Chapter 3
Activity-Based Costing
Solutions to Questions
3-1 The most common methods of assigning
overhead costs to products are plantwide over–
3-2 The assumption, implicit in conventional
costing systems, that overhead cost is propor-
tional to direct labor, is being increasingly ques–
tioned. Automation has decreased the amount
3-3 The departmental approach to assigning
overhead cost to products usually assumes that
overhead costs are proportional to direct labor-
hours or machine-hours. However, overhead
3-4 The hierarchical levels are:
1. Unit-level activities, which are performed
2. Batch-level activities, which are per–
3. Product-level activities, which are per–
4. Facility-level activities, which sustain an
organization’s general capabilities.
3-5 Activity-based costing involves two
stages of overhead cost assignments. In the first
3-6 In a conventional costing system, over–
head costs are allocated to products using some
measure of volume such as direct labor-hours or
product will be allocated exactly the same total
overhead as a low-volume product. In contrast,
if a measure of volume like direct labor-hours or
machine-hours were used to allocate this cost,
departmental pools, costs are accumulated for
each major activity. Second, the activity cost
cost pools. In principle, all of the costs in an ac-
costs of many different activities carried out in
changes the bases used to assign overhead
costs to products. Rather than assigning costs
© The McGraw-Hill Companies, Inc., 2016. All rights reserved.
2 Introduction to Managerial Accounting, 7th edition
of the activities that presumably cause overhead
costs.
3-8 While the product costs computed using
activity-based costing are almost certainly more
accurate than those computed using more con–
ventional costing methods, activity-based cost-
ing nevertheless rests on some questionable
assumptions about cost behavior. In particular,
activity-based costing assumes that costs are
proportional to activity. In reality, costs appear
to increase less than in proportion to increases
in activity. This implies that activity-based prod-
uct costs will be overstated for purposes of
making decisions. (The same criticism can be
leveled at conventional product costs.) Second,
the costs of implementing and maintaining an
activity-based costing system can be high and
its benefits may not justify this cost.
The Foundational 15
1. The plantwide overhead rate is computed as follows:
Total estimated overhead cost (a) …………
$684,000
Total expected direct labor-hours (b) ……..
12,000
DLHs
Predetermined overhead rate (a) ÷ (b) ….
$57.00
per DLH
2. The overhead cost assignments to Products Y and Z are as follows:
Product Y
Product Z
9,000
3,000
$57.00
$57.00
$513,000
$171,000
3-6.
The activity rates are computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
(a) ÷ (b)
Activity
Rate
Machining ……………
$200,000
10,000
MH
$20
per MH
Machine setups …….
$100,000
200
setups
$500
per setup
Product design ……..
$84,000
2
products
$42,000
per product
General factory …….
$300,000
12,000
DLHs
$25
Per DLH
7. Machine setups is a batch-level activity. A setup is performed to run a
8. The product design activity is a product-level activity. The product
The Foundational 15 (continued)
9-10. Using the ABC system, the total overhead assigned to Products Y and Z is computed as follows:
Product Y
Product Z
Expected
Activity
Amount
Expected
Activity
Amount
Machining, at $20.00 per machine-hour ……………
8,000
$160,000
2,000
$ 40,000
Machine setups, at $500.00 per setup ………………
40
20,000
160
80,000
Product design, at $42,000 per product ……………
1
42,000
1
42,000
General factory, at $25.00 per direct labor-hour …
9,000
225,000
3,000
75,000
Total overhead cost assigned …………………………
$447,000
$237,000
The Foundational 15 (continued)
11–15. The percentages of overhead assigned using the plantwide and ABC approaches are computed
as follows:
Product Y
Product Z
Total
Plantwide Approach
(a)
Amount
(a) ÷ (c)
%
(b)
Amount
(b) ÷ (c)
%
(c)
Amount
Manufacturing overhead ……..
$513,000
75.0%
$171,000
25.0%
$684,000
Activity-Based Costing System
Machining ………………………..
$160,000
80.0%
$ 40,000
20.0%
$200,000
Machine setups …………………
20,000
20.0%
80,000
80.0%
100,000
Product design ………………….
42,000
50.0%
42,000
50.0%
84,000
General factory ………………….
225,000
75.0%
75,000
25.0%
300,000
Total cost assigned to products
$447,000
$237,000
$684,000
The Machining allocation percentages used in the ABC system are similar to the plantwide allocation
percentages because the Machining cost pool uses a unit-level activity measure (machine-hours).
Since the plantwide cost pool also uses a unit-level allocation base (direct labor-hours), it is
reasonable to expect these cost allocations percentages to be comparable.
Under the ABC system, 20% and 80% of the Machine Setups cost is allocated to Products Y and Z,
respectively, whereas the plantwide approach allocates 75% and 25% of all overhead costs to the
two products. These allocation percentages are different because Machine Setups is a batch-level
cost pool. Although Product Y is the high-volume product (14,000 units) and Product Z is the low-
volume product (6,000 units), Product Y only consumes 20% of the total machine setups and Product
The Foundational 15 (continued)
Under the ABC system, 50% of the Product Design cost is allocated to each
product, whereas the plantwide approach allocates 75% and 25% of all
Exercise 3-1 (10 minutes)
a.
Various individuals manage the parts inventories.
Product-level
b.
A clerk in the factory issues purchase orders for a
job.
Batch-level
c.
The personnel department trains new production
workers.
Facility-level
d.
The factory’s general manager meets with other
department heads to coordinate plans.
Facility-level
e.
Direct labor workers assemble products.
Unit-level
f.
Engineers design new products.
Product-level
g.
The materials storekeeper issues raw materials to
be used in jobs.
Batch-level
h.
The maintenance department performs periodic
preventative maintenance on general-use
equipment.
Facility-level
Exercise 3-2 (15 minutes)
1. The activity rates are computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
(a) ÷ (b)
Activity
Rate
Labor related …………………
$ 52,000
8,000
DLHs
$ 6.50
per DLH
Machine related ……………..
15,000
20,000
MHs
0.75
per MH
Machine setups ………………
42,000
1,000
setups
42.00
per setup
Production orders ……………
18,000
500
orders
36.00
per order
Product testing ……………….
48,000
2,000
tests
24.00
per test
Packaging ……………………..
75,000
5,000
packages
15.00
per package
General factory ………………
108,800
8,000
DLHs
13.60
per DLH
Total …………………………...
$358,800
2. The predetermined overhead rate based entirely on direct labor-hours would be computed as follows:
Total estimated overhead cost (a) …………
$358,800
Total expected direct labor-hours (b) ……..
8,000
DLHs
Predetermined overhead rate (a) ÷ (b) ….
$ 44.85
per DLH
Exercise 3-3 (30 minutes)
The unit product costs for the products are a combination of direct materials, direct labor, and overhead
costs. The overhead costs assigned to each product would be computed as follows:
J78
B52
Expected
Activity
Amount
Expected
Activity
Amount
Labor related, at $7.00 per direct labor-hour ……..
1,000
$ 7,000
40
$ 280
Machine related, at $3.00 per machine-hour ……..
3,200
9,600
30
90
Machine setups, at $40.00 per setup ……………….
5
200
1
40
Production orders, at $160.00 per order ……………
5
800
1
160
Shipments, at $120.00 per shipment………………..
10
1,200
1
120
General factory, at $4.00 per direct labor-hour …..
1,000
4,000
40
160
Total overhead cost assigned (a) …………………….
$22,800
$ 850
Number of units produced (b) ………………………..
4,000
100
Overhead cost per unit (a) ÷ (b) …………………….
$ 5.70
$8.50
The unit product costs combine direct materials, direct labor, and overhead costs as follows:
J78
B52
Direct materials …………………………..………….
$ 6.50
$31.00
Direct labor ……………………………………………
3.75
6.00
Manufacturing overhead (see above) …………..
5.70
8.50
Unit product cost …………………………..………..
$15.95
$45.50
Exercise 3-4 (30 minutes)
1. Using the company‘s conventional costing system, the overhead costs applied to the products would
be computed as follows:
Product H
Product L
Total
Number of units produced (a) ………..
40,000
8,000
Direct labor-hours per unit (b) ………..
0.40
0.40
Total direct labor-hours (a) × (b) ……
16,000
3,200
19,200
Total manufacturing overhead (a) ………….
$1,632,000
Total direct labor-hours (b) …………………..
19,200
DLHs
Predetermined overhead rate (a) ÷ (b) ……
$ 85.00
per DLH
Product H
Product L
Total
Manufacturing overhead applied per unit
0.40 DLH per unit × $85.00 per DLH ……
$ 34.00
$ 34.00
Number of units produced ……………………
40,000
8,000
Total manufacturing overhead applied ……
$1,360,000
$272,000
$1,632,000
2. Using the proposed ABC system, overhead costs would be assigned as follows:
Product H
Product L
Total
Total manufacturing overhead assigned (a) ……….
$816,000
$816,000
$1,632,000
Number of units produced (b) ………………………..
40,000
8,000
Manufacturing overhead per unit (a) ÷ (b) ………..
$ 20.40
$ 102.00
Exercise 3-4 (continued)
3. Under the company’s old method of allocating overhead costs, the high–
volume product, Product H, was allocated most of the overhead cost.
This occurred simply because the high-volume product is responsible for
Exercise 3-5 (30 minutes)
1. The activity rates are computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
(a) ÷ (b)
Activity
Rate
Labor related …………………
$ 156,000
26,000
DLHs
$6.00
per DLH
Purchase orders ……………..
11,000
220
orders
$50.00
per order
Parts management ………….
80,000
100
part types
$800.00
per setup
Board etching ………………..
90,000
2,000
boards
45.00
per board
General factory ………………
180,000
20,000
MHs
9.00
per MH
Total …………………………...
$517,000
Exercise 3-5 (continued)
2. The overhead assigned to each product can be computed as follows:
Product A
Activity Cost Pool
(a)
Activity Rate
(b)
Actual Activity
(a) × (b)
ABC Cost
Labor related ……….
$6
per DLH
6,000
DLHs
$ 36,000
Purchase orders …..
$50
per order
60
orders
3,000
Parts management .
$800
per part type
30
part types
24,000
Board etching ………
$45
per board
500
boards
22,500
General factory …….
$9
per MH
3,000
MHs
27,000
Total ………………….
$112,500
Product B
Activity Cost Pool
(a)
Activity Rate
(b)
Actual Activity
(a) × (b)
ABC Cost
Labor related ……….
$6
per DLH
11,000
DLHs
$ 66,000
Purchase orders …..
$50
per order
30
orders
1,500
Parts management .
$800
per part type
15
part types
12,000
Board etching ………
$45
per board
900
boards
40,500
General factory …….
$9
per MH
8,000
MHs
72,000
Total ………………….
$192,000
Activity Cost Pool
(a)
Activity Rate
(b)
Actual Activity
(a) × (b)
ABC Cost
Labor related ……….
$6
per DLH
4,000
DLHs
$ 24,000
Purchase orders …..
$50
per order
40
orders
2,000
Parts management .
$800
per part type
40
part types
32,000
Board etching ………
$45
per board
600
boards
27,000
General factory …….
$9
per MH
3,000
MHs
27,000
Total ………………….
$112,000
Exercise 3-5 (continued)
Product D
Activity Cost Pool
(a)
Activity Rate
(b)
Actual Activity
(a) × (b)
ABC Cost
Labor related ………..
$6
per DLH
5,000
DLHs
$ 30,000
Purchase orders ……
$50
per order
90
orders
4,500
Parts management ..
$800
per part type
15
part types
12,000
Board etching ……….
$45
per board
0
boards
0
General factory ……..
$9
per MH
6,000
MHs
54,000
Total …………………..
$100,500
Exercise 3-6 (15 minutes)
1. & 2.
Activity
Activity
Classification
Examples of Activity
Measures
a.
Preventive maintenance is
performed on general-
purpose production
equipment.
Facility-level
Not applicable; these
costs probably should
not be assigned to
products or customers.
b.
Products are assembled by
hand.
Unit-level
Time spent assembling
products.
c.
A security guard patrols
the company grounds after
normal working hours.
Facility-level
Not applicable; these
costs probably should
not be assigned to
products or customers.
d.
Purchase orders are issued
for materials to be used in
production.
Batch-level
Number of purchase
orders; time spent
preparing purchase
orders.
e.
Modifications are made to
product designs.
Product-
level
Number of modifications
made; time spent
making modifications.
f.
New employees are hired
by the personnel office.
Facility-level
Not applicable; these
costs probably should
not be assigned to
products or customers.
g.
Machine settings are
changed between batches
of different products.
Batch-level
Number of batch setups;
time spent doing setups.
h.
Parts inventories are
maintained in the
storeroom. (Each product
requires its own unique
parts.)
Product-
level
Number of products;
number of parts; time
spent maintaining
inventories of parts.
i.
Insurance costs are
incurred on the company’s
facilities.
Facility-level
Not applicable; these
costs probably should
not be assigned to
products or customers.
Exercise 3-7 (45 minutes)
1. The unit product costs under the company’s conventional costing system
would be computed as follows:
Mercon
Wurcon
Total
Number of units produced (a) …………………
10,000
40,000
Direct labor-hours per unit (b) …………………
0.20
0.25
Total direct labor-hours (a) × (b) …………….
2,000
10,000
12,000
Total manufacturing overhead (a) ……………
$336,000
Total direct labor-hours (b) …………………….
12,000
DLHs
Predetermined overhead rate (a) ÷ (b) ……..
$28.00
per DLH
Mercon
Wurcon
Direct materials …………………………..……….
$10.00
$ 8.00
Direct labor …………………………………………
3.00
3.75
Manufacturing overhead applied:
0.20 DLH per unit × $28.00 per DLH ………
5.60
0.25 DLH per unit × $28.00 per DLH ………
7.00
Unit product cost ………………………………….
$18.60
$18.75
Exercise 3-7 (continued)
2. The unit product costs with the proposed ABC system can be computed as follows:
Activity Cost Pool
Estimated
Overhead
Cost*
(b)
Expected
Activity
(a) ÷ (b)
Activity
Rate
Labor related ………….
$168,000
12,000
direct labor-hours
$14.00
per direct labor-hour
Engineering design …..
168,000
8,000
engineering-hours
$21.00
per engineering-hour
$336,000
*The total manufacturing overhead cost is split evenly between the two activity cost pools.
Manufacturing overhead is assigned to the two products as follows:
Mercon
Wurcon
Expected
Expected
Activity
Amount
Activity
Amount
Labor related, at $14.00 per direct labor-hour ……….
2,000
$ 28,000
10,000
$140,000
Engineering design, at $21.00 per engineering-hour .
4,000
84,000
4,000
84,000
Total overhead cost assigned (a)………………………..
$112,000
$224,000
Number of units produced (b) …………………………...
10,000
40,000
Overhead cost per unit (a) ÷ (b) ………………………..
$11.20
$5.60
Exercise 3-7 (continued)
The unit product costs combine direct materials, direct labor, and
Exercise 3-8 (30 minutes)
1. Activity rates can be computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
(a) ÷ (b)
Activity Rate
Machine setups …….
$21,600
180
setups
$120
per setup
Special processing …
$180,000
4,000
MHs
$45
per MH
General factory …….
$288,000
24,000
DLHs
$12
per DLH
2. The unit product costs would be computed as follows, starting with the
computation of the manufacturing overhead:
Rims
Posts
Machine setups:
$120 per setup × 100 setups …………
$ 12,000
$120 per setup × 80 setups …………..
$ 9,600
Special processing:
$45 per MH × 4,000 MHs ………………
180,000
$45 per MH × 0 MHs ……………………
0
General factory:
$12 per DLH × 8,000 DLHs ……………
96,000
$12 per DLH × 16,000 DLHs ………….
192,000
Total overhead cost (a) …………………..
$288,000
$201,600
Number of units produced (b) …………..
20,000
80,000
Overhead cost per unit (a) ÷ (b) ……….
$14.40
$2.52
Rims
Posts
Direct materials ……………………………..
$17.00
$10.00
Direct labor:
$16 per DLH × 0.40 DLHs ……………..
6.40
$16 per DLH × 0.20 DLHs ……………..
3.20
Manufacturing overhead (see above) ….
14.40
2.52
Unit product cost …………………………...
$37.80
$15.72
Exercise 3-9 (30 minutes)
1. Activity Rates:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
(a) ÷ (b)
Activity Rate
Customer deliveries …………
$400,000
5,000
deliveries
$80.00
per delivery
Manual order processing …..
$300,000
4,000
orders
$75.00
per manual order
Electronic order processing .
$200,000
12,500
orders
$16.00
per electronic order
Line item picking …………….
$500,000
400,000
line items
$1.25
per line item picked