Appendix C – Activity-Based Costing
Exercise C-6 (30 minutes)
Calculation of predetermined overhead rates to apply ABC
Overhead Cost
Category (Activity
Cost Pool) Total
Cost
Total Amount
of Cost Driver Predetermined Overhead Rate
Supervision…………………………$ 5,400 $36,000 15% of direct labor cost
1. Assignment of overhead costs to the two products using ABC
Rounded edge
Cost
Driver
Cost per
Driver Unit Assigned Cost
Supervision………………………. $12,200 15% $ 1,830
Squared edge
Cost
Driver
Cost per
Driver Unit Assigned Cost
Supervision………………………. $23,800 15% $ 3,570
2. Average cost per foot of the two products
Rounded edge Squared edge
Direct materials ……………………… $19,000 $ 43,200
Direct labor …………………………… 12,200 23,800
*Rounded
3. Using ABC, the average cost of rounded edge shelves declines and the
average cost of squared edge shelves increases. Under the current
allocation method, the rounded edge shelving was allocated 34% of all of
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Appendix C – Activity-Based Costing
PROBLEM SET A
Problem C-1A (40 minutes)
1. Grinding & Polishing ($320,000+$135,000)/13,000 MH $35/MH
2.
Job 3175 Job 4286
Grinding & polishing 550 MH x $35……………….. $19,250 5,500 MH x $35………………. $192,500
3. Job 3175 Job 4286
Total overhead cost of job $74,650 $383,425
4. Plantwide rate
Grinding………………………………………………………………….. $ 320,000
Polishing…………………………………………………………………. 135,000
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Appendix C – Activity-Based Costing
Per DLH (rounded)……………………………………………………. $106.47/DLH
Problem C-1A (concluded)
Job 3175 Job 4286
Overhead
500 DLH x $106.47 $ 53,235
*Rounded
5. Average overhead cost
Job 3175 Job 4286
The plantwide rate, which is closely associated with the volume of
production, overstates the cost of the high-volume product (in this case
Job 4286), and understates the cost of the low-volume product (Job
3175). ABC more accurately represents the cost of producing a product
because it considers how much of each resource is consumed by each
product in the manufacturing process.
Problem C-2A (50 minutes)
1. Total overhead = $215,630 + $399,480 + $515,600
Total direct labor hours 2,600 DLH + 1,600 DLH
*Rounded
Pup Tent Pop-Up Tent
Overhead cost by product line
Pup: 2,600 DLH @ $269.22/DLH $699,972*
Pop-Up: 1,600 DLH @ $269.22/DLH $430,752*
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Appendix C – Activity-Based Costing
It appears that the Pup Tent is not profitable and management may
decide to eliminate this product line if it cannot reduce cost (or raise the
selling price) to generate a profit.
4. Pattern alignment $64,400/560 batches $115/batch
Cutting $50,430/12,300 machine hours $4.10/MH
Moving product $100,800/2,400 moves $42/move
Pup Tent Pop-Up Tent
Pattern alignment 140 batches x $115……….$ 16,100 420 batches x $115………..$ 48,300
Cutting 7,000 MH x $4.10…………..28,700 5,300 MH x $4.10……………21,730
Moving product 800 moves x $42…………..33,600 1,600 moves x $42…………67,200
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Appendix C – Activity-Based Costing
Problem C-2A (concluded)
5.
Pup Tent Pop-Up Tent
Selling price $65.00 $200.00
Both product lines are profitable without any cost cutting. The ABC cost
assignment method more accurately reflects the costs associated with
6. Departmental overhead rates based on direct labor hours and machine
hours are still volume-based measures and would not improve the
Problem C-3A (25 minutes)
1. When companies experience strong price pressure on their
high-volume, commodity-type products, they should be concerned.
Many managers will blame competitive price cutting on attempts by
2. The company may be charging less for its low-volume, custom-order
products than the competitors because the company is using a
volume-based costing system, which understates the true cost of
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Appendix C – Activity-Based Costing
3. While prices are really set in the marketplace based on customer
demand and supply of the product, companies still look at costs to
4. Custom-order furniture requires handling special fabrics, buying in
smaller quantities (which may be more expensive than buying “in bulk”),
5. In addition to obtaining a more accurate picture of the costs of making
various products, activity based costing also gives information about
the cost of the activities that are performed. Managers may be surprised
Problem C-4A (45 minutes)
1. Plantwide overhead rate:
Engineering support $ 24,500
* Product A 10,000 units x 0.3 DLH/unit = 3,000 DLH
Product A Product B
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Appendix C – Activity-Based Costing
B: 1.6 DLH/unit @ $20/DLH 32.00
Manufacturing overhead per unit
Product A Product B
Selling price per unit………………… $30.00 $120.00
2. Product A Product B
Gross profit per unit $ 3.63 $35.36
x units purchased per customer
We see that the gross profit per customer from Product A ($72.60) is not
adequate to cover the cost of providing service to customers of this
product ($90). It appears that the company is incurring a loss of $17.40
($72.60 – $90) associated with each customer of Product A.
Problem C-4A (concluded)
3. Engineering Support $24,500/(12 + 58) modifications $350/modification
Product A Product B
Engineering support
A: 12 modifications @ $350 $ 4,200
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Appendix C – Activity-Based Costing
B: 225 batches @ $150/batch ______ 33,750
Total overhead cost by product line $32,950 $78,050
4. Product A Product B
Gross profit per unit (from above) $5.70 $24.97
The gross profit per customer is adequate to cover the cost of providing
customer service under ABC for both Product A and Product B.
Problem C-4A (concluded)
5. Activity based costing gives better information than the plantwide rate
based on volume-related measures because ABC associates the cost of
the various activities that must be performed in order to make, sell, and
Problem C-5A (25 minutes)
1. Liquid materials $2,304/(1,400 + 37,000) gallons $0.06/gallon
Dry materials $6,941/(620 + 12,000) pounds $0.55/pound
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Appendix C – Activity-Based Costing
PowerPunch SlimLife
Liquid material 1,400 gal x $0.06……………… $ 84 37,000 gal x $0.06……….$ 2,220
Dry material 620 pounds x $0.55………… 341 12,000 pounds x $0.55. . 6,600
2. PowerPunch SlimLife
Total cost of line $19,122 $95,070
*Rounded
Problem C-5A (concluded)
3. For PowerPunch:
4. The price of SlimLife must cover the costs associated with the product,
so the minimum price for this product is $0.53/bottle.
Problem C-6A (45 minutes)
Part 1
Determination of cost per driver unit
Cost Center Cost Driver Cost per Driver
Professional salaries…………………..$2,000,000 10,000 hours $200 per hour
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Appendix C – Activity-Based Costing
Part 2
Allocation of cost to the surgical departments using ABC
GENERAL SURGERY
Cost
Driver
Cost per
Driver Unit
Allocated
Cost
Professional salaries…………. 2,500 hours $200 per hr. $ 500,000
Problem C-6A (concluded)
ORTHOPEDIC SURGERY
Cost
Driver
Cost per
Driver Unit
Allocated
Cost
Professional salaries…………. 7,500 hours $200 per hr. $1,500,000
[Note that the sum of the amounts allocated to General Surgery and Orthopedic
Part 3
If all center costs were allocated on the number of patients, the average
cost of general surgery would increase. Since general surgery sees 80% of
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