Chapter 6
Cost Allocation and Activity-Based Costing
QUESTIONS
1. The statement is false. Cost allocation refers to the process of assigning indirect
costs. Direct costs are traced to cost objects. Costs are allocated for a variety of
2. A cost objective is a product, service, or department that receives an allocation of
3. A concern in forming a cost pool is that the costs within the cost pool be similar or
homogeneous. It is unlikely that variable and fixed costs are similar (i.e., that one
6. In a responsibility accounting system, revenues and costs are traced to
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8. Traditional allocation methods use a small number of cost pools and allocation
bases related to production volume. However, some costly activities are not
9. The traditional costing approach typically uses allocation bases that are measures
of production volume (e.g., direct labor hours, direct labor cost, or machine hours).
Also, relatively few cost pools are used under the traditional approach (e.g., one or
two cost pools).
10. ABC will tend to give more relevant costs than a traditional cost system when:
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EXERCISES
E1. [LO 2]
Fixed costs (e.g., administrative costs) are sometimes allocated based on a
E2. [LO 2]
This allocation is potentially harmful. A hotel manager will tend to overestimate the
costs that increase with revenue. And this may lead to poor decisions that affect
E3. [LO 1]
Student answers will vary. However, deans with relatively costly operations (e.g.,
E4. [LO 2]
Warner might want to encourage department managers to evaluate security
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E5. [LO 1]
a. Service Department Allocation Base
Human resources Number of employees
Services costs.
E6. [LO 1]
Total fixed costs to be allocated = $100,000 + 12,500 + 10,000 + 5,000 =
$127,500.
E7. [LO 1]
Allocation Base Prod. Dept.1 Prod. Dept.2
Square footage $2,250,000 $3,000,000
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E8. [LO 1]
P1 has 200 ÷ 500 = 40% of production department employees.
Service Service dept. Cost Allocated to
Department Costs P1 P2
E9. [LO 2]
a. The manufacturing overhead allocation includes $56 of fixed cost which will not
increase if the special order is accepted (i.e., it is not an incremental cost). The
incremental revenue and incremental costs associated with the order suggests
b. Managers who focus on reported cost may (incorrectly) treat the $56 of fixed
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E10. [LO 1, 2]
a. The reason that allocated general and administrative costs are higher for the
Services Department is that revenue in the Sales Department has decreased.
b. If service department costs are affected by Vance Mason’s decisions, then he
E11. [LO 1, 2]
a. The manager of Auburn Business Banking will perceive that allocated service
b. In performing incremental analysis, the president of Auburn Business Banking
E12. [LO 2]
The use of a single cost pool causes A1 to be undercosted and B1 to be
overcosted. With a single cost pool, both products receive the same allocation of
cost per labor hour. However, A1 uses relatively more time in P1 where overhead
costs are high while B1 uses relatively more time in P2 where overhead costs are
low.
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Now let’s calculate the amount of overhead allocated to each product if
Morton used a separate overhead cost pool for each production department.
E13. [LO 1]
a. If the costs of the design department are fixed and the department is able to
b. Subsidiaries often have to go outside for design work because of time delays.
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E14. [LO 2]
COST POOL COST DRIVER
Inspection of raw materials Number of receipts
E15. [LO 1, 2]
E16. [LO 1, 2]
E17. [LO 2]
If the cost to process an order is much higher at one plant than at the other and
E18. [LO 2]
a. The cost of filling orders at Hearthstone Appliances is:
PROBLEMS
P1. [LO 1]
a. Allocation Base Software Consulting
Employee benefits Head count 375 125
Proportion .75 .25
Amount allocated $2,500,000 $1,875,000 $625,000
Profit Report: (using multiple cost pools/allocation bases)
Software Consulting
Sales $15,000,000 $8,000,000
b. Assuming the controller’s assumptions are correct (that benefits and
P2. [LO 1]
a.
Stock Stuffed
Animals
Custom Stuffed
Animals
Employee Benefits
240
80
Proportion*
0.75
0.25
Amount allocated
$1,125,000
$375,000
Rent
Proportion
0.50
Telecommunications
Amount allocated
$125,000
General and Adm. Costs
Proportion*
0.60
0.40
Amount allocated
$400,000
Total
*rounded to two decimal places
Profit Report (using multiple cost pools/allocation bases):
Custom
Stuffed
Sales
Less direct costs
Less allocated costs
Income (loss) before taxes
b. Assuming the controller’s assumptions are correct (that benefits and
P3. [LO 1]
a. The opportunity cost of producing a Model 350 motor is simply the incremental
cost of production (given that Binder has excess capacity and sales to Dacon
will not affect sales to other customers).
b. Since 60 percent of the overhead is fixed ($9 per motor), the incremental cost
c. The opportunity cost related to overhead, in this case, is simply the variable
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P4. [LO 1]
a. The opportunity cost of producing a case of syrup is simply the incremental cost
of production (given that Brennen has excess capacity and sales to Quality
Candy will not affect sales to other customers).
b. Since fixed OH is 75% of total OH ($810,000 ÷ $1,080,000), the fixed OH rate
c. The opportunity cost related to overhead, in this case, is simply the variable
P5. [LO 1]
a. Overhead rate based on direct-labor dollars
Civilian Military
Labor $ Mach.Hrs. Labor $ Mach.Hrs.
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b. The price charged for the civilian version of the Model KV10 does not depend
on allocated costs. However, the military version is sold for “cost” plus 10
P6. [LO 1]
a. Twenty-five percent of air miles are by Domestic (7,500,000 miles ÷ 30,000,000
miles) and International flights accounts for 75 percent of the total air miles.
Therefore, Domestic flights will be allocated 25 percent of the service
departments’ costs and International will be allocated 75 percent.
Allocated to
Costs Domestic International
Ticketing $ 4,000,000 $ 1,000,000 $3,000,000
b. The best cause-and-effect relation is probably between maintenance costs and
P7. [LO 1]
Production department use of service
Service depts. Assembly Testing
Maintenance ($700,000) 70% * 30%
P8. [LO 1]
Service departments:
Assembly
Testing
Maintenance ($600,000)
Service department cost allocated
to Assembly:
66.67% × $600,000
$400,020
Service department cost allocated
P9. [LO 1]
a.
Allocation Base Financial Planning Business Consulting
Proportion Amount Proportion Amount
b. Both headcount and salary appear to be plausible allocation bases, but they
P10. [LO 1]
a. Old overhead rate $12 per labor hour
Current overhead rate
b. Small jobs in the current year appear to be less profitable compared to the prior
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P11. [LO 2]
a. The recreation kayaks are uniform and probably made in large batches. The
b. Summit needs to look at the costs of activities that each line of kayaks requires.
c.
Cost Pool Cost Recreation Competition
use of base* allocation use of base allocation
Building $ 35,000 .800 $ 28,000 .200 $ 7,000
Equipment 35,000 .850 29,750 .150 5,250
Total unit costs for each model boat:
Recreation Competition