Chapter 10 – Activity-based costing
MULTIPLE CHOICE
1. Products might consume overhead in different proportions due to
a.
differences in product size.
b.
differences in setup times.
c.
differences in product complexity.
d.
all of the above.
2. The activity-based resource usage model improves managerial control and decision making such as
a.
the best way to use excess activity capacity in the system.
b.
maximization of individual unit performance.
c.
increasing the allocation of costs.
d.
focusing on managing costs rather than activities.
Figure 10-1
Wheat Manufacturing has four categories of overhead. The four categories and the expected overhead
costs for each category for next year are as follows:
Maintenance
£120,000
Materials handling
18,000
Setups
16,000
Inspection
60,000
Currently, overhead is applied using a predetermined overhead rate based upon budgeted direct labour
hours. For next year, 20,000 direct labour hours are budgeted.
The company has been asked to submit a bid for a proposed job. The plant manager feels that
obtaining this job would result in new business in future years. Usually bids are based upon full
manufacturing cost plus 15 per cent.
Estimates for the proposed job are as follows:
Direct materials
£2,000
Direct labour (600 hours)
£6,000
Number of materials moves
4
Number of inspections
6
Number of setups
8
Number of machine hours
80
In the past, full manufacturing cost has been calculated by allocating overhead using a volume-based
cost driver—direct labour 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 as follows:
Machine hours
5,000
Material moves
600
Setups
200
Quality inspections
1,000
3. Refer to Figure 10-1. If Wheat Manufacturing used direct labour hours as the cost driver and the
company’s bid is full cost plus 15 per cent, the company’s bid would be
a.
£17,480.
b.
£16,583.
c.
£13,110.
d.
£12,765.
4. Refer to Figure 10-1. If Wheat Manufacturing used activity-based cost drivers to assign overhead and
the company’s bid is full cost plus 15 per cent, the company’s bid would be
a.
£12,696.00
b.
£13,965.60
c.
£10,120.00
d.
£9,936.00
Direct materials
Direct labour
Overhead:
Maintenance (£24 80)
Materials handling (£30 4)
Setups (£80 8)
Inspections (£60 6)
Total cost
Figure 10-2
Direct materials
Direct labour
Overhead (£214,000/20,000) 600
Total cost
Anderson Company manufactures a variety of toys and games. John Boone, president, is disappointed
in the sales of a new board game. The game sold only 10,000 units in 2011 when 30,000 were
projected. Sales for 2008 look no better. At £100 per game, it is not a hot seller. Direct costs of the
board game are £56 variable cost and £100,000 fixed. John is considering several options. Option One:
Cut the price to £70 and perhaps sell 15,000 units. Option Two: Cut the price to £60, reduce material
costs by £10, and cut advertising by £60,000. Anticipated volume for this option is 10,000 units.
Option Three: Cut the price to £80 and include a £10 mail-in rebate offer. It is anticipated that 15,000
units could be sold and only 30 per cent of the rebate coupons would be redeemed.
5. Refer to Figure 10-2. What is the profit (loss) from Option One?
a.
£1,050,000
b.
£210,000
c.
£950,000
d.
£110,000
6. Refer to Figure 10-2. What is the profit (loss) from Option Two?
a.
£600,000
b.
£100,000
c.
£40,000
d.
(£100,000)
7. Refer to Figure 10-2. What is the profit (loss) from Option Three?
a.
£215,000
b.
£1,200,000
c.
£110,000
d.
(£60,000)
8. Refer to Figure 10-2. Which option is preferred?
a.
Option One
b.
Option Two
c.
Option Three
d.
Options One and Three are equally preferred.
9. Which of the following statements is FALSE?
a.
The mark up is a percentage applied to base cost.
b.
The mark up is an absolute rule.
c.
A major advantage of mark up pricing is that standard mark ups are easy to apply.
d.
The mark up can be calculated using a variety of bases.
10. Refer to Figure 10-3. What is the mark up based on cost of goods sold?
a.
50.0%
b.
100.0%
c.
37.5%
d.
62.5%
11. Refer to Figure 10-3. What is the mark up based on prime costs?
a.
300.0%
b.
133.3%
c.
50.0%
d.
166.7%
Figure 10-4
Jamie Ltd. had the following information:
Revenues
£250,000
Cost of goods sold:
Direct materials
£50,000
Direct labour
37,500
Overhead
_62,500
_150,000
Gross profit
£100,000
Selling and administrative expenses
__37,500
Operating income
£ 62,500
12. Refer to Figure 10-4. What is the mark up based on materials?
a.
400.0%
b.
185.7%
c.
42.9%
d.
71.4%
13. Refer to Figure 10-4. What would be the price for something that has a cost of £500, assuming that the
mark up is based on cost of goods sold?
a.
£833
b.
£625
c.
£708
d.
£2,000
14. Price skimming occurs in which of the following life-cycle stages?
a.
Introduction
b.
Growth
c.
Maturity
d.
Decline
15. ____ is the pricing of a new product at a low initial price to build market share quickly.
a.
Penetration pricing
b.
Predatory pricing
c.
Price skimming
d.
Target costing
16. ____ is where a higher price is charged at the beginning of a product’s life cycle.
a.
Penetration pricing
b.
Predatory pricing
c.
Price skimming
d.
Target costing
17. Which of the following is a FALSE statement about target costing?
a.
Target costing is a method of determining the cost of a product or service based on the
price that customers are willing to pay.
b.
The cost is calculated by subtracting the desired profit from the target price.
c.
Target costing is an interactive process.
d.
Target costing is cost driven.
18. Which of the following stages is characterized by rapid increases in sales and production?
a.
Introduction
b.
Growth
c.
Maturity
d.
Decline
19. Which of the following stages has revenues for the entire industry decreasing?
a.
Introduction
b.
Growth
c.
Maturity
d.
Decline
Figure 10-5
Ander Company produces precision equipment for major buyers. Of the six customers, one accounts
for 40 per cent of the sales, with the remaining five accounting for the rest of the sales. The five
smaller customers purchase equipment in roughly equal quantities. Orders placed by the smaller
customers are about the same size. Data concerning Ander’s customer activity follow:
Large Customer
Five Smaller
Customers
Units purchased
400,000
600,000
Orders placed
10
350
Number of sales calls
20
230
Manufacturing cost
£1,200,000
£1,800,000
Order-filling costs for Ander Company total £360,000, and sales-force costs are £375,000.
20. Refer to Figure 10-5, what amount of order-filling costs would be allocated to the large customer if
these costs are allocated based on sales volume?
a.
£144,000
b.
£216,000
c.
£150,000
d.
£225,000
21. Refer to Figure 10-5 above, what amount of order-filling costs would be allocated to the large
customer if these costs are allocated using an activity-based costing approach?
a.
£10,000
b.
£350,000
c.
£28,800
d.
£331,200
22. Refer to Figure 10-5 above, what amount of order-filling costs would be allocated to the five smaller
customers if these costs are allocated using an activity-based costing approach?
a.
£10,000
b.
£350,000
c.
£28,800
d.
£331,200
23. Refer to Figure 10-5 above, what amount of sales-force costs would be allocated to the five smaller
customers if these costs are allocated based on sales volume?
a.
£144,000
b.
£216,000
c.
£150,000
d.
£225,000
24. A target cost is computed as
a.
the cost to manufacture plus a desired mark up.
b.
the cost to manufacture plus the designated selling expenses.
c.
the market willingness to pay less the cost to manufacture.
d.
the market willingness to pay less the desired profit.
25. Setting prices below cost for the purpose of injuring competitors and eliminating competition is
a.
predatory pricing.
b.
target pricing.
c.
price discrimination.
d.
price gouging.
26. World-class organizations operating in competitive markets are more likely to take which one of the
following approaches toward pricing?
a.
Begin with cost data as given and determine price by adding a reasonable mark-up.
b.
Determine price based on the amount management believes customers are willing to pay.
c.
Employ a cost-based approach to pricing.
d.
Determine the price that keeps the facilities fully utilized.
27. When cost-based pricing is employed and mark up is based on manufacturing costs, the mark up must
be sufficiently large enough to:
a.
cover selling expenses.
b.
cover administrative expenses.
c.
provide for the desired profit.
d.
accomplish all of the above.
28. Which of the following statements describes a legitimate disadvantage of cost-based pricing?
a.
Marginal costs and revenues are difficult to measure.
b.
Determining the amount a customer is willing to pay may require sufficient estimation.
c.
Customers may not be willing to pay the price determined by the procedure.
d.
all of the above
29. Cost-based pricing has traditionally been important because:
a.
cost data are available.
b.
cost-based prices are defensible.
c.
revenues must exceed costs if the firm is to remain in business.
d.
of all of the above.
Figure 10-6
Multiple Products Co. has predicted the following costs for this year for 100,000 units:
Selling and
Manufacturing
Administrative
Variable
£ 400,000
£100,000
Fixed
600,000
300,000
Total
£1,000,000
£400,000
30. Refer to Figure 10-6. What is the mark up on variable costs needed to achieve a target profit of
£100,000?
a.
375 per cent
b.
275 per cent
c.
250 per cent
d.
200 per cent
31. Refer to Figure 10-6. What is the manufacturing cost mark up needed to obtain a target profit of
£100,000?
a.
100 per cent
b.
67 per cent
c.
50 per cent
d.
25 per cent
32. Refer to Figure 10-6. What is the mark up on variable costs needed to break even?
a.
100 per cent
b.
40 per cent
c.
140 per cent
d.
180 per cent
33. Which of the following accurately describes the effect target costing has on the manufacturing design
function?
a.
Target costing allows the design engineer’s job to end once the product is designed.
b.
Target costing forces design engineers to explicitly consider the costs of manufacturing
and other aspects of business that traditionally fall outside the engineering department.
c.
Target costing defines clear lines of responsibility among departments allowing for design
engineers to be evaluated purely on meeting the customer’s functional requirements.
d.
Target costing has no implications for design engineering.
34. Which of the following statements concerning target costing is NOT true?
a.
Implementing target costing requires detailed information on the cost of alternative
activities.
b.
Target costing can be applied to components of products as well as the new products as a
whole.
c.
A primary advantage of target costing is that it requires little or no coordination among
processes.
d.
Short product life cycles increase the importance of target costing.
35. If activity-based costing is used, materials handling would be classified as a
a.
unit-level activity.
b.
batch-level activity.
c.
product-level activity.
d.
facility-level activity.
36. If activity-based costing is used, modifications made by engineering to the product design of several
products would be classified as a
a.
unit-level activity.
b.
batch-level activity.
c.
product-level activity.
d.
facility-level activity.
37. Which of the following quantities is an example of an activity cost driver in activity-based costing?
a.
number of direct labour hours
b.
number of labour transactions
c.
number of machine hours
d.
all of the above
SHORT ANSWER
1. Provide a short critique of cost-based pricing. What are the four major drawbacks to this pricing
approach?
ANS:
PROBLEM
1. Baker Manufacturing has four categories of overhead. The four categories and the expected overhead
costs for each category for next year are as follows:
£140,000
60,000
50,000
100,000
Currently, overhead is applied using a predetermined overhead rate based upon budgeted direct labour
hours. For next year, 50,000 direct labour hours are budgeted.
The company has been asked to submit a bid for a proposed job. The plant manager feels that
obtaining this job would result in new business in future years. Usually bids are based upon full
manufacturing cost plus 30 per cent.
Estimates for the proposed job are as follows:
£5,000
£7,500
8
5
3
300
In the past, full manufacturing cost has been calculated by allocating overhead using a traditional
volume-based cost driver system—direct labour 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 as follows:
16,000
4,000
2,000
8,000
Required:
a.
Determine the amount of overhead that would be allocated to the proposed job if direct
labour hours are used as the traditional volume-based cost driver.
Determine the total cost of the proposed job.
Determine the company’s bid if the bid is based upon full manufacturing cost plus 30 per
cent.
b.
Determine the amount of overhead that would be applied to the proposed job if
activity-based costing is used.
Determine the total cost of the proposed job if activity-based costing is used.
Determine the company’s bid if activity-based costing is used and the bid is based upon full
manufacturing cost plus 30 per cent.
c.
Which product costing method produces the more competitive bid?
a.
£5,250 (£140,000 + £60,000 + £50,000 + £100,000)/50,000 = £7 per DLH
£7 750 DLH = £5,250
£17,750 £5,000 + £7,500 + £5,250
£23,075 £17,750 130%
b.
£2,882.50
Maintenance: £140,000/16,000 = £8.75 per machine hour
Materials handling: £60,000/4,000 = £15 per move
Setups: £50,000/2,000 = £25 per setup
Inspection: £100,000/8,000 = £12.50 per inspection
2. Nordholm Construction Company builds houses. Each job requires a bid. Nordholm’s bidding policy is
to estimate the costs of materials, direct labour, and subcontractor’s costs. These are totaled and a mark
up is applied to cover overhead and profit. In the coming year, Nordholm believes it will be the
successful bidder on ten jobs with the following total revenues and costs:
Revenues
£648,000
Materials
£200,000
Direct labour
250,000
Subcontractors
_150,000
_600,000
Residual
£ 48,000
The residual will cover overhead and profits.
Required:
a.
What is the mark up percentage on total direct costs?
b.
Suppose Nordholm is asked to bid on a job with estimated direct costs of £55,000. What is the
bid? If the customer complains that the profit seems pretty high, how might Nordholm counter
that?
b.
Bid = £55,000 ?6? 1.08 = £59,400
3. Many products have a predictable profit or product life cycle. Describe the product life cycle from the
marketing perspective. In addition, graph profit versus the different phases. Finally, discuss the impact
of the product life cycle on products, learning effects, setups, purchasing, and marketing expenses.
Overhead assigned:
£8.75 300
£15 8
£25 3
£12.50 5
£15,382.50 £5,000 + £7,500 + £2,882.50
£19,997.25 £15,382.50 130%
c.
Activity-based costing produces more accurate cost information and a more competitive bid.
4. Bay Company produces boats for 11 major buyers. Of the 11 customers, one accounts for 45 per cent
of the sales, with the remaining ten accounting for the rest of the sales. The ten smaller customers
purchase boats in roughly equal quantities. Orders placed by the smaller customers are about the same
size. Data concerning Bay’s customer activity follow:
Large Customer
Ten Smaller Customers
Units purchased
4,500
5,500
Orders placed
5
545
Number of sales calls
15
245
Manufacturing cost
£800,000
£980,000
Order-filling costs for Bay Company total £401,500, and sales-force costs are £260,000.
Required:
a.
Determine the amount of selling costs (order-filling and sales-force costs) allocated to (1) the
large customer and (2) the ten smaller customers if these costs are allocated based on sales
volume.
b.
Determine the amount of selling costs (order-filling and sales-force costs) allocated to (1) the
large customer and (2) the ten smaller customers if these costs are assigned using
activity-based costing.
c.
Comment on the differences in amounts attributed to the smaller customers in requirements a
and b.
Order-filling costs:
Large customer:
£401,500 ?6? .45 = £180,675
Smaller customers:
£401,500 ?6? .55 = £220,825
Sales-force costs:
Large customer:
£260,000 ?6? .45 = £117,000
Smaller customers:
£260,000 ?6? .55 = £143,000
b.
Order-filling costs: £401,500/(5 + 545) = £730 per order
Large customer:
£730 ?6? 5 = £3,650
Smaller customers:
£730 ?6? 545 = £397,850
Sales-force costs: £260,000/(15 + 245) = £1,000 per sales call
Large customer:
£1,000 ?6? 15 = £15,000
Smaller customers:
£1,000 ?6? 245 = £245,000
contact with the sales force. The order-filling costs for smaller customers increase from
£220,825 to £397,850 (the increase is £177,025), and the sales-force costs increase from
£143,000 to £245,000 (the increase is £102,000).
5. Johnson Company produces office equipment for 16 major buyers. Of the 16 customers, one accounts
for 50 per cent of the sales, with the remaining 15 accounting for the rest of the sales. The 15 smaller
customers purchase equipment in roughly equal quantities. Orders placed by the smaller customers are
about the same size. Data concerning Johnson’s customer activity follow:
Large Customer
15 Smaller Customers
Units purchased
50,000
50,000
Orders placed
6
294
Number of sales calls
26
224
Manufacturing cost
£750,000
£750,000
Order-filling costs for Johnson Company total £270,000, and sales-force costs are £300,000.
Required:
a.
Determine the amount of selling costs (order-filling and sales-force costs) allocated to (1)
the large customer and (2) the 15 smaller customers if these costs are allocated based on
sales volume.
b.
Determine the amount of selling costs (order-filling and sales-force costs) allocated to (1)
the large customer and (2) the 15 smaller customers if these costs are assigned using
activity-based costing.
c.
Comment on the differences in amounts attributed to the smaller customers in
requirements a and b.
Order-filling costs:
Large customer:
£270,000 ?6? .50 = £135,000
Large Smaller customers:
£270,000 ?6? .50 = £135,000
Sales-force costs:
Large customer:
£300,000 ?6? .50 = £150,000
Large Smaller customers:
£300,000 ?6? .50 = £150,000
b.
Order-filling costs: £270,000/(6 + 294) = £900 per order
Large Large customer:
£900 ?6? 6 = £5,400
Large Smaller customers:
£900 ?6? 294 = £264,600
Sales-force costs: £300,000/(26 + 224) = £1,200 per sales call
Large Large customer:
£1,200 ?6? 26 = £31,200
Large Smaller customers:
£1,200 ?6? 224 = £268,800
contact with the sales force. The order-filling costs for smaller customers increase from
£135,000 to £264,600 (the increase is £129,600), and the sales-force costs increase from
£150,000 to £268,800 (the increase is £118,800).
6. Etro Company sells a product used in many manufacturing processes. The sales activity involves three
activity areas:
Activity Area
Cost Driver and Rate
Order taking
£100 per purchase order
Sales visits
£50 per visit
Delivery vehicles
£1 per delivery mile
Product handling
£0.05 a unit
Special runs
£300 per run
The following customer information is given:
A
B
D
Units sold
100,000
80,000
60,000
List price
£50
£50
£50
Actual sales price
£45
£48
£50
Number of purchase orders
30
20
10
Number of sales visits
6
5
3
Number of deliveries
10
8
6
Miles traveled per delivery
40
5
20
Number of special runs
1
0
2
Required:
What is the profitability of customer B?
7. Todd Ltd. sells a product for £400 per unit. Its market share is 22 per cent of the units sold. The
marketing manager feels that the market share can be increased to 28 per cent of the units sold with a
reduction in price to £340. The product is currently earning a profit of £64 per unit. The president of
Todd Ltd. feels that his company needs to maintain the same profit level per unit. The market share
consists of £4,000,000 (10,000 units).
Required:
a.
How many units does Todd Ltd. currently sell of the product?
b.
What is the target price per unit?
c.
What is the original cost per unit?
d.
What is the target cost per unit?
a.
10,000 ?6? 0.22 = 2,200
b.
£340
c.
£400 – £64 = £336
d.
£340 – £64 = £276
8. Spencer Manufacturing Company sells a product for £200 per unit. Its market share is 18 per cent of
the units sold. The marketing manager feels that the market share can be increased to 25 per cent of the
units sold with a reduction in price to £170. The product is currently earning a profit of £32 per unit.
The president of Spencer Manufacturing Company feels that his company needs to maintain the same
profit level per unit. The market share consists of £2,000,000 (10,000 units).
Required:
a.
How many pounds does Spencer Manufacturing Company currently sell of the product?
b.
What is the target price per unit?
c.
What is the original cost per unit?
d.
What is the target cost per unit?
9. Foley Ltd. has predicted the following costs for this year for 100,000 units:
Manufacturing
Selling and
Administrative
Variable
£800,000
£200,000
Fixed
1,200,000
600,000
Total
£2,000,000
£800,000
Required:
a.
What is the mark up on variable costs needed to achieve a target profit of £200,000?
b.
What is the initial unit selling price needed to obtain a target profit of £200,000 using the
variable cost mark up method?
c.
What is the manufacturing cost mark up needed to obtain a target profit of £200,000?
d.
What is the initial unit selling price needed to obtain a target profit of £200,000 using the
manufacturing cost mark up method?
a.
b.
(£800,000 + £200,000)/100,000 units = £10 per unit + (£1?8? ?6? 200 per cent) = £30
c.
(£800,000 + £200,000)/£2,000,000 = 50 per cent
d.
£2,000,000/100,000 units = £20 per unit + (£20 ?6? 50 per cent) = £30
a.
£2,000,000 ?6? 0.18 = £360,000
b.
£170
d.
£170 – £32 = £138
10. Wurster Company sells a product for £400 per unit. Its market share is 20 percent of the units sold.
The marketing manager believes that the market share can be increased to 28 percent of the units sold
with a reduction in price to £360. The product is currently earning a profit of £62 per unit. The
president of Wurster Company believes that his company needs to maintain the same profit level per
unit. The total market for the product has annual sales of 5,000 units.
Required:
a.
How many units does Wurster Company currently sell of the product?
b.
What is the target price per unit?
c.
What is the target cost per unit?
a.
5,000 ?6? .20 = 1,000 units
b.
£360
c.
£360 – £62 = £298