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10
Fundamentals of Cost Management
Solutions to Review Questions
10-1.
Activity-based costing provides management with detailed costing information about
10-2.
Activity-based management can be implemented without an activity-based costing
10-3.
Value-added activities add value to the product or service whereas nonvalue-added
10-4.
Customers affect costs by the way they interact with the company and place demands
10-5.
10-6.
Resources supplied represent the capacity of the organization. They are the resources
10-7.
Capacity costs, generally included in the fixed overhead allocation, affect reported
product costs. Managers use reported costs to make decisions such as what price to
10-8.
The cost of excess capacity should be assigned to products or customers if the reason
10-9.
Quality affects cost in two major ways. Conformance costs are those that the firm incurs
in order to ensure the product or service meets required quality levels. Examples
10-10.
The four categories of a cost of quality system are:
1. Prevention: Costs to ensure good quality (product design, training).
Solutions to Critical Analysis and Discussion Questions
10-11.
Answers will vary.
10-12.
10-13.
10-14.
Answers will vary.
10-15.
10-16.
10-17.
10-18.
Two important factors managers need to consider are what competitors will do and how
10-19.
There is an opportunity cost associated with idle capacity. Knowing that capacity is not
10-20.
10-21.
Answers will vary. The answer depends on why excess demand exists and what
10-22.
Answers will vary but should include reasons why the elements are not important. For
instance, when purchasing a low-cost item, like paint to touch up minor scratches,
10-23.
Answers will vary. One example follows. The quality-based view would encourage
continuous improvement of the production process and might offer incentives (i.e. cash
Solutions to Exercises
10-24. (10 min.) Activity-Based Cost Management in a College.
10-25. (10 min.) Activity-Based Cost Management for a Hotel.
1. b. Improves efficiency. Having guests check in on-line means less work for the
10-26. (10 min.) Cost Hierarchy for a Not-for-Profit.
10-27. (20 min.) Driver Identification.
a. Number of calls to new commercial customers; records kept by sales reps.
10-28. (20 min.) Driver Identification.
10-29. (20 min.) Activity-Based Costing of Customers: Marvin’s Kitchen Supply.
a. Delivery cost based on order value:
Customer
Order
Value
Delivery Charge
(@10%)
b. Delivery cost based on activity-based costing:
Cost driver rates:
Activity
Cost Driver
Cost ÷
Driver Volume =
Rate
Cost of delivery:
City Diner
Le Chien Chaud
Activity
Units of Cost
Driver
Cost
Units of Cost
Driver
Cost
Processing order ..................
52 orders
$780a
110 orders
$1,650
10-30. (30 min.) Activity-Based Costing of Customers: Rock Solid Bank & Trust.
a.
Operating profit .................
$2,625,000
b.
Customer A
Customer B
Deposit ................................
$6,000
$6,000
10-30. (continued)
c.
Activity
Cost Driver
Cost
Driver Volume
Rate
Use ATM
Number of
uses
$1,500,000
÷
2,000,000
= $0.75 per use
Customer A
Customer B
Activity
Units of
Cost
Driver
Units of
Cost
Driver
Sales revenue ....................................................
$312.00
$312.00
Interest on deposit .............................................
30.00
30.00
10-31. (15 min.) Activity-Based Costing of Customers: Rock Solid Bank & Trust.
10-32. (15 min.) Activity-Based Costing of Customers—Ethical Issues: Red’s
Lumber.
a. Red could use the information to offer “discounts” for weekday orders, which is
equivalent to a premium for weekend orders. Before Red makes any changes, he
10-33. (15 min.) Activity-Based Costing of Customers—Ethical Issues: Central
State College.
a. Possible allocation bases include number of students, student hours in the lab,
b. This is a difficult question and answers will vary. The dean views the training
10-34. (15 min.) Activity-Based Costing of Suppliers: Hult Games.
This can be answered using the format of Exhibit 10.9. First compute the cost of
a late delivery.
Number of cartons delivered late
(100,000 x 25% + 60,000 x 10%)
31,000
10-35. (10 min.) Activity-Based Costing of Suppliers: Hult Games.
10-36. (20 min.) Activity-Based Costing of Suppliers: Kinnear Plastics.
The approach to this problem is to determine how much it costs to purchase a
ton of “good” plastic. The effective price is the quoted price divided by the
percentage of good tons that can be expected:
10-37. (10 min.) Activity-Based Costing of Suppliers: Kinnear Plastics.
10-38. (15 min.) Resources Used versus Resources Supplied: Tri-State Mill.
Resources Used
Resources
Supplied
Unused Resource
Capacity
10-39. (10 min.) Resources Used versus Resources Supplied: Tri-State Mill.
a.
Finishing sales ...................................
$ 30,000
b.
Resources
Used
Unused
Resource
Capacity
Resources
Supplied
Finishing sales ...................
$ 30,000
Costs
10-40. (15 min.) Resources Used versus Resources Supplied: Conlon
Enterprises.
Resources Used
Resources
Supplied
Unused Resource
Capacity
10-41. (10 min.) Resources Used versus Resources Supplied: Conlon Enterprises.
a.
Sales revenue .........................
$ 240,000
b.
Resources
Used
Unused
Resource
Capacity
Resources
Supplied
10-42. (40 min.) Resources Used versus Resources Supplied: Carbon Company.
a.
Resources
Supplieda
Unused Resource
Capacitya
Resources Used
Materials ............................................................
$98,000
$2,000
$96,000
Purchasing .........................................................
÷ Cost Driver Volume
= Cost Driver Rate
$21,000
$1,800
$19,200
÷ 80 orders
= $240 per order
10-43. (20 min.) Assigning Cost of Capacity: Mimi’s Fixtures.
a. Because the plant was purchased with excess capacity for future growth, current
production should not be charged with excess capacity. Therefore, the cost
c. If the minimum plant size was 30,000 tiles, then the capacity is for the customers’
benefit and the costing system should charge the cost of excess capacity to
10-44. (20 min.) Assigning Cost of Capacity: Curt’s Castings.
a. Because the plant was purchased for the benefit of Curt, current production
should not be charged with excess capacity. Therefore, the cost system should
report a cost of $8 per ton computed as follows:
10-45. (15 min.) Costs of Quality: Waterloo Company.
Customer complaints
EF
10-46. (20 min.) Costs of Quality: Domingo Corporation.
a. Prevention: Process inspection, quality training, preventive maintenance,
materials inspection.
b.
March
April
Prevention
$41,450 ÷ $490,000 .......................................
8.5%
10-47. (30 min.) Trading-Off Costs of Quality: Domingo Corporation.
Domingo Corporation
Cost of Quality Report
March
%
April
%
Sales revenue ....................................................
$490,000
$440,000
Prevention costs:
Process inspection .........................................
$ 1,650
$ 1,880
Quality training ................................................
19,800
13,000
10-48. (20 min.) Costs of Quality: Nuke-It-Now.
a. Prevention: Redesign process, training on equipment, preventative maintenance.
b.
Year 1
Year 2
Prevention
$393,000 ÷ $3,500,000 ..................................
11.2%
10-49. (30 min.) Trading-off Costs of Quality: Nuke-It-Now.
Nuke-It-Now Corporation
Cost of Quality Report
Year 1
%
Year 2
%
Sales revenue ....................................................
$3,500,000
$3,800,000
Prevention:
Redesign process ...........................................
$ 29,000
$ 37,000
10-50. (15 min.) Cost of Quality—Environmental Issues.
a. Criminal penalties for illegal dumping. (EF)
10-51. (15 min.) Cost of Quality—Financial Reporting Issues.
a. Extra work done by external auditors to complete the audit because new
Solutions to Problems
10-52. (50 min.) Activity-Based Reporting and Capacity: Carbon Company.
a.
Sales revenue .................
$300,000
b.
Sales revenue
$300,000
Resources
Used
Unused
Resource
Capacity
Resources
Supplied
Costs
Unit
Materials .....................................................
$96,000
$ 2,000
$98,000
Energy ........................................................
16,320
1,560
17,880
10-52. (continued)
c. A traditional income statement shows management resources supplied, but gives
no indication of the resources used and unused resource capacity. Management
10-53. (50 min.) Activity-Based Reporting: Allcott Computer Services.
a.
Sales revenue ..........................................
$1,350,000
Marketing .............................................
$120,000
b.
Resources
Used
Unused
Resource
Capacity
Resources
Supplied
Costs
Unit
Energy .........................................................
$80,000
$5,500
$ 85,500
10-53. (continued)
c. A traditional income statement shows management resources supplied, but gives
no indication of the resources used and unused resource capacity. Management
10-54. (50 min.) Customer Profitability: SkiBlu, Ltd.
a.
Customer Costs
Gold
Silver
Number of customers ………
30,000
70,000
Number of customer representatives
30
7
10-55. (50 min.) Customer Profitability: Carmel Company.
a.
Customer Costs
Titanium
Platinum
Number of customers ...................................................
6,000
24,000
Number of customer representatives ...........................
30
12
10-56. (30 min.) Activity-Based Costing of Suppliers: JFI Foods.
The effective price is the price to buy a “good” ton of feedstock. This can be
computed as the bid price divided by the yield (the ratio of good output to total
input).
Rex
Materials
Red Oak
Chemicals
10-57. (20 min.) Activity-Based Costing of Suppliers: JFI Foods.
a. $156.52. If Red Oak has an exclusive contract, the price per ton, adjusted for
10-58. (50 min.) Activity-Based Reporting: Leidenheimer Corporation.
a.
Sales revenue ....................................................
$1,700,000
Quality inspections .............................................
100,000
10-58. (continued)
b.
Sales revenue
$1,700,000
Resources
Used
Unused
Resource
Capacity
Resources
Supplied
Costs
Unit
Batch
Quality inspections ......................................
$ 90,000
$ 10,000
$100,000
Product and customer sustaining
10-58. (continued)
c. A traditional income statement shows management resources supplied, but gives
no indication of the resources used and unused resource capacity. Management
has no way of knowing the amount of unused resource capacity or the cost of
10-59. (30 min.) Assigning Capacity Costs: Cathy and Tom’s Specialty Ice Cream
Company.
Cathy and Tom's Specialty Ice Cream Company illustrates in a very simple way the
issues of cost system design when costing excess capacity. Although the problem
There are two possible approaches to costing the ice cream:
1. Cost at capacity:
Overhead rate =
($27,000 ÷ 18,000 gallons) =
$1.50/gallon
How do you choose between the two? Why did Cathy and Tom buy a plant with a
capacity of 18,000 gallons? Possible reasons include:
10-60. (30 min.) Assigning Capacity Costs—Seasonality: Cathy and Tom’s
Specialty Ice Cream.
With seasonal demand fluctuations, the reason for the excess capacity is for the benefit
of the two customers (Cathy and Tom need all the capacity in the summer). The issue is
how to treat the excess capacity costs. The capacity costs in each season are $13,500
(= $27,000 ÷ 2 seasons). Two approaches to costing are:
1. Excess capacity costs assigned to season in which it is incurred, then to products
in that season. Thus,
2. Excess capacity costs assigned to the season requiring it, then to products
produced in that season. Thus,
Winter:
Overhead rate =
($13,500 50%) ÷ 4,500
gallons) =
$1.50/gallon
10-61. (30 min.) Assigning Capacity Costs—Seasonality: Cathy and Tom’s
Specialty Ice Cream.
With seasonal demand fluctuations, the reason for the excess capacity is for the benefit
of the two customers (Cathy and Tom need all the capacity in the summer). The issue is
how to treat the excess capacity costs. The capacity costs in each season are $9,000 (=
$27,000 ÷ 3 seasons).
The capacity costs and capacity in each season is:
Capacity Costs
Winter
Fall/Spring
Summer
Total ...............................................................
$9,000
$9,000
$9,000
Unused..........................................................
(4,500)
(2,250)
–0–
10-62. (30 min.) Assigning Capacity Costs: Mercia Chocolates.
Mercia Chocolates illustrates in a very simple way the issues of cost system design
There are two customers who demand a total of 60,000 packages, which is 80% of
plant capacity. The cost of the capacity (all assumed fixed) is $540,000.
There are two possible approaches to costing the chocolate:
How do you choose between the two? Why did Mercia buy a plant with a capacity of
90,000 packages? Possible reasons include:
(1) They hope to grow the market, i.e., for future expansion.
10-63. (30 min.) Assigning Capacity Costs—Seasonality: Mercia Chocolates.
With seasonal demand fluctuations, the reason for the excess capacity is for the benefit
1. Excess capacity costs assigned to season in which it is incurred, then to products
in that season. Thus,
2. Excess capacity costs (= $540,000 x 33-1/3%, or $180,000) are assigned to the
season requiring it, then to products produced in that season. Thus,
Non-holiday:
Overhead rate =
($360,000 ÷ 30,000 packages) =
$12.00/package
10-64. (30 min.) Quality Improvement: IPort Products.
a. There are two alternatives: continue with the current material or use the new
material. To determine the best alternative (considering only the financial
consequenses), compute profit under each alternative:
Current Material
New Material
Number of units sold .....................................................
127,500
142,500
Price per unit .................................................................
$20
$20
10-65. (30 min.) Quality Improvement: Metallic, Inc.
a. There are two alternatives: continue with the current material or use the new
material. To determine the best alternative (considering only the financial
consequenses), compute profit under each alternative:
Current Material
New Material
Number of units sold .....................................................
8,500
9,500
Price per unit .................................................................
$500
$500
Alternatively, we can do a differential analysis:
Additional revenue ............................................
($500 x 1,000 units)
$500,000
Solutions to Integrative Cases
10-66. (50 Min) Cost Hierarchies, Cost of Customers, and Pricing: WSM
Corporation.
a.
($000)
Sales revenue ..................
(40 Passengers
x 1,400 flights x $225)
$12,600
10-66. (continued)
b.
We can first consider the incremental revenues and costs that would result:
Increase in revenues: (5% x 40 passengers x 1,400 flights x $225) = $630,000
Based on a purely financial analysis, we might recommend that WSM not adopt the
Internet sales alternative. However, there are other considerations that may make this
alternative attractive. For example, some issues that would need to be considered
include:
c.
10-67. (50 Min) Unused Capacity: The Grape Cola Caper.
(Refer to the solution for 9-53.)
a. Percentage utilization of resource by activities:
Activity
Setups
Production
Runs
Products
Machine
Time
Indirect labor (including fringe benefits)
50%
40%
10%
0%
Costs assigned to activiities:
Activity
Cost
Setups
Production
Runs
Products
Machine
Time
Indirect labor
$28,000
$14,000
$11,200
$2,800
$ 0
IT
10,000
0
8,000
2,000
0
10-67. (continued)
The only change is the cost driver rate for machine time:
Unit Costs on Cola Bottling Line
Diet
Regular
Cherry
Grape
Total
Materials
$ 25,000
$ 20,000
$ 4,680
$ 550
$ 50,230
Direct labor
10,000
8,000
1,800
200
20,000
Fringe benefits on direct labor
4,000
3,200
720
80
8,000
10-67. (continued)
c.
First, compute the costs per unit of Diet Cola, except for the machine costs:
Diet cola costs:
Materials
$ 25,000
Direct labor
10,000
Fringe benefits on direct labor
4,000
