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ACTIVITY-BASED COSTING: A TOOL TO AID DECISION MAKING

EXERCISE 7–14 Calculating and Interpreting Activity-Based Costi


Hiram’s Lakeside is a popular restaurant located on Lake Washington in
restaurant has been trying to better understand costs at the restaurant a
to conduct an activity-based costing study. The intern, in consultation w
three major activities and then completed the first-stage allocations of c
pools. The results appear below.

Activity Cost Pool Activity Measure


Serving a party of diners Number of parties served
Serving a diner Number of diners served
Serving drinks Number of drinks ordered

The above costs include all of the costs of the restaurant except for orga
such as rent, property taxes, and top-management salaries.
A group of diners who ask to sit at the same table are counted as a party
the costs of cleaning linen, are the same whether one person is at a tabl
costs, such as washing dishes, depend on the number of diners served.
Prior to the activity-based costing study, the owner knew very little abou
restaurant. She knew that the total cost for the month (including organiz
$240,000 and that 15,000 diners had been served. Therefore, the avera
Required:
1. According to the activity-based costing system, what is the total cost
following parties of diners?
a. A party of four diners who order three drinks in total.
b. A party of two diners who do not order any drinks.
c. A lone diner who orders two drinks.
2. Convert the total costs you computed in (1) above to costs per diner.
the average cost per diner for serving each of the following parties?
a. A party of four diners who order three drinks in total.
b. A party of two diners who do not order any drinks.
c. A lone diner who orders two drinks.
3. Why do the costs per diner for the three different parties differ from e
overall average cost of $16 per diner?
…………………………………………………………………………………

Activity-based costing versus traditional costing methods such a


As stated above, traditional absorption costing is designed to provide d
financial reports. In contrast, activity-based costing is designed to be use
decision making. As a consequence, activity-based costing differs from t
accounting in three ways. In activity-based costing:
1. Nonmanufacturing as well as manufacturing costs may be assigned to
only on a cause-and-effect basis.
2. Some manufacturing costs may be excluded from product costs.
3. Numerous overhead cost pools are used, each of which is allocated to
other cost objects using its own unique measure of activity.

…………………………………………………………………………………

PROBLEM 7–17 Comparing Traditional and Activity-Based Produc


Smoky Mountain Corporation makes two types of hiking boots—Xtreme a
concerning these two product lines appear below:

Selling price per unit


Direct materials per unit
Direct labor per unit
Direct labor-hours per unit
Estimated annual production and sales

The company has a traditional costing system in which manufacturing ov


based on direct labor-hours. Data concerning manufacturing overhead a
the upcoming year appear below:
Estimated total manufacturing overhead . . . . . . . .
Estimated total direct labor-hours . . . . . . . . . . . . . .

Required:
1. Compute the product margins for the Xtreme and the Pathfinder prod
traditional costing system.

2. The company is considering replacing its traditional costing system w


costing system that would assign its manufacturing overhead to the follo
cost pools (the Other cost pool includes organization-sustaining costs an
costs):

Activities and Activity Measures Overhead Cost


Supporting direct labor (direct labor-hours)
Batch setups (setups)
Product sustaining (number of products)
Other
Total manufacturing overhead cost

Compute the product margins for the Xtreme and the Pathfinder product

3 Explain why the traditional and activity-based cost assignments differ.

Five classifications of activities:


Unit-level activities are performed each time a unit is produced. T
activities should be proportional to the number of units produced. F
providing power to run processing equipment would be a unit-level
power tends to be consumed in proportion to the number of units p
Batch-level activities are performed each time a batch is handled
regardless of how many units are in the batch. For example, tasks s
purchase orders, setting up equipment, and arranging for shipment
Product-level activities relate to specific products and typically m
regardless of how many batches are run or units of product are prod
example, activities such as designing a product, advertising a produ
a product manager and staff are all product-level activities.
Customer-level activities relate to specific customers and include
sales calls, catalog mailings, and general technical support that are
specific product.
Organization-sustaining activities are carried out regardless of
are served, which products are produced, how many batches are ru
units are made. Example Includes: heating the factory, cleaning exe
a computer network, arranging for loans, preparing annual reports t

Why is the activity-based costing described in this chapter unacc


financial reports?
The activity-based costing approach described in the chapter is probably
financial reports for two reasons. First, activity-based product costs, as d
exclude some manufacturing costs and include some nonmanufacturing
allocations are based on interviews rather than verifiable, objective data

When activity-based costing is used, why do manufacturing over


from high-volume products to low-volume products?

In traditional cost systems, product-level costs are indiscriminately sprea


labor-hours or some other allocation base related to volume. As a conseq
assigned the bulk of such costs. If a product is responsible for 40% of th
be assigned 40% of the manufacturing overhead cost in the factory—inc
of low-volume products. In an activity-based costing system, batch-level
more appropriately. This results in shifting product-level costs back to th
from the high-volume products. (A similar effect will be observed with ba
products are produced in larger batches than low-volume products.)

…………………………………………………………………………………

PROBLEM 7–16 Comparing Traditional and Activity-Based Produc

Hi-Tek Manufacturing Inc. makes two types of industrial component part


T500. An absorption costing income statement for the most recent perio

Hi-Tek Manufacturing Inc.


Income Statement
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . . . . . . . . . . .
Gross margin . . . . . . . . . . . . . . . . . . . . . . .
Selling and administrative expenses . . . . . .
Net operating loss . . . . . . . . . . . . . . . . . . .

Hi-Tek produced and sold 70,000 units of B300 at a price of $20 per unit
at a price of $40 per unit. The company’s traditional cost system allocate
to products using a plantwide overhead rate and direct labor dollars as t
information relating to the company’s two product lines is shown below:

B300
Direct Materials $436,300
Direct Labor 200000
Manufacturing Overhead

The company has created an activity-based costing system to evaluate t


Hi-Tek’s ABC implementation team concluded that $50,000 and $100,00
advertising expenses could be directly traced to B300 and T500, respect
the selling and administrative expenses was organization-sustaining in n
distributed the company’s manufacturing overhead to four activities as s

Manufacturing
Activity Cost Pool (Activity Measure) Overhead
Machining (machine-hours) . . . . . . . . . $213,500
Setups (setup hours) . . . . . . . . . . . . . . 157500
Product-sustaining (number of products 120000
Other (organization-sustaining costs) . . 117000
Total manufacturing overhead cost . . . $608,000

Required:
1. Compute the product margins for the B300 and T500 under the comp
2.Compute the product margins for B300 and T500 under the activity-ba

3. Explain why the traditional and activity-based cost assignments differ

…………………………………………………………………………………

The operations vice president of Security Home Bank has been intereste
efficiency of the bank’s operations. She has been particularly concerned
routine transactions at the bank and would like to compare these costs a
branches. If the branches with the most efficient operations can be ident
studied and then replicated elsewhere. While the bank maintains meticu
other costs, there has been no attempt thus far to show how those costs
services provided by the bank. The operations vice president has asked
activity-based costing study of bank operations. In particular, she would
opening an account, the cost of processing deposits and withdrawals, an
other customer transactions.
The Westfield branch of Security Home Bank has submitted the following
last year:

Teller wages . . . . . . . . . . . . . . . . . . . . . . .
Assistant branch manager salary . . . . . . . .
Branch manager salary . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Virtually all other costs of the branch—rent, depreciation, utilities, and so


costs that cannot be meaningfully assigned to individual customer trans
depositing checks.

In addition to the cost data above, the employees of the Westfield branc
concerning how their time was distributed last year across the activities
activity-based costing study. The results of those interviews appear belo

Distribution of Resource Consumption Across Activiti


Processing
Opening Deposits and
Accounts Withdrawals

Teller wages 5% 65%


Assistant branch manager 15% 5%
Branch manager salary 5% 0%

Req 01: Prepare the first-stage allocation for the activity-based costing

The manager of the Westfield branch of Security Home Bank has provide
data concerning the transactions of the branch during the past year:

Total Activity at
Activity the Westfield Branch
Opening accounts 500
Processing deposits and withdrawals 100000
Processing other customer transactio 5000

The lowest costs reported by other branches for these activities are disp

Lowest Cost among All Security


Activity Home Bank Branches

Opening accounts 26.75


Processing deposits and withdrawals 1.24
Processing other customer transactio 11.86
Req 02: Using the first-stage allocation from the above data, compute
activity-based costing system. Round all computations to the nearest w

Req 03: What do these results suggest to you concerning operations at

**********************************************
ID DECISION MAKING MRE

ting Activity-Based Costing Data


ated on Lake Washington in Seattle. The owner of the
and costs at the restaurant and has hired a student intern
he intern, in consultation with the owner, identified
e first-stage allocations of costs to the activity cost

Total Cost Total Activity


$33,000 6,000 parties
$138,000 15,000 diners
$24,000 10,000 drinks

e restaurant except for organization-sustaining costs


ement salaries.
table are counted as a party. Some costs, such as
ether one person is at a table or the table is full. Other
e number of diners served.
owner knew very little about the costs of the
he month (including organization-sustaining costs) was
erved. Therefore, the average cost per diner was $16.

stem, what is the total cost of serving each of the

drinks in total.
any drinks.

1) above to costs per diner. In other words, what is


f the following parties?
drinks in total.
any drinks.

fferent parties differ from each other and from the

………………………………………………

l costing methods such as job-order costing:


ing is designed to provide data for external
costing is designed to be used for internal
based costing differs from traditional cost

ng costs may be assigned to products, but

ed from product costs.


each of which is allocated to products and
sure of activity.

……………………………………………………………

nd Activity-Based Product Margins


es of hiking boots—Xtreme and the Pathfinder. Data

Xtreme Pathfinder
$140.00 $99.00
72 53
24 12
2 DLHs 1 DLHs
20000 Units 80,000 Units

m in which manufacturing overhead is applied to units


g manufacturing overhead and direct labor-hours for
###
..... 120,000 DHLs

me and the Pathfinder products under the company’s

raditional costing system with an activity-based


cturing overhead to the following four activity
nization-sustaining costs and idle capacity

Estimated Expected Activity


Overhead Cost Xtreme Pathfinder Total
783600 40000 80,000 120000
495000 200 100 300
602400 1 1 2
99000 NA NA NA
1980000

e and the Pathfinder products under the activity-based costing system.

sed cost assignments differ.

h time a unit is produced. The costs of unit level


mber of units produced. For example,
ment would be a unit-level activity because
n to the number of units produced.
ch time a batch is handled or processed,
atch. For example, tasks such as placing
nd arranging for shipments to customers
c products and typically must be carried out
or units of product are produced or sold.
oduct, advertising a product, and maintaining
ct-level activities.
cific customers and include activities such as
technical support that are not tied to any

carried out regardless of which customers


how many batches are run, or how many
g the factory, cleaning executive offices, providing
preparing annual reports to shareholders, and so on.

bed in this chapter unacceptable for external

ed in the chapter is probably unacceptable for external


ty-based product costs, as described in this chapter,
de some nonmanufacturing costs. Second, the first-stage
an verifiable, objective data.

hy do manufacturing overhead costs often shift


me products?

ts are indiscriminately spread across all products using direct


ated to volume. As a consequence, high-volume products are
is responsible for 40% of the direct labor in a factory, it will
ead cost in the factory—including 40% of the product-level costs
costing system, batch-level and product-level costs are assigned
oduct-level costs back to the products that cause them and away
ect will be observed with batch-level costs if high-volume
n low-volume products.)

………………………………………………………

nd Activity-Based Product Margins MRE

f industrial component parts—the B300 and the


nt for the most recent period is shown below:

ing Inc.
ment
2100000
1600000
500000
550000
(50,000)

00 at a price of $20 per unit and 17,500 units of T500


ditional cost system allocates manufacturing overhead
and direct labor dollars as the allocation base. Additional
oduct lines is shown below:

T500 Total
$251,700 $688,000
104000 304000
$608,000
###

costing system to evaluate the profitability of its products.


d that $50,000 and $100,000 of the company’s
d to B300 and T500, respectively. The remainder of
organization-sustaining in nature. The ABC team also
erhead to four activities as shown below:

B300 T500 Total


90000 62500 152500
75 300 375
1 1 2
N/A N/A N/A

0 and T500 under the company’s traditional costing system.


d T500 under the activity-based costing system.

sed cost assignments differ.

………………………………………………..

me Bank has been interested in investigating the


been particularly concerned about the costs of handling
ke to compare these costs at the bank’s various
ient operations can be identified, their methods can be
e the bank maintains meticulous records of wages and
far to show how those costs are related to the various
ns vice president has asked your help in conducting an Solutions
ns. In particular, she would like to know the cost of
eposits and withdrawals, and the cost of processing

has submitted the following cost data for Teller wages


Assistant branch m
Branch manager s

160000
75000
80000 Distribution of Res
315000

depreciation, utilities, and so on—are organizationsustaining


o individual customer transactions such as Teller wages
Assistant branch m
Branch manager s
yees of the Westfield branch have been interviewed
st year across the activities included in the
hose interviews appear below: Distribution of Res

Processing
Other
Customer Other
Transactions Activities Total
Teller wages
20% 10% 100% Assistant branch m
30% 50% 100% Branch manager s
10% 85% 100% Total Costs

r the activity-based costing study. Req : 02


Computations of t
urity Home Bank has provided the following
ch during the past year: Activity Cost Pools

tivity at Opening Accounts


stfield Branch Processing deposi
New accounts opened Processing other c
Deposits and withdrawals processed
Other customer transactions processed
Req : 03
The cost of openin
for these activities are displayed below: versus $26.75). O
cost branch ($1.0
Cost among All Security Westfield branch (
ank Branches concerning proces
of the other branc
Per new account compare the deta
Per deposit or withdrawal because of the inv
Per other cistomer transaction accounts at other

The apparent diffe


the above data, compute the activity rates for the reports of the amo
mputations to the nearest whole cent. For example, the
The higher cost of
ou concerning operations at the Westfield branch? satisfied custome
identifying best p
************
The first step is to determine the activity rates:

Activity Cost Pools Total Cost


Serving Parties $33,000
Serving Diners $138,000
Serving Drinks $24,000
According to the activity-based costing system, the cost of serving each of the parties c
be computed as follows:
a. Party of 4 persons with 3 drinks

Activity Cost Pool Activity Rate


Serving Parties $5.50 Per Party
Serving Diners $9.20 Per Dinar
Serving Drinks $2.40 Per Drink

b. Party of 2 persons with no drinks

Activity Cost Pool Activity Rate


Serving Parties $5.50 Per Party
Serving Diners $9.20 Per Dinar
Serving Drinks $2.40 Per Drink

b. Party of 1 person with 2 drinks

Activity Cost Pool Activity Rate


Serving Parties $5.50 Per Party
Serving Diners $9.20 Per Dinar
Serving Drinks $2.40 Per Drink
2. Average Cost per Dinar = Total cost of the party / the number of diners

a 49.5 ÷ 4
b 23.9 ÷ 2
c 19.5 ÷ 1

3. The average cost per diner differs from the overall average cost of $16 per diner for se

One: the average cost of $16 per diner includes organization-sustaining costs that are ex
costing system.

Two: the $16 per diner figure does not recognize differences in the diners’ demands on r
more drinks than others nor does it recognize the economies of scale in serving larger pa

Problem 7-17

Requirement 1. Under the traditional direct labor-hour based costing system,


manufacturing overhead is applied to products using the predetermined overhe
rate computed as follows:

Estimated Total Manufacturng Overhead C


Predetermined OH Rate =
Estimated total direct labor - hours

$1,980,000
= =
120,000

*20,000 units of Xtreme @ 2.00 DLH per unit + 80,000 units of the Pathfinder@
= 40,000 DLHs + 80,000 DLHs = 120,000 DLHs.

Product margins using the traditional approach as follows:

Xtreme Pathfinder
Sales $ 2,800,000 $ 7,920,000
Direct materials 1440000.00 4240000.00
Direct labor 480000.00 960000.00
Manufacturing overhead 660000.00 1320000.00
(Applied @ $16.50 per DLH)
Total manufacturing cost 2580000.00 6520000.00
Product margin 220000.00 1400000.00

Note that all of the manufacturing overhead cost is applied to the products unde
the company’s traditional costing system.

Requirement 02:
Calculation of the activity rate:

Activity Cost Pools Total Cost Total Activity


Supporting direct labor 783600 120000 DLH
Batch setups 495000 300 Setups
Product sustaining 602400 2 Products

*The Other activity cost pool is not shown above because it includes organization-sustai
and idle capacity costs that should not be assigned to products under activity ba
system.

Product Margin _ Activity-Based Costing System:

Xtreme Pathfinder
Sales $ 2,800,000 $ 7,920,000
Direct materials 1440000.00 4240000.00
Direct labor 480000.00 960000.00
Supporting direct labor 261,200 522,400
Batch setups 330,000 165,000
Product sustaining 301,200 301,200
Total cost 2,812,400 6,188,600
Product margin (12,400) 1,731,400

Requirement 3:
The traditional and activity-based cost assignments differ for two reasons.

First, the traditional system assigns all $1,980,000 of manufacturing overhead


The ABC system assigns only $1,881,000 of manufacturing overhead to product
system does not assign the $99,000 of Other activity costs to products because
organization-sustaining and idle capacity costs.

Second, the traditional system uses one unit-level activity measure, direct labo
overhead to the Xtreme product line and Pathfinder product line. The ABC syste
costs to products based on the several allocation bases such as direct labor hou
and number of products.

……………………………………………………………………………………………………

1 Under the traditional direct labor-dollar based costing system, manufacturin


products using the predetermined overhead rate computed as follows:
Estimated Total Manufacturng Overhead C
Predetermined OH Rate =
Estimated total direct labor - hours

$608,000
= =
304,000

The product margins using the traditional approach would be computed as fol
B300 T500
Sales $1,400,000 $700,000
Direct materials 436,300 251,700
Direct labor 200,000 104,000
Manufacturing
overhead applied @
400,000 208,000
$2.00 per direct labor-
dollar
Total manufacturing
1,036,300 563,700
cost
Product margin $ 363,700 $136,300

Note that all of the manufacturing overhead cost is applied to the products unde
company’s traditional costing system.

The first step is to determine the activity rates:

(a) (b)
Activity Cost Pools Total Cost Total Activity
Machining $213,500 152,500 MHR
Setups $157,500 375 setup hrs.
Product sustaining $120,000 2 products

The Other activity cost pool is not shown above because it includes organization
that should not be assigned to products.

Under the activity-based costing system, the product margins would

B300 T500
Sales $1,400,000 $700,000
Direct materials 436,300 251,700
Direct labor 200,000 104,000
Advertising expense 50,000 100,000
Machining 126,000 87,500
Setups 31,500 126,000
Product sustaining 60000 60000
Total cost 903,800 729,200
Product margin $496,200 -$29,200
Req 03:
The traditional and activity-based cost assignments differ for three reasons. Firs
of manufacturing overhead to products. The ABC system assigns only $491,000
ABC system does not assign the $117,000 of Other activity costs to products be

Second, the traditional system uses one unit-level activity measure, direct labor
costs to different products. On the other hand activity based costing applies mu
overhead costs objects.

Third: Third, the traditional system does not trace any advertising expenses to t
$50,000 of advertising to the B300 and $100,000 of advertising to the T500 pro

…………………………………………………………………………

Solutions

Teller wages $160,000


Assistant branch manager salary $75,000
Branch manager salary $80,000

Distribution of Resource Consumption Across Activities Processing


Processing Other
Opening Deposits and Customer
Accounts Withdrawals Transactions
Teller wages 5% 65% 20%
Assistant branch manager sa 15% 5% 30%
Branch manager salary 5% 0% 10%

Distribution of Resource Consumption Across Activities


Processing
Processing Other
Opening Deposits and Customer
Accounts Withdrawals Transactions

Teller wages 8000.00 104000.00 32000.00


Assistant branch manager sa 11250.00 3750.00 22500.00
Branch manager salary 4000.00 0.00 8000.00
Total Costs 23250.00 107750.00 62500.00

Req : 02
Computations of the activitiy rates :

Activity Cost Pools Total Cost Total Activity

Opening Accounts 23250.00 500


Processing deposits and withdrawals 107750.00 100000
Processing other customer transactions 62500.00 5000

Req : 03
The cost of opening an account at the Westfield branch is much higher than at the
versus $26.75). On the other hand, the cost of processing deposits and withdrawal
cost branch ($1.08 versus $1.24). And the cost of processing other customer trans
Westfield branch ($12.50 versus $11.86). The other branches may have something
concerning processing deposits and withdrawals and Westfield may benefit from lea
of the other branches open accounts and process other transactions. It may be part
compare the details of the activity rates. For example, is the cost of opening accoun
because of the involvement of the assistant branch manager in this activity? Perhap
accounts at other branches.

The apparent differences in the costs of the activities at the various branches may
reports of the amount of time they devote to the activities. The differences in costs
For example, the Westfield branch may purposely spend more time with new custo
The higher cost of opening new accounts at the Westfield branch may be justified b
satisfied customers. Nevertheless, comparative studies of the costs of activities ma
identifying best practices within a company and where improvements can be made

********************************************************
MRE

Total Activity Activity Rate


6000 Parties $5.50 Per Party
15000 Diners $9.20 Per Dinar
10000 Drinks $2.40 Per Drink
each of the parties can

Activity ABC Cost


1 Party $5.50
4 Diners $36.80
3 Drinks $7.20
$ 49.50

Activity ABC Cost


1 Party $5.50
2 Diners $18.40
0 Drinks $0.00
$23.90

Activity ABC Cost


1 Party $5.50
1 Diners $9.20
2 Drinks $4.80
$19.50

of diners

Diners 12.375 Per Diner


Diners 11.95 Per Diner
Diner 19.5 Per Diner

f $16 per diner for several reasons.

ning costs that are excluded from the computations in the activity-based

diners’ demands on resources. It does not recognize that some diners order
e in serving larger parties.

MRE

d costing system,
determined overhead

cturng Overhead Cost


bor - hours

$16.50

of the Pathfinder@ 1.0 DLH per unit


Total
$ 10,720,000
$ 5,680,000
$ 1,440,000
$ 1,980,000

$ 9,100,000
1620000.00

o the products under

Activity Rate
6.53
1650.00
301200.00

s organization-sustaining
ts under activity based costing

Total
$ 10,720,000
$ 5,680,000
$ 1,440,000
$ 783,600
$ 495,000
$ 602,400
$ 9,001,000
1,719,000

two reasons.

acturing overhead to products.


verhead to products. The ABC
products because they represent

easure, direct labor hours, to assign


ine. The ABC system assigns overhead
as direct labor hours, batch setup,

tem, manufacturing overhead is applied to


ed as follows:
cturng Overhead Cost
bor - hours

$2.00

be computed as follows:
Total
$2,100,000
688,000
304,000

608,000

1,600,000
$ 500,000

o the products under the

(a) ÷ (b)
Activity Rate
$1.40 per MHR
$420 per setup hr.
$60,000 per product

cludes organization-sustaining and idle capacity costs

t margins would be computed as follows:

Total
$2,100,000
688,000
304,000
150,000
213,500
157,500
120,000
1,633,000
$ 467,000
three reasons. First, the traditional system assigns all $608,000
gns only $491,000 of manufacturing overhead to products. The
osts to products because they represent organization-sustaining costs.

easure, direct labor dollars, to assign manufacturing overhead


costing applies multiple bases to to assign manufacturing

ising expenses to the two products. The ABC system traces


ng to the T500 product line.

……………………………………………………………

Other
Activities Total
10% 100%
50% 100%
85% 100%

Other
Activities Total

16000.00 160000.00
37500.00 75000.00
68000.00 80000.00
121500.00 315000.00

Activity Rate

46.5
1.0775
12.5

higher than at the lowest cost branch ($46.50


its and withdrawals is lower than at the lowest
her customer transactions is higher at the
ay have something to learn from Westfield
may benefit from learning about how some
ons. It may be particularly instructive to
t of opening accounts at Westfield high
his activity? Perhaps tellers open new

ous branches may be due to inaccuracies in employees'


differences in costs may also reflect different strategies.
me with new customers in order to win their loyalty.
may be justified by future benefits of having more
sts of activities may provide a useful starting point for
ments can be made.

**************************
ACTIVITY-BASED COSTING: A TOOL TO AID DECISION MAKING

EXERCISE 7–14 Calculating and Interpreting Activity-Based Costi


Hiram’s Lakeside is a popular restaurant located on Lake Washington in
restaurant has been trying to better understand costs at the restaurant a
to conduct an activity-based costing study. The intern, in consultation w
three major activities and then completed the first-stage allocations of c
pools. The results appear below.

Activity Cost Pool Activity Measure


Serving a party of diners Number of parties served
Serving a diner Number of diners served
Serving drinks Number of drinks ordered

The above costs include all of the costs of the restaurant except for orga
such as rent, property taxes, and top-management salaries.
A group of diners who ask to sit at the same table are counted as a party
the costs of cleaning linen, are the same whether one person is at a tabl
costs, such as washing dishes, depend on the number of diners served.
Prior to the activity-based costing study, the owner knew very little abou
restaurant. She knew that the total cost for the month (including organiz
$240,000 and that 15,000 diners had been served. Therefore, the avera
Required:
1. According to the activity-based costing system, what is the total cost
following parties of diners?
a. A party of four diners who order three drinks in total.
b. A party of two diners who do not order any drinks.
c. A lone diner who orders two drinks.
2. Convert the total costs you computed in (1) above to costs per diner.
the average cost per diner for serving each of the following parties?
a. A party of four diners who order three drinks in total.
b. A party of two diners who do not order any drinks.
c. A lone diner who orders two drinks.
3. Why do the costs per diner for the three different parties differ from e
overall average cost of $16 per diner?
…………………………………………………………………………………

Activity-based costing versus traditional costing methods such a


As stated above, traditional absorption costing is designed to provide d
financial reports. In contrast, activity-based costing is designed to be use
decision making. As a consequence, activity-based costing differs from t
accounting in three ways. In activity-based costing:
1. Nonmanufacturing as well as manufacturing costs may be assigned to
only on a cause-and-effect basis.
2. Some manufacturing costs may be excluded from product costs.
3. Numerous overhead cost pools are used, each of which is allocated to
other cost objects using its own unique measure of activity.

…………………………………………………………………………………

PROBLEM 7–17 Comparing Traditional and Activity-Based Produc


Smoky Mountain Corporation makes two types of hiking boots—Xtreme a
concerning these two product lines appear below:

Selling price per unit


Direct materials per unit
Direct labor per unit
Direct labor-hours per unit
Estimated annual production and sales

The company has a traditional costing system in which manufacturing ov


based on direct labor-hours. Data concerning manufacturing overhead a
the upcoming year appear below:
Estimated total manufacturing overhead . . . . . . . .
Estimated total direct labor-hours . . . . . . . . . . . . . .

Required:
1. Compute the product margins for the Xtreme and the Pathfinder prod
traditional costing system.

2. The company is considering replacing its traditional costing system w


costing system that would assign its manufacturing overhead to the follo
cost pools (the Other cost pool includes organization-sustaining costs an
costs):

Activities and Activity Measures Overhead Cost


Supporting direct labor (direct labor-hours)
Batch setups (setups)
Product sustaining (number of products)
Other
Total manufacturing overhead cost

Compute the product margins for the Xtreme and the Pathfinder product

3 Explain why the traditional and activity-based cost assignments differ.

Five classifications of activities:


Unit-level activities are performed each time a unit is produced. T
activities should be proportional to the number of units produced. F
providing power to run processing equipment would be a unit-level
power tends to be consumed in proportion to the number of units p
Batch-level activities are performed each time a batch is handled
regardless of how many units are in the batch. For example, tasks s
purchase orders, setting up equipment, and arranging for shipment
Product-level activities relate to specific products and typically m
regardless of how many batches are run or units of product are prod
example, activities such as designing a product, advertising a produ
a product manager and staff are all product-level activities.
Customer-level activities relate to specific customers and include
sales calls, catalog mailings, and general technical support that are
specific product.
Organization-sustaining activities are carried out regardless of
are served, which products are produced, how many batches are ru
units are made. Example Includes: heating the factory, cleaning exe
a computer network, arranging for loans, preparing annual reports t

Why is the activity-based costing described in this chapter unacc


financial reports?
The activity-based costing approach described in the chapter is probably
financial reports for two reasons. First, activity-based product costs, as d
exclude some manufacturing costs and include some nonmanufacturing
allocations are based on interviews rather than verifiable, objective data

When activity-based costing is used, why do manufacturing over


from high-volume products to low-volume products?

In traditional cost systems, product-level costs are indiscriminately sprea


labor-hours or some other allocation base related to volume. As a conseq
assigned the bulk of such costs. If a product is responsible for 40% of th
be assigned 40% of the manufacturing overhead cost in the factory—inc
of low-volume products. In an activity-based costing system, batch-level
more appropriately. This results in shifting product-level costs back to th
from the high-volume products. (A similar effect will be observed with ba
products are produced in larger batches than low-volume products.)

…………………………………………………………………………………

PROBLEM 7–16 Comparing Traditional and Activity-Based Produc

Hi-Tek Manufacturing Inc. makes two types of industrial component part


T500. An absorption costing income statement for the most recent perio

Hi-Tek Manufacturing Inc.


Income Statement
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . . . . . . . . . . .
Gross margin . . . . . . . . . . . . . . . . . . . . . . .
Selling and administrative expenses . . . . . .
Net operating loss . . . . . . . . . . . . . . . . . . .

Hi-Tek produced and sold 70,000 units of B300 at a price of $20 per unit
at a price of $40 per unit. The company’s traditional cost system allocate
to products using a plantwide overhead rate and direct labor dollars as t
information relating to the company’s two product lines is shown below:

B300
Direct Materials $436,300
Direct Labor 200000
Manufacturing Overhead

The company has created an activity-based costing system to evaluate t


Hi-Tek’s ABC implementation team concluded that $50,000 and $100,00
advertising expenses could be directly traced to B300 and T500, respect
the selling and administrative expenses was organization-sustaining in n
distributed the company’s manufacturing overhead to four activities as s

Manufacturing
Activity Cost Pool (Activity Measure) Overhead
Machining (machine-hours) . . . . . . . . . $213,500
Setups (setup hours) . . . . . . . . . . . . . . 157500
Product-sustaining (number of products 120000
Other (organization-sustaining costs) . . 117000
Total manufacturing overhead cost . . . $608,000

Required:
1. Compute the product margins for the B300 and T500 under the comp
2.Compute the product margins for B300 and T500 under the activity-ba

3. Explain why the traditional and activity-based cost assignments differ

…………………………………………………………………………………

The operations vice president of Security Home Bank has been intereste
efficiency of the bank’s operations. She has been particularly concerned
routine transactions at the bank and would like to compare these costs a
branches. If the branches with the most efficient operations can be ident
studied and then replicated elsewhere. While the bank maintains meticu
other costs, there has been no attempt thus far to show how those costs
services provided by the bank. The operations vice president has asked
activity-based costing study of bank operations. In particular, she would
opening an account, the cost of processing deposits and withdrawals, an
other customer transactions.
The Westfield branch of Security Home Bank has submitted the following
last year:

Teller wages . . . . . . . . . . . . . . . . . . . . . . .
Assistant branch manager salary . . . . . . . .
Branch manager salary . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Virtually all other costs of the branch—rent, depreciation, utilities, and so


costs that cannot be meaningfully assigned to individual customer trans
depositing checks.

In addition to the cost data above, the employees of the Westfield branc
concerning how their time was distributed last year across the activities
activity-based costing study. The results of those interviews appear belo

Distribution of Resource Consumption Across Activiti


Processing
Opening Deposits and
Accounts Withdrawals

Teller wages 5% 65%


Assistant branch manager 15% 5%
Branch manager salary 5% 0%

Req 01: Prepare the first-stage allocation for the activity-based costing

The manager of the Westfield branch of Security Home Bank has provide
data concerning the transactions of the branch during the past year:

Total Activity at
Activity the Westfield Branch
Opening accounts 500
Processing deposits and withdrawals 100000
Processing other customer transactio 5000

The lowest costs reported by other branches for these activities are disp

Lowest Cost among All Security


Activity Home Bank Branches

Opening accounts 26.75


Processing deposits and withdrawals 1.24
Processing other customer transactio 11.86
Req 02: Using the first-stage allocation from the above data, compute
activity-based costing system. Round all computations to the nearest w

Req 03: What do these results suggest to you concerning operations at

**********************************************
ID DECISION MAKING MRE

ting Activity-Based Costing Data


ated on Lake Washington in Seattle. The owner of the
and costs at the restaurant and has hired a student intern
he intern, in consultation with the owner, identified
e first-stage allocations of costs to the activity cost

Total Cost Total Activity


$33,000 6,000 parties
$138,000 15,000 diners
$24,000 10,000 drinks

e restaurant except for organization-sustaining costs


ement salaries.
table are counted as a party. Some costs, such as
ether one person is at a table or the table is full. Other
e number of diners served.
owner knew very little about the costs of the
he month (including organization-sustaining costs) was
erved. Therefore, the average cost per diner was $16.

stem, what is the total cost of serving each of the

drinks in total.
any drinks.

1) above to costs per diner. In other words, what is


f the following parties?
drinks in total.
any drinks.

fferent parties differ from each other and from the

………………………………………………

l costing methods such as job-order costing:


ing is designed to provide data for external
costing is designed to be used for internal
based costing differs from traditional cost

ng costs may be assigned to products, but

ed from product costs.


each of which is allocated to products and
sure of activity.

……………………………………………………………

nd Activity-Based Product Margins


es of hiking boots—Xtreme and the Pathfinder. Data

Xtreme Pathfinder
$140.00 $99.00
72 53
24 12
2.5 DLHs 1.5 DLHs
20000 Units 80,000 Units

m in which manufacturing overhead is applied to units


g manufacturing overhead and direct labor-hours for
###
..... 170,000 DHLs

me and the Pathfinder products under the company’s

raditional costing system with an activity-based


cturing overhead to the following four activity
nization-sustaining costs and idle capacity

Estimated Expected Activity


Overhead Cost Xtreme Pathfinder Total
792000 50000 120,000 170000
505000 200 100 300
603000 1 1 2
150000 NA NA NA
2050000

e and the Pathfinder products under the activity-based costing system.

sed cost assignments differ.

h time a unit is produced. The costs of unit level


mber of units produced. For example,
ment would be a unit-level activity because
n to the number of units produced.
ch time a batch is handled or processed,
atch. For example, tasks such as placing
nd arranging for shipments to customers
c products and typically must be carried out
or units of product are produced or sold.
oduct, advertising a product, and maintaining
ct-level activities.
cific customers and include activities such as
technical support that are not tied to any

carried out regardless of which customers


how many batches are run, or how many
g the factory, cleaning executive offices, providing
preparing annual reports to shareholders, and so on.

bed in this chapter unacceptable for external

ed in the chapter is probably unacceptable for external


ty-based product costs, as described in this chapter,
de some nonmanufacturing costs. Second, the first-stage
an verifiable, objective data.

hy do manufacturing overhead costs often shift


me products?

ts are indiscriminately spread across all products using direct


ated to volume. As a consequence, high-volume products are
is responsible for 40% of the direct labor in a factory, it will
ead cost in the factory—including 40% of the product-level costs
costing system, batch-level and product-level costs are assigned
oduct-level costs back to the products that cause them and away
ect will be observed with batch-level costs if high-volume
n low-volume products.)

………………………………………………………

nd Activity-Based Product Margins MRE

f industrial component parts—the B300 and the


nt for the most recent period is shown below:

ing Inc.
ment
2100000
1600000
500000
550000
(50,000)

00 at a price of $20 per unit and 17,500 units of T500


ditional cost system allocates manufacturing overhead
and direct labor dollars as the allocation base. Additional
oduct lines is shown below:

T500 Total
$251,700 $688,000
104000 304000
$608,000
###

costing system to evaluate the profitability of its products.


d that $50,000 and $100,000 of the company’s
d to B300 and T500, respectively. The remainder of
organization-sustaining in nature. The ABC team also
erhead to four activities as shown below:

B300 T500 Total


90000 62500 152500
75 300 375
1 1 2
N/A N/A N/A

0 and T500 under the company’s traditional costing system.


d T500 under the activity-based costing system.

sed cost assignments differ.

………………………………………………..

me Bank has been interested in investigating the


been particularly concerned about the costs of handling
ke to compare these costs at the bank’s various
ient operations can be identified, their methods can be
e the bank maintains meticulous records of wages and
far to show how those costs are related to the various
ns vice president has asked your help in conducting an Solutions
ns. In particular, she would like to know the cost of
eposits and withdrawals, and the cost of processing

has submitted the following cost data for Teller wages


Assistant branch m
Branch manager s

160000
75000
80000 Distribution of Res
315000

depreciation, utilities, and so on—are organizationsustaining


o individual customer transactions such as Teller wages
Assistant branch m
Branch manager s
yees of the Westfield branch have been interviewed
st year across the activities included in the
hose interviews appear below: Distribution of Res

Processing
Other
Customer Other
Transactions Activities Total
Teller wages
20% 10% 100% Assistant branch m
30% 50% 100% Branch manager s
10% 85% 100% Total Costs

r the activity-based costing study. Req : 02


Computations of t
urity Home Bank has provided the following
ch during the past year: Activity Cost Pools

tivity at Opening Accounts


stfield Branch Processing deposi
New accounts opened Processing other c
Deposits and withdrawals processed
Other customer transactions processed
Req : 03
The cost of openin
for these activities are displayed below: versus $26.75). O
cost branch ($1.0
Cost among All Security Westfield branch (
ank Branches concerning proces
of the other branc
Per new account compare the deta
Per deposit or withdrawal because of the inv
Per other cistomer transaction accounts at other

The apparent diffe


the above data, compute the activity rates for the reports of the amo
mputations to the nearest whole cent. For example, the
The higher cost of
ou concerning operations at the Westfield branch? satisfied custome
identifying best p
************
The first step is to determine the activity rates:

Activity Cost Pools Total Cost


Serving Parties $33,000
Serving Diners $138,000
Serving Drinks $24,000
According to the activity-based costing system, the cost of serving each of the parties c
be computed as follows:
a. Party of 4 persons with 3 drinks

Activity Cost Pool Activity Rate


Serving Parties $5.50 Per Party
Serving Diners $9.20 Per Dinar
Serving Drinks $2.40 Per Drink

b. Party of 2 persons with no drinks

Activity Cost Pool Activity Rate


Serving Parties $5.50 Per Party
Serving Diners $9.20 Per Dinar
Serving Drinks $2.40 Per Drink

b. Party of 1 person with 2 drinks

Activity Cost Pool Activity Rate


Serving Parties $5.50 Per Party
Serving Diners $9.20 Per Dinar
Serving Drinks $2.40 Per Drink
2. Average Cost per Dinar = Total cost of the party / the number of diners

a 49.5 ÷ 4
b 23.9 ÷ 2
c 19.5 ÷ 1

3. The average cost per diner differs from the overall average cost of $16 per diner for se

One: the average cost of $16 per diner includes organization-sustaining costs that are ex
costing system.

Two: the $16 per diner figure does not recognize differences in the diners’ demands on r
more drinks than others nor does it recognize the economies of scale in serving larger pa

Problem 7-17

Requirement 1. Under the traditional direct labor-hour based costing system,


manufacturing overhead is applied to products using the predetermined overhe
rate computed as follows:

Estimated Total Manufacturng Overhead C


Predetermined OH Rate =
Estimated total direct labor - hours

$2,050,000
= =
170,000

*20,000 units of Xtreme @ 2.00 DLH per unit + 80,000 units of the Pathfinder@
= 40,000 DLHs + 80,000 DLHs = 120,000 DLHs.

Product margins using the traditional approach as follows:

Xtreme Pathfinder
Sales $ 2,800,000 $ 7,920,000
Direct materials 1440000.00 4240000.00
Direct labor 480000.00 960000.00
Manufacturing overhead 602941.18 1447058.82
(Applied @ $16.50 per DLH)
Total manufacturing cost 2522941.18 6647058.82
Product margin 277058.82 1272941.18

Note that all of the manufacturing overhead cost is applied to the products unde
the company’s traditional costing system.

Requirement 02:
Calculation of the activity rate:

Activity Cost Pools Total Cost Total Activity


Supporting direct labor 792000 170000 DLH
Batch setups 505000 300 Setups
Product sustaining 603000 2 Products

*The Other activity cost pool is not shown above because it includes organization-sustai
and idle capacity costs that should not be assigned to products under activity ba
system.

Product Margin _ Activity-Based Costing System:

Xtreme Pathfinder
Sales $ 2,800,000 $ 7,920,000
Direct materials 1440000.00 4240000.00
Direct labor 480000.00 960000.00
Supporting direct labor 232,941 559,059
Batch setups 336,667 168,333
Product sustaining 301,500 301,500
Total cost 2,791,108 6,228,892
Product margin 8,892 1,691,108

Requirement 3:
The traditional and activity-based cost assignments differ for two reasons.

First, the traditional system assigns all $1,980,000 of manufacturing overhead


The ABC system assigns only $1,881,000 of manufacturing overhead to product
system does not assign the $99,000 of Other activity costs to products because
organization-sustaining and idle capacity costs.

Second, the traditional system uses one unit-level activity measure, direct labo
overhead to the Xtreme product line and Pathfinder product line. The ABC syste
costs to products based on the several allocation bases such as direct labor hou
and number of products.

……………………………………………………………………………………………………

1 Under the traditional direct labor-dollar based costing system, manufacturin


products using the predetermined overhead rate computed as follows:
Estimated Total Manufacturng Overhead C
Predetermined OH Rate =
Estimated total direct labor - hours

$750,000
= =
152,500

The product margins using the traditional approach would be computed as fol
B300 T500
Sales $1,500,000 $700,000
Direct materials 436,300 251,700
Direct labor 195,000 104,000
Manufacturing
overhead applied @
442,623 307,377
$2.00 per direct labor-
dollar
Total manufacturing
1,073,923 663,077
cost
Product margin $426,077 $36,923

Note that all of the manufacturing overhead cost is applied to the products unde
company’s traditional costing system.

The first step is to determine the activity rates:

(a) (b)
Activity Cost Pools Total Cost Total Activity
Machining $394,500 152,500 MHR
Setups $157,500 375 setup hrs.
Product sustaining $120,000 2 products

The Other activity cost pool is not shown above because it includes organization
that should not be assigned to products.

Under the activity-based costing system, the product margins would

B300 T500
Sales $1,500,000 $700,000
Direct materials $436,300 $251,700
Direct labor $195,000 $104,000
Advertising expense 75,000 100,000
Machining 232,820 161,680
Setups 31,500 126,000
Product sustaining $60,000.00 $60,000.00
Total cost 1,030,620 803,380
Product margin $469,380 -$103,380
Req 03:
The traditional and activity-based cost assignments differ for three reasons. Firs
of manufacturing overhead to products. The ABC system assigns only $491,000
ABC system does not assign the $117,000 of Other activity costs to products be

Second, the traditional system uses one unit-level activity measure, direct labor
costs to different products. On the other hand activity based costing applies mu
overhead costs objects.

Third: Third, the traditional system does not trace any advertising expenses to t
$50,000 of advertising to the B300 and $100,000 of advertising to the T500 pro

…………………………………………………………………………

Solutions

Teller wages $160,000


Assistant branch manager salary $75,000
Branch manager salary $80,000

Distribution of Resource Consumption Across Activities Processing


Processing Other
Opening Deposits and Customer
Accounts Withdrawals Transactions
Teller wages 5% 65% 20%
Assistant branch manager sa 15% 5% 30%
Branch manager salary 5% 0% 10%

Distribution of Resource Consumption Across Activities


Processing
Processing Other
Opening Deposits and Customer
Accounts Withdrawals Transactions

Teller wages 8000.00 104000.00 32000.00


Assistant branch manager sa 11250.00 3750.00 22500.00
Branch manager salary 4000.00 0.00 8000.00
Total Costs 23250.00 107750.00 62500.00

Req : 02
Computations of the activitiy rates :

Activity Cost Pools Total Cost Total Activity

Opening Accounts 23250.00 500


Processing deposits and withdrawals 107750.00 100000
Processing other customer transactions 62500.00 5000

Req : 03
The cost of opening an account at the Westfield branch is much higher than at the
versus $26.75). On the other hand, the cost of processing deposits and withdrawal
cost branch ($1.08 versus $1.24). And the cost of processing other customer trans
Westfield branch ($12.50 versus $11.86). The other branches may have something
concerning processing deposits and withdrawals and Westfield may benefit from lea
of the other branches open accounts and process other transactions. It may be part
compare the details of the activity rates. For example, is the cost of opening accoun
because of the involvement of the assistant branch manager in this activity? Perhap
accounts at other branches.

The apparent differences in the costs of the activities at the various branches may
reports of the amount of time they devote to the activities. The differences in costs
For example, the Westfield branch may purposely spend more time with new custo
The higher cost of opening new accounts at the Westfield branch may be justified b
satisfied customers. Nevertheless, comparative studies of the costs of activities ma
identifying best practices within a company and where improvements can be made

********************************************************
MRE

Total Activity Activity Rate


6000 Parties $5.50 Per Party
15000 Diners $9.20 Per Dinar
10000 Drinks $2.40 Per Drink
each of the parties can

Activity ABC Cost


1 Party $5.50
4 Diners $36.80
3 Drinks $7.20
$ 49.50

Activity ABC Cost


1 Party $5.50
2 Diners $18.40
0 Drinks $0.00
$23.90

Activity ABC Cost


1 Party $5.50
1 Diners $9.20
2 Drinks $4.80
$19.50

of diners

Diners 12.375 Per Diner


Diners 11.95 Per Diner
Diner 19.5 Per Diner

f $16 per diner for several reasons.

ning costs that are excluded from the computations in the activity-based

diners’ demands on resources. It does not recognize that some diners order
e in serving larger parties.

MRE

d costing system,
determined overhead

cturng Overhead Cost


bor - hours

$12.06

of the Pathfinder@ 1.0 DLH per unit


Total
$ 10,720,000
$ 5,680,000
$ 1,440,000
$ 2,050,000

$ 9,170,000
1550000.00

o the products under

Activity Rate
4.66
1683.33
301500.00

s organization-sustaining
ts under activity based costing

Total
$ 10,720,000
$ 5,680,000
$ 1,440,000
$ 792,000
$ 505,000
$ 603,000
$ 9,020,000
1,700,000

two reasons.

acturing overhead to products.


verhead to products. The ABC
products because they represent

easure, direct labor hours, to assign


ine. The ABC system assigns overhead
as direct labor hours, batch setup,

tem, manufacturing overhead is applied to


ed as follows:
cturng Overhead Cost
bor - hours

$4.92

be computed as follows:
Total
$2,200,000
$688,000
$299,000

$750,000

$1,737,000
$463,000

o the products under the

(a) ÷ (b)
Activity Rate
$2.59 per MHR
$420.00 per setup hr.
$60,000.00 per product

cludes organization-sustaining and idle capacity costs

t margins would be computed as follows:

Total
$2,200,000
$688,000
$299,000
$175,000
$394,500
$157,500
$120,000
$1,834,000
$366,000
three reasons. First, the traditional system assigns all $608,000
gns only $491,000 of manufacturing overhead to products. The
osts to products because they represent organization-sustaining costs.

easure, direct labor dollars, to assign manufacturing overhead


costing applies multiple bases to to assign manufacturing

ising expenses to the two products. The ABC system traces


ng to the T500 product line.

……………………………………………………………

Other
Activities Total
10% 100%
50% 100%
85% 100%

Other
Activities Total

16000.00 160000.00
37500.00 75000.00
68000.00 80000.00
121500.00 315000.00

Activity Rate

46.5
1.0775
12.5

higher than at the lowest cost branch ($46.50


its and withdrawals is lower than at the lowest
her customer transactions is higher at the
ay have something to learn from Westfield
may benefit from learning about how some
ons. It may be particularly instructive to
t of opening accounts at Westfield high
his activity? Perhaps tellers open new

ous branches may be due to inaccuracies in employees'


differences in costs may also reflect different strategies.
me with new customers in order to win their loyalty.
may be justified by future benefits of having more
sts of activities may provide a useful starting point for
ments can be made.

**************************

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