis,infact,atypeofqualitycontroland,assuch,couldbeviewedinits
entiretyasNVA.However,ifRelianceviewstheauditprocessasvalueaddedto
the organization, the following activities are most likely to be the ones the
companywouldmostlikelywanttopayfor.
Auditplanninganddiscussionofauditrisk
Fieldwork,transactiontesting,completingworkpapers
Draftingandissuingauditreport;discussionwithboardofdirectors
23
TotalVAtime
Draftingengagementletter
4
Internalcontrolreview(likelyseenasNVAb/cjobisrecurringand,ifno
changeshavebeenmade,assessmentshouldhavebeenperformed
previously)
32
Preparingauditprogram(likelyseenasNVAb/cjobisrecurringand,ifno
changeshavebeenmade,programcouldbeusedagain)24
Clientdiscussionsandrework
16
Auditfollowupdiscussions
Chapter 4
TotalNVAtime
96
Giventheseclassifications,theSCEis[168(168+96)]=168264=63.6%.
Otherefficiencypercentagesareequallylikely.
23.a.Step
Patient arrives at doctors office and checks in with receptionist.
VA or NVA
NVA
Patient is asked to review previously provided information for

changes; there are none.
NVA
Patient returns forms to receptionist.
NVA
Receptionist verifies patient insurance and collects co-pay.
NVA
Patient waits in waiting room.
NVA
Nurse escorts patient to exam room and takes vital signs.
VA
Patient waits in exam room.
NVA
Physician examines and treats patient.
VA
Patient checks out with receptionist, if needed.
NVA
b. TotalVAtime=11minutes
Totalcycletime=47minutes
SCE=1147=23.4%
24. a. Noneoftheactivitiesshouldbeperceivedasvalueaddedbecausetheproduct
shouldhavebeenproperlydesignedoriginallysothatnocorrectionprocess
shouldhavebeenneeded.
b.
Iftheproblemcouldnothavebeenforeseen,thendevelopmentofthe
solution(30minutes)shouldbeconsideredvalueadded.Allreviewsmaybe
seenasbusinessvalueadded,butthatstillmeansthatthoseactivitiesareNVA.
Thus,cycleefficiencyis
Totaltime=(15days24hours60minutes)=21,600minutes
Cycleefficiency=3021,600=0.0014
c. Cycleefficiency=30[30+(4hours60minutes)]=30270=11%
d. 21,60010minutes=2,160callsbeforethesolutiondocumentisposted;
2,160$15=$32,400
27010minutes=27calls;27$15=$405
25. a. TheproductionprocessinMcAllenCo.musthaveasignificantamountofnon
valueaddedtimebuiltintothecycletime.ThemostlikelycauseofthisNVA
timeisatleastonebottleneckprocessthatcreatesalongwaitperiodwhenno
productionisoccurringandgoodsaresimplystoredorstackeduntiltheycan
passthroughtheprocess.
Afairlysimplewaytodeterminewherethebottlenecksareistowalkthrough
74
Chapter 4
theplantandseewherematerialsorpartiallycompletedunitsarebeingstacked
orbeingbroughtbackintotheproductionareafromastoragelocation.Another
indicatorofabottleneckiswherelaboriswaitingforamachinetocompletea
processsothatadditionalmaterialscanbeinput.
Inadditiontobottlenecks,thecompanycouldbeengaginginrushordersthat
remove regularly scheduled production from processing. Always trying to
catchuponbackorderswillcreatedelaysinprocessingcurrentorders.Itis
possiblethatifallbackorderswerefilled,thecurrentorderscouldbeprocessed
at a much more rapid pace. Finally, defective units caused by rushing to
completeorderswillhavetobereworked,therebycausinganevenlongerdelay
inprocessingtime.
b. Avaluechartallowsacompanytoanalyzeallactivitiesthatcomprisetotal
cycletime.Theroleofthevaluechartistoidentifythoseactivitiesthatdonot
addvalueintheeyesoftheconsumer.Byfocusingmanagerialattentionon
reducingoreliminatingsuchactivities,totalcycletimeisreducedandtotal
costsarereduced.
26. Eachstudentwillhaveadifferentanswer;thefollowingareillustrativeexamples.
a.
number of print ads (volume measure), seconds of air time (cost

measure)
b.
number of clients (volume measure), number of invoices sent (for

usage)
c.
assessedvalueoffactorybuilding(costmeasure)
d.
numberoftransactionsprocessed(volumemeasure),numberofcalls
(for usage), number of installations (for usage), number of documents
processed(forusage)
e.
number of employees (volume measure), number of payroll checks

processed(volumemeasure)
f.
hoursofoperation(timemeasure)
27. Eachstudentwillhaveadifferentanswer;thefollowingareillustrativeexamples.
a. amountofinvestmentinfactorymachineryandbuildings(totalcostbasisfor
depreciation)
b. poundsofmaterialsreceived(volumemeasure),distanceofaverageshipment
received(costdriverforcommercialfreightcarriers)
c. number of setups (volume driver), total time of setups (alternative volume
measure)
d. numberoftransactionsprocessed(volumemeasure),numberofservicecalls
(forusage),numberofinstallations(forusage),numberofviruses/worms(for
usage),pagesofdocumentsprinted(volume)
Chapter 4
e. average amount of material inventory (volume of material stored), square

footageofstoragearea(storagecapacity)
f. poundsofmaterialprocessed(volumeofworkprocessed),numberofdifferent
types of material handled (complexity of material handling), number of
purchaseorders(volumeofworkprocessedbystaffandnumberofsuppliers
used)
g. numberofengineeringchanges(volumeofengineeringchanges),numberof
processchanges(volumeofchangestothemanufacturingprocesses),number
ofengineeringchangeorders(numberofrequestsforchangestoproductsand
processes)
h. numberofprintads(volumemeasure),secondsofairtime(costmeasure),
numberofnewadsdeveloped(measureofprofessionaltime)
i. machinehours(formachinedrivenusage),outsideairtemperature(forweather
relatedusage)
j. numberofproductdefects(volumeofqualitydefects),poundsofscrapand
waste(volumeofqualitydefects),numberofqualityinspections(numberof
batches)
k. machinehours(formaintenancerelatedtothevolumeofusageofmachinery),
averageageofequipment(forobsolescenceandagerelatedmaintenance)
28. a. O
O
P
O
U(couldbeproduct/processifleftonallthetime)
U
O
U
O
U(perorder)
29. a.
b.
c.
d.
e.
f.
g.
h.
i.
P
P
U
B
U
B
P
P
O
30. a. Totalsetupcost=$20,4456=$122,670
Totalsetupcostperunit=$122,670(68,500+15,200+900)
76
Chapter 4
=$122,67084,600
=$1.45
Product#453($1.4568,500)
Product#529($1.4515,200)
Product#663($1.45900)
Totalsetupcostassigned
$99,325
22,040
1,305
$122,670
b.
Totalcost#ofUnits=Costperunit(rounded)
Product#453($20,4453)=$61,33568,500=$0.90(rounded)
Product#529($20,4451)=$20,44515,200=$1.35(rounded)
Product#663($20,4452)=$40,890900=$45.43(rounded)
c.
Totalnumberofsetupswouldhavebeenthree;totalsetupcost=
($20,4453)=$61,335
Product#453=$20,44568,500=$0.30(rounded)
Product#529=$20,44515,200=$1.35(rounded)
Product#663=$20,445900=$22.72(rounded)
31. a. Totalcostpercall=$20,98017,500=$1.20(rounded)
$11,040
ClientA[$1.20(7,000+2,200)]=$1.209,200
5,160
ClientB($1.204,300)
4,800
ClientC($1.204,000)
$21,000
Totalsetupcostassigned(off due to rounding)
b.
Totalcost#ofunits=Costperunit
Service#359:$5,8107,000=$0.83percall
Service#360:$7,0856,500=$1.09percall
Service#361:$3,1981,300=$2.46percall
Service#362:$4,8872,700=$1.81percall
c.
ClientAwillbebilledanadditional$8,208[$5,810+($1.092,200)]
or ($5,810 + $2,398) for Babineauxs equipment upgrades. Client A could
choosetospreadthatcostoverallcalls($8,20830,000=$0.27)orcould
assignthecostonlytothespecificcallsbenefitedbytheupgrades.Thelatter
wouldbeamorereasonableallocationprocess.(Forexample,assumethatthe
feeswerefordirectoryassistance.Ifyouneveruseddirectoryassistance,would
itseemreasonableforyoutobechargedanadditional$0.27merelybecause
youwereacallerofClientA?)
32. a. Totalsupportcost=$312,750+$125,100=$437,850
Partnerhours=52,100=10,500
Staffhours=122,600=31,200
Totalhours=10,500+31,200=41,700hours
Supportrateperhour=$437,85041,700=$10.50
Chapter 4
b.
Totalhours=60+220=280
Totalsupportcost=280$10.50=$2,940
c.
Professionalsupportrateperhour=$312,75041,700=$7.50
Administrativesupportrateperhour=$125,10010,500=$11.91
d. Professionalsupport(280totalhours$7.50)
$2,100.00
Administrativesupport(60$11.91)714.60
Totalsupportcost
$2,814.60
33. a. Allocationrate=CostAllocationbase
Contractsrate=$270,000500,000=$0.54percontractpage
Regulationrate=$379,500750=$506perreviewrequest
Courtrate=$862,5003,750=$230perprofessionalhour
b Contracts:21,000$0.54
.
Regulation:27$506
Court:315$230
Total
c.
$11,340
13,662
72,450
$97,452
Therateswillbeusedtobillotherdepartmentsforthecostsincurredin
thelegaldepartment.Ifthelegaldepartmentoperatesefficiently,itsbillings
shouldequalorexceedthecostsitincurs.
Thefirmcanhireanoutsidelawfirmtoperformthelegalworkratherthando
theworkinternally.Itisdifficulttodetermine,withoutmoreinformation,how
thisactionwouldaffecttotalcosts.However,itwouldtendtomakethelegal
costsmuchmorevariableandlessfixed.
34. a. 60beds360days=21,600
b.
$3,620,40021,600=$168(rounded)
c Rooms[$504,000(35360)]=$504,00012,600
.
Laundry[$151,200(60180)]=$151,20010,800
Nursingcare($1,314,00043,800)
Physicaltherapy($960,0008,000)
Generalservices($691,20021,600)
$40
14
30
120
32
d.Traditional:6$168=$1,008
ABC:
Room($406)
Laundry($143)
$240
42
78
Chapter 4
Nursingcare($306)
Physicaltherapy($12030)
Generalservices($326)
Total
e.
180
3,600
192
$4,254
Traditional:6$168=$1,008
ABC:
Room[($402)6)]
Laundry($143)
Nursingcare($306)
Generalservices($326)
Total
$120
42
180
192
$534
35. a. $375,00075,000calls=$5percall
$187,50046,875purchaseorders=$4perpurchaseorder
$168,75028,125receivingreports=$6perreceivingreport
Costassignment:
$125
25calls$5
200
50purchaseorders$4
210
35receivingreports$6
Totalcostassigned
$535
b.
$535100units=$5.35perunit
c.
$731,25075,000=$9.75percall
$9.7525calls=$243.75
36. a. $2,000,000(170,000+30,000)=$2,000,000200,000=$10perMH
TotalOHassignedtoregulardictionaries=$10170,000=$1,700,000
TotalOHassignedtohandsewndictionaries=$1030,000=$300,000
b.
c.
Utilitiesrelated:$800,000200,000=$4perMH
Inspectionrelated:$1,200,00060,000=$20perinspectionhour
TotalOHtoregulardictionaries=($4170,000)+($2010,000)
=$680,000+$200,000
=$880,000
TotalOHtohandsewndictionaries=($430,000)+($2050,000)
=$120,000+$1,000,000
=$1,120,000
Revenues
Directcosts
Overheadassigned
Profitbeforetax
Regular
$6,400,000
(5,000,000)
(880,000)
$520,000
HandSewn
$5,600,000
(4,400,000)
(1,120,000)
$80,000
Managementshouldnotstopproducingtheregulardictionariesastheseare
generating a rate of return on revenues of 8 percent, while the handsewn
Chapter 4
dictionariesareonlygenerating1.4percent.
37. a. Overheadrate=$3,960,000330,000units=$12perunit
Revenue
Less:
Directmaterial
Directlabor
Overhead*
Profit(loss)
Less:Admin.expense
Incomebeforetax
Numberofunits
Profitperunit
Mowers
$19,500,000
Tractors
$17,850,000
Total
$37,350,000
(4,000,000)
(2,800,000)
(3,600,000)
$9,100,000
(2,700,000)
(6,000,000)
(360,000)
$8,790,000
(6,700,000)
(8,800,000)
(3,960,000)
$17,890,000
(7,400,000)
$10,490,000
300,000
$30.33
30,000
$293.00
*Mowers:$12300,000=$3,600,000;Tractors:$1230,000=$360,000
b.
Mowers:$2,800,000$20perhour=140,000directlaborhours
Tractors:$6,000,000$20perhour=300,000directlaborhours
Overheadrate=$3,960,000440,000=$9perDLH
Revenue
Less:
Directmaterial
Directlabor
Overhead*
Profit(loss)
Less:Admin.expense
Incomebeforetax
Numberofunits
Profitperunit(rounded)
Mowers
$19,500,000
Tractors
$17,850,000
(4,000,000)
(2,800,000)
(1,260,000)
$11,440,000
(2,700,000)
(6,000,000)
(2,700,000)
$6,450,000
300,000
$38.13
30,000
$215.00
Total
$37,350,000
(6,700,000)
(8,800,000)
3,960,000)
$17,890,000
(7,400,000)
$10,490,000
*Mowers:$9140,000=$1,260,000;Tractors:$9300,000=$2,700,000
c.
RateperDLH:$1,320,000440,000=$3.00
RateperMH:$2,640,000150,000=$17.60
Revenue
Less:
Directmaterial
Directlabor
Overhead*
Mowers
$19,500,000
Tractors
$17,850,000
(4,000,000) (2,700,000)
(2,800,000) (6,000,000)
(860,000) (3,100,000)
Total
$37,350,000
(6,700,000)
(8,800,000)
(3,960,000)
80
Chapter 4
Profit(loss)
Less:Admin.expense
Incomebeforetax
Numberofunits
Profitperunit(rounded)
$11,840,000
$6,050,000
300,000
$39.47
$17,890,000
(7,400,000)
$10,490,000
30,000
$201.67
*Mowers:($3140,000)+($17.6025,000)=$420,000+$440,000
=$860,000
Tractors:($3300,000)+($17.60125,000)=$900,000+
$2,200,000=$3,100,000
d.
Theprofitperunitin(c)providesthebestpicture.Thesolutionto(a)
doesnotrecognizethedifferenceindirectlabortimeandthesolutionto(b)
doesnotrecognizethedifferenceinmachinetime.Costsshouldbeattachedto
productsusingthemostrationaleandmeasurablebasesofactivity.However,
giventhattheprofitsperunitarenotsignificantlydifferent,theallocationbase
in(b)wouldbeacceptableiftheadditionaltrackingofmachinehoursisnot
easilynorinexpensivelyhandled.
38. a. Asvarietyinproductsincreases,costswillalsoincrease.Thus,theshiftto
smallspecialorderswillincreasecostsinpurchasing(moreorders,morecalls
togetprices,morespacerequiredforcatalogs,etc.),receiving(moreorders
andreceiptstohandleandaccountfor),storage(differentproductsmustbe
groupedtogetheranddifferentiatedfromotherproductsforeasyaccessibility),
accounting(moreinventorytoaccountfor,potentiallymoresupplierstopay),
customerservice(newlargercatalogs,possiblecomplaints fromcustomers
receiving wrong or slightly wrong orders, more time for sales calls),
productionscheduling(varietyinsetups,increaseinmovementofmaterials
dependingonproductionrun),andlaboratorywork(researchanddevelopment
tests incurred to make certain that the products meet the appropriate
environmentalandtechnicalrequirements).
b.
Yes,itisverypossiblethatmanagementiscorrectinitsbeliefbecause
totaloverheadcostsaretypicallyallocatedtoproductsbasedonsomesingle
allocation base such as direct labor hours or machine hours. These single
allocation bases do not reflect the actual causeandeffect relationships
betweencostdriversandoverheadcosts.
c.
The memo should suggest that management consider the use of

multipleoverheadallocationbasesandactivitybasedcosting.Thismethodof
overheadallocationattemptstomorefairlyattachcoststotheproductsand/or
servicesthatactuallycausedthecoststobeincurred.
39. a. Outlinedbelowarethepurposeandseveralcharacteristicsofthetwonoted
costsystems:
(1)
Inventorymeasurement
Meets external reporting requirements for aggregate balance sheet
valuationandincomedetermination.
Chapter 4
(2)
Providesmonthlyandquarterlyreporting.
Activitybasedcosting
Differentiates costs between valueadded and nonvalueadded
activities.
Assigns costs to products according to activities involved in the
productionprocessthatcausethesecosts.
b.
Acostsystemdevelopedtovalueinventorymaydistortproductcost
informationbecausethatsystem
c.
wasdesignedtovalueinventoryintheaggregateandnotrelatetoproduct
costinformation;
usesacommondepartmentalorfactorywidemeasureofactivity,suchas
directlaborhoursordollars(nowasmallportionofoverallproduction
costs)todistributemanufacturingoverheadtoproducts;
deemphasizes longterm product analysis (when fixed costs become
variablecosts);and
causesmanagers,whoareawareofdistortionsinthetraditionalsystem,to
makeintuitive,impreciseadjustmentstothetraditionalcostinformation
withoutunderstandingthecompleteimpact.
Thebenefitsthatmanagementcanexpectfromactivitybasedcosting
systemarethatsuchasystem:
Leadstoamorecompetitivepositionbyevaluatingactivitycosts(thatis,
coststhatareassociatedwiththecomplexityofthetransactionratherthan
theproductionvolume)andthecostdriversthatcausetheactivities.
82
Chapter 4
d.
Streamlinesproductionprocessesbyreducingnonvalueaddedactivities,
therebycreatingreducedsetuptimes,optimalplantlayout,andimproved
quality.
Provides management with a more thorough understanding of product
costsandproductprofitabilityforstrategiesandpricingdecisions.
Highlightsinterrelationshipsamongactivities.
Providesfeedbackforopportunitiesforimprovementsinproductdesign
andproductionprocesses.
Encouragesuseofnonfinancialmeasuresofactivityandperformance.
Providesamoreappropriatemeansofassigningoverheadtoproducts.
Thestepsthatacompany,usingatraditionalcostsystem,wouldtake
toimplementactivitybasedcostinginclude:
Identifyactivitycentersandcostdrivers.
Assigncoststoactivitycentercostpoolsusingappropriatefirststagecost
drivers.
Assignactivitycentercostpoolstoproducts,services,orothercostobjects
using appropriate secondstage cost drivers, according to level of cost
(unit,batch,products,process,andorganizationallevels).
(CMAadapted)
40. a. Inthemoderncompetitiveenvironment,firmsmustbewillingtorelinquish
unprofitablecustomerssothatthehighestqualityofserviceisprovidedtothe
mostprofitablecustomers.Smallcustomersarenotabletoprovidethesame
economyofoperationsthatareavailablefromlargercustomers.
b.
Thereare ethicalobligations inending allbusiness relationships.This is

particularlytrueforfirmsthataresolesuppliersofpartsormaterialsthatare
criticaltotheircustomers.Ataminimum,anethicalfiringofacustomer
should
involveanexplanationastowhyserviceisbeingdiscontinued;
beannouncedwellinadvanceofdiscontinuingservicestothecustomer;
beaccompaniedbysuggestionsofalternativesourcesofsupply;and
besensitivetoallnegativeeffectsthatwillbesufferedbythecustomer
whenserviceisended.
c.
Activitybasedcostingisafinancialmanagementtool.Itisnotatoolfor
ethicalmanagementofafirm,norisitatoolthatcanexpresslyimpoundnon
financial,qualitativeinformation.Totheextentthatfactorssuchascustomer
goodwill and market reputation are involved in decisions driven by ABC
prescriptions, those factors will be ignored by activitybased management.
However,itisimportanttoacknowledgethatthesequalitativefactorsshould
notbeignoredand,infact,maybeimportantenoughtooverturntheactivity
basedprescriptions.
Chapter 4
PROBLEMS
41. a. Basewages:$63,000,0003,150,000=$20perregularhourworked
Healthcarebenefits:$10,500,0002,100=$5,000perworker
Payrolltaxes:$5,018,832$71,697,600=$0.07per$1offactorywages
Overtime:$8,697,600288,000=$30.20perovertimehour
Training:$1,875,000300=$6,250pernewhire
Retirementbenefits:$6,898,5002,100=$3,285perworker
Workerscompensation:$1,199,9402,100=$571.40perworker
b.
Although more laborrelated items are driven by the number of factory

workers,thebasewagesaccountformostofthelaborcost.
c.
It can be inferred that the use of overtime hours minimizes some cost
drivers.Inthisexample,useofovertimehourswouldhelpcontainhealthcare
benefits,trainingcosts,retirementbenefits,andworkerscompensation.
42. a. Surgery:professionalhours(thisisanactivitybasethatwoulddrivemany
costsrelatedtosurgeryandwouldbeeasytotrack)
Housingpatients:daysinhospital(thisactivitybasewouldbeeasytofollow
andwouldaccountforuseoftimeandspace)
Outpatientcare:professionalhours(thiswouldcaptureserviceprovisionto
outpatients);orexpectedpatientvolume(thiswouldcapturethosecoststhat
aremorerelatedtocapacitytoprovideservice)
b.
c.
Totalcosts=$13,125,000+$6,187,500+$850,000=$20,162,500
$20,162,50075,000=$269perprofessionalhour(rounded)
Professionalsalaries:$13,125,00075,000=$175perhr.
Buildingcosts:$6,187,50056,250=$110persq.ft.
Riskmanagement:$850,0002,500=$340perpatient
d. Surgery=(3,750$175)+(12,500$110)+(500$340)=$656,250+
$1,375,000+$170,000=$2,201,250
Housing=(70,000$175)+(27,500$110)+(1,250$340)=$12,250,000
+$3,025,000+$425,000=$15,700,000
Outpatient care = (1,250 $175) + (16,250 $110) + (750 $340) =
$218,750+$1,787,500+$255,000=$2,261,250
e.
Surgery:$2,201,2503,750=$587perprofessionalhour
Housing:$15,700,00070,000=$224perprofessionalhour(rounded)
Outpatientcare:$2,261,2501,250=$1,809perprofessionalhour
Thecostperhourforhousingpatientsissignificantlylowerthanfortheother
twoservicesbecausethemajorityofcostsisfixedandarespreadoveralarger
numberofhours.Theothertwoservicescreatesubstantialvariablecostsfor
professionalcontactforshortperiodsoftime.
84
Chapter 4
43. a. Thehighlowmethodcanbeusedtodeterminethevariableandfixedcost
portions:
High44POs $12,400
Low20Pos (10,000)
24 $2,400
$2,40024=$100variablecost
$10,000($10020)=$10,000$2,000=$8,000fixedcost
Variable purchasing costs could include supplies, longdistance telephone
calls, postage, and equipment maintenance. Fixed purchasing costs could
includepurchasingagentsandassistantssalaries,depreciationonfloorspace
andequipment,rentalcharges,orflatmonthlyfeefortelephoneandutilities.
b. Thenumberofmachinesetupscouldhaveincreasedby14forthefollowing
reasons:(1)allpartsofthespecialorderswerenotrunatthesametime;(2)
desk sizes could have differed substantially; (3) desks may have needed
rework after quality inspections; or (4) special orders could have been
interspersedwithproductionofregulardesks.
c. Thecostofqualitycontrolandinspectionscouldhaveincreasedbecause(1)
specialordersmaybeinspectedmorecarefullyormoreoftenthanregular
ordersor(2)eachdeskinaspecialordermaybeinspectedratherthanthe
randomselectionofdesksinregularorders.
d. Engineeringdesignandspecificationcostswerenotincludedintheoriginal
listofoverheadcostsbecausethatlistpertainedonlytoregularproduction.It
isonlywhenspecialordersareobtainedthatnewdesignsandspecifications
needtobedeveloped.
e. Purchasingcost:numberofpurchaseorders
Machinesetup:numberofdifferenttypesofproduction;numberofsetups
Utilities:numberofmachinehours
Supervisors:numberofsupervisors;numberofdirectlaborhours;numberof
productionruns
Depreciation:periodoftime
Qualitycontrolandinspection:numberofdesksinspected;hoursofquality
controltime;machinehours
Engineering design and specification: number of special orders accepted;
hoursofdesigntime
f. OHratebasedonMHs=$44,8006,400=$7perMH
No. First, the method used did not consider additional costs such as
engineering. Second, the method used failed to discriminate in costing
between the regular and the special orders. Activitybased costing would
overcomethesedifficulties.
Chapter 4
44. a. $2,362,500(30,000+37,500)=$2,362,50067,500=$35
Directmaterialcost=$544,500330,000=$1.65perpound
Directmaterialcost
Directlaborcost
Overhead
Totalcost
Dividedby#ofunits
Costperunit
b.
ProductB
$314,325
450,000
1,312,500
$2,076,825
7,500
$276.91
$2,362,500(52,500+22,500)=$2,362,50075,000=$31.50
Directmaterialcost
Directlaborcost
Overhead
Totalcost
Dividedby#ofunits
Costperunit
c.
ProductA
$230,175
360,000
1,050,000
$1,640,175
15,000
$109.345
ProductA
$230,175
360,000
1,653,750
$2,243,925
15,000
$149.595
ProductB
$314,325
450,000
708,750
$1,473,075
7,500
$196.41
Utilities:$750,00075,000=$10perMH
Setup:$193,5001,290=$150persetup
Materialhandling:$1,419,000330,000=$4.30perpound
Directmaterialcost
Directlaborcost
Utilities
Setup
Materialhandling
Totalcost
Dividedby#ofunits
Costperunit
ProductA
$230,175
360,000
525,000
64,500
599,850
$1,779,525
15,000
$118.635
ProductB
$314,325
450,000
225,000
129,000
819,150
$1,937,475
7,500
$258.33
45. a. Umbrella:$24$30=80%ofanhour;0.8060minutes=48minutes
Gazebo:$180$30=6DLHs
Chaiselounge:$60$30=2DLHs
b. Umbrellas($24300,000)$7,200,000
Gazebos($18030,000)
5,400,000
Chaiselounge($6090,000)5,400,000
Total$18,000,000
86
Chapter 4
c. Allocationrates:
Qualitycontrol:$630,000420,000=$1.50perunit
Setups:$600,0003,000=$200persetup
Materialhandling:$1,800,0006,000,000=$0.30perpound
Equipmentoperation:$14,970,0003,000,000=$4.99perMH
Chapter 4
OHCostAllocation
Umbrellas
Qualitycontrol:
$1.50300,000
$1.5030,000
$1.5090,000
Setups:
$200600
$2001,300
$2001,100
Materialhandling:
$0.301,200,000
$0.303,000,000
$0.301,800,000
Equipmentoperation:
$4.99600,000
$4.991,100,000
$4.991,300,000
Totaloverhead
Numberofunits
Costperunit
*Rounded
Totalcostperunit:
DM
DL
OH
Total
d.
ChaiseLounge
$450,000
$45,000
$135,000
120,000
260,000
220,000
360,000
900,000
540,000
2,994,000
$3,924,000
300,000
$13.08
$12.00
18.00
13.08
$43.08
5,489,000
$6,694,000
30,000
$223.13*
6,487,000
$7,382,000
90,000
$82.02*
$120.00
135.00
223.13
$478.13
$12.00
45.00
82.02
$139.02
Ifpricesaresetbasedonproductcosts,activitybasedcostingwould
generatelowerpricesforumbrellasandhigherpricesfortheothertwo
products.
46.a. Indirectlabor
Dept.1($682,000$375,000)
Dept.2($462,000$200,000)
Machine($400,000+$800,000)
Power
Building
Purchasing
Total
b.
Gazebos
$307,000
262,000
1,200,000
400,000
1,000,000
100,000
$3,269,000
TotalDLHs=Dept.1+Dept.2=25,000+10,000=35,000
$3,269,00035,000=$93.40perDLH
88
Chapter 4
c.
DLHforProductA=20,000inDept.1+5,000inDept.2=25,000
DLHs
DLHforProductB=5,000inDept.1+5,000inDept.2=10,000DLHs
DM:
(1/2toeachforX;
allYtoB)
DL:
Dept.1(4/5,1/5)
Dept.2(1/2,1/2)
OH$93.40perDLH
Totalcost
Numberofunits
Costperunit
d.
ProductA
ProductB
$400,000
$300,000
100,000
400,000
2,335,000
$3,135,000
10,000
$313.50
$600,000
$75,000
100,000
175,000
934,000
$1,709,000
10,000
$170.90
Buildingoccupancy:$1,000,000500,000=$2persq.ft.
Purchasing:10,000$2=$20,000
Power:40,000$2=$80,000
Dept.1:200,000$2=$400,000
Dept.2:250,000$2=$500,000
Purchasing:$100,000directcosts+$20,000allocatedbuildingoccupancy
cost=$120,000;$120,000500purchaseorders=$240perpurchaseorder
MaterialX:200$240=$48,000
MaterialY:300$240=$72,000
Power:$400,000directcosts+$80,000allocatedbuildingoccupancy
cost=$480,000;$480,00010,000,000kWh=$0.048perkWh
Department1:1,500,000$0.048=$72,000
Department2:8,500,000$0.048=$408,000
Chapter 4
e.
f.
ProductA ProductB
Indirectlabor
Department1($307,000)
(TotalILHsforA=2,500+5,000+252=7,752)
(TotalILHsforB=2,400+10,000+248=12,648)
Totalindirectlaborhours=20,400
(7,75220,400=38%)
$116,660
(12,64820,400=62%)
$190,340
Department2($262,000)
(TotalILHsforA=2,680+1,000+250=3,930)
(TotalILHsforB=5,000+3,860+310=9,170)
Totalindirectlaborhours=13,100
(3,93013,100=30%)
78,600
(9,17013,100=70%)
183,400
Power
TotalMHsinDept.1=5,000+10,000=15,000
Dept.1=$72,000(ProductA,1/3;ProductB,2/3)
24,000
48,000
TotalMHsinDept.2=5,000+20,000=25,000
Dept.2=$408,000(ProductA,1/5;ProductB,4/5)
81,600
326,400
Machineryrelated(samebasisasPower)
Department1(1/3,2/3)
133,333
266,667
160,000
640,000
Buildingoccupancy(samebasisasPower)
133,333
266,667
100,000
400,000
Purchasing
Totallbs.ofX=50,000+50,000=100,000
Totallbs.ofY=100,000
MaterialX$48,000(ProductA,1/2;ProductB,1/2)
24,000
24,000
MaterialY$72,000(allProductB)
0 72,000
Totaloverheadcost
$851,526 $2,417,474
RawmaterialX(1/2,1/2)
RawmaterialY(allB)
DirectlaborDept.1(4/5,1/5)
DirectlaborDept.2(1/2,1/2)
Overhead(fromparte)
Totalproductcosts
Numberofunits
Costperunit
ProductA
ProductB
$400,000 $400,000
0
200,000
300,000
75,000
100,000
100,000
851,526 2,417,474
$1,651,526 $3,192,474
10,000
10,000
$165.15* $319.25*
*Rounded
[AdaptedfromRothandBorthick,GettingClosertoRealProductCosts,
ManagementAccounting(May1989),pp.2833.]
90
Chapter 4
47. a. Allocationrates:
Utilities:$1,800,00090,000=$20perMH;assignedtoproductsusing
45,000,15,000,and30,000MHs,respectively
Scheduling&setup:$1,638,0001,170=$1,400persetup;assignedto
productsusing195,570,and405setups,respectively
Materialhandling:$3,840,0002,400,000=$1.60perlb.;assignedto
productsusing750,000,450,000,and1,200,000pounds,respectively
Directcosts
Utilities
Scheduling&setup
Materialhandling
Total
Units produced
Cost per unit
A
$120,000
900,000
273,000
1,200,000
$2,493,000
60,000
$41.55
PRODUCTS
B
$120,000
300,000
798,000
720,000
$1,938,000
30,000
$64.60
C
$135,000
600,000
567,000
1,920,000
$3,222,000
90,000
$35.80
b. Totaloverhead=$1,800,000+$1,638,000+$3,840,000=$7,278,000;Total
DLHs=48,000+27,000+75,000=150,000;Overheadrate=$7,278,000
150,000=$48.52;assignedtoproductsusing48,000,27,000,and75,000
DLHs,respectively
(1)
Directcosts
Overhead
Total
Unitsproduced
Costperunit
ProductA
$120,000
2,328,960
$2,448,960
60,000
$40.82
ProductB
$120,000
1,310,040
$1,430,040
30,000
$47.67
ProductC
$135,000
3,639,000
$3,774,000
90,000
$41.93
(2) Traditional
ProductA:$40.821.25=$51.03
ProductB:$47.671.25=$59.59
ProductC:$41.931.25=$52.41
ABC
ProductA:$41.551.25=$51.94
ProductB:$64.601.25=$80.75
ProductC:$35.801.25=$44.75
c.
Thetraditionalapproachtoproductcostingusedonlyoneallocation
base,directlaborhours.Thisallocationbasewasunabletofullycapturethe
causes of overhead cost incurrence. The ABC approach developed better
overhead allocation because of the superior relationship between the cost
poolsandthecostdriversusedtoallocatetheoverheadcost.
Totheextentthatthereiserrorindeterminingcosts,mispricingwillalsoexist
Chapter 4
whenpricesaresetbasedoncosts,asisevidentinthisproblem.Although
ProductAisrelativelyunaffectedbythechoiceofcostingsystem,ProductsB
andChavesubstantiallydifferentcostsandpricesunderthetwosystems.The
traditional costing system would result in underpricing Product B and
overpricingProductC,whichwouldaffectbothsalesvolumeandcompany
profitability.
48. a. PredeterminedrateusingMHs:$5,850,0001,000,000=$5.85perMH
b. Directmaterial
Directlabor
Appliedoverhead(5,000$5.85)
Totalcost
Dividedbynumberofdoors
Costperdoor
c.
Predeterminedrateperactivityperunitofcostdriver:
Electricpower:$500,000200,000=$2.50perkilowatthour
Workcells:$3,000,000300,000=$10persquarefoot
Materialhandling:$1,000,000200,000=$5permaterialmove
Qualitycontrolinspections:$1,000,00050,000=$20perinspection
Machinesetups:$350,00025,000=$14persetup
Costperdoor:
Directmaterial
Directlabor
Appliedoverhead
Electricpower($2.50500)
Workcells($101,000)
Materialhandling($520)
Qualitycontrol($2015)
Setups($146)
Totalcost
Numberofdoors
Costperdoor(rounded)
d.
$50,000
150,000
29,250
$229,250
2,500
$91.70
$50,000
150,000
$1,250
10,000
100
300
84
11,734
$211,734
2,500
$84.69
The activitybased costing method allocates the cost pools of

manufacturingoverheadtovariouscostdriversandthentoproductsbasedon
theamountornumberorotherbasesthateachproductconsumesinvarious
cost drivers. Assume that Stricklands policy is to add 40 percent to
manufacturing costs as gross profit to cover costs such as administrative
expenses,sellingexpenses,financialexpenses,andresearchanddevelopment
expenses,andtheremainderwillbeaprofit.Indeterminingthesellingprice
ofthedoorunderbothmethods,add40percentoftotalmanufacturingcosts:
Unitcosts
Plusgrossprofitat40%
Sellingprice
PresentSystem
$91.70
36.68
$128.38
ABCSystem
$84.69
33.88
$118.57
92
Chapter 4
It is evident that a selling advantage results from the ABC method. As

illustratedinthiscase,theABCmethodshouldresultinapricingdecisionthat
makesthecompanymorecompetitiveinthemarketplace.Savingsinapplying
manufacturingoverheadcoststoproductswillenablethecompanytosellits
productsatalowerpricethancompetitorswhilemaintainingthesamegross
marginratio.
e.
If ABM were implemented first, Strickland might be able to

significantlyreduceoreliminatethematerialhandlingandqualityinspections
costs. Both of these items are NVA and create $2,000,000 of the total
$5,850,000(or34percent)ofmanufacturingoverheadcosts.
[AdaptedfromNabilHassa,HerbertE.Brown,andPaulM.Saunders,Management
AccountingCaseStudy: Beaver WindowInc., Management AccountingCampus
Report(Fall1990).CopyrightInstituteofManagementAccountants,Montvale,NJ.]
49. a. Advantagesassociatedwithactivitybasedcostingsystemsinclude:
highlighting nonvalueadded activities so that they can be reduced or
eliminated;
improving the accuracy of product costing by tightening associations
betweencostsandtheircauses;
betterdecisionmakinginsettingprices;and
improving processes by highlighting the associations among production
activities.
b.
VOHrate=$1,120,000280,000=$4perDLH
Product#347
Directmaterial
65,000$80
40,000$140
Directlabor
65,0001.5$14
40,0004$14
Variableoverhead
65,0001.5$4
40,0004$4
Machinecharge
65,0000.5$10
40,0001.5$10
Materialhandlingcharge
65,000$800.10
40,000$1400.10
Totalcostofproduction
520,000
$7,800,000
Sales
Totalcosts
Contribution
$9,750,000
(7,800,000)
$1,950,000
Product#658
$5,200,000
$5,600,000
1,365,000
2,240,000
390,000
640,000
325,000
600,000
560,000
$9,640,000
$12,000,000
(9,640,000)
$2,360,000
Chapter 4
c.
Product#347
Directmaterial
65,000$80
40,000$140
Materialoverhead
Procurement($0.10perpart)
Prod.scheduling($2perunit)
Pack.&ship.($4perunit)
Variableoverhead
Machinesetup($1.60persetup)
Wastedisposal($3perpound)
Qualitycontr.($3.50perinsp.)
Generalsup.($0.60perunit)
Manufacturing:
Mach.ins.($0.40perpart)
Manualins.($4perpart)
Wavesolder.($1.20perunit)
Totalcosts
Sales
Totalcosts
Contribution
d.
Product#658
$5,200,000
$5,600,000
162,500
130,000
260,000
220,000
80,000
160,000
208,000
3,900
227,500
39,000
192,000
42,000
280,000
24,000
624,000
260,000
78,000
$7,192,900
$9,750,000
(7,192,900)
$2,557,100
560,000
3,200,000
48,000
$10,406,000
$12,000,000
(10,406,000)
$1,594,000
Basedonthecalculationsmadein(a),Product#658appearsto
bemoreprofitable(intotaldollarsofgrossprofit)thanProduct#347.UnderABC
allocations,Product#347appearstogenerateagreaterdollarcontributiontoward
profitsthanProduct#658;additionallytherateofreturnforProduct#347(26.2%)
ismuchhigherthanthatforProduct#658(13.3%).Thedifferenceisattributable
tothefactthatthestandardcostsystemdoesnotaccountforthecostofthe
complexitiesassociatedwiththeproductionofProduct#658.Theseeffectsare
mostevidentwiththecostsofmanualinsertionsrequiredforProduct#658.
(CMAadapted)
50.a. Assignmentofoverheadcosts:
Altamont Ballard
Generaladministration
$155,420
$122,700
Projectcosting
21,600
13,920
A/P/Receiving
62,550
52,820
A/R
24,440
18,330
Payroll
10,200
11,700
Personnelrecruiting
15,200
7,600
Employeeins.processing
4,760
5,460
Proposals
54,210
68,110
Circleville
$130,880
12,480
23,630
4,230
8,100
15,200
3,780
16,680
94
Chapter 4
Salesmeetings
Shipping
Ordering
Duplicatingcosts
Blueprinting
Total
Directoverhead
Totaloverhead
b.
Sales
Directlabor
Directmaterial
Netcontribution
c.
Netcontribution
Overhead
Contribution
d.
96,960
74,740
30,300
9,600
12,000
2,400
20,160
16,320
11,520
19,780
17,940
8,280
34,650
27,720
14,630
$529,530
$449,360
$282,110
195,000
286,100
203,500
$724,530
$735,460
$485,610
Altamont
Ballard
Circleville
$1,500,000 $1,419,000
$1,067,000
(382,000 (317,000)
(325,000)
)
(281,000 (421,000)
(185,000)
)
$837,000 $
$557,000
681,000
Altamont
$837,000
(724,530
)
$112,470
Ballard
$681,000
(735,460)
Circleville
$557,000
(485,610)
$ $71,390
(54,460)
Itisapparentthatthereareweaknessesinthetraditionalproductcosting
systemthatarehavingaprofoundeffectonprofitabilitymeasures.Relativeto
profitmeasuresbasedonthetraditionalcostingmeasures,theABCallocations
make it apparent that the Ballard office is much less profitable and the
Circlevilleofficeismuchmoreprofitable.
(IMAadapted)
51. a. Send/receivegoods:$50,000500,000=$0.10perlb.
Storegoods:$16,00080,000=$0.20percubicfoot
Movegoods:$20,0005,000=$4.00persquarefoot
Identifygoods:$8,000500=$16.00perpackage
Barfield:(40,000$0.10)+(3,200$0.20)+(1,100$4)+(15$16)
=$4,000+$640+$4,400+$240=$9,280
Glover:(40,000$0.10)+(800$0.20)+(600$4)+(10$16)=$4,000
+$160+$2,400+$160=$6,720
Dozier:(40,000$0.10)+(1,400$0.20)+(1,900$4)+(50$16)
=$4,000+$280+$7,600+$800=$12,680
Barfield:40,000$0.16=$6,400
Glover:40,000$0.16=$6,400
Dozier:40,000$0.16=$6,400
c.
Barfield:$9,2801.4=$12,992
Glover:$6,7201.4=$9,408
Chapter 4
Dozier:$12,6801.4=$17,752
d. Thecurrentpricingplancapturesonlyonedimensionofcostcausality:sendingor
receivinggoods.Accordingly,thepriceschargedforwarehousingservicesare
almostindependentofthecausesofthecosts.Asindicatedinacomparisonofthe
answersto(b)and(c),theexistingpricingplangeneratesthesamepriceforthe
threecustomerswhereasanABCbasedpriceresultsinverydifferentpricestobe
chargedtothethreecustomers.
[Adapted from Harold P. Roth and Linda T. Sims, Costing for Warehousing and
Distribution,ManagementAccounting(August1991),pp.4245.PublishedbyInstitute
ofManagementAccountants,Montvale,NJ.]
96
Chapter 4
52. a. $1,200,000100,000=$12perunit
b.
Setups:$360,00040=$9,000persetup
Materialhandling:$480,000$500,000=$0.96per$1ofDMcost
Qualitycontrol:$120,0003,000hours=$40perhour
Otheroverhead:$240,000100,000units=$2.40perunit
Regular
Special
$180,000 $180,000
Setups(20$9,000;20$9,000)
307,200 172,800
MH($320,000$0.96;$180,000$0.96)
48,000
72,000
QC*(1,200$40;1,800$40)
192,000 48,000
Other(80,000$2.40;20,000$2.40)
Total
$727,200 $472,800
Numberofunits
80,000 20,000
OHcostperunit
$9.09
$
23.64
Total
$360,000
480,000
120,000
240,000
$1,200,000
*X=Regularunithours;1.5X=Specialunithours
2.5X=3,000;X=1,200Regular;1.5X=1,800Special
c. Traditionalsystem:
Directmaterial
Directlabor
OH(80,000$12;20,000$12)
Totalcost
Numberofunits
Costperunit
ABCsystem:
Directmaterial
Directlabor
OH
Totalcost
Numberofunits
Costperunit
d.
Costperunit(traditional)
Costperunit(ABC)
Increase(decrease)perunit
Percentageincrease(decrease)
Regular
$320,000
480,000
960,000
$1,760,000
80,000
$22.00
Special
$180,000
140,000
240,000
$560,000
20,000
$28.00
Total
$500,000
620,000
1,200,000
$2,320,000
$320,000
480,000
727,200
$1,527,200
80,000
$19.09
$180,000
140,000
472,800
$792,800
20,000
$39.64
$500,000
620,000
1,200,000
$2,320,000
Regular Special
$22.00
$28.00
19.09
39.64
$(2.91)
$11.64
(13.2)%
41.6%
Underthetraditionalvolumebasedsystem,80percentofalloverheadcostis
assigned to the regular units. Under activitybased costing, only other
overheadcostsappeartobedirectlycorrelatedtovolume.UnderABC,the
regular units are assigned 50 percent of setup time, 64 percent of material
handling costs, and 40 percent of inspection costs. Therefore, a total of 80
percentoftheoverheadhasbeenallocatedinamannerwheretheregularunits
aresubsidizingthespecialunitstosomeextent.
Chapter 4
e.
Anonvalueadded(NVA)activity
lengthenstheproductionorperformancetime.
increasesthecostofproductorserviceswithoutaddingproductorservice
value.
isoneforwhichthecustomerwouldnotbewillingtopay.
PotentialnonvalueaddedactivitiesatPowerProductionincludesomematerial
handling costs, setup costs, and quality control inspection. Given that the
company produces only two products, 40 total setups of machinery seem
excessive.Fortypercentofoverheadcostisrelatedtomaterialhandling,andthe
companycurrentlypayshighlytrainedqualitycontrolinspectorstohandinspect
everyunit.Alloftheseareasarepotentialareasforeliminationofunnecessary
costsorimprovementofefficienciesinthosethataredeemednecessary.
f.
Powercouldreducecostsbyconsideringsomeorallofthefollowing
actions:
Negotiate with customers to take larger quantities of units with each

delivery.Itappearsthattheexcessivenumberofsetupsisrelatedtoalarge
number of small shipments. If customers are unwilling to increase their
ordersize,thecompanyshouldstudywhetherthecostsavingsofhaving
largerproductionrunswouldexceedthecostofstoringthoseunits.
Management could review the design of the companys products and
processestostandardizethem.Bothproductsdesignsshouldbestudiedto
seeifthemostefficientprocessesarebeingused.Thecompanymaybeable
toreducethecomplexityandnumberofparts,tools,andprocessesrequired,
especiallyinthespecialmodel.Notonlywouldmaterialrelatedhandling
costsbereduced,butcostsavingsmayalsoresultinlowerdirectmaterial
costforeachproduct.
The company should examine the factory layout; significant material
handlingcosts couldberesultingfromaninefficientlayout,resultingin
excessmovementofmaterialstoworkstations.
Managementshouldexaminetheneedforhandinspectionofeachunit.The
company should workwith suppliers to besure that incoming parts are
defect free. Placing the burden of higher quality on the suppliers could
potentiallyresultinlargesavingsintheareaofqualitycontrol.
53. a. Machinesetup:$20,000200=$100persetup
Inspection:$130,0006,500=$20perinspection
Materialhandling:$80,0008,000=$10permove
Engineering:$50,0001,000=$50perhour
Job101:
Machinesetup(1$100)
Inspection(20$20)
Materialhandling(30$10)
$100
400
300
98
Chapter 4
Engineering(10$50)
TotalOH
b. Job102:
Machinesetup(2$100)
Inspection(10$20)
Engineering(50$50)
TotalOH
CostofJob102:
Directmaterial
Directlabor
OH
Totalcost
Numberofunits
Costperunit
c. Job103:
Machinesetup(4$100)
Inspection(30$20)
Engineering(10$50)
TotalOH
CostofJob103:
Directmaterial
Directlabor
OH
Totalcost
Numberofunits
Costperunit
500
$1,300
$200
200
100
2,500
$3,000
$12,000
2,000
3,000
$17,000
50
$340
$400
600
500
500
$2,000
$8,000
4,000
2,000
$14,000
200
$70
Sellingprice=$701.4=$98perunit
d. TotalbudgetedOHcost
TotalbudgetedDLcost
OHperDL$
CostofJob103:
Directmaterial
Directlabor
OH($2.80$4,000)
Totalcost
Numberofunits
Costperunit
$280,000
$100,000
$2.80
$8,000
4,000
11,200
$23,200
200
$116
Chapter 4
TheresultsshowthatJob103wouldbesignificantlyovercostedusinganOH
allocationbasedondirectlaborcost.Thecostperunitunderactivitybased
costingwas$70;thatcostincreasedby66percentto$116perunitundera
traditionalcostingsystem.Basedonthecompanyspricingsystem,thischange
would result in a selling price significantly higher than competitors. The
companywouldmostlikelybelosingmarketsharebecauseofanexcessively
highsellingprice.Otherproductsmayhavebeensignificantlyundercosted.The
companymighthavechosennottoenterthemarketbecauseitwouldhavefelt
thatitcouldnotcompetewiththecompetitiononthisproduct.
e.
Anonvalueadded(NVA)activity
lengthenstheproductionorperformancetime.
increasesthecostofproductorserviceswithoutaddingproductorservice
value.
isoneforwhichthecustomerwouldnotbewillingtopay.
potential nonvalueadded activities at Jessica Corp. include machine
setups, inspections, and material handling. Engineering could be value
added but inefficient. Company management could reduce costs by
consideringsomeorallofthefollowingactions:
Someproductsseemtorequireexcessivesetups.Forexample,Job103
requiredfoursetupstocomplete200units,whileJob101requiredonly
onesetuptocomplete100units.Companymanagementshouldreview
themanufacturingproceduresthatrequireadditionalsetups.
Managementcouldreviewthedesignofthecompanysproductsand
processestostandardizethem.Job102requiredfivetimesasmany
engineeringhoursasJobs101and103.Allproductsdesignsshould
bestudiedtoseeifthemostefficientprocessesarebeingused.Jessica
Corp.maybeabletoreducethecomplexityandnumberofparts,tools,
andprocessesrequired,especiallyintheproductproducedinJob102.
JessicaCorp.shouldexaminethedesignofthefactoryrelatedtothe
numberofmaterialmovesrequired.Job102used$12,000ofdirect
material,yetonlyrequiredtenmaterialmoves,whileJob103required
50materialmovesfor$8,000ofmaterials.Additionalmovesmaybe
the result of inefficient plant design, where work stations are not
locatedstrategicallyforthemostefficientproductionprocess.
f. JessicaCorp.currentlyhasabudgetedcostof$130,000forinspections.Ifthe
inspections were outsourced for $10 apiece and the total number of
inspectionswasthesameasbudgeted,thecostofinspectionswoulddropto
$65,000(6,500inspections $10),asavingsof50percent.Thisprojection
assumesthatthecompanywouldbeabletoeliminate$130,000ofinspection
labor.Ifinspectionlaborpersonnelperformotherduties,thismightnotbe
possible.Companymanagementshouldalsoconsiderotherqualitativefactors:
companymoralemaybeaffectedbyjobreductions;theoutsourcedlabormay
notbeaswelltrainedorreliableasthecurrentworkforce;orthecompany
maylosecontroloverthedeliveryofinspectionservices.
100
Chapter 4
(CIAadapted)
54. a. PredeterminedOHrate=$1,800,00030,000=$60perMH.
Eachbatchproduces5,000units.Sincethereare80machinehoursrequired
foreachbatch,theMHsperunitare805,000or0.016.AllocatedOHcost
perunit=$600.016=$0.96.
Alternatively:Eachbatchhasatotalmachinehourscostof$4,800(80$60);
theoverheadcostperunitis$4,8005,000unitsperbatchor$0.96perunit.
Perunitcostundertraditionalsystem:
b.
Directmaterial
Directlabor
Overhead
Total
$4.40
0.75
0.96
$6.11
Materialhandling:$720,0006,000,000=$0.12perpart
Setups:$315,000750=$420.00persetup
Machining:$540,00030,000=$18.00perMH
Qualitycontrol:$225,000500=$450.00perbatch
OHperbatch:
Handling:5,000unitsperbatch5partsperunit=
25,000partsperbatch$0.12perpart
Setups:2perbatch$420persetup
Machining:80MHsperbatch$18.00perMH
Qualitycontrol:1perbatch$450
Totalperbatch
$3,000.00
840.00
1,440.00
450.00
$5,730.00
Overheadcostperunit=$5,7305,000=$1.146perunit
PerunitcostunderABCsystem:Directmaterial
Directlabor
Overhead
$4.400
0.750
1.146
$6.296
or$6.30(rounded)
ABCsystemcostis$0.19(3.1percent)morethantraditionalsystemperunit.
c.
Sincethecompanydesiresagrossprofitof40percent,the
costofeachunitmustbe60percentofthesellingprice:
Traditional:
ABC:
$6.110.6=$10.18
$6.300.6=$10.50
(CIAadapted)
55.a. 50guestsat$0.90perguest
1tierat$34.41pertier
1orderat$150perorder
Purchaseddecorations
Breakevenpriceofcake
$45.00
34.41
150.00
22.50
$251.91
Chapter 4
101
b. 164guestsat$0.90perguest
5tiersat$34.41pertier
Purchaseddecorations
Costofcake
SellingpriceofNussbaumcake
CostofNussbaumcake
Grossmargin
$147.60
172.05
150.00
58.86
$528.51
$650.00
(528.51)
$121.49
c. 200guestsat$0.90perguest
Specialflowers(20$5)
Costofcake
$180.00
137.64
150.00
100.00
$567.64
IftherequiredgrossmarginontheOBriencakeis35percent,thenthecostof
thecakeequals65percentofthesellingprice:0.65X=$567.64;X=$873.29.
d.
Ifthecompanyswitchedtoatraditionalsystem,thecostof
cakesforweddingswithfewerthanaverageguestswouldtendtodecreaseand
thecostofcakeswithmorethantheaveragenumberofguestswouldtendto
increase.Thisiscontrarytothenormaleffectofswitchingtoanactivitybased
costingsystem,wheretypicallyordersinsmallerquantitiestendtoincreasein
costperorderandlargerquantities tendtodecrease.Becausethecostper
orderisfixedat$150,theaverageperunitcostbasedon125guestsis$150
125,or$1.20perguest.Aweddingwithfewerthantheaveragenumberof
guestswillbearaproportionatelylowertotalcostthanaweddingwithmore
guests.IfTillsonbasesthecostofacakeontheaveragewedding,theper
guestcostwouldbeasfollows:
125guestsat$0.90perguest
Costofaverageweddingcake
Averagenumberofguests
Averageperguestcost
$112.50
103.23
150.00
$365.73
125
$2.93
ComparethecostoftheSacksandNussbaumweddingcakeifthecostofcake
isbasedonthenumberofguestsinsteadofanactivitybasedcost:
Numberofguests
Costperguest
Totalcost
ABCcost(withoutdecorations)
%increase(decrease)fromABC
Sacks
50
$2.93
$146.50
$229.41
(36.1)%
Nussbaum
164
$2.93
$480.52
$469.65
2.3%
(CIAadapted)
102
Chapter 4
56. a. Engineering:$300,0003,000=$100perhour
Machinesetups:$50,000100=$500persetup
Materialpurchaseandsupport:$200,0002,000,000=$0.10perpound
Machinesanding:$100,00010,000=$10perMH
Productcertification:$270,0006,000=$45perorder
Ravel
Nortell
$1,000
$200
Engineeringhours(10$100;2$100)
2,000
500
Machinesetups(4$500;1$500)
100
250
Materialsupport(1,000$0.10;2,500$0.10)
50
N/A
Machinesanding(5$10)
45
45
Productcertification(1ordereach$45)
Totaloverhead
$3,195
$995
b.
TotalDLHs=10employees2,000hours=20,000DLHs
OHperDLH=$920,00020,000=$46perDLH
Ravel:4hours$46.00=$184.00
Nortell:2hours$46.00=$92.00
c.
Traditionalcosting:
Directmaterial
Directlabor(4$25;2$25)
Specialpackaging
(1,000units250percarton;4$5)
Overhead (4 $46; 2 $46)
Totalordercost
Numberofunits(inthousands)
Costperthousand
Ravel
$200
100
Nortell
$500
50
20
184
$504
1
$504
92
$642
10
$64.20
Ravel
$200
100
Nortell
$500
50
20
3,195
$3,515
1
$3,515
995
$1,545
10
$154.50
Activitybasedcosting:
Directmaterial
Directlabor(4$25;2$25)
Specialpackaging
(1,000units250percarton;4$5)
Overhead
Totalordercost
Numberofunits(inthousands)
Costperthousand
d.
Theresultsshowasignificantdiscrepancyintheperorder
costusingtraditionalcosting.Themostlikelyexplanationisthattherelative
amountofdirectlaborisimmaterialrelativetootheractivities.Usingdirect
laborasthecostdriverdoesnotcapturethecauseandeffectofoverheadcosts,
resultinginasignificantundercostingofbothproducts.Suchundercostingcan
leadtoasignificantundercostingofthecompanysproductinthemarket,an
Chapter 4
inabilityofmanagementtoexplainprofits,andultimatelyaninabilityofthe
companytomaintaincompetitivenessinthemarketplace.
e.
Toearna40percentgrossprofit,theordercostmustbe60
percentofthesellingprice.
Ravel:$3,515=0.6X;X=$5,858
Nortell:$1,545=0.6X;X=$2,575
f. Itisclearthattheincreasednumberofsetupsisasignificantcostoftheorders
fromRavel.Itisalsounlikelythatthecompanycansetasellingpricethat
allowsittorecoverthiscost.MahoneyshouldmeetwiththebuyerfromRavel
andencourageordersinlargerquantities.Hemightimposeasetupchargeof
$500 on orders less than 10,000 units. Alternatively, the company could
manufactureinlargerquantitiesandstoretheunits.Thecostofstoragemaybe
lessthantheprohibitivecostofmultiplesetups.
57. a. Althoughdifficulttoquantify,somecostsareassociatedwithjustcarryinga
partnumberinthedatabase.Eachpartnumbermustbeoriginallysetupinthe
system,builtintothestructureofabillofmaterials,andmaintaineduntilitis
nolongerused.Moreover,eachpartmustbeplanned,scheduled,negotiated
withvendors,purchased,received,stored,moved,andpaidfor.Havingtwo
parts similar enough that one could be used forboth applications requires
unnecessaryduplicationoftheseactivitiesand,therefore,unnecessarycosts.
Standardizing parts results in several indirect benefits. Fewer unique part
numbersusuallymeansfewervendorsandgreaterqualityofdeliveredparts.It
alsomeanssmootherJITproduction,fewershutdownsofmanufacturinglines,
andgreaterfieldreliability.
b. To appropriately influence the behavior of design and costreduction
engineers,theMOHallocationmethodshouldassignlittlecosttoproductsfor
eachhighusagecommonpartandmorecostforeachlowusageuniquepart,
inproportiontothetotalusageoftheparts.
Annualcosttocarryeachpart#=BudgetedMOHcost#ofactivepart#s
MOHrateforeachpart#=Annualcosttocarryeachpart#Annualusageof
eachpart#
Annualcosttocarry=$5,500,0008,000=$687.50
MOHrateforhighusagepart=$687.5035,000=$0.02(rounded)
MOHrateforlowusagepart=$687.50200=$3.44(rounded)
TheMOHcostforeachproductisbasedonthepartnumbersinitsbillof
materials.Therateforeachpartnumberismultipliedbythenumberoftimes
thepartisusedintheproduct.Theresultingamountsarethenaggregatedfor
allpartnumbersinthebillofmaterials.Thegreaterthenumberofpartsina
productandthehigherthepercentageofuniqueparts,thegreatertheamount
ofallocatedcost.
103
104
Chapter 4
c. Studentswilldiscusstheappropriatenessoftheallocationbasestheyselected,
thewaysinwhichtheirmethodswouldcommunicateaccurateinformationto
design and costreduction engineers concerning the indirect costs of
engineering products with unique versus common parts, and the need to
providethoseengineerswithincentivestousetheinformationintheirpart
selectiondecisions.
Regardingthelatterpoint,engineersatStrategic Supplyareinfactevaluated
onthecostsoftheproductstheydesign.Althoughtheyaredrivenbyemerging
technologiesandotherconsiderationssuchasqualityandcustomerneeds,the
evaluationprocessmotivatesthemtoseekminimumcostdesignsconsistent
withtheseconsiderations.
WiththepartnumberbasedMOHallocationmethod,engineerswilltendto
designproducts differently.Theproductcostingsystemwilltellthemthat
engineeringlowvolume,uniquepartsintoproductscausesoverhead.Having
thematerialoverheadcostassociatedwitheachindividualpartnumberwill
help engineers to evaluate the use of a new part versus an existing part.
Knowing the previously hidden costs of components, the engineers can
properlyassess
notonlythetradeoffsbetweenpartsproliferationanddirectlaborreduction
but also the cost of selecting a unique component to satisfy a specific
functionalrequirementofacustomer.
d. AMOHallocationmethodshouldprovideaccurateestimatesofthelongrun
variable costs of all of the demands made on the organizations material
relatedoverheadresourcesbyeachproductintheproductline.Toapproach
100percentaccuracy,theMOHcostpoolwouldhavetobedecomposedinto
smallerhomogeneouscostpoolsinwhichcostvariationscouldbeexplained
by a single costdriver. The resulting costing system would be marginally
more accuratebut substantiallymore complex,difficult tounderstand,and
morecostlytomaintainthanthesinglecostpoolmethodthatwasdecidedon
inthissituation.Also,addingmorecostdriverstothesystemwouldprobably
haveinitiallycreatedconfusionanddefinitelywouldhavebeenresistedby
manufacturing,engineering,andmarketingpersonnel.
Manufacturing costs are a crucial element of profitability in highly
competitivemarketsofcomplexproducts.Itisthereforeveryimportantthat
thebenefitsofmoreaccuratetracingofcoststoproductsexceedthecostof
achievingtheincrementalaccuracy(forexample,thecostsofdeterminingand
measuring additional cost drivers). It would be counterproductive to
implementanelaborateoverheadallocationsystemtocostproductswithvery
high accuracy if the system would cost so much to maintain that the
companies wouldbecome less,not more, competitive. A singlecostdriver
methodmaybeacompromisethatreflectsthecostsandbenefitsofachieving
additionalaccuracy.
A final consideration related to accuracy is the proper interpretation of
computedrates.The$687.50annualcosttocarryeachpartnumberisnota
Chapter 4
shorttermvariablecost.MostofthecostsintheMOHcostpoolarefixedin
theshorttermonaunitvolumebasis.Eliminationofonepartnumberinthe
database therefore will not immediately reduce the total materialrelated
overheadcostbythisamount.Norinthecaseofthelowusagepartwillusing
one less save $3.44inoutofpocketcosts.These rates reflecta longterm
perspective; the company believes that, by supporting the manufacturing
strategy,theallocationmethodwillleadtorealcostsavingsovertimeasthe
nextgenerationofproductsisdesignedwithfewerdifferentpartnumbers.
e. The costs of all demands made by products on both manufacturing and
nonmanufacturing resources are proper elements of product costs used for
managementdecisions,whereasinventoryvaluesforexternalreportingconsistof
manufacturingcostsonly.TheMOHcostpoolincludessomeorallofthecostsof
threetypesofcostareas.Becauseallsuchcostareasaremanufacturingrelated,
their costs are appropriately assigned to inventory, and the accurate MOH
allocationmethodisanappropriatetechniqueformakingtheassignments.
Thecompany,however,decidedtousetheMOHratesasmanagementcosts
onlyandtocontinuetousetheoldallocationmethodtocomputefinancial
costs.Onefactorthatledtothisdecisionwasthecompanysdesiretovalue
inventory consistently. If the new method were used to compute financial
costs,thereportedinventoryvaluationswouldchangebecause,amongother
reasons,moremanufacturingsupportcostswouldbeallocatedtoproducts.
Amorecompellingreasonforthetwosetsofcostsapproachistheneedto
maintain flexibility in product costing. The part numberbased MOH
allocationmethodwasdevelopedtomodifybehaviortoenactthestrategyof
parts standardization.Itwillceasetobeaneffectivebehavioraltoolwhen
designandcostreductionengineersfullyunderstandthecostsofpartnumber
proliferationandnaturallydesignproductswithcommonpartstotheextent
eachsituationallows.Afterpartsstandardizationbecomessecondnatureto
engineers,managementwillchangeitsstrategy,andtheaccountingstaffwill
developanewproductcostingmethodtosupportthenewstrategy.Inthis
way, product costs can continue to be effective management tools for
influencing behavior without affecting the accountants ability to value
inventoryonaconsistentbasis.
[Michael A. Robinson, ed., Cases from Management Accounting Practice No. 5
InstructorsManual(Montvale,NJ:NationalAssociationofAccountants,1989),pp.7
11,adapted.]
58. a. In particular, the other initiatives would include management methods to

improvequality.Forexample,anadoptionoftheTQMphilosophywouldbe
one of the initiatives; others could include adoption of ABC, employee
empowerment, formation of quality circles, JIT inventory management,
decentralizationofdecisionmaking,anduseofkaizencostingtechniques.
b.
Thesetoolshelporientthefirmtomanagingbasedona
customers perspective of value. Worldclass competition is based on
satisfyingthecustomer.Ifafirmconcentratesonaccentuatingthoseactivities
105
106
Chapter 4
thatarehighlyvaluedbycustomersanddiminishingthoseactivitiesthatare
notperceivedasvalueaddingbycustomers,itshouldbesuccessfulinboth
managingcostsandmaintainingmarketshare.
c.
Yes.Activitybasedcostingismostusefulifmanagers
arewillingtoactbasedontheinformationprovidedbytheABCsystem.For
example, activitybased costing could lead to changes in product mix and
productpricing.TopmanagementmustsupporttheABCprescriptionsforthe
costingsystemtoleadtooperationalimprovements.
d.
Preferably, both would be adopted. Without adopting

ABC, the ABM prescriptions may not be understood by managers. But,
withoutABM,theremaybereducedopportunitytoidentifyandeliminate
NVA activities. The ABC approach would require a separate information
systemtogenerateactivitybasedinformation.Thiswouldnotnecessarilybe
thesystemthatmanagerswouldattendto;rather,theywouldcontinuetouse
the firms traditional and formal information systems. The two sources of
information would inevitably give some conflicting signals and confuse
managers. By using both an ABC system and ABM, actions taken by
managers will be consistent with the information provided by the firms
formalinformationsystems.
59. a. This problem indicates that ABC and ABM can cause conflict among the
variousstakeholdersinabusiness.Theequipmentinstallationwouldlikelybe
viewedwithfavorbythestockholders.Analysisindicatingthattheequipment
would be valueadding obviously underlies the decision to make the
installation.Employeeswouldbestronglyagainstanymovethatwouldresult
in displacement of 60 percent of the workforce. Such an action would
demoralizeboththoseworkerswhowerefiredandthosewhoremained.The
customerswouldlikelyhavebothshorttermandlongtermconcerns.Short
termcustomerswouldbeveryconcernedabouttheimpactonqualityoflaying
off60percentoftheworkers.However,customersmayhaveafavorablelong
termviewofthemovebecauseofthepotentialtoimprovethequalityand
reducethecostsofproducts.
b.
No matter how articulate the explanation given, it is difficult to

visualizeacceptanceoftheexplanationbyworkerswhomayhavededicated
muchoftheirlivestolearningskillsrequiredfortheircurrentpositions.One
approach,however,wouldbetodiscusswhatcustomersvalueintheproducts
currentlyproducedbythebusiness;then,explainhoweachinternalareainthe
business contributes (or fails to contribute) to customer value. This
explanationwouldneedtoclearlyshowthatthefunctionperformedbythe
displacedworkersisnolongervalueaddingintheeyesofthecustomer.Also,
itwouldbeimportanttoexplaintotheemployeesthatthisconclusionholdsno
matterhowwelltheemployeesperformthefunctions.
c. Cycle time is reduced or eliminated largely by reducing nonvalueadded

activities. When nonvalueadded activities are reduced, work is no longer
required of the employees who performed those activities. Only if the
Chapter 4
employeescanberedeployedtootheroperationalareasthatarevalueadding
canemployeelayoffsbetotallyavoided.However,totheextentpossible,the
companycouldaggressivelyimplementtrainingprogramstoqualifydisplaced
workers for other positions. Second, the company could seek market
opportunitiestoexpandthebusinesssothatgrowthwouldcreateaninternal
demandforthoseworkersservicesinotherareasofthebusiness.Third,the
companycould provideemployee counseling services toworkers andhelp
retrainthemforworkinotherbusinesses.
107

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Cost Accounting Ch. 4

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CHAPTER 4

ACTIVITY-BASED MANAGEMENT AND

Patient is asked to review previously provided information for

Patient returns forms to receptionist.

Receptionist verifies patient insurance and collects co-pay.

Patient waits in waiting room.

Nurse escorts patient to exam room and takes vital signs.

Patient waits in exam room.

Physician examines and treats patient.

Patient checks out with receptionist, if needed.

number of print ads (volume measure), seconds of air time (cost

number of clients (volume measure), number of invoices sent (for

number of employees (volume measure), number of payroll checks

e. average amount of material inventory (volume of material stored), square

The memo should suggest that management consider the use of

Thereare ethicalobligations inending allbusiness relationships.This is

Although more laborrelated items are driven by the number of factory

The activitybased costing method allocates the cost pools of

It is evident that a selling advantage results from the ABC method. As

If ABM were implemented first, Strickland might be able to

Negotiate with customers to take larger quantities of units with each

58. a. In particular, the other initiatives would include management methods to

Preferably, both would be adopted. Without adopting

No matter how articulate the explanation given, it is difficult to

c. Cycle time is reduced or eliminated largely by reducing nonvalueadded

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