Midterm - Ch.

5
5-25 Special Order, Activity-Based Costing
The Medal Plus Company manufactures medals for winners of athletic events and other contests. Its
manufacturing plant has the capacity to produce 12,000 medals each month; current production and sales
are 9,000 medals per month. The company normally charges $200 per medal. Cost information for the
current activity level is as follows:
Variable Costs (vary with units produced):
Direct materials $360,000
Direct labour 405,000
Variable costs (vary with number of batches): Setups, materials, handling, quality control 126,000*
Fixed manufacturing costs 325,000
Fixed marketing costs 224,000
Total costs $1,440,000
*Costs of $126,000 are based on 180 batches at $700 per batch
Medal Plus has just received a special one-time-only order for 2,500 medals at $168 per medal.
Accepting the special order would not affect the company’s regular business. Medal Plus makes medals
for its existing customers in batch sizes of 50 medals (180 batches x 50 medals per batch = 9,000
medals). The special order requires Medal Plus to make the medals in 25 batches of 100 each.
a) Should Medal Plus accept this special order? Explain briefly.
Without With
One Time One Time
Only Special Only Special Difference
Order 9,000 Units Order 11,500 Units 2,500 Units
Sales $1,800,000 $2,220,000 $420,000
Variable costs:
Direct materials 360,000 460,000* 100,000
Direct manufacturing labour 405,000 517,500** 112,500
Batch manufacturing costs 126,000 143,500*** 17,500
Fixed costs:
Fixed manufacturing costs 325,000 325,000 0
Fixed marketing costs 224,000 224,000 0
Total costs 1,440,000 1,670,000 230,000
Operating income $360,000 $550,000 $190,000
*Unit Cost Direct materials = $360,000 / 9,000 = $40 pe medal x 11,500 = $460,000
**Unit cost direct labour = $405,000 / 9,000 = $45 per medal x 11,500 = $517,500
***Batch costs $126,000 + (25 * $700)
Medal Plus should accept the order because accepting the order increases the operating income by $190,000.
b) Suppose plant capacity was only 10,000 medals instead of 12,000 medals each month. The special
order must either be taken in full or rejected totally. Should Medal Plus accept the special order?
Medal Plus’s operating income from selling 7,500 medals to regular customers and 2,500 medals under the one-time
special order follows:
Sales (7,500 x $200) + (2,500 x $168) $1,920,000
Direct materials (10,000 * $40) 400,000
Direct manufacturing labour (10,000 * $45) 450,000
Batch manufacturing costs (150 x $700) + (25 x $700) 122,500
Fixed manufacturing costs 325,000
Fixed marketing costs 224,000
Total costs 1,521,500
Operating income $398,500
Medal Plus should accept the order because accepting the order increases the operating income by $38,500
($398,500 - $360,000).
c) As in part a), assume that monthly capacity is 12,000 medals. Medal Plus is concerned that if it accepts
the special order, its existing customers will immediately demand a price discount of $11 in the month in
which the special order is being filled. They would argue that Medal Plus’s capacity costs are now being
spread over more units and that existing customers should get the benefit of these lower costs. Should
Medal Plus accept the special order under these conditions? Show all calculations.
Increase in operating income by selling 2,500 units under the special order (part b) $190,000
Operating income lost from existing customers ($11 x 9,000) (99,000)
Net effect on operating income of accepting special order $91,000
Medal Plus should accept the order under these conditions because accepting the order increases the operating
income by $91,000.
5-27 ABC, Wholesale, Customer Profitability
Ames Wholesalers sells furniture items to four department-store chains. Sharon Ames commented, “We
apply ABC to determine profit line profitability. The same ideas apply to customer profitability, and we
should find out our customer profitability as well.” Ames Wholesalers sends catalogues to the corporate
purchasing departments on a monthly basis. The customers are entitled to return unsold merchandise
within a six-month period from the purchase date and receive a full purchase-price refund. The following
data were collected from last year’s operations:

Chain 1 Chain 2 Chain 3 Chain 4

Gross Sales $50,000 $30,000 $100,000 $70,000

Sales Returns:

# of items 100 26 60 40

Amount $10,000 $5,000 $7,000 $6,000

# of Orders

Regular 40 150 50 70

Rush 10 50 10 30

Ames has calculated the following activity rates:

Activity Cost Driver Rate
Regular order processing $20 per regular order
Rush order processing 100 per rush order
Returned items processing 20 per item
Catalogues and customer support 1,000 per customer
Determine the contribution to profit from each chain last year. Cost of goods sold is 70% of net sales.
Comment on your solution.

1 2 3 4

Gross sales $50,000 $30,000 $100,000 $70,00

Sales returns 10,000 5,000 7,000 6,000

Net sales 40,000 25,000 93,000 64,000

Cost of goods sold (80%) 28,000 17,500 74,400 51,200

Gross margin 12,000 7,500 27,000 19,200

Customer-related costs:

Regular Orders 800 3,000 1,000 1,400

$20 x 40; 150; 50; 70
 Rush Order 1,000 5,000 1,000 3,000
$100 x 10; 50; 10; 30

Returned Items 2,000 520 1,200 800

$20 x 100; 26; 60; 40

Catalogues and customer support 1,000 1,000 1,000 1,000

Customer related costs 3,800 9,260 3,600 5,800

Contribution (loss) margin $8,200 $(1,760) $24,300 $13,400

Contribution (loss) margin as % of 16.4% (5.87%) 24.3% 19.14%

gross sales

Contribution Margin (loss) Percentage = (Contribution Margin / Gross Sales) x 100

The analysis indicates that customers’ profitability (loss) contribution varies widely. This is due to the customer-
related costs. Immediate attention to Chain 2 is required which is currently showing a contribution loss, is required.
The chain has a disproportionate number of both regular orders and rush orders. Ames should work with the
management of Chain 2 to find ways to reduce the number of orders, while maintaining or increasing the sales
volume.
5-29 ABC, Product Costing at Banks, Cross-Subsidization
International Trust (IT) is examining the profitability of its Premier Account, a combined savings and
checking account. Depositors receive a 6% annual interest rate on their average deposit. IT earns an
interest rate spread of 2.5% (the difference between the rate at which it lends money and the rate it pays
depositors) by lending money for residential home loan purposes at 8.5%. Thus, IT would gain $250 on
the interest spread if a depositor had an average Premier Account balance of $10,000 in 2018 ($10,000 x
2.5% = $250)
The Premier Account allows depositors unlimited use of services such as deposits, withdrawals, chequing
account, and foreign currency drafts. Depositors with Premier Account balances of $2,500 or more
receive unlimited free use of services. Depositors with minimum balances of less than $2,500 pay a $35
monthly service fee for their Premier Account.
IT recently conducted an ABC study of its services. It assessed the following cost for six individual
services. The use of these services in 2018 by three Premier Account customers is as follows:
ABC Cost per Accounts Usage
Transaction Robinson Skerrett Farrel
Deposits/withdrawals with teller $4.00 45 55 10
Dospits/withdrawals at ATM 1.20 12 24 18
Prearranged monthly deposit/withdrawal 0.80 0 15 60
Cheques written 11.25 10 5
4
Foreign currency drafts 12.50 4 1 7
Account balances inquires 2.50 12 20 11
Average cash balance $2,600 $1,200 $40,000

Assume Robinson and Farrell always maintain a balance above $2,500 while Skerrett always has a
balance below $2,500 in 2018.
a) Compute the 2018 profitability of the Robinson, Skerrett, and Farrell Premier Accounts at IT.
Robinson Skerrett Farrel Total

Revenue
Spread revenue on annual basis
(2.5% x; $2,600, $1,200, $40,000) $65.00 $30.000 $1,000.00
$1,095.00
Monthly fee charges
($35; 0, 12, 0) 0.00 420.00 0.00 420.00
Total revenue 65.00 450.00 1,000.00 1,515.00
Costs
Deposit/withdrawal with teller
$4.00 x 45; 55; 10 180.00 220.00 40.00 440.00
Deposit/withdrawal with ATM
$1.20 x 12; 24; 18 14.40 28.80 21.60 64.80
Deposit/withdrawal prearranged monthly
$0.80 x 0; 15; 60 0 12.00 48.00 60.00
Bank cheques written
$11.25 x 10; 5; 4 112.50 56.25 45.00 213.75
Foreign currency drafts
$12.50 x 4; 1; 7 50.00 12.50 87.50 150.00
Inquires
$2.50 x 12; 20; 11 30.000 50.00 27.50 107.50
Total Costs 386.90 279.55 269.60 $1,036.05
Operating Income $(321.90) $70.45 $730.40 $478.95
The assumption that the Robinson and Farrell accounts exceed $2,500 every month and the Skerrett account is less
than $2,500 each month means the monthly charges apply only to Skerrett.
b) What evidence is there of cross-subsidization across Premier Accounts? Why might IT worry about this
cross-subsidization if the Premier Account product offering is profitable as a whole?
Cross-subsidization across individual Premier Accounts occurs when profits made on some accounts are offset by
losses on other accounts. The Grant account is highly profitable, while the Holt account is sizably unprofitable. The
Slaton account shows a small profit but only because of the monthly fees. It is unlikely that Slaton will keep paying
these high fees and that the US would want this customer to pay such higher fees from a customer relationship
standpoint.
The facts also suggest that the customers do not use the bank services uniformly. For example, Holt and Slaton have
a lot of transactions with the teller or ATM and also inquire about their account balances more often than Grant. US
should be very concerned about the cross-subsidization. Competition likely would “understand” that high-balance,
low-activity type accounts are highly profitable. Offering free services to these customers is not likely to retain these
accounts if other banks offer higher interest rates. Competition liley will reduce the interest rate spread US can earn
on the high-balance, low-activity accounts it is able to retain.
c) What changes at IT would you recommend for its Premier Account?

Possible changes US could make are as follows

a) Offer higher interest rates on high-balance accounts to increase US’s compeittiveness in attracting and
retaining these accounts
b) Introduce charges for the individual services. In determining its pricing strategy, US would need to
consider how other competing banks are pricing their products and services
c) Increase the minimum balance for unlimited use of services
5-32 Job Costing with Multiple Direct-Cost Categories, Single Indirect-Cost Pool, Law Firm
Hanley asks his assistant to collect details on those costs included in the $21,000 indirect-cost pool that
can be traced to each individual case. After further analysis, Marc and Associates is able to reclassify
$14,000 of the $21,000 as direct costs:
Other Direct Costs Widnes Coals St. Helen’s Glass
Research support labour $1,600 $3,400
Computer time 500 1,300
Travel and allowances 600 4,400
telephone/faxes 200 1,000
Photocopying 250 750
Total $3,150 $10,850
Hanley decides to calculate the costs of each case had Marc and Associates used six direct-cost pools
and a single indirect-cost pool. The single indirect-costs pool would have $7,000 of cost and would be
allocated to each case using the professional labour-hours base.
a) What is the revised indirect cost allocation rate per professional labour-hour for Marc and Associates
when total indirect costs are $7,000?
Indirect Cost Rate per Hour = Indirect costs / Total professional labour-hours = $7,000 / (104 + 96) = $35 / hour
b) Compute the costs of the Widnes and St. Helen’s cases if Marc and Associates had used its refined
costing system with multiple direct-cost categories and one indirect-cost pool.
Indirect Costs Allocated to Job = Professional Labour-Hours for Job x Indirect Cost Rate per Hour
Widnes Coal St. Helen’s Total

Direct Costs:
Direct professional labour,
$70 x 104; 96 $7,280 $6,720 $14,000
Research support labour 1,600 3,400 5,000
Computer time 500 1,300 1,800
Travel and allowances 600 4,400 5,000
Telephone/faxes 200 1,000 1,200
Photocopying 250 750 1,000
Total direct costs 10,430 17,570 28,000
Indirect Costs Allocated,
$35 x 104; 96 3,640 3,360 7,000
Total costs to be billed $14,070 $20,930 $35,000
c) Compare the costs of Widnes and St. Helen's jobs in requirement 2 with those calculated using the
simple costing system. Comment on the results.
It appears that using a simple costing system does not give an accurate representation of costs. Although St. Helen’s
Glass uses fewer professional hours, it has a higher proportion of the reclassified costs. This leads us to believe that
the job is undercosted using the simple costing system.
5-35 Uses ABC Systems for ABM
Family Supermarket (FS) found that its ABC analysis provided important insights. FS extends the analysis
to cover three more product lines: baked goods, milk and fruit juice, and frozen products. It identifies four
activities and activity costs rate for each activity as:
Ordering $120 per purchase order
Delivery and receipt of merchandise 96 per delivery
Shelf-stocking 24 per hour
Customer support and assistance 0.24 per item sold
The revenues, cost of goods sold, store support costs, and activity area usage of the three product lines
are as follows:
 Baked Goods Milk and Fruit Juice Frozen Products

Financial data:

Revenues $78,400 $85,600 $72,400

Cost of goods sold 45,600 56,400 42,000

Store support 13,680 16,920 12,600

Activity area usage (cost driver):

Ordering (purchase orders) 30 25 13

Delivery (deliveries) 98 36 28

Shelf-stocking (hours) 183 166 24

Customer support (items sold) 15,500 20,500 7,900

There are no bottle returns for any of these three product lines.
a) Use the previous costing system (support costs allocated to products at the rate of 30% of cost of
goods sold) to compute a product line profitability report for FS.
Baked Goods Milk & Fruit Juice Frozen Products Total

Revenue $78,400 $85,600 $72,400 $236,400

Costs
COGS 45,600 56,400 42,000 144,000
Store Support (30% of COGS) 13,680 16,920 12,600 43,200
Total costs 59,280 73,320 54,600 187,200
Operating income $11,680 $13,840 $23,680 $39,200
Operating income / Revenue 14.89% 16.16% 32.7% 16.50%
b) Use the ABC system (ordering at $120 per purchase order, delivery at $96 per delivery, shelf-stocking
at $24 per hour, and customer support at $0.24 per item sold) to compute a product line profitability report
for FS.
Baked Goods Milk & Fruit Juice Frozen Products Total

Revenue $78,400 $85,600 $72,400 $236,400

Costs
COGS 45,600 56,400 42,000 144,000
Ordering 3,600 3,000 1,560 8,160
Delivery 9,408 3,456 2,688 15,552
Shelf-stocking 4,392 3,984 576 8,952
Customer support 3,720 4,920 1,896 10,536
Total costs 66,720 71,760 48,720 187,200
Operating income $11,680 $13,840 $23,680 $39,200
Operating income / revenue 14.89% 16.16% 32.7% 16.50%
These activity cost are based on the following:
Activity Cost Allocation Rate Baked Goods Milk & Juice Frozen Products
Ordering $120 per purchase order 30 25 13
Delivery $96 per delivery 98 36 28
Shelf-shocking $24 per hour 183 166 24
Customer support $0.24 per item sold 15,500 20,500 7,900

The rankings of products in terms of relative profitability are:

Previous Costing System ABC System
1. Baked Goods 13.33% Frozen Products 21.92%
2. Frozen Products 12.50% Milk & Fruit Juice 5.08%
3. Milk & Fruit Juice 3.02% Baked Goods 2.46%
The percentage revenue, COGS, and activity costs for each product line are:
Baked Goods Milk & Fruit Juice Frozen Products Total

Revenue 33.14 36.63 30.23 100.00

COGS 31.67 39.17 29.16 100.00
Activity Areas
Ordering 44.12 36.76 19.12 100.00
Delivery 60.49 22.22 17.29 100.00
Shelf-stocking 49.06 44.50 6.44 100.00
Customer Support 35.31 46.70 17.99 100.00
c) What new insights does the ABC system in b) provide to FS managers?
The baked goods line drops sizably in profitability when ABC is used. The product line uses more resources in each
activity area. In contrast, frozen products used less of the total resources in each activity area. Hence, under ABC,
frozen products are much more profitable. Carlson Supermarkets may want to explore price increases on baked
goods.
5-20 (Plantwide Indirect Cost Rates) - Assignment
Parts World (PW) designs, manufactures, and sells automotive parts. Actual variable manufacturing
overhead costs for 2018 were $317,250. PW's simple costing system allocates variable manufacturing
overhead to its three customers based on machine-hours and prices its contracts based on full costs. One
of its customers has regularly complained of being charged non-competitive prices, so PW's controller,
Matthew Draper, realizes that it is time to examine the consumption of resources more closely. PW has
three main operating departments: design, engineering, and production.
● Design - the design of parts, using state of the art, computer-aided design (CAD) equipment
● Engineering - the prototyping of parts and testing of their specifications
● Production - the manufacture of parts
Interviews with the department personnel and examination of time records yield the following detailed
information.
Variable Us of Cost Drivers by Customer
Department Cost Driver MOH in 2018 State Motors Holden Motors Island Vehicle
Design CAD design-hours $44,100 120 210 90
Engineering Engineering-hours 33,150 80 50 260
Production Machine-hours 240,000 90 2,000 910
Total $317,250
a) Using the simple costing system, compute the plantwide variable manufacturing overhead rate for 2018
and the variable manufacturing overhead allocated to each contract in 2018.
Variable OH Rate (Simple Costing) = Total Variable OH / Total Machine-Hours
= $317,250 / (90 + 2,000 + 910)
= $105.75 per machine-hour
State Motors Holden Motors Island Motors Total
Variable OH Allocations $9,517.50* $211,500** $96,232.50*** $317,250
*$105.75 x 90 = $9,517.50
**$105.75 x 2,000 = $211,500
***$105.75 x 910 = $96,232.50
b) Compute the variable manufacturing overhead rate for 2018 and the variable manufacturing overhead
allocated to each contract in 2018 usingdepartment-based variable overhead rates.
Variable OH Rate by Department = Variable OH per Department / Total Hours per Department
Department Variable MOH Rate (by department)
Design $105* per CAD design-hour
Engineering $85** per engineering-hour
Production $80*** per machine-hour
*$44,100 / (120 + 210 + 90) = $105
**$33,150 / (80 + 50 + 260) = $85
***$240,000 / (90 + 2,000 + 910) = $80

Department State Motors Holden Motors Island Motors Total

Design $12,600* $22,050 $9,450 $44,100
Engineering $6,800** $4,250 $22,100 $33,150
Production $7,200*** $160,000 $72,800 $240,000
Total $26,600 $186,300 $104,250 $317,250
*120 / (120 + 210 + 90) = 0.285714 x $44,100 = $12,600
**80 / (80 + 50 + 260) = 0.205128 x $33,150 = $6,800
***90 / (90 + 2,000 + 910) = 0.03 x $240,000 = $7,200
c) Comment on your answers in requirements 1 and 2. Which customer do you think was complaining
about being overcharged in the simple system? If the newdepartment-based rates are used to price
contracts, which customer(s) will beunhappy? How would you respond to these concerns?
● Under the simple costing system, Holden was likely unhappy about its bill because the contract appears to
have been overcosted. If the new department-based rates are used to price contracts, Holden will likely be
happier about its bill.
● If the new department-based rates are used to price contracts, State and Island will likely be unhappy. This
is because their bills under the simple costing system appears to have been undercosted. Using the
department-based rates, their bills will be higher.
d) How else might PW use the information available from itsdepartment-by-department analysis of
variable manufacturing overhead costs?
● Other than for pricing, PW can also use the information from the department-based system to examine and
streamline its own operations so that there is maximum value added from all indirect resources. It might set
targets over time to reduce both the consumption of each indirect resource and the unit costs of the
resources. The department-based system gives PW more opportunities for targeted cost management
e) PW’s managers are wondering if they should further refine thedepartment-by-department costing
system into an ABC system by identifying different activities within each department. Under what
conditions would it not be worthwhile to further refine the department costing system into an ABC system?
● It would not be worthwhile to further refine the costing system into an ABC system if there weren’t muh
variation among contracts in the consumption of activities within a department. If, for example, most
activities within the design department were, in fact, driven by CAD design-hours, then the more refined
system would be more costly and no more accurate than the department-based cost system.
● Even if there were sufficient variation, considering the relative sizes of the three department cost pools, it
may only be cost-effective to further analyze the production cost pool, which consumes 76%* of the
manufacturing overhead.

*$240,000 / $317,250 = 75.65%

5-36 (Department and Activity Cost Rates, Service Sectors) - Assignment
Reston’s Radiology Centre (RRC) performs X-rays, ultrasounds, CT scans, and MRIs. RRC has
developed a reputation as a top radiology centre in the area. RRC has achieved this status because it
constantly reexamines its processes and procedures. RRC has been using a single, facility-wide
overhead allocation rate. The VP of Finance believes that RRC can make better process improvements if
it uses more disaggregated cost information. She says, "We havestate-of-the-art medical imaging
technology. Can't we have state-of-the-art accounting technology?"
The following budgeted information is available.

Reston’s Radiology Centre

Budgeted Information
For the Year Ending May 30, 2019

X-Rays Ultrasound CT Scan MRI Total

Technician labour $65,000 $107,500 $98,500 $100,000
$371,000
Depreciation 32,800 272,000 438,000 891,000
1,633,800
Materials 22,200 16,000 24,100 31,500 93,800
Administration 19,500
Maintenance 246,000
Sanitation 196,000
Utilities _______ ________ _______ ________ 129,000
Totals $120,000 $395,500 $560,600 $1,022,500 $2,689,100

Number of procedures 3,700 4,500 3,200 2,500

Min to clean after each procedure 5 5 20 30
Minutes for each procedure 10 15 20 40

RRC operates at capacity. The proposed allocation bases for overhead are as follows:
Administrative Number of procedures
Maintenance (including parts) Capital costs of the equipment (depreciation)
Sanitation Total cleaning minutes
Utilities Total procedure minutes
a) Calculate the budgeted cost per service for X-rays, ultrasounds, CT cans, and MRIs using direct
technician labour as the cost allocation base.
Service Labour x(Total Indirect Costs / Total Labour) = Indirect Costs Allocated to Service
X-Rays $65,000 x($590,500* / $371,000) = $103,457
Ultrasound $107,500 x ($590,500 / $371,000) = $171,102
CT Scan $98,500 x($590,500 / $371,000) = $156,777
MRI $100,000 x ($590,500 / $371,000) = $159,164
*$19,500 + $246,000 + $196,000 + $129,000 = $590,500
X-Rays Ultrasound CT Scan MRI
Technician Labour $65,000 $107,500 $98,500 $100,000
Depreciation 32,800 272,000 438,000 891,000
Materials 22,200 16,000 24,100 31,500
Indirect Costs $103,457 $171,102 $156,777 $159,164
Total Budgeted Costs $223,457 $566,602 $717,377 $1,181,664
Budgeted Cost per Service $60.39* $125.91 $244.18 $472.67
$223,457 / 3,700 procedures = $60.39 per service
b) Calculate the budgeted cost per service for X-rays, ultrasound, CT scans, and MRIs if RRC allocated
overhead costs using ABC.
Administrative Costs Allocated = Service Procedures x (Administrative Costs / Total Procedures)
Maintenance Costs Allocated = Service Depreciation x (Maintenance Costs / Total Depreciation)
Sanitation Costs Allocated = Total Service Minutes x (Sanitation Costs / Total of all Minutes to Clean)
Utility Costs Allocated = Total Service Minutes x (Utilities Costs / Total of all Procedure Minutes)
******Using the formulas above, calculate the following table*******
X-Rays Ultrasound CT Scan MRI
Technician Labour $65,000 $107,500 $98,500 $100,000
Depreciation 32,800 272,000 438,000 891,000
Materials 22,200 16,000 24,100 31,500
Administrative $5,191* $6,313 $4,489 $3,507
Maintenance $4,939** $40,955 $65,949 $134,157
Sanitation $20,144^ $24,500 $69,689 $81,667
Utilities $17,777 $32,430 $30,749 $48,045
Total $168,051 $499,698 $731,476 $1,289,876
*3,700 x (19,500 / (3,700 + 4,500 + 3,200 + 2,500) = $5,191
**$32,800 x (246,000 / 1,633,800) = $4,949
^(5 x 3,700) x (196,000 / [(5 x 3,700) + (5 x 4,500) + (20 x 3,200) + (30 x 2,500)] = $20,144
^^(10 x 3,700) x (129,000 / [(10 x 3,700) + (15 x 4,500) + (20 x 3,200) + (40 x 2,500)] = $17,777
X-Rays Ultrasound CT Scan MRI
Budgeted cost per service $45.42* $111.04 $228.59 $515.95
*$168,051 / 3,700 = $45.42

c) Explain how the disaggregation of information could be helpful to RRC’s intention to continuously
improve its services.
● Using the disaggregated activity-based costing data, managers can see that MRIs cost substantially more
and x-rays and ultrasounds substantially less than the traditional system indicated. In particular, an MRI
activity generates a lot of maintenance activity and sanitation activity. Managers should examine the use of
these two activities to search for ways to reduce the activity consumption and ultimately its cost.
DGD (Activity-Based Costing)
Eloquence Publishing is concerned about the profitability of its paperback dictionaries. Company
managers are considering producing only the top-quality, hand-sewn dictionaries with gold-edged pages.
Eloquence is currently assigning the $1,000,000 of overhead costs to both types of dictionaries based on
machine hours. Of the overhead, $400,000 is utilities related and the remainder is primarily related to
quality control inspectors’ salaries. The following information about the products is also available:
Regular Hand-Sewn
Number produced 1,000,000 700,000
Machine hours 85,000 15,000
Inspection hours 5,000 25,000
Revenues $3,200,000 $2,800,000
Direct costs $2,500,000 $2,200,000
a) Determine the total overhead costs that are being assigned to each type of dictionary using the current
allocation system.
Total overhead costs = $1,000,000
Machine Hours = 85,000 + 15,000 = 100,000
Overhead Allocation Rate = Total Overhead Costs / Total Machine Hours
= $1,000,000 / 100,000
= $10 per machine hour
Regular
85,000 machine hours x $10 per machine hour = $850,000
Hand-Sewn
15,000 machine hours x $10 per machine hour = $150,000
b) Determine the total overhead cost that would be assigned to each type of dictionary if more appropriate
cost drivers were used (ABC method).
Overhead Rates
Utilities: Total Cost $400,000
Total Machine Hours 100,000
Allocation Rate $4 per machine hour
Quality Control Inspections Salaries: Total Cost $600,000
Total Inspection Hours 30,000
Allocation Rate $20 per inspection hour
Regular
Utilities = $4 x 85,000 Quality Control = $20 x 5,000
= $340,000 = $100,000
Total OH Costs = Utilities + Quality Control = $340,000 + $100,000 = $440,000
Hand-Sewn
Utilities = $4 x 15,000 Quality Control = $20 x 25,000
= $60,000 = $500,000
Total OH Costs = $60,000 + $500,000 = $560,000
c) Provide specific explanations for the changes in cost allocation between parts a and b.
In part a, regular uses much larger proportions of the total machine hours (which is the only allocation base used). In
part b, hand-sewn uses a much larger proportion of the total inspection hours (used as a second allocation base in the
ABC system).
So, in part a (one allocation rate) the regular is overcosted while hand-sewn is undercosted. In part b, it uses the
ABC system, which provides for more accurate overhead costing.

d) Should the company stop producing the regular dictionaries? Explain.

No. In part a), regular appears to lose money: 3.2 million (revenue) - 2.5M (direct cost) - 850,000 (OH) =
$(150,000).
However, part b uses a better, more accurate cost system. Thus:
2.3 M - 2.5M - 440,000 (OH) = $260,000 profit
DGD (Activity-Based-Costing)
Odyssey Inc. has a total $2,362,500 in production overhead costs. The company’s products and the
related information follow:
Product A Product B
Direct material in pounds 139,500 190,500
Direct labour hours 30,000 37,500
Machine hours 52,500 22,500
Number of setups 430 860
Number of units produced 15,000 7,500
Additional information: The 330,000 pounds of materials were purchased for $544,500. One direct labour
hour costs $12.
a) Assume that Odyssey Inc. uses direct labour hours to allocate overhead to products. Determine the
total cost for each product and the cost per unit.
Total Overhead Costs = $2,362,500
Total Direct Labour Hours = 30,000 + 37,500 = 67,500 hours
Overhead Allocation Rate = 2,362,500 / 67,500
= $35 per labour hour
Direct Material Cost = $544,500
Direct Material Pounds = 330,000
Direct Material Rate = $544,500 / 330,000
= $1.65 per pound
Product A
Direct Materials = $1.65 x 139,500 pounds = $230,175
Direct Labour = $12 x 30,000 = $360,000
MOH = $35 x 30,000 = $1,050,000
Total Product Cost = $1,640,175
Total Cost Per Unit = $1,640,175 / 15,000 units produced = $109.35 per unit
Product B
Direct Materials = $1.65 x 190,500 pounds = $314,325
Direct Labour = $12 x 37,500 = $450,000
MOH = $35 x 37,500 = $1,312,500
Total Product Cost = $2,076,,825
Total Cost Per Unit = $2,076,825 / 7,500 units produced = $276.91
b) If Odyssey Inc. uses activity-based-costing (ABC) to allocate overhead costs based on the following
activities, determine the total cost for each product and the cost per unit:
Cost Pool Cost Driver Cost
Utilities # of machine hours $750,000
Setup # of setups 193,500
Material Handling # of pounds of material 1,419,000
Allocation Rates
Utilities: Total Costs $750,000
Total Machine Hours 75,000
Allocation Rate $10 per machine hour
Setup Total Costs $193,500
Total Setups 1,290
Allocation Rate $150 per setup
Material Handling Total Costs $1,419,000
Total Pounds 330,000
Allocation Rate $4.3 per pound

Product A
Direct Materials = $230,175
Direct Labour = $360,000
Utilities = $10 x 52,500 = $525,000
Setup = $150 x 430 = $64,500
Material Handling = $4.3 x 139,5000 = $599,850
Total Cost = $1,779,525
Cost Per Unit = $1,779,525 / 15,000 = $118.64
Product B
Direct Materials = $314,325
Direct Labour = $450,000
Utilities = $225,000
Setup = $129,000
Material Handling = $819,150
Total Cost = $1,937,475
Cost per Unit = $258.33
c) Is there cross-subsidization incurred? Which product is overcosted? Which product is under-costed?
Yes. Product A was undercosted (118.64 part b ? 109.35 part b). Product b was overcosted (258.33 par b < 276.91)
d) Discuss one pro and one con of the activity-based-costing method.
Pro: ABC is more accurate in allocating indirect costs
Con: ABC is more costly and takes more time to calculate everything
5-Capstone
Lionel Corporation produces custom machine parts on a job order basis. The company has two direct
product costs: direct material and direct labour. In the past, indirect manufacturing costs were allocated to
products using a single indirect cost pool, allocated based on direct labour hours.
The managers of Lionel Corporation decided to switch from a manual system to software programs that
release materials and that signal machine when to begin working. Simultaneously, the company adopted
an activity-based costing system. The managers predicted the total amount of direct labour hours of next
year is 1,470 hours. The manufacturing process has been organized into six activities, each with its own
supervisor who is responsible for controlling costs. The following lists indicates the activity cost pools,
estimated activity costs, cost drivers and total expected activity volume:
Activity Cost Pools Cost Driver Estimated Indirect Costs Expected Activities
Materials handling # of Parts $21,200 53,000
Milling Machine Hrs $76,176 6,348
Grinding # of Parts $42,400 53,000
Assembly Hrs Spent in Assembly $280 56
Inspection # of Units Produced $12,500 500
Shipping # of Orders Shipped $16,500 11
$169,056
The company’s information system automatically collects the necessary data for these six activity areas.
The data for two recent jobs follow:
Job Order 410 Job Order 411
Direct material cost $9,700 $59,500
Direct labour cost $750 $11,250
Direct labour hours 25 375
Number of parts 500 2,000
Number of machine hours 150 1,050
Number of job orders shipped 1 1
Number of units 10 200
Number of hours in assembly 2 30
a) Suppose the company had not adopted an ABC system. Compute the manufacturing cost per unit for
Job Orders 410 and 411 under the traditional costing system.
Estimated Allocation Rate = Total Indirect Costs / Allocation Base [which is DLH]
= $169,056 / 1,470
= 115 per DLH

Job #410 Job #411

Direct Cost:
DM $9,700 $59,500
DL $750 $11,250
Total Direct Cost $10,450 $70,750
Indirect Cost Allocated $115 x 25hrs = $2,875 $115 x 375hrs = $43,125
Total Cost $13,325 $113,875
Units 10 200
Unit Total Cost $1,332.50 $569.38
b) Under the new ABC system, compute the manufacturing cost per unit for Job Orders 410 and 411.
Activity Allocation Rate Job #410 Job #411
Materials Handling $21,200/53,000=0.4 $0.4 x 500 = $200
Milling 12 per machine hour $12 x 150 = $1,800
Grinding 0.8 per hour $0.8 x 500 = 400
Assembly 5 per hour $5 x 2 = $10
Inspection 25 per unit $25 x 10 = $250
Shipping 1,500 per order $1,500 x 1 = $1,500 ________
Total $4,160 $21,650
Job #410 Job #411
Direct Cost $10,450 $70,750
Indirect Cost Allocated $4,160 $21,650
Total Cost $14,610 $92,400
Units 10 200
Unit Total Cost $1,461 $462