5-1
CHAPTER 5
ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT
5-1 Broad averaging (or “peanut-butter costing”) describes a costing approach that uses broad
averages for assigning (or spreading, as in spreading peanut butter) the cost of resources
5-2 Overcosting may result in overpricing and competitors entering a market and taking
market share for products that a company erroneously believes are low-margin or even
5-3 Costing system refinement means making changes to a simple costing system that
2. Expand the number of indirect cost pools until each of these pools is more
homogenous.
5-4 An activity-based approach refines a costing system by focusing on individual activities
5-5 Four levels of a cost hierarchy are
(i) Output unit-level costs: costs of activities performed on each individual unit of a
product or service.
5-6 It is important to classify costs into a cost hierarchy because costs in different cost pools
relate to different cost-allocation bases and not all cost-allocation bases are unit-level. For
5-2
be to consider all costs as unit-level costs, leading to misallocation of those costs that are not
unit-level costs.
5-7 An ABC approach focuses on activities as the fundamental cost objects. The costs of
these activities are built up to compute the costs of products, and services, and so on. Simple
1. pricing and product mix decisions,
3. product design decisions, and
5-9 No. Department indirect-cost rates are similar to activity-cost rates if (1) a single activity
accounts for a sizable fraction of the department’s costs, or (2) significant costs are incurred on
5-10 “Tell–tale” signs that indicate when ABC systems are likely to provide the most benefits
are as follows:
2. All or most indirect costs are identified as output-unit-level costs (i.e., few indirect
costs are described as batch-level, product-sustaining, or facility-sustaining costs).
4. Products that a company is well suited to make and sell show small profits, whereas
products that a company is less suited to produce and sell show large profits.
5-11 The main costs and limitations of ABC are the measurements necessary to implement the
systems. Even basic ABC systems require many calculations to determine costs of products and
5-12 No, ABC systems apply equally well to service companies such as banks, railroads,
5-3
5-13 No. An activity-based approach should be adopted only if its expected benefits exceed its
5-14 Increasing the number of indirect-cost pools does NOT guarantee increased accuracy of
product or service costs. If the existing cost pool is already homogeneous, increasing the number
5-15 The controller faces a difficult challenge. The benefits of a better accounting system
show up in improved decisions by managers. It is important that the controller have the support
5-4
5-16 (20 min.) Cost hierarchy.
1. a. Indirect manufacturing labor costs of $1,450,000 support direct manufacturing labor
and are output unit-level costs. Direct manufacturing labor generally increases with
output units, and so will the indirect costs to support it.
b. Batch-level costs are costs of activities that are related to a group of units of a product
rather than each individual unit of a product. Purchase order-related costs (including
2. The complex boom box made in many batches will use significantly more batch-level
overhead resources compared to the simple boom box that is made in a few batches. In addition,
the complex boom box will use more product-sustaining overhead resources because it is
3. Using the cost hierarchy to calculate activity-based costs can help Hamilton to identify
both the costs of individual activities and the cost of activities demanded by individual products.
Hamilton can use this information to manage its business in several ways:
a. Pricing and product mix decisions. Knowing the resources needed to manufacture and
5-5
5-17 (25 min.) ABC, cost hierarchy, service.
1. Output unit-level costs
a. Direct-labor costs, $146,000
b. Equipment-related costs (rent, maintenance, energy, and so on), $350,000
These costs are output unit-level costs because they are incurred on each unit of materials
2.
Heat Testing (HT)
Stress Testing (ST)
Total
(1)
Per Hour
(2) = (1) 40,000
Total
(3)
Per Hour
(4) = (3) 30,000
Direct labor costs (given)
$100,000
$ 2.50
$ 46,000
$ 1.53
Equipment-related costs
$5 per hour* 40,000 hours
200,000
5.00
$5 per hour* 30,000 hours
150,000
5.00
Setup costs
$25 per setup-hour† 13,600 setup-hours
340,000
8.50
$25 per setup-hour† 3,600 setup-hours
90,000
3.00
Costs of designing tests
$60 per hour** 3,000 hours
180,000
4.50
$60 per hour** 1,400 hours
84,000
2.80
Total costs
$820,000
$20.50
$370,000
$12.33
5-6
3. The ABC system better captures the resources needed for heat testing and stress testing
because it identifies all the various activities undertaken when performing the tests and
recognizes the levels of the cost hierarchy at which costs vary. Hence, the ABC system generates
5-7
1.
Direct Professional Time
Support Services
Amount
Rate per
Hour
Number
of Hours
Total
Rate
Total
Billed to
Client
(2)
(3)
(4) = (2) (3)
(5)
(6) = (4) (5)
(7) = (4) + (6)
$640
220
100
26
5
39
$16,640
1,100
3,900
30%
30
30
$4,992
330
1,170
$21,632
1,430
5,070
$28,132
$640
220
100
4
14
52
$2,560
3,080
5,200
30%
30
30
$768
924
1,560
$ 3,328
4,004
6,760
$14,092
2.
Direct Professional Time
Support Services
Client
Rate
per
Hour
Number
of Hours
Total
Rate per
Hour
Total
Amount
Billed to
Client
(1)
(2)
(3)
(4) = (2) (3)
(5)
(6) = (3) (5)
(7) = (4) + (6)
SAN ANTONIO
DOMINION
Walliston
Boutin
Abbington
$640
220
100
26
5
39
$16,640
1,100
3,900
$75
75
75
$1,950
375
2,925
$18,590
1,475
6,825
$26,890
AMSTERDAM
ENTERPRISES
Walliston
Boutin
Abbington
$640
220
100
4
14
52
$2,560
3,080
5,200
$75
75
75
$ 300
1,050
3,900
$ 2,860
4,130
9,100
$16,090
Requirement 1 Requirement 2
San Antonio Dominion $28,132 $26,890
Amsterdam Enterprises 14,092 16,090
$42,224 $42,980
Both clients use 70 hours of professional labor time. However, San Antonio Dominion uses a
higher proportion of Walliston’s time (26 hours), which is more costly. This attracts the highest
support-services charge when allocated on the basis of direct professional labor costs.
5-8
3. Assume that the Walliston Group uses a cause-and-effect criterion when choosing the
allocation base for support services. You could use several pieces of evidence to determine
whether professional labor costs or hours is the driver of support-service costs:
5-9
1.
Actual plant-wide variable
MOH rate based on machine
hours, $308,600
4,000
$77.15 per machine hour
United
Motors
Holden
Motors
Leland
Vehicle
Total
Variable manufacturing overhead, allocated
based on machine hours
($77.15
120; $77.15
2,800; $77.15
1,080)
$9,258
$216,020
$83,322
$308,600
2.
Department
Variable MOH
in 2011
Total
Driver Units
Rate
Design
$39,000
390
$100
per CAD-design hour
Production
29,600
370
$ 80
per engineering hour
Engineering
240,000
4,000
$ 60
per machine hour
United
Motors
Holden
Motors
Leland
Vehicle
Total
Design-related overhead, allocated on CAD-design hours
(110
$100; 200
$100; 80
$100)
$11,000
$ 20,000
$ 8,000
$ 39,000
Production-related overhead, allocated on engineering hours
(70
$80; 60
$80; 240
$80)
5,600
4,800
19,200
29,600
Engineering-related overhead, allocated on machine hours
(120
$60; 2,800
$60; 1,080
$60)
7,200
168,000
64,800
240,000
Total
$23,800
$192,800
$92,000
$308,600
3.
United
Motors
Holden
Motors
Leland
Vehicle
a. Department rates
(Requirement 2)
b. Plantwide rate
(Requirement 1)
$23,800
$ 9,258
$192,800
$216,020
$92,000
$83,322
Ratio of (a) ÷ (b)
2.57
0.89
1.10
The variable manufacturing overhead allocated to United Motors increases by 157% under the
department rates, the overhead allocated to Holden decreases by about 11% and the overhead
allocated to Leland increases by about 10%.
The three contracts differ sizably in the way they use the resources of the three
departments.
5-10
The percentage of total driver units in each department used by the companies is:
Department
Cost
Driver
United
Motors
Holden
Motors
Leland
Vehicle
Design
Engineering
Production
CAD-design hours
Engineering hours
Machine hours
28%
19
3
51%
16
70
21%
65
27
4. Other than for pricing, AP can also use the information from the department-based
system to examine and streamline its own operations so that there is maximum value-added from
5. It would not be worthwhile to further refine the cost system into an ABC system if (1) a
or (3) there wasn’t much variation among contracts in the consumption of activities within a
department. If, for example, most activities within the design department were, in fact, driven by
overhead.