# Required a use an activity based costing system and

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Required: A. Use an activity-based-costing system and determine the cost of processing, underwriting, and closing the two loan applications. B. Determine the cost of processing the two loans if Heartland uses the traditional labor-hour-based system. Conversations with management found that, on average, each application took nine labor hours of processing time, excluding underwriting and closure. C. Is Heartland making a mistake by continuing to use a traditional system that is based on an average labor cost per hour? Why? LO: 5, 8 Type: A, N Answer: A. Cost pool rates: Application processing: \$900,000 ÷ 4,000 = \$225 per application Loan underwriting: \$800,000 ÷ 16,000 = \$50 per underwriting hour Loan closure: \$880,000 ÷ 8,000 = \$110 per legal hour Application no. 7439: Application (\$225) + underwriting (3.5 x \$50 = \$175) + closure (1.5 x \$110 = \$165) = \$565 Application no. 7809: Application (\$225) + underwriting (2.0 x \$50 = \$100) + closure (3.0 x \$110 = \$330) = \$655 B. Total labor hours: Application processing (4,000 x 9 = 36,000) + underwriting (16,000) + closure (8,000) = 60,000 Average rate per hour: \$2,580,000 ÷ 60,000 = \$43 per hour Application no. 7439: (9 + 5) x \$43 = \$602 Application no. 7809: (9 + 5) x \$43 = \$602 C. Yes. The traditional system results in an average cost per hour of \$43; yet, Heartland’s hourly charges vary greatly based on the function being performed. Rates range from \$25 per hour (\$225 ÷ 9) for application processing, to \$50
per hour for underwriting, to \$110 for legal services. ABC produces a more accurate determination of cost because three separate drivers are used rather than just one. Effect of Environment on Product-Costing System 66. At a recent professional meeting, two controllers discussed product-costing problems in their respective companies. Both controllers are familiar with ABC systems, but neither of their firms utilizes such a system. Controller D reported that part of the problem in his firm results from major differences among product lines with respect to unit volume, utilization of activities, quality assurance requirements established by customers, and product size. Controller M noted that in her firm, which manufactures consumer goods, all items undergo the same basic production processes in the same sequence. However, lately there has been a significant increase in the number of item colors. Cost Drivers 67. Define the term "cost driver" and discuss the factors that are important in the selection of appropriate cost drivers. LO: 6 Type: RC Answer: A cost driver is an event or activity that results in the incurrence of costs. For example, many of the costs in an automated environment are created by the operation of machines, and machine hours may be a suitable cost driver for overhead application. The first factor important in the selection of cost drivers is the degree of correlation (i.e., relationship) among the driver, the activity, and the cost. This relationship is crucial to achieve credibility and accuracy. Another factor is the cost of measurement. Cost/benefit tradeoffs must be taken into account. The system should contain drivers that identify key costs but if too many drivers are used, the system will be burdensome and expensive. Behavioral effects