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Managerial Accounting - Decision Making and Motivating Performance

Srikant M. Datar, Madhav V. Rajan

Chapter 6

Activity-Based Costing and Activity-Based Management - all with Video Answers

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Chapter Questions

01:19

Problem 1

What is broad averaging and what consequences can it have on costs?

Ameer Said
Ameer Said
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02:17

Problem 2

Why is it important to classify costs into a cost hierarchy?

Ameer Said
Ameer Said
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04:48

Problem 3

What are the key reasons for product-cost differences between simple costing systems and ABC systems?

Ameer Said
Ameer Said
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Problem 4

What is the benefit of distinguishing costs incurred from resources used?

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05:37

Problem 5

Describe four signs that help indicate when ABC systems are likely to provide the most benefits.

Ameer Said
Ameer Said
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02:11

Problem 6

Describe four decisions for which $\mathrm{ABC}$ information is useful. What are the main costs and limitations of implementing ABC systems?

Ameer Said
Ameer Said
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02:13

Problem 7

"ABC systems only apply to manufacturing companies." Do you agree? Explain.

Ameer Said
Ameer Said
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00:56

Problem 8

"Activity-based costing is the wave of the present and the future. All companies should adopt it." Do you agree? Explain.
controller respond?

Amany Waheeb
Amany Waheeb
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00:49

Problem 9

"Increasing the number of indirect-cost pools is guaranteed to sizably increase the accuracy of product or service costs." Do you agree? Why?

Amany Waheeb
Amany Waheeb
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01:13

Problem 10

The controller of a retail company has just had a $$\$ 50,000$$ request to implement an $A B C$ system quickly turned down. A senior vice president, in rejecting the request, noted, "Given a choice, I will always prefer a $$\$ 50,000$$ investment in improving things a customer sees or experiences, such as our shelves or our store layout. How does a customer benefit by our spending $$\$ 50,000$$ on a supposedly better accounting system?" How should the

Amany Waheeb
Amany Waheeb
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10:17

Problem 11

Cost hierarchy. Harrison, Inc., manufactures karaoke machines for several well-known companies. The machines differ significantly in their complexity and their manufacturing batch sizes. The following costs were incurred in 2013:
a. Indirect manufacturing labor costs such as supervision that supports direct manufacturing labor, $$\$ 725,000$$
b. Procurement costs of placing purchase orders, receiving materials, and paying suppliers related to the number of purchase orders placed, $$\$ 425,000$$
c. Cost of indirect materials, $$\$ 137,500$$
d. Costs incurred to set up machines each time a different product needs to be manufactured, $$\$ 315,000$$
e. Designing processes, drawing process charts, making engineering process changes for products, $$\$ 387,500$$
f. Machine-related overhead costs such as depreciation, maintenance, and production engineering, $$\$ 750,000$$ (These resources relate to the activity of running the machines.)
g. Plant management, plant rent, and plant insurance, $$\$ 462,500$$
1. Classify each of the preceding costs as output unit-level, batch-level, product-sustaining, or facilitysustaining. Explain each answer.
2. Consider two types of karaoke machines made by Harrison, Inc. One machine, designed for professional use, is complex to make and is produced in many batches. The other machine, designed for home use, is simple to make and is produced in few batches. Suppose that Harrison needs the same number of machine-hours to make each type of karaoke machine and that Harrison allocates all overhead costs using machine-hours as the only allocation base. How, if at all, would the machines be miscosted? Briefly explain why.
3. How is the cost hierarchy helpful to Harrison in managing its business?

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator

Problem 12

ABC, cost hierarchy, service. (CMA, adapted) Ayer Test Laboratories does heat testing (HT) and stress testing (ST) on materials and operates at capacity. Under its current simple costing system, Ayer aggregates all operating costs of $$\$ 1,330,000$$ into a single overhead cost pool. Ayer calculates a rate per test-hour of $$\$ 14$$ ( $$\$ 1,330,000 \div 95,000$$ total test-hours). HT uses 55,000 test-hours, and ST uses 40,000 test-hours. Gary Daley, Ayer's controller, believes that there is enough variation in test procedures and cost structures to establish separate costing and billing rates for HT and ST. The market for test services is becoming competitive. Without this information, any miscosting and mispricing of its services could cause Ayer to lose business. Daley divides Ayer's costs into four activity-cost categories.
a. Direct-labor costs, $$\$ 222,000$$. These costs can be directly traced to $$\mathrm{HT}, \$ 155,000$$, and $$\mathrm{ST}, \$ 67,000$$.
b. Equipment-related costs (rent, maintenance, energy, and so on), $$\$ 475,000$$. These costs are allocated to HT and ST on the basis of test-hours.
c. Setup costs, $$\$ 385,000$$. These costs are allocated to HT and ST on the basis of the number of setup-hours required. HT requires 13,000 setup-hours, and ST requires 4,500 setup-hours.
d. Costs of designing tests, $$\$ 248,000$$. These costs are allocated to HT and ST on the basis of the time required for designing the tests. HT requires 3,000 hours, and ST requires 1,000 hours.
1. Classify each activity cost as output unit-level, batch-level, product- or service-sustaining, or facilitysustaining. Explain each answer.
2. Calculate the cost per test-hour for $$\mathrm{HT}$$ and $$\mathrm{ST}$$ using $\mathrm{ABC}$. Explain briefly the reasons why these numbers differ from the $$\$ 14$$ per test-hour that Ayer calculated using its simple costing system.
3. Explain the accuracy of the product costs calculated using the simple costing system and the ABC system. How might Ayer's management use the cost hierarchy and ABC information to better manage its business?

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Problem 13

Alternative allocation bases for a professional services firm. The Wilmer Group (WG) provides tax advice to multinational firms. WG charges clients for (a) direct professional time (at an hourly rate) and (b) support services (at $30 \%$ of the direct professional costs billed). The three professionals in WG and their rates per professional hour are as follows.$$
\begin{array}{c|c}
\hline \text { Professional } & \text { Billing Rate per Hour } \\
\hline \text { Mark Wilmer } & \$ 500 \\
\text { Ashley Bennet } & 170 \\
\text { John Amesbury } & 70 \\
\hline
\end{array}
$$
WG has just prepared the May 2013 bills for two clients. The hours of professional time spent on each client are as follows.
(TABLE CAN'T COPY)
1. What amounts did WG bill to San Antonio Dominion and Amsterdam Enterprises for May 2013 ?
2. Suppose support services were billed at $$\$ 55$$ per professional labor-hour (instead of $30 \%$ of professional labor costs). How would this change affect the amounts WG billed to the two clients for May 2013? Comment on the differences between the amounts billed in requirements 1 and 2 .
3. How would you determine whether professional labor costs or professional labor-hours is the more appropriate allocation base for WG's support services?

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Problem 14

Plantwide and ABC indirect cost rates. Driven Products (DP) designs and produces automotive parts. In 2013, actual manufacturing overhead is $$\$ 617,200$$. DP's simple costing system allocates manufacturing overhead to its three customers based on machine-hours and prices its contracts based on full costs. One of its customers has regularly complained of being charged noncompetitive prices, so DP's controller Mike Jones realizes that it is time to examine the consumption of overhead resources more closely by adopting an activity-based costing (ABC) system. He knows that there are three main activities that consume overhead resources: design, production, and engineering. Interviews with operating personnel and examination of time records yield the following detailed information:
(TABLE CAN'T COPY)
1. Compute the manufacturing overhead allocated to each customer in 2013 using the simple costing system that uses machine-hours as the allocation base.
2. Compute the manufacturing overhead allocated to each customer in 2013 using activity-based manufacturing overhead rates.
3. Comment on your answers in requirements 1 and 2 . Which customer do you think was complaining about being overcharged in the simple system? If the new activity-based rates are used to price contracts, which customer(s) will be unhappy? How would you respond to these concerns?
4. How else might DP use the information available from its activity-based costing analysis of manufacturing overhead costs?
5. DP's managers are wondering if they should further refine the ABC system by identifying more activities. Under what conditions would it not be worthwhile to further refine the ABC system?

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38:52

Problem 15

Department and activity-cost rates. Triumph Trophies makes trophies and plaques and operates at capacity. Triumph does large custom orders, such as the participant trophies for the Minnetonka Little League. The controller has asked you to compare Triumph's current costing system that allocates total overhead costs of each department to products and an activity-based costing system.
Triumph Trophies Budgeted Information for the Year Ended November 30, 2013
$$
\begin{array}{l|r|r|r|}
\hline \text { Forming Department } & \text { Trophies } & \text { Plaques } & \text { Total } \\
\hline \text { Direct materials } & \$ 26,000 & \$ 22,500 & \$ 48,500 \\
\text { Direct manufacturing labor } & 31,200 & 18,000 & 49,200 \\
\text { Overhead costs } & & & \\
\quad \text { Setup } & & & 24,000 \\
\quad \text { Supervision } & & & 20,772 \\
\hline
\end{array}
$$
$$
\begin{array}{l|r|r|r}
\hline \text { Assembly Department } & \text { Trophies } & \text { Plaques } & \text { Total } \\
\hline \text { Direct materials } & \$ 5,200 & \$ 18,750 & \$ 23,950 \\
\text { Direct manufacturing labor } & 15,600 & 21,000 & 36,600 \\
\text { Overhead costs } & & & \\
\quad \text { Setup } & & & 46,000 \\
\quad \text { Supervision } & & & 21,920 \\
\hline
\end{array}
$$
Other information follows.
Setup costs in each department vary with the number of batches processed in each department. The budgeted number of batches for each product line in each department is as follows.
$$
\begin{array}{l|c|c}
\hline & \text { Trophias } & \text { Plaques } \\
\hline \text { Forming department } & 40 & 116 \\
\text { Assembly department } & 43 & 103 \\
\hline
\end{array}
$$
Supervision costs in each department vary with direct manufacturing labor costs in each department.
1. Calculate the budgeted cost of trophies and plaques based on departmental overhead rates, where forming department overhead costs are allocated based on direct manufacturing labor costs of the forming department, and assembly department overhead costs are allocated based on total direct costs of the assembly department.
2. Calculate the budgeted cost of trophies and plaques if Triumph allocates overhead costs in each department using activity-based costing.
3. Explain how the disaggregation of information could improve or reduce decision quality.

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator

Problem 16

ABC, process costing. Potvin Company produces mathematical and financial calculators and operates at capacity. Data related to the two products are presented here:$$
\begin{aligned}
&\begin{array}{l|r|r|}
\hline & \text { Mathematical } & \text { Financial } \\
\hline \text { Annual production in units } & 25,000 & 50,000 \\
\text { Direct material costs } & \$ 62,500 & \$ 125,000 \\
\text { Direct manufacturing labor costs } & \$ 25,000 & \$ 50,000 \\
\text { Direct manufacturing labor-hours } & 1,250 & 2,500 \\
\text { Machine-hours } & 20,000 & 50,000 \\
\text { Number of production runs } & 50 & 50 \\
\text { Inspection hours } & 800 & 400 \\
\hline
\end{array}\\
&\text { Total manufacturing overhead costs are as follows. }
\end{aligned}
$$
$$
\begin{array}{l|r}
\hline & \text { Total } \\
\hline \text { Machining costs } & \$ 350,000 \\
\text { Setup costs } & 117,000 \\
\text { Inspection costs } & 96,000 \\
\hline
\end{array}
$$
1. Choose a cost driver for each overhead cost pool and calculate the manufacturing overhead cost per unit for each product.
2. Compute the manufacturing cost per unit for each product.
3. How might Potvin use the new cost information from its activity-based costing system to better manage its business?

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Problem 17

Activity-based costing, service company. Speediprint Corporation owns a small printing press that prints leaflets, brochures, and advertising materials. Speediprint classifies its various printing jobs as standard jobs or special jobs. Speediprint's simple job-costing system has two direct-cost categories (direct materials and direct labor) and a single indirect-cost pool. Speediprint operates at capacity and allocates all indirect costs using printing machine-hours as the allocation base.

Speediprint is concerned about the accuracy of the costs assigned to standard and special jobs and therefore is planning to implement an activity-based costing system. Speediprint's ABC system would have the same direct-cost categories as its simple costing system. However, instead of a single indirect-cost pool there would now be six categories for assigning indirect costs: design, purchasing, setup, printing machine operations, marketing, and administration. To see how activity-based costing would affect the costs of standard and special jobs, Speediprint collects the following information for the fiscal year 2013 that just ended.
(TABLE CAN'T COPY)

1. Calculate the cost of a standard job and a special job under the simple costing system.
2. Calculate the cost of a standard job and a special job under the activity-based costing system.
3. Compare the costs of a standard job and a special job in requirements 1 and 2 . Why do the simple and activity-based costing systems differ in the cost of a standard job and a special job?
4. How might Speediprint use the new cost information from its activity-based costing system to better manage its business?

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Problem 18

Activity-based costing, manufacturing. Decorative Doors, Inc., produces two types of doors, interior and exterior. The company's simple costing system has two direct cost categories (materials and labor) and one indirect cost pool. The simple costing system allocates indirect costs on the basis of machine-hours. Recently, the owners of Decorative Doors have been concerned about a decline in the market share for their interior doors, usually their biggest seller. Information related to Decorative Doors production for the most recent year follows.
$$
\begin{array}{|c|c|c|}
\hline & \text { Interior } & \text { Exterior } \\
\hline \text { Units sold } & 3,200 & 1,800 \\
\hline \text { Selling price } & \$ 125 & \$ 200 \\
\hline \text { Direct material cost per unit } & \$ \quad 30 & \$ 45 \\
\hline \text { Direct manufacturing labor cost per hour } & \$ \quad 16 & \$ 16 \\
\hline \text { Direct manufacturing labor-hours per unit } & 1.50 & 2.25 \\
\hline \text { Production runs } & 40 & 85 \\
\hline \text { Material moves } & 72 & 168 \\
\hline \text { Machine setups } & 45 & 155 \\
\hline \text { Machine-hours } & 5,500 & 4,500 \\
\hline \text { Number of inspections } & 250 & 150 \\
\hline
\end{array}
$$
The owners have heard of other companies in the industry that are now using an activity-based costing system and are curious how an ABC system would affect their product costing decisions. After analyzing the indirect cost pool for Decorative Doors, six activities were identified as generating indirect costs: production scheduling, material handling, machine setup, assembly, inspection, and marketing. Decorative Doors collected the following data related to the indirect cost activities:(TABLE CAN'T COPY)
Marketing costs were determined to be $3 \%$ of the sales revenue for each type of door.
1. Calculate the cost of an interior door and an exterior door under the existing simple costing system.
2. Calculate the cost of an interior door and an exterior door under an activity-based costing system.
3. Compare the costs of the doors in requirements 1 and 2 . Why do the simple and activity-based costing systems differ in the cost of an interior and exterior door?
4. How might Decorative Doors, Inc., use the new cost information from its activity-based costing system to address the declining market share for interior doors?

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Problem 19

ABC, retail product-line profitability. Granger Supermarkets (GS) operates at capacity and decides to apply ABC analysis to three product lines: baked goods, milk and fruit juice, and frozen foods. It identifies four activities and their activity cost rates:$$
\begin{array}{ll}
\text { Ordering } & \$ 98 \text { per purchase order } \\
\text { Delivery and receipt of merchandise } & \$ 81 \text { per delivery } \\
\text { Shelf-stocking } & \$ 22 \text { per hour } \\
\text { Customer support and assistance } & \$ 0.18 \text { per item sold }
\end{array}
$$
The revenues, cost of goods sold, store support costs, the activities that account for the store support costs, and activity-area usage of the three product lines are as follows.$$
\begin{array}{l|c|c|c|}
\hline & \text { Baked Goods } & \text { Milk and Fruit Juice } & \text { Frozen Prodicts } \\
\hline \text { Financial data } & & & \\
\text { Revenues } & \$ 58,000 & \$ 64,000 & \$ 52,500 \\
\text { Cost of goods sold } & \$ 37,000 & \$ 45,000 & \$ 36,000 \\
\text { Store support } & \$ 11,100 & \$ 13,500 & \$ 10,800 \\
\text { Activity-area usage (cost-allocation base) } & & & \\
\text { Ordering (purchase orders) } & 35 & 30 & 20 \\
\text { Delivery (deliveries) } & 175 & 45 & 30 \\
\text { Shelf-stocking (hours) } & 12,000 & 155 & 25 \\
\text { Customer support (items sold) } & 16,000 & 7,000 \\
\hline
\end{array}
$$
Under its simple costing system, GS allocated support costs to products at the rate of $30 \%$ of cost of goods sold.
1. Use the simple costing system to prepare a product-line profitability report for GS.
2. Use the $A B C$ system to prepare a product-line profitability report for $G S$.
3. What new insights does the ABC system in requirement 2 provide to GS's managers?

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26:59

Problem 20

ABC, wholesale, customer profitability. Ruiz Wholesalers operates at capacity and sells furniture items to four department-store chains (customers). Mr. Ruiz commented, "We apply ABC to determine product-line profitability. The same ideas apply to customer profitability, and we should find out our customer profitability as well." Ruiz Wholesalers sends catalogs to corporate purchasing departments on a monthly basis. The customers are entitled to return unsold merchandise within a 6 -month period from the purchase date and receive a full purchase price refund. The following data were collected from last year's operations:(TABLE CAN'T COPY)$$
\begin{aligned}
&\text { Ruiz has calculated the following activity rates: }\\
&
\end{aligned}
$$

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator

Problem 21

ABC, activity area cost-driver rates, product cross-subsidization.
Ionia Potatoes (IP) operates at capacity and processes potatoes into potato cuts at its highly automated Pocatello plant. It sells potatoes to the retail consumer market and to the institutional market, which includes hospitals, cafeterias, and university dormitories.

IP's simple costing system, which does not distinguish between potato cuts processed for retail and institutional markets, has a single direct-cost category (direct materials; that is, raw potatoes) and a single indirect-cost pool (production support). Support costs, which include packaging materials, are allocated on the basis of pounds of potato cuts processed. The company uses $1,800,000$ pounds of raw potatoes to process $1,600,000$ pounds of potato cuts. At the end of 2013 , IP unsuccessfully bid for a large institutional contract. Its bid was reported to be $30 \%$ above the winning bid. This feedback came as a shock because IP included only a minimum profit margin on its bid, and the Pocatello plant was acknowledged as the most efficient in the industry.

As a result of its review process of the lost contract bid, IP decided to explore ways to refine its costing system. The company determined that $90 \%$ of the direct materials (raw potatoes) related to the retail market and $10 \%$ to the institutional market. In addition, the company identified that packaging materials could be directly traced to individual jobs ( $$\$ 190,000$$ for retail and $$\$ 9,000$$ for institutional). Also, the company used $A B C$ to identify three main activity areas that generated support costs: cleaning, cutting, and packaging.
- Cleaning Activity Area-The cost-allocation base is pounds of raw potatoes cleaned.
- Cutting Activity Area -The production line produces (a) 150 pounds of retail potato cuts per cutting-hour and (b) 200 pounds of institutional potato cuts per cutting-hour. The cost-allocation base is cutting-hourČ™ on the production line.
- Packaging Activity Area-The packaging line packages (a) 25 pounds of retail potato cuts per packaging-hour and (b) 80 pounds of institutional potato cuts per packaging-hour. The cost-allocation base is packaging-hours on the production line.
The following table summarizes the actual costs for 2013 before and after the preceding cost analysis.
(TABLE CAN'T COPY)

1. Using the simple costing system, what is the cost per pound of potato cuts produced by IP?
2. Calculate the cost rate per unit of the cost driver in the (a) cleaning, (b) cutting, and (c) packaging activity areas.
3. Suppose IP uses information from its activity cost rates to calculate costs incurred on retail potato cuts and institutional potato cuts. Using the ABC system, what is the cost per pound of (a) retail potato cuts and (b) institutional potato cuts?
4. Comment on the cost differences between the two costing systems in requirements 1 and 3 . How might IP use the information in requirement 3 to make better decisions?

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Problem 22

Activity-based costing. The job costing system at Sheri's Custom Framing has five indirect cost pools (purchasing, material handling, machine maintenance, product inspection, and packaging). The company is in the process of bidding on two jobs; Job 215, an order of 15 intricate personalized frames, and Job 325, an order of 6 standard personalized frames. The controller wants you to compare overhead allocated under the current simple job-costing system and a newly designed activity-based job-costing system. Total budgeted costs in each indirect cost pool and the budgeted quantity of activity driver are as follows.
(TABLE CAN'T COPY)
Information related to Job 215 and Job 325 follows. Job 215 incurs more batch-level costs because it uses more types of materials that need to be purchased, moved, and inspected relative to Job 325 .
(TABLE CAN'T COPY)
1. Compute the total overhead allocated to each job under a simple costing system, where overhead is allocated based on machine-hours.
2. Compute the total overhead allocated to each job under an activity-based costing system using the appropriate activity drivers.
3. Explain why Sheri's Custom Framing might favor the ABC job-costing system over the simple job-costing system, especially in its bidding process.

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Problem 23

ABC, product costing at banks, cross-subsidization. United International Bank (UIB) is examining the profitability of its Premier Account, a combined savings and checking account. Depositors receive a $7 \%$ annual interest rate on their average deposit. UIB earns an interest rate spread of $3 \%$ (the difference between the rate at which it lends money and the rate it pays depositors) by lending money for home loan purposes at $10 \%$. Thus, UIB would gain $$\$ 60$$ on the interest spread if a depositor had an average Premier Account balance of $$\$ 2,000$$ in $$2013(\$ 2,000 \times 3 \%=\$ 60)$$.

The Premier Account allows depositors unlimited use of services such as deposits, withdrawals, checking accounts, and foreign currency drafts. Depositors with Premier Account balances of $$\$ 1,000$$ or more receive unlimited free use of services. Depositors with minimum balances of less than $$\$ 1,000$$ pay a $$\$ 20$$-a-month service fee for their Premier Account.

UIB recently conducted an activity-based costing study of its services. It assessed the following costs for six individual services. The use of these services in 2013 by three customers is as follows.

Assume Harvin and Flynn always maintain a balance above $\$ 1,000$, whereas Slaton always has a balance below $\$ 1,000$.
1. Compute the 2013 profitability of the Harvin, Slaton, and Flynn Premier Accounts at UIB.
2. Why might UIB worry about the profitability of individual customers if the Premier Account product offering is profitable as a whole?
3. What changes would you recommend for UIB's Premier Account?

(TABLE CAN'T COPY)

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Problem 24

Job costing with single direct-cost category, single indirectcost pool, law firm. Timlin Associates is a recently formed law partnership. Ellery Hanley, the managing partner of Timlin Associates, has just finished a tense phone call with Martin Offiah, president of Widnes Coal. Offiah strongly complained about the price Timlin charged for some legal work done for Widnes Coal.

Hanley also received a phone call from its only other client, St. Helen's Glass, which was very pleased with both the quality of the work and the price charged on its most recent job.

Timlin Associates operates at capacity and uses a cost-based approach to pricing (billing) each job. Currently, it uses a simple costing system with a single direct-cost category (professional labor-hours) and a single indirect-cost pool (general support). Indirect costs are allocated to cases on the basis of professional labor-hours per case. The job files show the following:$$
\begin{array}{l|c|c}
\hline & \text { Widnes Coal } & \text { St. Helen's Class } \\
\hline \text { Professional labor } & 115 \text { hours } & 95 \text { hours } \\
\hline
\end{array}
$$
Professional labor costs at Timlin Associates are $$\$ 83$$ an hour. Indirect costs are allocated to cases at $$\$ 120$$ an hour. Total indirect costs in the most recent period were $$\$ 25,200$$.
1. Why is it important for Timlin Associates to understand the costs associated with individual jobs?
2. Compute the costs of the Widnes Coal and St. Helen's Glass jobs using Timlin's simple costing system.

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Problem 25

Job costing with multiple direct-cost categories, single indirectcost pool, law firm (continuation of 6-24). Hanley asks his assistant to collect details on those costs included in the $$\$ 25,200$$ indirect-cost pool that can be traced to each individual job. After analysis, Timlin is able to reclassify $$\$ 18,900$$ of the $$\$ 25,200$$ as direct costs:
(TABLE CAN'T COPY)

Hanley decides to calculate the costs of each job as if Timlin had used six direct cost-pools and a single indirectcost pool. The single indirect-cost pool would have $$\$ 6,300$$ of costs and would be allocated to each case using the professional labor-hours base.
1. What is the revised indirect-cost allocation rate per professional labor-hour for Timlin Associates when total indirect costs are $$\$ 6,300$$ ?
2. Compute the costs of the Widnes and St. Helen's jobs if Timlin Associates had used its refined costing system with multiple direct-cost categories and one indirect-cost pool.
3. Compare the costs of the Widnes and St. Helen's jobs in requirement 2 with those in requirement 2 in Problem 6-24. Comment on the results.
6

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Problem 26

Job costing with multiple direct-cost categories, multiple indirect-cost pools, law firm (continuation of 6-24 and 6-25). Timlin has two classifications of professional staff: partners and associates. Hanley asks his assistant to examine the relative use of partners and associates on the recent Widnes Coal and St. Helen's jobs. The Widnes job used 30 partner-hours and 85 associate-hours. The St. Helen's job used 60 partner-hours and 35 associate-hours. Therefore, totals of the two jobs together were 90 partner-hours and 120 associate-hours. Hanley decides to examine how using separate direct-cost rates for partners and associates and using separate indirect-cost pools for partners and associates would have affected the costs of the Widnes and St. Helen's jobs. Indirect costs in each indirect-cost pool would be allocated on the basis of total hours of that category of professional labor. From the total indirect cost-pool of $$\$ 6,300, \$ 3,600$$ is attributable to the activities of partners, and $$\$ 2,700$$ is attributable to the activities of associates.
The rates per category of professional labor are as follows.$$
\begin{array}{l|c|c}
\hline \text { Category of Professional Labor } & \text { Direct Cost per Hour } & \text { Indirect Cost per Hour } \\
\hline \text { Partner } & \$ 115.00 & \$ 3,600 \div 90 \text { hours }=\$ 40.00 \\
\text { Associate } & 59.00 & \$ 2,700 \div 120 \text { hours }=\$ 22.50 \\
\hline
\end{array}
$$
1. Compute the costs of the Widnes and St. Helen's cases using Timlin's further refined system, with multiple direct-cost categories and multiple indirect-cost pools.
2. For what decisions might Timlin Associates find it more useful to use this job-costing approach rather than the approaches in Problem 6-24 or 6-25?

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Problem 27

First stage allocation, activity-based costing, manufacturing sector. Marshall Precision Devices uses activity-based costing to allocate overhead to customer orders for pricing purposes. Many customer orders are won through competitive bidding. Direct material and direct manufacturing labor costs are traced directly to each order. Marshall's direct manufacturing labor rate is $$\$ 18$$ per hour. The company reports the following yearly overhead costs:
$$
\begin{array}{lr}
\text { Wages and salaries } & \$ 400,000 \\
\text { Depreciation } & 50,000 \\
\text { Rent } & 100,000 \\
\text { Other overhead } & \underline{200,000} \\
\text { Total overhead costs } & \underline{\$ 750,000} \\
\hline
\end{array}
$$Marshall has established four activity cost pools:
$$
\begin{array}{|c|c|c|}
\hline \text { Activity Cost Pool } & \text { Activity Measure } & \text { Total Activity for the Year } \\
\hline \text { Direct manufacturing labor support } & \text { Number of direct manufacturing labor-hours } & 30,000 \text { direct manufacturing labor-hours } \\
\hline \text { Order processing } & \text { Number of customer orders } & 500 \text { orders } \\
\hline \text { Design support } & \text { Number of custom designs } & 100 \text { custom designs } \\
\hline \text { Other } & \begin{array}{l}
\text { Facility-sustaining costs that are not allocated to } \\
\text { orders }
\end{array} & \text { Not applicable } \\
\hline
\end{array}
$$
Only about $20 \%$ of Marshall's yearly orders require custom designs.
Jen Chandler, Marshall's controller, has prepared the following estimates regarding distribution of the overhead costs across the four activity cost pools:$$
\begin{array}{l|c|c|c|c|c}
\hline & \begin{array}{c}
\text { Direct } \\
\text { Manufacturing } \\
\text { Labor Support }
\end{array} & \begin{array}{c}
\text { Order } \\
\text { Processing }
\end{array} & \begin{array}{c}
\text { Design } \\
\text { Support }
\end{array} & \text { Other } & \text { Total } \\
\hline \text { Wages and salaries } & 50 \% & 25 \% & 20 \% & 5 \% & 100 \% \\
\text { Depreciation } & 25 \% & 10 \% & 15 \% & 50 \% & 100 \% \\
\text { Rent } & 30 \% & 5 \% & 10 \% & 55 \% & 100 \% \\
\text { Other overhead } & 40 \% & 20 \% & 15 \% & 25 \% & 100 \% \\
\hline
\end{array}
$$
Order 448200 required $$\$ 10,550$$ of direct materials, 120 direct manufacturing labor-hours, and one custom design.
1. Allocate the overhead costs to each activity cost pool. Calculate the activity rate for each pool.
2. Determine the cost of Order 448200 .
3. How does activity-based costing enhance Marshall's ability to price its orders? If Marshall used a traditional costing system allocating all overhead to orders on the basis of direct manufacturing labor-hours, how might this have impacted Marshall's profitability?

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Problem 28

Department and activity-cost rates, service sector. Raynham's Radiology Center (RRC) performs X-rays, ultrasounds, computer tomography (CT) scans, and magnetic resonance imaging (MRI). RRC has developed a reputation as a top Radiology Center in the state. RRC has achieved this status because it constantly reexamines its processes and procedures. RRC has been using a single, facilitywide overhead allocation rate. The vice president of finance believes that RAC can make better process improvements if it uses more disaggregated cost information. She says, "We have state-of-the-art medical imaging technology. Can't we have state-of-the-art accounting technology?"
$$
\begin{aligned}
&\text { Raynham's Radiology Center Budgeted Information for the Year Ended May 30, } 2013\\
&
\end{aligned}
$$(TABLE CAN'T COPY)
$$
\begin{aligned}
&\text { RRC operates at capacity. The proposed allocation bases for overhead are: }\\
&\begin{array}{ll}
\text { Administration } & \text { Number of procedures } \\
\text { Maintenance (including parts) } & \text { Capital cost of the equipment (use Depreciation) } \\
\text { Sanitation } & \text { Total cleaning minutes } \\
\text { Utilities } & \text { Total procedure minutes }
\end{array}
\end{aligned}
$$
1. Calculate the budgeted cost per service for X-rays, ultrasounds, CT scans, and MRI using direct technician labor costs as the allocation basis.
2. Calculate the budgeted cost per service of X-rays, ultrasounds, CT scans, and MRI if RRC allocated overhead costs using activity-based costing.
3. Explain how the disaggregation of information could be helpful to RRC's intention to continuously improve its services.

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Problem 29

First-stage allocation, activity-based costing, service sector.
Green Thumb, Inc., provides lawn care and landscaping services to commercial clients. Green Thumb uses activitybased costing to bid on jobs and to evaluate their profitability. Green Thumb reports the following annual costs:$$
\begin{array}{lr}
\text { Wages and salaries } & \$ 300,000 \\
\text { Depreciation } & 60,000 \\
\text { Supplies } & 100,000 \\
\text { Other overhead } & \underline{240,000} \\
\text { Total overhead costs } & \underline{\$ 700,000} \\
\hline
\end{array}
$$$$
\begin{aligned}
&\text { John Gibson, controller of Green Thumb, has established four activity cost pools: }\\
&
\end{aligned}
$$(TABLE CAN'T COPY)
$$
\begin{aligned}
&\text { He estimates that Green Thumb's costs are distributed to the activity-cost pools as follows. }\\
&\begin{array}{l|c|c|c|c|c|}
\hline & \text { Estimating Jobs } & \text { Lawn Care } & \text { Landiscape Design } & \text { Other } & \text { Total } \\
\hline \text { Wages and salaries } & 5 \% & 70 \% & 15 \% & 10 \% & 100 \% \\
\text { Depreciation } & 10 \% & 65 \% & 10 \% & 15 \% & 100 \% \\
\text { Supplies } & 0 \% & 100 \% & 0 \% & 0 \% & 100 \% \\
\text { Other overhead } & 15 \% & 50 \% & 20 \% & 15 \% & 100 \% \\
\hline
\end{array}
\end{aligned}
$$
Vista Office Park, a new development in a nearby community, has contacted Green Thumb to provide an estimate on landscape design and annual lawn maintenance. The job is estimated to require a single landscape design requiring 40 design hours in total and 250 direct labor-hours annually. Green Thumb has a policy of pricing estimates at $150 \%$ of allocated cost.
1. Allocate Green Thumb's costs to the activity-cost pools and determine the activity rate for each pool.
2. Estimate total cost for the Vista Office Park job.
3. How much should Green Thumb bid to perform the job?
4. Vista Office Park asks Green Thumb to give an estimate for providing its services for a 2-year period. What are the advantages and disadvantages for Green Thumb to provide a 2-year estimate??

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Problem 30

Activity-based costing, merchandising. Medtech, Inc., a distributor of special pharmaceutical products, operates at capacity and has three main market segments:
a. General supermarket chains
b. Drugstore chains
c. Mom-and-pop single-store pharmacies

Evan Kennedy, the new controller of Medtech, reported the following data for 2013:$$
\begin{array}{l|c|c|c|c}
\hline & \text { Ceneral Supermarket Chains } & \text { Drugstore Chains } & \text { Mom-and-Pop Single Store } & \text { Wedtech } \\
\hline \text { Revenues } & \$ 3,708,000 & \$ 3,150,000 & \$ 1,980,000 & \$ 8,838,000 \\
\text { Cost of goods sold } & \underline{3,600,000} & \underline{3,000,000} & \underline{1,800,000} & \underline{8,400,000} \\
\text { Gross margin } & \underline{\$ 108,000} & \underline{\$ 150,000} & \underline{\$ 180,000} & 438,000 \\
\text { Other operating costs } & & & & \underline{301,080} \\
\text { Operating income } & & & & \underline{\$ 136,920} \\
\hline
\end{array}
$$
For many years, Medtech has used gross margin percentage [(Revenue - Cost of goods sold) $\div$ Revenue $]$ to evaluate the relative profitability of its market segments. However, Kennedy recently attended a seminar on activity-based costing and is considering using it at Medtech to analyze and allocate "other operating costs." He meets with all the key managers and several of his operations and sales staff and they agree that there are five key activities that drive other operating costs at Medtech:
(TABLE CAN'T COPY)
Each customer order consists of one or more line items. A line item represents a single product (such as ExtraStrength Tylenol tablets). Each product line item is delivered in one or more separate cartons. Each store delivery entails the delivery of one or more cartons of products to a customer. Medtech's staff stacks cartons directly onto display shelves in customers' stores. Currently, there is no additional charge to the customer for shelf-stocking and not all customers use Medtech for this activity. The level of each activity in the three market segments and the total cost incurred for each activity in 2013 is as follows.

1. Compute the 2013 gross-margin percentage for each of Medtech's three market segments.
2. Compute the cost driver rates for each of the five activity areas.
3. Use the activity-based costing information to allocate the $$\$ 301,080$$ of "other operating costs" to each of the market segments. Compute the operating income for each market segment.
4. Comment on the results. What new insights are available with the activity-based costing information?

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Problem 31

Choosing cost drivers, activity-based costing, activity-based management. Pink Bags (PB) is a designer of high-quality backpacks and purses. Each design is made in small batches. Each spring, PB comes out with new designs for the backpack and for the purse. The company uses these designs for a year, and then moves on to the next trend. The bags are all made on the same fabrication equipment, which is expected to operate at capacity. The equipment must be switched over to a new design and set up to prepare for the production of each new batch of products. When completed, each batch of products is immediately shipped to a wholesaler. Shipping costs vary with the number of shipments. Budgeted information for the year is as follows.
Pink Bags Budget for Costs and Activities for the Year Ended February 28, 2013$$
\begin{array}{l|r}
\hline \text { Direct materials—purses } & \$ 283,575 \\
\text { Direct materials—backpacks } & 496,625 \\
\text { Direct manufacturing labor—purses } & 95,000 \\
\text { Direct manufacturing labor—-backpacks } & 119,000 \\
\text { Setup } & 65,000 \\
\text { Shipping } & 72,400 \\
\text { Design } & 162,500 \\
\text { Plant utilities and administration } & \underline{253,500} \\
\text { Total } & \underline{\$ 1,547,600} \\
\hline
\end{array}
$$$$
\begin{aligned}
&\text { Other budget information follows. }\\
&\begin{array}{l|r|r|r}
\hline & \text { Backpacks } & \text { Purses } & \text { Total } \\
\hline \text { Number of bags } & 6,250 & 3,100 & 9,350 \\
\text { Hours of production } & 1,600 & 2,625 & 4,225 \\
\text { Number of batches } & 125 & 75 & 200 \\
\text { Number of designs } & 2 & 3 & 5 \\
\hline
\end{array}
\end{aligned}
$$
1. Identify the cost hierarchy level for each cost category.
2. Identify the most appropriate cost driver for each cost category. Explain briefly your choice of cost driver.
3. Calculate the budgeted cost per unit of cost driver for each cost category.
4. Calculate the budgeted total costs and cost per unit for each product line.
5. Explain how you could use the information in requirement 4 to reduce costs.

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05:15

Problem 32

ABC, health care. Crossroads Health Center runs two programs: drug addict rehabilitation and aftercare (counseling and support of patients after release from a mental hospital). The center's budget for 2013 follows.
(TABLE CAN'T COPY)
Kim Yu, the director of the center, is keen on determining the cost of each program. Yu compiled the following data describing employee allocations to individual programs:
(TABLE CAN'T COPY)

Akash M
Akash M
Numerade Educator
00:00

Problem 33

Unused capacity, activity-based costing, activity-based management. Wybock's Netballs is a manufacturer of high-quality basketballs and volleyballs. Setup costs are driven by the number of batches. Equipment and maintenance costs increase with the number of machine-hours, and lease rent is paid per square foot. Capacity of the facility is 17,000 square feet and Wybock is using only $80 \%$ of this capacity. Wybock records the cost of unused capacity as a separate line item, and not as a product cost. The following is the budgeted information for Wybock.(TABLE CAN'T COPY)

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator
00:00

Problem 34

Unused capacity, activity-based costing, activity-based management. Whitewater Adventures manufactures two models of kayaks, Basic and Deluxe, using a combination of machining and hand finishing. Machine setup costs are driven by the number of setups. Indirect manufacturing labor costs increase with direct manufacturing labor costs. Equipment and maintenance costs increase with the number of machine-hours, and facility rent is paid per square foot. Capacity of the facility is 6,250 square feet and Whitewater is using only $80 \%$ of this capacity. Whitewater records the cost of unused capacity as a separate line item, and not as a product cost. For the current year, Whitewater has budgeted the following.

Whitewater Adventures Budgeted Costs and Activities for the Year Ended December 31, 2013
(TABLE CAN'T COPY)

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator

Problem 35

Activity-based job costing, unit-cost comparisons. The Taylor Corporation has a machining facility specializing in jobs for the aircraft-components market. Taylor's previous simple job-costing system had two direct-cost categories (direct materials and direct manufacturing labor) and a single indirect-cost pool (manufacturing overhead, allocated using direct manufacturing labor-hours). The indirect cost-allocation rate of the simple system for 2013 would have been $$\$ 113$$ per direct manufacturing labor-hour.

Recently a team with members from product design, manufacturing, and accounting used an $A B C$ approach to refine its job-costing system. The two direct-cost categories were retained. The team decided to replace the single indirect-cost pool with five indirect-cost pools. The cost pools represent five activity areas at the plant, each with its own supervisor and budget responsibility. Pertinent data are as follows.(TABLE CAN'T COPY)

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Problem 36

ABC, implementation, ethics. (CMA, adapted) Plum Electronics, a division of Berry Corporation, manufactures two large-screen television models: the Mammoth, which has been produced since 2009 and sells for $$\$ 990$$, and the Maximum, a newer model introduced in early 2011 that sells for $$\$ 1,254$$. Based on the following income statement for the year ended November 30, 2013, senior management at Berry have decided to concentrate Plum's marketing resources on the Maximum model and to begin to phase out the Mammoth model because Maximum generates a much bigger operating income per unit.
Plum Electronics Income Statement for the Fiscal Year Ended November 30, 2013
(TABLE CAN'T COPY)

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Problem 37

Activity-based costing, activity-based management, merchandising. Super Bookstore (SB) is a large city bookstore that sells books and music CDs and has a cate.. SB operates at capacity and allocates selling, general, and administration ( $S, G \& A)$ costs to each product line using the cost of merchandise of each product line. SB wants to optimize the pricing and cost management of each product line. SB is wondering if its accounting system is providing it with the best information for making such decisions.(TABLE CAN'T COPY)

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