7-1 In what fundamental ways does activity-based costing differ from traditional costing methods such as those described in Chapters 2 and 8? A: Activity-based costing differs from traditional costing systems in a number of ways. In activity-based costing, nonmanufacturing as well as manufacturing costs may be assigned to products. And, some manufacturing costs – including the costs of idle capacity – may be excluded from product costs. An activity – based costing system typically includes a number of activity cost pools, each of which as its unique measure of activity. These measures of activity often differ from the allocation bases used in traditional costing systems. 7-4 What are unit-level, batch-level, product-level, customer-level, and organization-sustaining activities? A: 1. Unit-level activities are performed for each unit that is produced. 2. Batch-level activities are performed for each batch regardless of how many units are in the batch. 3. Product-level activities must be carried out to support a product regardless of how many batches are run or units produced. 4. Customer-level activities must be carried out to support customers regardless of what products or services they buy. 5. Organization-sustaining activities are carried out regardless of the company’s precise product mix or mix of customers 7-5 What types of costs should not be assigned to products in an activity-based costing system? A: Organizing-sustaining costs, customer-level costs, and the costs of idle capacity should not be assigned to products. These costs represent resources that are not consumed by the products. 7-6 Why are there two stages of allocation in activity-based costing? A: In activity-based costing, costs must first be allocated to activity cost pools and then they are allocated from the activity cost pools to products, customers, and other cost objects. Exercise 7-1 ABC Cost Hierarchy The following activities occur at Greenwich Corporation, a company that manufactures a variety of products. a. b. c. d. e. f. g. Receive raw materials from suppliers. Manage parts inventories. Do rough milling work on products. Interview and process new employees in the personnel department. Design new products. Perform periodic preventive maintenance on general-use equipment. Use the general factory building. h. Issue purchase orders for a job. Required: Classify each of the activities above as either a unit-level, batch-level, product-level, or organization-sustaining activity. a. b. c. d. Receive raw materials from suppliers Manage parts inventories Do rough milling work on products Interview and process new employees in the personnel department. e. Design new products. f. Perform periodic preventive maintenance on general-use equipment. g. Use the general factory building. h. Issue purchase orders for a job Batch-level Product-level Unit-level Organization-sustaining Product-level Organization-sustaining Organization-sustaining Batch-level Exercise 7-2 First-Stage Allocation SecuriCorp operates a fleet of armored cars that make scheduled pickups and deliveries in the Los Angeles area. The company is implementing an activity-based costing system that has four activity cost pools: Travel, Pickup and Delivery, Customer Service, and Other. The activity measures are miles for the Travel cost pool, number of pickups and deliveries for the Pickup and Delivery cost pool, and number of customers for the Customer Service cost pool. Th Other cost pool has no activity measure because it is an organization-sustaining activity. The following costs will be assigned using the activity-based costing system: Driver and guard wages $720,000 Vehicle operating expense 280,000 Vehicle depreciation 120,000 Customer representative salaries and expenses 160,000 Office expenses 30,000 Administrative expenses 320,000 Total cost $1,630,000 The distribution of resource consumption across the activity cost pools is as follows: Travel Pickup Customer Other Total and Service Delivery Driver and guard wages 50% 35% 10% 5% 100% Vehicle operating expense 70% 5% 0% 25% 100% Vehicle depreciation 60% 15% 0 25% 100% Customer representative salaries and 0% 0% 90% 10% 100% expenses Office expenses 0% 20% 30% 50% 100% Administrative expense 0% 5% 60% 35% 100% Required: Complete the first-stage allocations of cost to activity cost pools as illustrated in Exhibit 7-5. Travel Driver and guard wages Vehicle operating expense Vehicle depreciation Customer representative salaries and expenses Office expenses Administrative expense $360,000 196,000 72,000 0 0 0 Pickup and Customer Delivery Service $252,000 $72,000 14,000 0 18,000 0 0 144,000 6,000 9,000 16,000 192,000 Other Total $36,000 70,000 30,000 16,000 15,000 112,000 $720,0 280,0 120,0 160,0 30,0 320,0 Each entry in the table is derived by multiplying the total cost for the cost category by the percentage from the table that shows the distribution of resource consumption. Exercise 7-3 Compute Activity Rates Green Thumb Gardening is a small gardening service that uses activity-based costing to estimate costs for pricing a purposes. The proprietor of the company believes that costs are driven primarily by the size of customer lawns, the s customer garden beds, the distance to travel to customers, and the number of customers. In addition, the costs of ma beds depend on whether the beds are low maintenance beds (mainly ordinary trees and shrubs) or high maintenance flowers and exotic plants). Accordingly, the company uses the five activity cost pools listed below: Activity Cost Pool Caring for lawn Caring for garden beds-low maintenance Caring for garden beds-high maintenance Travel to jobs Customer billing and service Activity Measure Square feet of lawn Square feet of low maintenance Square feet of high maintenance beds Miles Number of customers The company has already completed its first-stage allocation of costs and has summarized its annual costs and activ Activity Cost Pool Caring for lawn Caring for garden beds-low maintenance Caring for garden beds-high maintenance Travel to jobs Customer billing and service Estimated Overhead Cost $72,000 $26,400 $41,400 $3,250 $8,750 Expected activity 15,000 square f 20,000 square feet of low m 15,000 square feet of high mainte 1 25 Required: Compute the activity rate for each of the activity cost pools. Activity Cost Pool Caring for lawn Estimated Overhead Cost $72,000 Expected activity A 15,000 square feet of lawn Caring for garden beds-low maintenance $26,400 20,000 square feet of low maintenance Caring for garden beds-high maintenance $41,400 15,000 square feet of high maintenance beds Travel to jobs $3,250 12,500 miles Customer billing and service $8,750 25 customers $ The activity rate for each activity cost pool is computed by dividing its estimated overhead cost by its expected activity. Exercise 7-4 Second-Stage Allocation Klumper Corporation is a diversified manufacturer of industrial goods. The company’s activity-based costing contains the following six activity cost pools and activity rates: Activity Cost Pool Supporting direct Machine processing Machine setups Production orders Shipments Product sustaining Activity Rates $6.00 per direct labor hour $4.00 per machine-hour $50.00 per setup $90.00 per order $14.00 per shipment $840.00 per product Activity data have been supplied for the following two products. Number of units produced per year Direct labor-hours Machine processing Machine setups Production orders Shipments Product sustaining Total Expected Activity K425 M67 200 2,000 80 500 100 1,500 1 4 1 4 1 10 1 1 Required: Compute the cost of the units transferred to the next department during the period and the cost of endi process inventory. K425 Activity Cost Pool Supporting direct Machine processing Machine setups Production orders Shipments Product sustaining Total $6.00 $4.00 $50.00 $90.00 $14.00 $840.00 Activity Rate per direct labor hour per machine-hour per setup per order per shipment per product 80 100 1 1 1 1 Activity Direct labor-hours Machine processing Machine setups Production orders Shipments Product sustaining M67 Activity Cost Pool Supporting direct Machine processing Machine setups Production orders Shipments Product sustaining Total $6.00 $4.00 $50.00 $90.00 $14.00 $840.00 Activity Rate per direct labor hour per machine-hour per setup per order per shipment per product 500 1,500 4 4 10 1 Activity Direct labor-hours Machine processing Machine setups Production orders Shipments Product sustaining Exercise 7-5 Product and Customer Profitability Analysis Thermal Rising, Inc., makes paragliders for sale through specialty sporting goods stores. The company has a standa model, but also makes custom-designed paragliders. Management has designed an activity-based costing system wit following activity cost pools and activity rates: Activity Cost Pool Activity Rate Supporting direct labor $26 per direct labor-hour Order processing $284 per order Custom design process $186 per custom design Customer service $379 per customer Management would like an analysis of the profitability of a particular customer, Big Sky Outfitters, which has ordere following products over the last 12 months: Activity Cost Pool Number of gliders Number of orders Number of custom designs Direct labor-hours per glider Selling price per glider Direct materials cost per glider The company’s direct labor rate is $19.50 per hour 20 1 0 26.35 $1,850 $564 Activity Rate 3 3 3 28.00 $2,400 $634 Required: Prepare a cost reconciliation report for the Baking Department for June Sales ($1,850 per standard model glider × 20 standard model gliders + $2,400 per custom designed glider × 3 custom designed gliders) Costs: Direct materials ($564 per standard model glider × 20 standard model gliders + $634 per custom designed glider × 3 custom designed gliders) Direct labor ($19.50 per direct labor-hour × 26.35 direct labor-hours per standard model glider × 20 standard model gliders + $19.50 per direct labor-hour × 28 direct labor-hours per custom designed laborhours per custom designed glider × 3 custom designed gliders) Supporting direct labor ($26 per direct labor-hour × 26.35 direct labor-hours per standard model glider × 20 standard model gliders + $26 per direct labor-hour × 28 direct labor-hours per custom designed glider × 3 custom designed gliders) Order processing ($284 per order × 4 orders) Custom designing ($186 per custom design × 3 custom designs) Customer service ($379 per customer × 1 customer) Customer margin $44,200 $`13,182 11,915 15,886 1,136 558 379 43,056 $1,144 Exercise 7-13 Contrasting Traditional and ABC Product Costs Model X100 sells for $120 per unit whereas Model X200 offer advanced features and sells for $500 per unit. Management expects to sell 50,000 units of Model X100 and 5,000 units of Model X200 next year. The direct material cost per unit is $50 for Model X100 and $220 for Model X200. The company’s total manufacturing overhead for the year is expected to be $1,995,000. A unit of Model X100 requires two direct labor-hours and a unit of Model X200 requires five direct labor-hours. The direct labor wage rate is $20 per hour. Required: 1. The company currently applies manufacturing overhead to products using direct labor-hours as the allocation base. Using this traditional approach, compute the product margins for X100 and X200. 2. Management is considering an activity-based costing system and would like to know what impact this would have on product costs. Preliminary analysis suggests that under activity-based costing, a total of $1,000,000 in manufacturing overhead cost would be assigned to Model X100 and a total of $600,000 would be assigned to Model X200. In addition, a total of $150,000 in nonmanufacturing overhead would be applied to Model X100 and a total of $350,000 would be applied to Model X200. Using the activity-based costing approach, compute the product margins for X100 and X200. 3. Explain why the product margins computed in requirement (1) differ from those computed in requirement (2). 1. Under the traditional direct labor-hour based costing system, manufacturing overhead is applied to products using the predetermined overhead rate computed as follows: Predetermined overhead rate = Predetermined overhead rate = Estimated total manufacturing overhead cost Estimated total direct labor−hours $1,995,000 125,000 DLHS∗ = $15.96 per DLH *50,000 units of Model × 100 @ 2.0 DLH per unit + 5,000 units of Model X200 @ 5.0 DLH per unit = 100,000 DLHs + 25,000 DLHs = 125,000DLHs Consequently, the product margins using the traditional approach would be computed as follows: Sales Direct materials Direct labor Manufacturing overhead applied @ $15.96 per direct labor-hour Total manufacturing cost Product margin Model X100 Model X200 $6,000,000 $2,500,000 2,500,000 1,100,000 2,000,000 500,000 1,596,000 399,000 6,096,000 $(96,000) 1,999,000 $501,000 Total $8,500,000 3,600,000 2,500,000 1,995,000 8,095,000 $450,000 Note that all of the manufacturing overhead cost is applied to the products under the company’s traditional costing system. 2. Sales Direct materials Direct labor Manufacturing overhead applied Nonmanufacturing overhead applied Total manufacturing cost Product margin Model X100 Model X200 $6,000,000 $2,500,000 2,500,000 1,100,000 2,000,000 500,000 1,000,000 600,000 150,000 350,000 5,650,000 2,550,000 $350,000 $(50,000) Total $8,500,000 3,600,000 2,500,000 1,600,000 500,000 8,200,000 $300,000 3. Under activity-based costing, a total of $1,150,000 of manufacturing and nonmanufacturing overhead is assigned to Model X100 and a total of $950,000 is assigned to Model X200. This is in contrast to $1,596,000 of manufacturing overhead being assigned to Model X100 and $399,000 being assigned to Model X200 under the traditional costing method. Also note that the total amount of overhead applied to both products is $2,100,000 under activity-based costing and $1,995,000 under the traditional costing method. A number of reasons exist for these differences. First, not all manufacturing overhead costs are assigned to products under activity-based costing. Apparently $395,000 (= $1,995,000 – $1,600,000) of manufacturing overhead consists of the costs of idle capacity and organization-sustaining costs that are not assigned to products under activity-based costing. Counterbalancing this, a total of $500,000 in nonmanufacturing costs are assigned to products under activity-based costing, but not under the traditional method. Additionally, manufacturing overhead costs have been shifted from Model X100, the high-volume product, to Model X200, the low-volume product under activity-based costing. This is probably due to the existence of batch-level or product-level costs that are more appropriately assigned under activity-based costing.