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Comparison
Incrrease
Total Total Batch Batch Total Total Batch Batch Total Total Batch Batch (Drop) in
Cost Cost Total Gross Cost Cost Total Gross Cost Cost Total Gross Gross
Product per Reel per Batch Revenues Margin per Reel per Batch Revenues Margin per Reel per Batch Revenues Margin Margin
A9,840$ 492,000$ 630,000$ 138,000$ 11,702$ 585,103$ 630,000$ 44,897$ 119% 119% 100% 33%
-67%
B10,660 21,320 27,000 5,680 15,812 31,625 27,000 (4,625) 148% 148% 100% n/a
-181%
C11,480 401,800 497,000 95,200 13,332 466,606 497,000 30,394 116% 116% 100% 32%
-68%
D15,170 2,654,750 3,412,500 757,750 14,209 2,486,536 3,412,500 925,964 94% 94% 100% 122% 22%
3,569,870$ 4,566,500$ 996,630$ 3,569,870$ 4,566,500$ 996,630$
One Step Cost Analysis
ABC Cost Analysis
ABC Cost / One Step Cost
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Key points from ABC Analysis
1. Products A,B, and C are more costly than thought, because of the high cost of grade change (has to
be averaged over the number of reels, smaller for A,B, and C) and the high cost of slitting (for A and
C). Note that the grade changes are made between batches, while slitting is done for each reel,
so the effect of the slitting is potentially much greater than the effect of grade change. This does not
happen for product B however, since there are so few reels for product B, so for product B, the main
effect on cost is the grade change – so few reels per batch.
2. Gross margins after ABC are much smaller for A, B and C, and B’s gross margin is negative. Need
to consider the pricing issues for B and whether we can make this product more profitable.
3. How should we use the ABC information in pricing, in planning, and in performance evaluation?
Increase the price of B
ABC information is better for planning which products to drop, keep or add
ABC information is better for performance evaluation
4 How would you change the competitive strategy of the company? What is the role of cost
information in determining the strategy of the company?
Reduce product variety
Batch size
Slitting, or charge appropriately for it
Go to a time based costing system
5. How would analysis of the value chain help FHPC meet its strategic goals?
• Look for ways to add value and reduce costs
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The Value Chain
Timber; do we harvest our own timber?
Sorting and preparing timber; receiving the lumber in the pulp plant
Pulp manufacturing
Debarking; a 16×100 ft drum; tumbling the logs
Chipping; into 1” cubes
Digesting; heat and soak with chemicals
Bleaching; brown to white
Paperboard production
Headbox; mix pulp cubes with water and chemicals
Wire; paper mixture is applied to wire mesh that travels through a press and forces the
Pulp mixture against the wire to remove water
Drying; cylindrical dryers and steam are used
Rolling; into “parent” rolls
Further processing
Coating
Rewinding and slitting
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5-5 Harrison Products, Inc
The Harrison Products Inc (HPI) case is based on disguised information and data taken from that of a U.S.
multinational company. Many of the costing and strategic issues addressed in the case are faced by that
company. The main issues are (1) what costing system to use and (2) what manufacturing strategy to
use to best serve the company’s customers and to meet the competitive challenge of low cost. The case
is intended for the undergraduate cost course, the advanced cost/managerial course and the MBA
managerial course.
Because of the amount of data involved and the analysis required, Excel is strongly recommended for the
solution of the case.
The main learning objectives of the case are to examine the application of volume-based and activity-
based costing in a manufacturing context. There are three unique issues in the case:
1. How to determine the cost driver for setup costs. The student is asked to determine the
amount of ABC cost allocated to a sample of jobs using two different assumptions of how
2. To understand the possible influence of batch size not only on batch level costs but also on
unit level costs. In the case data, which (while disguised) reflects the actual experience of
3. To understand how manufacturing strategy can affect product costs. In this case, one of the
company’s plants was designed for relatively large batch sizes and the other was designed for
smaller batches. Both batch-level and unit-level costs are affected by these design decisions.
Answers to Questions:
1, 2, and 3: The answers to parts 1,2 and 3 are shown in TN-1. The solution also shows the
operating margin per unit which is useful in the discussion of the requirement 4. The calculation of the
volume-based and activity-based rates is shown on the right-hand side of the Exhibit. It is highly
4. In comparing the results for parts 1,2 and 3, it is apparent that the volume-based approach, as
it is based only on volume, produces the same unit costs for each job, irrespective of job size.
Thus, the operating margin per unit is the same for each job ($0.30 for the Los Angeles plant
Chapter 5 – Activity-Based Costing and Customer Profitability Analysis
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The standard deviation of the operating margin per unit is shown for each of the three
methods and each plant; the variation is greatest for activity-based costing (part 2 method)
and of course zero for the volume-based method.
The activity-based methods in parts 2 and 3 are preferred over the volume-based method
because they appropriately apply the job-related setup costs to each job and thereby
recognizing the more accurate cost for each job. The method in part 3 would be preferred
since it takes into account the additional clean-up and preparation time required after the
larger jobs. Generally, determining which of the two activity-based methods is best would
require a careful study of what drives setup time and costs, information which is not available
5. A graphical and correlation analysis for both plants, showing the relationship between job
size and runtime is in Exhibit TN-2. The graphs in particular show clearly that the Los
Angeles plant, the newer plant, has faster runtime for smaller jobs. This can be seen from
the graph and also by reviewing the 6-8 smallest jobs in both plants together with the related
runtimes. Small orders at the Youngstown plant have much longer runtimes. Both plants,
with larger orders, show about two minutes per 1,000 units average runtime (though the
Youngstown plant gets to the two minute mark at a slightly lower job size than the Los
Angeles plant). The bottom line: orders under approximately 50,000 units have relatively
high runtimes at Youngstown, and only somewhat elevated runtimes at Los Angeles. There
are two implications of this finding:
a. It is clear that, for small orders, job size affects not only setup costs per unit but also
runtime cost per unit. An operations employee at the company originally studied in
this case explained that a key reason for the effect of batch size on average runtime is
that the equipment operators normally ran the machines slowly at the start of the job
to make sure that the job was running properly, and then increased the processing
speed as the job progressed. Thus, for smaller jobs, there was a longer “wait time”
cost) but also potentially the unit-level costs.
b. The implication for manufacturing strategy is the importance of matching factory
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TN-1 Manufacturing Cost and Operating Margin for Both Plants under Volume-Based and
two methods for Activity Based Costing
(setup driver: the job)
(driver: job & job size)
Volume-Based
Activity-Based
Activity-Based
Volume Based Rate:
Unit costs
Los Angeles: $1.10
Youngstown: $1.00
Activity Based Rate (driver: the
job):
Los Angeles:
Setup Costs: $6,000,000/2,000
= $3,000 per job
Youngstown:
Setup Costs: $10,000,000/1,600
=$6,250 per job
Other costs for Los Angeles
($.40+$.40+$.2=$1.00) and
Youngstown : ($.40+$.40+$.01 =
ActivityBased Rate (driver:
job&units) (split setup costs; one–
half to job and one-half to units)
Los Angeles:
Setup Costs: $3,000,000/2,000
= $1,500 per job
plus: $3,000,000/60,000,000
=$.05 per unit
Youngstown:
Setup Costs: $5,000,000/1,600
=$3,125 per job
plus: $5,000,000/100,000,000
=$.05 per unit
Other costs for Los Angeles :
($.40+$.40+$.2=$1.00)
and Youngstown : ($.40+$.40+$.01 =
$.90)
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TN-2: Analysis of the Relationship between Runtime and Job Size for Los Angeles
and Youngstown Plants
Los Angeles Plant
0
1
2
3
4
5
0 50,000 100,000 150,000
Minuntes/1,000
Job Size
Correlation: Job Size and Runtime
Job Size Minuntes/1000
Job Size 1
Minuntes/1000 –0.93236127 1
Youngstown Plant
0
5
10
15
20
0 50,000 100,000 150,000 200,000 250,000
Minutes/1,000
Job Size
Correlation: Job Size and Runtime
Job Size Minutes/1000
Job Size 1
Minutes/1000 –0.64444884 1
Chapter 5 – Activity-Based Costing and Customer Profitability Analysis
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Teaching Strategies for Readings
5-1 Activity-Based Costing and Predatory Pricing: The Case of the Petroleum Retail Industry
1. What are product-cost subsidizations?
Product-cost subsidizations are where excessive costs are charged to one or more products, usually
2. What are possible consequences of product-cost subsidizations?
Undercosted products can lead to the appearance of predatory pricing where it actually does not exist.
3. List alternative approaches to assign costs in a gasoline service center.
Three approaches can be employed to assign gasoline service center costs to products:
4. Identify cost hierarchy level groups in classifying activities at the retail level of a gasoline service
center and give at least one example each.
Unit-level activities are undertaken for each gallon of gasoline sold (such as electricity to power
pumps when dispensing gasoline);
Batch-level activities are the same for each gasoline transaction irrespective of the volume of
gasoline purchased (for example, transactions to process customer payments for gasoline by cash,
5. What are overheads activity-cost pools pertaining to selling gasoline in a retail gasoline service center
and what is the activity level for each of the cost pools?
Gasoline Sales Attendants (Labor): Attendants are needed to receive payments from customers
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Also, it was necessary to determine a “reasonable rental value” for the gasoline-dispensing facility,
which, in general, can be classified as a product-level activity. This activity cost pool includes
assets that are specific to a particular gasoline grade and common gasoline dispensing assets. In a
more comprehensive activity analysis, this cost pool could be divided into two or more activity
cost pools that would be more homogeneous in nature.
6. Identify the activity drivers for overheads activity-cost pools identified in this study and explain the
reasons for the selection?
Gasoline Sales Attendants (Labor): Volume of gasoline sold (a unit-level activity driver).
The principal responsibility of a kiosk attendant is to receive payments from customers for
gasoline purchases, which is a batch-level activity. Given that the average volume of gasoline
sold to each customer is about the same, regardless of the gasoline grade, the volume of gasoline
sold can be used as a proxy activity driver for these payment transactions.
The number of gasoline sales transactions is a major factor in determining the number of kiosk
number of attendants, which directly impacts the imputed rental payments.
The volume of gasoline sales determines the hours a gasoline station is open, which directly
affects the level of repairs and maintenance, utilities costs, and so on.
Gasoline-Dispensing Facility: Number of gasoline grades.
The facilities used for dispensing the three grades of gasoline are identical in size and cost for
each grade of gasoline irrespective of the volume of gasoline sold (for example, the gasoline
tanks).
7. List examples of gasoline-dispensing facilities for a gasoline service center and identify whether each
of the facilities is a common or a gasoline grade-specific asset. (Please refer to Table 3 below for the
answer).
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5-2 Activity-Based Benchmarking and Process Management – Managing the Case of
Cardiac Surgery
1. Describe briefly the hospital’s costing system.
Generally, the hospital’s costing system begins with the division of each general ledger account
into cost types: variable direct cost, fixed direct cost, and fixed indirect cost.
At the cost center or department level, each indirect cost center is assigned an allocation base (such
as total cost, square feet, or gross revenue) to be used to spread the indirect costs to the direct cost
centers. The departmental direct costs and allocated indirect costs become departmental total costs.
The standard unit cost of the primary product/service is then calculated by first allocating the
departmental total cost based on the relative value units (RVUs) multiplied by the budgeted volumes
of each individual product/service to obtain the budgeted total cost of each basic product/service.
2. Describe steps in activity-based benchmarking for medical-care processes.
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5-3 Using ABC to Asses Channel/Customer Profitability
This article explains how ABC was used by a firm (TEC) in the temporary employment industry to better
identify the profitability of its service distribution channels and individual customers.
Discussion Questions:
1. What are the four steps used in implementing ABC costing at TEC?
Step 1. Develop the activity dictionary.
2. What are the activity consumption drivers that TEC has chosen for each of the three activities: filling
work orders, hiring temporaries, and processing payroll?
From Table 2:
• number of hours worked for processing payroll
3. Which customer channel is most profitable, clerical or industrial, and why?
The clerical channel has somewhat higher profitability (Table 3)because the industrial customers
demand lower rates and have significantly higher worker’s compensation rates.
4. Within the industrial channel, which class of customers is most profitable and why?
5. In the study of the four largest customers, which is the most profitable and why?
The newspaper publisher and the food processing company had negative contributions, while the
trailer manufacturer has a modest contribution. The highest contribution was for the chemical company
5-40
5-4 Cost System Redesign at a Medium-Sized Company
This article looks at a company that was experiencing unprofitable growth and weak cash-flow activity.
The authors examine how an ABC method allowed the company to become more competitive, to look at
their current product mix and product lines, and ultimately, to improve cash flow and product
profitability.
Discussion Questions
1. Why for any manufacturer is proper inventory management important?
For virtually any manufacturer, proper inventory management ensures the availability of the right items at
the right time and in the right place. This, in turn, supports organizational objectives of customer service,
2. What are the elements of an ABC system?
3. What is a cost objective?
4. Why are duration drives used in an ABC system?
5. What internal factors limit the ABC model’s ability to influence the decision-making process in a
company?
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5-5 Implementing Time-Driven Activity-Based Costing at a Medium-Sized Electronics
Company
This article revisits the company described in reading 5-4, which has now adopted a traditional ABC
system. In this article the authors examine how a time-driven ABC (TDABC) system might overcome
some of the drawbacks of the traditional ABC system while provide more insightful information about the
demand that products put on the available resources.
Discussion Questions
1. What are the goals of an ABC system?
At one level, the goal of an ABC system is to allocate indirect (support) costs in such a way that the
resulting cost information reflects more accurately the resource demands/resource consumption of an
2. What are the potential drawbacks of a traditional ABC system?
The issues faced by XYZ are representative of a major drawback of a traditional ABC system. First
is the complexity of the implementation. A traditional ABC system is very data intensive and
collecting and analyzing the data can prove to be overwhelming for a small to medium sized firm.
Additionally, there is the difficulty in keeping all the data current in order for management to be able
demanded by various cost objects that use the activity.
In short, a traditional ABC system can be expensive to build, time-consuming to operate and update,
difficult to maintain, and difficult to modify to meet management needs.
3. What benefits does a TDABC system offer over a traditional ABC system?
Advocates of time-driven activity-based costing maintain that this system is an improvement on
traditional ABC systems in the following respects:
• TDABC eliminates the need for the time consuming, subjective, interview-and-survey process to