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Managerial Accounting: Creating Value in a Dynamic Business Environment
CHAPTER 5 Activity-Based Costing Answers to Review Questions 5-1 In a traditional, volume-based product-costing system, only a single predetermined overhead rate is used. All manufacturing-overhead costs are combined into one cost pool, and they are applied to products on the basis of a single cost driver that is closely related to production volume. The most frequently used cost drivers in traditional product-costing systems are direct-labor hours, direct-labor dollars, machine hours, and units of production. 5-2 Management was being misled by the traditional product-costing system, because the high-volume product lines were being overcosted and the low-volume product line was being undercosted. The high-volume products essentially were subsidizing the low-volume line. The traditional product-costing system failed to show that the low-volume products were driving more than their share of overhead costs. As a result of these misleading costs, the company's management was mispricing its products. 5-3 An activity-based costing system is a two-stage process of assigning costs to products. In stage one, activity-cost pools are established. In stage two a cost driver is identified for each activity-cost pool. Then the costs in each pool are assigned to each product line in proportion to the amount of the cost driver consumed by each product line. 5-4 A cost driver is a characteristic of an event or activity that results in the incurrence of costs by that event or activity. In activity-based costing systems, the most significant cost drivers are identified. Then a database is created that shows how these cost drivers are distributed across products. This database is used to assign costs to the various products depending on the extent to which they use each cost driver. 5-5 The four broad categories of activities identified in an activity-based costing system are as follows: (a) Unit-level activities: Must be done for each unit of production. (b) Batch-level activities: Must be performed for each batch of products. (c) Product-sustaining activities: Needed to support an entire product line. (d) Facility-level (or general-operations-level) activities: Required for the entire production process to occur. 5-6 An activity-based costing system alleviated the problems management was having under its traditional, volume-based product-costing system by more accurately assigning costs to products. Products were assigned costs based on the extent to which they used various cost drivers that were determined to be closely related to the incurrence of a variety of overhead costs. 5-7 Product-costing systems based on a single, volume-based cost driver tend to overcost high-volume products, because all overhead costs are combined into one pool and distributed across all products on the basis of only one cost driver. This simple averaging process fails to recognize the fact that a disproportionate amount of costs often is associated with low-volume or complex products. The result is that low-volume products are assigned less than their share of manufacturing costs, and high-volume products are assigned more than their share of the costs. 5-8 In traditional, volume-based costing systems, only direct material and direct labor are considered direct costs. In contrast, under an activity-based costing system, an effort is made to account for as many costs as possible as direct costs of production. Any cost that can possibly be traced to a particular product line is treated as a direct cost of that product. 5-9 The pool rate is calculated by dividing the budgeted amount of an activity cost pool by the budgeted total quantity of the associated cost driver. The pool rate is the cost of a particular activity that is expected per unit of the associated cost driver. 5-10 Two factors that tend to result in product cost distortion under traditional, volume-based product-costing systems are as follows: (a) Non-unit level overhead costs: Many overhead costs vary with cost drivers that are not unit-level activities. Use of a unit-level cost driver to assign such costs tends to result in cost distortion. (b) Product diversity: When a manufacturer produces a diverse set of products, which exhibit different consumption ratios for overhead activities, use of a single cost driver to assign costs results in cost distortion. 5-11 Three important factors in selecting cost drivers for an ABC system are as follows: (a) Degree of correlation between consumption of an activity and consumption of the cost driver. (b) Cost of measurement of the cost driver. (c) Behavioral effects, that is, how the cost driver selected will affect the behavior of the individuals involved in the activity related to the cost driver. 5-12 An activity dictionary lists all of the activities identified and used in an activity-based costing analysis. The activity dictionary provides for consistency in the terminology and level of complexity in the ABC analysis in the organization?s various subunits. 5-13 Designing and implementing an ABC system requires a large amount of data from all facets of an organization's operations. A multidisciplinary team will be more effective in obtaining access to this data, and the result will be a better ABC system. Moreover, a multidisciplinary team typically helps in gaining acceptance of the new product-costing system. 5-14 Indicators that a new product-costing system may be needed include the following (eight required): (a) Line managers do not believe the product costs reported by the accounting department. (b) Marketing personnel are unwilling to use reported product costs in making pricing decisions. (c) Complex products that are difficult to manufacture are reported to be very profitable although they are not priced at a premium. (d) Product-line profit margins are difficult to explain. (e) Sales are increasing, but profits are declining. (f) Line managers suggest that apparently profitable products be dropped. (g) Marketing or production managers are using "bootleg costing systems," which are informal systems they designed, often on a personal computer. (h) Some products that have reported high profit margins are not sold by competitors. (i) The firm seems to have captured a highly profitable product niche all for itself. (j) Overhead rates are very high, and increasing over time. (k) Product lines are diverse. (l) Direct labor is a small percentage of total costs. (m) The results of bids are difficult to explain. (n) Competitors' high-volume products seem to be priced unrealistically low. (o) The accounting department spends significant amounts of time on special costing projects to support bids or pricing decisions. 5-15 Line managers are close to the production process and may realize that a complex product, which is difficult to manufacture, is undercosted by a traditional, volume-based costing system. Because of the cost distortion that is common in such systems, the undercosted product may appear to be profitable when it is really losing money. Line managers may have a "gut feeling" for this situation, even if the cost-accounting system suggests otherwise. 5-16 Diverse products typically consume support activities (such as purchasing, material handling, engineering, and inspection) in differing degrees. When there are significant differences among product lines in the ways that they consume support services (and thereby cause overhead costs), a traditional, volume-based costing system may distort product costs. Some products are overcosted; others are undercosted. An ABC system can eliminate (or at least alleviate) such cost distortion. 5-17 Activity-based costing is just as appropriate in the service industry as in the manufacturing industry. Just as in manufacturing firms, diverse services typically consume support activities in varying degrees. ABC systems are more accurate in tracking the usage of these support activities to the services (products) that are produced than are traditional, volume-based costing systems. 5-18 As indicated in the chapter, Pennsylvania Blue Shield, like many manufacturers, classifies activities as unit level, batch level, product-sustaining level, or facility level. Maintenance of the medical-services provider network (i.e., the physicians and hospitals that provide medical care to claimants) is a product-sustaining-level activity because it benefits an entire product line (service line, in this case) of personal health insurance policies. 5-19 Management could use the ABC information about the cost of various types of patient appointments for determining charges for appointments, making appointment staffing decisions (e.g., physician versus nurse practitioner), and justifying reimbursements from insurance companies or government agencies. 5-20 At Patio Grill Company, every unit of each product line manufactured requires all eight of the support activities covered by the ABC system. In contrast, at Delaware Medical Center, each patient sees a physician, or a nurse practitioner, or an intern, or a resident. Moreover, each patient is either a new patient or a continuing patient, but not both. Therefore, in determining the cost a patient appointment, the cost analyst would include only the relevant activity costs in the cost of a patient appointment. Solutions to exercises Exercise 5-21 (15 minutes) 1. Material-handling cost per lens: EMBED Equation.3 EMBED Equation.3 *The total number of direct-labor hours. An alternative calculation, since both types of product use the same amount of the cost driver, is the following: EMBED Equation.3 *The total number of units (of both types) produced. 2. Material-handling cost per mirror = $1,000. The analysis is identical to that given for requirement (1). 3. Material-handling cost per lens: EMBED Equation.3 *The total number of material moves. ?The number of material moves for the lens product line. 4. Material-handling cost per mirror: EMBED Equation.3 *The number of material moves for the mirror product line. Exercise 5-22 (15 minutes) 1. a. Quality-control costs assigned to the Satin Sheen line under the traditional system: Quality-control costs = 14.5% ( direct-labor cost Quality-control costs assigned to Satin Sheen line = 14.5% ( $27,500 = $3,988 (rounded) b. Quality-control costs assigned to the Satin Sheen line under activity-based costing: Quantity for Assigned Activity Pool Rate Satin Sheen Cost Incoming material inspection $11.50 per type 12 types $? 138 In-process inspection .14 per unit 17,500 units 2,450 Product certification 77.00 per order 25 orders 1,925 Total quality-control costs assigned $4,513 2. The traditional product-costing system undercosts the Satin Sheen product line, with respect to quality-control costs, by $525 ($4,513 ? $3,988). Exercise 5-23 (20 minutes) There is no single correct answer to this exercise. There are many reasonable solutions. Cost pool 1: Raw materials and components 2,950,000 yen Inspection of finished goods ??30,000 yen Total 2,980,000 yen Cost driver: raw-material cost exercise 5-23 (continued) Cost pool 2: Depreciation, machinery 1,400,000 yen Electricity, machinery 120,000 yen Equipment maintenance, wages 150,000 yen Equipment maintenance, parts ??30,000 yen Total 1,700,000 yen Cost driver: number of units produced. Cost pool 3: Setup wages 40,000 yen Total 40,000 yen Cost driver: number of production runs. Cost pool 4: Engineering design 610,000 yen Total 610,000 yen Cost driver: number of parts in a product. Cost pool 5: Depreciation, plant 700,000 yen Insurance, plant 600,000 yen Electricity, light 60,000 yen Custodial wages, plant 40,000 yen Property taxes 120,000 yen Natural gas, heating ??30,000 yen Total 1,550,000 yen Cost driver: for costs allocated to support departments, square footage; for costs assigned to products, number of units produced. Exercise 5-24 (5 minutes) Cost pool 1: unit-level Cost pool 2: unit-level Cost pool 3: batch-level Cost pool 4: product-sustaining-level Cost pool 5: facility-level EXERCISE 5-25 (30 MINUTES) Answers will vary widely, depending on the web site chosen. In general, though, activity-based costing could be a useful tool in helping any governmental unit understand what its cost drivers are for the various activities in which it engages. Exercise 5-26 (20 minutes) Wheelco's product-costing system probably is providing misleading cost information to management. A common problem in a traditional, volume-based costing system is that high-volume products are overcosted and low-volume products are undercosted. There is evidence of this in the exercise, since Wheelco's competitors are selling the high-volume A22 wheel at a price lower than Wheelco's reported manufacturing cost. In contrast, Wheelco is selling its specialty D52 wheel at a huge markup above the product's reported cost. An activity-based costing system probably would report a lower product cost for wheel A22 and a substantially higher cost for wheel D52. The president's strategy of pushing the firm's specialty products probably will aggravate Wheelco's problem even further. These products probably are not as profitable as the firm's traditional product-costing system makes them appear. Recommendation: Install an activity-based costing system. If the new reported product costs shift as suggested in the preceding comments, then lower the price on the high-volume products, such as wheel A22. The prices of the specialty wheels probably will need to be raised. It is possible that Wheelco should discontinue low-volume products. Exercise 5-27 (15 minutes) 1. Key features of an activity-based costing system: (a) Two-stage procedure for cost assignment. (b) Stage one: Establish activity cost pools. (c) Stage two: Select cost drivers for each activity-cost pool. Then assign the costs in each cost pool to the company's product lines in proportion to the amount of the related cost driver used by each product line. 2. As described in the answer to the preceding exercise, the new system probably will reveal distortion in the firm's reported product costs. In all likelihood, the high-volume products are overcosted and the low-volume specialty products are undercosted. 3. Strategic options: (a) Lower the prices on the firm's high-volume products to compete more effectively. (b) Increase the prices on low-volume specialty products. (c) Consider eliminating the specialty product lines. This option may not be desirable if there is a marketing need to produce a full product line. Also, the specialty wheels may give Wheelco prestige. Exercise 5-28 (20 minutes) The activity of the Finger Lakes Winery may be classified as follows: U: Unit-level B: Batch-level P: Product-sustaining-level F: Facility-level Activity Classification Activity Classification (1) P (11) B (2) P (12) B (3) P (13) U (4) P (14) U (5) P (15) U (6) P (16) U (7) P (17) B (8) B (18) F (9) B (19) F (10) B Exercise 5-29 (20 minutes) The definitions used by Carrier Corporation for each of the activity levels are as follows:* Unit: This activity or cost occurs every time a unit is produced. An example is the utility cost for production equipment. This level of activity usually relates directly to production volume. ________________ *Robert Adams and Ray Carter, "United Technologies' Activity-Based Accounting Is a Catalyst for Success? As Easy as ABC, 18, p.4. United Technologies uses the term structural-level activity, instead of facility-level activity as we have done. Exercise 5-29 (continued) Batch: This activity is performed for each batch produced or acquired. Examples include moving raw material between the stock room and production line or setting up a machine for a run. Product-sustaining: This activity is performed to maintain product designs, processes, models, and parts. Examples include expediting parts, maintaining the bill of materials, or issuing orders for product changes. Sustaining activities are required for supporting a key manufacturing capability or process. Facility: These activities are performed to enable production. They are fundamental to supporting the business entity at the most basic level. Examples are managing or cleaning the building. These definitions are consistent with those given in the chapter. An argument for the ABC project team's classification would be that the activity or account in question was characterized by the definition of the activity-level classification given above. An argument against the team's classification would be that the particular activity or account did not satisfy the definition. For example, moving materials is a batch-level activity because a raw material must be moved to the product area when a production run or batch is started. Depreciation is a facility-level account because depreciation on plant and equipment represents the cost of providing production facilities in which manufacturing can take place. Exercise 5-30 (30 minutes) 1. Redwood Company Computation of Selling Costs By Order Size and per Skein Within Each Order Size Order Size Small Medium Large Total Sales commissionsa (Unit cost: $675,000/225,000 = $3.00 per box) box) $?? 6,000 $135,000 $534,000 $? 675,000 Catalogsb (Unit cost: $295,400/590,800 = $.50 per catalog) catalog) 127,150 105,650 62,600 295,400 Costs of catalog salesc (Unit cost: $105,000/175,000 = $.60 per skein) skein) 47,400 31,200 26,400 105,000 Credit and collectiond (Unit cost: $60,000/6,000 = $10.00 per order) order) ??4,850 ??24,150 ??31,000 ??60,000 Total cost for all orders of a given size size $185,400 $296,000 $654,000 $1,135,400 Units (skeins) solde 103,000 592,000 2,180,000 Unit cost per order of a given sizef $1.80 $.50 $.30 aRetail sales in boxes???unit cost: Small, 2,000???$3 Medium, 45,000???$3 Large, 178,000???$3 bCatalogs distributed???unit cost cCatalog sales???unit cost dNumber of retail orders???unit cost eSmall: (2,000???12) + 79,000 = 103,000 Medium: (45,000???12) + 52,000 = 592,000 Large: (178,000???12) + 44,000 = 2,180,000 fTotal cost for all orders of a given size ÷ units sold Exercise 5-30 (Continued) 2. The analysis of selling costs shows that small orders cost more than large orders. This fact could persuade management to market large orders more aggressively and/or offer discounts for them. solutions to Problems Problem 5-31 (25 minutes) 1. a. Manufacturing overhead costs include all indirect manufacturing costs (all production costs except direct material and direct labor). Typical overhead costs include: Indirect labor (e.g., a lift-truck driver, maintenance and inspection labor, engineering labor, and supervisors). Indirect material. Other indirect manufacturing costs (e.g., building maintenance, machine and tool maintenance, property taxes, insurance, depreciation on plant and equipment, rent, and utilities). b. Companies develop overhead rates before production to facilitate the costing of products as they are completed and shipped, rather than waiting until actual costs are accumulated for the period of production. 2. The increase in the overhead rate should not have a negative impact on the company, because the increase in indirect costs was offset by a decrease in direct labor. 3. Rather than using a plantwide overhead rate, Borealis Manufacturing could implement separate activity cost pools. Examples are as follows: Separate costs into departmental overhead accounts (or other relevant pools), with one account for each production and service department. Each department would allocate its overhead to products on the basis that best reflects the use of these overhead services. Treat individual machines as separate cost centers, with the machine costs collected and charged to the products using machine hours. 4. An activity-based costing system might benefit Borealis Manufacturing because it assigns costs to products according to their usage of activities in the production process. More accurate product costs are the result. PROBLEM 5-32 (30 MINUTES) 1. Predetermined overhead rate = budgeted overhead ÷ budgeted direct-labor hours = $800,000 ÷ 25,000* = $32 per direct labor hour *25,000 budgeted direct-labor hours = (3,000 units of Standard)(3 hrs./unit) + (4,000 units of Enhanced)(4 hrs./unit) Standard Enhanced Direct material?????. $ 25 $ 40 Direct labor: 3 hours x $12???? 36 4 hours x $12???? 48 Manufacturing overhead: 3 hours x $32???? 96 4 hours x $32???? 128 Total cost???????. $157 $216 Activity-based overhead application rates: Activity Cost Activity Cost Driver Application Rate Order processing $150,000 ÷ 500 orders processed (OP) = $300 per OP Machine processing 560,000 ÷ 40,000 machine hrs. (MH) = $14 per MH Product inspection 90,000 ÷ 10,000 inspection hrs. (IH) = $9 per IH PROBLEM 5-32 (CONTINUED) Order processing, machine processing, and product inspection costs of a Standard unit and an Enhanced unit: Activity Standard Enhanced Order processing: 300 OP x $300?????... $ 90,000 200 OP x $300?????... $ 60,000 Machine processing: 18,000 MH x $14????... 252,000 22,000 MH x $14????... 308,000 Product inspection: 2,000 IH x $9??????.. 18,000 8,000 IH x $9??????. 72,000 Total $360,000 $440,000 Production volume (units) 3,000 4,000 Cost per unit $120* $110** * $360,000 ÷ 3,000 units = $120 ** $440,000 ÷ 4,000 units = $110 The manufactured cost of a Standard unit is $181, and the manufactured cost of an Enhanced unit is $198: Standard Enhanced Direct material????????????. $ 25 $ 40 Direct labor: 3 hours x $12??????????? 36 4 hours x $12??????????? 48 Order processing, machine processing, and product inspection??????.. 120 110 Total cost??????????????. $181 $198 3. a. The Enhanced product is overcosted by the traditional product-costing system. The labor-hour application base resulted in a $216 unit cost; in contrast, the more accurate ABC approach yielded a lower unit cost of $198. The opposite situation occurs with the Standard product, which is undercosted by the traditional approach ($157 vs. $181 under ABC). PROBLEM 5-32 (CONTINUED) b. Yes, especially since the company?s selling prices are based heavily on cost. An overcosted product will result in an inflated selling price, which could prove detrimental in a highly competitive marketplace. Customers will be turned off and will go elsewhere, which hurts profitability. With undercosted products, selling prices may be too low to adequately cover a product?s more accurate (higher) cost. This situation is also troublesome and will result in a lower income being reported for the company. 4. In the electronic version of the solutions manual, press the CTRL key and click on the following link: HYPERLINK "Build%20a%20Spreadsheet%20Solutions%20-%20MANAGERIAL%20ACCOUNTING%20Hilton%207E/Build%20a%20Spreadsheet%20%2005-32.xls" Build a Spreadsheet PROBLEM 5-33 (60 MINUTES) 1. The predetermined overhead rate is calculated as follows: Predetermined overhead rate = Budgeted manufacturing overhead/budgeted direct-labor hours = $1,224,000/102,000* = $12 per hour *Direct labor, budgeted hours: REG: 5,000 units ( 9 hours 45,000 hours ADV: 4,000 units ( 11 hours 44,000 hours SPE: 1,000 units ( 13 hours 13,000 hours Total direct-labor hours 102,000 hours PROBLEM 5-33 (CONTINUED) 2. Activity-based-costing analysis: Activity Activity Cost Pool Cost Driver Cost Driver Quantity Pool Rate Product Line Cost Driver Quantity for Product Line Activity Cost for Product Line Product Line Prod. Volume Activity Cost per Unit of Product Machine $310,500 Machine 115,000 $ 2.70 REG 50,000 $135,000 5,000 $27.00 Related Hours ADV 48,000 129,600 4,000 32.40 GMT 17,000 45,900 1,000 45.90 Total 115,000 $310,500 Material 52,500 Prod. 100 525.00 REG 40 $ 21,000 5,000 4.20 Hand. Runs ADV 40 21,000 4,000 5.25 GMT 20 10,500 1,000 10.50 Total 100 $ 52,500 Purch. 75,000 Purch. 300 250.00 REG 100 $ 25,000 5,000 5.00 Orders ADV 96 24,000 4,000 6.00 GMT 104 26,000 1,000 26.00 Total 300 $ 75,000 Setup 85,000 Prod. 100 850.00 REG 40 $ 34,000 5,000 6.80 Runs ADV 40 34,000 4,000 8.50 GMT 20 17,000 1,000 17.00 Total 100 $ 85,000 Inspect. 27,500 Inspect. 1,100 25.00 REG 400 $ 10,000 5,000 2.00 Hours ADV 400 10,000 4,000 2.50 GMT 300 7,500 1,000 7.50 Total 1,100 $ 27,500 Ship. 66,000 Ship. 1,100 60.00 REG 500 $ 30,000 5,000 6.00 ADV 400 24,000 4,000 6.00 GMT 200 12,000 1,000 12.00 Total 1,100 $ 66,000 Eng. 32,500 Eng. 650 50.00 REG 250 $ 12,500 5,000 2.50 Hours ADV 200 10,000 4,000 2.50 GMT 200 10,000 1,000 10.00 Total 650 $ 32,500 Fac. 575,000 Machine 115,000 5.00 REG 50,000 $250,000 5,000 50.00 Hours ADV 48,000 240,000 4,000 60.00 GMT 17,000 85,000 1,000 85.00 Total 115,000 $575,000 Grand Total $1,224,000 Grand Total $1,224,000 PROBLEM 5-33 (CONTINUED) 3. Calculation of new product costs under ABC. REG ADV GMT Direct material $129.00 $151.00 $203.00 Direct labor (not including set-up time) 171.00 (9 hr. @ $19) 209.00 (11 hr. @ $19) 247.00 (13 hr. @ $19) Total direct costs per unit $300.00 $360.00 $450.00 Manufacturing overhead (based on ABC): Machine-related $ 27.00 $ 32.40 $ 45.90 Setup 4.20 5.25 10.50 Purchasing 5.00 6.00 26.00 Material handling 6.80 8.50 17.00 Quality assurance 2.00 2.50 7.50 Packing/shipping 6.00 6.00 12.00 Engineering design 2.50 2.50 10.00 Facility 50.00 60.00 85.00 Total ABC overhead cost per unit $103.50 $123.15 $213.90 Total product cost per unit $403.50 $483.15 $663.90 PROBLEM 5-33 (CONTINUED) 4. Comparison of costs and target prices under two alternative product-costing systems: REG ADV GMT Reported unit overhead cost: Traditional, volume-based costing system $108.00 $132.00 $156.00 Activity-based costing system 103.50 123.15 213.90 Reported unit product cost (direct material, direct labor and overhead): Traditional, volume-based costing system 408.00 492.00 606.00 Activity-based costing system 403.50 483.15 663.90 Sales price data: Original target price (130% of product cost based on traditional, volume-based costing system) 530.40 639.60 787.80 New target price (130% of product cost based activity-based costing system) 524.55 628.10 863.07 Actual current selling price 525.00 628.00 800.00 5. The REG and ADV products were overcosted by the traditional system, and the GMT product was undercosted by the traditional system Reported unit product cost: Traditional, volume-based costing system $408.00 $492.00 $606.00 Activity-based costing system 403.50 483.15 663.90 Cost distortion: REG and ADV overcosted by traditional system $ 4.50 $ 8.85 GMT undercosted by traditional system ($ 57.90) 6. In the electronic version of the solutions manual, press the CTRL key and click on the following link: HYPERLINK "Build%20a%20Spreadsheet%20Solutions%20-%20MANAGERIAL%20ACCOUNTING%20Hilton%207E/Build%20a%20Spreadsheet%20%2005-33.xls" Build a Spreadsheet PROBLEM 5-34 (25 MINUTES) The information supplied by the ABC project team is in columns A, B, C, D, F, G, and I. Activity Activity Cost Pool Cost Driver Cost Driver Quantity Pool Rate Product Line Cost Driver Quantity for Product Line Activity Cost for Product Line Product Line Production Volume Activity Cost per Unit of Product Material $52,500 Production 100 $525.00 REG 40 $21,000 5,000 $ 4.20 Handling Runs ADV 40 21,000 4,000 5.25 GMT 20 10,500 1,000 10.50 Total 100 $52,500 The results of the ABC calculations are in columns E, H and J. The ABC calculations are as follows: (1) Compute pool rate for material-handling activity: Activity cost pool ÷ cost driver quantity = pool rate $52,500 ÷ 100 = $525.00 (2) Compute total activity cost for each product line: Product Line Pool Rate x Cost Driver Quantity for Product Line = Activity Cost for Each Product Line REG $525.00 x 40 = $21,000 ADV 525.00 x 40 = 21,000 GMT 525.00 x 20 = 10,500 (3) Compute product cost per unit for each product line: Product Line Activity Cost for Each Product Line ÷ Product Line Production Volume Activity Cost per Unit = of Product REG $21,000 ÷ 5,000 = $ 4.20 ADV 21,000 ÷ 4,000 = 5.25 GMT 10,500 ÷ 1,000 = 10.50 PROBLEM 5-35 (30 MINUTES) 1. Type A manufacturing overhead cost: 16,000 machine hours x $80 = $1,280,000 $1,280,000 ÷ 8,000 units = $160 per unit Type B manufacturing overhead cost: 22,500 machine hours x $80 = $1,800,000 $1,800,000 ÷ 15,000 units = $120 per unit Type A Type B Direct material??????. $ 35 $ 60 Direct labor???????.. 20 20 Manufacturing overhead?. 160 120 Unit cost??????? $215 $200 Activity-based application rates: Activity Cost Activity Driver Application Rate Manufacturing setups $ 672,000 ÷ 80 setups (SU) = $8,400 per SU Machine processing 1,848,000 ÷ 38,500 machine hours (MH) = $48 per MH Product shipping 560,000 ÷ 175 outgoing shipments (OS) = $3,200 per OS PROBLEM 5-35 (CONTINUED) Manufacturing setup, machine processing, and product shipping costs of a Type A unit and a Type B unit: Activity Type A Type B Manufacturing setups: 50 SU x $8,400?????.. $ 420,000 30 SU x $8,400?????.. $ 252,000 Machine processing: 16,000 MH x $48????... 768,000 22,500 MH x $48????... 1,080,000 Product shipping: 100 OS x $3,200????? 320,000 75 OS x $3,200?????.. 240,000 Total ???????????. $1,508,000 $1,572,000 Production volume (units)?. 8,000 15,000 Cost per unit???????.. $188.50* $104.80** * $1,508,000 ÷ 8,000 units = $188.50 ** $1,572,000 ÷ 15,000 units = $104.80 The manufactured cost of a Type A cabinet is $243.50, and the manufactured cost of a Type B cabinet is $184.80. The calculations follow: Type A Type B Direct material????????????? $ 35.00 $ 60.00 Direct labor??????????????. 20.00 20.00 Manufacturing setup, machine processing, and outgoing shipments.. 188.50 104.80 Total cost???????????????. $243.50 $184.80 3. Yes, the Type A storage cabinet is undercosted. The use of machine hours produced a unit cost of $215; in contrast, the more accurate activity-based-costing approach shows a unit cost of $243.50. The difference between these two amounts is $28.50. PROBLEM 5-35 (CONTINUED) 4. No, the discount is not advisable. The regular selling price of $260, when compared against the more accurate ABC cost figure, shows that each sale provides a profit to the firm of $16.50 ($260.00 - $243.50). However, a $30 discount will actually produce a loss of $13.50 ($243.50 - $230.00), and the more units that are sold, the larger the loss. Notice that with the less-accurate, machine-hour-based figure ($215), the marketing manager will be misled, believing that each discounted unit sold would boost income by $15 ($230 - $215). PROBLEM 5-36 (35 MINUTES) 1. Activity-based costing results in improved costing accuracy for two reasons. First, companies that use ABC are not limited to a single driver when allocating costs to products and activities. Not all costs vary with units, and ABC allows users to select a host of nonunit-level cost drivers. Second, consumption ratios often differ greatly among activities. No single cost driver will accurately assign costs for all activities in this situation. 2. Allocation of administrative cost based on billable hours: Information systems: 3,100 ÷ 5,000 = 62%; $342,000 x 62% = $212,040 E-commerce consulting: 1,900 ÷ 5,000 = 38%; $342,000 x 38% = $129,960 Information Systems Services E-Commerce Consulting Billings: 3,100 hours x $125???? $387,500 1,900 hours x $125???? $237,500 Less: Professional staff cost: 3,100 hours x $45??. (139,500) 1,900 hours x $45??. (85,500) Administrative cost??. (212,040) (129,960) Income??????????? $ 35,960 $ 22,040 Income ÷ billings??????. 9.28% 9.28% PROBLEM 5-36 (CONTINUED) Activity-based application rates: Activity Cost Activity Driver Application Rate Staff support $180,000 ÷ 250 clients = $720 per client In-house computing 136,400 ÷ 4,400 computer hours (CH) = $31 per CH Miscellaneous office charges 25,600 ÷ 1,000 client transactions (CT) = $25.60 per CT Staff support, in-house computing, and miscellaneous office charges of information systems services and e-commerce consulting: Activity Information Systems Services E-Commerce Consulting Staff support: 200 clients x $720????... $144,000 50 clients x $720?????. $ 36,000 In-house computing: 2,600 CH x $31??????. 80,600 1,800 CH x $31??????. 55,800 Miscellaneous office charges: 400 CT x $25.60?????... 10,240 600 CT x $25.60?????... 15,360 Total ????????????. $234,840 $107,160 PROBLEM 5-36 (CONTINUED) Profitability of information systems services and e-commerce consulting: Information Systems Services E-Commerce Consulting Billings: 3,100 hours x $125???.. $387,500 1,900 hours x $125???.. $237,500 Less: Professional staff cost: 3,100 hours x $45?? (139,500) 1,900 hours x $45?? (85,500) Administrative cost??. (234,840) (107,160) Income??????????.. $ 13,160 $ 44,840 Income ÷ billings?????... 3.40% 18.88% 4. Yes, his attitude should change. Even though both services are needed and professionals are paid the same rate, the income percentages show that e-commerce consulting provides a higher return per sales dollar than information systems services (18.88% vs. 3.40%). Thus, all other things being equal, professionals should spend more time with e-commerce. 5. Probably not. Although both services produce an attractive return, the firm is experiencing a very tight labor market and will likely have trouble finding qualified help. In addition, the professional staff is currently overworked, which would probably limit the services available to new clients. roblem 5-37 (40 minutes) 1. Overhead to be assigned to film development chemical order: Activity Cost Pool Pool Rate Level of Cost Driver Assigned Overhead Cost Machine setups $2,000 per setup ( 5 setups $10,000 Material handling $2 per pound ( 10,000 pounds 20,000 Hazardous waste control $5 per pound ( 2,000 pounds 10,000 Quality control $75 per inspection ( 10 inspections 750 Other overhead costs $10 per machine hour ( 500 machine hours ??5,000 Total $45,750 2. Overhead cost per box of chemicals = EMBED Equation.3 3. Predetermined overhead rate = EMBED Equation.3 = $31.25 per machine hr. 4. Overhead to be assigned to film development chemical order, given a single predetermined overhead rate: a. Total overhead assigned = $31.25 per machine hr. ( 500 machine hr. = $15,625 b. Overhead cost per box of chemicals = EMBED Equation.3 5. The film development chemicals entail a relatively large number of machine setups, a large amount of hazardous materials, and several inspections. Thus, they are quite costly in terms of driving overhead costs. Use of a single predetermined overhead rate obscures this characteristic of the production job. Underestimating the overhead cost per box could have adverse consequences for the company. For example, it could lead to poor decisions about product pricing. The activity-based costing system will serve management much better than the system based on a single, predetermined overhead rate. Problem 5-37 (CONTINUED) 6. In the electronic version of the solutions manual, press the CTRL key and click on the following link: HYPERLINK "Build%20a%20Spreadsheet%20Solutions%20-%20MANAGERIAL%20ACCOUNTING%20Hilton%207E/Build%20a%20Spreadsheet%20%2005-37.xls" Build a Spreadsheet Problem 5-38 (20 minutes) 1. Unit cost calculation: (a) Overhead assigned to photographic plates: Activity Cost Pool Pool Rate Level of Cost Driver Assigned Overhead Cost Machine setups $2,000 per setup ( 3 setups $ 6,000 Material handling $2 per pound ( 900 pounds 1,800 Hazardous waste control $5 per pound ( 300 pounds 1,500 Quality control $75 per inspection ( 3 inspections 225 Other overhead costs $10 per machine hour ( 50 machine hours 500 Total $10,025 EMBED Equation.3 (b) Unit cost per plate: Direct material $120.00 Direct labor 40.00 Manufacturing overhead ?100.25 Total cost per plate $260.25 2. In the electronic version of the solutions manual, press the CTRL key and click on the following link: HYPERLINK "Build%20a%20Spreadsheet%20Solutions%20-%20MANAGERIAL%20ACCOUNTING%20Hilton%207E/Build%20a%20Spreadsheet%20%2005-38.xls" Build a Spreadsheet Problem 5-39 (45 minutes) 1. An ABC system is a two-stage process of assigning costs to products. In stage one, activity-cost pools are established. In stage two a cost driver is identified for each activity-cost pool. Then the costs in each pool are assigned to each product line in proportion to the amount of the cost driver consumed by each product line. Problem 5-39 (Continued) 2. Montreal Electronics should not continue with its plans to emphasize the Royal model and phase out the Nova model. As shown in the following activity-based costing analysis, the Royal model has a contribution margin of less than 3 percent, while the Nova model generates a contribution margin of nearly 43 percent. Cost per event for each cost driver: Soldering $??942,000 EMBED Equation.3 1,570,000 = $??.60 per solder joint Shipments 860,000 EMBED Equation.3 20,000 = 43.00 per shipment Quality control 1,240,000 EMBED Equation.3 77,500 = 16.00 per inspection Purchase orders 950,400 EMBED Equation.3 190,080 = 5.00 per order Machine power 57,600 EMBED Equation.3 192,000 = .30 per hour Machine setups 750,000 EMBED Equation.3 30,000 = 25.00 per setup Costs per model: Royal Nova Direct costs: Materiala $2,336,000 $ 4,576,000 Direct laborb 168,000 396,000 Machine hoursc ??288,000 ? 3,168,000 Total direct costs $2,792,000 $ 8,140,000 Assigned costs: Solderingd $ ?231,000 $ ?711,000 Shipmentse 163,400 696,600 Quality controlf 340,800 899,200 Purchase ordersg 549,900 400,500 Machine powerh 4,800 52,800 Machine setupsi ??350,000 ???400,000 Total assigned costs $1,639,900 $ 3,160,100 Total cost $4,431,900 $11,300,100 Calculations follow. Problem 5-39 (Continued) Calculations: Royal Nova aMaterial 4,000 ( $584 22,000 ( $208 bDirect labor 4,000 (? $42 22,000 (? $18 cMachine hours 4,000 (? $72 22,000 ( $144 dSoldering 385,000 (?$.60 1,185,000 ( $.60 eShipments 3,800 (? $43 16,200 (? $43 fQuality control 21,300 (? $16 56,200 ( $16 gPurchase orders 109,980 (?? $5 80,100 (? $5 hMachine power 16,000 (?$.30 176,000 ( $.30 iMachine setups 14,000 (? $25 16,000 (? $25 Profitability analysis: Royal Nova Total Sales $4,560,000 $19,800,000 $24,360,000 Less: Cost of goods sold ?4,431,900 ?11,300,100 15,732,000 Gross margin $? 128,100 $?8,499,900 $ 8,628,000 Units sold 4,000 22,000 Per-unit calculations: Selling price $1,140.00 $900.00 Less: Cost of goods sold ?1,107.98 ?513.64 Contribution margin $?? 32.02 $386.36 Contribution margin percentage 2.8%a 42.9%b a$32.02/$1,140.00 = 2.8% b$386.36/$900.00 = 42.9% Problem 5-40 (60 minutes) 1. General advantages associated with activity-based costing include the following: Provides management with a more thorough understanding of complex product costs and product profitability for improved resource management and pricing decisions. Allows management to focus on value-added and non-value-added activities, so that non-value-added activities can be controlled or eliminated, thus streamlining production processes. Highlights the relationship between activities and identifies opportunities to reduce costs (i.e., designing products with fewer parts in order to reduce the cost of the manufacturing process). Provides a more appropriate means of charging overhead costs to products. Problem 5-40 (Continued) 2. Using Manchester Technology?s unit cost data, the total contribution margin expected from the PC board is $2,360,000, calculated as follows: Per Unit Total for 40,000 Units Revenue $300 $12,000,000 Direct material $140 $?5,600,000 Material-handling charge (10% of material) 14 560,000 Direct labor ($14 per hr.???4 hr.) 56 2,240,000 Variable overhead ($4 per hr.???4 hr.)* 16 640,000 Machine time ($10 per hr.???1.5 hr.) ??15 ?? ?600,000 Total cost $241 $?9,640,000 Unit contribution margin $?59 Total contribution margin (40,000???$59) $?2,360,000 *Variable overhead rate: $1,120,000 ÷ 280,000 hr. = $4 per hr. The total contribution margin expected from the TV board is $1,950,000, calculated as follows: Per Unit Total for 65,000 Units Revenue $150 $9,750,000 Direct material $ 80 $5,200,000 Material-handling charge (10% of material) 8 520,000 Direct labor ($14 per hr.???1.5 hr.) 21 1,365,000 Variable overhead ($4 per hr.???1.5 hr.)* 6 390,000 Machine time ($10 per hr.???.5 hr.) ???5 ??325,000 Total cost $120 $7,800,000 Unit contribution margin $?30 Total contribution margin (65,000???$30) $1,950,000 *Variable-overhead rate: $1,120,000 ÷ 280,000 hr. = $4 per hr. Problem 5-40 (Continued) 3. The pool rates, which apply to both the PC board and the TV board, are calculated as follows: Procurement $400,000/4,000,000 = $.10 per part Production scheduling $220,000/110,000 = $2.00 per board Packaging and shipping $440,000/110,000 = $4.00 per board Machine setup $446,000/278,750 = $1.60 per setup Hazardous waste disposal $48,000/16,000 = $3.00 per lb. Quality control $560,000/160,000 = $3.50 per inspection General supplies $66,000/110,000 = $.60 per board Machine insertion $1,200,000/3,000,000 = $.40 per part Manual insertion $4,000,000/1,000,000 = $4.00 per part Wave soldering $132,000/110,000 = $1.20 per board Using activity-based costing, the total contribution margin expected from the PC board is $1,594,000, calculated as follows: Per Unit Total for 40,000 Units Revenue $300.00 $12,000,000 Direct material $140.00 $?5,600,000 Procurement ($.10 per part???55 parts) 5.50 220,000 Production scheduling 2.00 80,000 Packaging and shipping 4.00 160,000 Machine setup ($1.60 per setup???3 setups) 4.80 192,000 Hazardous waste disposal ($3 per lb.???.35 lb.) 1.05 42,000 Quality control ($3.50 per inspection???2 inspections) 7.00 280,000 General supplies .60 24,000 Machine insertion ($.40 per part???35 parts) 14.00 560,000 Manual insertion ($4 per part???20 parts) 80.00 3,200,000 Wave soldering ????1.20 ????48,000 Total cost $?260.15 $10,406,000 Unit contribution margin $??39.85 Total contribution margin $?1,594,000 Problem 5-40 (Continued) Using activity-based costing, the total contribution margin expected from the TV board is $2,557,100, calculated as follows: Per Unit Total for 65,000 Units Revenue $? 150.00 $9,750,000 Direct material $?? 80.00 $5,200,000 Procurement ($.10 per part???25 parts) 2.50 162,500 Production scheduling 2.00 130,000 Packaging and shipping 4.00 260,000 Machine setups ($1.60 per setup???2 setups) 3.20 208,000 Hazardous waste disposal ($3 per lb.???.02 lb.) .06 3,900 Quality control 3.50 227,500 General supplies .60 39,000 Machine insertion ($.40 per part???24 parts) 9.60 624,000 Manual insertion 4.00 260,000 Wave soldering ????1.20 ????78,000 Total cost $?110.66 $7,192,900 Unit contribution margin $??39.34 Total contribution margin $2,557,100 4. The analysis using the previously reported costs shows that the unit contribution of the PC board is almost double that of the TV board. On this basis, management is likely to accept the suggestion of the production manager and concentrate promotional efforts on expanding the market for the PC boards. However, the analysis using activity-based costing does not support this decision. This analysis shows that the unit dollar contribution from each of the boards is almost equal, and the total contribution from the TV board exceeds that of the PC board by almost $1,000,000. As a percentage of selling price, the contribution from the TV board is double that of the PC board (26 percent versus 13 percent). Problem 5-41 (45 minutes) 1. a. WGCC's predetermined overhead rate, using direct-labor cost as the single cost driver, is $5 per direct labor dollar, calculated as follows: Overhead rate = EMBED Equation.3 = $3,000,000/$600,000 = $5 per direct-labor dollar b. The full product costs and selling prices of one pound of Kona and one pound of Malaysian coffee are calculated as follows: Kona Malaysian Direct material $3.20 $4.20 Direct labor .30 .30 Overhead (.30???$5) ?1.50 ?1.50 Full product cost $5.00 $6.00 Markup (30%) ?1.50 ?1.80 Selling price $6.50 $7.80 2. A new product cost, under an activity-based costing approach, is $7.46 per pound of Kona and $4.82 per pound of Malaysian coffee, calculated as follows: Activity Cost Driver Budgeted Activity Budgeted Cost Unit Cost Purchasing Purchase orders 1,158???? $579,000? $500??? Material handling Setups 1,800???? 720,000? 400??? Quality control Batches 720???? 144,000? 200??? Roasting Roasting hours 96,100???? 961,000? 10??? Blending Blending hours 33,600???? 336,000? 10??? Packaging Packaging hours 26,000???? 260,000? 10??? Problem 5-41 (Continued) Kona Coffee Standard cost per pound: Direct material $3.20 Direct labor .30 Purchasing (4 orders ( $500/2,000 lb.) 1.00 Material handling (12 setups ( $400/2,000 lb.) 2.40 Quality control (4 batches ( $200/2,000 lb.) .40 Roasting (20 hours ( $10/2,000 lb.) .10 Blending (10 hours ( $10/2,000 lb.) .05 Packaging (2 hours ( $10/2,000 lb.) ??.01 Total cost $7.46 Malaysian Coffee Standard cost per pound: Direct material $4.20 Direct labor .30 Purchasing (4* orders ( $500/100,000 lb.) .02 Material handling (30 setups ( $400/100,000 lb.) .12 Quality control (10 batches ( $200/100,000 lb.) .02 Roasting (1,000 hours ( $10/100,000 lb.) .10 Blending (500 hours ( $10/100,000 lb.) .05 Packaging (100 hours ( $10/100,000 lb.) ??.01 Total cost $4.82 *Budgeted sales ÷?purchase order size 100,000 lbs. ÷?25,000 lbs. = 4 orders problem 5-41 (continued) a. The ABC analysis indicates that several activities other than direct labor drive overhead. The cost computations show that the current system significantly undercosted Kona coffee, the low-volume product, and overcosted the high-volume product, Malaysian coffee. b. The implication of the ABC analysis is that the low-volume products are using resources but are not covering their share of the cost of those resources. The Kona blend is currently priced at $6.50 [see requirement 1(b)], which is significantly below its activity-based cost of $7.46. The company should set long-run prices above cost. If there is excess capacity and many of the costs are fixed, it may be acceptable to price some products below full activity-based cost temporarily in order to build demand for the product. Otherwise, the high-volume, high-margin products are subsidizing the low-volume, low-margin products. Problem 5-42 (50 minutes) 1. Activity Cost Pool Type of Activity I: Machine-related costs Unit-level II: Setup and inspection Batch-level III: Engineering Product-sustaining-level IV: Plant-related costs Facility-level Problem 5-42 (Continued) 2. Calculation of pool rates: I: Machine-related costs: EMBED Equation.3 = $50 per machine hr. II. Setup and inspection: EMBED Equation.3 = $4,500 per run III. Engineering: EMBED Equation.3 = = $900 per change order IV. Plant-related costs: EMBED Equation.3 = $50 per sq. ft. 3. Unit costs for odds and ends: I: Machine-related costs: Odds: $50 per machine hr.???4 machine hr. per unit = $200 per unit Ends: $50 per machine hr.???1 machine hr. per unit = $50 per unit II: Setup and inspection: Odds: $4,500 per run ÷ 50 units per run = $90 per unit Ends: $4,500 per run ÷ 250 units per run = $18 per unit problem 5-42 (continued) III: Engineering: Odds: EMBED Equation.3 = EMBED Equation.3 = $67.50 per unit Ends: EMBED Equation.3 = EMBED Equation.3 = $4.50 per unit IV. Plant-related costs: Odds: EMBED Equation.3 = EMBED Equation.3 = = $76.80 per unit Ends: EMBED Equation.3 = EMBED Equation.3 = $3.84 per unit Problem 5-42 (Continued) 4. New product cost per unit using the ABC system: Odds Ends Direct material $ 40.00 $ 60.00 Direct labor 30.00 45.00 Manufacturing overhead: Machine-related 200.00 50.00 Setup and inspection 90.00 18.00 Engineering 67.50 4.50 Plant-related ??76.80 ???3.84 Total cost per unit $504.30 $181.34 5. New target prices: Odds Ends New product cost (ABC) $504.30 $181.34 Pricing policy (??120% (??120% New target price $605.16 $217.61 (rounded) 6. Full assignment of overhead costs: Odds Ends Manufacturing overhead costs: Machine-related $200.00 $50.00 Setup and inspection 90.00 18.00 Engineering 67.50 4.50 Plant-related ??76.80 ????3.84 Total overhead cost per unit $434.30 $76.34 ( Production volume (??1,000 (??5,000 Total overhead assigned $434,300 $381,700 Total = $816,000 Problem 5-42 (Continued) 7. Cost distortion: Odds Ends Traditional volume-based costing system: reported product cost $ 166.00 $249.00 Activity-based costing system: reported product cost ??504.30 ? 181.34 Amount of cost distortion per unit $(338.30 ) $ 67.66 Traditional system undercosts odds by $338.30 per unit Traditional system overcosts ends by $67.66 per unit Production volume (???1,000 (??5,000 Total amount of cost distortion for entire product line $(338,300) $338,300 Sum of these two amounts is zero. Problem 5-43 (60 minutes) 1. Kara Lindley's predecessor at Northwest Aircraft Industries (NAI) would have used a 10 percent material-handling rate, calculated as follows: Payroll $180,000 Employee benefits 36,000 Telephone 38,000 Other utilities 22,000 Materials and supplies 6,000 Depreciation ??6,000 Total Material-Handling Department costs $288,000 Material-handling rate = EMBED Equation.3 = EMBED Equation.3 = 10% 2. a. The revised material-handling costs to be allocated on a per-purchase-order basis is $1.00, calculated as follows: Total Material-Handling Department costs $288,000 Deduct: Direct costs: Direct government payroll $36,000 Fringe benefits (20% ( $36,000) 7,200 Direct phone line ??2,800 ??46,000 Material-handling costs applicable to purchase orders $242,000 ( Total number of purchase orders (242,000 Material-handling cost per purchase order $? ??1.00 b. Purchase orders might be a more reliable cost driver than is the dollar amount of direct material, because resources are consumed in processing a purchase order. The size of the order does not necessarily have an impact on the consumption of resources. Problem 5-43 (Continued) 3. There is a $74,600 reduction in material-handling costs allocated to government contracts by NAI as a result of the new allocation method, calculated as follows: Previous method: Government material $2,006,000 ( Material-handling rate (? ???10% Total (previous method) $ 200,600 New method: Directly traceable material-handling costs [$36,000 + (20% ( $36,000) + $2,800] ? $ 46,000 Purchase orders (80,000 ( $1.00) ??80,000 Total (new method) $126,000 Net reduction $?74,600 Problem 5-43 (Continued) 4. A forecast of the cumulative dollar impact over a three-year period from 20x1 through 20x3 of Kara Lindley's recommended change for allocating Material-Handling Department costs to the Government Contracts Unit is $234,346, calculated as follows: 20x2 20x3? ? Calculation of forecasted variable material-handling costs: Direct-material cost: 20x2 ($2,880,000 ( 1.025) $2,952,000?? 20x3 ($2,952,000 ( 1.025) _________?? $ 3,025,800?? Material-handling rate (10%) $? 295,200?? $ ? 302,580?? Deduct: Direct traceable costs * ??? 46,000 ? ??46,000 Variable material-handling costs $? 249,200?? $ ? 256,580?? Calculation of forecasted purchase orders: 20x2 (242,000 ( 1.05) 254,100?? 20x3 (254,100 ( 1.05) _________?? ? ? 266,805?? Government purchase orders (33% of total) ?? ? 83,853?? ? ?? 88,046??(rounded)? ? Calculation of material-handling costs allocated to government contracts: Variable material-handling costs $? 249,200 $?? 256,580?? Purchase orders (??254,100?? (??266,805?? Variable material-handling costs per purchase order (rounded) $????? .98?? $ ????? .96?? Government purchase orders (? ?83,853?? ( ?? 88,046?? Projected variable material-handling costs (rounded) $? ?82,176?? $ ??84,524?? Fixed material-handling costs* ?? 46,000 ? ? 46,000 Total material-handling costs allocated to government contracts $ ?128,176?? $ ? 130,524?? *$36,000 + (20% ( $36,000) + $2,800 = $46,000 problem 5-43 (continued) Calculation of cumulative dollar impact: Government material at 70% $2,066,400b $2,118,060c Material-handling at 10% (previous method) $? 206,640d $? 211,806e Deduct: Material-handling costs allocated to government contracts (new method) 128,176?? 130,524?? Net reduction in government contract material-handling costs $ ? 78,464?? $ 81,282?? b70% ( $2,952,000 = $2,066,400 c70% ( $3,025,800 = $2,118,060 d10% ( $2,066,400 = $206,640 e10% ( $2,118,060 = $211,806 In summary, the cumulative dollar impact of the recommended change in allocating Material-Handling Department costs is $234,346, calculated as follows: 20x1 [from requirement (3)] $ ?74,600 20x2 78,464 20x3 ??81,282 Total $234,346 5. a. Referring to the standards of ethical conduct for management accountants, Kara Lindley faces the following ethical issues: Competence: Provide decision support information and recommendations that are accurate, clear, concise, and timely. Integrity: Refrain from engaging in any conduct that would prejudice Lindley's ability to carry out her duties ethically. Abstain from engaging in or supporting any activity that would discredit Lindley's profession. problem 5-43 (continued) Credibility: Disclose all relevant information that could reasonably be expected to influence an intended user?s understanding of the reports, analyses, or recommendations. Lindley has information that Jay Preston should see if he is going to make a reliable judgment about the results of the Government Contracts Unit. b. The steps Kara Lindley could take to resolve this ethical conflict are as follows: Lindley should first follow the established policies at NAI. If this approach does not resolve the conflict or if such policies do not exist, she should discuss the problem with her immediate superior, except when it appears that the superior is involved. If the Government Contracts Unit manager, Paul Anderson, is her superior, then she obviously cannot discuss the problem with him. In this case she should go to the next-higher managerial level and continue, up to the audit committee of the board of directors, until the conflict is resolved. She should also discuss the situation with an objective advisor to clarify the issues involved and obtain an understanding of possible courses of action. If the ethical conflict still exists after exhausting all levels of internal review, then she may have no other course of action than to resign from the company and submit an informative memorandum to an appropriate representative of the company. Problem 5-44 (50 minutes) 1. a. The calculation of total budgeted costs for the Manufacturing Department at Marconi Manufacturing is as follows: Direct material: Tuff Stuff ($5.00 per unit???20,000 units) $100,000 Ruff Stuff ($3.00 per unit???20,000 units) ??60,000 Total direct material $ ?160,000 Direct labor 800,000 Overhead: Indirect labor $ 24,000 Fringe benefits 5,000 Indirect material 31,000 Power 180,000 Setup 75,000 Quality assurance 10,000 Other utilities 10,000 Depreciation ??15,000 Total overhead ?? 350,000 Total Manufacturing Department budgeted cost $1,310,000 b. The unit costs of Tuff Stuff and Ruff Stuff, with overhead assigned on the basis of direct-labor hours, are calculated as follows: Tuff Stuff: Direct material $?5.00 Direct labor ($8.00 per hour???2 hours)* 16.00 Overhead ($3.50 per hour???2 hours)* ??7.00 Tuff Stuff unit cost $28.00 *Budgeted direct labor hours: Tuff Stuff (20,000 units ( 2 hours) 40,000 Ruff Stuff (20,000 units ( 3 hours) ?60,000 Total budgeted direct-labor hours 100,000 Direct-labor rate: $800,000 per 100,000 hours = $8.00 per hour Overhead rate: $350,000 per 100,000 hours = $3.50 per hour problem 5-44 (continued) Ruff Stuff: Direct material $ 3.00 Direct labor ($8.00 per hour???3 hours)* 24.00 Overhead ($3.50 per hour???3 hours)* ??10.50 Ruff Stuff unit cost $37.50 *Budgeted direct labor hours Tuff Stuff (20,000 units ( 2 hours) 40,000 Ruff Stuff (20,000 units ( 3 hours) ?60,000 Total budgeted direct-labor hours 100,000 Direct-labor rate: $800,000 per 100,000 hours = $8.00 per hour Overhead rate: $350,000 per 100,000 hours = $3.50 per hour 2. The total budgeted cost of the Fabricating and Assembly Departments, after separation of overhead into the activity cost pools, is calculated as follows: Total Fabricating Assembly Percent Dollars Percent Dollars Direct material $?160,000 100% $160,000 Direct labor ??800,000 ?75% ?600,000 25% $200,000 Overhead: Indirect labor $? 24,000 ?75% $?18,000 25% $? 6,000 Fringe benefits 5,000 ?80% 4,000 20% 1,000 Indirect material 31,000 20,000 11,000 Power 180,000 160,000 20,000 Setup 75,000 5,000 70,000 Quality assurance 10,000 ?80% 8,000 20% 2,000 Other utilities 10,000 ?50% 5,000 50% 5,000 Depreciation ??15,000??? ?80% ??12,000 20% ??3,000 Total overhead $ ?350,000 $232,000 $118,000 Total cost $1,310,000 $992,000 $318,000 problem 5-44 (continued) 3. The unit costs of the products using activity-based costing are calculated as follows: Fabricating: Total cost $992,000 Less: Direct material 160,000 Less: Direct labor ?600,000 Pool overhead cost $232,000 Hours: Tuff Stuff (4.4 hours ( 20,000 units) 88,000 hours Ruff Stuff (6.0 hours ( 20,000 units) 120,000 hours Total machine hours 208,000 hours Pool rate per machine hour ($232,000/208,000) $1.12 per hour (rounded) Fabricating cost per unit: Tuff Stuff ($1.12 ( 4.4 hours) $4.93 per unit (rounded) Ruff Stuff ($1.12 ( 6.0 hours) $6.72 per unit (rounded) Assembly: Total cost $318,000 Less: Direct labor ?200,000 Pool overhead cost $118,000 Setups: Tuff Stuff 1,000 Ruff Stuff ???? 272 Total setups ?? 1,272 Pool rate per setup ($118,000/1,272) $92.77 per setup (rounded) Setup cost per unit: Tuff Stuff ($92.77 per setup ( 1,000 set-ups) ÷ 20,000 units $4.64 per unit (rounded) Ruff Stuff ($92.77 per setup ( 272 set-ups) ÷ 20,000 units $1.26 per unit (rounded) Tuff Stuff unit cost: Direct material $?5.00 Direct labor (2 hours ( $8 per hour) 16.00 Fabrication overhead 4.93 Assembly overhead ??4.64 Tuff Stuff unit cost $30.57 Problem 5-44 (Continued) Ruff Stuff unit cost: Direct material $?3.00 Direct labor (3 hours ( $8 per hour) 24.00 Fabrication overhead 6.72 Assembly overhead ??1.26 Ruff Stuff unit cost $34.98 4. Ruff Stuff unit costs: Cost with overhead assigned on basis of direct-labor hours $37.50 Cost using activity-based costing $34.98 The activity-based costing unit costs may lead the company to decide to lower its price for Ruff Stuff in order to be more competitive in the market and continue production of the product. It now appears that Ruff Stuff has lower unit costs and can afford lower prices. Using ABC for assigning overhead costs generally leads to a more accurate estimate of the costs incurred to produce a product. Management should be able to make better informed decisions regarding pricing and production of the company?s products. Problem 5-45 (60 minutes) 1. Standard Model Deluxe Model Heavy-Duty Model Product costs based on traditional, volume- based costing system $105.00 $215.00 $232.00?? × 110% (?110% (?110% (?110%?? Target price $115.50 $236.50 $255.20?? problem 5-45 (continued) 2. Product costs based on activity-based costing system: Regular Model Standard Model Deluxe Model Direct material $10.00 $?25.00 $?42.00 Direct labor 10.00 20.00 20.00 Machinery depreciation and maintenancea 32.00 208.00 75.20 Engineering, inspection and repair of defectsb 17.04 43.50 34.08 Purchasing, receiving, shipping, and material handlingc 15.28 52.00 29.25 Factory depreciation, taxes, insurance, and miscellaneous overhead costsd ?12.50 ??89.25 ??25.59 Total $96.82 $437.75 $226.12 aPool I: Depreciation, machinery $1,480,000 Maintenance, machinery ?? 120,000 Total $1,600,000 Standard: ($1,600,000???40%) ( 20,000 = $32.00 Deluxe: ($1,600,000???13%) ( 1,000 = $208.00 Heavy-Duty: ($1,600,000???47%) ( 10,000 = $75.20 bPool II: Engineering $350,000 Inspection and repair of defects ?375,000 Total $725,000 Standard: ($725,000 (?47%) ( 20,000 = $17.04 Deluxe: ($725,000 (??6%) ( 1,000 = $43.50 Heavy-Duty: ($725,000 (?47%) ( 10,000 = $34.08 Problem 5-45 (Continued) cPool III: Purchasing, receiving, and shipping $250,000 Material handling ?400,000 Total $650,000 Standard: ($650,000 (?47%) ( 20,000 = $15.28 Deluxe: ($650,000 (??8%) ( 1,000 = $52.00 Heavy-Duty: ($650,000 (?45%) ( 10,000 = $29.25 dPool IV: Depreciation, taxes, and insurance for factory $300,000 Miscellaneous manufacturing overhead ?295,000 Total $595,000 Standard: ($595,000 ( 42%) ( 20,000 = $12.50 Deluxe: ($595,000 ( 15%) ( 1,000 = $89.25 Heavy-Duty: ($595,000 ( 43%) ( 10,000 = $25.59 3. Standard Model Deluxe Model Heavy Duty Model Product costs based on activity-based costing system $?96.82 $437.75 $226.12 × 110% (?110% (?110% (?110% New target price $106.50 $481.53 $248.73 The new target price of the standard model, $106.50, is lower than the current actual selling price, $110. Problem 5-45 (Continued) 4. Memorandum Date: Today To: President Morelli Electric Motor Corporation From: I.M. Student Subject: Product costing Based on the cost data from our traditional, volume-based product-costing system, our standard model is not very profitable. Its reported actual contribution margin is only $5 ($110 ? $105). However, the validity of this conclusion depends on the accuracy of the product costs reported by our product-costing system. Our competitors are selling motors like our standard model for $106. This price suggests that their product cost is substantially below our previously reported cost of $105. Our new activity-based-costing system reveals serious product cost distortions stemming from our old costing system. The new costing system shows that the standard model costs only $96.82, which implies a target price of $106.50. This price is lower than our current actual selling price and consistent with the price our competitors are charging. In contrast, our new product-costing system reveals that the deluxe model's product cost is $437.75 instead of the previously reported cost of $215. The new product cost suggests a target price of $481.53 for the deluxe model, rather than $236.50, which was our previous target price for the deluxe model. problem 5-45 (continued) 5. The company should adopt and maintain the activity-based costing system. The price of the standard model should be lowered to the $106. Lowering the price should enable the firm to regain its competitive position in the market for the standard model. Further price cuts should be considered if marketing studies indicate such a move will increase demand. The price of the deluxe model should be set near the target price of $481.53. If the deluxe model does not sell at this price, management should consider discontinuing the product line. Input from the marketing staff should be sought before such an action is taken. An important consideration is the extent to which sales in the standard model and heavy-duty model markets depend on the firm's offering a complete product line. A slight price reduction should be considered for the heavy-duty model (from $255.20 down to $248.73). However, the product cost distortion from the old costing system did not affect this model as seriously as it did the other two. Problem 5-46 (30 minutes) Standard Model Deluxe Model Heavy-Duty Model Traditional, volume-based costing system: reported product cost $105.00 $215.00 $232.00 Activity-based costing system: reported product cost ?96.82 ?? 437.75 ?226.12 Amount of cost distortion per unit $?8.18 $(222.75) $??5.88 Traditional Traditonal Traditional system system system overcosts undercosts overcosts standard deluxe heavy-duty model by model by model by $8.18 $222.75 $5.88 per unit per unit per unit Product volume (?20,000 (???1,000 ( 10,000 Total amount of cost distortion for entire product line $163,600 $(222,750) ?$58,800 Sum of these three amounts is $(350). It would be zero except for the slight rounding errors in the calculation of the new product costs to the nearest cent. Problem 5-47 (20 minutes) 1. The controller, Erin Jackson, has acted ethically up to this point. She correctly pointed out to the president that the firm's traditional, volume-based product-costing system was distorting the reported product cost for the company's three products. She designed an activity-based costing system to provide more accurate product-costing data. 2. The production manager, Alan Tyler, is not acting ethically. Although we can sympathize with his plight, we cannot condone his pressuring the controller to suppress or alter the new product-costing data she has compiled. What can Tyler do that is ethical and has the potential for positive results? First, he could take a hard look at the deluxe model's production process. Are there non-value-added activities that could be reduced or eliminated? Second, he could argue to the president that the company should carry a full product line, if he has reason to believe that is the firm's best strategy. 3. Jackson has an ethical obligation to the president, to the company, to her profession, and to herself to report accurate product-costing data to the president. There is nothing wrong with her offer to her friend to go over her analysis again to verify its accuracy. However, she must report what she finds with no suppression or alteration of the data. Several of the ethical standards for managerial accounting apply in this case. (See Chapter 1 for a listing of these standards.) The standards that are most clearly relevant include the following: Integrity: Communicate unfavorable as well as favorable information and professional judgments or opinions. Objectivity: Communicate information fairly and objectively. Disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, comments, and recommendations presented. problem 5-47 (continued) Jackson is in a tough spot. Her professional obligation to report accurate product costs is clear. She cannot ethically avoid this responsibility. Yet her friend Tyler is in a tenuous position. What can Jackson ethically do for him? First, she can be compassionate and understanding of his concern, yet remain firm in meeting her professional obligations. Second, she can assist the production manager in finding ways to manufacture the deluxe model electric motor more efficiently and at a lower cost. For example, she can share her ABC analysis with Tyler to help him identify non-value-added activities and costs. solutions to cases Case 5-48 (60 minutes) 1. Based on the cost data from Gigabyte's traditional, volume-based product-costing system, product G is the firm's least profitable product. Its reported actual gross margin is only $22.00, as compared with $84.75 and $104.50 for products T and W, respectively. However, the validity of this conclusion depends on the accuracy of the product costs reported by Gigabyte's product-costing system. 2. Again, based on the product costs reported by the firm's traditional, volume-based product-costing system, product W appears to be very profitable. As in requirement (1), however, the validity of this assessment depends on the accuracy of the reported product costs. 3. Gigabyte's competitors have moved aggressively into the market for gismos (product G), but they have abandoned the whatchamacallit (product W) market to Gigabyte. These competing firms apparently believe they can sell gismos at a much lower price than Gigabyte's management feels is feasible. This evidence suggests that Gigabyte's competitors may believe their product cost for gismos is below Gigabyte's reported product cost. In contrast, Gigabyte's competitors apparently believe that they cannot afford to sell whatchamacallits at Gigabyte's current price of $200. Perhaps the competing firms' reported production costs for product W are higher than the cost reported by Gigabyte's product-costing system. The danger to Gigabyte is that the company will be forced out of the market for its second largest selling product. This could be disastrous to Gigabyte, Inc. 4. Percentages for raw-material costs: Percentage Annual of Total Raw-Material Annual Raw-Material Raw-Material Product Cost per Unit Volume Cost Cost* G $35.00 8,000 $? 280,000 ??25% T 52.50 15,000 787,500 ??69% W 17.50 4,000 ??? 70,000 ?? 6% Total $1,137,500 100% *Percentages rounded to nearest whole percent. Case 5-48 (Continued) 5. Product costs based on an activity-based costing system (rounded): Product G Product T Product W Direct material $?35.00 $?52.50 $?17.50 Direct labor 16.00 12.00 8.00 Machine setupa .13 .11 .66 Machineryb 38.28 40.83 76.56 Inspectionc 9.84 15.75 52.50 Material handlingd 27.34 40.25 13.13 Engineeringe ??15.08 ???2.30 ??47.40 Total $141.67 $163.74 $215.75 aMachine setup: Product G: ($5,250 ( 20%) ( 8,000 units = $??.13 Product T: ($5,250 ( 30%) ( 15,000 units = $??.11 Product W: ($5,250 ( 50%) ( 4,000 units = $??.66 bMachinery: Product G: ($1,225,000 ( 25%) ( 8,000 units = $38.28 Product T: ($1,225,000 ( 50%) ( 15,000 units = $40.83 Product W: ($1,225,000 ( 25%) ( 4,000 units = $76.56 cInspection: Product G: ($525,000 ( 15%) ( 8,000 units = $?9.84 Product T: ($525,000 ( 45%) ( 15,000 units = $15.75 Product W: ($525,000 ( 40%) ( 4,000 units = $52.50 dMaterial handling: Product G: ($875,000 ( 25%) ( 8,000 units = $27.34 Product T: ($875,000 ( 69%) ( 15,000 units = $40.25 Product W: ($875,000 ( 6%) ( 4,000 units = $13.13 eEngineering: Product G: ($344,750 ( 35%) ( 8,000 units = $15.08 Product T: ($344,750 ( 10%) ( 15,000 units = $?2.30 Product W: ($344,750 ( 55%) ( 4,000 units = $47.40 Case 5-48 (Continued) 6. Comparison of reported product costs, new target prices, and actual selling prices: Product G Product T Product W Reported product costs: Traditional, volume-based costing system $191.00 $169.50 $?95.50 Activity-based costing system 141.67 163.74 215.75 Target price based on new product costs (150%???new product cost) 212.51 245.61 323.63 Current actual selling price 213.00 254.25 200.00 7. In the electronic version of the solutions manual, press the CTRL key and click on the following link: HYPERLINK "Build%20a%20Spreadsheet%20Solutions%20-%20MANAGERIAL%20ACCOUNTING%20Hilton%207E/Build%20a%20Spreadsheet%20%2005-48.xls" Build a Spreadsheet Case 5-49 (15 minutes) Memorandum Date: Today To: President, Gigabyte, Inc. From: I.M. Student Subject: Gigabyte's competitive position Gigabyte's product-costing system has been providing misleading product cost information. Our traditional, volume-based costing system overcosted gismos and thingamajigs, but it substantially undercosted whatchamacallits. As a result Gigabyte has been overpricing gismos and underpricing whatchamacallits. The company has been losing money on every sale in the product W market. Our competitors have taken advantage of our mispricing by moving aggressively into the gismo market and abandoning the whatchamacallit market to Gigabyte. As a result, our profitability has suffered. I recommend the following courses of action: 1. Implement the new activity-based costing system and revise its database frequently. 2. Lower the target price of gismos to $213, the current actual selling price. This price yields our usual 50 percent markup over product cost. 3. Consider lowering the price of thingamajigs to $246 in order to increase demand. The lower price still yields Gigabyte a 50 percent markup over product cost. Case 5-49 (continued) 4. Raise the price of whatchamacallits to $324. If the product does not sell at that price, consider discontinuing the product line. Case 5-50 (15 minutes) Product G Product T Product W Traditional, volume-based costing system: reported product cost $191.00 $169.50 $?? 95.50 Activity-based costing system: reported product cost ?141.67 ?163.74 ?? 215.75 Amount of cost distortion per unit $?49.33 $ 5.76 $(120.25 ) Traditional Traditonal Traditional system system system overcosts overcosts undercosts product product product G by T by W by $49.33 $5.76 $120.25 per unit per unit per unit Product volume (??8,000 (???15,000 (???4,000 Total amount of cost distortion for entire product line $394,640 $???86,400 $(481,000 ) EMBED Equation.3 Sum of these three amounts is $40. It would be zero except for the slight rounding errors in the calculation of the new product costs to the nearest cent. Case 5-51 (45 minutes) 1. Activity-based costing (ABC) differs from traditional costing in that it focuses on activities that consume resources as the fundamental cost drivers. ABC is a two-stage cost assignment process focused on causality and the determination of cost drivers. It usually uses several different activities to assign costs to products or services. Therefore, it is more detailed and more accurate than traditional costing. It also helps managers distinguish between value added and non-value added activities. 2. Calculations of total activity cost pools and pool rates: Machining ($424,528 ( 1.06) ( (15,000 hours + 30,000 hours) = $450,000* ( 45,000 hours = $10 per machine hour *Rounded Assembly ($216,981 ( 1.06) ( (6,000 hours + 5,500 hours) = $230,000* ( 11,500 hours = $20 per assembly hour *Rounded Material handling ($56,604 ( 1.06) ( [(5 parts ( 5,000 units) + (10 parts ( 5,000 units)] = $60,000* ( (25,000 parts + 50,000 parts) = $60,000 ( 75,000 parts = $.80 per part *Rounded Inspection ($117,925 ( 1.06) ( (5,000 hours + 7,500 hours) = $125,000* ( 12,500 hours = $10 per inspection hour *Rounded Case 5-51 (Continued) 3. JR-14 RM-13 20x1 Cost Data Estimated 20x2 Product Cost 20x1 Cost Data Estimated 20x2 Product Cost Direct material: No cost increase $1,000,000 $1,750,000 Direct labor: Direct labor $185,185 $92,593 ( 1.08 cost increase 200,000 (rounded) 100,000 (rounded) Machining: Machining activity in hours 15,000 30,000 ( $10 per hour 150,000 300,000 Assembly: Assembly activity in hours 6,000 5,500 ( $20 per hour 120,000 110,000 Material handling: Number of parts 5 10 ( units produced (??5,000 (?5,000 25,000 50,000 ( $.80 per unit 20,000 40,000 Inspection: Inspection hours 5,000 7,500 ( $10 per hour ??? 50,000 ??? 75,000 Total cost $1,540,000 $2,375,000 Case 5-51 (Continued) 4. Whitestone Company Budgeted Statement of Gross Margin for 20x2 JR-14 RM-13 Total Sales revenue $1,810,500 $2,229,500 $4,040,000 Cost of goods manufactured and sold: Beginning finished-goods inventory $ ?240,000 $? 300,000 $? 540,000 Add: Direct material 1,000,000 1,750,000 2,750,000 Direct labor 200,000 100,000 300,000 Machining 150,000 300,000 450,000 Assembly 120,000 110,000 230,000 Material handling 20,000 40,000 60,000 Inspection ??? 50,000 ??? 75,000 ?? 125,000 Cost of goods available for sale $1,780,000 $2,675,000 $4,455,000 Less: Ending finished-goods inventory* ?? 215,600 ?? 332,500 ?? 548,100 Cost of goods sold $1,564,400 $2,342,500 $3,906,900 Gross margin $ ?246,100 $ (113,000) $ ?133,100 *Ending finished-goods inventory = (total product cost EMBED Equation.3 units produced) ( ending inventory in units: JR-14: ($1,540,000 ( 5,000 units) ( 700 units = $215,600 RM-13: ($2,375,000 ( 5,000 units) ( 700 units = $332,500 focus on ethics (See page 195 in the text.) This scenario explores ethical issues surrounding activity-based costing. Among the potential ethical issues in this situation are the following: How did the product proliferation problem at the Charlotte plant come about? Were product-line managers more concerned with maintaining their spheres of influence than making product discontinuance decisions that would be in the company?s best interest? At the very least, the company seems to exhibit a lack of discipline and focus. Products that have been dropped as a result of sound analysis should not routinely creep back into the product line. Why did top management refuse to adopt the recommendations of the ABC analysis? It is sometimes said that top managers are compensated and rewarded with other perks in accordance with the size of the business unit they manage. More product lines, more departments, and more employees mean more prestige, higher pay and bonuses, and greater prospects for advancement in the company (or another company). Are top managers putting their own well-being ahead of the company?s? Alternatively, perhaps management is genuinely concerned about the implications for their employees if a large number of products are dropped. Is it ethical for management to put the interests of their employees ahead of those of the company?s shareholders? Was it ethical for Xavier?s top management to sell the Engine Parts Division, probably suspecting that the Charlotte plant would be closed and people would be laid off? McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc. 5- PAGE 2 Solutions Manual McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc. Managerial Accounting, 7/e 5- PAGE 1
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