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e. A non-value-added (NVA) activity
lengthens the production or performance time.
increases the cost of product or services without adding product or service
value.
Some products seem to require excessive setups. For example, Job 103
required four setups to complete 200 units, while Job 101 required only
Jessica Corp. should examine the design of the factory related to the
number of material moves required. Job 102 used $12,000 of direct
f. Jessica Corp. currently has a budgeted cost of $130,000 for inspections. If the
inspections were outsourced for $10 apiece and the total number of inspec-
tions was the same as budgeted, the cost of inspections would drop to $65,000
(6,500 inspections $10), a savings of 50 percent. This projection assumes
control over the delivery of inspection services.
(CIA adapted)
54. a. Predetermined OH rate = $1,800,000 ÷ 30,000 = $60 per MH.
Each batch produces 5,000 units. Since there are 80 machine hours required
Alternatively: Each batch has a total machine hours cost of $4,800 (80 $60);
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Per-unit cost under traditional system:
Direct material
$4.40
Direct labor
0.75
Overhead
0.96
Total
$6.11
b. Material handling: $720,000 ÷ 6,000,000 = $0.12 per part
Setups: $315,000 ÷ 750 = $420.00 per setup
OH per batch:
Handling: 5,000 units per batch 5 parts per unit =
25,000 parts per batch $0.12 per part
$3,000.00
Setups: 2 per batch $420 per setup
840.00
Machining: 80 MHs per batch $18.00 per MH
1,440.00
Quality control: 1 per batch $450
450.00
Total per batch
$5,730.00
Overhead cost per unit = $5,730 ÷ 5,000 = $1.146 per unit
Per-unit cost under ABC system: Direct material
$4.400
Direct labor
0.750
Overhead
1.146
$6.296
or $6.30 (rounded)
c. Since the company desires a gross profit of 40 percent, the cost of each unit
must be 60 percent of the selling price:
(CIA adapted)
50 guests at $0.90 per guest
$ 45.00
1 tier at $34.41 per tier
34.41
1 order at $150 per order
150.00
Purchased decorations
22.50
Break-even price of cake
$251.91
164 guests at $0.90 per guest
$ 147.60
5 tiers at $34.41 per tier
172.05
1 order at $150 per order
150.00
Purchased decorations
58.86
Cost of cake
$ 528.51
Selling price of Nussbaum cake
$ 650.00
Cost of Nussbaum cake
(528.51)
Gross margin
$ 121.49
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200 guests at $0.90 per guest
$180.00
4 tiers at $34.41 per tier
137.64
1 order at $150 per order
150.00
Special flowers (20 × $5)
100.00
Cost of cake
$567.64
If the required gross margin on the O’Brien cake is 35 percent, then the cost of
d. If the company switched to a traditional system, the cost of cakes for weddings
with fewer than average guests would tend to decrease and the cost of cakes
with more than the average number of guests would tend to increase. This is
contrary to the normal effect of switching to an activity-based costing system,
as follows:
125 guests at $0.90 per guest
$112.50
3 tiers at $34.41 per tier
103.23
1 order at $150 per order
150.00
Cost of average wedding cake
$365.73
Average number of guests
÷ 125
Average per guest cost
$ 2.93
Compare the cost of the Sacks and Nussbaum wedding cake if the cost of cake
is based on the number of guests instead of an activity-based cost:
Sacks
Nussbaum
Number of guests
50
164
Cost per guest
$ 2.93
$ 2.93
Total cost
$146.50
$480.52
ABC cost (without decorations)
$229.41
$469.65
% increase (decrease) from ABC
(36.1)%
2.3%
(CIA adapted)
56. a. Engineering: $300,000 ÷ 3,000 = $100 per hour
Machine setups: $50,000 ÷ 100 = $500 per setup
Ravel
Nortell
Engineering hours (10 $100; 2 $100)
$1,000
$200
Machine setups (4 $500; 1 $500)
2,000
500
Material support (1,000 $0.10; 2,500 $0.10)
100
250
Machine sanding (5 $10)
50
N/A
Product certification (1 order each $45)
45
45
Total overhead
$3,195
$995
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b. Total DLHs = 10 employees 2,000 hours = 20,000 DLHs
OH per DLH = $920,000 ÷ 20,000 = $46 per DLH
c. Traditional costing:
Ravel
Nortell
Direct material
$200
$ 500
Direct labor (4 $25; 2 $25)
100
50
Special packaging
(1,000 units ÷ 250 per carton; 4 $5)
20
Overhead (4 $46; 2 $46)
184
92
Total order cost
$504
$ 642
Number of units (in thousands)
÷ 1
÷ 10
Cost per thousand
$504
$64.20
Activity-based costing:
Ravel
Nortell
Direct material
$ 200
$ 500
Direct labor (4 $25; 2 $25)
100
50
Special packaging
(1,000 units ÷ 250 per carton; 4 $5)
20
Overhead
3,195
995
Total order cost
$3,515
$ 1,545
Number of units (in thousands)
÷ 1
÷ 10
Cost per thousand
$3,515
$154.50
management to explain profits, and ultimately an inability of the company to
maintain competitiveness in the marketplace.
e. To earn a 40 percent gross profit, the order cost must be 60 percent of the sell-
ing price.
than the prohibitive cost of multiple setups.
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accessible website, in whole or in part.
57. a. Although difficult to quantify, some costs are associated with just carrying a
part number in the database. Each part number must be originally set up in the
system, built into the structure of a bill of materials, and maintained until it is
no longer used. Moreover, each part must be planned, scheduled, negotiated
with vendors, purchased, received, stored, moved, and paid for. Having two
parts similar enough that one could be used for both applications requires un-
necessary duplication of these activities and, therefore, unnecessary costs.
and greater field reliability.
b. To appropriately influence the behavior of design and cost-reduction engi-
neers, the MOH allocation method should assign little cost to products for
Annual cost to carry = $5,500,000 ÷ 8,000 = $687.50
of allocated cost.
c. Students will discuss the appropriateness of the allocation bases they selected,
the ways in which their methods would communicate accurate information to
design and cost-reduction engineers concerning the indirect costs of engineer-
sions.
Regarding the latter point, engineers at Strategic Supply are in fact evaluated
on the costs of the products they design. Although they are driven by emerging
With the part number-based MOH allocation method, engineers will tend to
design products differently. The product costing system will tell them that en-
gineering low-volume, unique parts into products causes overhead. Having the
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not only the trade-offs between parts proliferation and direct labor reduction
tional requirement of a customer.
d. A MOH allocation method should provide accurate estimates of the long-run
variable costs of all of the demands made on the organization’s material-
related overhead resources by each product in the product line. To approach
have initially created confusion and definitely would have been resisted by
manufacturing, engineering, and marketing personnel.
Manufacturing costs are a crucial element of profitability in highly competi-
come less, not more, competitive. A single-cost-driver method may be a com-
promise that reflects the costs and benefits of achieving additional accuracy.
A final consideration related to accuracy is the proper interpretation of com-
the company believes that, by supporting the manufacturing strategy, the allo-
cation method will lead to real cost savings over time as the next generation of
products is designed with fewer different part numbers.
an appropriate technique for making the assignments.
The company, however, decided to use the MOH rates as “management costs”
only and to continue to use the old allocation method to compute “financial
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situation allows. After parts standardization becomes second nature to engi-
neers, management will change its strategy, and the accounting staff will de-
velop a new product costing method to support the new strategy. In this way,
product costs can continue to be effective management tools for influencing
consistent basis.
[Michael A. Robinson, ed., Cases from Management Accounting Practice No. 5 Instruc-
tor’s Manual (Montvale, NJ: National Association of Accountants, 1989), pp. 7–11,
adapted.]
b. These tools help orient the firm to managing based on a customer’s perspec-
tive of value. World-class competition is based on satisfying the customer. If a
firm concentrates on accentuating those activities that are highly valued by
c. Yes. Activity-based costing is most useful if managers are willing to act based
on the information provided by the ABC system. For example, activity-based
d. Preferably, both would be adopted. Without adopting ABC, the ABM pre-
scriptions may not be understood by managers. But, without ABM, there may
be reduced opportunity to identify and eliminate NVA activities. The ABC
formation provided by the firms’ formal information systems.
59. a. This problem indicates that ABC and ABM can cause conflict among the vari-
ous stakeholders in a business. The equipment installation would likely be
viewed with favor by the stockholders. Analysis indicating that the equipment
would be value-adding obviously underlies the decision to make the installa-
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placement of 60 percent of the workforce. Such an action would demoralize
the costs of products.
b. No matter how articulate the explanation given, it is difficult to visualize ac-
ceptance of the explanation by workers who may have dedicated much of their
lives to learning skills required for their current positions. One approach, how-
well the employees perform the functions.
c. Cycle time is reduced or eliminated largely by reducing non-value-added activi-
ties. When non-value-added activities are reduced, work is no longer required of
services in other areas of the business. Third, the company could provide em-
ployee counseling services to workers and help retrain them for work in other
businesses.