Activity-Based Costing 49

CHAPTER4
Activity-Based Costing

CHAPTER REVIEW

UNIT COSTS
Functional-based and activity-based costing assigns costs to cost objects such as products
and customers. Once costs are assigned to the cost object, the unit cost is calculated by
dividing the total cost assigned to the units produced by the number of units produced.
Unit cost information is used to:
value inventory
determine cost of goods sold, which affects income
determine bids to give to potential customers
decide whether to make or buy a product
decide whether to accept or reject a special order
decide whether to keep or drop a product line
decide whether to introduce a new product

Different cost information is needed for different purposes.

For external reporting, product costs include direct materials, direct labor, and overhead.
Cost measurement involves determining the dollar amount of direct materials, direct labor, and
overhead used in production.
Two cost measurement systems are:
actual costing
normal costing

Cost assignment involves associating costs with units produced.

Two cost assignment systems are:
functional-based costing
activity-based costing

Production of Unit Cost Information

Actual costing assigns actual costs of direct materials, direct labor, and overhead to
products.
Actual cost systems are rarely used because they cannot provide accurate unit cost informa -
tion on a timely basis.
Normal costing uses:
actual costs for direct materials
actual costs for direct labor
50 Chapter4

a predetermined rate for manufacturing overhead

A normal costing system can supply unit cost information on a timely basis.
The predetermined overhead rate is calculated as:
Budgeted (estimated) overhead cost
Predetermined overhead rate =
Estimated activity usage

Overhead is assigned to products using the predetermined overhead rate.

FUNCTIONAL-BASED PRODUCT COSTING

When functional-based costing is used, direct materials and direct labor are assigned to prod -
ucts using direct tracing.
Overhead costs are assigned using driver tracing and allocations with unit-level activity
drivers.
Unit-level activity drivers are factors that cause changes in cost as the units produced
change.
Examples of unit-level drivers include:
units produced
direct labor hours
direct labor dollars
machine hours
direct material dollars

An estimate for activity level can be based on:

expected activity capacity, the expected production level of activity for the next year.
normal activity capacity, the average activity that the firm expects in the long term (for
example, average activity for the next three to five years).
theoretical activity capacity, the maximum output possible under perfect operating
conditions.
practical activity capacity, the output a firm can achieve if it operates efficiently. Efficient
operations allow for equipment breakdowns, material shortages, etc.
Using practical or theoretical capacity avoids assigning unused capacity costs to products.
Unit-level activity drivers assign overhead using either:
plantwide rates, or
departmental rates.

Plantwide Rates
A plantwide overhead rate is calculated as:
Budgeted plantwide overhead cost
Plantwide rate =
Estimated activity of unit- level driver

Overhead cost assigned to product is calculated as:

Applied overhead = Plantwide rate Actual activity used on product
Activity-Based Costing 51

The overhead variance is the difference between actual overhead and applied overhead.
Underapplied overhead occurs when applied overhead is less than actual overhead for the
period.
Overapplied overhead occurs when applied overhead exceeds actual overhead for the
period.
The following T account for overhead illustrates the relationships:

Overhead
Actual overhead costs Applied overhead
(Plantwide rate Actual activity)
Underapplied overhead Overapplied overhead

If the overhead variance is relatively small, underapplied or overapplied overhead may be

treated as an adjustment to cost of goods sold. Underapplied overhead is added to cost of
goods sold, and overapplied overhead is subtracted from cost of goods sold.

Departmental Rates
Departmental rates are calculated as:
Budgeted departmental overhead cost
Departmental rate =
Estimated departmental activity

Overhead cost assigned to product is calculated as:

Applied overhead = Departmental rate Actual departmental activity used on product

See the summary below:

Allocation
Driver Tracing
Direct Tracing

Stage One:Pool Formation Stage One:Pool Formation

 Functional-Based Costing
Overhead Assignment

52 Chapter4

Plantwide Departmental
Rate Rates
Unit-Level Driver Unit-Level Drivers
Plantwide rate = Departmental rates =
Overhead Plantwide pool costs Departmental pool costs
Overhead
Unit-level driver Unit-level drivers
Costs Costs

Stage Two: Stage Two:

Assign Overhead costs assigned = Overhead costs assigned =
Assign
Plantwide overhead rate Departmental rate
Costs Actual activity used by product Actual activityCosts
used by product

LIMITATIONS
Plantwide
OF FUNCTIONAL-BASED COST ACCOUNTING SYSTEMS
Department A Department B
Plantwide
Pool and departmental rates may Pool
cause product cost distortions, which Pool
can be
damaging for companies operating in an environment characterized by:
firms engaged in intense competition
continuous improvement
Cost Assign Assign
Assignment Costs Costs
total quality management
total customer satisfaction
sophisticated technology
Products Products Products
As firms adopt new strategies to remain competitive, the cost accounting system must
change to produce more accurate product costs.
Symptoms of an outdated cost system include the following:
The outcome of bids is difficult to explain.
Competitors prices appear unrealistically low.
Products that are difficult to produce show high profits.
Operational managers want to drop products that appear profitable.
Profit margins are hard to explain.
The company has a highly profitable niche all to itself.
Customers do not complain about price increases.
The accounting department spends a lot of time on special projects.
Some departments are using their own cost accounting system.
Product costs change because of changes in financial reporting regulations.

Plantwide and departmental rates using unit-level drivers may not assign overhead costs
accurately if:
the proportion of nonunit-level overhead costs to total overhead costs is large, and
the degree of product diversity is great.

Nonunit-Related Overhead Costs

The main problem with the traditional approach of using plantwide and departmental
overhead rates is that a products consumption of overhead resources may not be strictly
related to units produced. For example, setup costs are related to the number of setups.
Nonunit-level activity drivers are factors, other than the number of units produced, that
measure use of overhead resources. For example, setup costs are not driven by the number of
units, but by the number of setups, a nonunit-level activity driver.
Activity-Based Costing 53

Using only unit-level activity drivers to assign nonunit-related overhead costs can create dis-
torted product costs. If nonunit-level overhead costs are only a small percentage of total over-
head costs, the distortion of product costs would be small and the use of unit-level cost
drivers might be acceptable.

Product Diversity
Product diversity occurs when products consume overhead activities in different proportions.
Reasons why products might consume overhead in different proportions include:
differences in product size
product complexity
setup time
size of batches

Consumption ratio is the proportion of each activity consumed by a product.

Product costs can be distorted if a unit-level cost driver is used and
nonunit-level overhead costs are a significant proportion of total overhead, and
the consumption ratios differ between unit-level and nonunit-level input categories.

ACTIVITY-BASED PRODUCT COSTING

An activity-based costing (ABC) system traces:
1. overhead costs to activities, and
2. then traces costs to products.
Cost of
Resources

Assign Costs
Direct Tracing Resource Drivers

Stage One: Activity 1 Activity 2 Activity 3 Activity 4

Activity Pools

Activity Drivers
Assign Costs Assign Costs Assign Costs Assign Costs

Stage Two: Products Products Products Products

Costs Assigned

Functional-based costing also involves two stages; however, overhead costs are traced to
departments (instead of activities), and then traced to products.
Functional-based costing and activity-based costing are compared below:
54 Chapter4

Functional-Based Costing Activity-Based Costing

First stage: traces costs to plant or department traces costs to activities

Second stage: assigns costs to products assigns costs to products

Cost tracing: usually allocation-intensive emphasizes direct tracing and driver tracing

Activity drivers: unit-level unit-level and nonunit-level

Activity-based cost assignment consists of the following steps:

1. Identify and define activities using interviews and surveys, then build an activity
dictionary.An activity dictionary lists activities and activity attributesfinancial and
nonfinancial information that describes the activities. Information includes:
activity nameusually consists of an action verb and an object
a description of the tasks that make up the activity
classification as a primary activity (activity consumed by a product or customer) or a
secondary activity (activity consumed by other primary or secondary activities)
activity drivera measure of activity output
2. Assign costs to activities.Determine the cost of resources (such as materials, labor, and
capital) consumed by each activity.
If the resource is exclusive to the activity (such as materials), use direct tracing.
If the resource is shared by several activities, use driver tracing to assign costs to the
activities. Resource drivers are factors that measure the consumption of resources by
activities.
The costs of secondary activities are ultimately assigned to primary activities using
activity drivers.
3. Assign costs to products.After the cost of primary activities is calculated, assign the cost
of these activities to products based on usage of the activity as measured by activity
drivers. Costs assigned to products are calculated as follows:
Cost assigned to product = Predetermined activity rate Actual usage of activity

HOMOGENEOUS POOLS OF ACTIVITIES

To reduce the number of predetermined overhead activity rates, activities can be grouped into
homogeneous pools.
A homogeneous cost pool is a collection of overhead costs associated with each set of
activities. Only one activity driver need be used to assign the pools costs, thus the number of
rates required can be reduced.
A pool rate is calculated as follows:
Pool rate = Pool costs/Practical capacity of activity driver

To build homogeneous sets of related activities, activities are classified into one of four
general activity categories:
Unit-level activities are activities performed each time a unit is produced. For example,
power is used each time a unit is produced.
Activity-Based Costing 55

Batch-level activities are activities performed each time a batch of products is produced.
The costs of batch-level activities vary with the number of batches but are fixed with
respect to the number of units in each batch. Examples include setups, inspections,
production scheduling, and materials handling.
Product-level (sustaining) activities are activities performed as needed to support the prod-
ucts. Examples include engineering changes and equipment maintenance.
Facility-level activities are activities that support a factorys general manufacturing
process. Examples include plant management and security.
All unit-level activities that have the same cost driver would be grouped into homogeneous
cost pools. For example, the unit-level category might have the following cost pools:
labor-related overhead cost pool
machine-related overhead cost pool
material-related overhead cost pool

All batch-level activities that use the same cost driver would be grouped into homogeneous
cost pools, and all product-level activities that use the same cost driver would be grouped into
homogeneous cost pools.
Unit-level costs vary as the number of units change; therefore, a unit-level cost driver can be
used.
Batch-level and product-level costs vary in proportion to factors other than changes in the
number of units; therefore, they are assigned using nonunit-level cost drivers.
Facility-level activities and costs are common to several products, and it is impossible to iden -
tify individual products that consume these activities. A pure ABC system would treat facility-
level costs as period costs and would not assign them to products. In practice, facility-level
costs might be allocated to individual products using unit-level, batch-level, or product-level
cost drivers.

Comparison with Functional-Based Costing

In a functional-based cost system, the demand for overhead is assumed to be explained only
by unit-level cost drivers.
ABC produces more accurate product costs by more accurately tracing the consumption of
overhead resources to products.

Activity-Based Customer Costing

Activity-based costing can be used to trace costs to specific customers. The cost of serving
different customers can affect pricing decisions and profitability.

Customer Costing versus Product Costing

Customer costing involves three steps:
1. Activities, such as order entry, shipping, and sales calls, are listed in an activity dictionary.
Different levels include order level, customer level, and channel level.
2. Cost of resources used are assigned to activities.
3. Cost of the activities are assigned to customers.
See the cost assignment summary below:
56 Chapter4

Cost Assignment

Customer Costing Product Costing

List customer activities List activities

Determine cost of activities Determine cost of activities

Group into homogeneous Group into homogeneous

customer-driven cost pools cost pools

Assign costs to customers Assign costs to products

Activity-Based Costing 57

Activity-Based Supplier Costing

Activity-based supplier costing uses activity-based costing to identify the true costs of
suppliers. Activity-based costing traces costs related to purchase, quality, reliability, and
delivery performance to specific suppliers.
58 Chapter4

KEY TERMS TEST

Test your recall of the key terms as follows. Try to recall as many key terms as possible without
assistance. If you need assistance, refer to the list of key terms at the end of this section.
1. Activities that are performed each time a batch is produced are _________-_________
_____________.
2. A(n) ___________ _____________ is a list of activities described by specific attributes such
as name, definition, classification as primary or secondary, and activity driver.
3. The proportion of an overhead activity consumed by a product is the ______________
_________.
4. __________ __________ assigns actual costs of direct materials, direct labor, and
overhead to products.
5. __________ __________ assigns actual costs of direct materials and direct labor to
products and uses a predetermined overhead rate to assign overhead costs.
6. A(n) __________________ _________ _________ is a collection of overhead costs associ-
ated with activities that have the same level and use the same cost driver to assign costs to
products.
7. A(n) __________________ _____________ ________ is an overhead rate computed using
estimated data.
8. ___________-_________ _____________ __________ are factors, other than the number
of units produced, that measure the demands that cost objects place on activities.
9. Activities performed to enable the production of each different type of product are
__________-________ _____________.
10. ___________ _____________ occurs when products consume overhead in different
proportions.
11. A cost system that first traces costs to activities and then traces costs from activities to
products is a(n) ___________-_________ __________ __________.
12. ________________ _____________ is overhead assigned to production using
predetermined rates.
13. ________________ _____________ is the amount by which applied overhead exceeds
actual overhead.
14. ________________ _____________ is the amount by which actual overhead exceeds
applied overhead.
15. _____________ _____________ is the difference between actual overhead and applied
overhead.
16. Activities that sustain a facilitys general manufacturing process are __________-________
_____________.
17. ________-_________ _____________ _________ are factors that cause changes in cost
as the number of units produced change.
Activity-Based Costing 59

18. _____________ _____________ are nonfinancial and financial information items that
describe individual activities.
19. _____________ _____________ measure the consumption of activities by products and
other cost objects.
20. ________-_________ _____________ are performed each time a unit is produced.
21. The ________ ________ equals overhead costs for a homogeneous cost pool divided by
the activity driver for the pool.
22. _______________ _____________ are activities consumed by products or customers.
23. _______________ _____________ are activities consumed by primary activities and/or
other secondary activities.

KEY TERMS:
activity attributes overapplied overhead
activity-based costing system overhead variance
activity dictionary pool rate
activity drivers predetermined overhead rate
actual costing primary activities
applied overhead product diversity
batch-level activities product-level activities
consumption ratio secondary activities
facility-level activities underapplied overhead
homogeneous cost pool unit-level activities
nonunit-level activity drivers unit-level activity drivers
normal costing

Compare your answers with those at the end of the chapter. Review any key terms missed.
60 Chapter4

CHAPTER QUIZ
Write your answers in the spaces provided.
1. Complete the following:
Costing Systems

Functional-Based Costing Activity-Based Costing

First stage:

Second stage:

Cost tracing:

Activity drivers:

2. The two types of overhead rates used in functional-based costing are:

a. ____________________________________________
b. ____________________________________________

3. The overhead rates of functional-based product costing use ____________-

_________ activity drivers.

4. Activity-based cost systems use ____________-_________ cost drivers.

5. When activity-based costing is used, activities are classified into one of four categories:
a. ___________________________ activities
b. ___________________________ activities
c. ___________________________ activities
d. ___________________________ activities

6. When activity-based costing is used, the first-stage procedure involves identifying cost pools
and calculating a pool rate for each cost pool. The pool rate is calculated as follows:
Pool rate = _________________________ / ________________________________

7. The second stage of activity-based costing involves tracing the costs of each overhead cost
pool to products. The overhead assigned to each product is calculated as follows:
Applied overhead = __________________ ________________________________________
Activity-Based Costing 61

Circle the single best answer.

8. Unit-level costs are assigned using: (a) unit-level activity drivers; (b) nonunit-level activity
drivers
9. Batch-level costs are assigned using: (a) unit-level activity drivers; (b) nonunit-level activity
drivers
10. Product-level costs are assigned using: (a) unit-level activity drivers; (b) nonunit-level activity
drivers
11. A functional-based product costing system uses a two-stage procedure of (1) tracing overhead
to activities, and (2) then tracing the costs to products: (a) true; (b) false
12. The use of unit-level activity drivers, such as direct labor hours or machine hours, can produce
distorted product costs: (a) true; (b) false
13. A products consumption of overhead always increases in proportion to increases in produc-
tion volume: (a) true; (b) false
14. When customer costing is used, both manufacturing and nonmanufacturing costs are traced
to customers to produce more accurate cost information for decision making: (a) true;
(b) false

Use the following information to answer Questions 15 through 23:

The following data is available for the two products, Model E and Model Z, that Pack, Inc., manu -
factures:
Item Quantity Prime Costs Machine Hours Material Moves Setups
Model E 350,000 $900,000 60,000* 600,000 175
Model Z 100,000 $250,000 15,000* 400,000 75
Dollar value $1,150,000 $400,000* $500,000 $600,000
*The cost of maintenance

Pack currently uses a functional-based costing system that assigns the costs of maintenance,
material handling, and setups to the models based on machine hours, a unit-level driver. (Round
numbers to two decimal places.)
15. The plantwide overhead rate is: (a) $12.00; (b) $14.67; (c) $20.00; (d) $25.00
16. Overhead assigned to Model E is: (a) $1,500,000; (b) $1,200,000; (c) $880,200;
(d) $720,000
17. Overhead assigned to Model Z is: (a) $300,000; (b) $375,000; (c) $220,050; (d) $320,000
18. The unit cost of Model E is: (a) $5.40; (b) $6.00; (c) $5.50; (d) $6.86
19. The unit cost of Model Z is: (a) $4.58; (b) $5.40; (c) $6.00; (d) $5.50
20. If activity-based costing is used, overhead assigned to Model E is: (a) $1,039,800;
(b) $939,800; (c) $799,800; (d) $739,800
21. If activity-based costing is used, overhead assigned to Model Z is: (a) $359,950; (b) $279,950;
(c) $380,000; (d) $459,950
62 Chapter4

22. If activity-based costing is used, the unit cost of Model E is: (a) $5.26; (b) $5.54; (c) $4.31;
(d) $4.86
23. If activity-based costing is used, the unit cost of Model Z is: (a) $6.30; (b) $4.28; (c) $7.10;
(d) $4.60

Write your answers in the spaces provided.

Use the following information to answer Questions 24 through 29:
Classify each of the following activities as a:
unit-level activity
batch-level activity
product-level activity
facility-level activity
24. Setups: ________________________________________________
25. Electricity: ______________________________________________
26. Plant management: ______________________________________
27. Engineering changes: _____________________________________
28. Inspections: ____________________________________________
29. Plant security: ___________________________________________

Compare your answers with those at the end of the chapter. Review any questions missed.

PRACTICE TEST

PROBLEM 1
Pauls Plastics uses an activity-based cost system. The company produces Product X and Product
Z. Information concerning the two products is given below:
Product X Product Z
Units produced................................................. 50,000 75,000
Machine hours.................................................. 22,000 18,000
Direct labor hours............................................. 40,000 40,000
Material handling (number of moves)............... 10,000 15,000
Engineering labor (hours)................................. 6,000 4,000
Setups.............................................................. 40 20
Maintenance (hours used)............................... 1,500 1,000
Kilowatt hours................................................... 16,000 14,000
Inspections....................................................... 18,000 12,000

The following overhead costs are reported:

Material handling.............................................. $70,000
Maintenance..................................................... 50,000
Activity-Based Costing 63

Power............................................................... 24,000
Engineering...................................................... 60,000
Setups.............................................................. 75,000
Labor-related overhead.................................... 60,000
Machine-related overhead............................... 120,000
Inspection......................................................... 108,000
64 Chapter4

PROBLEM 1(Continued)
Instructions:
1. Using the format below, classify the overhead activities as unit-level activities, batch-level
activities, or product-level activities.

Unit-level activities:
_________________________________________
_________________________________________
_________________________________________

Batch-level activities:
_________________________________________
_________________________________________
_________________________________________

Product-level activities:
_________________________________________
_________________________________________
_________________________________________

2. Group all overhead costs into homogeneous cost pools. Select an activity driver for each cost
pool and compute a pool rate.

Homogeneous Cost Pool Activity Driver Pool Rate

/ =
/ =
/ =
/ =
/ =
/ =
/ =
/ =
Activity-Based Costing 65

PROBLEM 1(Continued)
3. Using the pool rates, assign overhead costs to the two products and compute the overhead
cost per unit for each. Round answers to two decimal places.

Product X Product Z

Unit-level activities:

Batch-level activities:

Product-level activities:
66 Chapter4

Overhead cost per unit $ $

PROBLEM 2
Peach, Inc., has identified the following overhead costs and cost drivers for next year:
Expected Actual
Overhead Item Expected Cost Cost Driver Transactions
Setup costs........................... $90,000 Number of setups.................. 400
Ordering costs....................... 50,000 Number of orders.................. 4,000
Maintenance costs................ 150,000 Machine hours....................... 25,000
Power.................................... 30,000 Kilowatt hours....................... 75,000

The following are two of the jobs completed during the year:
Job 700 Job 701
Direct materials................................. $1,200 $600
Direct labor....................................... $900 $400
Units completed................................ 250 100
Direct labor hours............................. 40 20
Number of setups............................. 2 1
Number of orders.............................. 10 4
Machine hours.................................. 50 40
Kilowatt hours................................... 60 25

The companys practical activity is 5,000 direct labor hours.

Instructions:
1. Determine the unit cost for each job using direct labor hours to apply overhead. Round
answers to two decimal places.
Activity-Based Costing 67

PROBLEM 2(Continued)
2. Determine the unit cost for each job using the four activity drivers. Round answers to two
decimal places.

3. Which method produces the more accurate cost assignment? Why?

68 Chapter4

PROBLEM 3
Hanover Manufacturing has four categories of overhead. The four categories and expected over-
head costs for each category for next year are listed below:
Maintenance................................... $200,000
Materials handling........................... 32,000
Setups............................................ 100,000
Inspection....................................... 120,000

Currently, overhead is applied using a predetermined overhead rate based upon budgeted direct
labor hours. For next year, 50,000 direct labor hours are budgeted.
The company has been asked to submit a bid for a proposed job. The plant manager thinks getting
this job would result in new business in future years. Usually bids are based upon full
manufacturing cost plus 20 percent.
Estimates for the proposed job (Job No. P902) are as follows:

Direct materials............................... $6,000

Direct labor (1,000 hours)............... $10,000
Machine hours................................ 500
Number of material moves.............. 12
Number of setups........................... 2
Number of inspections.................... 10

In the past, full manufacturing cost has been calculated by allocating overhead using a volume-
based cost driver (direct labor hours). The plant manager has heard of a new way of applying
overhead that uses cost pools and cost drivers.
Expected activity for the four activity-based cost drivers that would be used are:

Machine hours................................ 20,000

Material moves............................... 1,600
Setups............................................ 2,500
Quality inspections.......................... 4,000

Instructions:
1. a. Determine the amount of overhead that would be allocated to the proposed job if a plant-
wide rate with direct labor hours used the unit-level driver.
Activity-Based Costing 69

PROBLEM 3(Continued)
b. Determine the total cost of the proposed job.

c. Determine the companys bid if the bid is based upon full manufacturing cost plus 20 percent.

2. a. Determine the amount of overhead that would be applied to the proposed project if
activity-based drivers are used.

b. Determine the total cost of the proposed job if activity-based costing is used.

c. Determine the companys bid if activity-based costing is used and the bid is based upon
full manufacturing cost plus 20 percent.
70 Chapter4

PROBLEM 3(Continued)
3. Prepare a memorandum to the plant manager with your recommendation regarding the bid
the company should submit. Include the reasons for your recommendation as well as any
supporting calculations.

MEMORANDUM
DATE:
TO:
FROM:
SUBJECT:
__________________________________________________________________________
Activity-Based Costing 71

PROBLEM 4
Ortegren, Inc., has two producing departments: Assembly and Finishing. The company has been
using a plantwide predetermined overhead rate based on direct labor cost. The following
amounts are for the current year:
Assembly Finishing
Actual overhead............................................... $220,000 $215,000
Budgeted overhead.......................................... $240,000 $180,000
Budgeted direct labor hours............................. 30,000 12,000
Budgeted machine hours................................. 8,000 10,000
Actual activity in direct labor hours................... 31,000 13,000
72 Chapter4

Actual activity in machine hours....................... 9,000 11,000

Instructions:
1. a. Calculate a plantwide predetermined overhead rate using direct labor hours.

b. Calculate applied overhead.

c. Calculate the amount of underapplied or overapplied overhead.

2. a. Calculate separate departmental overhead rates using direct labor hours for Assembly
and machine hours for Finishing.

b. Calculate the total amount of applied overhead for each department.

c. Calculate the amount of underapplied or overapplied overhead for each department.

Activity-Based Costing 73

ANSWERS

KEY TERMS TEST

1. batch-level activities 13. Overapplied overhead
2. activity dictionary 14. Underapplied overhead
3. consumption ratio 15. Overhead variance
4. Actual costing 16. facility-level activities
5. Normal costing 17. Unit-level activity drivers
6. homogeneous cost pool 18. Activity attributes
7. predetermined overhead rate 19. Activity drivers
8. Nonunit-level activity drivers 20. Unit-level activities
9. product-level activities 21. pool rate
10. Product diversity 22. Primary activities
11. activity-based costing system 23. Secondary activities
12. Applied overhead

CHAPTER QUIZ
1. See page 53. 17. a ($20 15,000 machine hours) = $300,000
2. a. a plantwide overhead rate 18. b ($900,000 + $1,200,000)/350,000 units =
b. departmental overhead rates $6.00
3. unit-level 19. d ($250,000 + $300,000)/100,000 units = $5.50
4. nonunit-level 20. a Maintenance:$400,000/75,000 machine
5. a. unit-level hours = $5.33/machine hour
b. batch-level Materials handling:$500,000/1,000,000
c. product-level moves = $0.50/move
d. facility-level Setups:$600,000/250 setups = $2,400/setup
6. Cost pool/Activity driver Model E:
7. Pool rate Activity driver consumed by product $5.33 60,000 = $ 319,800
8. a $0.50 600,000 = $ 300,000
9. b $2,400 175 = $ 420,000
10. b Total $1,039,800
11. b FalseFunctional-based product costing uses 21. d
a two-stage procedure: (1) costs are traced to Model Z:
the plant or departments (instead of $5.33 15,000 = $79,950
activities), and then (2) costs are traced to $0.50 400,000 = $200,000
products. $2,400 75 = $180,000
12. a True Total $459,950
13. b FalseA products consumption of overhead 22. b ($900,000 + $1,039,800)/350,000 units =
does NOT always increase in proportion to $5.54
increases in production volume. For example, 23. c ($250,000 + $459,950)/100,000 units = $7.10
setup costs are related to the number of 24. batch-level activity
setups instead of production volume. 25. unit-level activity
14. a True 26. facility-level activity
15. c ($400,000 + $500,000 + $600,000)/75,000 27. product-level activity
machine hours = $20.00 28. batch-level activity
16. b ($20 60,000 machine hours) = $1,200,000 29. facility-level activity

PRACTICE TEST
PROBLEM 1
1. Unit-level activities: Batch-level activities: Product-level activities:
Labor-related overhead Material handling Engineering
Machine-related overhead Setups Maintenance
Power Inspection
2. Homogeneous Cost Pool Activity Driver Pool Rate
Labor-related overhead$60,000 / Direct labor hours80,000 = $0.75
Machine-related overhead$120,000 / Machine hours40,000 = $3.00
Power$24,000 / Kilowatt hours30,000 = $0.80
Material handling$70,000 / Number of moves25,000 = $2.80
Setups$75,000 / Number of setups60 = $1,250.00
Inspection$108,000 / Number of inspections30,000 = $3.60
Engineering$60,000 / Engineering labor hours10,000 = $6.00
Maintenance$50,000 / Maintenance hours used2,500 = $20.00

3. Product X Product Z
Unit-level activities:
Labor-related overhead:
($0.75 40,000)/50,000 units $0.60
($0.75 40,000)/75,000 units $0.40
Machine-related overhead:
($3.00 22,000)/50,000 units $1.32
($3.00 18,000)/75,000 units $0.72
Power:
($0.80 16,000)/50,000 units $0.26
($0.80 14,000)/75,000 units $0.15

Batch-level activities:
Material handling:
($2.80 10,000)/50,000 units $0.56
($2.80 15,000)/75,000 units $0.56
Setups:
($1,250 40)/50,000 units $1.00
($1,250 20)/75,000 units $0.33
Inspections:
($3.60 18,000)/50,000 units $1.30
($3.60 12,000)/75,000 units $0.58

Product-level activities:
Engineering:
($6.00 6,000)/50,000 units $0.72
($6.00 4,000)/75,000 units $0.32
Maintenance:
($20.00 1,500)/50,000 units $0.60
($20.00 1,000)/75,000 units $0.27

Overhead cost per unit $6.36 $3.33

Activity-Based Costing 75

PROBLEM 2
1. Total overhead costs = $90,000 + $50,000 + $150,000 + $30,000
= $320,000
Plantwide overhead rate = $320,000/5,000
= $64 per direct labor hour
Job 700 Job 701
Direct materials............................................ $1,200 $ 600
Direct labor.................................................. 900 400
Overhead assigned:
($64 40 direct labor hours).................. 2,560
($64 20 direct labor hours).................. 1,280
Total cost...................................................... $4,660 $2,280
Cost per unit:
($4,660/250 units)................................... $18.64
($2,280/100 units)................................... $22.80
2. Activity-based overhead rates:
Setup costs: $90,000/400 setups = $225 per setup
Ordering costs: $50,000/4,000 orders = $12.50 per order
Maintenance costs: $150,000/25,000 machine hours = $6 per machine hour
Power: $30,000/75,000 kilowatt hours = $0.40 per kilowatt hour
Job 700 Job 701
Direct materials............................................ $1,200 $ 600
Direct labor.................................................. 900 400
Overhead applied:
($225 2 setups).................................... 450
($12.50 10 orders)............................... 125
($6.00 50 machine hours)................... 300
($0.40 60 kilowatt hours)..................... 24
($225 1 setup)...................................... 225
($12.50 4 orders)................................. 50
($6.00 40 machine hours)................... 240
($0.40 25 kilowatt hours)..................... 10
Total cost...................................................... $2,999 $1,525
Cost per unit:
($2,999/250 units)................................... $12.00
($1,525/100 units)................................... $15.25
3. Activity-based costing produces the more accurate cost assignment because it uses multiple drivers that are
related to overhead consumption. A product or jobs consumption of overhead does not always increase in
proportion to a single volume-based cost driver, such as direct labor hours.
Setup costs are related to the number of setups, ordering costs are related to the number of orders,
maintenance costs are related to the number of machine hours, and power costs are related to the number of
kilowatt hours.

PROBLEM 3
1. a. Total overhead = $200,000 + $32,000 + $100,000 + $120,000
= $452,000
Overhead rate = $452,000/50,000 direct labor hours
= $9.04 per direct labor hour
Overhead assigned to proposed job= $9.04 1,000 direct labor hours
= $9,040
b. Total cost of proposed job:
Direct materials............................................ $6,000
Direct labor.................................................. 10,000
Overhead applied......................................... 9,040
 Total cost...................................................... $25,040
c. Companys bid = Full manufacturing cost 120%
= $25,040 120%
= $30,048
2. a. Maintenance: $200,000/20,000 machine hours = $10 per machine hour
Materials handling: $32,000/1,600 material moves = $20 per move
Setups: $100,000/2,500 setups = $40 per setup
Inspection: $120,000/4,000 inspections = $30 per inspection
Overhead assigned to proposed job:
Maintenance($10 500)........................... $5,000
Materials handling($20 12).................... 240
Setups($40 2)........................................ 80
Inspections($30 10)............................... 300
Total overhead assigned to job.................... $5,620
b. Total cost of proposed project:
Direct materials............................................ $6,000
Direct labor.................................................. 10,000
Overhead applied......................................... 5,620
Total cost...................................................... $21,620
c. Companys bid = Full manufacturing cost 120%
= $21,620 120%
= $25,944
3. Your memorandum should contain the following:
(a) A brief introductory sentence to inform the reader of the purpose of the memorandum.
Example:This memorandum regards the recommended bid price for proposed Job No. P902.
(b) A concise and specific recommendation.
Example:I recommend that Hanover Manufacturing submit a bid of $25,944 for Job No. P902.
(c) A discussion of the reasons why your recommendation should be followed.
Example:This bid price was developed using activity-based costing (ABC) because ABC produces more
accurate product costs and more competitive bids.
(d) Supporting calculations included in the body of the memorandum or attached on a separate page.
Example:The bid price of $25,944 was determined as follows:
Direct materials............................................ $6,000
Direct labor.................................................. 10,000
Overhead assigned:
Maintenance($10 500)...................... $5,000
Materials handling($20 12)............... 240
Setups($40 2).................................... 80
Inspections($30 10).......................... 300
Total overhead assigned to job............... 5,620
Total cost...................................................... $21,620
Markup......................................................... 120%
Bid price....................................................... $25,944
(e) A closing sentence.
Example:If you have any questions, please contact me at Extension 76.

PROBLEM 4
1. a. Plantwide rate = Budgeted plant overhead/Budgeted direct labor hours
= ($240,000 + $180,000)/(30,000 + 12,000)
= $10 per direct labor hour
Activity-Based Costing 77

b. Applied overhead = Plantwide overhead rate Actual activity

= $10 (31,000 + 13,000)
= $440,000
c. Overhead
Actual overhead Applied overhead
$220,000 $440,000
215,000
$ 5,000 overapplied

2. a. Assembly departmental rate = $240,000/30,000 direct labor hours

= $8.00 per direct labor hour
Finished departmental rate = $180,000/10,000 machine hours
= $18.00 per machine hour
b. Applied overhead:Assembly = $8.00 31,000 direct labor hours
= $248,000
Applied overhead:Finishing = $18.00 11,000 machine hours
= $198,000

c. Overhead:Assembly Overhead:Finishing
Actual overhead Applied overhead Actual overhead Applied overhead

$220,000 $248,000 $215,000 $198,000

$28,000 overapplied $17,000 underapplied