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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


(5-10 min) S 4-3

Req. 1

Manufacturing Overhead Machine Hours

Plant-wide Overhead Rate

$3,500,000 ÷ 17,500 = $200 per machine hour

Req. 2

Production Departments

Departmental Manufacturing

OverheadMachine

Hours

Departmental Overhead

RatesPotato Chips $1,800,000 11,250 = $160 per

machine hourCorn Chips $1,000,000 ÷ 3,450 = $289.86

(rounded) per machine hour

Cheese Puffs

$ 700,000 ÷ 2,800 = $250 per machine hour

TOTAL $3,500,000 17,500

Req. 3

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.


(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


(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.


(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

run

Req. 2

Job Cost RecordJOB #624

Manufacturing Costs

Direct Materials $1,050Direct Labor:

Evan Berg: 10 × $25 = $250Stephanie Berg: 5 × $30 = $150

400

Manufacturing Overhead:1 set-up × $50 / set-up = $505 machine hours × $200 /

machine hour = $1,0002 tests × $75 / test = $150

1,200

TOTAL JOB COST $2,650


(15-20 min.) S 4-7

Req. 1

Narnia TechnologyActivity Cost Allocation

Activity Cost Allocated to Each BoardStart station 1 × $ 0.90 = $ 0.90Dip insertion 20 × $ 0.25 = 5.00Manual insertion 5 × $ 0.40 = 2.00Wave solder 1 × $ 4.50 = 4.50Backload 4 × $ 0.70 = 2.80Test 0.15 × $90.00 = 13.50Defect analysis 0.16 × $50.00 = 8 .00 Total activity costs $36 .70

Direct materials cost……………………………………. $14.00Direct labor cost…………………………………………. $42.00Activity costs allocated………………………………… 36 .70 Manufacturing product cost…………………………… $92 .70

Req. 2

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.


(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


(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


(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


(10 min.) S 4-11

Req. 1

Indirect cost=

Estimated total indirect costsallocation rate Estimated total quantity of cost allocation base

=$706,000

5,000 hours

= $141.20 / hour

Req. 2

Webb GregDirect labor (100 hours × $350 / hour) $35,000 $35,000Indirect costs (100 hours × $141.20 / hour) 14,120 14,120 Total costs $49,120 $49,120

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.

Req. 3

Webb GregService revenue (150% × $35,000) $52,500 $52,500 Direct labor (from Req. 2) 35,000 35,000Indirect costs (from Req. 2) 14,120 14,120 Total costs 49,120 49,120 Operating income $ 3,380 $ 3,380


(5-10 min.) S 4-12

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.


(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

Cost allocation rate foractivity $ 32 / page $ 200 / application $ 90 / DL

hour


(10-15 min.) S 4-14

Req. 1

Webb GregDirect labor (100 hours × $350) $35,000 $35,000Documentation preparation:

( 50 pages × $32) 1,600(300 pages × $32) 9,600

Information technology support: (1 application × $200) 200(78 applications × $200) 15,600

Training (100 hours × $90) 9,000 9,000 Total costs $45,800 $69,200

Req. 2

Webb GregService revenue (150% × $35,000) $52,500 $ 52,500 Direct labor 35,000 35,000Indirect costs:

Documentation preparation 1,600 9,600Information technology support 200 15,600Training 9,000 9,000

Total costs $45,800 $ 69,200 Operating income (loss) $ 6,700 $(16,700 )


(10-15 min.) S 4-15

a. Non-value added

b. Non-value added

c. Value added

d. Non-value added

e. Non-value added

f. Value added

g. Non-value added

h. Non-value added


(10-15 min.) S 4-16

1. Non-value added

2. Non-value added

3. Non-value added

4. Value added

5. Non-value added

6. Non-value added

7. Non-value added

8. Value added


(5-10 min.) S 4-17

a. Lean

b. Traditional

c. Traditional

d. Lean

e. Traditional

f. Lean

g. Lean

h. Traditional

i. Lean

j. Lean

k. Lean

l. Lean

m. Traditional


(5 min.) S 4-18

1. Reworking defective units — internal failure

2. Litigation costs from product liability claims — external

failure

3. Inspecting incoming raw materials — appraisal

4. Training employees — prevention

5. Warranty repairs — external failure

6. Redesigning the production process — prevention

7. Lost productivity due to machine breakdown — internal

failure

8. Inspecting products that are half the way through the

production process — appraisal

9. Incremental cost of using a higher grade raw material —

prevention

10.Cost incurred producing and disposing of defective units —

internal failure


(10-15 min.) S 4-19

Req. 1

Prevention costs:

Negotiating with and training suppliers to obtain higher

quality materials and on-time delivery.

Redesigning the speakers to make them easier to

manufacture.

Appraisal costs:

Additional 20 minutes of testing for each speaker.

Avoid inspection of raw materials.

Internal failure costs:

Rework avoided because of fewer defective units.

Avoid lost profits from lost production time due to rework.

External failure costs:

Reduced warranty repair costs.

Avoid lost profits from lost sales due to disappointed

customers.


(continued) S 4-19

Req. 2

Cost /<Benefit> AnalysisCosts

<Savings>

Prevention costs:Negotiating with and training suppliers to obtain

higher quality materials and on-time delivery…………. $ 300,000Redesigning the speakers to make them

easier to manufacture……………………………………… 1,400,000

Appraisal costs:Additional 20 minutes of testing for each speaker………. 600,000

Savings on Inspection of raw materials………………………. $<400,000>

Internal failure costs:Savings on Rework………………………………………………... <650,000>Savings on Lost profits from lost production time due to

rework……………………………………………………………. <300,000>

External failure costs:Savings on Warranty repair costs……………………………… <200,000>Savings on Lost profits from lost sales due to

disappointed customers…………………………………........ <850,000 >

Net <Benefit> from implementing quality program…………. $ <100,000 >

Wharfedale should implement the new quality program. The

company should save $100,000 by implementing the new

program.


(5-10 min.) S 4-20

1. External failure cost



4. Appraisal cost

5. Prevention cost

6. Internal failure cost


Exercises (Group A)

(15-20 min.) E 4-21A

Req. 1

Plant-wideallocation rate

==

Estimated total indirect costsEstimated total quantity of cost allocation

base

==

$1,100,00025,000* direct labor

hours

= $44 per direct labor hour

*When calculating plant-wide overhead rates, all direct labor hours incurred in the plant are used.


(continued) E 4-21A

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

=$750,000

15,000 machine hours

= $50 per machine hour

Finishing Dept. overhead rate

=$350,000

17,500** direct labor hours


**When calculating the finishing departmental rate, only the direct labor hours incurred in the finishing department are used.


(continued) E 4-21A

Req. 3

Overhead allocation based on single, plant-wide rate:

Job 450 Job 455Total direct labor hours 6 DL hours 6 DL hours × Plant-wide allocation rate × $44/ DL hour × $44 / DL hourOverhead allocation $264 $264

Req. 4 Overhead allocation based on departmental rates:

Job 450 Job 455Machining Department:Departmental allocation rate $50/ MH $50/ MH× Machine hours used by Job × 2 MH × 6 MHOverhead allocation $100 $300

Finishing Department:Departmental allocation rate $20/ DL hr $20/ DL hr× DL hours used by Job × 5 DL hrs × 4 DL hrsOverhead allocation $100 $80

Total overhead allocation (fromboth departments $200 $380


(continued) E 4-21A

Req. 5

The single plant-wide overhead rate assigns the same amount

of manufacturing overhead to both jobs ($264). On the other

hand, the departmental allocation rates assign $200 of

manufacturing overhead to Job 450 and $380 of manufacturing

overhead to Job 455. The single plant-wide rate overcosts Job

450 by $64 ($264 − $200) and undercosts Job 455 by $116 ($380

− $264). Since Cermak sets his sales price at 125% of cost, and

the job cost is affected by the allocation system he uses, his

sales price will also be affected by the allocation system he

uses.


(15-20 min.) E 4-22A

Req. 1

NorthstarComputation of Indirect Cost Allocation Rates

Activity

Total Estimated

Cost

Estimated Quantity of

Cost Allocation

Base

ActivityCost Allocation

RateMaterials handling $12,000 ÷ 3,000 parts = $ 4.00 per partMachine setups $ 3,400 ÷ 10 setups = $340.00 per setupInsertion of parts $48,000 ÷ 3,000 parts = $ 16.00 per partFinishing $80,000 ÷ 2,000 hours = $ 40.00 per hour


(continued) E 4-22A

Req. 2

The amount of manufacturing overhead to be assigned to Job 420 is computed as follows

Northstar- Job 420Manufacturing overhead allocation

Activity

Actual Quantity of Cost Allocation

Base Used

Cost Allocation

RateMOH

assignedMaterials handling 150 parts × $4.00/part = $ 600

Machine setups 1 setups × $340.00/setup = 340Insertion of parts 150 parts × $16.00/part = 2400Finishing 120 hours × $ 40.00/hr = 4800 Total manufacturing

overhead $8,140


(continued) E 4-22A

Req. 3


Northstar- Job 510Manufacturing overhead allocation

Activity


Base Used

Cost Allocation

RateMOH


Machine setups 2 setups × $340.00/setup = 680Insertion of parts 425 parts × $16.00/part = 6800Finishing 320 hours × $ 40.00/hr = 12,800 Total manufacturing

overhead $21,980


(15-20 min.) E 4-23A

Req. 1

ImagineActivity Cost Allocation

Activity Cost Allocated To Each UnitStart station 2 × $ 1.30 = $ 2.60Dip insertion 30 × $ 0.40 = 12.00Manual insertion 12 × $ 0.80 = 9.60Wave solder 1 × $ 1.40 = 1.40Backload 7 × $ 0.60 = 4.20Test 0.40 × $80.00 = 32.00Defect analysis 0.10 × $50.00 = 5 .00

Total activity costs $66 .80

Direct materials cost……………………………………. $ 51.00Direct labor cost…………………………………………. $ 30.00Activity costs allocated………………………………… 66.80 Manufacturing product cost…………………………… $147.80

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.


(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


(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.


(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:

( 9,000 DL hours × $32) = 288,000 (16,000 DL hours × $32) = 512,000

Total manufacturing cost $1,164,000 $2,136,000Number of units produced ÷ 3,000 ÷ 4,000 Cost per unit $ 388 $ 534


(continued) E 4-25A

Req. 2

First, compute the activity cost allocation rates:

Activity

Manufacturingoverhead related

to activityTotal activity


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


(continued) E 4-25A

Req. 2 (continued)

Then, apply them to the two products:


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


(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.


(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

__________a (4 × 1,000) + (6 × 1,000)b 15 + 15c (1 × 1,000) + (2.5 × 1,000)


(continued) E 4-26A

Req. 2

EnkeABC Indirect Manufacturing Cost per Unit

Activity

CostAllocation

Rate

Quantity of Cost Allocation Base

Used By:Allocated Activity Cost Per Wheel

Standard Deluxe Standard DeluxeMaterials handling

$ 3.75 4 6 $ 15.00 $ 22.50

Machine setups

$300.00 0.015* 0.015* 4.50 4.50

Insertion of parts

$ 24.00 4 6 96.00 144.00

Finishing $ 50.00 1.0 2.5 50.00 125.00 Total ABC allocated indirect cost

$165.50 $296.00

__________*15 setups ÷ 1,000 wheels = 0.015 per wheel


(continued) E 4-26A

Req. 3

Budgeted total manufacturing overhead cost = $461,500 (Req. 1)

Budgeted total direct labor hours = (1,000 × 2) + (1,000 × 3)= 2,000 + 3,000= 5,000

Plant-wide overhead allocation =$461,500

5,000

= $92.30 per direct labor hour

Manufacturing overhead cost per wheel:

Standard model: 2 × $92.30 = $184.60Deluxe model: 3 × $92.30 = $276.90


(continues E 4-26A) (15-20 min.) E 4-27A

The Manufacturing overhead costs per wheel computed in E 4-36A are as follows:

EnkeManufacturing overhead Costs per Unit

ModelStandard Deluxe

ABC costs $165.50 $296.00Plant-wide overhead rate $184.60 $276.90

Req. 1

The gross profits (using ABC Data) for the two models are:

EnkeGross profit per unit using ABC Data

Standard DeluxeSale price $300 .00 $440 .00 Direct materials 30.00 46.00Direct labor 45.00 50.00Manufacturing overhead 165 .50 296 .00 Gross profit $ 59 .50 $ 48 .00


(continued) E 4-27A

Req. 2

EnkeGross profit per unit using Plant-wide overhead Rate


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.


(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.


(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


(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


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).


(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.


(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.


(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%


(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.


(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


Avoid rework and spoilage



customers

Avoid warranty costs


(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


Exercises (Group B)

(15-20 min.) E 4-32B

Req. 1

Plant-wideallocation rate

==


base

==

$1,200,00025,000* direct labor

hours


*When calculating plant-wide overhead rates, all direct labor hours incurred in the plant are used.


(continued) E 4-32B

Req. 2

Departmental cost allocation rate =




Machining Dept. overhead rate

=$800,000

15,400 machine hours

= $52 per machine hour*

Finishing Dept. overhead rate

=$400,000


= $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.


(continued) E 4-32B

Req. 3


Job 450 Job 455Total direct labor hours 7 DL hours 7 DL hours × Plant-wide allocation rate × $48/ DL hour × $48/ DL hourOverhead allocation $336 $336


Job 450 Job 455Machining Department:Departmental allocation rate $52/ MH $52/ MH× Machine hours used by Job × 3 MH × 4 MHOverhead allocation $156 $208

Finishing Department:Departmental allocation rate $23/ DL hr $23/ DL hr× DL hours used by Job × 6 DL hrs × 5 DL hrsOverhead allocation $138 $115

Total overhead allocation (fromboth departments $294 $323


(continued) E 4-32B

Req. 5

The single plant-wide overhead rate assigns the same amount

of manufacturing overhead to both jobs ($336). On the other

hand, the departmental allocation rates assign $294 of

manufacturing overhead to Job 450 and $323 of manufacturing

overhead to Job 455. The single plant-wide rate overcosts Job

450 by $42 ($336 − $294) and overcosts Job 455 by $13 ($336 −

$323). Since Garvey sets his sales price at 125% of cost, and

the job cost is affected by the allocation system he uses, his

sales price will also be affected by the allocation system he

uses.


(15-20 min.) E 4-33B

Req. 1

Central PlainComputation of Indirect Cost Allocation Rates

Activity

Total Estimated

Cost

Estimated Quantity of

Cost Allocation

Base

ActivityCost Allocation

RateMaterials handling $ 5,600 ÷ 2,800 parts = $ 2.00 per partMachine setups $ 6,400 ÷ 20 setups = $320.00 per setupInsertion of parts $39,200 ÷ 2,800 parts = $ 14.00 per partFinishing $96,800 ÷ 2,200 hours = $ 44.00 per hour


(continued) E 4-33B

Req. 2


Central Plain - Job 420Manufacturing overhead allocation

Activity


Base Used

Cost Allocation

RateMOH


Machine setups 3 setups × $320.00/setup = 960Insertion of parts 250 parts × $14.00/part = 3,500Finishing 130 hours × $ 44.00/hr = 5,720 Total manufacturing

overhead $10,680


(continued) E 4-33B

Req. 3


Central Plain - Job 510Manufacturing overhead allocation

Activity


Base Used

Cost Allocation

RateMOH


Machine setups 6 setups × $320.00/setup = 1,920Insertion of parts 475 parts × $14.00/part = 6,650Finishing 300 hours × $ 44.00/hr = 13,200 Total manufacturing

overhead $22,720


(15-20 min.) E 4-34B

Req. 1

Best GadgetsActivity Cost Allocation

Activity Cost Allocated To Each UnitStart station 8 × $ 1.80 = $ 14.40Dip insertion 40 × $ 0.40 = 16.00Manual insertion 18 × $ 1.60 = 28.80Wave solder 7 × $ 2.20 = 15.40Backload 15 × $ 0.34 = 5.10Test 0.70 × $110.00 = 77.00Defect analysis 0.50 × $22.00 = 11 .00

Total activity costs $167 .70

Direct costs…………..……………………………………. $ 76.00*Activity costs allocated………………………………… 167.70 Manufacturing product cost…………………………… $243.70

* 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.


(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 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


c 2,200 + 2,800 = 5,000


(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.


(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:


Large (63 inch)

Direct materials $ 661,000 $1,240,000Direct labor 223,000 386,000Manufacturing overhead:

( 9,600 DL hours × $31.25) = 300,000(16,900 DL hours × $31.25) = 528,125

Total manufacturing cost $1,184,000 $2,154,125Number of units produced ÷ 3,180 ÷ 4,120 Cost per unit $ 372 .33 $ 522.85


(continued) E 4-36B

Req. 2

First, compute the activity cost allocation rates:

Activity

Manufacturingoverhead related

to activityTotal activity


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


(continued) E 4-36B

Req. 2 (continued)

Then, apply them to the two products:


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


(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.


(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

__________a (4 × 1,000) + (6 × 1,000)b 10 + 10c (1.1 × 1,000) + (3.5 × 1,000)


(continued) E 4-37B

Req. 2

EnkeABC Indirect Manufacturing Cost per Unit

Activity

CostAllocation

Rate

Quantity of Cost Allocation Base

Used By:Allocated Activity Cost Per Wheel

Standard Deluxe Standard DeluxeMaterials handling

$ 3.85 4 6 $ 15.40 $ 23.10

Machine setups

$345.00 0.010* 0.010* 3.45 3.45

Insertion of parts

$ 27.00 4 6 108.00 162.00

Finishing $ 55.00 1.1 3.5 60.50 192.50 Total ABC allocated indirect cost

$187.35 $381.05

__________*10 setups ÷ 1,000 wheels = 0.010 per wheel


(continued) E 4-37B

Req. 3

Budgeted total manufacturing overhead cost = $568,400 (Req. 1)

Budgeted total direct labor hours = (1,000 × 2.7) + (1,000 × 3.8)= 2,700 + 3,800= 6,500

Plant-wide overhead allocation =$568,400

6,500

= $87.45 per direct labor hour

Manufacturing overhead cost per wheel:

Standard model: 2.7 × $87.45 = $236.12Deluxe model: 3.8 × $87.45 = $332.31


(continues E 4-37B) (15-20 min.) E 4-38B

The Manufacturing overhead costs per wheel computed in E 4-37B are as follows:

ZekeManufacturing overhead Costs per Unit

ModelStandard Deluxe

ABC costs $187.35 $381.05Plant-wide overhead rate $236.12 $332.31

Req. 1

The gross profits (using ABC Data) for the two models are:

ZekeGross profit per unit using ABC Data



(continued) E 4-38B

Req. 2

ZekeGross profit per unit using Plant-wide overhead Rate


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.


(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.


(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


(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


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).


(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


(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%


(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.


(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


Avoid rework and spoilage



customers

Avoid warranty costs


(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.


Problems (Group A)

(40 min.) P 4-43AReq. 1

Plant-wideallocation rate =


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=




Machining =$600,000

4,000 machine hours

= $150 per machine hour

Assembly =$400,000


= $40 per direct labor hour**When calculating the assembly departmental rate, only the direct labor hours incurred in the assembly department are used.


(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


Job 500 Job 501Total direct labor hours 14 DL hours 14 DL hours × Plant-wide allocation rate × $80 / DL hour × $80 / DL hourOverhead allocation $1,120 $1,120


(continued) P 4-43A


Job 500 Job 501Machining Department:Departmental allocation rate $150/ MH $150/ MH× Machine hours used by Job × 3 MH × 6 MH Overhead allocation $450 $900

Assembly Department:Departmental allocation rate $40/ DL hr $40/ DL hr× DL hours used by Job × 12 DL hrs × 12 DL hrs Overhead allocation $480 $480

Total overhead allocation $930 $1,380 (from both departments)

Req. 6

The single plant-wide overhead rate assigned the same amount

of overhead to both jobs ($1,120). This doesn’t seem equitable

since Job 501 uses more of the company’s indirect resources.

On the other hand, the departmental rates assign more

overhead cost to Job 501 than Job 500 due to the extra

machine hours used by Job 501. This seems like a much

“fairer” allocation of overhead.


(continued) P 4-43A

Req. 7

Manufacturing cost and sales price using current costing system:

Job 500 Job 501Direct Materials $1,000 $1,000Direct Labor (14 DL hours × $25) 350 350Manufacturing overhead 1,120 1,120 Total manufacturing cost $2,470 $2,470Markup for pricing × 110 % × 110 % Sales price $2,717 $2,717

Req. 8

Gross profit using current costing system:

Job 500 Job 501Sales Price (from Req. 1) $2,717 $2,717

Less: Total manufacturing cost 2,470 2,470 Gross profit (loss) $ 247 $ 247


(continues) P 4-43A

Req. 8 (continued)

Gross profit using departmental rate costing system:

Job 500 Job 501Sales price (from Req. 7) $2,717 $2,717 Less: Total manufacturing cost: Direct Materials $1,000 $1,000 Direct Labor (14 DL hours × $25) 350 350 Manufacturing overhead 930 1,380 Total manufacturing cost $2,280 $2,730Gross profit (loss) $ 437 $ (13 )

Req. 9

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.


(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

Manufacturing product costs 48.00 35.00Postmanufacturing activities

(such as distribution, marketing,and customer service) 25 .00 22 .00

Full product cost per unit $78 .00 $60 .00


(continued) P 4-44A

Req. 3

Manufacturing product costs computed in Req. 1 are reported

in the financial statements.

Managers use full product costs computed in Req. 2 for

decisions, such as pricing and product emphasis.

Full product cost includes the costs of pre-manufacturing

activities and post-manufacturing activities that are expensed

as incurred for external financial reporting. However, these

costs often are assigned to products for internal decisions. For

example, the sale price must exceed full product cost for the

product to be profitable.

Req. 4

Full product cost……………………. $ 78.00Desired profit………………………… 42.00 Sale price per unit…………………... $120.00


(30-40 min.) P 4-45A

Req. 1

XnetABC Cost Allocation Rates

ApplicationsDevelopment

ContentProduction Testing

Estimated indirect activity costs $1,600,000 $2,400,000 $288,000

÷ 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


(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

__________*Rounded

Req. 4

X-Page X-SecureABC system............................... $17.20 $199,600Original system......................... $33.33 $150,000

Thus, under ABC the unit cost decreases by $16.13 for X-Page and increases $49,600 for X-Secure.

The original system overcosted X-Page and undercosted X-

Secure. The original system allocated 50% more overhead to X-

Secure ($1,500,000) than to X-Page ($1,000,000). But X-Secure

required 15 times as many lines of code ($7,500,000/500,000)

and 6 times as much testing (600/100) as X-Page. The ABC

system recognizes this difference and allocates more of the

content production and testing costs to X-Secure.


(continued) P 4-45A

Req. 5

Xnet’s different software applications use different

amounts of resources.

Xnet has high indirect costs.

Xnet produces high volumes of some software

applications (X-Page) and low volumes of other software

applications (X-Secure).

Xnet is in a competitive environment and needs

accurate product costs.

Xnet has accounting and information system expertise

to implement the system.


(30-40 min.) P 4-46A

Req. 1

HCI PharmaceuticalsABC Cost Allocation Rates

Materials Handling Packaging Quality AssuranceEstimated indirect

activity costs $190,000 $400,000 $112,500÷ Estimated quantity of

cost allocation base ÷ 19,000 kilos ÷ 2,000 hours ÷ 1,875 samples Cost allocation rate $ 10 / kilo $ 200 / hour $ 60 / sample

Req. 2

HCI PharmaceuticalsActivity Costs Per Unit

Commercial Container Travel Pack

Materials handling (8,000 and 6,000) × $10 $ 80,000 $ 60,000Packaging (1,200 and 400) × $200 240,000 80,000Quality assurance (200 and 300) × $60 12,000 18,000 Total indirect costs $332,000 $158,000÷ Number of units ÷ 2,500 ÷ 50,000 Indirect activity cost per unit $ 132.80 $ 3.16


(continued) P 4-46A

Req. 3

HCI PharmaceuticalsCosts per Unit Under Original Machine-Hour Based System


Indirect costs (1,200 and 400) × $300 $360,000 $120,000÷ Number of units ÷ 2,500 ÷ 50,000Indirect cost per unit $ 144 $ 2.40

Req. 4


ABC System.................................... $132.80 $3.16Original System.............................. $144.00 $2.40

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.


(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


(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.


Problems (Group B)

(40 min.) P 4-48BReq. 1

Plant-wideallocation rate =


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=




Machining =$670,000

4,000 machine hours

= $167.50 per machine hour

Assembly =$420,000


= $35 per direct labor hour**When calculating the assembly departmental rate, only the direct labor hours incurred in the assembly department are used.


(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


Job 500 Job 501Total direct labor hours 20 DL hours 20 DL hours × Plant-wide allocation rate × $77.86 / DL

hour× $77.86 / DL

hourOverhead allocation $1,557.20 $1,557.20


(continued) P 4-48B


Job 500 Job 501Machining Department:Departmental allocation rate $167.50/ MH $167.50/ MH× Machine hours used by Job × 8 MH × 16 MH Overhead allocation $1,340 $2,680

Assembly Department:Departmental allocation rate $35/ DL hr $35/ DL hr× DL hours used by Job × 15 DL hrs × 15 DL hrs Overhead allocation $525 $525

Total overhead allocation $1,865 $3,205 (from both departments)

Req. 6

The single plant-wide overhead rate assigned the same amount

of overhead to both jobs ($1,557.20). This doesn’t seem

equitable since Job 501 uses more of the company’s indirect

resources. On the other hand, the departmental rates assign

more overhead cost to Job 501 than Job 500 due to the extra

machine hours used by Job 501. This seems like a much

“fairer” allocation of overhead.


(continued) P 4-48B

Req. 7

Manufacturing cost and sales price using current costing system:

Job 500 Job 501Direct Materials $1,200 $1,200Direct Labor (20 DL hours × $30) 600 600Manufacturing overhead 1,557 .20 1,557 .20 Total manufacturing cost $3,357.20 $3,357.20Markup for pricing × 130 % × 130 % Sales price $4,364 .36 $4,364 .36

Req. 8

Gross profit using current costing system:

Job 500 Job 501Sales Price (from Req. 7) $4,364.36 $4,364.36

Less: Total manufacturing cost 3,357 .20 3,357 .20 Gross profit (loss) $ 1,007 .16 $ 1,007 .16


Req. 8 (continued)

Gross profit using departmental rate costing system:

Job 500 Job 501Sales price (from Req. 7) $4,364 .36 $4,364 .36 Less: Total manufacturing cost: Direct Materials $1,200.00 $1,200.00 Direct Labor (20 DL hours × $30) 600.00 600.00 Manufacturing overhead 1,865 .00 3,205 .00 Total manufacturing cost $3,365 .00 $5,005 .00 Gross profit (loss) $ 699 .36 $ (640 .64

Req. 9

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.


(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

Manufacturing product costs 44.10 24.65Postmanufacturing activities

(such as distribution, marketing,and customer service) 22 .00 19 .00

Full product cost per unit $70 .10 $46 .65


(continued) P 4-49B

Req. 3

Manufacturing product costs computed in Req. 1 are reported

in the financial statements.

Managers use full product costs computed in Req. 2 for

decisions, such as pricing and product emphasis.

Full product cost includes the costs of pre-manufacturing

activities and post-manufacturing activities that are expensed

as incurred for external financial reporting. However, these

costs often are assigned to products for internal decisions. For

example, the sale price must exceed full product cost for the

product to be profitable.

Req. 4

Full product cost……………………. $ 70.10Desired profit………………………… 39.00 Sale price per unit…………………... $109.10


(30-40 min.) P 4-50B

Req. 1

GibsonABC Cost Allocation Rates

ApplicationsDevelopment

ContentProduction Testing

Estimated indirect activity costs $1,500,000 $2,700,000 $270,000

÷ 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


(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*

__________*Rounded to nearest cent

Req. 4

X-Page X-SecureABC system............................... $26.26 $303,955.56Original system......................... $58.24 $242,666.67

Thus, the cost decreased by $31.98 for X-Page and increased $61,288.89 for X-Secure.

The original system overcosted X-Page and undercosted X-

Secure. The original system allocated 50% more overhead to X-

Secure ($2,184,000) than to X-Page ($1,456,000). But X-Secure

required 15 times as many lines of code ($7,200,000/480,000)

and 6 times as much testing (420/70) as X-Page. The ABC

system recognizes this difference and allocates more of the

content production and testing costs to X-Secure.


(continued) P 4-50B

Req. 5

Gibson’s different software applications use different

amounts of resources.

Gibson has high indirect costs.

Gibson produces high volumes of some software

applications (X-Page) and low volumes of other software

applications (X-Secure).

Gibson is in a competitive environment and needs

accurate product costs.

Gibson has accounting and information system

expertise to implement the system.


(30-40 min.) P 4-51B

Req. 1

Maloney PharmaceuticalsABC Cost Allocation Rates

Materials Handling Packaging Quality AssuranceEstimated indirect

activity costs $160,000 $390,000 $110,000÷ Estimated quantity of

cost allocation base ÷ 20,000 kilos ÷ 2,000 hours ÷ 2,200 samples Cost allocation rate $ 8 / kilo $ 195 / hour $ 50 / sample

Req. 2

Maloney PharmaceuticalsActivity Costs Per Unit


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


(continued) P 4-51B

Req. 3

Maloney PharmaceuticalsCosts per Unit Under Original Machine-Hour Based System


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


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.


(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


(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.


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


(continued) C 4-53

Req. 2

Axis SystemsProduct Costs Per Unit (ABC System)

Job A Job BDirect materials $ 210,000 $30,000Direct labor 160,000 12,000Allocated overhead:

Materials handlinga 12,750 1,700Machine setupb 3,000 2,000Assemblingc 120,000 16,000Shippingd 1,500 1,500

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.


(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.


(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.


(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%)

$3,000$2,700

Direct Labor 1,200 1,200Allocated overhead:

Materials handling 170 170Machine setup 200 200Assembling 1,600 980*Shipping 150 150

Total unit cost $6,320 $5,400 __________*The new assembly process must result in a revised assembling cost per unit of no more than $980:

$980 = $5,400 − ($2,700 + $1,200 + $170 + $200 + $150)

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.


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.


(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.


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).


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?


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?


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.


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


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


Student responses will vary.


Bthma2e Ch04 Sm

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