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C HAPTER 10 A CTIVITY - BASED COSTING AND MANAGEMENT SOLUTIONS 10-16 No. The costs of developing a product are sunk at the time the product goes into production. These costs are not controllable. Proponents of activity based costing express the view that these costs should not be viewed as product level costs and therefore should not be assigned to products. Once incurred, these costs are not relevant for short-term decisions about pricing. Of course, prudent managers will estimate these costs prior to incurring them. That is, they will evaluate profitability including these costs, using long- term prices to estimate revenues and quantities. The key challenge facing managers is to ensure that both the short- and the long-run views are given appropriate weight when they make decisions. 10-19 As we have discussed in the text, there are many reasons why ABC systems are difficult to implement and maintain in practice. First, ABC systems are information intensive. Numerous measurements are necessary. Second, they require a stable operational environment. As firms change over time, cost structures change and cost drivers and cost rates have to be routinely updated. Therefore, maintaining the decision usefulness of ABC systems in changing environments is onerous, time consuming and costly. Indeed, a popular estimate is maintaining an ABC system for a medium sized facility requires a 0.5 FTE person or about $75,000 per year. 10-25 If the firm does not cut spending on the resources freed up, and revenues stay the same, then the reported profits will not change because the company is not translating improved efficiencies into cash flow savings. The key additional step required is to either cut spending on freed up resources or gainfully utilize freed up resources by producing and selling more goods and services. 10-31 a. The current system is a volume-based allocation. Let us first compute the overhead rate per labor hour. Total overhead cost = $12,776,400 Total labor hours = (1,000,000 × 2.2) + (2,000,000 × 1.9) + (40,000 × 2.1) = 6,084,000 Rate/labor hour = $12,776,400/6,084,000 = $2.10/labour hour We can now compute product profitability as follows: Hand Held Lawn Sprinklers Estate Sprinklers
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Price $9.00 $8.50 $15.00 Variable cost 2.00 4.00 4.50 Contribution margin 7.00 4.50 10.50 Allocated overhead 4.62 3.99 4.41 (Hours × rate) Profit margin $2.38 $0.51 $6.09 b. We now have to divide the overhead costs into two pools: labor related and batch related. Let us compute the rate for each: Labor Batch Total overhead cost in pool $7,300,800 $5,475,600* Total of driver volume 6,084,000 hours 540 batches* Rate /driver unit $1.2/labor hour $10,140/batch * 540 batches = (1,000,000/10,000) + (2,000,000/5,000) + (40,000/1,000) * $5,475,600 = $12,776,400 - $7,300,800. With this data, we have:
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This note was uploaded on 02/08/2012 for the course ACG 2023 taught by Professor Goslinga during the Fall '10 term at University of Florida.

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