SOLUTION
(30 min.) Activity-based costing, service company.
1. Total indirect costs = $75,000 + $45,000 + $18,000 + $20,000 + $19,500 +
$24,000
Simple Costing System
Standard
Job
Special
Job
Cost of supplies per job $100.00 $125.00
1. Activity-based costing system
Quantity of Cost
Driver Consumed
during 2017
(see column (1))
Activity Cost Driver
Standar
d Job
Special
Job
Total
Cost of
Activity
(given)
Allocation
Rate
(1) (2) (3) (4) (5)
(6) = (5) ((3) + (4)), or
given
Machine operations
(400 jobs 10 mach.
Machine hours 4,000 2,000 $75,000 $
12.50
per machine
hour
200)
15.00
5-1
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´
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Total Costs
Standard
Job
Special
Job
Cost of supplies ($100 400; $125 200)
Direct labor costs ($90 400; $100 200)
Indirect costs allocated:
Machine operations ($12.50 per mach. hr. 4,000; 2,000)
Setups ($15 per setup hr. 1,600; 1,400)
Purchase orders ($20 per order 400; 500)
Marketing (0.05 $240,000; 0.05 $150,000)
Administration (0.42857 $36,000; $20,000)
Cost of each job ($189,429 400; $133,071 200)
3.
Cost per job
Standard
Job
Special
Job
Simple Costing System $525.83 $560.83
Relative to the ABC system, the simple costing system overcosts standard jobs and undercosts
special jobs. Both types of jobs need 10 machine hours per job, so in the simple system, they are
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´ ´
´
´
´
´ ´
´
¸ ¸
4. Speediprint can use the information revealed by the ABC system to change its pricing
based on the ABC costs. Under the simple system, Speediprint was making a gross margin of
12% on each standard job ([$600 – $525.83] $600) and 25% on each special job ([$750 –
Speediprint can also use the ABC information to improve its own operations. It could
examine each of the indirect cost categories and analyze whether it would be possible to deliver
5-26 Activity-based costing, manufacturing. Decorative Doors, Inc., produces two types of
doors, interior and exterior. The company’s simple costing system has two direct-cost categories
(materials and labor) and one indirect-cost pool. The simple costing system allocates indirect
costs on the basis of machine-hours. Recently, the owners of Decorative Doors have been
concerned about a decline in the market share for their interior doors, usually their biggest seller.
Information related to Decorative Doors production for the most recent year follows:
The owners have heard of other companies in the industry that are now using an activity-based
costing system and are curious how an ABC system would affect their product costing decisions.
After analyzing the indirect-cost pool for Decorative Doors, the owners identify six activities as
generating indirect costs: production scheduling, material handling, machine setup, assembly,
inspection, and marketing. Decorative Doors collected the following data related to the
indirect-cost activities:
5-3
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Marketing costs were determined to be 3% of the sales revenue for each type of door.
Required
1. Calculate the cost of an interior door and an exterior door under the existing simple costing
system.
2. Calculate the cost of an interior door and an exterior door under an activity-based costing
system.
3. Compare the costs of the doors in requirements 1 and 2. Why do the simple and
activity-based costing systems differ in the cost of an interior door and an exterior door?
4. How might Decorative Doors, Inc., use the new cost information from its activity-based
costing system to address the declining market share for interior doors?
SOLUTION
(30 min.) Activity-based costing, manufacturing.
1. Simple costing system:
Simple Costing System Interior Exterior
Direct materialsa$ 96,000 $ 81,000
Direct manufacturing laborb 76,800 64,800
Indirect cost allocated to each job
Total cost per unit
5-4
2. Activity-based costing system
Activity
(1)
Total
Cost of
Activity
(2)
Cost Driver
(3)
Cost
Driver
Quantity
(4)
Allocation Rate
(5) = (2) (4)
Product
scheduling $95,000 Production runs 125c$760.00
per production
run
ABC System Interior Exterior
Direct materials $ 96,000 $ 81,000
Direct manufacturing labor 76,800 64,800
Indirect costs allocated:
´
´
´
´
´
Total cost per unit
3.
Cost per unit Interior Exterior
Simple Costing System $97.97 $144.95
5-5
4. Decorative Doors, Inc. can use the information revealed by the ABC system to change its
pricing based on the ABC costs. Under the simple system, Decorative Doors was making an
operating margin of 21.6% on each interior door ([$125 – $97.97]
¸
$125) and 27.5% on each
5-27 ABC, retail product-line profitability. Fitzgerald Supermarkets (FS) operates at capacity
and decides to apply ABC analysis to three product lines: baked goods, milk and fruit juice, and
frozen foods. It identifies four activities and their activity cost rates as follows:
The revenues, cost of goods sold, store support costs, activities that account for the store support
costs, and activity-area usage of the three product lines are as follows:
5-6
Under its simple costing system, FS allocated support costs to products at the rate of 30% of cost
of goods sold.
Required
1. Use the simple costing system to prepare a product-line profitability report for FS.
2. Use the ABC system to prepare a product-line profitability report for FS.
3. What new insights does the ABC system in requirement 2 provide to FS managers?
SOLUTION
(30 min.) ABC, retail product-line profitability.
1. The simple costing system (Panel A of Solution Exhibit 5-27) reports the following:
Baked
Goods
Milk &
Fruit Juice
Frozen
Products Total
Revenues
Costs
$60,000
$66,500
$50,500
$177,000
2. The ABC system (Panel B of Solution Exhibit 5-27) reports the following:
Baked
Goods
Milk &
Fruit Juice
Frozen
Products Total
Revenues
Costs
Operating income ÷ Revenues
$60,000
$66,500
$50,500
$177,000
These activity costs are based on the following:
Activity Cost Allocation Rate
Baked
Goods
Milk &
Fruit Juice
Frozen
Products
5-7
3. The rankings of products in terms of relative profitability are:
Simple Costing System ABC System
1. Frozen products 17.62%
2. Baked goods 11.17
3. Milk & fruit juice 0.30
Frozen products 25.47%
Milk and fruit juice 4.18
Baked goods 0.27
The percentage revenue, COGS, and activity costs for each product line are:
Baked
Goods
Milk &
Fruit Juice
Frozen
Products Total
The baked goods line drops sizably in profitability when ABC is used. Although it constitutes
33.06% of COGS, it uses a higher percentage of total resources in each activity area, especially
Fitzgerald Supermarkets may want to explore ways to increase sales of frozen products.
It may also want to explore price increases on baked goods.
SOLUTION EXHIBIT 5-27
Product-Costing Overviews of Fitzgerald Supermarkets
PANEL A: SIMPLE COSTING SYSTEM
5-8
COST OBJECT:
PRODUCT LINE
Indirect Costs
Direct Costs
Store
Support
COGS
COGS
INDIRECT
COST
POOL
COST
ALLOCATION
BASE
DIRECT
COST
PANEL B: ABC SYSTEM
5-28 ABC, wholesale, customer profitability. Veritek Wholesalers operates at capacity and
sells furniture items to four department-store chains (customers). Mr. Veritek commented, “We
apply ABC to determine product-line profitability. The same ideas apply to customer
profitability, and we should find out our customer profitability as well.” Veritek Wholesalers
sends catalogs to corporate purchasing departments on a monthly basis. The customers are
entitled to return unsold merchandise within a six-month period from the purchase date and
receive a full purchase price refund. The following data were collected from last year’s
operations:
5-9
Ordering Delivery Shelf-
Stocking
Customer
Support
Number of
Purchase Order
Number of
Deliveries
Hours of
Shelf-Stocking
Number of
Items Sold
Indirect Costs
Direct Costs
COGS
INDIRECT
COST
POOL
COST
ALLOCATION
BASE
COST OBJECT:
PRODUCT LINE
DIRECT
COST
Veritek has calculated the following activity rates:
Required
Customers pay the transportation costs. The cost of goods sold averages 75% of sales.
Determine the contribution to profit from each customer last year. Comment on your solution.
SOLUTION
(15–20 min.) ABC, wholesale, customer profitability.
Customer
1 2 3 4
Gross sales $40,000 $20,000 $110,000 $95,000
Customer-related costs:
Regular orders
$30 × 30; 140; 55; 100 900 4,200 1,650 3,000
Rush orders
Returned items
5-10
The analysis indicates that customers’ profitability (loss) contribution varies widely from
(42.1%) to 18.2%. Immediate attention to Chain 2 is required which is currently showing a loss
Chain 1 has a disproportionate number of the items returned as well as value of sale
returns. The causes of these should be investigated so that the profitability contribution of Chain
1 could be improved.
5-29 Activity-based costing. The job-costing system at Melody’s Custom Framing has five
indirect cost pools (purchasing, material handling, machine maintenance, product inspection,
and packaging). The company is in the process of bidding on two jobs: Job 220, an order of 17
intricate personalized frames, and Job 330, an order of 5 standard personalized frames. The
controller wants you to compare overhead allocated under the current simple job-costing
system and a newly designed activity-based job-costing system. Total budgeted costs in each
indirect-cost pool and the budgeted quantity of activity driver are as follows.
Information related to Job 220 and Job 330 follows. Job 220 incurs more batch-level costs
because it uses more types of materials that need to be purchased, moved, and inspected relative
to Job 330.
Required
1. Compute the total overhead allocated to each job under a simple costing system, where
overhead is allocated based on machine-hours.
2. Compute the total overhead allocated to each job under an activity-based costing system
using the appropriate activity drivers.
3. Explain why Melody’s Custom Framing might favor the ABC job-costing system over the
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simple job-costing system, especially in its bidding process.
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