Accounting Chapter 4 Homework However This Still Vast Improvement Over The

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CHAPTER 4

ACTIVITY-BASED COSTING

DISCUSSION QUESTIONS

1. A predetermined overhead rate is simply an

estimate of the overhead used per unit of

driver. It is calculated using budgeted over-

head and budgeted levels of the associated

driver. Predetermined rates are used be-

cause actual overhead may be incurred

nonuniformly throughout the year.

2. Under- and overapplied overhead are mea–

sures of the difference between the actual

and applied overhead assigned to production.

Underapplied overhead means too little was

applied, and overapplied means too much

was applied.

3. Plantwide overhead rates assign overhead to

products in proportion to the amount used of

the unit-based driver. If all products consume

overhead in proportion to this unit-based driv-

er, no distortion will occur. Cost distortion can

occur if the products consume some over-

head activities in different proportions than

those

assigned by the unit-based driver (the product

diversity factor). No significant distortion will

occur unless the activities that are consumed

in different proportions make up a significant

proportion of the total overhead costs. Thus,

two key factors are product diversity and sig-

nificant non-unit-level overhead costs.

4. Non-unit-related overhead activities are

those overhead activities that are not highly

correlated with production volume mea-

sures. Examples include setups, materials

handling, and inspection. Non-unit-based

cost drivers are causal factors that explain

the consumption of non-unit-related over-

head. Examples include setup hours, num-

ber of moves, and hours of inspection.

5. An overhead consumption ratio measures the

proportion of an overhead activity consumed

by a product.

6. Agree. Prime costs can be assigned using

direct tracing and therefore do not cause

cost distortions. Overhead costs, however,

are not directly traceable and can cause dis-

tortions. For example, using unit-based driv-

ers to trace non-unit-based overhead costs

would cause distortions.

7. Activity-based product costing is a costing

approach that first assigns costs to activities

and then to products. The assignment is

made possible through the identification of ac-

tivities, their costs, and the use of cost drivers.

8. The six steps are: (1) identify, define, and

classify activities and key attributes; (2) as-

sign the cost of resources to activities;

(3) assign the cost of secondary activities to

primary activities; (4) identify cost objects and

specify the amount of each activity consumed

by specific cost objects; (5) calculate primary

activity rates; and (6) assign activity costs to

cost objects.

9. The cost of resources is assigned to activities

using direct tracing and resource drivers. Re-

source drivers such as effort expended and

material usage trace costs to activities using

causal relationships. Assigning costs to activi-

ties requires unbundling the general ledger.

General ledger accounts accumulate costs by

department and by account—not by activity.

Thus, the costs in the general ledger account

must be reassigned to activities—this is what

unbundling means.

10. A bill of activities specifies the product, ex-

pected product quantity, activities, and amount

of each activity expected to be consumed by

each product.

11. Two types of activity drivers are transaction

drivers and duration drivers. Transaction driv-

ers measure the demands placed on an ac-

tivity using the number of times an activity is

performed. Duration drivers measure de-

mands by the time it takes to perform an ac-

tivity.

12. Unit-level activities are those that occur each

time a unit of product is produced. Batch–

level activities are those that are performed

each time a batch of products is produced.

Product-level or sustaining activities are

those that are performed as needed to sup-

port the various products produced by a

company. Facility-level activities are those

that sustain a factory’s general manufacturing

process.

13. TDABC simplifies ABC by eliminating the

need to do detailed interviews and surveys

to assess activity costs. By using objectively

determined capacity cost rates, activity rates

can be calculated directly.

14. Updating a TDABC model is easy because

activity rates are updated simply by updating

the capacity cost rate. Most changes in oper-

ating conditions are reflected by changes in

either resource costs or system time. These

changes are reflected in the capacity cost

rate which is then used to update the activity

rate.

15. Reduced systems can be achieved by apply-

ing the Pareto principle (or 80/20 rule) to ac-

tivity cost or a series of simultaneous equa-

tions based on consumption ratios. The

Pareto principle approach creates an approx-

imately relevant ABC system. The simultane-

ous equation approach creates a reduced

system that duplicates the accuracy. The Pa-

reto approach is easy to understand and im-

plement. The simultaneous equation ap-

proach creates a system that duplicates the

accuracy of the more complex system, and it

may be even smaller in size than the Pareto

approach. Preserving accuracy probably pro-

duces the most benefit and thus has the most

merit of the two approaches.

CORNERSTONE EXERCISES

Cornerstone Exercise 4.1

1. Plantwide rate = $2,000,000/50,000 = $40.00 per hour

Applied overhead:

Deluxe Regular

2. Overhead per unit (deluxe) = $400,000/20,000 = $20

3. There would be an increase of $400,000 ($40 × 10,000) of overhead assigned

to the deluxe speakers and so profitability for this product line would de-

Cornerstone Exercise 4.2

1. Overhead variance = $470,000 – $500,000 = $30,000 overapplied

2. Proration: (0.40 × $30,000; 0.2 × $30,000; 0.4 × $30,000)

Overhead Control …………………………………….. 30,000

Cost of Goods Sold …………………………….. 12,000

Prorated

Unadjusted Overapplied Adjusted

Balance Overhead Balance

Work-in-Process Inventory ……………. $100,000 $ 6,000 $94,000

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Cornerstone Exercise 4.2 (Concluded)

3.

Cost of Goods Sold …………………………………. 30,000

Cornerstone Exercise 4.3

2. Overhead assignment:

Form A Form B

($80 × 3,500) + ($4 × 5,000) ………………………………… $300,000

($80 × 1,500) + ($4 × 15,000) ………………………………. $180,000

3. Overhead assignment:

Form A Form B

($80 × 1,200) + ($4 × 5,000) ………………………………… $116,000

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Cornerstone Exercise 4.3 (Concluded)

Cornerstone Exercise 4.4

1.

Consumption Ratios

Overhead Activity Part X12 Part YK7 Activity Driver

Machining ……………………. 0.14a 0.86a Machine hours

Setups …………………………. 0.33b 0.67b Number of setups

2.

Consumption Ratios

Overhead Activity Part X12 Part YK7 Activity Driver

Plantwide:

Manufacturing ………….. 0.30a 0.70a Direct labor hours

3.

Consumption Ratios

Overhead Activity Part X12 Part YK7 Activity Driver

Plantwide:

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Cornerstone Exercise 4.4 (Concluded)

The plantwide rate using machine hours may make the assignments better—all

but one of Part X12’s activities has a consumption ratio close to 0.14. If the

Cornerstone Exercise 4.5

1. Machining rate: $6,000,000/600,000 = $10per machine hour

2.

Basic Advanced

Prime costs ………………………. $8,000,000 $ 30,000,000

Overhead costs:

Machining:

$10 × 100,000 ……………… 1,000,000

$10 × 500,000 ……………… 5,000,000

Engineering:

Prime cost per unit:

Overhead cost per unit: Basic: $94.60 − $80.00 = $14.60; YK7: $124.87 −

Cornerstone Exercise 4.5 (Concluded)

3. Using consumption ratios will yield exactly the same overhead assignments

as activity rates, if the actual activity usage is the same as the expected us-

Cornerstone Exercise 4.6

1.

Percentage of Time on Each Activity

Activity Supervisor Clerks Supporting Calculation

Supervising clerks …………………. 100% 0% (2,000/2,000)

Processing accounts ……………… 0 40 (10,000/25,000)

2.

Activity Phonea Salariesb Computerc Total

Supervising clerks …………. $ 9,000 $ 70,000 $ 79,000

Processing accounts ……………… 9,000 110,000 119,000

a0.60 × $90,000 for customer inquiries; 0.10 × $90,000 for other activities

b1.0 × $70,000; 0.40 × $275,000; 0.20 × $275,000; 0.28 × $275,000; 0.12 ×

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Cornerstone Exercise 4.6 (Concluded)

3. Supervising is a secondary activity and its costs are consumed by primary

activities (assigned in proportion to the labor content of each activity).

Processing accounts ………………… $150,600a

Issuing statements …………………… 87,300b

Cornerstone Exercise 4.7

2. Rates:

Processing accounts: 0.20 × $18.40 = $3.68 per account

3. Capacity cost rate = $450,000/22,500* = $20 per hour

*25,000 – 0.10(25,000)

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Cornerstone Exercise 4.8

1. Expected Consumption

Budgeted Activity Ratios

Activity Costa Wafer A Wafer B

3. Testing products …………. $ 720,000 0.60 0.40

7. Inserting dies ………………. 840,000 0.70 0.30

11. Moving materials …………. 600,000 0.50 0.50

Total activity cost ………… $3,000,000

Approximate ABC cost:b $1,578,000 $1,422,000

a Original activity cost plus share of the costs of the remaining “inexpensive”

activities (allocated in proportion to the original costs of the expensive

activities: $600,000 + [($600,000/$2,500,000) × $500,000] = $720,000

$300,000 + [($300,000/$2,500,000) × $500,000] = $360,000

2. Relative error, Wafer A: ($1,578,000 – $1,500,000)/$1,500,000 = 0.052 (5.2%)

3. Using consumption ratios, the ABC cost of Wafer A is $650,000(0.25 + 0.10 +

0.15 + 0.20) + $50,000(0.60 + 0.55 + 0.45 + 0.70 + 0.35 + 0.65 + 0.50 + 0.30) =

$660,000. Since the cost is the same for each of the four most expensive activi-

ties, the reassigned cost for each of the four activities is $750,000[$650,000 +

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Cornerstone Exercise 4.9

1. Global ratios:

Wafer A = 0.50 ($1,500,000/$3,000,000)

Wafer B = 0.50 ($1,500,000/$3,000,000)

Equations:

0.70w1 + 0.20w2 = 0.50 (Wafer A)

2. Using the consumption ratios, the same ABC cost assignment is realized with

two drivers:

Wafer A: (0.70 × $1,800,000) + (0.20 × $1,200,000) = $1,500,000

3. Equations:

0.25w1 + 0.60w2 = 0.50 (Wafer A)

0.75w1 + 0.40w2 = 0.50 (Wafer B)

Multiplying both sides of the first equation by 3, subtracting the second from

the first, and solving, we obtain:

Solving: w1 = 2/7 and w2 = 5/7

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EXERCISES

Exercise 4.10

1. Predetermined overhead rate = $285,600/10,200 = $28 per direct labor hour

3. Actual overhead ………………………………………………. $285,000

4. Prime cost ……………………………………………………….. $1,050,000

Applied overhead …………………………………………….. 278,040

Exercise 4.11

1. Findley predetermined overhead rate = $912,000/48,000

= $19 per machine hour

2. Findley:

Actual overhead ………………………………………….. $915,000

Applied overhead ($19 × 47,780) ………………….. 907,820

Underapplied overhead …………………………... $ 7,180

Lemon:

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Exercise 4.12

1. $5,700,000/375,000 = $15.20 per machine hour

2. $ 5,814,000 Applied overhead ($15.20 × 382,500)

4. Work-in-process inventory …. $ 576,000 (19.2%: $576,000/$3,000,000)

Finished goods inventory ….. 624,000 (20.8%: $624,000/$3,000,000)

Exercise 4.13

2. Department A: $720,000/120,000 = $6 per machine hour

3. Product X75 Product Y15

Plantwide:

210 × $5 = $1,050 210 × $5 = $1,050

Exercise 4.13 (Concluded)

4. Plantwide rate: $1,080,000/180,000 = $6

Department B: $360,000/60,000 = $6

Product X75 Product Y15

Plantwide:

Departmental:

Exercise 4.14

1. Yes. Direct materials and direct labor are directly traceable to each product;

their cost assignment should be accurate.

2. Note: Overhead rate = $150,000/$120,000 = 1.25 per direct labor dollar

(or 125% of direct labor dollars)

Standard: (1.25 × $30,000)/7,500 = $5.00 per purse

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Exercise 4.14 (Concluded)

3. Setup rate = $45,000/1,500 hours

= $30 per setup hour

Standard Handcrafted

Setup rate:

$30 × 1,000 ………………… $ 30,000

$30 × 500 …………………… $15,000

Setup hours were chosen because the time per setup differs significantly

between standard and handcrafted purses. Transaction drivers measure

the number of times an activity is performed, while duration drivers measure

the time required. Duration drivers typically provide greater accuracy whenever

the time required per transaction is not the same for all products. This cost as-

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Exercise 4.15

1. Overhead rate = $2,080,000/8,000 = $260 per direct labor hour

Model A Model B

Direct materials …….. $ 600,000 $ 800,000

Direct labor …………… 480,000 480,000

2. Activity rates:

Setups: $480,000/600 = $800 per setup

Ordering: $360,000/18,000 = $20 per order

3. In a firm with product diversity and significant non-unit overhead costs, multi-

ple rates using unit and non-unit drivers produce better cost assignments be-

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Exercise 4.16

Activity Dictionary: Credit Card Department

Activity

Name

Activity

Description

Activity

Type

Cost

Object(s)

Activity

Driver

Supervising

employees

Scheduling,

coordinating,

and performance

evaluation

Secondary

Activities

within

department

Total labor

time for each

activity

Processing

transactions

Sorting, keying,

and verifying

Primary

Credit cards

Number of

transactions

Answering

Answering,

Primary

Credit cards

Number of

Providing

Accessing

Primary

Credit cards,

Number of

Exercise 4.17

1. Labor cost is assigned to the activities using direct tracing and a resource

driver (percentage of time):

Supervising employees $64,600 (direct tracing)

Processing transactions $84,000 (0.40 × $210,000)

Issuing statements $63,000 (0.30 × $210,000)

assigned to the clerical group and then traced to the activities in proportion

to hours of computer usage.

Telephone cost is assigned to two activities:

Supervising employees** $ 500 (direct tracing)

Answering questions $3,500 (direct tracing)

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Exercise 4.17 (Concluded)

2. The cost of supervision is assigned to the following primary activities (using

relative labor content of each activity):

Exercise 4.18

1. Unbundling means that general ledger costs are assigned to activities. Know-

2. The general ledger system collects costs by accounts. It reports what is

3. Activity Cost

Creating BOMs $ 63,000a

Studying capabilities 61,500b

Improving processes 220,500c

4. First, assign the cost of the activity, studying capabilities, to the other four

activities. A possible driver is engineering time (assign costs in proportion to

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Exercise 4.18 (Concluded)

Second, assign the costs of the primary activities to jobs. Creating BOMs can

be assigned using number of BOMs (transaction) or time required to develop

BOMs (duration). Designing tools can be assigned to jobs using number of

Exercise 4.19

1. and 2.

Process Activities Level

Sustaining Providing space Facility

Procurement: Receiving goods Batch

Paying suppliers Batch

Manufacturing: Cutting Unit

Sewing Unit

Exercise 4.20

1. Capacity cost rate = $630,000/20,000 = $31.50 per hour

2. Activity rates:

Creating BOMs $31.50 × 0.5 = $15.75 per BOM

3. TDABC:

Job 150: $170.10 × 10 = $1,701

Job 151: $170.10 × 20 = $3,402

ABC:

4. BOM time = 0.50 + 0.30 (if custom product)