Chapter 4 Activity-Based Costing, Lean Production, and the Costs of Quality Quick Check Answers: QC4-1. d QC4-3. c QC4-5. c QC4-7. c QC4-9. a QC4-2. d QC4-4. c QC4-6. d QC4-8. d QC4-10. c Chapter 4 Activity-Based Costing and Other Cost Management Tools 282
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Chapter 4
Activity-Based Costing, Lean Production, and the Costs of Quality
Quick Check
Answers:
QC4-1. d QC4-3. c QC4-5. c QC4-7. c QC4-9. aQC4-2. d QC4-4. c QC4-6. d QC4-8. d QC4-10. c
Chapter 4 Activity-Based Costing and Other Cost Management Tools 282
Short Exercises(5 min) S 4-1
a. Prevention costs
b. Lean production
c. Activity-based costing
d. Appraisal costs
e. Unit-level costs
f. Value-added activities
g. Internal failure costs
h. Product-level costs
i. Non-value added activities
j. External failure costs
k. Batch-level costs
l. Plantwide overhead rate
m. Cost distortion
n. Facility-level costs
Managerial Accounting 2e Solutions Manual283
(5 min) S 4-2Req. 1
JOB 392 Cutting DepartmentFinishing
DepartmentDepartmental overhead rate $10 per machine
hour$17 per direct
labor hourDirect labor hours incurred in the Finishing Department
× 6 direct labor hours
Machine hours incurred in the Cutting Department
× 8 machine hours
Allocation of manufacturing overhead $80 $102
The total manufacturing overhead allocated to Job 392 is $182. This consists of $80 of manufacturing overhead in the Cutting Department and $102 of manufacturing from the Finishing Department.
Req. 2
The manufacturing cost of Job 392 is determined by summing the three manufacturing costs assigned to the job.
Direct Materials $2,500Direct Labor ($25 per hour × 8 hours) 200Manufacturing overhead 182 Total Job Cost $2,882
Chapter 4 Activity-Based Costing and Other Cost Management Tools 284
The plant-wide overhead rate ($200 per machine hour) had been overcosting potato chips and undercosting corn chips and cheese puffs. The departmental rates more accurately allocate manufacturing overhead costs because they take into consideration the unique amount of manufacturing overhead and machine hours associated with each production department.
Managerial Accounting 2e Solutions Manual285
(5 min.) S 4-4
ActivityManufacturing
Overhead Cost DriverActivity Cost
Allocation Rate
Preparation $600,000 ÷12,000 preparation hours
=$50 per preparation hour
Cooking and Draining
$900,000 ÷
30,000 cooking and draining hours
=
$30 per cooking and draining hour
Packaging $300,000 ÷6,000,000 packages
=$0.05 per package
Chapter 4 Activity-Based Costing and Other Cost Management Tools 286
(5-10 min.) S 4-5
Req. 1 and 2
The total amount of manufacturing overhead allocated to the order (and the amount of manufacturing overhead per bag) is computed as follows:
Activity Cost Allocation Rate Use of Cost Driver
Allocated Manufacturing
Overhead$50 per preparation hour 16 preparation hours $ 800$30 per cooking and
draining hour32 cooking and draining hours 960
$0.05 per package 12,000 bags 600 TOTAL $2,360Number of bags ÷ 12,000Manufacturing overhead per bag $ 0.20 (rounded)
Req. 3
The total manufacturing cost of the order is the sum of the direct materials, direct labor, and manufacturing overhead assigned to the order. Therefore, in addition to the manufacturing overhead computed above, Uncle Bruce will need to determine the cost of direct materials (potatoes) and direct labor incurred by the order before he can arrive at the total cost to manufacture this order.
Managerial Accounting 2e Solutions Manual287
(5-10 min.) S 4-6
Req. 1
Activity
Estimated Total Manufacturing
Overhead Costs
(A)
Estimated Total Usage of
Cost Driver (B)
Activity Cost Allocation Rate
(A ÷ B)Machine set-
up$ 150,000 3,000 set-ups $ 50 per set-
upMachining $1,000,000 5,000 machine
hours$200 per
machine hourQuality control $ 337,500 4,500 tests run $ 75 per test
Managers might favor this multiple-rate, activity-based costingsystem primarily because it better pinpoints activities for planning and control and it provides more accurate data for product costing. Managers will have more confidence in their decisions about pricing and about which products to emphasize or deemphasize. The older system yields less accurate and, therefore, less useful cost figures.
Managerial Accounting 2e Solutions Manual289
(15-20 min.) S 4-8
a. Product-level
b. Facility-level
c. Batch-level
d. Unit-level
e. Unit-level or Batch-level
f. Facility-level
g. Product-level
h. Unit-level
i. Unit-level
j. Facility-level
k. Product-level
l. Unit-level or Batch-level
Chapter 4 Activity-Based Costing and Other Cost Management Tools 290
(15-20 min.) S 4-9
1. Unit-level
2. Product-level
3. Unit-level
4. Facility-level
5. Facility-level
6. Product-level
7. Batch-level
8. Product-level
9. Facility-level
10. Facility-level
Managerial Accounting 2e Solutions Manual291
(5 min) S 4-10
1. The company has re-engineered its production process but has not changed its accounting system — more likely
2. The company produces few products, and the products consume resources in a similar manner — less likely
3. The company operates in a very competitive industry — more likely
4. The company has very few indirect costs — less likely
5. The company produces high volumes of some of its products and low volumes of other products — more likely
6. In bidding for jobs, managers lose bids they expected to win and win bids they expected to lose — more likely
Chapter 4 Activity-Based Costing and Other Cost Management Tools 292
(10 min.) S 4-11
Req. 1
Indirect cost=
Estimated total indirect costsallocation rate Estimated total quantity of cost allocation base
Each engagement used the same direct labor hours, so direct labor and indirect costs (allocated based on direct labor hours) are the same for both engagements.
There are several warning signs that Mission’s cost system may be “broken”:
1. One client (Webb) is complaining that the firm's fees are too high, while the other client (Greg) called to say he is happy with the fees. This causes a question as to whether Webb’s fees are too high and Greg’s fees are too low.
2. The client complaining about the high fees is an engagement where Nelson felt especially efficient and capable. On the other hand, the client happy with his fees is a complex engagement where Nelson felt less efficient.
3. Mission's competitor (Delta Applications) is able to undercut her fees — even in Mission's area of expertise —and still earn a good profit.
4. Mission's cost system has not changed since the firm was founded.
5. Mission allocates indirect costs using a single allocation base — direct labor hours.
These signals suggest it is time for Nelson to reevaluate her cost system.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 294
(5 min.) S 4-13
Mission, Inc.ABC Cost Allocation Rates
Documentation Preparation
InformationTechnology Support Training
Estimated indirect cost of activity $100,000 $156,000 $450,000
Divide by estimated quantity
of cost allocation base ÷ 3,125 pages ÷ 780 applications ÷ 5,000 DL hours
Managers might favor this multiple-rate, activity-based costing
system primarily because it better pinpoints activities for
planning and control and it provides more accurate data for
product costing. Managers will have more confidence in their
decisions about pricing and about which products to
emphasize or de-emphasize. The older system yields less
accurate, and therefore less useful, cost figures.
Managerial Accounting 2e Solutions Manual311
(15-20 min) E 4-24AReq. 1
Operatingoverhead
Total professional hours
Current operating overhead allocation rate
$234,000 ÷ 10,000 =$23.40 per
professional hour
Req. 2
Billing Calculations for the Amy Lee Kitchen Remodeling JobBased on current allocation system
Professional time (24 hours × $65 per hour) $1,560.00Operating overhead (24 hours × $23.40 per hour) + 561 .60 Total cost of job $2,121.60Markup on cost × 135 %Bill to client $2,864 .16
Req. 3
Activity CostTotal activity
allocation baseActivity
allocation rateTransportation
to clients $ 9,000 ÷15,000a
miles driven = $0.60 per mileBlueprint
copying 35,000 ÷1,000b
copies = $35 per copyOffice
support 190,000 ÷5,000c
secretarial hours =$38 per secretarial hour
To calculate the activity cost allocation rates, you must use the total activity for the year:a 3,000 + 12,000 = 15,000b 300 + 700 = 1,000c 2,200 + 2,800 = 5,000
Chapter 4 Activity-Based Costing and Other Cost Management Tools 312
(continued) E 4-24A
Req. 4
Billing Calculations for the Amy Lee Kitchen Remodeling JobBased on ABC information
Professional time (24 hours × $65 per hour) $1,560.00Operating overhead:
125 miles × $0.60 per mile = $754 blueprints × $35 per copy = $14018 secretarial hours × $38 per secretarial hour =
$684 + 899.00 Total cost of job $2,459.00Markup on cost × 135 %Bill to client $3,319.65
Req. 5
The billing system based on ABC costs should be fairer to
clients because they are charged according to the resources
they used. For example, copying blueprints is very expensive.
Under ABC, clients are charged according to how many or how
few blueprint copies their job required. The ABC system better
recognized the extent to which operating costs are incurred by
each unique client job.
Managerial Accounting 2e Solutions Manual313
Chapter 4 Activity-Based Costing and Other Cost Management Tools 314
(20-25 min.) E 4-25A
Req. 1
First, compute the current plant-wide manufacturing overhead rate:
Total manufacturing
overheadTotal direct labor hours
Plant-wide overhead rate
$800,000 ÷ 25,000 =$32 per
direct labor hour
Then, apply it to the two products:
Manufacturing CostMedium (42-inch)
Large (63 inch)
Direct materials $ 660,000 $1,240,000Direct labor 216,000 384,000Manufacturing overhead:
Total manufacturing cost $1,164,000 $2,136,000Number of units produced ÷ 3,000 ÷ 4,000 Cost per unit $ 388 $ 534
Managerial Accounting 2e Solutions Manual315
(continued) E 4-25A
Req. 2
First, compute the activity cost allocation rates:
Activity
Manufacturingoverhead related
to activityTotal activity
allocation baseActivity
allocation rate
Materials handling $150,000 ÷
500a
material orders handled =
$300 per material order handled
Machine processing 560,000 ÷
40,000b machine hours =
$14 per machine hour
Packaging 90,000 ÷
10,000c packaging hours =
$9 per packaging hour
You must use the TOTAL activity for the year as follows. Since
Owens only manufactures two products, you add the activity of
each of the individual products to find the total activity:a 300 + 200 = 500b 20,000 + 20,000 = 40,000c 4,000 + 6,000 = 10,000
Chapter 4 Activity-Based Costing and Other Cost Management Tools 316
(continued) E 4-25A
Req. 2 (continued)
Then, apply them to the two products:
Manufacturing CostMedium (42-inch)
Large (63 inch)
Direct materials $ 660,000 $1,240,000Direct labor 216,000 384,000Manufacturing overhead:Medium:
(300 material orders × $300 = $90,000)
(20,000 machine hours ×$14 = $280,000)
(4,000 packaging hours × $9 = $36,000)
Total allocation of overhead 406,000 Large:
(200 material orders × $300 = $60,000)
(20,000 machine hours ×$14 = $280,000)
(6,000 packaging hours ×$9 = $54,000)
Total allocation of overhead 394,000 Total manufacturing cost $1,282,000 $2,018,000Number of units produced ÷ 3,000 ÷ 4,000 Cost per unit $ 427.33 $ 504.50
Managerial Accounting 2e Solutions Manual317
(continued) E 4-25A
Req. 3
Medium Large Cost per unit using current
system $ 388.00 $ 534.00Cost per unit using ABC 427.33 504.50 Overcosting / (Undercosting) ($ 39.33) $ 29.50Number of units × 3,000 × 4,000 Total cost distortion ($117,990)* $118,000*
* The $10 difference between the total amount overcosted and undercosted is due to the fact that unit answers were rounded to the nearest cent.
The Medium units had been undercosted and the Large units
had been overcosted. Since Owen’s sets its sales price at 300%
of manufacturing cost, the resulting sales price should have
been about $118 higher for the Medium units ($39.33 × 300%)
and about $88.50 lower for the Large units ($29.50 × 300%).
This helps to explain why Owens is the low cost leader for
Medium plasma TVs, but faces competitive pressure on the
Large plasma TVs.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 318
(20-30 min.) E 4-26A
Req. 1
EnkeTotal Budgeted Indirect Manufacturing Costs
Activity
Budgeted Quantity of
Cost Allocation Base
Activity Cost
Allocation Rate
Total Budgeted
Indirect CostMaterials handling 10,000a $ 3.75 $ 37,500Machine setups 30b $300.00 9,000Insertion of parts 10,000a $ 24.00 240,000Finishing 3,500c $ 50.00 175,000 Total budgeted indirect cost $461,500
If they rely on the plant-wide allocation rate data, Enke’s
managers will produce the deluxe model. It will appear to
maximize income.
Req. 3
The standard model is more profitable than the deluxe model.
Activity-based costing data generally are more accurate than
cost data generated by a plant-wide overhead allocation rate.
ABC systems have more cost categories (activities), each with
its own allocation base. ABC cost assignments more accurately
represent the cost of resources consumed to manufacture (and
support) products.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 322
(continued) E 4-27A
Req. 4
The ABC system is likely to pass the cost-benefit test because
Enke manufactures two different products that use different
amounts of resources. The old cost system appears “broken”
because profits at the company declined when the product mix
was shifted to the product that appeared most profitable under
the old costing system. In addition, the production process
had been reengineered but the old plantwide single-allocation-
base costing system had not.
Managerial Accounting 2e Solutions Manual323
(15-20 min.) E 4-28A
Req. 1
Either the materials handling cost or the grinding cost is
inaccurate. Both costs were assigned based on the number of
parts. Thus, the ratio of Job 409 materials handling cost to Job
622 materials handling cost should be the same as the ratio of
Job 409 grinding cost to Job 622 grinding cost. The materials
handling cost ratio is 1:3 ($500 to $1,500), but the grinding cost
ratio is 1:5 ($300 to $1,500). Job 622 cannot have three times as
many parts as Job 409 and five times as many parts
simultaneously.
Req. 2
The first step is to determine the allocation rate for each of the four activities:
Channell FabricatorsABC Allocation Rates
ActivityJob 622
Activity Cost
Divide by Quantity of the Cost
Allocation BaseActivity Cost
Allocation RateLathe work $15,000 ÷ 60,000 turns $0.25 / lathe turnMilling $28,000 ÷ 1,400 hours $20 / machine hourGrinding $ 1,500 ÷ 3,000 parts $0.50 / partTesting $ 2,700 ÷ 300 units $9 / unit
Chapter 4 Activity-Based Costing and Other Cost Management Tools 324
(continued) E 4-28A
Req. 2 (continued)
The second step is to use the cost allocation rate for each activity to determine the quantity of the allocation base Job 409 used.
Channell FabricatorsQuantity of the Allocation Base Used by Job 409
ActivityJob 409
Activity CostDivide by
Activity Cost Allocation Rate
Quantity of the Allocation Base Used by Job 409
Lathe work $5,000 ÷ $0.25 / turn 20,000 turnsMilling $4,000 ÷ $20 / hour 200 hoursGrinding $ 300 ÷ $0.50 / part 600 partsTesting $ 126 ÷ $9 / unit 14 units
Req. 3
Based on the ABC information, Channell should not accept the
company's offer to test units for $13 each. Channell’s cost of
performing this activity is only $9 per unit ($2,700 ÷ 300 units
tested for Job 622).
Managerial Accounting 2e Solutions Manual325
(15-20 min) E 4-29A
Traditional and lean systems vary greatly along several dimensions of production. Some of the differences are as follows:
1. Inventory levels — Lean production systems strive to maintain low inventory levels. Lean producers try to purchase raw materials “just in time” to meet the production schedule, and have the finished inventory ready “just in time” to meet customer demand. Traditional production systems maintain greater quantities of raw materials, work in process, and finished goods inventory.
2. Batch sizes — Lean production systems produce units in much smaller batches than traditional production systems. These batches are “demand-pulled” through production, rather than “pushed through” production (like a traditional system), allowing the company to only produce what customers have ordered.
3. Set-up times — Lean production systems stress short set-up times so that they can produce and deliver the product to the end customer in a very short amount of time. By keeping set-up times short, lean producers don’t have to worry about keeping extra inventory on hand just to be able to quickly meet demand.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 326
(continued) E 4-29A
4. Physical layout of plant — Lean producers tend to physically organize their manufacturing plants by self-contained production cells. Each cell contains all of the machinery necessary to produce the product. By organizing the plant this way, lean producers are able to minimize interruptions and time spent moving materials and work in process inventory. This, in turn, reduces the time it takes to produce the product. In contrast, traditional producers tend to group like machinery together in different areas of the plant.
5. Roles of plant employees — At lean producers, plant employees tend to have broader roles. They are cross-trained to perform about every role that is needed in each production cell. They set-up, operate, and repair the machines in the cell. They also perform the quality inspections. As a result, employees tend to have higher morale. Additionally, this decreases bottlenecks caused by having to wait for the “right person” to come do the job.
6. Manufacturing cycle times — Lean producers put great emphasis on shortening their manufacturing cycle times. Lean producers need to have short cycle times since they have very little, if any, safety stock ready to sell to customers. By having short cycle times, they are able to fill customer orders quickly, keeping customers satisfied.
7. Quality — Lean producers stress high quality in every aspect of production. Since lean producers do not carry much, if any stock, they need to be able to produce the product right, the first time. Lean producers tend to “build-in” quality, rather than “inspect-in” quality as traditional firms do.
Managerial Accounting 2e Solutions Manual327
(15-20 min) E 4-30AReq. 1
Cost of Quality Report for Smith Snack foods
Total Costs of Quality
Percentage of total costs of quality
(rounded)
Prevention Costs:
Personnel training $ 26,000
Preventative maintenance 7,000
Total prevention costs $ 33,000 4%
Appraisal Costs:
Inspecting products at half-way point $ 55,000
Inspection of raw materials 5,000
Total appraisal costs $ 60,000 7%
Internal Failure Costs:
Production loss due to machine breakdowns $ 15,000
Cost of defective products 94,000
Cost of disposing of rejected products 12,000
Total internal failure costs $121,000 15%
External Failure Costs:
Recall of Batch #59374 $175,000
Warranty claims 420,000
Total external failure costs $595,000 74%
Total Costs of Quality $809,000 100%
Chapter 4 Activity-Based Costing and Other Cost Management Tools 328
(continued) E 4-30AReq. 2
Because the company has warranty returns and has had a
product recall, the company may suffer from a reputation for
poor quality products. If so, they are probably losing profits
from losing sales. Unsatisfied customers will be reluctant to
buy from the company again. They may also tell their friends
and family not to buy from the company. This report does not
include an estimate of the lost profits arising from a reputation
for poor-quality products.
Req. 3
The Cost of Quality report shows that very little is being spent
on prevention and appraisal, which is probably why the internal
and external failure costs are so high. It appears that the
company is only inspecting the product half-way through the
production process, and not again at the end of the process.
Perhaps that is the reason their external failure costs are so
high. The CEO should use this information to develop quality
initiatives in the areas of prevention and appraisal. Such
initiatives should reduce future internal and external failure
costs.
Managerial Accounting 2e Solutions Manual329
(15-20 min.) E 4-31A
Req. 1
Prevention costs:
Training employees in TQM
Training suppliers in TQM
Identifying preferred suppliers who commit to on-time
delivery of perfect quality materials
Appraisal costs:
Strength-testing one item from each batch of panels
Avoid inspection of raw materials
Internal failure costs:
Avoid rework and spoilage
External failure costs:
Avoid lost profits from lost sales due to disappointed
customers
Avoid warranty costs
Chapter 4 Activity-Based Costing and Other Cost Management Tools 330
(continued) E 4-31A
Req. 2
Cost / <Benefit> Analysis Cost/<Savings>
Prevention costs:Training employees in TQM…………………………… $ 30,000Training suppliers in TQM……………………………... 40,000Identifying preferred suppliers who commit to on-
time delivery of perfect quality materials……….. 60,000
Appraisal costs:Strength-testing one item from each batch of
panels…………………………………………………... 65,000
Savings on Inspection of raw materials………………… $ <45,000>
Internal failure costs:Savings on Rework and spoilage…………………….. <55,000>
External failure costs:Savings on Lost profits from lost sales due to
disappointed customers……………………………. <90,000>Savings on Warranty costs……………………………….. < 15,000>
Net <Benefit> ………………………………………………... $<10,000>
Chihooli should adopt the new quality program. The program should save the company $10,000
Managerial Accounting 2e Solutions Manual331
Exercises (Group B)
(15-20 min.) E 4-32B
Req. 1
Plant-wideallocation rate
==
Estimated total indirect costsEstimated total quantity of cost allocation
base
==
$1,200,00025,000* direct labor
hours
= $48 per direct labor hour
*When calculating plant-wide overhead rates, all direct labor hours incurred in the plant are used.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 332
(continued) E 4-32B
Req. 2
Departmental cost allocation rate =
Estimated total indirect costs of department
Estimated total quantity of cost allocation
base used in department
Machining Dept. overhead rate
=$800,000
15,400 machine hours
= $52 per machine hour*
Finishing Dept. overhead rate
=$400,000
17,800** direct labor hours
= $23 per direct labor hour*
*Rounded to the nearest dollar.**When calculating the finishing departmental rate, only the direct labor hours incurred in the finishing department are used.
Managerial Accounting 2e Solutions Manual333
(continued) E 4-32B
Req. 3
Overhead allocation based on single, plant-wide rate:
* Made up of direct materials of $44 and direct labor of $32.
Req. 2
Managers might favor this multiple-rate, activity-based costing
system primarily because it better pinpoints activities for
planning and control and it provides more accurate data for
product costing. Managers will have more confidence in their
decisions about pricing and about which products to
emphasize or de-emphasize. The older system yields less
accurate, and therefore less useful, cost figures.
Managerial Accounting 2e Solutions Manual339
(15-20 min) E 4-35BReq. 1
Operatingoverhead
Total professional hours
Current operating overhead allocation rate
$236,000 ÷ 10,000 =$23.60 per
professional hour
Req. 2
Billing Calculations for the Amy Lee Kitchen Remodeling JobBased on current allocation system
Professional time (21 hours × $63 per hour) $1,323.00Operating overhead (21 hours × $23.60 per hour) + 495 .60 Total cost of job $1,818.60Markup on cost × 131 %Bill to client $2,382 .37
Req. 3
Activity CostTotal activity
allocation baseActivity
allocation rateTransportation
to clients $11,000 ÷15,000a
miles driven = $0.73 per mileBlueprint
copying 31,000 ÷1,000b
copies = $31 per copyOffice
support 194,000 ÷5,000c
secretarial hours =$38.80 per secretarial hour
To calculate the activity cost allocation rates, you must use the total activity for the year:a 4,000 + 11,000 = 15,000b 500 + 500 = 1,000
Chapter 4 Activity-Based Costing and Other Cost Management Tools 340
c 2,200 + 2,800 = 5,000
Managerial Accounting 2e Solutions Manual341
(continued) E 4-35B
Req. 4
Billing Calculations for the Amy Lee Kitchen Remodeling JobBased on ABC information
Professional time (21 hours × $63 per hour) $1,323.00Operating overhead:
123 miles × $0.73 per mile = $89.794 blueprints × $31 per copy = $12413 secretarial hours × $38.80 per secretarial hour
= $504.40 + 718.19 Total cost of job $2,041.19Markup on cost × 131 %Bill to client $2673.96
Req. 5
The billing system based on ABC costs should be fairer to
clients because they are charged according to the resources
they used. For example, copying blueprints is very expensive.
Under ABC, clients are charged according to how many or how
few blueprint copies their job required. The ABC system better
recognized the extent to which operating costs are incurred by
each unique client job.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 342
Managerial Accounting 2e Solutions Manual343
(20-25 min.) E 4-36B
Req. 1
First, compute the current plant-wide manufacturing overhead rate:
Total manufacturing
overheadTotal direct labor hours
Plant-wide overhead rate
$828,000 ÷ 26,500 =$31.25 per
direct labor hour
Then, apply it to the two products:
Manufacturing CostMedium (42-inch)
Large (63 inch)
Direct materials $ 661,000 $1,240,000Direct labor 223,000 386,000Manufacturing overhead:
Total manufacturing cost $1,184,000 $2,154,125Number of units produced ÷ 3,180 ÷ 4,120 Cost per unit $ 372 .33 $ 522.85
Chapter 4 Activity-Based Costing and Other Cost Management Tools 344
(continued) E 4-36B
Req. 2
First, compute the activity cost allocation rates:
Activity
Manufacturingoverhead related
to activityTotal activity
allocation baseActivity
allocation rate
Materials handling $156,000 ÷
580a
material orders handled =
$268.97 per material order handled
Machine processing 570,000 ÷
43,400b machine hours =
$13.13 per machine hour
Packaging 102,000 ÷
10,080c packaging hours =
$10.12 per packaging hour
You must use the TOTAL activity for the year as follows. Since
Owens only manufactures two products, you add the activity of
each of the individual products to find the total activity:a 340 + 240 = 580b 20,000 + 23,400 = 43,400c 4,040 + 6,040 = 10,080
Managerial Accounting 2e Solutions Manual345
(continued) E 4-36B
Req. 2 (continued)
Then, apply them to the two products:
Manufacturing CostMedium (42-inch)
Large (63 inch)
Direct materials $ 661,000 $1,240,000Direct labor 223,000 386,000Manufacturing overhead:Medium:
(340 material orders × $268.97 = $91,449.80)
(20,000 machine hours ×$13.13 = $262,600)
(4,040 packaging hours × $10.12 = $40,884.80)
Total allocation of overhead 394,935* Large:
(240 material orders × $268.97 = $64,552.80)
(23,400 machine hours ×$13.15 = $307,242)
(6,040 packaging hours ×$10.12 = $61,124.80)
Total allocation of overhead 432,920*Total manufacturing cost $1,278,935 $2,058,920Number of units produced ÷ 3,180 ÷ 4,120 Cost per unit $ 402.18 $ 499.74
* Rounded to nearest dollar
Chapter 4 Activity-Based Costing and Other Cost Management Tools 346
(continued) E 4-36B
Req. 3
Medium Large Cost per unit using current
system $ 372.33 $ 522.85Cost per unit using ABC 402.18 499.74Overcosting / (Undercosting) ($ 29.85) $ 23.11Number of units × 3,180 × 4,120 Total cost distortion ($ 94,923.00)* $95,213.20 *
* The $290.20 difference between the total amount overcosted and undercosted is due to the fact that unit answers were rounded to two decimal points.
The Medium units had been undercosted and the Large units
had been overcosted. Since Jefferis’s sets its sales price at
300% of manufacturing cost, the resulting sales price should
have been about $90 higher for the Medium units ($29.85 ×
300%) and about $70 lower for the Large units ($23.11 × 300%).
This helps to explain why Jefferis is the low cost leader for
Medium plasma TVs, but faces competitive pressure on the
Large plasma TVs.
Managerial Accounting 2e Solutions Manual347
(20-30 min.) E 4-37B
Req. 1
ZekeTotal Budgeted Indirect Manufacturing Costs
Activity
Budgeted Quantity of
Cost Allocation Base
Activity Cost
Allocation Rate
Total Budgeted
Indirect CostMaterials handling 10,000a $ 3.85 $ 38,500Machine setups 20b $345.00 6,900Insertion of parts 10,000a $ 27.00 270,000Finishing 4,600 $ 55.00 253,000 Total budgeted indirect cost $568,400
If they rely on the plant-wide allocation rate data, Zeke’s
managers will produce the deluxe model. It will appear to
maximize income.
Req. 3
The standard model is more profitable than the deluxe model.
Activity-based costing data generally are more accurate than
cost data generated by a plant-wide overhead allocation rate.
ABC systems have more cost categories (activities), each with
its own allocation base. ABC cost assignments more accurately
represent the cost of resources consumed to manufacture (and
support) products.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 352
(continued) E 4-38B
Req. 4
The ABC system is likely to pass the cost-benefit test because
Zeke manufactures two different products that use different
amounts of resources. The old cost system appears “broken”
because profits at the company declined when the product mix
was shifted to the product that appeared most profitable under
the old costing system. In addition, the production process
had been reengineered but the old plant-wide single-allocation-
base costing system had not.
Managerial Accounting 2e Solutions Manual353
(15-20 min.) E 4-39B
Req. 1
Either the materials handling cost or the grinding cost is
inaccurate. Both costs were assigned based on the number of
parts. Thus, the ratio of Job 409 materials handling cost to Job
622 materials handling cost should be the same as the ratio of
Job 409 grinding cost to Job 622 grinding cost. The materials
handling cost ratio is 1:3 ($400 to $1,200), but the grinding cost
ratio is 1:5 ($336 to $1,680). Job 622 cannot have three times as
many parts as Job 409 and five times as many parts
simultaneously.
Req. 2
The first step is to determine the allocation rate for each of the four activities:
Burke FabricatorsABC Allocation Rates
ActivityJob 622
Activity Cost
Divide by Quantity of the Cost
Allocation BaseActivity Cost
Allocation RateLathe work $15,500 ÷ 77,500 turns $0.20 / lathe turnMilling $26,000 ÷ 1,625 hours $16 / machine hourGrinding $ 1,680 ÷ 2,400 parts $0.70 / partTesting $ 2,500 ÷ 400 units $6.25 / unit
Chapter 4 Activity-Based Costing and Other Cost Management Tools 354
(continued) E 4-39B
Req. 2 (continued)
The second step is to use the cost allocation rate for each activity to determine the quantity of the allocation base Job 409 used.
Burke FabricatorsQuantity of the Allocation Base Used by Job 409
ActivityJob 409
Activity CostDivide by
Activity Cost Allocation Rate
Quantity of the Allocation Base Used by Job 409
Lathe work $4,700 ÷ $0.20 / turn 23,500 turnsMilling $3,600 ÷ $16 / hour 225 hoursGrinding $ 336 ÷ $0.70 / part 480 partsTesting $ 125 ÷ $6.25 / unit 20 units
Req. 3
Based on the ABC information, Burke should not accept the
company's offer to test units for $10 each. Burke’s cost of
performing this activity is only $6.25 per unit ($2,500 ÷ 400 units
tested for Job 622).
Managerial Accounting 2e Solutions Manual355
(15-20 min) E 4-40B
1. Quality tends to be “inspect-in” rather than “build-in” --traditional
2. Manufacturing plants tend to be organized with self-contained production cells –lean production
3. Maintain greater quantities of raw materials, work in process, and finished goods inventories –traditional production
4. Setup times are longer -- traditional
5. High quality is stressed in every aspect of production –lean production
6. Produced in smaller batches –lean production
7. Emphasis is placed on shortening manufacturing cycle times –lean production
8. Manufacturing plants tend to group like machinery together in different parts of the plant -- traditional
9. Setup times are shorter –lean production
10. Produced in larger batches –traditional manufacturing
11. Strives to maintain low inventory levels –lean production
12. Cycle time tends to be longer –traditional
Chapter 4 Activity-Based Costing and Other Cost Management Tools 356
(15-20 min) E 4-41BReq. 1
Cost of Quality Report for Shaun Snack foods
Total Costs of Quality
Percentage of total costs of quality
(rounded)
Prevention Costs:
Personnel training $ 25,000
Preventative maintenance 8,000
Total prevention costs $ 33,000 4%
Appraisal Costs:
Inspecting products at half-way point $ 52,000
Inspection of raw materials 4,000
Total appraisal costs $ 56,000 7%
Internal Failure Costs:
Production loss due to machine breakdowns $ 16,000
Cost of defective products 91,000
Cost of disposing of rejected products 11,000
Total internal failure costs $118,000 14%
External Failure Costs:
Recall of Batch #59374 $175,000
Warranty claims 436,000
Total external failure costs $611,000 75%
Total Costs of Quality $818,000 100%
Managerial Accounting 2e Solutions Manual357
(continued) E 4-41BReq. 2
Because the company has warranty returns and has had a
product recall, the company may suffer from a reputation for
poor quality products. If so, they are probably losing profits
from losing sales. Unsatisfied customers will be reluctant to
buy from the company again. They may also tell their friends
and family not to buy from the company. This report does not
include an estimate of the lost profits arising from a reputation
for poor-quality products.
Req. 3
The Cost of Quality report shows that very little is being spent
on prevention and appraisal, which is probably why the internal
and external failure costs are so high. It appears that the
company is only inspecting the product half-way through the
production process, and not again at the end of the process.
Perhaps that is the reason their external failure costs are so
high. The CEO should use this information to develop quality
initiatives in the areas of prevention and appraisal. Such
initiatives should reduce future internal and external failure
costs.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 358
(15-20 min.) E 4-42B
Req. 1
Prevention costs:
Training employees in TQM
Training suppliers in TQM
Identifying preferred suppliers who commit to on-time
delivery of perfect quality materials
Appraisal costs:
Strength-testing one item from each batch of panels
Avoid inspection of raw materials
Internal failure costs:
Avoid rework and spoilage
External failure costs:
Avoid lost profits from lost sales due to disappointed
customers
Avoid warranty costs
Managerial Accounting 2e Solutions Manual359
(continued) E 4-42B
Req. 2
Cost / <Benefit> Analysis Cost/<Savings>
Prevention costs:Training employees in TQM…………………………… $ 30,000Training suppliers in TQM……………………………... 32,000Identifying preferred suppliers who commit to on-
time delivery of perfect quality materials……….. 60,000
Appraisal costs:Strength-testing one item from each batch of
panels…………………………………………………... 68,000
Savings on Inspection of raw materials………………… $ <57,000>
Internal failure costs:Savings on Rework and spoilage…………………….. <67,000>
External failure costs:Savings on Lost profits from lost sales due to
disappointed customers……………………………. <95,000>Savings on Warranty costs……………………………….. < 16,000>
Net <Benefit> ………………………………………………... $<45,000>
Clegg should adopt the new quality program. The program should save the company $45,000.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 360
Problems (Group A)
(40 min.) P 4-43AReq. 1
Plant-wideallocation rate =
Estimated total indirect costsEstimated total quantity of cost allocation
base
=$1,000,000
12,500* direct labor hours
= $80 per direct labor hour*When calculating plant-wide overhead rates, all direct labor hours incurred in the plant are used.
Req. 2
Departmental cost allocation
rate=
Estimated total indirect costs of department
Estimated total quantity of cost allocation
base used in department
Machining =$600,000
4,000 machine hours
= $150 per machine hour
Assembly =$400,000
10,000** direct labor hours
= $40 per direct labor hour**When calculating the assembly departmental rate, only the direct labor hours incurred in the assembly department are used.
Managerial Accounting 2e Solutions Manual361
(continued) P 4-43A
Req. 3
Job #501 uses more of the company’s resources than Job 500.
While both jobs use the same number of direct labor hours in
both production departments, Job 501 uses twice as many
machine hours (6 MH) as Job 500 (3 MH). Running the
machines requires resources, such as utilities, depreciation,
and repairs and maintenance. The accounting system should
show that Job 501 actually “costs” the company more
resources to make than Job 500.
Req. 4
Overhead allocation based on single, plant-wide rate:
Perreth thought that both jobs were equally profitable ($247)
because the original costing system assigned the same amount
of manufacturing cost to each job. However, using a refined
costing system, we see that Perreth was making more profit on
Job 500 than previously reported and actually losing money on
Job 501.
Managerial Accounting 2e Solutions Manual365
(20-30 min.) P 4-44A
Req. 1
HonePer-Unit Manufacturing Costs
StandardDesk
UnpaintedDesk
Direct materials $ 96,000 $21,000Materials handling (120,000 and 30,000) × $0.60 72,000 18,000Assembling (6,000 and 900) × $15 90,000 13,500Painting (6,000 × $5.00) 30,000 — Total manufacturing costs $288,000 $52,500Divide by number of units ÷ 6,000 ÷ 1,500 Manufacturing product cost per unit $ 48.00 $ 35.00
Req. 2
HoneFull Product Costs
Standard Desk
Unpainted Desk
Premanufacturing activities(such as product design) $ 5.00 $ 3.00
÷ Estimated quantity of cost allocation base ÷ 4 applications ÷ 12 million lines ÷ 1,800 testing hours
Cost allocation rate $400,000/application $0.20 / line $160 / hour
Req. 2
XnetActivity Costs per Unit
X-Page X-SecureApplications development
(1 and 1) × $400,000 $400,000 $ 400,000Content production
(500,000 and 7,500,000) × $0.20 100,000 1,500,000Testing (100 and 600) × $160 16,000 96,000 Total indirect cost $516,000 $1,996,000÷ Number of units ÷ 30,000 units ÷ 10 unitsIndirect activity cost per unit $ 17.20 $ 199,600
Chapter 4 Activity-Based Costing and Other Cost Management Tools 368
(continued) P 4-45A
Req. 3
XnetCosts per Unit Under Original Direct-Labor Based System
X-Page X-SecureIndirect costs
(10,000 and 15,000) × $100 $1,000,000 $1,500,000÷ Number of units ÷ 30,000 units ÷ 10 unitsIndirect costs per unit $ 33.33* $ 150,000
The original system overcosted the commercial containers and undercosted the travel packs. The original system allocated 3 times as much indirect cost to the commercial containers as to the travel packs (1,200 ÷ 400 = 3). However, commercial containers did not use 3 times as much of the material handling and quality assurance resources. Commercial containers used only 33% more material handling than travel packs (8,000 / 6,000). And commercial containers required less quality assurance than travel packs. The ABC system recognizes that commercial containers do not require 3 times as much material handling and quality assurance as travel packs. So, relative to the original system, ABC allocates less of the material handling and quality assurance costs to commercial containers.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 372
(20-30 min.) P 4-47A
Req. 1
Real ToysPredicted Quality Cost Savings
Activity
Predicted Reduction In
Activity Units
×
Activity Cost
Allocation Rate
=
PredictedReductionIn Activity
CostsInspection of incoming materials 300 $20 $ 6,000Inspection of finished goods 300 $30 9,000Defective units discovered in-house 3,200 $15 48,000Defective units discovered
by customers 900 $35 31,500Lost sales to dissatisfied customers 300 $55 16,500 Total predicted quality cost savings $111,000
Req. 2
Real ToysNet Benefit of Design Engineering Effort
Total predicted quality cost savings $111,000Cost of design engineering 60,000 Net benefit of design engineering $ 51,000
Managerial Accounting 2e Solutions Manual373
(continued) P 4-47A
Req. 3
Measuring the costs of quality-related activities is difficult.
Estimating some costs, such as the cost of design engineering
to improve the quality of a particular product, may require
allocation of engineers’ salaries. Other costs, such as the cost
of lost sales, are not recorded in the accounts and are difficult
to predict. For these reasons, many companies also monitor
non-financial measures of quality (for example, number of
machine breakdowns and number of customer complaints) and
attempt to improve them.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 374
Problems (Group B)
(40 min.) P 4-48BReq. 1
Plant-wideallocation rate =
Estimated total indirect costsEstimated total quantity of cost allocation
base
=$1,090,000
14,000* direct labor hours
= $77.86 per direct labor hour*When calculating plant-wide overhead rates, all direct labor hours incurred in the plant are used.
Req. 2
Departmental cost allocation
rate=
Estimated total indirect costs of department
Estimated total quantity of cost allocation
base used in department
Machining =$670,000
4,000 machine hours
= $167.50 per machine hour
Assembly =$420,000
12,000** direct labor hours
= $35 per direct labor hour**When calculating the assembly departmental rate, only the direct labor hours incurred in the assembly department are used.
Managerial Accounting 2e Solutions Manual375
(continued) P 4-48B
Req. 3
Job #501 uses more of the company’s resources than Job 500.
While both jobs use the same number of direct labor hours in
both production departments, Job 501 uses twice as many
machine hours (16 MH) as Job 500 (8 MH). Running the
machines requires resources, such as utilities, depreciation,
and repairs and maintenance. The accounting system should
show that Job 501 actually “costs” the company more
resources to make than Job 500.
Req. 4
Overhead allocation based on single, plant-wide rate:
Quintana thought that both jobs were equally profitable
($1,007.16) because the original costing system assigned the
same amount of manufacturing cost to each job. However,
using a refined costing system, we see that Quintana was
making more profit on Job 500 than previously reported and
actually losing money on Job 501.
Managerial Accounting 2e Solutions Manual379
(20-30 min.) P 4-49B
Req. 1
Johnston’sPer-Unit Manufacturing Costs
StandardDesk
UnpaintedDesk
Direct materials $ 98,000 $18,000Materials handling (120,500 and 30,500) × $0.60 72,300 18,300Assembling (6,300 and 1,000) × $13 81,900 13,000Painting (6,500 × $5.30) 34,450 — Total manufacturing costs $286,650 $49,300Divide by number of units ÷ 6,500 ÷ 2,000 Manufacturing product cost per unit $ 44.10 $ 24.65
Req. 2
Johnston’sFull Product Costs
Standard Desk
Unpainted Desk
Premanufacturing activities(such as product design) $ 4.00 $ 3.00
÷ Estimated quantity of cost allocation base ÷ 3 applications ÷ 9 million lines ÷ 1,500 testing hours
Cost allocation rate $500,000/application $0.30 / line $180 / hour
Req. 2
GibsonActivity Costs per Unit
X-Page X-SecureApplications development
(1 and 1) × $500,000 $500,000 $ 500,000Content production
(480,000 and 7,200,000) × $0.30 144,000 2,160,000Testing (70 and 420) × $180 12,600 75,600 Total indirect cost $656,600 $2,735,600÷ Number of units ÷ 25,000 units ÷ 9 unitsIndirect activity cost per unit $ 26.26* $ 303,955 .56*
*Rounded to nearest cent
Chapter 4 Activity-Based Costing and Other Cost Management Tools 382
(continued) P 4-50B
Req. 3
GibsonCosts per Unit Under Original Direct-Labor Based System
X-Page X-SecureIndirect costs
(14,000 and 21,000) × $104 $1,456,000 $2,184,000÷ Number of units ÷ 25,000 units ÷ 9 unitsIndirect costs per unit $ 58.24 $ 242,666 .67*
Materials handling (8,200 and 6,500) × $8 $ 65,600 $ 52,000Packaging (1,200 and 400) × $195 234,000 78,000Quality assurance (270 and 370) × $50 13,500 18,500 Total indirect costs $313,100 $148,500÷ Number of units ÷ 2,700 ÷ 40,000 Indirect activity cost per unit* $ 115.96 $ 3.71
*Rounded
Managerial Accounting 2e Solutions Manual385
(continued) P 4-51B
Req. 3
Maloney PharmaceuticalsCosts per Unit Under Original Machine-Hour Based System
Commercial Container Travel Pack
Indirect costs (1,200 and 400) × $350 $420,000 $140,000÷ Number of units ÷ 2,700 ÷ 40,000Indirect cost per unit* $ 155 .56 $ 3.50
*Rounded
Req. 4
Commercial Container Travel Pack
ABC System.................................... $115.96 $3.71Original System.............................. $155.56 $3.50Thus, the costs under ABC decreased by $39.60 for the Commercial Container and increased $0.21 for the Travel Pack.
The original system overcosted the commercial containers and undercosted the travel packs. The original system allocated 3 times as much indirect cost to the commercial containers as to the travel packs (1,200 ÷ 400 = 3). However, commercial containers did not use 3 times as much of the material handling and quality assurance resources. Commercial containers used only 26% more material handling than travel packs (8,200 / 6,500). And commercial containers required less quality assurance than travel packs. The ABC system recognizes that commercial containers do not require 3 times as much material handling and quality assurance as travel packs. So, relative to the original system, ABC allocates less of the material handling and quality assurance costs to commercial containers.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 386
(20-30 min.) P 4-52B
Req. 1
Teensy ToysPredicted Quality Cost Savings
Activity
Predicted Reduction In
Activity Units
×
Activity Cost
Allocation Rate
=
PredictedReductionIn Activity
CostsInspection of incoming materials 310 $16 $ 4,960Inspection of finished goods 310 $26 8,060Defective units discovered in-house 3,200 $15 48,000Defective units discovered by customers 850 $42 $35,700Lost sales to dissatisfied customers 330 $61 20,130 Total predicted quality cost savings $116,850
Req. 2
Teensy ToysNet Benefit of Design Engineering Effort
Total predicted quality cost savings $116,850Cost of design engineering 75,000 Net benefit of design engineering $ 41,850
Managerial Accounting 2e Solutions Manual387
(continued) P 4-52B
Req. 3
Measuring the costs of quality-related activities is difficult.
Estimating some costs, such as the cost of design engineering
to improve the quality of a particular product, may require
allocation of engineers’ salaries. Other costs, such as the cost
of lost sales, are not recorded in the accounts and are difficult
to predict. For these reasons, many companies also monitor
non-financial measures of quality (for example, number of
machine breakdowns and number of customer complaints) and
attempt to improve them.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 388
Decision Cases
(20-40 min.) C 4-53
Req. 1
Axis SystemsProduct Costs per Unit (Original Cost System)
Job A Job BDirect materials $210,000 $30,000Direct labor 160,000 12,000Allocated overhead (8,000 and 600) × $22 176,000 13,200 Total cost $546,000 $55,200Divide by number of units ÷ 100 ÷ 10 Product cost per unit $ 5,460 $ 5,520
Total cost $ 507,250 $63,200Divide by number of units ÷ 100 ÷ 10 Product cost per unit $5,072.50 $ 6,320 __________a (15,000 and 2,000) × $0.85b (6 and 4) × $500c (1,500 and 200) × $80d (1 and 1) × $1,500
The change in costs of Job A does not exactly offset the change
in costs of Job B between the original system and ABC, because
Axis has more than these two jobs. If Axis had only these two
jobs, then the change in one job’s costs would exactly offset the
change in the other job’s costs.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 390
(continued) C 4-53
Req. 3
The activity-based costing system is more accurate than the single-rate system in assigning the costs of the resources each job consumes. The single rate allocates all overhead cost based on direct labor hours. Job A units require 80 direct labor hours each (8,000 ÷ 100), and Job B units require 60 direct labor hours each (600 ÷ 10). Consequently, the single rate system assigns to each unit of Job A 133% (80 ÷ 60) of the overhead cost assigned to each unit of Job B.
But a unit of Job A does not consume 133% as much of each activity as does a unit of Job B. The data given in the problem reveal the following resource consumption patterns:
Job A Job BParts per unit 150 200Setups per unit 0.06 0.4Assembling hours per unit 15 20Shipments per unit 0.01 0.1
These data show that a unit of Job B actually consumes more of every overhead resource than a unit of Job A. The ABC system recognizes the actual resource consumption. The single rate undercosts Job B and overcosts Job A.
Students’ responses will probably not be this complete. The response above is intended to provide a basis for class discussion.
Managerial Accounting 2e Solutions Manual391
(continued) C 4-53
Req. 4
a. If Axis Systems’ managers base their decision on original
system costs, they will outsource both jobs. The original
cost system indicates that Axis can produce the A and B
jobs for $5,460 and $5,520 per unit, respectively, which is
more than the $5,400 outsourcing cost.
b. If the managers base their decision on ABC system costs,
they will only outsource Job B. The ABC system shows
that Axis Systems will incur $327.50 ($5,400 − $5,072.50)
less in costs to make the Job A units than to buy them.
Because the ABC costs are more accurate, Axis’
managers should outsource Job B and produce Job A to
maximize income.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 392
(15 min.) C 4-54
Axis SystemsOriginal and Revised Product Costs per Unit (ABC System)
Job B Original Job B RevisedDirect Materials:OriginalRevised ($3,000 × 0.90%)
Therefore, the value engineering needs a minimum cost saving
in assembling of $620 per unit ($1,600† − $980).
†$16,000 / 10 units = $1,600 assembly cost per unit from Decision Case 4-69.
Managerial Accounting 2e Solutions Manual393
Ethical Issue
(15-20 min.) I 4-55
The IMA Statement of Ethical Professional Practice includes
overarching ethical principles that express values (honesty,
fairness, objectivity and responsibility) and four standards that
guide conduct (competence, confidentiality, integrity and
credibility). Three of the four specific standards are relevant to
Mary Lipe.
Competence: Lipe has the responsibility to maintain her
professional competence (as evidenced by attending the
ABC conference), and also to apply that competence to
benefit her employer. Lipe can apply her knowledge of
ABC by identifying the Order Department as a likely
candidate for ABC.
Integrity: Lipe is responsible for communicating
unfavorable as well as favorable information and
judgments. The unfavorable outcome that some
employees may lose their jobs does not excuse Lipe from
pursuing the ABC opportunity in the Order Department.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 394
(continued) I 4-55
Credibility: Lipe is responsible for communicating all
relevant information about the ABC proposal fairly and
objectively. She should recognize the benefits and the
costs, including how cost savings will require the
termination of some employees.
Termination of long-term employees can hurt the morale of
remaining employees and possibly even subject the firm to
age-discrimination lawsuits. Therefore, Lipe should carefully
consider all the relevant implications, not just those for which
"hard" numbers are available. Lipe should consider alternatives
to terminations, such as transferring "extra" employees to
other departments, or offering early retirement packages.
Student responses will probably be less complete.
Managerial Accounting 2e Solutions Manual395
Discussion & Analysis
Discussion Questions1. Explain why departmental overhead rates might be used
instead of a single plantwide overhead rate.
A single plantwide overhead rate doesn’t always do a good job of matching the cost of overhead resources with the products that consume those resources. By using department overhead rates, companies can more equitably assign overhead to their jobs, products, or services. As a result, less cost distortion occurs and managers have more accurate information for making business decisions.
2. Using activity-based costing, why are indirect costs allocated while direct costs are not allocated?
Since direct costs can be traced to products, they are not allocated. Indirect costs, such as overhead, cannot be traced as easily as direct costs, so must be allocated to products and services.
Discuss the difference between “allocate” and “assign.”
In terms of overhead, allocation can be described as a distribution of the cost to products or services via some predetermined cost base such as machine hours. To assign overhead costs rather than allocate, a company will develop a model that refines the costs of overhead into departments or various activity pools and cost drivers. Then the overhead is traced to the products/services as they are used.
3. Compare and contrast activity-based costing (ABC) and
activity-based management (ABM).
Chapter 4 Activity-Based Costing and Other Cost Management Tools 396
ABC focuses on activities as the fundamental cost objects. The costs of those activities become building blocks for compiling the indirect costs of products, services, and customers.
ABM uses ABC information to make decisions that increase profits while satisfying customers’ needs.
4. How can using a single predetermined manufacturing overhead rate based on a unit-level cost driver cause a high-volume product to be overcosted?
When a company uses a plantwide allocation system that is based on a volume-related driver, such as direct labor hours, the high-volume products will be allocated more cost than the low volume products simply because there are more of them produced, not necessarily because they use more overhead. This can result in the higher volume product being overcosted.
5. Assume a company uses a plantwide predetermined manufacturing overhead rate that is calculated using direct labor hours as the cost driver. The use of this plantwide predetermined manufacturing overhead rate has resulted in cost distortion. The company’s high-volume products are overcosted and its low-volume products are undercosted. What effects of this cost distortion will the company most likely be experiencing?
A company that overcosts its high-volume products may be experiencing low sales while the undercosted low-volume products are experiencing high sales.
Why might the cost distortion be harmful to the company’s competitive position in the market?
Managerial Accounting 2e Solutions Manual397
The cost distortion can be harmful to a company’s competitive position in the market because they could be losing sales of their high-volume products due to the overcosting and therefore over-pricing. They could also be harmed by losing money on the undercosted low-volume products due to under-pricing.
6. A hospital can use activity-based costing (ABC) for costing its services. In a hospital, what activities might be considered to be value-added activities?
Operating on a patient Dispensing medication to a patient Evaluating test results
What activities at that hospital might be considered to be non-value-added?
Waiting for a procedure Fixing equipment Inspecting prescriptions
7. A company makes shatterproof, waterproof cases for iPhones. The company makes only one model and has been very successful in marketing its case; no other company in the market has a similar product. The only customization available to the customer is the color of the case. There is no manufacturing cost difference between the different colors of the cases. Since this company has a high-volume product, its controller thinks that the company should adopt activity-based costing. Why might activity-based costing not be as beneficial for this company as for other companies?
Activity-based costing is beneficial to companies who are in highly competitive markets produce many different products that require different
types and amounts of resources Chapter 4 Activity-Based Costing and Other Cost Management Tools 398
produce high volume of some products and low volume of others.
Since this company does not fit into these categories, it might not be beneficial for them to incur the cost of developing and using ABC.
8. Compare a traditional production system with a lean production system. Discuss the similarities and the differences.
Some of the differences between a traditional production system and a lean production system are like machines grouped together vs. production cells longer vs. shorter setup times larger vs. smaller batches higher vs. lower inventories many suppliers vs. fewer, well-coordinated suppliers single tasked labor vs. wider range of labor tasks longer vs. shorter manufacturing cycles
Similarities include machinery needed labor needed inspection of products
9. It has been said that external failure costs can be catastrophic and much higher than the other categories. What are some examples of external failure costs?
Lost sales Sales returns Warranty repairs/replacements
Why is it often difficult to arrive at the cost of external failures?
Managerial Accounting 2e Solutions Manual399
Often the largest external failure cost - lost sales/profits - is hard to measure because of its nature. There are no records kept of lost sales. They must be estimated using subjective experiences and judgments. Defect rates, the number of customer complaints, and warranty repairs/replacements can help in the estimation.
10. What are the four categories of quality-related costs? Name a cost in each of the four categories for each of the following types of organizations:a. Restaurantb. Hospitalc. Law firmd. Banke. Tire manufacturerf. University
The four categories of quality-related costs are prevention, appraisal, internal failure costs, and external failure costs.
Chapter 4 Activity-Based Costing and Other Cost Management Tools 400
Prevention Appraisal Internal Failure Costs
External Failure Costs
a. Restaurant
Training for cooks/servers
Wait staff inspects orders before serving
Meals not as ordered
Mold/insect found on meal by customer
b. Hospital Training for ER employees
Evaluating an ER patient
Reissuing medication due to inaccurate recording
Re-casting improperly set broken arm
c. Law firm Training for paralegals
Attorney review of paralegal’s work
Underestimated case time
Losing a case due to carelessness
d. Bank Training for tellers
Manager approval for certain transactions
Cashed an NSF check
Customer reporting bank error on statement
e. Tire manufacturer
Training for factory employees
Tires inspected before shipping
Tires returned to factory for rework or scraped
Warranty repairs
f. University
Training for admissions staff
Dean approval for departmental
Canceled classes
Losing alumni support
Managerial Accounting 2e Solutions Manual401
budgets
Application & Analysis4-1 ABC in Real CompaniesBasic Discussion Questions1. Describe the company selected, including its products or services.
A bookstore provides books and other products to its customers. In addition, it could offer events such as book signings or book clubs for its customers.
2. List eight key activities performed at this company. Choose at least one activity in the areas of production, sales, human resources, and accounting.
1. Process customer purchases2. Process customer special orders3. Handle customer inquiries4. Hiring and training new employees5. Stock shelves6. Advertise events7. Close out cash registers daily8. Record daily transactions
3. For each of the key activities, list a potential cost driver for that activity and describe why this cost driver would be appropriate for the associated activity.
1. customer sales2. special orders3. customer inquiries4. training sessions held5. packages delivered6. events scheduled 7. cash registers used8. bookkeeper’s hours
Chapter 4 Activity-Based Costing and Other Cost Management Tools 402