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CHAPTER 7 Activity Based Costing and Management
P 7-54
1. Plantwide Rate = $990,000/440,000 DLHs = $2.25 per DLH
Overhead cost per unit:
Model A: ($2.25 × 140,000)/10,000 units = $31.50
Model B: ($2.25 × 300,000)/100,000 units = $6.75
Activity rates:
Driver
2. Overhead assignment: Model A Model B
Setups:
$2,700 × 40…...………...………………...
…
$108,000
$2,700 × 60…...………...………………...
…
$162,000
Inspections:
3. Departmental rates:
Overhead cost per unit:
4. A common justification is to use machine hours for machine-intensive departments
and labor hours for labor-intensive departments. Using activity-based costs as the
Activity Activity Rate
7-19
CHAPTER 7 Activity Based Costing and Management
P 7-55
1. Labor and gasoline are driver tracing.
Labor (0.75 × $120,000)…………………
…
$ 90,000 Time = Resource Driver
2. Plantwide Rate = $600,000/20,000 direct labor hours
= $30 per DLH
Unit cost: Basic Deluxe
3. Activity rates:
Maintenance: $114,000/4,000 = $28.50 per maintenance hour
Engineering: $120,000/6,000 = $20 per engineering hour
Unit cost: Basic Deluxe
Prime costs……………………………
…
$3,200,000 $3,200,000
Overhead:
Maintenance:
CHAPTER 7 Activity Based Costing and Management
P 7-55 (Continued)
Setting up:
$53.33 × 250……….…………….………
…
13,333
$53.33 × 500……….…………….………
…
26,665
Paying suppliers:
$40 × 250……….…………….…………
…
10,000
$40 × 500……….…………….…………
…
20,000
4. Consumption ratios: Basic Deluxe
Maintenance……………….…………….
…
0.25 0.75
Engineering………………….……………. 0.25 0.75
5. When products consume activities in the same proportion, the activities with the
same proportions can be combined into one pool. This is so because the pooled
*
CHAPTER 7 Activity Based Costing and Management
P 7-55 (Continued)
Pool 1:
Pool 2:
Materials handling……………………………………
…
$120,000
Pool 3:
Purchasing……………………………………………
…
$ 60,000
Receiving………………………………………………
…
40,000
Pool 4:
Providing space………………………………………
…
$20,000
7-22
CHAPTER 7 Activity Based Costing and Management
P 7-56
1. The cost of supervision is computed as follows:
Salary of supervisor (Direct)…………………………
…
$ 80,000
Salary of secretary (Direct)…………………………… 35,000
2. First, the cost of the secondary activity (supervision) must be assigned to
the primary activities (various nursing care activities) that consume it
(the driver is the number of nurses):
Maternity nursing care assignment:
Nursing care:
$1,270,000/50,000 = $25.40 per nursing hour
Finally, the cost per patient day type can be computed:
Patient Daily Rate
Normal…………………………………
…
$213.50
a
7-23
CHAPTER 7 Activity Based Costing and Management
P 7-56 (Continued)
3. The laundry department cost would increase the total cost of the maternity
department by $115,200 (240,000/1,250,000 × $600,000). This would
increase the cost per patient day by $11.52 ($115,200/10,000). The activity
7-24
CHAPTER 7 Activity Based Costing and Management
P 7-57
1. Cost per Account = $6,105,000/75,000 accounts = $81.40
Average Fee per Month = $81.40/12 months = $6.78
2. Activity rates:
Opening and closing accounts:
$300,000/30,000 accounts = $10 per accoun
t
Issuing monthly statements:
Costs assigned: Low Medium High
Opening and closing:
$10 × 22,500………………………
…
$ 225,000
Customer inquiries:
$0.20 × 1,500,000………………… 300,000
$0.20 × 900,000…………………
…
180,000
$0.20 × 600,000…………………
…
120,000
Providing ATM services:
7-25
CHAPTER 7 Activity Based Costing and Management
P 7-57 (Continued)
3. Average profit per account: $90.00 – $81.40 = $8.60
ABC profit measure:
4. First, calculate the profits from loans, credit cards, and other products by
customer category (using ABC data). Next, compare 50% of the cross-sales
P 7-58
1. GAAP mandates that all nonmanufacturing costs be expensed during the
period in which they are incurred. GAAP is the most likely cause of the practice.
The limitations of GAAP-produced information for cost management should be
CHAPTER 7 Activity Based Costing and Management
P 7-58 (Continued)
2. The average order-filling cost per unit produced is computed as follows:
$9,000,000/180,000,000* units = $0.05 per uni
t
*(600 × 100,000) + (1,000 × 60,000) + (1,500 × 40,000) = 180,000,000
Thus, order-filling costs are about 6 to 10% of the selling price, clearly not a
3. With the pricing incentive feature, the average order size has been increased
to 2,000 units for all three product families. The number of orders now
processed can be calculated as follows:
CHAPTER 7 Activity Based Costing and Management
P 7-58 (Continued)
Customers were placing smaller and more frequent orders than necessary.
They were receiving a benefit without being charged for it. By charging for
the benefit and allowing customers to decide whether the benefit is worth
Competitive advantage is created by providing the same customer value
for less cost or better value for the same or less cost. By reducing the
cost, Grundvig can increase customer value by providing a lower price
(decreasing customer sacrifice) or by providing some extra product
features without increasing the price (increasing customer realization,
holding customer sacrifice constant). This is made possible by the
decreased cost of producing and selling the bolts.
7-28
CHAPTER 7 Activity Based Costing and Management
P 7-59
1. Supplier cost:
First, calculate the activity rates for assigning costs to suppliers:
Next, calculate the cost per engine by supplier:
Supplier cost:
Watson Johnson
Purchase cost:
$900 × 18,000………………………….…
…
$16,200,000
$1,000 × 4,000………………………….… $4,000,000
Replacing engines:
2. In the short run, buy 20,000 from Johnson and 2,000 from Watson. In the
long run, one possibility is to encourage Watson to increase its quality
7-29
CHAPTER 7 Activity Based Costing and Management
P 7-60
1. Activity-based management is a system-wide, integrated approach that focuses
management’s attention on activities. It involves two dimensions: a cost dimension
and a process dimension. Key elements in activity management are identifying
2. Setup………………………………………………
…
$125,000
Materials handling………………………………
…
180,000
Inspection…………………………………………
…
122,000
7-30
CHAPTER 7 Activity Based Costing and Management
P 7-60 (Continued)
Units produced and sold………………………………… 120,000 *
Potential unit cost reduction……………………………
…
$7.10 **
*$1,920,000/$16 (Total Cost/Unit Cost)
** $852,000/120,000 = $7.10
The consultant’s estimate of cost reduction was on target. Per-unit costs
can be reduced by at least $7, and further reductions may be possible if
improvements in value-added activities are possible.
We have identified $7.10 per unit of potential cost reduction. We don't know
3. Unit cost to maintain sales = $14 – $4 = $10
Unit cost to expand sales = $12 – $4 = $8
4. Total potential reduction:
$ 852,000 (from Requirement 2)
150,000 (by automating)
$1,002,000
÷ Units………………………………
…
120,000
Unit savings………………………… $ 8.35
Costs can be reduced by at least $7, enabling the company to maintain
CHAPTER 7 Activity Based Costing and Management
P 7-60
(
Concluded
)
5. Current:
Sales………………………………………
…
$ 2,160,000 ($18 × 120,000 units)
Costs………………………………………
…
(1,920,000)
Income…………………………………
…
$ 240,000
P 7-61
1. Nonvalue-added usage and costs, 2013:
Nonvalue Usage Nonvalue Cost
AQ*
V
AQ**
A
Q – VAQ (AQ – VAQ)SP
2. Expected values for the coming year (2014):
Materials: EQ = 480,000 + 0.60(120,000) = 552,000 pounds
Engineering: EQ = 27,840 + 0.60(20,160) = 39,936 engineering hours
Excess Excess
Nonvalue Usage Nonvalue Cost
AQ EQ*
A
Q – EQ (AQ – EQ)SP
***
*
CHAPTER 7 Activity Based Costing and Management
P 7-61 (Concluded)
The company failed to meet the materials standard but beat the engineering
standard. The engineering outcome is of particular interest. The actual usage
of the engineering resource is 35,400 hours, and activity availability is 48,000.
P 7-62
1. Theoretical Velocity = 90,000/12,000 hours = 7.5 telescopes per hour
Theoretical Cycle Time = 60/7.5 telescopes = 8 minutes per telescope
P 7-63
a. Prevention (SD) i. Detection (SD)
b. Prevention (SD) j. External failure (societal)
7-33
CHAPTER 7 Activity Based Costing and Management
Case 7-64
1. Shipping and warehousing costs are currently assigned using tons of paper
produced, a unit-based measure. Many of these costs, however, are not driven by
2. The new method proposes assigning the costs of shipping and warehousing
separately for the low-volume products. To do so requires three cost assignments:
receiving, shipping, and carrying. The cost drivers for each cost are tons processed,
items shipped, and tons sold.
Pool rate, receiving costs:
CASES
CHAPTER 7 Activity Based Costing and Management
Case 7-64 (Continued)
3. Profit analysis:
Revised profit per ton (LLHC):
Loss…………………………………………………………………………
…
$ (35.41)
Original profit per ton:
The revised profit, reflecting a more accurate assignment of shipping and
warehousing costs, presents a much different picture of LLHC. The product is,
in reality, losing money for the company. Its earlier apparent profitability was
attributable to a subsidy being received from the high-volume products (by
spreading the special shipping and handling costs over all products, using
tons produced as the cost driver). The same effect is also true for the other
low-volume products. Essentially, the system is understating the handling
costs for low-volume products and overstating the cost for high-volume
products.
4. The decision to drop some high-volume products and emphasize low-volume
products could clearly be erroneous. As LLHC has demonstrated, its apparent
profitability is attributable to distorted cost assignments. A significant change in
5. Ryan’s strategy changed because his information concerning the individual
products changed. Apparently, the accounting system was undercosting the
CHAPTER 7 Activity Based Costing and Management
Case 7-65
1. Disagree. Chuck is expressing an uninformed opinion. He has not spent the
2. and 3.
At first glance, it may seem strange to even ask if Chuck’s behavior is unethical.
After all, what is unethical about expressing an opinion, albeit uninformed? While
