costacctg13_sm_ch05

costacctg13_sm_ch05 - CHAPTER 5 ACTIVITY­BASED COSTING AND...

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Unformatted text preview: CHAPTER 5 ACTIVITY­BASED COSTING AND ACTIVITY­BASED MANAGEMENT 5­1 Broad averaging (or “peanut­butter costing”) describes a costing approach that uses broad averages for assigning (or spreading, as in spreading peanut butter) the cost of resources uniformly to cost objects when the individual products or services, in fact, use those resources in non­uniform ways. Broad averaging, by ignoring the variat ion in the consumption o f resources by different cost objects, can lead to inaccurate and misleading cost data, which in turn can negatively impact the marketing and operating decisio ns made based on that informat ion. 5­2 Overcosting may result in co mpet itors entering a market and taking market share for products that a company erroneously believes are low­margin or even unprofitable. Undercosting may result in co mpanies selling products on which they are in fact losing mo ney, when they erroneously believe them to be profitable. 5­3 Costing system refinement means making changes to a simple cost ing system that reduces the use of broad averages for assigning the cost of resources to cost objects and provides better measurement of the costs of overhead resources used by different cost objects. Three guidelines for refinement are 1. Classify as many o f the total costs as direct costs as is econo mically feasible. 2. Expand the number of indirect cost pools until each o f these pools is more ho mogenous. 3. Use the cause­and­effect criterion, when possible, to ident ify the cost­allocat ion base for each indirect­cost pool. 5­4 An activit y­based approach refines a costing system by focusing on individual act ivit ies as the fundamental cost objects. It uses the cost of these activit ies as the basis for assigning costs to other cost objects such as products or services. 5­5 Four levels o f a cost hierarchy are (i) Output unit­level costs: costs of act ivit ies performed on each individual unit of a product or service. (ii) Batch­level costs: costs of activit ies related to a group of units of products or services rather than to each individual unit of product or service. (iii)Product­sustaining costs or service­sustaining costs: costs of activit ies undertaken to support individual products or services regardless of the number of unit s or batches in which the units are produced. (iv) Facilit y­sustaining costs: costs of act ivit ies that cannot be traced to individua l products or services but support the organizat ion as a who le. 5­6 It is important to classify costs into a cost hierarchy because costs in different cost pools relate to different cost­allocat ion bases and not all cost­allocat ion bases are unit­level. For example, an allo cation base like setup hours is a batch­level allocat ion base, and design hours is a product­sustaining base, both insensit ive to the number o f unit s in a batch or the number o f units o f product produced. If costs were not classified into a cost hierarchy, the alternat ive would be to consider all costs as unit­level costs, leading to misallocat ion of those costs that are not unit­level costs. 5­1 5­7 An ABC approach focuses on activit ies as the fundamental cost objects. The costs of these act ivit ies are built up to compute the costs of products, and services, and so on. Simple costing systems have one or a few indirect cost pools, irrespective of the heterogeneit y in the facilit y while ABC systems have mult iple indirect cost pools. An ABC approach attempts to use cost drivers as the allocat ion base for indirect costs, whereas a simple costing system generally does not. The ABC approach classifies as many indirect costs as direct costs as possible. A simple costing system has more indirect costs. 5­8 Four decisio ns for which ABC informat ion is useful are 1. pricing and product mix decisio ns, 2. cost reduction and process improvement decisio ns, 3. product design decisio ns, and 4. decisio ns for planning and managing activit ies. 5­9 No. Department indirect­cost rates are similar to activit y­cost rates if (1) a single activit y accounts for a sizable fraction o f the department’s costs, or (2) significant costs are incurred on different activit ies wit hin a depart ment but each activit y has the same cost­allocat ion base, or (3) significant costs are incurred on different activit ies wit h different cost­allo cation bases wit hin a department but different products use resources fro m the different activit y areas in the same proportions. 5­10 “Tell­tale” signs that indicate when ABC systems are likely to provide the most benefit s are as fo llows: 1. Significant amounts of indirect costs are allocated using only one or two cost pools. 2. All or most indirect costs are ident ified as output­unit­level costs (i.e., few indirect costs are described as batch­level, product­sustaining, or facilit y­sustaining costs). 3. Products make diverse demands on resources because o f differences in vo lume, process steps, batch size, or complexit y. 4. Products that a company is well suited to make and sell show small pro fits, whereas products that a company is less suited to produce and sell show large profits. 5. Operations staff has significant disagreements wit h the account ing staff about the costs of manufacturing and market ing products and services. 5­11 The main costs and limitat ions o f ABC are the measurements necessary to implement the systems. Even basic ABC systems require many calculat ions to determine costs of products and services. Activit y­cost rates often need to be updated regularly. Very detailed ABC systems are costly to operate and difficult to understand. Somet imes the allocat ions necessary to calculate activit y costs often result in act ivit y­cost pools and quant ities of cost­allocat ion bases being measured with error. When measurement errors are large, activit y­cost informat ion can be misleading. 5­12 No, ABC systems apply equally well to service companies such as banks, railroads, hospitals, and account ing firms, as well merchandising co mpanies such as retailers and distributors. 5­13 No. An act ivit y­based approach should be adopted only if it s expected benefit s exceed it s expected costs. It is not always a wise invest ment. If the jobs, products or services are alike in the way they consume indirect costs of a company, then a simple costing system will suffice. 5­2 5­14 Increasing the number o f indirect­cost pools does NOT guarantee increased accuracy o f productor service costs. If the exist ing cost pool is already homogeneous, increasing the number of cost pools will not increase accuracy. If the existing cost pool is not homogeneous, accurac y will increase only if the increased cost pools themselves increase in ho mogeneit y vis­a­vis the single cost pool. 5­15 The controller faces a difficult challenge. The benefits o f a better accounting syste m show up in improved decisio ns by managers. It is important that the controller have the support of these managers when seeking increased investments in account ing systems. Statements by these managers showing how their decis io ns will be improved by a better accounting system are the controller’s best arguments when seeking increased funding. For example, the new syste m will result in more accurate product costs which will influence pricing and product mix decisio ns. The new system can also be used to reduce product costs which will lower selling prices. As a result, the customer will benefit from the new system. 5­16 (20 min.) Cost hierarchy. 1. a. Indirect manufacturing labor costs of $1,200,000 support direct manufacturing labor and are output unit­level costs. Direct manufacturing labor generally increases wit h output units, and so will the indirect costs to support it. b. Batch­level costs are costs of act ivit ies that are related to a group of units o f a product rather than each individual unit o f a product. Purchase order­related costs (including costs of receiving materials and paying suppliers) of $600,000 relate to a group of units of product and are batch­level costs. c. Cost of indirect materials o f $350,000 generally changes wit h labor hours or machine hours which are unit­level costs. Therefore, indirect material costs are output unit­ level costs. d. Setup costs of $700,000 are batch­level costs because they relate to a group of units of product produced after the machines are set up. e. Costs of designing processes, drawing process charts, and making engineering changes for individual products, $900,000, are product­sustaining because they relate to the costs of activit ies undertaken to support individual products regardless of the number of unit s or batches in which the product is produced. f. Machine­related overhead costs (depreciation and maintenance) of $1,200,000 are output unit­level costs because they change with the number of units produced. g. Plant management, plant rent, and insurance costs of $950,000 are facilit y­sustaining costs because the costs of these act ivit ies cannot be traced to individual products or services but support the organizat ion as a who le. 5­3 2. The co mplex boom box made in many batches will use significantly more batch­level overhead resources compared to the simple boom box that is made in a few batches. In addit ion, the co mplex boom box will use more product­sustaining overhead resources because it is complex. Because each boom box requires the same amount of machine­hours, both the simple and the co mplex boom box will be allocated the same amount of overhead costs per boom box if Teledor uses only machine­hours to allocate overhead costs to boom boxes. As a result, the complex boom box will be undercosted (it consumes a relat ively high level of resources but is reported to have a relat ively low cost) and the simple boom box will be overcosted (it consumes a relatively low level o f resources but is reported to have a relat ively high cost). 3. Using the cost hierarchy to calculate activit y­based costs can help Teledor to ident ify both the costs of individual act ivit ies and the cost of act ivit ies demanded by individual products. Teledor can use this informat ion to manage its business in several ways: a. Pricing and product mix decisio ns. Knowing the resources needed to manufacture and sell different types o f boom boxes can help Teledor to price the different boom boxes and also ident ify which boom boxes are more profitable. It can then emphasize its more profitable products. b. Teledor can use informat ion about the costs of different activit ies to improve processes and reduce costs of the different activit ies. Teledor could have a target of reducing costs of act ivit ies (setups, order processing, etc.) by, say, 3% and constant ly seek to eliminate activit ies and costs (such as engineering changes) that its customers perceive as not adding value. c. Teledor management can ident ify and evaluate new designs to improve performance by analyzing how product and process designs affect activit ies and costs. d. Teledor can use it s ABC systems and cost hierarchy informat ion to plan and manage activit ies. What activit ies should be performed in the period and at what cost? 5­17 (25 min.) ABC, cost hierarchy, service. 1. Output unit­level costs a. Direct­labor costs, $243,000 b. Equipment­related costs (rent, maintenance, energy, and so on), $400,000 These costs are output unit­level costs because they are incurred on each unit of materials tested, that is, for every hour of testing. Batch­level costs c. Setup costs, $385,000 These costs are batch­level costs because they are incurred each time a batch of materials is set up for either HT or ST, regardless o f the number of hours for which the tests are subsequent ly run. Service­sustaining costs d. Costs of designing tests, $252,000. These costs are service­sustaining costs because they are incurred to design the HT and ST tests, regardless o f the number of batches tested or the number of hours of test time. 5­4 2. Heat Testing (HT) Total (1) Direct labor costs (given) Equipment­r elated costs $5 per hour * ´ 50,000 hours $5 per hour * ´ 30,000 hours Setup costs † $22 per setup­hour ´ 13,500 setup­hours † $22 per setup­hour ´ 4,000 setup­hours Costs of designing tests $60 per hour ** ´ 2,800 hours $60 per hour ** ´ 1,400 hours Total costs $183,000 250,000 Per Hour (2) = (1) ¸ 50,000 $ 3.66 5.00 150,000 297,000 5.94 88,000 168,000 $898,000 3.36 $17.96 84,000 $382,000 2.80 $12.73 2.93 5.00 Stress Testing (ST) Total (3) $ 60,000 Per Hour (4) = (3) ¸ 30,000 $ 2.00 *$400,000 ¸ (50,000 + 30,000) hours = $5 per test­hour † $385,000 ¸ (13,500 + 4,000) setup hours = $22 per setup­hour **$252,000 ¸ (2,800 + 1,400) hours = $60 per hour At a cost per test­hour of $16, the simple costing system undercosts heat testing ($17.96) and overcosts stress testing ($12.73). The reason is that heat testing uses direct labor, setup, and design resources per hour more intensively than stress testing. Heat tests are more complex, take lo nger to set up, and are more difficult to design. The simple costing system assumes that testing costs per hour are the same for heat testing and stress testing. 3. The ABC system better captures the resources needed for heat testing and stress testing because it ident ifies all the various act ivit ies undertaken when performing the tests and recognizes the levels o f the cost hierarchy at which costs vary. Hence, the ABC system generates more accurate product costs. Plymouth’s management can use the informat ion from the ABC system to make better pricing and product mix decisio ns. For example, it might decide to increase the prices charged for the more costly heat testing and consider reducing prices on the less costly stress testing. Plymouth should watch if co mpet itors are underbidding Plymouth in stress testing, and causing it to lose business. Plymouth can also use ABC informat ion to reduce costs by eliminat ing processes and act ivit ies that do not add value, ident ifying and evaluat ing new methods to do testing that reduce the act ivit ies needed to do the tests, reducing the costs of do ing various activit ies, and planning and managing act ivit ies. 5­5 5­18 (15 min.) Alternative allocation bases for a professional services firm. 1. Direct Professional Time Rate per Number Hour of Hours Total (2) (3) (4) = (2) ´ (3) Support Services Rate (5) Amount Billed to Total Client (6) = (4) ´ (5) (7) = (4) + (6) Client (1) SEATTLE DOMINION Wo lfson Brown Anderson TOKYO ENTERPRISES Wo lfson Brown Anderson $500 120 80 15 3 22 $7,500 360 1,760 30% 30 30 $2,250 108 528 $ 9,750 468 2,288 $12,506 $500 120 80 2 8 30 $1,000 960 2,400 30% 30 30 $300 288 720 $1,300 1,248 3,120 $5,668 2. Direct Professional Time Support Services Amount Rate Number Rate per Billed to per of Hours Total Hour Total Client Hour (2) (3) (5) (4) = (2) ´ (3) (6) = (3) ´ (5) (7) = (4) + (6) Client (1) SEATTLE DOMINION Wo lfson Brown Anderson TOKYO ENTERPRISES Wo lfson Brown Anderson $500 120 80 15 3 22 $7,500 360 1,760 $50 50 50 $ 750 150 1,100 $ 8,250 510 2,860 $11,620 $500 120 80 2 8 30 $1,000 960 2,400 $50 50 50 $ 100 400 1,500 $1,100 1,360 3,900 $6,360 Seattle Do minio n Tokyo Enterprises Requirement 1 $12,506 5,668 $18,174 Requirement 2 $11,620 6,360 $17,980 Both clients use 40 hours of professio nal labor time. However, Seattle Dominio n uses a higher proportion o f Wo lfson’s t ime (15 hours), which is more costly. This attracts the highest support­ services charge when allocated on the basis of direct professio nal labor costs. 5­6 3. Assume that the Wo lfson Group uses a cause­and­effect criterion when choosing the allocat ion base for support services. You could use several pieces o f evidence to determine whether professio nal labor costs or hours is the dr iver of support­service costs: a. Interviews with personnel. For example, staff in the major cost categories in support services could be interviewed to determine whether Wo lfson requires more support per hour than, say, Anderson. The professio nal labor costs allocat ion base implies that an hour of Wo lfso n’s t ime requires 6.25 ($500 ÷ $80) times more support­service dollars than does an hour of Anderson’s time. b. Analysis of tasks undertaken for selected clients. For example, if co mputer­related costs are a sizable part of support costs, you could determine if there was a systemat ic relat ionship between the percentage invo lvement of professio nals wit h high billing rates on cases and the computer resources consumed for those cases. 5­19 (20 min.) Plantwide, department and ABC indirect cost rates. 1. Actual plant­wide variable MOH rate based on machine hours, $308,600 ¸ 4,000 $77.15 per machine hour United Motors Holden Motors Leland Vehicle Total Variable manufacturing overhead, allocated based on machine hours ($77.15 ´ 120; $77.15 ´ 2,800; $77.15 ´ 1,080) 2. Department Design Production Engineering Variable MOH in 2007 $39,000 29,600 240,000 Total Driver Units 390 370 4,000 $9,258 $216,020 $83,322 $308,600 Rate $100 $ 80 $ 60 United Motors per CAD­design hour per engineering hour per machine hour Holden Motors Leland Vehicle Total Design­related overhead, allocated on CAD­design hours (110 ´ $100; 200 ´ $100; 80 ´ $100) Production­related overhead, allocated on engineering hours (70 ´ $80; 60 ´ $80; 240 ´ $80) Engineering­related overhead, allocated on machine hours (120 ´ $60; 2,800 ´ $60; 1,080 ´ $60) Total $11,000 $ 20,000 $ 8,000 $ 39,000 5,600 4,800 19,200 29,600 7,200 168,000 64,800 240,000 $23,800 $192,800 $92,000 $308,600 5­7 3. United Motors a. Department rates (Requirement 2) b. Plantwide rate (Requirement 1) Ratio of (a) ÷ (b) $23,800 $ 9,258 2.57 Holden Motors $192,800 $216,020 0.89 Leland Vehicle $92,000 $83,322 1.10 The variable manufacturing overhead allocated to United Motors increases by 157% under the department rates, the overhead allocated to Holden decreases by about 11% and the overhead allocated to Leland increases by about 10%. The three contracts differ sizably in the way they use the resources of the three departments. The percentage of total driver units in each department used by the co mpanies is: Cost Department Driver Design CAD­design hours Engineering Engineering hours Production Machine hours United Motors 28% 19 3 Holden Motors 51% 16 70 Leland Vehicle 21% 65 27 The United Motors contract uses only 3% of total machines hours in 2004, yet uses 28% of CAD design­hours and 19% of engineering hours. The result is that the plantwide rate, based on machine hours, will great ly underest imate the cost of resources used on the United Motors contract. This explains the 157% increase in indirect costs assigned to the United Motors contract when department rates are used. In contrast, the Ho lden Motors contract uses less of design (51%) and engineering (16%) than o f machine­hours (70%). Hence, the use of department rates will report lower indirect costs for Holden Motors than does a plantwide rate. Holden Motors was probably co mplaining under the use of the simple system because it s contract was being overcosted relat ive to its consumpt ion o f MOH resources. United, on the other hand was having its contract undercosted and underpr iced by the simple system. Assuming that AP is an efficient and co mpetit ive supplier, if the new department­based rates are used to price contracts, United will be unhappy. AP should explain to United how the calculat ion was done, and po int out United’s high use of design and engineering resources relat ive to production machine hours. Discuss ways of reducing the consumpt ion o f those resources, if possible, and show willingness to partner with them to do so. If the price rise is go ing to be steep, perhaps offer to phase in the new prices. 4. Other than for pricing, AP can also use the informat ion fro m the department­based system to examine and streamline its own operations so that there is maximum value­added fro m all indirect resources. It might set targets over time to reduce both the consumption of each indirect resource and the unit costs of the resources. The department­based system gives AP more opportunities for targeted cost management. 5­8 5. It would not be worthwhile to further refine the cost system into an ABC system if there wasn’t much variation amo ng contracts in the consumpt ion o f activit ies wit hin a department. If, for example, most activit ies wit hin the design department were, in fact, driven by CAD­design hours, then the more refined system would be more costly and no more accurate than the department­based cost system. Even if there was sufficient variat ion, considering the relat ive sizes o f the 3 department cost pools, it may only be cost­effect ive to further analyze the engineering cost pool, which consumes 78% ($240,000 ¸ $308,600) of the manufacturing overhead. 5­20 (10–15 min.) ABC, process costing. Note to instructors: The “number of production runs” for the financial calculator should be 50 and not 0. Please announce this change to your students before assigning this problem. Rates per unit cost driver. Activity Cost Driver Machining Machine­hours Rate $375,000 ÷ (25,000 + 50,000) = $5 per machine­hour $120,000 ÷ (50 + 50) = $1,200 per production run $105,000 ÷ (1,000 + 500) = $70 per inspect ion­hour Set up Production runs Inspect ion Inspect ion­hours Overhead cost per unit: Machining: $5 × 25,000; 50,000 Set up: $1,200 × 50; $1,200 × 50 Inspect ion: $70 × 1,000; $70 × 500 Total manufacturing overhead costs Divide by number of unit s Manufacturing overhead cost per unit 2. Mathematical Financial Manufacturing cost per unit: Direct materials $150,000 ÷ 50,000 $300,000 ÷ 100,000 Direct manufacturing labor $50,000 ÷ 50,000 $100,000 ÷ 100,000 Manufacturing overhead ( from requirement 1) Manufacturing cost per unit Mathematical Financial $125,000 $250,000 60,000 60,000 70,000 35,000 $255,000 $345,000 ÷ 50,000 ÷100,000 $ 5.10 $ 3.45 $3.00 $3.00 1.00 5.10 $9.10 1.00 3.45 $7.45 5­9 5­21 (30 min.) Activity­based costing, service company. 1. Total indir ect costs = $150,000 + $90,000 + $36,000 + $40,000 + $39,000 + $48,000 = $403,000 Total machine­hours = (400 ´ 10) + (200 ´ 10) = 6,000 Indirect cost rate per machine­hour = $403,000 ¸ 6,000 = $67.17 per machine­hour Simple Costing System Cost of supplies per job Direct manufacturing labor cost per job Indirect cost allocated to each job (10 machine hours ´ $67.17 per machine hour) Total costs 2. Activity­based Costing System Q uantity of Cost Driver Consumed during 2007 (see column (1)) Standard Job (3) 4,000 Special Job (4) 2,000 Standard Job $ 200.00 180.00 671.70 $1,051.70 Special Job $ 250.00 200.00 671.70 $1,121.70 Activity (1) Machine operations (400 jobs ´ 10 mach. hrs. per job; 200 jobs ´ 10 mach. hrs. per job) Setups (4 ´ 400; 7 ´ 200) Purchase orders (given) Design Marketing Administration ($180 ´ 400; $200 ´ 200) Cost Driver (2) machine hours Total Cost of Activity (given) (5) $150,000 Allocation Rate (6) = (5) ¸ ((3) + (4)), or given $ 25.00 per machine hour setup hours no. of purchase orders selling price dir. mfg. labor costs 1,600 400 1,400 500 $72,000 $40,000 $ 90,000 $ 36,000 $ 40,000 $ 39,000 $ 48,000 $ 30.00 per setup hour $ 40.00 per purchase order $ 0.05 per dollar of sales $0.42857 per dollar of direct manuf. labor cost Cost of supplies ($200 ´ 400; $250 ´ 200) Direct manuf. labor costs ($180 ´ 400; $200 ´ 200) Indirect costs allocated: Machine operations ($25 per mach. hr. ´ 4,000; 2,000) Setups ($30 per setup hr. ´ 1,600; 1,400) Purchase orders ($40 per order ´ 400; 500) Design Marketing (0.05 ´ $1,200 ´ 400; 0.05 ´ $1,500 ´ 200) Administration ($0.42857 ´ 72,000; 40,000) Total costs Cost of each job ($378,857 ¸ 400; $266,143 ¸ 200) 5­10 Total Costs Standard Special Job Job $ 80,000 $ 50,000 72,000 40,000 100,000 50,000 48,000 42,000 16,000 20,000 8,000 32,000 24,000 15,000 30,857 17,143 $378,857 $266,143 $ 947.14 $1,330.72 3. Cost per job Simple Costing System Act ivit y­based Costing System Difference (Simple – ABC) Standard Job $1,051.70 $ 947.14 $ 104.56 Special Job $1,121.70 $1,330.72 $ (209.02) Relative to the ABC system, the simple costing system overcosts standard jobs and undercosts special jo bs. Both types o f jobs need 10 machine hours per job, so in the simple system, they are each allocated $671.70 in indirect costs. But, the ABC study reveals that each standard jo b consumes less of the indirect resources such as setups, purchase orders, and design costs than a special jo b, and this is reflected in the higher indirect costs allocated to special jo bs in the ABC system. 4. Quikprint can use the informat ion revealed by the ABC system to change its pricing based on the ABC costs. Under the simple system, Quikprint was making a gross margin o f 12% on each standard jo b (($1,200 – $1,051.70) ¸ $1,200) and 25% on each special jo b (($1,500 – $1,121.70) ¸ $1,500). But, the ABC system reveals that it is actually making a gross margin o f about 21% (($1,200 – $947) ¸ $1,200) on each standard job and about 11% (($1,500 – $1,331) ¸ $1,500) on each special jo b. Depending on the market compet it iveness, Quikprint may eit her want to reprice the different types o f jo bs, or, it may choose to market standard jo bs more aggressively than before. Quikprint can also use the ABC informat ion to improve its own operations. It could examine each of the indirect cost categories and analyze whether it would be possible to deliver the same level of service, but consume fewer indirect resources, or find a way to reduce the per unit­cost­driver cost of so me of those indirect resources. 5­11 5­22 (25 min.) 1. Allocation of costs to activities, unused capacity. Percentage of Costs Used by Each Activity Indirect Resources Teachers’ salaries and benefits Principals’ salaries and benefits Facilities cost Office staff salaries and benefits Sports program staff salaries and benefits Academic Instruction 60% 10% 35% 5% 35% Administration 20% 60% 15% 60% 10% Sports Training 8% 5% 45% 10% 45% Community 2009 Relationships Expenditures 12% $4,000,000 25% 400,000 5% 2,600,000 25% 300,000 10% 500,000 $7,800,000 Actual Resource Cost Used by Each Activity Indirect Resources Teachers’ salaries and benefits Principals’ salaries and benefits Facilities cost Office staff salaries and benefits Sports program staff salaries and benefits Total No. of students Cost per student Percent of total cost by activity Academic Instruction $2,400,000 40,000 910,000 15,000 175,000 $3,540,000 500 $7,080 45% Sports Administration Training $ 800,000 $ 320,000 240,000 20,000 390,000 1,170,000 180,000 30,000 50,000 225,000 $1,660,000 $1,765,000 500 $ 3,320 21% 500 $3,530 23% Community 2006 Relationships Expenditures $480,000 $4,000,000 100,000 400,000 130,000 2,600,000 75,000 300,000 50,000 500,000 $835,000 $7,800,000 500 $1,670 11% 500 $15,600 100% The overall cost of educat ing each student is $15,600. Of this, $7,080 (or 45%) is spent on academic instruction and $3,320 (or 21%) is spent on administration. 2. Cost of ice hockey program $ 300,000 Total cost of activit ies without ice hockey program = $7,800,000 – $300,000 = $7,500,000 Per student cost of educat ional program wit hout hockey = $7,500,000 ¸ 500 = $ 15,000 Net cost of ice hockey program with $1,000 fee = $300,000 – (30 ´ $1,000) = $ 270,000 Total cost of activit ies with ice hockey program fee = $7,500,000 + $270,000 = $7,770,000 Per student cost of educat ional program wit h hockey fee = $7,770,000 ¸ 500 = $ 15,540 3. Charging a fee helps a bit but the net cost of the ice hockey program is st ill high and significant ly increases the cost of educating each student 5­12 4. Academic instruction capacit y Cost of academic instruction act ivit y (fro m requirement 1 calculat ions) Cost of academic instruction per student at full utilizat ion = $3,540,000 ¸ 600 Academic instruction resource costs used by current student populat ion = 500 ´ $5,900 Cost of excess academic instruction capacit y = $3,540,000 – $2,950,000 600 students $3,540,000 $ 5,900 $2,950,000 $ 590,000 Most of the costs at Harmon school are fixed in the short­run. So, Smith must try to recruit more students to the school. If, in the long run, it seems like the student populat ion is going to be stable at around 500, he should plan how so me of the excess capacit y can be cut back so that the fixed school capacit y is better utilized, that is, he should work to reduce the cost of excess capacit y. One problem with that plan is that “cutting excess academic instruction capacit y” ma y eventually mean reducing the number of sect ions in each grade and letting teachers go, and if this invo lves the loss of experienced teachers, that could cause long­term damage to the school. Unrelated to the excess capacit y issue, but with the aim o f improving the school’s economics, he should consider doing away wit h expensive activit ies like the ice hockey program which raises the cost per student substantially, even after a large fee is charged fro m students who choose to play the sport. 5­13 5­23 (30 min.) ABC, retail product­line profitability. 1. The simple costing system (Panel A of Solut ion Exhibit 5­23) reports the fo llowing: Baked Milk & Frozen Goods Fruit Juice Products Total Revenues $57,000 $63,000 $52,000 $172,000 Costs Cost of goods sold 38,000 47,000 35,000 120,000 Store support (30% of COGS) 11,400 14,100 10,500 36,000 Total costs 49,400 61,100 45,500 156,000 Operating inco me $ 7,600 $ 1,900 $ 6,500 $ 16,000 Operating inco me ÷ Revenues 2. 13.33% 3.02% 12.50% 9.30% The ABC system (Panel B o f Solut ion Exhibit 5­23) reports the fo llowing: Baked Milk & Frozen Goods Fruit Juice Products Total Revenues $57,000 $63,000 $52,000 $172,000 Costs Cost of goods sold 38,000 47,000 35,000 120,000 Ordering ($100 × 30; 25; 13) 3,000 2,500 1,300 6,800 Delivery ($80 × 98; 36; 28) 7,840 2,880 2,240 12,960 Shelf­stocking ($20 × 183; 166; 24) 3,660 3,320 480 7,460 Customer support ($0.20 × 15,500; 20,500; 7,900) 3,100 4,100 1,580 8,780 Total costs 55,600 59,800 40,600 156,000 Operating inco me $ 1,400 $ 3,200 $11,400 $ 16,000 Operating inco me ÷ Revenues 2.46% 5.08% Baked Goods 30 98 183 15,500 21.92% 9.30% These act ivit y costs are based on the fo llowing: Activity Ordering Delivery Shelf­stocking Customer support 3. Cost Allocation Rate $100 per purchase order $80 per delivery $20 per hour $0.20 per item so ld Milk & Frozen Fruit Juice Products 25 13 36 28 166 24 20,500 7,900 The rankings o f products in terms of relative profitabilit y are: Simple Costing System ABC System 1. Baked goods 13.33% Frozen products 2. Frozen products 12.50 Milk & fruit juice 3. Milk & fruit juice 3.02 Baked goods 21.92% 5.08 2.46 5­14 The percentage revenue, COGS, and act ivit y costs for each product line are: Baked Goods 33.14 31.67 44.12 60.49 49.06 35.31 Milk & Frozen Fruit Juice Products Total 36.63 30.23 100.00 39.17 29.16 100.00 36.76 22.22 44.50 46.70 19.12 17.29 6.44 17.99 100.00 100.00 100.00 100.00 Revenues COGS Act ivit y areas: Ordering Delivery Shelf­stocking Customer support The baked goods line drops sizably in pro fitabilit y when ABC is used. Although it const itutes 31.67% of COGS, it uses a higher percentage of total resources in each activit y area, especially the high cost delivery act ivit y area. In contrast, frozen products draws a much lower percentage of total resources used in each act ivit y area than its percentage of total COGS. Hence, under ABC, frozen products is much more profitable. Family Supermarkets may want to explore ways to increase sales o f frozen products. It may also want to explore price increases on baked goods. 5­15 SOLUTION EXHIBIT 5­23 Product­Costing Overviews of Family Supermarkets PANEL A: SIMPLE COSTING SYSTEM INDIRECT CO ST PO O L CO ST ALLO CATIO N BASE } } } } St o r e Support CO G S CO ST O BJECT: PRO DUCT LINE Indirect Costs Direct Costs DIRECT CO ST CO G S PANEL B: ABC SYSTEM INDIRECT COST POOL COST ALLOCATION BASE COST OBJECT: PRODUCT LINE Customer Support Ordering Delivery Shelf­ Stocking Number of Purchase Order Number of Deliveries Hours of Shelf­Stocking Number of Items Sold Indirect Costs Direct Costs DIRECT COST COGS 5­16 5­24 (15–20 min.) ABC, wholesale, customer profitability. Chain 1 Gross sales $50,000 Sales returns 10,000 Net sales 40,000 Cost of goods sold (80%) 32,000 Gross margin 8,000 Customer­related costs: Regular orders $20 × 40; 150; 50; 70 800 Rush orders $100 × 10; 50; 10; 30 1,000 Returned items $10 × 100; 26; 60; 40 1,000 Catalogs and customer support 1,000 Customer related costs 3,800 Contribution (loss) margin $ 4,200 Contribution (loss) margin as percentage of gr oss sales 8.4% 2 $30,000 5,000 25,000 20,000 5,000 3 4 $100,000 $70,000 7,000 6,000 93,000 64,000 74,400 51,200 18,600 12,800 3,000 5,000 260 1,000 9,260 $ (4,260) (14.2%) 1,000 1,000 1,400 3,000 600 400 1,000 1,000 3,600 5,800 $ 15,000 $ 7,000 15.0% 10.0% The analys is indicates that customers’ profitabilit y (loss) contribution varies widely fro m (14.2%) to 15.0%. Immediate attention to Chain 2 is required which is currently showing a loss contribution. The chain has a disproportionate number of both regular orders and rush orders. Villeagas should work with the management of Chain 2 to find ways to reduce the number of orders, while maintaining or increasing the sales volume. If this is not possible, Villeagas should consider dropping Chain 2, if it can save the customer­related costs. Chain 1 has a disproportionate number of the items returned as well as sale returns. The causes of these should be invest igated so that the profitabilit y contribut ion o f Chain 1 could be improved. 5­17 5­25 (50 min.) ABC, activity area cost­driver rates, product cross­subsidization. 1. Direct costs Direct materials Indirect costs Product support Total costs Cost per pound of potato cuts 2. Cost Pool Cleaning Cutting Packaging Costs in Pool $120,000 $231,000 $444,000 $ ,133 000 1 , = = $1.133 1 000 000 , , Number of Driver Units 1,200,000 raw pounds 3,850 hours* 37,000 hours** Costs per Driver Unit $ 0.10 $60.00 $12.00 $ 150,000 983,000 $1,133,000 *(900,000 ÷ 250) + (100,000 ÷ 400) = 3,600 + 250 = 3,850 **(900,000 ÷ 25) + (100,000 ÷ 100) = 36,000 + 1,000 = 37,000 3. Retail Potato Cuts Institutional Potato Cuts Direct costs Direct materials $135,000 $15,000 Packaging 180,000 $ 315,000 8,000 $23,000 Indirect costs Cleaning $0.10 × 90% × 1,200,000 108,000 $0.10 × 10% × 1,200,000 12,000 Cutting $60 × 3,600 hours 216,000 $60 × 250 hours 15,000 Packaging $12 × 36,000; $12 × 1,000 432,000 756,000 12,000 39,000 Total costs $1,071,000 $62,000 Pounds produced 900,000 100,000 Costs per pound $ 1.19 $ 0.62 Note: The total costs of $1,133,000 ($1,071,000 + $62,000) are the same as those in Requirement 1. 5­18 4. There is much evidence of product­cost cross­subsidizat ion. Cost per Pound Simple costing system ABC system Retail $1.133 $1.190 Institutional $1.133 $0.620 Assuming the ABC numbers are more accurate, potato cuts sold to the retail market are undercosted while potatocuts sold to the inst itutional market are overcosted. The simple costing system assumes each product uses all the activit y areas in a ho mogeneous way. This is not the case. Inst itutio nal sales use sizably less resources in the cutting area and the packaging area. The percentages o f total costs for each cost category are as fo llo ws: Retail Institutional Total Direct costs Direct materials 90.0% 10.0% 100.0% Packaging 95.7 4.3 100.0 Indirect costs Cleaning 90.0 10.0 100.0 Cutting 93.5 6.5 100.0 Packaging 97.3 2.7 100.0 Units produced 90.0% 10.0% 100.0% Idaho can use the revised cost informat ion for a variet y of purposes: a. Pricing/product emphasis decisions. The sizable drop in the reported cost of potatoes sold in the inst itutional market makes it possible that Idaho was overpricing potato products in this market. It lost the bid for a large inst itutional contract with a bid 30% above the winning bid. Wit h its revised product cost dropping fro m $1.133 to $0.620, Idaho could have bid much lower and st ill made a profit. An increased emphasis on the inst itutional market appears warranted. b. Product design decisions. ABC provides a road map as to how to reduce the costs of individual products. The relative co mponents of costs are: Retail Direct costs Direct materials Packaging Indirect costs Cleaning Cutting Packaging Total costs 12.6% 16.8 10.1 20.2 40.3 100.0% Institutional 24.20% 12.90 19.35 24.20 19.35 100.00% Packaging­related costs constitute 57.1% (16.8% + 40.3%) of total costs of the retail product line. Design efforts that reduce packaging costs can have a big impact on reducing total unit costs for retail. c. Process improvements. Each act ivit y area is now highlighted as a separate cost. The three indirect cost areas comprise over 60% of total costs for each product, indicat ing the upside fro m improvements in the efficiency o f processes in these act ivit y areas. 5­19 5­26 (20-25 min.) Activity­based costing, job­costing system. 1. An overview of the activit y­based jo b­costing system is: INDI REC T C O S T P O O L } Ax ial In sertion D ip I nsertion M anu al Inser tio n Wav e Sold er B ackload Tes t Defect A nalysis C O S T A LLOC ATIO N B A S E } } } Nu mber of A x ial I nsertion s Nu mb er o f Dip I nsertio ns N umb er o f Man ual Inser tio ns Nu mb er o f Bo ard s So lder ed Nu mb er o f B acklo ad I nsertion s B ud geted Time in Tes t B ud geted Time in An alysis C OST O BJEC T: PC BOA RD Indirect Costs Direct Costs DIRECT DIR EC T COSTS C O S T Direct Materials Diect D irre ct M anuufacturnng Man facturi i g Lab r Laboor 2. Activity Area 1. Axial insertion 2. Dip insertion 3. Manual insert ion 4. Wave so lder 5. Backload 6. Test 7. Defect analys is Total Indirect Manufacturing Costs Allocated $ 0.08 ´ 45 = $ 3.60 0.25 ´ 24 = 6.00 0.50 ´ 11 = 5.50 3.50 ´ 1 = 3.50 0.70 ´ 6 = 4.20 90.00 ´ .25 = 22.50 80.00 ´ .10 = 8.00 $53.30 Direct manufacturing costs: Direct materials Direct manufacturing labor Indirect manufacturing costs: Manufacturing overhead (see above) Total manufacturing costs $75.00 15.00 $ 90.00 53.30 $143.30 3. The manufacturing manager likely would find the ABC job­costing system useful in cost management. Unlike direct manufacturing labor costs, the seven indirect cost pools are systemat ically linked to the activit y areas at the plant. The result is more accurate product costing. Productivit y measures can be developed that direct ly link to the management accounting system. Marketing managers can use ABC informat ion to price jo bs as well as to advise customers about how select ing different product features will affect price. 5­20 5­27 (30 min.) ABC, product­costing at banks, cross­subsidization. 1. Robinson Skerrett Revenues Spread revenue on annual basis (3% ´ ; $1,100, $800, $25,000) Monthly fee charges ($20 ´; 0, 12, 0) Total revenues Costs Deposit/withdrawal wit h teller $2.50 ´ 40; 50; 5 Deposit/withdrawal wit h ATM $0.80 ´ 10; 20; 16 Deposit/withdrawal on prearranged basis $0.50 ´ 0; 12; 60 Bank checks written $8.00 ´ 9; 3; 2 Foreign currency drafts $12.00 ´ 4; 1; 6 Inquiries $1.50 ´ 10; 18; 9 Total costs Operating inco me ( loss) Farrel Total $ 33 0 33 $ 24 240 264 $750.00 $ 807.00 0.00 240.00 750.00 1,047.00 100 8 0 72 48 15 243 $(210) 125 16 6 24 12 27 210 $ 54 12.50 12.80 30.00 16.00 72.00 237.50 36.80 36.00 112.00 132.00 13.50 55.50 156.80 609.80 $593.20 $ 437.20 The assumpt ion that the Robinson and Farrel accounts exceed $1,000 every month and the Skerrett account is less than $1,000 each mo nth means the mo nthly charges apply o nly to Skerrett. One student with a banking background noted that in this so lut ion 100% of the spread is attributed to the “depositor side o f the bank.” He noted that often the spread is divided between the “depositor side” and the “lending side” of the bank. 2. Cross­subsidization across individual Premier Accounts occurs when profits made on some accounts are offset by lo sses on other accounts. The aggregate profitabilit y on the three customers is $437.20. The Farrel account is highly pro fitable ($593.20), while the Robinson account is sizably unprofitable. The Skerrett account shows a small pro fit but only because o f the $240 monthly fees. It is unlikely that Skerrett will keep paying these high fees and that FIB would want Skerret to pay such high fees fro m a customer relat ionship standpoint. The facts also suggest that the customers do not use the bank services uniformly. For example, Robinson and Skerret have a lot of transact ions wit h the teller or ATM, and also inquire about their account balances more often than Farrell. This suggests cross­subsidization. FIB should be very concerned about the cross­subsidization. Co mpet it ion likely would “understand” that high­balance low­act ivit y t ype accounts (such as Farrel) are highly pro fitable. Offering free services to these customers is not likely to retain these accounts if other banks o ffer higher interest rates. Compet it ion likely will reduce the interest rate spread FIB can earn on the high­balance low­activit y accounts they are able to retain. 5­21 3. Possible changes FIB could make are: a. Offer higher interest rates on high­balance accounts to increase FIB’s compet it iveness in attracting and retaining these accounts. b. Introduce charges for individual services. The ABC study reports the cost of eac h service. FIB has to decide if it wants to price each service at cost, below cost, or above cost. If it prices above cost, it may use advert ising and other means to encourage addit ional use o f those services by customers. Of course, in determining its pricing strategy, FIB would need to consider how other compet ing banks are pricing their products and services. 5­28 (15 min.) Job costing with single direct­cost category, single indirect­cost pool, law firm. 1. Pricing decisio ns at Wigan Associates are heavily influenced by reported cost numbers. Suppose Wigan is bidding against another firm fo r a client with a jo b similar to that of Widnes Coal. If the costing system overstates the costs of these jo bs, Wigan may bid too high and fail to land the client. If the costing system understates the costs of these jo bs, Wigan may bid low, land the client, and then lose mo ney in handling the case. 2. Direct professio nal labor, $70 × 104; $70 × 96 Indirect costs allocated, $105 × 104; $105 × 96 Total costs to be billed Widnes Coal $ 7,280 10,920 $18,200 St. Helen’s Glass $ 6,720 10,080 $16,800 Total $14,000 21,000 $35,000 5­22 5­29 (20–25 min.) Job costing with multiple direct­cost categories, single indirect­cost pool, law firm (continuation of 5­28). 1. Indirect costs = $7,000 Total professional labor­hours = 200 hours (104 hours on Widnes Coal + 96 hours on St. Helen’s Glass) Indirect cost allocated per professional labor­hour (revised) = $7,000 ÷ 200 = $35 per hour 2. Direct costs: Direct professio nal labor, $70 × 104; $70 × 96 Research support labor Computer time Travel and allowances Telephones/faxes Photocopying Total direct costs Indirect costs allocated, $35 × 104; $35 × 96 Total costs to be billed 3. Widnes Coal St. Helen’s Glass Total $ 7,280 1,600 500 600 200 250 10,430 3,640 $14,070 $ 6,720 3,400 1,300 4,400 1,000 750 17,570 3,360 $20,930 $14,000 5,000 1,800 5,000 1,200 1,000 28,000 7,000 $35,000 Widnes Coal Problem 5­28 Problem 5­29 $18,200 14,070 St. Helen’s Glass $16,800 20,930 Total $35,000 35,000 The Problem 5­29 approach direct ly traces $14,000 of general support costs to the individua l jo bs. In Problem 5­28, these costs are allocated on the basis of direct professio nal labor­hours. The averaging assumption implicit in the Problem 5­28 approach appears incorrect—for example, the St. Helen’s Glass jo b has travel costs over seven t imes higher than the Widnes Coa l case despite having lower direct professio nal labor­hours. 5­23 5­30 (30 min.) Job costing with multiple direct­cost categories, multiple indirect­cost pools, law firm (continuation of 5­28 and 5­29). 1. Widnes Coal Direct costs: Partner professio nal labor, $100 × 24; $100 × 56 $ 2,400 Associate professio nal labor, $50 × 80; $50 × 40 4,000 Research support labor 1,600 Computer time 500 Travel and allowances 600 Telephones/faxes 200 Photocopying 250 Total direct costs 9,550 Indirect costs allocated: Indirect costs for partners, $57.50 × 24; $57.50 × 56 1,380 Indirect costs for associates, $20 × 80; $20 × 40 1,600 Total indirect costs 2,980 Total costs to be billed $12,530 Widnes Comparison Coal Single direct cost/ Single indirect cost pool $18,200 Mult iple direct costs/ Single indirect cost pool $14,070 Mult iple direct costs/ Mult iple indirect cost pools $12,530 St. Helen’s Glass Total $ 5,600 2,000 3,400 1,300 4,400 1,000 750 18,450 $ 8,000 6,000 5,000 1,800 5,000 1,200 1,000 28,000 3,220 800 4,020 $22,470 St. Helen’s Glass $16,800 $20,930 $22,470 4,600 2,400 7,000 $35,000 Total $35,000 $35,000 $35,000 The higher the percentage of costs direct ly traced to each case, and the greater the number o f ho mogeneous indirect cost pools linked to the cost drivers o f indirect costs, the more accurate the product cost of each individual case. The Widnes and St. Helen’s cases differ in how they use “resource areas” of Wigan Associates: Widnes Coal 30.0% 66.7 32.0 27.8 12.0 16.7 25.0 5­24 St. Helen’s Glass 70.0% 33.3 68.0 72.2 88.0 83.3 75.0 Partner professio nal labor Associate professio nal labor Research support labor Computer time Travel and allowances Telephones/faxes Photocopying The Widnes Coal case makes relat ively low use of the higher­cost partners but relat ively higher use of the lower­cost associates than does St. Helen’s Glass. As a result, it also uses less o f the higher indirect costs required to support partners compared to associates. The Widnes Coal case also makes relat ively lower use of the support labor, computer time, travel, phones/faxes, and photocopying resource areas than does the St. Helen’s Glass case. 2. The specific areas where the mult iple direct/mult iple indirect (MD/MI) approach can provide better informat ion for decisions at Wigan Associates include: Pricing and product (case) emphasis decisions. In a bidding situat ion using single direct/single indirect (SD/SI) or mult iple direct/single indirect (MD/SI) data, Wigan may win bids for legal cases on which it will subsequent ly lo se money. It may also not win bids on which it would make mo ney wit h a lower­priced bid. From a strategic viewpo int, SD/SI or MD/SI exposes Wigan Associates to cherr y­picking by co mpetitors. Other law firms may focus exclusively o n Widnes Coal­t ype cases and take sizable amounts of “pro fitable” business fro m Wigan Associates. MD/MI reduces the likelihood of Wigan Associates losing cases on which it would have made money. Client relationships. MD/MI provides a better “road map” for clients to understand how costs are accumulated at Wigan Associates. Wigan can use this road map when meet ing wit h clients to plan the work to be done on a case before it commences. Clients can negotiate ways to get a lower­cost case fro m Wigan, given the informat ion in MD/MI—for example, (a) use a higher proportion o f associate labor time and a lower proportion o f a partner t ime, and (b) use fax machines more and air travel less. If clients are informed in advance how costs will be accumulated, there is less likelihood of disputes about bills submitted to them after the work is done. Cost control. The MD/MI approach better highlights the individual cost areas at Wigan Associates than does the SD/SI or MD/SI approaches: MD/MI 7 2 9 SD/SI 1 1 2 MD/SI 7 1 8 Number of direct cost categories Number of indirect cost categories Total MD/MI is likely to promote better cost­control practices than SD/SI or MD/SI, as the nine cost categories in MD/MI give Wigan a better handle on how to effect ively manage different categories of both direct and indirect costs. 5­25 5­31 (50 min.) Plantwide, department, and activity­cost rates. 1. Trophies Direct materials Forming Assembly Packaging Total Direct Labor Forming Assembly Packaging Total $2.50 0.50 0.75 $3.75 $3.00 1.50 0.75 $5.25 Plaques $1.50 1.25 0.50 $3.25 $1.20 1.50 0.25 $2.95 Trophies Direct materials ($3.75 × 5,200; $3.25 × 7,500; $0.85 × 16,700) Direct labor ($5.25 × 5,200; $2.95 × 7,500; $1.20 × 16,700) $19,500 27,300 $46,800 Medallions $0.50 0.25 0.10 $0.85 $0.60 0.50 0.10 $1.20 Plaques Medallions $24,375 22,125 $46,500 $14,195 20,040 $34,235 Total $ 58,070 69,465 $127,535 $0.77296 Budgeted = ($22, 386 + $33, 960 + $42, 234) = $98, 580 = per dollar of direct cost overhead rate $127, 535 $127, 535 Trophies (1) (2)=(1)÷5200 (3) Direct materials $19,500 $ 3.75 $24,375 Direct labor 27,300 5.25 22,125 Total direct cost 46,800 9.00 46,500 Allocated overhead* 36,175 6.96 35,943 Total costs $82,975 $15.96 $82,443 Plaques (4)=(3)÷7,500 $ 3.25 2.95 6.20 4.79 $10.99 Medallions (5) (6)=(5)÷16,700 $14,195 $0.85 20,040 1.20 34,235 2.05 26,462 1.58 $60,697 $3.63 Total (7) $ 58,070 69,465 127,535 98,580 $226,115 *Allocated overhead = Total direct cost ×Budgeted overhead rate (0.77296) 5­26 Budgeted Budgeted Forming Dept. overhead costs 2. overhead rate — = Forming Dept. Budgeted Forming Dept. direct­labor costs $22, 386 = ($3 ´ 5, 200) + ($1.20 ´ 7, 500) + ($0.60 ´ , 700) 16 $22, 386 = $15, 600 + $9, 000 + $10, 020 $22, 386 = $0.64662 per Forming Dept. direct­labor $ = $34, 620 Budgeted Budgeted Assembly Dept. overhead costs overhead rate — = Budgeted Assembly Dept. direct costs Assembly Dept. $33, 960 = ($2 ´ 5, 200) + ($2.75 ´ 7, 500) + ($0.75 ´ , 700) 16 $33, 960 = $10, 400 + $20, 625 + $12, 525 $33, 960 = $0.77979 per Assembly Dept. direct cost $ = $43, 550 Budgeted Budgeted Packaging Dept. overhead costs overhead rate — = Packaging Dept. Budgeted Packaging Dept. direct material costs $42, 234 = ($0.75 ´ 5, 200) + ($0.50 ´ 7, 500) + ($0.10 ´ , 700) 16 $42, 234 = $3, 900 + $3, 750 + $1, 670 $42, 234 = $4.53155 per Packaging Dept. direct material $ = $9, 320 5­27 Direct materials Direct labor Total direct cost Allocated overhead Forming Dept.a b Assembly Dept. c Packaging Dept. _______Trophies______ (1) (2)=(1)÷5200 $19,500 $ 3.75 27,300 46,800 10,087 8,110 17,673 $82,670 5.25 9.00 1.94 1.56 3.40 $15.90 Trophies _______Plaques________ _______Medallions______ (3) (4)=(3)÷7,500 (5) (6)=(5)÷16,700 $24,375 $ 3.25 $14,195 $0.85 22,125 46,500 5,820 16,083 16,993 $85,396 2.95 6.20 0.78 2.14 2.27 $11.39 20,040 34,235 6,479 9,767 7,568 $58,049 1.20 2.05 0.39 0.59 0.45 $3.48 Total (7) $ 58,070 69,465 127,535 22,386 33,960 42,234 $226,115 Total costs Plaques Medallions $9,000 $10,020 a Forming Dept. $15,600 Direct labor costs Allocated overhead (0.64662 × $15,600; $9,000; $10,020) $10,087 b $5,820 $ 6,479 Assembly Dept. $10,400 $20,625 $12,525 Total direct costs Allocated overhead (0.77979 × $10,400; $20,625 $12,525) $ 8,110 c $16,083 $ 9,767 Packaging Dept. $ 3,900 $ 3,750 $ 1,670 Direct material costs Allocated overhead (4.53155 × $3,900; $3,750 $1,670) $17,673 $16,993 $ 7,568 3. Forming Assembly Packaging Total batches Trophies Plaques Medallio ns Total Total direct labor costs Trophies 5,200 × $3; $1.50; $0.75 Plaques 7,500 × $1.20; $1.50; $0.25 Medallio ns 16,700 × $0.60; $0.50; $0.10 Total 116 40 44 200 63 83 84 230 80 100 190 370 Total 259 223 318 800 $15,600 9,000 10,020 $34,620 $ 7,800 11,250 8,350 $27,400 $3,900 1,875 1,670 $7,445 $27,300 22,125 20,040 $69,465 5­28 Forming Dept. Budgeted materials – = $5, 700 = $28.50 per batch handling rate 200 batches Budgeted quality inspection rate Budgeted utilities rate = $6, 300 = $31.50 per batch 200 batches = $10, 386 $34, 620 = $0.30 per direct­labor $ Assembly Dept. $9, 200 Budgeted materials – = = $40 per batch handling rate 230 batches Budgeted quality inspection rate Budgeted utilities rate = $13, 80 0 = $60 per batch 230 batches = $10, 960 $27, 400 = $0.40 per direct­labor $ Packaging Dept. Budgeted materials – = $18, 315 = $49.50 per batch handling rate 370 batches Budgeted quality inspection rate Budgeted utilities rate = $1 4, 985 = $40.50 per batch 370 batches = $8, 934 $7, 445 = $1.20 per direct­labor $ 5­29 Direct material costs Direct labor costs Total direct costs Forming Dept. overhead Materials handling $28.50 ´ 116; 40; 44 Qualit y inspect ion $31.50 ´ 116; 40, 44 Utilit ies 0.30 ´ $15,600;$9,000; $10,020 Assembly Dept. overhead Materials handling $40 ´ 63; 83; 84 Qualit y inspect ion $60 ´ 63; 83; 84 Utilit ies 0.40 ´ $7,800; $11,250; $8,350 Packaging Dept. overhead Materials handling $49.50 ´ 80; 100; 190 Qualit y inspect ion $40.50 ´ 80; 100; 190 Utilit ies 1.20 ´ $3,900; $1,875; $1,670 Total costs Trophies (1) (2) = (1) ÷ 5,200 $19,500 $ 3.75 27,300 5.25 46,800 9.00 Plaques (3) (4) = (3) ÷ $7,500 $24,375 $ 3.25 22,125 2.95 46,500 6.20 Medallions (5) (6) = (5) ÷ 16,700 $14,195 $0.85 20,040 1.20 34,235 2.05 Total (7) $ 58,070 69,465 127,535 3,306 3,654 4,680 0.64 0.70 0.90 1,140 1,260 3,000 0.15 0.17 0.40 1,254 1,386 3,006 0.08 0.08 0.18 5,700 6,300 10,386 2,520 3,780 3,120 0.48 0.73 0.60 3,320 4,980 4,500 0.44 0.67 0.60 3,360 5,040 3,340 0.20 0.30 0.20 9,200 13,800 10,960 3,960 3,240 4,680 $79,740 0.76 0.62 0.90 $15.33 4,950 4,050 2,250 $75,950 0.66 0.54 0.30 $10.13 9,405 7,695 2,004 $70,725 0.56 0.46 0.12 $4.23 18,315 14,985 8,934 $226,115 5­30 4. Disaggregated informat ion can improve decisio ns by allo wing managers to see the details which helps them understand how different aspects of cost influence total cost per unit. Managers can also understand the dr ivers o f different cost categories and use this informat ion for pricing and product­mix decis io ns, cost reduction and process­improvement decisio ns, desig n decisio ns, and to plan and manage act ivit ies. However, too much detail can overload managers who don’t understand the data or what it means. Also, managers looking at per unit data may be misled when considering costs that aren’t unit­level costs. 5­31 5­32 (30­40 min.) Department and activity­cost rates service sector. 1. Overhead costs = $20,610 + $247,320 + $196,180 + $134,350 = $598,460 Budgeted overhead= $598, 460 = $1.626 per DL $ rate $368, 040 X­rays $ 61,440 32,240 22,080 99,901 $215,661 ÷3,840 $ 56.16 Ultrasound $105,600 268,000 16,500 171,706 $561,806 ÷4,400 $ 127.68 CT scan $ 96,000 439,000 24,000 156,096 $715,096 ÷3,000 $ 238.37 MRI $ 105,000 897,500 31,250 170,730 $1,204,480 ÷2,500 $ 481.79 Total $ 368,040 1,636,740 93,830 598,433 $2,697,043 Technicia n labor Depr eciation Materials Allocated over hea d* Total budgeted costs Budgeted number of procedures Budgeted cost per service * Allocated overhead = Budgeted overhead rate × Technician labor costs 2. Budgeted Informat ion Number of procedures Cleaning minutes per procedure Total cleaning minutes Number of procedures Minutes for each procedure Total procedure minutes X­rays 3,840 ×5 19,200 3,840 ×5 19,200 Ultrasound 4,400 ×5 22,000 4,400 ×15 66,000 CT scan 3,000 ×15 45,000 3,000 ×20 60,000 MRI 2,500 ×35 87,500 2,500 ×45 112,500 Total 13,740 173,700 13,740 257,700 Units of Budgeted Cost Cost Driver Cost Driver Activity Rate Activity (1) (2) (3) (4) = (1) ÷ (3) Administration $ 20,610 Total number 13,740 $1.50 per procedure of procedures Maintenance $247,320 Total dollars $1,636,740 $0.151105 per dollar of depreciat ion of depreciat ion Sanitat ion $196,180 Total cleaning 173,700 $1.12942 per cleaning minute minutes Utilit ies $134,350 Total procedure 257,700 $0.52134 per procedure minute minutes X­rays $ 61,440 32,240 22,080 Ultrasound $105,600 268,000 16,500 CT scan $ 96,000 439,000 24,000 MRI $ 105,000 897,500 31,250 Total $ 368,040 1,636,740 93,830 Technician labor Depreciation Materials Allocated activity costs: Administration ($1.50×3,840; 4,400; 3,000; 2,500) 5,760 6,600 4,500 3,750 20,610 5-32 Maintenance ($0.151105×$32,240; $268,000; $439,000; $897,500) Sanitation ($1.12942×19,200; 22,000; 45,000; 87,500) Utilities ($0.52134×19,200; 66,000; 60,000; 112,500) Total budgeted cost Budgeted number of procedures Budgeted cost per service 4,872 21,685 10,010 $158,087 ÷3,840 $ 41.17 40,496 24,847 34,409 $496,452 ÷4,400 $ 112.83 66,335 50,824 31,280 $711,939 ÷3,000 $ 237.31 135,617 98,824 58,651 $1,330,592 ÷2,500 $ 532.24 247,320 196,180 134,350 $2,697,070 3. Using the disaggregated activit y­based costing data, managers can see that the MRI actually costs substant ially more and x­rays and ultrasounds substant ially less than the tradit ional system indicated. In particular, the MRI activit y generates a lot of maintenance act ivit y and sanitat ion activit y. Managers should examine the use of these two activit ies to search for ways to reduce the activit y consumption and ult imately its cost. 5-33 5­33 (30 min.) Choosing cost drivers, activity­based costing, activity­based management. 1. Direct costs = Dance teacher salaries, Child care teacher salaries, Fitness instructor salaries Indirect costs = Supplies; Rent, maintenance, and utilit ies; Administration salaries; Marketing expenses 2. Indirect Cost Supplies Rent, maintenance, and utilit ies Administration salaries Marketing expenses Cost Driver Number of participants Square footage Number of participants Number of advertisements Budgeted Cost Driver Rate $21,984 ÷ 2,205 = $9.97 per participant $97,511÷ 11,650 = $8.37 per square foot $50,075 ÷ 2,205 = $22.71 per participant $21,000 ÷ 70 = $300 per advertisement Supplies – Larger programs with more participants will require more supplies. For example, as the number of dance part icipants increases, so will the cost of dance accessories. Rent, maintenance and utilit ies are all building­related costs. Square­footage is the only space­ oriented cost driver available. Administration salaries – Larger programs require more time to enroll students and collect fees. Consequent ly, the number of participants appears to be a reasonable cost driver. Marketing expenses – Marketing expenses include the cost of advertising the studio. As the number of ads increases so do total market ing costs. 3. Salaries Allocated costs: Supplies ($9.97×1,485; 450; 270) Rent, maintenance, and utilit ies ($8.37×6,000; 3,150; 2,500) Administration salaries ($22.71×1,485; 450; 270) Marketing expenses ($300×26; 24; 20) Budgeted total costs ÷ Number of participants Budgeted cost per participant Dance $ 62,100 Childcare $ 24,300 Fitness $ 39,060 Total $ 125,460 14,805 50,220 33,724 7,800 $ 168,649 ÷ 1,485 $ 113.57 4,487 26,366 10,219 7,200 $ 72,572 ÷450 $ 161.27 2,692 20,925 6,132 6,000 $ 74,809 ÷270 $ 277.07 21,984 97,511 50,075 21,000 $ 316,030 4. By dividing the full cost of each service line by the number of participants, Annie can see that fitness classes should be charged a higher price. Most of the higher unit cost is attributable to the cost of Aerobic instructors. Besides cost data, Annie should also consider a variet y of other factors before setting the price for each service. Examples of other issues she should consider include the act ions of co mpet itors in her market, and the qualit y o f her facilit ies and instructors. 5-34 5­34 (30–40 min.) Activity­based costing, merchandising. 1. General Supermarket Drugstore Chains Chains $3,708,000 $3,150,000 3,600,000 3,000,000 $ 108,000 $ 150,000 Mom­and­Pop Single Stores Total $1,980,000 $8,838,000 1,800,000 8,400,000 $ 180,000 $ 438,000 301,080 $ 136,920 9.09% Revenues Cost of goods sold Gross margin Other operating costs Operating inco me Gross margin % 2.91% 4.76% The gross margin of Pharmacare, Inc., was 4.96% ($438,000 ÷ $8,838,000). The operating inco me margin o f Pharmacare, Inc., was 1.55% ($136,920 ÷ $8,838,000). 2. The per­unit cost driver rates are: 1. Customer purchase order processing, $80,000 ÷ 2,000 (140 + 360 + 1,500) orders 2. Line item ordering, $63,840 ÷ 21,280 (1,960 + 4,320 + 15,000) line items 3. Store delivery, $71,000 ÷ 1,480 (120 + 360 + 1,000) deliveries 4. Cartons shipped, $76,000 ÷ 76,000 (36,000 + 24,000 + 16,000) cartons 5. Shelf­stocking, $10,240 ÷ 640 (360 + 180 + 100) hours 3. = $40 per order = $ 3 per line item = $47.973 per delivery = $ 1 per carton = $16 per hour The activit y­based costing of each distribut ion market for August 2008 is: General Supermarket Chains Drugstore Chains $14,400 12,960 17,270 24,000 2,880 $71,510 Mom­and­ Pop Single Stores $ 60,000 45,000 47,973 16,000 1,600 $170,573 Total $ 80,000 63 ,840 71,000 76,000 10,240 $301,080 1. Customer purchase order processing ($40 ´ 140; 360; 1,500) 2. Line item ordering ($3 ´ 1,960; 4,320; 15,000) 3. Store deliver y, ($47.973 ´ 120; 360; 1,000) 4. Cartons shipped ($1 ´ 36,000; 24,000; 16,000) 5. Shelf­stocking ($16 ´ 360; 180; 100) $ 5,600 5,880 5,757 36,000 5,760 $58,997 5-35 The revised operating inco me statement is: General Supermarket Drugstore Chains Chains Revenues $3,708,000 $3,150,000 Cost of goods sold 3,600,000 3,000,000 Gross margin 108,000 150,000 Operating costs 58,997 71,510 Operating inco me $ 49,003 $ 78,490 Operating inco me margin 1.32% 4. 2.49% Mom­and­Pop Single Stores $1,980,000 1,800,000 180,000 170,573 $ 9,427 0.48% Total $8,838,000 8,400,000 438,000 301,080 $ 136,920 1.55% The ranking of the three markets are: Using Gross Margin 1. Mom­and­Pop Single Stores 9.09% 2. Drugstore Chains 4.76% 3. General Supermarket Chains 2.91% Using Operating Income 1. Drugstore Chains 2. General Supermarket Chains 3. Mom­and­Pop Single Stores 2.49% 1.32% 0.48% The act ivit y­based analysis o f costs highlights how the Mom­and­Pop Single Stores use a larger amount of Pharmacare’s resources per revenue do llar than do the other two markets. The ratio o f the operating costs to revenues across the three markets is: General Supermarket Chains Drugstore Chains Mom­and­Pop Single Stores 1.59% 2.27% 8.61% ($58,997 ÷ $3,708,000) ($71,510 ÷ $3,150,000) ($170,573 ÷ $1,980,000) This is a classic illustration of the maxim that “all revenue dollars are not created equal.” The analys is indicates that the Mom­and­Pop Single Stores are the least profitable market. Pharmacare should work to increase profits in this market through: (1) a possible surcharge, (2) decreasing the number of orders, (3) offering discounts for quant ity purchases, etc. Other issues for Pharmacare to consider include a. Choosing the appropriate cost drivers for each area. The problem gives a cost driver for each chosen act ivit y area. However, it is likely that over time further refinements in cost drivers would occur. For example, not all store deliveries are equally easy to make, depending on parking availabilit y, accessibilit y o f the storage/shelf space to the delivery point, etc. Similarly, not all cartons are equally easy to deliver––their weight, size, or likely breakage component are factors that can vary across carton types. b. Developing a reliable data base on the chosen cost drivers. For some items, such as the number o f orders and the number of line items, this informat ion likely would be available in machine readable form at a high level o f accuracy. Unless the deliver y personnel have hand­held co mputers that they use in a systemat ic way, est imates of shelf­stocking t ime are likely to be unreliable. Advances in informat ion techno logy likely will reduce problems in this area over time. 5-36 c. Deciding how to handle costs that may be common across several activities. For example, (3) store delivery and (4) cartons shipped to stores have the co mmo n cost of the same trip. So me organizat ions may treat (3) as the primary act ivit y and attribute only incremental costs to (4). Similarly, (1) order processing and (2) line item ordering may have commo n costs. d. Behavioral factors are likely to be a challenge to Flair. He must now tell those salespeople who specialize in Mo m­and­Pop accounts that they have been less profitable than previously thought. 5-37 5­35 (30­40 min.) Choosing cost drivers, activity­based costing, activity­based management. 1. Direct materials—purses Direct materials—backpacks Direct manufacturing labor—purses Direct manufacturing labor—backpacks Setup Shipping Design Plant utilit ies and administration 2. Direct materials—purses Direct materials—backpacks Direct manufacturing labor—purses Direct manufacturing labor—backpacks Setup Shipping Design Plant utilit ies and administration Output unit­level costs Output unit­level costs Output unit­level costs Output unit­level costs Batch­level costs Batch­level costs Product­sustaining costs Facilit y­sustaining costs Number of bags Number of bags Number of bags Number of bags Number of batches Number of batches Number of designs Hours of production Direct material and direct manufacturing labor are costs that can be easily traced to output, which in this case is the number of bags produced. Setup and shipping are both a funct ion of the number of batches produced. Design is related to the number of designs created for each product. Plant utilit ies and administration result fro m general act ivit y level in the plant. Thus, hours of production seems to be an appropriate cost driver. 3. Direct materials—purses $362,000 ÷ 3,150 purses = $114.92 per purse Direct materials—backpacks $427,000 ÷ 6,000 backpacks = $71.17 per backpack Direct manufacturing labor—purses $98,000 ÷ 3,150 purses = $31.11 per purse Direct manufacturing labor—backpacks $115,597 ÷ 6,000 backpacks = $19.27 per backpack Setup $64,960 ÷ 203 = $320 per batch Shipping $72,065 ÷ 203 = $355 per batch Design $167,000 ÷ 5 = $33,400 per design Plant utilit ies and administration $225,000 ÷ 4,160 hours = $54.0865 per hour 5-38 4. Direct materials Direct manufacturing labor Setup ($320×133; 70) Shipping ($355×133; 70) Design ($33,400×3; 2) Plant utilit ies and administration ($54.0865×1,560; 2,600) Budgeted total costs ÷ Number of bags Budgeted cost per bag Backpacks $427,000 115,597 42,560 47,215 100,200, 84,375 $816,947 ÷ 6,000 $ 136.16 Purses $362,000 98,000 22,400 24,850 66,800 140,625 $714,675 ÷ 3,150 $ 226.88 Total $ 789,000 213,597 64,960 72,065 167,000 225,000 $1,531,622 5. Based on this analys is, over 50% of product cost relates to direct material. Managers should determine whether the material costs can be reduced. Producing in small lots increases the setup and shipping costs. While both are relatively small components of product cost, management may want to evaluate ways to reduce the number of setups and the cost per setup. Of the indirect costs, the product­ and facilit y­sustaining costs are the highest. Management should review the design process for cost savings and examine why it takes so long to produce purses relative to backpacks. 5-39 5­36 (40 min.) ABC, health care. 1a. Medical supplies rate = = Rent and clinic maintenance rate = = Admin. cost rate for patient­charts food and laundry Medical supplies costs $300, 000 = Total number of patient ­ years 150 $2,000/patient­year Rent and clinic maint. costs $180,000 = Total amount of square feet of space 30,000 $6 per square foot Admin. costs to manage patient charts, food, laundry $600, 000 = Total number of patient ­ years 150 $4,000/patient­year Laboratory services costs $100,000 = Total number of laboratory tests 2,500 $40 per test = = Laboratory services rate = = These cost drivers are chosen as the ones that best match the descript ions o f why the costs arise. Other answers are acceptable, provided that clear explanat ions are given. 1b. Act ivit y­based costs for each program and cost per patient­year of the alcoho l and drug program fo llow: Alcohol Direct labor Physicians at $150,000 × 0; 4; 0 Psychologists at $75,000 × 6; 4; 8 Nurses at $30,000 × 4; 6; 10 Direct labor costs Medical supplies1 $2,000 × 40; 50; 60 Rent and clinic maintenance2 $6 × 9,000; 9,000; 12,000 Administrative costs to manage 3 patient charts, food, and laundry $4,000 × 40; 50; 60 Laboratory services4 $40 × 400; 1,400; 700 Total costs Cost per patient­year 1 2 Drug $ 600,000 300,000 180,000 1,080,000 100,000 54,000 After­Care — $ 600,000 300,000 900,000 120,000 72,000 Total $ 600,000 1,350,000 600,000 2,550,000 300,000 180,000 — $450,000 120,000 570,000 80,000 54,000 160,000 16,000 $880,000 $880,000 40 200,000 56,000 $1,490,000 $1,490,000 50 240,000 28,000 $1,360,000 600,000 100,000 $3,730,000 = $22,000 = $29,800 Allocated using patient­years Allocated using square feet of space 3 Allocated using patient­years 4 Allocated using number of laboratory tests 5-40 1c. The ABC system more accurately allo cates costs because it ident ifies better cost drivers. The ABC system chooses cost drivers for overhead costs that have a cause­and­effect relat ionship between the cost drivers and the costs. Of course, Clayton should cont inue to evaluate if better cost drivers can be found than the ones they have ident ified so far. By implement ing the ABC system, Clayton can gain a more detailed understanding o f costs and cost drivers. This is valuable informat ion fro m a cost management perspective. The system can yield insight into the efficiencies with which various activit ies are performed. Clayton can then examine if redundant activit ies can be eliminated. Clayton can study trends and work toward improving the efficiency o f the activities. In addit io n, the ABC system will help Clayton determine which programs are the most costly to operate. This will be useful in making lo ng­run decis io ns as to which programs to offer or emphasize. The ABC system will also assist Clayton in setting prices for the programs that more accurately reflect the costs of each program. 2. The concern wit h using costs per patient­year as the rule to allocate resources among its programs is that it emphasizes “input” to the exclusion o f “outputs” or effect iveness of the programs. After­all, Clayton’s goal is to cure patients while controlling costs, not minimize costs per­patient year. The problem, of course, is measuring outputs. Unlike many manufacturing co mpanies, where the outputs are obvious because they are tangible and measurable, the outputs of service organizat ions are more difficult to measure. Examples are “cured” patients as dist inguished from “processed” or “discharged” pat ients, “educated” as dist inguished fro m “partially educated” students, and so on. 5-41 5­37 (25 min.) Unused capacity, activity­based costing, activity­based management. 1. Number of batches Machine­hours Basketballs 300 11,000 Volleyballs 400 12,500 Total 700 23,500 Setup cost per batch = $143,500 ÷ 700 batches = $205 per batch. Equipment and maintenance = $109,900 ÷ 23,500 machine­hours = $4.6766 per machine­hour. Lease rent, insurance, utilit ies = $216,000 ÷ 12,000 sq. ft. of capacit y = $18 per sq. ft. Capacity Capacity used for 2. Unused capacity = Total capacity - basketball used for v olleyball production production = 12, 000 - 3, 360 - 5, 040 = 3, 600 sq. ft. Cost of unused capacit y = $18 per sq. ft × 3,600 sq. ft. = $64,800 3. Basketballs Volleyballs Total Direct materials $209,750 $358,290 $ 568,040 Direct manufacturing labor 107,333 102,969 210,302 Setup ($205 × 300; 400) 61,500 82,000 143,500 Equipment and maintenance ($4.6766 × 11,000; 12,500) 51,442 58,458 109,900 Lease rent, etc. ($18 × 3,360; 5,040) 60,480 90,720 151,200 $490,505 Budgeted total costs $692,437 $1,182,942 ÷ 66,000 ÷ Number of unit s ÷100,000 $ 7.43 Budgeted cost per unit $ 6.92 4. Currently, Nivag only utilizes 70% of its available capacit y. Managers should consider whether the excess capacit y is sufficient to produce footballs. Other issues to consider include demand for the proposed product, the compet it ion, capital invest ment needed to start and support this product line, and the availabilit y of skilled and unskilled labor needed to manufacture footballs. 5-42 5­38 (40-50 min.) Activity­based job costing, unit­cost comparisons. An overview of the product­costing system is: INDI RECT COST POOL } Materials Handling Lathe Work Milling Grinding Testing COST ALLOCAT ION BASE } } } Number of Parts Number of Turns Number of Machine­Hours Number of Parts Number of Units Tested COST OB JECT: COMPONENTS Indirect Costs Direct Costs DIRE CT COST Direct Materials Direct Manufacturing Labor 1. Job Order 410 Direct manufacturing cost Direct materials Direct manufacturing labor $30 ´ 25; $30 ´ 375 Indirect manufacturing cost $115 ´ 25; $115 ´ 375 Total manufacturing cost Number of unit s Manufacturing cost per unit $9,700 750 $10,450 2,875 $13,325 ÷ 10 $ 1,332.50 Job Order 411 $59,900 11,250 $ 71,150 43,125 $114,275 ÷ 200 $ 571.375 5-43 2. Direct manufacturing cost Direct materials Direct manufacturing labor $30 ´ 25; $30 ´ 375 Indirect manufacturing cost Materials handling $0.40 ´ 500; $0.40 ´ 2,000 Lathe work $0.20 ´ 20,000; $0.20 ´ 60,000 Milling $20.00 ´ 150; $20.00 ´ 1,050 Grinding $0.80 ´ 500; $0.80 ´ 2,000 Testing $15.00 ´ 10; $15.00 ´ 200 Total manufacturing cost Number of unit s Manufacturing cost per unit Job Order 410 $9,700 750 $10,450 Job Order 411 $59,900 11,250 $ 71,150 200 4,000 3,000 400 150 7,750 $18,200 ÷ 10 $ 1,820 800 12,000 21,000 1,600 3,000 38,400 $109,550 ÷ 200 $ 547.75 3. Number of unit s in job Costs per unit with prior costing system Costs per unit with act ivit y­based costing Job Order 410 10 $1,332.50 1,820.00 Job Order 411 200 $571.375 547.750 Job order 410 has an increase in reported unit cost of 36.6% [($1,820 – $1,332.50) ÷ $1,332.50], while jo b order 411 has a decrease in reported unit cost of 4.1% [($547.75 – $571.375) ÷ $571.375]. A co mmo n finding when act ivit y­based costing is implemented is that low­vo lume products have increases in their reported costs while high­vo lume products have decreases in their reported cost. This result is also found in requirements 1 and 2 o f this problem. Costs such as materials­handling costs vary wit h the number of parts handled (a funct ion of batches and complexit y o f products) rather than with direct manufacturing labor­hours, an output­unit leve l cost driver, which was the only cost driver in the previous jo b­costing system. The product cost figures co mputed in requirements 1 and 2 differ because a. the job orders differ in the way they use each of five activit y areas, and b. the act ivit y areas differ in their indirect cost allocation bases (specifically, each area does not use the direct manufacturing labor­hours indirect cost allocation base). 5-44 The fo llowing table documents how the two job orders differ in the way they use each of the five activit y areas included in indirect manufacturing costs: Usage Based on Analysis of Usage Assumed with Direct Manuf. Activity Area Cost Drivers Labor­Hours as Application Base Job Order Job Order Job Order Job Order 410 411 410 411 20.0% 80.0% 6.25% 93.75% 25.0 75.0 6.25 93.75 12.5 87.5 6.25 93.75 20.0 80.0 6.25 93.75 4.8 95.2 6.25 93.75 Activity Area Materials handling Lathe work Milling Grinding Testing The differences in product cost figures might be important to Tracy Corporation for product pricing and product emphasis decisio ns. The act ivit y­based account ing approach indicates that job order 410 is being undercosted while jo b order 411 is being overcosted. Tracy Corporation may erroneously push job order 410 and deemphasize jo b order 411. Moreover, by its act ions, Tracy Corporation may encourage a compet itor to enter the market for job order 411 and take market share away fro m it. 4. Informat ion fro m the ABC system can also help Tracy manage its business better in several ways. a. Product design. Product designers at Tracy Corporation likely will find the numbers in the act ivit y­based cost ing approach more believable and credible than those in the simple system. In a machine­paced manufacturing environment, it is unlikely that direct labor­hours would be the major cost driver. Activit y­based costing provides more credible signals to product designers about the ways the costs of a product can be reduced––for example, use fewer parts, require fewer turns on the lathe, and reduce the number of machine­hours in the milling area. b. Cost management. Tracy can reduce the cost of jo bs both by making process improvements that reduce the activit ies that need to be done to complete jobs and by reducing the costs of doing the act ivit ies. c. Cost planning. ABC provides a more refined mo del to forecast costs and to explain why actual costs differ fro m budgeted costs. 5-45 5­39 (50 min.) ABC, implementation, ethics. 1. Applewood Electronics should not emphasize the Regal model and should not phase out the Monarch model. Under activit y­based costing, the Regal model has an operating inco me percentage of less than 3%, while the Monarch model has an operating inco me percentage of nearly 43%. Cost driver rates for the various activit ies ident ified in the act ivit y­based costing (ABC) system are as fo llows: Soldering $ 942,000 ¸ 1,570,000 = $ 0.60 per solder point Shipments 860,000 ¸ 20,000 = 43.00 per shipment Qualit y control 1,240,000 ¸ 77,500 = 16.00 per inspection Purchase orders 950,400 ¸ 190,080 = 5.00 per order Machine power 57,600 ¸ 192,000 = 0.30 per machine­hour Machine setups 750,000 ¸ 30,000 = 25.00 per setup Applewood Electronics Calculation of Costs of Each Model under Activity­Based Costing Monarch Direct costs Direct materials ($208 ´ 22,000; $584 ´ 4,000) $ 4,576,000 Direct manufacturing labor ($18 ´ 22,000; $42 ´ 4,000) 396,000 Machine costs ($144 ´ 22,000; $72 ´ 4,000) 3,168,000 Total direct costs 8,140,000 Indirect costs Soldering ($0.60 ´ 1,185,000; $0.60 ´ 385,000) 711,000 Shipments ($43 ´ 16,200; $43 ´ 3,800) 696,600 Quality control ($16 ´ 56,200; $16 ´ 21,300) 899,200 Purchase orders ($5 ´ 80,100; $5 ´ 109,980) 400,500 Machine power ($0.30 ´ 176,000; $0.30 ´ 16,000) 52,800 Machine setups ($25 ´ 16,000; $25 ´ 14,000) 400,000 Total indir ect costs 3,160,100 Total costs $11,300,100 Regal $2,336,000 168,000 288,000 2,792,000 231,000 163,400 340,800 549,900 4,800 350,000 1,639,900 $4,431,900 5-46 Profitability analysis Revenues Cost of goods sold Gross margin Per­unit calculat ions: Units so ld Selling price ($19,800,000 ¸ 22,000; $4,560,000 ¸ 4,000) Cost of goods sold ($11,300,100 ¸ 22,000; $4,431,900 ¸ 4,000) Gross margin Gross margin percentage Monarch $19,800,000 11,300,100 $ 8,499,900 Regal $4,560,000 4,431,900 $ 128,100 Total $24,360,000 15,732,000 $ 8,628,000 22,000 4,000 $900.00 $1,140.00 513.64 $386.36 42.9% 1,107.98 $ 32.02 2.8% 2. Applewood’s simple costing system allocates all manufacturing overhead other than machine costs on the basis of machine­hours, an output unit­level cost driver. Consequently, the more machine­hours per unit that a product needs, the greater the manufacturing overhead allocated to it. Because Monarch uses twice the number of machine­hours per unit compared to Regal, a large amount of manufacturing overhead is allocated to Monarch. The ABC analysis recognizes several batch­level cost drivers such as purchase orders, shipments, and setups. Regal uses these resources much more intensively than Monarch. The ABC system recognizes Regal’s use o f these overhead resources. Consider, for example, purchase order costs. The simple system allocates these costs on the basis o f machine­hours. As a result, each unit of Monarch is allo cated twice the purchase order costs of each unit of Regal. The ABC system allocates $400,500 of purchase order costs to Monarch (equal to $18.20 ($400,500 ¸ 22,000) per unit) and $549,900 of purchase order costs to Regal (equal to $137.48 ($549,900 ¸ 4,000) per unit). Each unit of Regal uses 7.55 ($137.48 ¸ $18.20) times the purchases order costs of each unit of Monarch. Recognizing Regal’s more intensive use o f manufacturing overhead result s in Rega l showing a much lower profitabilit y under the ABC system. By the same token, the ABC analys is shows that Monarch is quite profitable. The simple costing system overcosted Monarch, and so made it appear less profitable. 3. Duval’s co mments about ABC implementation are valid. When designing and implement ing ABC systems, managers and management accountants need to trade off the costs of the system against its benefits. Adding more activit ies would make the system harder to understand and more costly to implement but it would probably improve the accuracy o f cost informat ion, which, in turn, would help Applewood make better decisions. Similarly, using inspection­hours and setup­hours as allocat ion bases would also probably lead to more accurate cost informat ion, but it would increase measurement costs. 5-47 4. Act ivit y­based management (ABM) is the use o f informat ion fro m act ivit y­based costing to make improvements in a firm. For example, a firm could revise product prices on the basis o f revised cost informat ion. For the long term, activit y­based costing can assist management in making decisio ns regarding the viabilit y o f product lines, distribut ion channels, market ing strategies, etc. ABM highlights possible improvements, including reduct ion or eliminat ion o f non­value­added act ivit ies, select ing lower cost activit ies, sharing activit ies wit h other products, and eliminat ing waste. ABM is an integrated approach that focuses management’s attention on activit ies wit h the ult imate aim of cont inuous improvement. As a who le­co mpany philosophy, ABM focuses on strategic, as well as tactical and operational act ivit ies of the company. 5. Incorrect reporting of ABC costs with the goal of retaining both the Monarch and Rega l product lines is unethical. In assessing the situat ion, the specific “Standards o f Ethical Conduct for Management Accountants” (described in Exhibit 1­7) that the management accountant should consider are listed below. Competence Clear reports using relevant and reliable informatio n should be prepared. Preparing reports on the basis of incorrect costs in order to retain product lines vio lates competence standards. It is unethical for Benzo to change the ABC system with the specific goal of reporting different product cost numbers that Duval favors. Integrity The management accountant has a responsibilit y to avoid actual or apparent conflicts of interest and advise all appropriate parties o f any potential conflict. Benzo may be tempted to change the product cost numbers to please Duval, the division president. This act ion, however, would vio late the responsibilit y for integrit y. The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable informat ion. Credibility The management accountant’s standards of ethical conduct require that informat ion should be fairly and object ively communicated and that all relevant informat ion should be disclosed. From a management accountant’s standpo int, adjust ing the product cost numbers to make both the Monarch and Regal lines look profitable would vio late the standard of object ivit y. Benzo should indicate to Duval that the product cost calculations are, indeed, appropriate. If Duval st ill insists on modifying the product cost numbers, Benzo should raise the matter with one of Duval’s superiors. If, after taking all these steps, there is cont inued pressure to modify product cost numbers, Benzo should consider resigning fro m the company, rather than engage in unethical behavior. 5-48 5­40 (30­40 mins.) Activity­based costing, cost hierarchy. 1. Super Bookstore Income Statement For the Year Ended 31 December, 2010 Book CDs Café Total $3,720,480 $2,315,360 $736,216 $6,772,056 2,656,727 1,722,311 556,685 4,935,723 18,250 18,250 799,638 $ 264,115 518,392 167,554 1,485,584 $ 74,657 $ (6,273) $ 332,499 Revenues Cost of Merchandise Cost of Café Cleaning a Allocated Selling, General and Administration Costs (0.300986 × $2,656,727; $1,722,311; $556,685) Operating income a Overhea d Rate = $1,485,584 ÷ $4,935,723 = 0.300986 per cost of merchandise $ 2. Selling, general and administration (S,G & A) is comprised of a variet y of costs that are unlikely to be consumed uniformly across product lines based on the cost of merchandise. Super Bookstore should consider an act ivit y­based costing system to clarify how each product line uses these S, G & A resources. Books Number of purchase orders 2,800 Number of deliveries received 1,400 Hours of shelf­stocking time 15,000 Items so ld 124,016 CDs 2,500 1,700 14,000 115,768 Café 2,000 1,600 10,000 368,108 Total 7,300 4,700 39,000 607,892 Purchasing Receiving Stocking Customer support $474,500 ÷ 7,300 orders placed = $65 per purchase order $432,400 ÷ 4,700 deliveries = $92 per delivery $487,500 ÷ 39,000 hours = $12.50 per stocking hour $91, 184 ÷ 607,892 items so ld = $0.15 per item so ld Books $3,720,480 2,656,727 1,063,753 CDs $2,315,360 1,722,311 593,049 Café $ 736,216 556,685 179,531 18,250 130,000 147,200 125,000 55,216 475,666 $(296,135) Total $6,772,056 4,935,723 1,836,333 18,250 474,500 432,400 487,500 91,184 1,503,834 $ 332,499 Revenues Cost of Merchandise Gross margin Cost of Café Cleaning Purchasing ($65 × 2,800; 2,500; 2,000) Receiving ($92 × 1,400; 1,700; 1,600) Shelf­stocking ($12.50 × 15,000; 14,000; 10,000) Customer support ($0.15 × 124,016; 115,768; 368,108 Total S, G & A costs Operating inco me 182,000 128,800 187,500 18,603 516,903 $ 546,850 5-49 162,500 156,400 175,000 17,365 511,265 $ 81,784 Comparing product line inco me statements in requirements 1 and 2, it appears that books are much more profitable and café loses a lot more money under the ABC system co mpared to the simple system. The reason is that books use far fewer S,G & A resources relative to its merchandise costs and café uses far greater S, G & A resources relat ive to its merchandise costs. 3. To: Super Bookstore Management Team From: Cost Analyst Re: Costing System The current accounting system allo cates indirect costs (S,G & A) to product lines based on the Cost of Merchandise sold. Using this method, the S, G & A costs are assigned 54%, 35%, 11%, to the Books, CDs, and Café product lines, respectively. I recommend that the organizat ion switch to an activit y­based costing (ABC) method. With ABC, the product lines are assigned indirect costs based on their consumpt ion of the act ivit ies that give rise to the costs. An ABC analys is reveals that the Café consumes considerably more than 11% of indirect costs. Instead, the café generally requires 25­35% of the purchasing, receiving and stocking activit y and 60% of the customer support. The current accounting technique masks the losses being produced by the café because it assumes all indirect costs are driven by the dollar amount of merchandise so ld. By adopting ABC, management can evaluate the costs of operating the three product lines and make more informed pricing and product mix decis io ns. For example, management may want to consider increasing prices of the food and drinks served in the café. Before deciding whether to increase prices or to close the café, management must consider the beneficial effect that having a cafe has on the other product lines. An ABC analysis can also help Super Bookstore manage its costs by reducing the number of activit ies that each product line demands and by reducing the cost of each act ivit y. These act ions will improve the profitabilit y o f each product line. ABC analysis can also be used to plan and manage the various activit ies. 5-50 ...
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This note was uploaded on 10/11/2010 for the course ACCT 321 taught by Professor Cole during the Spring '10 term at University of Miami.

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