SOLUTION
(50 min.) ABC, implementation, ethics.
1. Plum Electronics should not emphasize the Maximum model and should not phase out
the Mammoth model. Under activity-based costing, the Maximum model has an operating
income percentage of less than 3%, while the Mammoth model has an operating income
percentage of nearly 43%.
Cost driver rates for the various activities identified in the activity-based costing (ABC) system
are as follows:
Plum Electronics
Calculation of Costs of Each Model
under Activity-Based Costing
Mammoth Maximum
Direct materials ($228.80 22,000; $642.40 4,000) $ 5,033,600
Direct manuf. labor ($13.20 1.5 hrs. 22,000;
$13.20 3.5hrs. 4,000) 435,600
184,800
Indirect costs
Soldering ($0.66 1,185,000; $0.66 385,000) 782,100
Shipments ($47.30 16,200; $47.30 3,800) 766,260
5-1
Total indirect costs 3 ,476,110
Profitability analysis
Mammoth Maximum Total
Revenues $21,780,000 $5,016,000 $26,796,000
Per-unit calculations:
Selling price
($21,780,000 22,000;
Cost of goods sold
($12,430,110 22,000;
Gross margin percentage 42.9% 2.8%
2. Plum’s simple costing system allocates all manufacturing overhead other than machine
costs on the basis of machine-hours, an output unit-level cost driver. Consequently, the more
The ABC analysis recognizes several batch-level cost drivers such as purchase orders,
shipments, and setups. Maximum uses these resources much more intensively than Mammoth.
The ABC system recognizes Maximum’s use of these overhead resources. Consider, for example,
Recognizing Maximum’s more intensive use of manufacturing overhead results in
Maximum showing a much lower profitability under the ABC system. By the same token, the
3. Clark’s comments about ABC implementation are valid. When designing and
implementing ABC systems, managers and management accountants need to trade off the costs
5-2
4. Activity-based management (ABM) is the use of information from activity-based costing
to make improvements in a firm. For example, a firm could revise product prices on the basis of
5. Incorrect reporting of ABC costs with the goal of retaining both the Mammoth and
Maximum product lines is unethical. In assessing the situation, the specific “Standards of Ethical
Competence
Integrity
accountant to communicate favorable as well as unfavorable information.
Credibility
Jacobs should indicate to Clark that the product cost calculations are, indeed, appropriate.
If Clark still insists on modifying the product cost numbers, Jacobs should raise the matter with
5-43 Activity-based costing, activity-based management, merchandising. Mountain
Outfitters operates a large outdoor clothing and equipment store with three main product lines:
clothing, equipment, and shoes. Mountain Outfitters operates at capacity and allocates selling,
general, and administration (S, G & A) costs to each product line using the cost of merchandise
5-3
of each product line. The company wants to optimize the pricing and cost management of each
product line and is wondering if its accounting system is providing it with the best information
for making such decisions. Store manager Aaron Budd gathers the following information
regarding the three product lines:
For 2017, Mountain Outfitters budgets the following selling, general, and administration costs:
Required
1. Suppose Mountain Outfitters uses cost of merchandise to allocate all S, G & A costs. Prepare
budgeted product-line and total company income statements.
2. Identify an improved method for allocating costs to the three product lines. Explain. Use the
method for allocating S, G & A costs that you propose to prepare new budgeted product-line
and total company income statements. Compare your results to the results in requirement 1.
3. Write a memo to Mountain Outfitters management describing how the improved system
might be useful for managing the store.
SOLUTION
(30-40 mins.) Activity-based costing, activity-based management, merchandising.
1.
Mountain Outfitters
Budgeted Income Statement
For the Year Ended 31 December, 2017
Clothing Equipment Shoes Total
Revenues $1,440,000 $1,840,000
$720,00
0 $4,000,000
5-4
Allocated Selling, General and Administration
Costsa
2. Selling, general, and administration (S, G, & A) is comprised of a variety of costs that are
unlikely to be consumed uniformly across product lines based on the cost of merchandise.
Mountain Outfitters should consider an activity-based costing system to clarify how each
product line uses these S, G, & A resources.
Clothing
Equipment
Shoes
Total
Number of purchase orders
Number of boxes received
Square feet of store space
Purchasing department
Receiving department
Customer support
Rent
General store advertising
5-5
Store manager’s salary
Clothing
Equipment
Shoes
Total
Revenues
Cost of Merchandise
Gross margin
Purchasing
($640 × 200; 125; 175 orders)
Receiving
($210 × 450; 200; 350 deliveries)
Customer Support
($0.0625 × $1,440,000; 1,840,000; $720,000)
Rent
5-6
General store advertising
($0.025 × $1,440,000; 1,840,000; $720,000)
Store manager’s salary
($0.05 × $850,000; $1,250,000; $400,000)
Total S, G, & A costs
Operating income
$ 29,000
3.
To: Mountain Outfitters Management Team
From: Cost Analyst
Re: Costing System
The percentage revenue, COGS, and activity costs for each product line are:
Clothing Equipment Shoes Total
5-7
Revenues
Cost of merchandise
Activity areas:
36%
34%
46%
50%
18%
16%
100%
100%
The current accounting system allocates indirect costs (S,G, & A) to product lines based on the
Cost of Merchandise sold. Using this method, the S, G, & A costs are assigned 34%, 50%, 16%,
to the Clothing, Equipment, and Shoes product lines, respectively. As the preceding table
I recommend that the organization switch to an activity-based costing (ABC) method. With ABC,
the product lines are assigned indirect costs based on their consumption of the activities that give
An ABC analysis can also help Mountain Outfitters manage its costs by reducing the number of
Try It 5-1 Solution
We first calculate the budgeted indirect cost rate for the overhead cost pool
Total budgeted direct manufacturing labor-hours = 0.5hrs. × 20,000 + 0.6 hrs. × 5,000 = 13,000 hours
Budgeted total costs in indirect-cost pool
Budgeted indirect-cost rate Budgeted total quantity of cost-allocation base
$234,000
13,000 direct manufacturing labor-hours
$18 per direct manufacturing labor-ho
=
=
=ur
5-8
20,000 5,000
Basic Lamps Designer Lamps
Total per Unit Total per Unit Total
(1) (2)=(1)÷20,0
00
(3) (4)=(3)÷5,00
0
(5)=(1)+(
3)
Direct materials $180,00
0
$
9
$
75,000
$15.
00
$255,00
0
Direct manufacturing labor
(Basic: $20 × 0.5hrs. × 20,000;
0
28
0
80
0
Try It Solution 5-2
We first calculate the overhead rates for each indirect cost pool.
Basic Lamps Designer Lamps Total
1Quantity of lamps produced 20,000 lamps 5,000 lamps
2Number of lamps produced per batch 250 lamps per
batch
50 lamps per
batch
3 = (1)÷(2) Number of batches 80 batches 100 batches
7 Direct manufacturing labor-hours per lamp 0.5 hours 0.6 hours
5-9
8 = (1)×(7) Total direct manufacturing
10,000 hours 3,000 hours 13,000 hours
labor-hrs.
2
2
54
5-11