Test Bank for Accounting for Decision Making and Control- 9th Edition –Zimmerman

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Test Bank for Accounting for Decision Making and Control- 9th Edition Zimmerman
SAMPLE
Chapter 11
Criticisms of Absorption Cost Systems: Inaccurate Product Costs
Multiple Choice Questions
When traditional absorption costing is employed, which of the following is false?
1.
A.
In a multi-product organization, product costs are properly reported for financial reporting purposes
B.
In a single product organization, product costs are properly reported for financial reporting purposes
C.
In a multi-product organization, product costs are accurately reported for decision-making purposes
D.
In a single product organization, product costs are accurately reported for decision-making purposes
E.
None of the above
Which of the following is a correct matching of terms?
A.
Depreciation of equipment is a batch-level cost
B.
Cutting a table leg is a unit-level cost
C.
Insurance is a product-level cost
D.
Package design is a production-sustaining cost
2.
E.
None of the above
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
For a Standard inkstone, which is true of the materials input needed (to 3 significant figures)?
A.
Total weight is 2.279 pounds
B.
Total weight is 2.213 pounds
C.
Total weight is 2.140 pounds
D.
Total weight is 1.875 pounds
E.
None of the above
3.
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
For a Masterpiece inkstone, which is true of the direct labor hours (DLH) needed (to 3 decimal places)
A.
Total DLH are 4.100
B.
Total DLH are 4.401
C.
Total DLH are 4.406
D.
Total DLH are 4.450
E.
None of the above
4.
5.
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
For a Standard inkstone, which is true of the machine hours (MH) needed (to 3 decimal places)?
A.
Total MH are 1.188
B.
Total MH are 1.305
C.
Total MH are 1.338
D.
Total MH are 1.397
E.
None of the above
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
6.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor hours are used as the cost d
A.
$133.47
B.
$106.47
C.
$102.55
D.
$96.10
E.
None of the above
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
7.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
Which is the full (absorption) cost of a Standard inkstone, if machine hours are used as the cost driver?
A.
$94.81
B.
$101.89
C.
$107.25
D.
$107.88
E.
None of the above
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
8.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor dollars are used as the cost
to 3 decimal places).
A.
$131.01
B.
$134.15
C.
$121.11
D.
$127.87
E.
None of the above
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
9.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
Dehli Inkstone recently employed a cost analyst, who recommended the adoption of an ABC system to
the costs of the Standard and Masterpiece products. She has classified the overheads into the following
appropriate cost drivers:
Cost Pool
Dollars
Cost Driver
Materials handling
$121,000
Pounds of raw materials
Inspection
$48,400
Inspections
Machine operation & maint.
$163,350
Machine hours
Labor-related costs
$254,650
Direct Labor dollars
$587,400
Independent of your answers above, assume total planned output is 25,595 units. What is the correct m
A.
$2.209 per lb.
B.
$2.521 per lb.
C.
$2.136 per lb.
D.
$2.572 per lb.
E.
None of the above
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress th
solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special mat
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per h
preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are r
and they have no salvage value. Each approved stone is handed to a master craftsperson who spends tw
three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one
again before packing. Four percent of finished products fail the final quality control assessment and are
per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping
and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Prod
output to be Standard inkstones and the balance Masterpieces.
What is true when ABC is used in Dehli Inkstone?
A.
Machine operations costs run $5.025 per machine hour
B.
Labor-related costs are $0.143 per direct labor dollar
C.
Inspection costs are $1.891 per inspection
D.
Labor-based overheads are 19.6% per direct labor dollar
E.
None of the above
10.
What is true when ABC is used?
A.
The full cost of the Masterpiece is $132.96
B.
Prime cost of the Standard is $50.75
C.
The full cost of the Standard is $107.43
D.
ABC overheads allocated to Masterpiece total $25.52
E.
None of the above
11.
For Dehli Inkstone, is it worth implementing a full-fledged ABC system, based upon the findings for these two p
A.
No, for Standard the cost difference between using machine hours and ABC is less than 30 cents per un
cost-beneficial
B.
Yes, all of the single-base allocation systems over cost the Masterpiece
12.
C.
No, for Masterpiece the cost difference between using labor hours and ABC is less than 40 cents per un
cost-beneficial
D.
No, the ABC system has failed to reduce total overheads
E.
No, the proportions of the different inputs consumed by each product are not sufficiently different to m
Essay Questions
Honey Lake Summer Camp
For many years the Honey Lake Summer Camp had used the number of campers per week to estimate
for ten weeks during the summer with a different number of campers each week. July is busiest with Ju
from the last week of summer camp in Year 1 are used to estimate costs for Year 2 for pricing purpose
last week of Year 1 and the costs of each cost category are expected to be the same for Year 2:
Weekly
Cost
13.
Supervisor’s salary
$400
Cook’s salary
300
Camp counselor salaries (1 for each occupied cabin, each
of
which hold 10 campers) (5 counselors × $200/counselor)
1,000
Food (50 campers × $100/camper)
5,000
Supplies (50 campers × $20/camper)
1,000
Utilities (50 campers × $10/camper)
500
Insurance (50 campers × $20/camper)
1,000
Property tax ($10,000/10 weeks)
Weekly total
1,000
$12,200
Cost per camper: $12,200/50 campers = $244/camper
The Honey Lake Summer Camp expects 75 campers during the second week of July.
Required:
a. What is the expected cost of that week using the average cost?
b. What is the expected cost of that week using ABC?
Different Overhead Allocation Bases
14.
Step Up Inc. produces blue things and gray things. Blue things are in much greater demand in the mark
year. Step Up Inc. sells 6,000 gray things per year in small boutiques. Things have a short shelf life. Th
consumed within two months of manufacture.
Both things use the identical production process and production facilities. Direct labor is $0.50 per thin
Things are produced in batches. Blue things are produced in batches of 600 units and gray things in bat
through the thingamajig, which is the machine that converts raw inputs into things. Each batch requires
next batch, calibrate settings, and test the first 10 things for product quality and conformity to standard
things are made, setups must be performed for each new batch. All the overhead costs are incurred in s
and supplies consumed during setup cost $360,000 per year. The only costs of producing things are dir
overhead of setups. The company is currently allocating setup costs to things based on direct labor cost
The firm has been selling blue things for $4 per unit and gray things for $6 per unit. But foreign compe
pressure on the $4 price. Some competitors are selling blue things for as low as $3 per unit. Manageme
on selling gray things, whose margins are higher. On the other hand, management worries that the curr
misrepresenting the costs of the two products because direct labor costs are not representative of the tim
thingamajig. Management is considering allocating setup costs using machine hours on the thingamajig
of machine time and a batch of blue things requires 20 hours of machine time.
Required:
Analyze the present situation. Is there anything wrong with the costing system? If so, should managem
of machine hours?
Describe ABC
15.
Required:
a. What is activity-based costing and how does it differ from traditional absorption costing?
b. Describe the advantages and disadvantages of activity-based costing systems.
Decision Management vs. Decision Control of ABC
16.
17.
Critically discuss the following quotation:
“ABC (activity-based cost) information, by itself, does not invoke actions and decisions leading to imp
performance…. For ABC systems to be effective, everyone in the company—from top management to
cost management tools rather than as accounting tools. To achieve this objective, the accounting or fina
ownership of these systems to the users. If accounting or finance fails to understand this key point, then
traditional systems are the property of accounting and are used to support the financial accounting proc
by the functions and are designed to support the needs of cost management, not financial accounting. T
accounting in the management of costs. [M]ost companies that implement ABC systems run them in pa
systems. Parallel systems remove the risk of compromising the cost management capabilities of ABC t
and regulations.” (Source: R. Cooper, “Look Out, Management Accountants,” Management Accountin
ABC Systems Can Still Produce Inaccurate Product Costs
Accurate Cost Manufacturing, Inc., manufactures and sells large business equipment for the office and
Manufacturing is to provide components and subassemblies for the profit centers within the company.
center can purchase parts either from Manufacturing or from outside firms. Manufacturing operates as
for the full cost of the parts. Costs are computed once a year using full absorption costing. The volume
by the profit centers to Manufacturing in August; the fiscal year begins in January. With these numbers
the year. These cost estimates are then used throughout the year to charge the profit centers. Any over/
the bottom line of the company, not to any of the profit centers.
Within Manufacturing there is a department called finishing. The finishing department provides a servi
and profit centers as well as generating some external sales. Types of finishing include painting and pla
fixed assets in both automation and environmental compliance for finishing. The finishing operation be
through its high quality and its close location to the manufacturing departments.
During the past year, the profit centers have begun taking work away from Manufacturing and giving i
costs. Manufacturing then has lower volumes and has to raise the prices on the products it is producing
more work out. Manufacturing feels it is caught in a death spiral.
The death spiral situation has affected finishing the most. The finishing department is currently operati
facilities that are too large for the low volume of work. Table 1 summarizes the data pertaining to finis
the current cost structure. Other manufacturing departments are beginning to tell finishing that they wil
and painting so as not to lose any work because of the high internal cost of finishing.
Finishing is trying to attract business from outside Accurate Cost Manufacturing. The external sales gu
applied to the full cost for all external work. With the current low level of work and high fixed costs, fi
cost.
In an effort to gain control of the true cost drivers of the business, the manager of the finishing operatio
Tables 2 and 3 project the cost for products and volumes for one plating operation. The problem that th
manufacturing departments are about to send the 12-inch and 18-inch work to an outside shop due to lo
In implementing activity-based costing, the manager thinks he has truly identified the proper system. T
sizes and generate more paperwork. Smaller parts tend to be run in larger lot sizes and generate less pa
In a recent meeting with the management of the manufacturing department and profit centers, it was sta
costing is in direct conflict with the change in the mix of work from small parts to large parts and the n
manufacturing department and profit centers would like to pursue just-in-time manufacturing and furth
large parts. During this meeting, the profit centers and manufacturing departments said the implementa
them to move their work out of the finishing department to outside shops.
Table 1
Finishing Annual Cost Structure
Annual
Cost
Fixed asset
depreciation
$400,000
$4,000,000 machine purchased 2
years ago
Tank operations
costs
250,000
Cost to operate tanks—fixed cost,
not volume dependent
Tank material cost
50,000
Cost to operate tanks—
$0.007575/inch
Variable labor
cost
210,000
$10/hour × 21,000 hours of
operation
Total
$910,000
Table 2
Finishing Costs before and after Activity-Based Costing
Volume of
Pieces per
Year*
Old Cost
per Piece
Activity-Based
Cost per Piece
Outside
Cost per
Piece
3″
parts
1,000,000
$0.50
$0.31
$0.30
6″
parts
200,000
1.00
1.00
1.10
12″
50,000
1.20
2.00
0.90
parts
18″
parts
100,000
1.50
3.00
1.20
Table 3
Forecasted Costs
Old Cost
Activity-Based Cost
Outside Cost
3″ parts
$500,000
$310,000
$300,000
6″ parts
200,000
200,000
220,000
12″ parts
60,000
100,000
45,000
18″ parts
150,000
300,000
120,000
Total per year
$910,000
$910,000
$685,000
Required:
a. Analyze the current situation in this company. What should be done?
b. Compare and comment on the costs before and after ABC is implemented.
c. Has finishing management made a mistake by installing activity-based costing?
ABC versus Traditional Absorption Costing
Last year CCB Medical Technologies (CCB) introduced a proprietary orthopedic surgical saw that is u
However, its largest demand is in hip replacement surgeries. The electric reciprocating saw’s patented
noise and vibration and increases precision cutting, thereby reducing postoperative complications. CCB
blades. CCB blades are designed and engineered specifically for the CCB saw, and CCB saws are desig
When an orthopedic surgeon performs a surgery, each blade is dedicated to one particular patient and,
often use two or three blades during surgery on a patient. CCB saws sell for $2,000 each and CCB blad
CCB manufactures both the saw and blades in the same factory. The following table summarizes the va
blades and the number of units of each product produced and sold last year.
Saws
Blades
Units produced
330
12,000
Units sold
300
9,000
Beginning inventory
0
0
Direct labor per unit
$54.00
$12.00
Direct materials per unit
$185.00
$38.00
Variable manufacturing overhead per unit
$22.00
$8.00
18.
CCB uses an activity-based costing system to assign fixed manufacturing overhead to the saws and bla
overhead cost pools in the ABC system: batch costs, product-line engineering costs, and other factory o
ABC methodology:
• Batch costs ($173,000 last year): Batch costs are allocated to the two product lines based on the numb
year. Saws are produced in batch sizes of 10 saws per batch and blades are manufactured in batch sizes
• Product-line engineering costs ($724,000 last year): Product-line engineering costs are assigned to the
a survey of the engineers inquiring how they spent their time. Based on last year’s survey, $289,000 wa
assigned to blades.
• Other factory overhead ($330,000): Other factory overhead consists of all other fixed manufacturing
or product-line engineering costs. These costs are allocated to the saws and blades based on direct labo
Required:
a. Compute CCB’s unit manufacturing costs and operating margins (revenues less cost of goods sold) f
the activity-based costing methodology described above.
b. Having seen the ABC income statements prepared in part (a), CCB management wants to see how th
goods sold) for the saws and blades would look if traditional absorption costing is used where the total
saws and blades using direct labor dollars.
c. Make a recommendation to management as to whether ABC (part a) or traditional absorption costing
recommendation.
Chapter 11 Criticisms of Absorption Cost Systems: Inaccurate Product Costs Answer
Key
Multiple Choice Questions
When traditional absorption costing is employed, which of the following is false?
A.
In a multi-product organization, product costs are properly reported for financial reporting purpos
B.
In a single product organization, product costs are properly reported for financial reporting purpo
C.
In a multi-product organization, product costs are accurately reported for decision-making purpos
D.
In a single product organization, product costs are accurately reported for decision-making purpo
E.
None of the above
1.
Where a company makes multiple products or offers a variety of services, simple full costing, whi
and then allocates them to products utilizing one cost base (such as direct labor hours, or sometime
accurately costs generated to the products that caused them.
In a single product or single service organization, overhead allocation is irrelevant.
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Topic: Inaccurate Product Costs
Which of the following is a correct matching of terms?
A.
Depreciation of equipment is a batch-level cost
B.
Cutting a table leg is a unit-level cost
C.
Insurance is a product-level cost
D.
Package design is a production-sustaining cost
2.
E.
None of the above
This activity can be traced directly to a unit of product, whether the activity is performed manually
The correct matching of the other terms appears below:
Depreciation of equipment is a product-level cost. Depreciation of air-conditioning plant or buildin
Insurance is production-sustaining. Package design is a product-level cost.
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Topic: Choosing Cost Drivers
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progr
correct solutions, because these values will be used again later in the problem set.
3.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 p
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
For a Standard inkstone, which is true of the materials input needed (to 3 significant figures)?
A.
Total weight is 2.279 pounds
B.
Total weight is 2.213 pounds
C.
Total weight is 2.140 pounds
D.
Total weight is 1.875 pounds
E.
None of the above
‘Standard’ Quantities
Materials
Bubble wrap, carton, lbs.
0.375
Materials, gross lbs.
1.838
Total inputs
2.213
When there is waste in the process, work backwards to find the inputs needed.
Gross up the last stage items first to find the needed input.
Packing is performed on 100% good units.
Package materials do not need adjustment.
Materials are wasted at both stages in the process, so they must be grossed up twice.
To get one good preliminary unit, 1.17647 units must be started (1 ÷ .85). To get a good standard y
units (1.17647 ÷ .96). So the total materials used to get one good standard is 1.838 lbs. (1.2255 × 1
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progr
correct solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 p
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
For a Masterpiece inkstone, which is true of the direct labor hours (DLH) needed (to 3 decimal pla
A.
Total DLH are 4.100
B.
Total DLH are 4.401
C.
Total DLH are 4.406
D.
Total DLH are 4.450
4.
E.
None of the above
‘Masterpiece’ Quantities
DLH
Packaging labor
0.100
Craftsperson labor, gross DLH
3.125
Drilling, gross DLH
1.225
Total inputs
4.450
Using the same logic as in Q11-3, to get one good standard, you must drill 1.225 units (see Q11-3)
Each master craftsman wastes 4% of the units, so to get 1 good unit, they must start 1.0417 prelim
Since each Masterpiece inkstone requires 3 hours, to produce one acceptable masterpiece requires
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progr
correct solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
For a Standard inkstone, which is true of the machine hours (MH) needed (to 3 decimal places)?
A.
Total MH are 1.188
B.
Total MH are 1.305
C.
Total MH are 1.338
D.
Total MH are 1.397
E.
None of the above
5.
Standard Quantities
MH
Craftsperson labor, gross MH
0.521
Drilling, gross MH
0.817
Total inputs
1.338
To get one good standard unit, you must drill 1.225 units (see Q11-3), which requires 2/3 machine
Also, to finish a standard requires another half hour of machine time. Before waste of 4%, 1.0417
requires 0.521 MH (1.0417 × 0.5 MH).
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6.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 p
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor hours are used as the c
errors).
A.
$133.47
B.
$106.47
C.
$102.55
D.
$96.10
E.
None of the above
Qty
Cost
Masterpiece
Materials, gross lb.
1.838
$20
$36.76
Bubble wrap, carton
0.375
$0.50
$0.50
Drilling, gross DLH
1.225
$10
$12.25
Craftsperson labor
3.125
$18
$56.25
Packaging time
1/10
Total DLH
4.450
$10
Direct cost
$1.00
$106.77
Overheads applied, per DLH
$6.00
Full cost
$26.70
$133.47
Est. Overheads
$587,400
OH Rate =
= $6.00
Est. DLH
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Topic: Inaccurate Product Costs
97,900
per DLH
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progr
correct solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 p
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
Which is the full (absorption) cost of a Standard inkstone, if machine hours are used as the cost dr
A.
$94.81
B.
$101.89
C.
$107.25
D.
$107.88
E.
None of the above
7.
The problem data did not provide the number of machine hours available, only budgeted labor hou
first step is to compute the units of product that can be made with the labor hours, split into the pro
machine hours needed.
COMPUTATIONS
1. Standard craftsperson MH
Input =
Output
0.521
(1 -waste 2%)
1/2
MH
96.00%
2. Masterpiece craftsperson MH
Input =
Output
1.042
(1 -waste 2%)
1
MH
96.00%
3. Basic MH
Input =
Output
0.817
(1 -waste 1%) (1- waste 2%)
Output%
2/3
MH
85.00%
96.00%
Standard
Masterpiece
60%
40%
DLH
3.409
4.450
Product Weighted
DLH
2.045
1.780
3.825
Available DLH
97,900
25,595
units of good
output
Product Weighted
DLH
3.825
Units of output
(rounded up)
15,357
10,238
25,595
Standard, gross MH
0.521
Masterpiece, gross
MH
1.042
Drilling, gross MH
0.817
0.817
Total MH input
1.338
1.859
Total MH needed
20,547.67
19,032.44
39,580.11
Once budgeted total machine hours are known, it is then possible to derive the overhead rate per m
multiplied by planned product machine hours to determine overheads applied.
Qty
Cost
Standard
Materials,
gross lb.
1.838
$20
$36.76
Bubble wrap,
carton
0.375
$0.50
$0.50
Drilling, gross
DLH
1.225
$10
$12.25
Craftsperson
labor, gross
DLH
2.083
$18
$37.50
Packaging time
1/10
$10
$1.00
Total DLH
3.409
Direct cost
Gross MH
$88.02
1.338
Overheads
applied, per
MH
$14.84
Full cost
OH Rate =
$19.86
$107.88
Est. Overheads
Est. MH
$587,400
39,580
= $14.841
per MH
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Topic: Inaccurate Product Costs
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progr
correct solutions, because these values will be used again later in the problem set.
8.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 p
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor dollars are used as the
rate to 3 decimal places).
A.
$131.01
B.
$134.15
C.
$121.11
D.
$127.87
E.
None of the above
Qty
Cost
Masterpiece
Materials, gross lb.
1.838
$20
$36.76
Bubble wrap, carton
0.375
$0.50
$0.50
Drilling, gross DLH
1.225
$10
$12.25
Craftsperson labor
3.125
$18
$56.25
Packaging time
1/10
$10
$1.00
Total DLH, DL$ per unit
4.450
Overheads applied, per DL$
$69.50
$0.3940
Full cost
$27.38
$134.15
COMPUTATIONS
Est.
Overheads
$587,400
OH Rate =
Units of output
(rounded up)
= $0.394
Est. DL$
$1,490,909
Standard
Masterpiece
Total
15,357
10,238
25,595
per
DL$
* DL$ per unit
Total DL$
$50.75
$69.50
$779,368
$711,541
$1,490,909
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Topic: Inaccurate Product Costs
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progr
correct solutions, because these values will be used again later in the problem set.
9.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 p
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
Dehli Inkstone recently employed a cost analyst, who recommended the adoption of an ABC syste
of the costs of the Standard and Masterpiece products. She has classified the overheads into the fo
appropriate cost drivers:
Cost Pool
Dollars
Cost Driver
Materials handling
$121,000
Pounds of raw materials
Inspection
$48,400
Inspections
Machine operation & maint.
$163,350
Machine hours
Labor-related costs
$254,650
Direct Labor dollars
$587,400
Independent of your answers above, assume total planned output is 25,595 units. What is the corre
A.
$2.209 per lb.
B.
$2.521 per lb.
C.
$2.136 per lb.
D.
$2.572 per lb.
E.
None of the above
Overhead cost
pools
Cost
Cost driver units
OH$
per
Materials
handling
$121,000
56,641.7
$2.136
Pounds
COMPUTATIONS
Materials
Per unit
Output units
Total
Pounds
2.213
25,595
56,641.7
Weight
Bubble wrap, carton, lbs.
0.375
Materials, gross lb.
1.838
Total inputs
2.213
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Topic: Choosing Cost Drivers
This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progr
correct solutions, because these values will be used again later in the problem set.
Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of specia
pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 p
The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the ba
rework these, and they have no salvage value. Each approved stone is handed to a master craftsper
‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine
inkstones are inspected again before packing. Four percent of finished products fail the final qualit
Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkston
which cost 50 cents in materials and weigh 6 ounces in total.
Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted.
of output to be Standard inkstones and the balance Masterpieces.
What is true when ABC is used in Dehli Inkstone?
A.
Machine operations costs run $5.025 per machine hour
B.
Labor-related costs are $0.143 per direct labor dollar
C.
Inspection costs are $1.891 per inspection
D.
Labor-based overheads are 19.6% per direct labor dollar
10.
E.
None of the above
All are false. The correct calculations are shown below.
Determination of Cost Driver Rates
Inspection
$48,400
51,190.0
Inspections
$0.945
Machine
operation &
maint.
$163,350
39,580.1
Machine
hours
$4.127
Labor-related
costs
$254,650
$1,490,908.8
DL$
$0.171
Per unit
Output
units
Total
Inspections
2
25,595
51,190.0
Machine operations
Standard
Masterpiece
Total
Units of output (rounded
up)
15,357
10,238
25,595
Standard, gross MH
0.521
Masterpiece, gross MH
1.042
Drilling, gross MH
0.817
0.817
Total MH input
1.338
1.859
Total MH needed
20547.67
19032.44
Units of output
15,357
10,238
× DL$ per unit
$50.750
$69.500
Total DL$
$779,368
$711,541
39580.11
Direct labor costs
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$1,490,909
Topic: Choosing Cost Drivers
What is true when ABC is used?
A.
The full cost of the Masterpiece is $132.96
B.
Prime cost of the Standard is $50.75
C.
The full cost of the Standard is $107.43
D.
ABC overheads allocated to Masterpiece total $25.52
E.
None of the above
11.
Materials,
gross lb
Qty
Cost
Standard
Masterpiece
1.838
$20
$36.76
$36.76
Bubble wrap,
carton
0.375
$0.50
$0.50
Drilling, gross
DLH
1.225
$10
$12.25
1.225
$12.25
craftsperson
labor
2.083
$18
$37.50
3.125
$56.25
Packaging
time
1/10
$10
$1.00
1/10
$1.00
Total DLH,
DL$ per unit
3.409
$50.75
4.450
$69.50
Direct cost
$0.50
$88.02
$106.77
ABC Overheads
applied
Overhead cost
pools
OH$
per
Materials
handling, per lb
$2.136
2.213
$4.73
2.213
$4.73
Inspection, per
$0.945
2
$1.89
2
$1.89
Machine costs,
per MH
$4.217
1.305
$5.50
1.826
$7.70
Labor-related
costs, per DLH
$0.171
$50.75
$69.50
$11.87
$8.67
Total overheads
$20.79
$26.19
Full cost
$108.81
$132.96
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Topic: Absorption versus Activity-Based Costing: An Example
Topic: Choosing Cost Drivers
For Dehli Inkstone, is it worth implementing a full-fledged ABC system, based upon the findings for these
12.
A.
No, for Standard the cost difference between using machine hours and ABC is less than 30 cents p
not cost-beneficial
B.
Yes, all of the single-base allocation systems over cost the Masterpiece
C.
No, for Masterpiece the cost difference between using labor hours and ABC is less than 40 cents p
not cost-beneficial
D.
No, the ABC system has failed to reduce total overheads
E.
No, the proportions of the different inputs consumed by each product are not sufficiently differen
All are false. The correct calculations are shown below.
In summary, ABC overheads charged to the Masterpiece were $26.19. Using DLH, the charge was
MH. Thus B seems plausible.
However, as the exercise demonstrated, a substantial amount of calculation (and for the firm, cons
investigation and implementation) were incurred for little benefit in this case. The panel below sho
consumption of resources was relatively stable, and thus the difference between ABC costs and th
$1.50.
Standard
Output
Input
15,357
Masterpiece
60%
10,238
Total
40%
25,595
Materials
1.838
60%
1.838
40%
47,050
Packaging
0.375
60%
0.375
40%
9,598
Inspections
2
60%
2
40%
51,190
Machine
hours
1.338
52%
1.859
48%
39,580
Labor
hours
3.409
53%
4.450
47%
97,911
Labor
dollars
$50.75
52%
$69.50
48%
$1,490,909
ABC is probably not a good investment in this case. However, where utilization of resources diffe
vast majority of labor hours and Masterpiece used the vast majority of machine hours, etc.), then A
approaches at matching costs to resources consumed.
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Topic: Absorption versus Activity-Based Costing: An Example
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Topic: Choosing Cost Drivers
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing
Essay Questions
Honey Lake Summer Camp
For many years the Honey Lake Summer Camp had used the number of campers per week to estim
open for ten weeks during the summer with a different number of campers each week. July is busi
busy. Costs from the last week of summer camp in Year 1 are used to estimate costs for Year 2 for
occurred during the last week of Year 1 and the costs of each cost category are expected to be the
Weekly
Cost
13.
Supervisor’s salary
$400
Cook’s salary
300
Camp counselor salaries (1 for each occupied cabin,
each of
which hold 10 campers) (5 counselors ×
$200/counselor)
1,000
Food (50 campers × $100/camper)
5,000
Supplies (50 campers × $20/camper)
1,000
Utilities (50 campers × $10/camper)
500
Insurance (50 campers × $20/camper)
1,000
Property tax ($10,000/10 weeks)
Weekly total
1,000
$12,200
Cost per camper: $12,200/50 campers = $244/camper
The Honey Lake Summer Camp expects 75 campers during the second week of July.
Required:
a. What is the expected cost of that week using the average cost?
b. What is the expected cost of that week using ABC?
a. The average cost per camper using last year’s last week of camp is $204/camper. The total expe
(75 campers) ($204/camper) = $15,300
b. ABC recognizes how the costs would change with different uses of activities and changing num
Weekly
Cost
Supervisor’s salary
$400
Cook’s salary
300
Camp counselor salaries (1 for each occupied cabin,
each of
which hold 10 campers) (8 counselors ×
$200/counselor)
1,600
Food (75 campers × $100/camper)
7,500
Supplies (75 campers × $20/camper)
1,500
Utilities (75 campers × $10/camper)
750
Insurance (75 campers × $20/camper)
1,500
Property tax ($10,000/10 weeks)
Weekly total
1,000
$14,550
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Different Overhead Allocation Bases
14.
Step Up Inc. produces blue things and gray things. Blue things are in much greater demand in the
things a year. Step Up Inc. sells 6,000 gray things per year in small boutiques. Things have a short
and consumed within two months of manufacture.
Both things use the identical production process and production facilities. Direct labor is $0.50 per
thing. Things are produced in batches. Blue things are produced in batches of 600 units and gray th
things goes through the thingamajig, which is the machine that converts raw inputs into things. Ea
machine for the next batch, calibrate settings, and test the first 10 things for product quality and co
batches of the same things are made, setups must be performed for each new batch. All the overhe
labor, indirect materials, and supplies consumed during setup cost $360,000 per year. The only cos
direct materials, and the overhead of setups. The company is currently allocating setup costs to thi
The firm has been selling blue things for $4 per unit and gray things for $6 per unit. But foreign co
pressure on the $4 price. Some competitors are selling blue things for as low as $3 per unit. Manag
emphasis on selling gray things, whose margins are higher. On the other hand, management worrie
overhead costs is misrepresenting the costs of the two products because direct labor costs are not r
product on the thingamajig. Management is considering allocating setup costs using machine hour
things requires one hour of machine time and a batch of blue things requires 20 hours of machine
Required:
Analyze the present situation. Is there anything wrong with the costing system? If so, should mana
base of machine hours?
In this problem, there are three possible overhead allocation bases: direct labor (present system), m
number of batches. First, calculate product costs under each of the three allocation schemes:
1. Direct labor cost as the allocation base (present system):
Bluethings
Graythings
Total
Number of units
120,000
6,000
126,000
Direct labor/unit
.50
.50
Direct labor cost
$60,000
$3,000
% of total direct labor cost
95.238%
4.762%
Overhead allocated
342,857
17,143
$63,000
360,000
Direct material cost
60,000
3,000
63,000
Total cost
$462,857
$23,143
$486,000
Unit cost
$3.857
$3.857
2. Machine hours as the allocation base (proposed system):
Number of units/year
÷ number of units/batch
Number of batches/year
× number of hours per batch
Number of machine
hours/year
% of total machine hours
Bluethings
Graythings
Total
120,000
6,000
126,000
600
200
30
200
20
1
4000
200
95.238%
4.762%
4200
Overhead allocated
$342,857
$17,143
$360,000
Direct labor cost
60,000
3,000
63,000
Direct material cost
60,000
3,000
63,000
Total cost
$462,857
$23,143
$486,000
Unit cost
$3.857
$3.857
3. Number of batches as the allocation base:
Number of units/year
÷ number of units/batch
Bluethings
Graythings
Total
120,000
6,000
126,000
600
30
Number of batches/year
200
200
% of total batches
50%
50%
Overhead allocated
$180,000
$180,000
400
$360,000
Direct labor cost
60,000
Direct material cost
60,000
3,000
63,000
3,000
63,000
Total cost
$300,000
$186,000
Unit cost
$2.50
$31.00
$486,000
Notice that allocating overhead by either direct labor or machine hours produces identical product
will not affect decision making.
There are two cost drivers in Step Up Company. Unit volume drives direct materials and direct lab
to drive overhead costs. Allocating overhead using direct labor gives an incorrect impression of ho
product costs. Overhead costs are incurred in set-ups. While run times per unit of thing is the same
considerably. In fact, bluethings and graythings each required 200 batches. Therefore, each produc
should be allocated an equal dollar amount of overhead. If this is done, then graythings become m
profitable, even with market price of $3 per unit.
But these allocated costs using number of batches still do not necessarily represent opportunity co
are not operating at full capacity, then the opportunity cost of a batch of graythings is $30 (just var
reducing the number of bluethings it can produce to make graythings (production is at capacity), th
the forgone margin on a batch of bluethings plus the variable costs of the graythings. Or,
Contribution margin on batch of bluethings ($4- 1)
× 600
Plus: Variable cost of a batch of graythings ($1 ×
30)
$1800
30
$1,830
÷ Units of graythings per batch
30
Opportunity cost of producing a graything
$61
The decision to continue to make graythings depends on i) how overhead costs vary with batches a
be sold if graythings are not produced. If the size and cost of the set-up crew is invariant to the num
probably not too bad an allocation base. If more bluethings cannot be sold, again it is not optimum
covering variable cost. Just because all overhead costs are incurred in set-ups does not make set-up
Some of the overhead costs are sunk costs and do not vary with batches (e.g., depreciation of the “
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Topic: Absorption versus Activity-Based Costing: An Example
Topic: Benefits and Costs of Activity-Based Costing
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing
Describe ABC
15.
Required:
a. What is activity-based costing and how does it differ from traditional absorption costing?
b. Describe the advantages and disadvantages of activity-based costing systems.
An ABC system provides a finer partitioning of indirect costs than absorption costs and a different
Indirect costs are broken into batch-level processes, product-line processes, and all others (produc
allocated directly to units produced using a volume-related measure but rather are assigned using t
how costs vary in each bucket (e.g., number of batches, number of products, number of part numb
allocated to the unit level, but usually are. The distinction between ABC and absorption costing is
unit-based volume measure. ABC allocates batch and product line costs using non-unit-based volu
Advantages:
more accurate product costs for decision making
focus managers’ attention on the “true” cost drivers
Disadvantages:
costly to implement
costly to operate
organizational problems might increase if ABC systems provide less control
Since few firms use ABC for internal and external reporting one must question whether for the typ
the costs (i.e., apply the parable of the marmots and the bears).
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Topic: Activity-Based Costing
Topic: Benefits and Costs of Activity-Based Costing
Topic: Reasons for Implementing Activity-Based Costing
Decision Management vs. Decision Control of ABC
16.
Critically discuss the following quotation:
“ABC (activity-based cost) information, by itself, does not invoke actions and decisions leading to
performance…. For ABC systems to be effective, everyone in the company—from top manageme
them as cost management tools rather than as accounting tools. To achieve this objective, the acco
relinquish ownership of these systems to the users. If accounting or finance fails to understand this
succeed…. While traditional systems are the property of accounting and are used to support the fin
ABC systems are owned by the functions and are designed to support the needs of cost manageme
reduction in the role of accounting in the management of costs. [M]ost companies that implement
financial accounting systems. Parallel systems remove the risk of compromising the cost managem
financial accounting rules and regulations.” (Source: R. Cooper, “Look Out, Management Accoun
1996, pp. 20-21.)
The author of this quote, Robin Cooper, an early advocate of ABC, makes the following implicit p
i. ABC will not replace traditional costing methods for financial accounting.
ii. ABC will be a supplemental source of information in most firms.
iii. Dual cost systems will be used.
The author fails to discuss which system (ABC or financial accounting) will be used for performan
control over the ABC system does not change their incentives if they are still evaluated and reward
accounting system that remains under the control of accounting and finance.
This quotation correctly points out that in most firms successful implementation of ABC requires t
system design, not the accounting department. The likely, unstated reason why the users have deci
they have better specialized knowledge of the underlying cost drivers than the accounting departm
two critical issues:
i. Why will anyone pay attention to the ABC numbers if they are still evaluated and compensated
accounting numbers?
ii. How large are the costs of having two accounting systems reporting costs for the same products
reconciliation costs and influence costs if two systems are used?
The quote is typical of ABC proponents. They assume that cost systems serve primarily a decision
decision control role served by traditional systems under the control of accounting departments.
AACSB: Communication
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Blooms: Understand
Difficulty: 2 Medium
Topic: Acceptance of Activity-Based Costing
Topic: Benefits and Costs of Activity-Based Costing
ABC Systems Can Still Produce Inaccurate Product Costs
17.
Accurate Cost Manufacturing, Inc., manufactures and sells large business equipment for the office
function of Manufacturing is to provide components and subassemblies for the profit centers withi
competitiveness, each profit center can purchase parts either from Manufacturing or from outside f
center and charges the profit centers for the full cost of the parts. Costs are computed once a year u
of parts used to calculate costs is provided by the profit centers to Manufacturing in August; the fi
numbers, Manufacturing projects costs per part for the year. These cost estimates are then used thr
centers. Any over/under-absorbed overhead goes directly to the bottom line of the company, not to
Within Manufacturing there is a department called finishing. The finishing department provides a
departments and profit centers as well as generating some external sales. Types of finishing includ
large investments in fixed assets in both automation and environmental compliance for finishing. T
value to customers through its high quality and its close location to the manufacturing departments
During the past year, the profit centers have begun taking work away from Manufacturing and giv
costs. Manufacturing then has lower volumes and has to raise the prices on the products it is produ
even more work out. Manufacturing feels it is caught in a death spiral.
The death spiral situation has affected finishing the most. The finishing department is currently op
facilities that are too large for the low volume of work. Table 1 summarizes the data pertaining to
of the current cost structure. Other manufacturing departments are beginning to tell finishing that t
plating and painting so as not to lose any work because of the high internal cost of finishing.
Finishing is trying to attract business from outside Accurate Cost Manufacturing. The external sale
margin applied to the full cost for all external work. With the current low level of work and high fi
sales due to cost.
In an effort to gain control of the true cost drivers of the business, the manager of the finishing ope
costing. Tables 2 and 3 project the cost for products and volumes for one plating operation. The pr
faces is that the manufacturing departments are about to send the 12-inch and 18-inch work to an o
In implementing activity-based costing, the manager thinks he has truly identified the proper syste
lot sizes and generate more paperwork. Smaller parts tend to be run in larger lot sizes and generate
In a recent meeting with the management of the manufacturing department and profit centers, it w
based costing is in direct conflict with the change in the mix of work from small parts to large part
manufacturing department and profit centers would like to pursue just-in-time manufacturing and
and large parts. During this meeting, the profit centers and manufacturing departments said the im
would force them to move their work out of the finishing department to outside shops.
Table 1
Finishing Annual Cost Structure
Annual
Cost
Fixed asset
depreciation
$400,000
$4,000,000 machine purchased 2
years ago
Tank operations
costs
250,000
Cost to operate tanks—fixed cost,
not volume dependent
Tank material
cost
50,000
Cost to operate tanks—
$0.007575/inch
Variable labor
cost
210,000
$10/hour × 21,000 hours of
operation
Total
$910,000
Table 2
Finishing Costs before and after Activity-Based Costing
Volume of
Pieces per
Old Cost
per
ActivityBased Cost
Outside
Cost per
Year*
Piece
per Piece
Piece
3″
parts
1,000,000
$0.50
$0.31
$0.30
6″
parts
200,000
1.00
1.00
1.10
12″
parts
50,000
1.20
2.00
0.90
18″
parts
100,000
1.50
3.00
1.20
Table 3
Forecasted Costs
Old Cost
Activity-Based Cost
Outside Cost
3″ parts
$500,000
$310,000
$300,000
6″ parts
200,000
200,000
220,000
12″ parts
60,000
100,000
45,000
18″ parts
150,000
300,000
120,000
Total per year
$910,000
$910,000
$685,000
Required:
a. Analyze the current situation in this company. What should be done?
b. Compare and comment on the costs before and after ABC is implemented.
c. Has finishing management made a mistake by installing activity-based costing?
This case study illustrates that poorly designed ABC systems trying to recover the cost of excess c
a. The problem is they are trying to recover a sunk cost — fixed asset depreciation of $400,000. B
decision to acquire this much capacity turns out to have been wrong. They should take a one-time
most of the $400,000 machine. This will then lower unit costs. Other issues include:
• The volume-related death spiral. When volume decreases you raise prices, volume decreases mo
• Is the accounting system broken? They are installing ABC to fix a broken accounting system but
the historical cost of excess capacity is the problem.
• Unitized transfer price. Unitization of fixed costs provides the wrong decision information to ma
such as pricing special orders. Beware of unitized costs.
• Both the old absorption and new ABC accounting systems are sending the wrong signal for short
higher costs and thus the apparent necessity to raise prices. Given the high fixed costs and decreas
• Allocation of decision rights (decision management versus decision control). How should manag
the systems’ changes do to the focus of management? Are the benefits of the imperfect decentraliz
b. In reviewing the data provided in Table 2, the apparent cost drivers have been identified and “pr
costing. What is not apparent is that the unitized costs are misleading in the first place. Unitizing t
profitability of parts to vary with volume. This unitization is misleading and should be avoided. Si
the opportunity cost of this capacity is close to zero. Thus, none of the depreciation on the plant sh
The details of the cost drivers are not provided, although one can see shifts in parts costs of up to 1
what effect the changes in cost will have on the workload and whether the costs of these drivers sh
placed on using the data obtained from the ABC system to reduce the cost of the elements, then w
ABC? The cost and benefits of the system need to be evaluated.
c. If management is gaining a better understanding of the cost drivers of the business and impleme
reductions outweigh the cost of ABC, then they have not made a mistake.
They may have made a mistake in the implementation process. The ABC costing system is aimed
finishing department did not understand the implications of the signals that ABC costs send to the
short-run decisions. If the department management operated the ABC system in parallel to the old
information required to reduce costs and not send the misleading signals within the firm.
AACSB: Analytical Thinking
AACSB: Communication
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Decision Making
Blooms: Evaluate
Difficulty: 3 Hard
Topic: Absorption versus Activity-Based Costing: An Example
Topic: Acceptance of Activity-Based Costing
Topic: Benefits and Costs of Activity-Based Costing
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing
ABC versus Traditional Absorption Costing
Last year CCB Medical Technologies (CCB) introduced a proprietary orthopedic surgical saw tha
applications. However, its largest demand is in hip replacement surgeries. The electric reciprocatin
the blade) reduces noise and vibration and increases precision cutting, thereby reducing postoperat
sells both the saw and blades. CCB blades are designed and engineered specifically for the CCB sa
used with CCB blades. When an orthopedic surgeon performs a surgery, each blade is dedicated to
blade is discarded. Surgeons often use two or three blades during surgery on a patient. CCB saws s
for $450 per blade.
CCB manufactures both the saw and blades in the same factory. The following table summarizes t
and blades and the number of units of each product produced and sold last year.
Saws
Blades
Units produced
330
12,000
Units sold
300
9,000
Beginning inventory
0
0
18.
Direct labor per unit
$54.00
$12.00
Direct materials per unit
$185.00
$38.00
Variable manufacturing overhead per unit
$22.00
$8.00
CCB uses an activity-based costing system to assign fixed manufacturing overhead to the saws an
manufacturing overhead cost pools in the ABC system: batch costs, product-line engineering costs
following describes the ABC methodology:
• Batch costs ($173,000 last year): Batch costs are allocated to the two product lines based on the n
the year. Saws are produced in batch sizes of 10 saws per batch and blades are manufactured in ba
• Product-line engineering costs ($724,000 last year): Product-line engineering costs are assigned t
after a survey of the engineers inquiring how they spent their time. Based on last year’s survey, $2
was assigned to blades.
• Other factory overhead ($330,000): Other factory overhead consists of all other fixed manufactur
costs or product-line engineering costs. These costs are allocated to the saws and blades based on d
Required:
a. Compute CCB’s unit manufacturing costs and operating margins (revenues less cost of goods so
using the activity-based costing methodology described above.
b. Having seen the ABC income statements prepared in part (a), CCB management wants to see h
cost of goods sold) for the saws and blades would look if traditional absorption costing is used wh
allocated to the saws and blades using direct labor dollars.
c. Make a recommendation to management as to whether ABC (part a) or traditional absorption co
recommendation.
a. ABC operating margins (revenues less cost of goods sold) of saws and blades:
Saws
Blades
Direct labor per unit
$54.00
$12.00
Direct materials per unit
$185.00
$38.00
Total
Variable overhead per unit
$22.00
$8.00
Selling price
$2,000.00
$450.00
Units produced
330
12,000
Units sold
300
9,000
Batch size
10
500
Number of batches
33
24
57
Batch costs
$173,000
Cost per batch
$3,035.09
Batch cost per unit
manufactured
$303.51
Saws
Blades
$6.07
Total
Product line
engineering cost
$289,000
$435,000
Product line cost
per unit
manufactured
$875.76
$36.25
Total direct labor
$17,820
$144,000
$724,000
$161,820
Other factory
overhead
$330,000
Other factory
overhead per DL $
$2.0393
Other factory OH
per unit
$110.12
$24.47
Total ABC cost per
unit manufactured
$1,550.39
$124.79
$600,000.00
$4,050,000.00
ABC Operating
margin:
Revenues
$4,650,000.00
Cost of goods sold
465,116.61
1,123,126.30
1,588,242.91
Operating margin
$134,883.39
$2,926,873.70
$3,061,757.09
b. Absorption costing operating margins (revenues less cost of goods sold) of saws and blades:
Saws
Blades
Direct labor per
unit
$54.00
$12.00
Direct materials
per unit
$185.00
$38.00
Variable overhead
per unit
$22.00
$8.00
Selling price
$2,000.00
$450.00
Units produced
330
12,000
Units sold
300
9,000
Absorption Costing:
Total
Batch cost
$173,000
Product line
engineering cost
$724,000
Other factory
overhead
$330,000
Total fixed
manufacturing OH
$1,227,000
Total direct labor
$161,820
Fixed mfg OH per
DL $
$7.5825
Allocated fixed mfg
OH per unit
$409.45
$90.99
Total cost per unit
manufactured
$670.4549
$148.9900
Operating margin
$398,863.52
$2,709,090.10
$3,107,953.62
c. Management may prefer the absorption costing method because it increases operating margin by
temporary artifact caused by the fact that some of the fixed costs ended up in inventory because m
produced than sold. When these units are sold, these higher fixed costs in inventory will flow thro
absorption costing is recognizing that absorption costing better supports the firm’s strategy of pric
product — saws and blades. CCB wants to sell saws at a “low” price in order to generate more bla
cost” the saws and “over cost” blades. Absorption costing accomplishes this better than ABC.
AACSB: Analytical Thinking
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Decision Making
AICPA: FN Measurement
Blooms: Apply
Difficulty: 3 Hard
Topic: ABC Measures Costs, Not Benefits
Topic: Absorption versus Activity-Based Costing: An Example
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing
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