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1 1 of 34 6/9/ :35 PM Chapter 7 Ening SUMMARY Uner traitional cost accounting methos, all manufacturing costs even those not cause by specific proucts are allocate to proucts. Non-manufacturing costs that are cause by proucts are not assigne to proucts. Traitional costing methos also allocate the costs of ile capacity to proucts, which, in effect, charges them for resources not use. [LO1] Traitional costing methos rely on unit-level allocation bases, such as irect labour-hours an machine-hours. This results in overcosting high-volume proucts an unercosting low-volume proucts an can lea to mistakes when making ecisions. [LO1] Activity-base costing (ABC) estimates the costs of the resources consume by cost objects such as proucts an customers. The approach taken in ABC recognizes that cost objects generate the nee for activities that in turn consume costly resources. Activities form the link between costs an cost objects. [LO1, LO2] ABC is concerne with overhea both manufacturing overhea an selling an aministrative overhea. The accounting for irect labour an irect materials is usually unaffecte by the use of ABC. [LO1, LO2] To evelop an ABC system, companies typically choose a small set of activities that summarize much of the work performe in overhea epartments. Associate with each activity is an activity cost pool. Where possible, overhea costs are irectly trace to these activity cost pools. Remaining overhea costs are assigne to the activity cost pools in the first-stage allocation. [LO2] An activity rate is compute for each cost pool by iviing the costs assigne to the cost pool by the measure of activity for the cost pool. In the secon-stage allocation, activity rates are use to apply costs to cost objects such as proucts an customers. [LO3, LO4] Activity-base management (ABM) utilizes information from the ABC system to target activities in nee of process improvements. Benchmarking performance against worl-class organizations or other high-performing ivisions within the same organization can help ientify activities most in nee of improvement. [LO4] Prouct costs compute uner ABC are often quite ifferent from the costs generate by a company s traitional cost accounting system because ABC assigns only costs cause by proucts, uses activity measures that are not necessarily volume relate, an assigns non-manufacturing costs such as shipping on a cause-an-effect basis. [LO5] REVIEW PROBLEM 1: ACTIVITY-BASED COSTING Avance Proucts Corporation prouces a fire-resistant commercial filing cabinet that it sells to office furniture istributors. The company has a simple ABC system that it uses for internal ecision-making purposes. The company has two overhea epartments, whose costs are liste below:

2 2 of 34 6/9/ :35 PM Page 275 The company s ABC system has the following activity cost pools an activity measures: Costs assigne to the Other activity cost pool have no activity measure; they consist of the costs of unuse capacity an organization-sustaining costs, neither of which are assigne to orers, customers, or the prouct. Avance Proucts istributes the costs of manufacturing overhea an selling an aministrative overhea to the activity cost pools base on interviews with employees as reporte below: Require: 1. Prepare a report showing the first-stage allocations of overhea costs to the activity cost pools. (Use Exhibit 7-7 as a guie.) 2. Compute the activity rates for the activity cost pools. (Use Exhibit 7-8 as a guie.) 3. Prepare a report showing the overhea costs attributable to Shenzhen Enterprises, one of Avance Proucts customers. Last year, Shenzhen orere filing cabinets four ifferent times. Shenzhen orere 80 filing cabinets in total uring the year. (Use Exhibit 7-11 as a guie.) 4. The selling price of a filing cabinet is $595. The cost of irect materials is $180 per filing cabinet, an irect labour is $50 per filing cabinet. What is the customer margin of Shenzhen Enterprises? (Use Exhibit 7-13 as a guie.) Solution to Review Problem 1 1. The first-stage allocation is as follows:

3 3 of 34 6/9/ :35 PM Example: Accoring to the istribution of resources across activities, 50% of the $500,000 manufacturing overhea cost is attributable to assembling units activities: Other entries in the table are etermine in a similar manner. Page Computation of activity rates: 3. Computation of the overhea costs attributable to Shenzhen Enterprises: 4. The customer margins for Shenzhen can be compute as follows: REVIEW PROBLEM 2: COMPARISON OF TRADITIONAL COSTING AND ACTIVITY-BASED

4 4 of 34 6/9/ :35 PM COSTING Rocky Mountain Corporation makes two types of hiking boots Xactive an Pathbreaker. Data concerning these two prouct lines appear below: The company has a traitional costing system in which manufacturing overhea is applie to units base on irect labour-hours. Data concerning manufacturing overhea an irect labour-hours for the upcoming year appear below: Require: 1. Using Exhibit 7-14 as a guie, compute the prouct margins for the Xactive an Pathbreaker proucts uner the company s traitional costing system. 2. The company is consiering replacing its traitional costing system with an ABC system that woul assign its manufacturing overhea to the following four activity cost pools (the Other cost pool inclues organization-sustaining costs an ile capacity costs): Page 277 Using Exhibit 7-12 as a guie, compute the prouct margins for the Xactive an Pathbreaker proucts uner the ABC system. 3. Using Exhibit 7-15 as a guie, prepare a quantitative comparison of the traitional an activity-base cost assignments. Explain why the traitional an activity-base cost assignments iffer. Solution to Review Problem 2

5 5 of 34 6/9/ :35 PM 1. Uner the traitional irect labour-hour base costing system, manufacturing overhea is applie to proucts using the preetermine overhea rate compute as follows: *25,000 units of 1.4 DLH per unit + 75,000 units of 1.0 DLH per unit = 35,000 DLHs + 75,000 DLHs = 110,000 DLHs. Consequently, the prouct margins using the traitional approach are compute as follows: 2. The first step is to etermine the activity rates: Page 278 Uner the ABC system, the prouct margins are compute as follows:

6 6 of 34 6/9/ :35 PM 3. The quantitative comparison is as follows: The traitional an activity-base cost assignments iffer for two reasons. First, the traitional system assigns all $2,200,000 of manufacturing overhea to proucts. The ABC system assigns only $2,127,500 of manufacturing overhea to proucts. The ABC system oes not assign the $72,500 of Other activity costs to proucts because they represent organization-sustaining an ile capacity costs. Secon, the traitional system uses one unit-level activity measure, irect labour-hours, to assign 31.8% of all overhea to the Xactive prouct line an 68.2% of all overhea to the Pathbreaker prouct line. The ABC system assigns 62.5% of Batch setup costs (a batch-level activity) to the Xactive prouct line an 37.5% to the Pathbreaker prouct line. The ABC system assigns 50% of prouct-sustaining costs (a prouct-level activity) to each prouct line. GLOSSARY Review key terms an efinitions on Connect. Page 279 DISCUSSION CASE DISCUSSION CASE 7-1 Implementing an ABC system shoul procee only if management believes the benefits of oing so will excee the costs. The costs of an ABC system are not ifficult to quantify. They inclue ientifying the key

7 7 of 34 6/9/ :35 PM activities, eveloping an information system to recor an report information, collecting ata for activity measures, an maintaining the system. More ifficult to quantify are the benefits of aopting an ABC system. Require: Can you ientify some qualitative benefits of aopting ABC? Can any of these be quantifie? How coul management eal with uncertainty relate to any potential benefits of aopting an ABC system? QUESTIONS 7-1 How are non-manufacturing costs relate to selling, shipping, an istribution activities treate uner the ABC approach? 7-2 Why is irect labour a poor base for allocating overhea in many companies? 7-3 Why are overhea rates in ABC base on the level of activity at capacity rather than on the bugete level of activity? 7-4 What is an activity cost pool? 7-5 What are unit-level, batch-level, prouct-level, customer-level, an organization-sustaining activities? 7-6 What types of costs shoul not be assigne to proucts in an ABC system? 7-7 Why are transaction rivers typically use more often than uration rivers in practice? 7-8 Why is the first stage of the allocation process in ABC often base on interviews? 7-9 What is benchmarking? 7-10 When ABC is use, why are manufacturing overhea costs often shifte from high-volume proucts to low-volume proucts? 7-11 What is the secon-stage allocation in ABC? 7-12 What are the two chief limitations of ABC? 7-13 Why is ABC as escribe in the chapter unacceptable for external reporting purposes? EXERCISES To help ientify which exhibits to refer to when working on the exercises, problems, an cases, use the following guie: (a) first-stage allocations to activity cost pools: Exhibit 7-7; (b) computation of activity rates: Exhibit 7-8; (c) assigning overhea costs to proucts: Exhibit 7-10; () assigning overhea costs to customers: Exhibit 7-11; (e) prouct margins: Exhibit 7-12; an (f) customer margins: Exhibit EXERCISE 7-1 Activity-Base Costing Cost Hierarchy [LO1] Exercise 7-1: Help Me Solve It Tutorial Click here to view a transcript of this vieo

8 8 of 34 6/9/ :35 PM The following activities occur at Greenwich Corporation, a company that manufactures a variety of proucts: 1. Various iniviuals manage the parts inventories. 2. A clerk in the factory issues purchase orers for a job. 3. The Personnel Department trains new prouction workers. 4. The factory s general manager meets with other epartment heas, such as marketing, to coorinate plans. 5. Direct labour workers assemble proucts. 6. Engineers esign new proucts. 7. The materials storekeeper issues raw materials to be use in jobs. 8. The Maintenance Department performs perioic preventive maintenance on general-use equipment. Require: Classify each of the activities above as a unit-level, a batch-level, a prouct-level, or an organizationsustaining activity. Page 280 EXERCISE 7-2 First-Stage Allocation in a Service Company [LO2] Exercise 7-2: Help Me Solve It Tutorial Click here to view a transcript of this vieo MobileCash Corporation operates a fleet of armoure cars that make scheule pickups an eliveries for its customers. The company is implementing an ABC system that has four activity cost pools: Travel, Pickup an Delivery, Customer Service, an Other. The activity measures are kilometres for the Travel cost pool, number of pickups an eliveries for the Pickup an Delivery cost pool, an number of customers for the Customer Service cost pool. The Other cost pool has no activity measure. The following costs will be assigne using the ABC system: The istribution of resource consumption across the activity cost pools is as follows:

9 9 of 34 6/9/ :35 PM Require: Carry out the first-stage allocations of costs to activity cost pools as illustrate in Exhibit 7-7. EXERCISE 7-3 First-Stage Allocation in a Manufacturing Company [LO2] MovieTime Corporation prouces furniture an fixtures for home theatre installations. John Jones, the owner of the company, recognize a tren in home theatre installations starting about three years ago an began working with local esign firms an home builers to offer afforable yet high-quality furnishings for new construction an renovation markets. The company s most popular prouct is a leather upholstere recliner with a cup holer an snack tray built into each chair s arms. Last year, John ecie to implement an ABC system to better unerstan the overall cost structure an to ensure he was charging competitive prices that woul also allow the firm to remain profitable over the longer term. The ABC system is esigne to allow irect material an irect labour to be trace irectly to each of the company s four main proucts. The system also inclues four activity cost pools for overhea: Quality Control an Inspection, Orer Processing, Delivery an Installation, an Other. The activity measures are units prouce for Quality Control an Inspection, number of orers for Orer Processing, an number of eliveries for Delivery an Installation. The Other cost pool has no activity measure. The following costs will be assigne using the ABC system: Page 281 The istribution of resource consumption across the activity cost pools is as follows:

10 10 of 34 6/9/ :35 PM Require: Carry out the first-stage allocations of costs to activity cost pools as illustrate in Exhibit 7-7. EXERCISE 7-4 Compute Activity Rates an Assign to a Cost Object [LO3] (This exercise is a continuation of Exercise 7-3; it shoul be assigne only if Exercise 7-3 is also assigne.) The ABC system at MovieTime contains the following activity cost pools an activity rates this year: Activity ata have also been supplie for the leather recliner prouct line: Require: 1. Using the first-stage allocation from Exercise 7-3 an the above ata, compute the activity rates for the ABC system. (Use Exhibit 7-8 as a guie). Roun to the nearest whole cent. 2. Determine the total overhea cost that woul be assigne to the leather recliner prouct line using the ABC system. EXERCISE 7-5 Compute Activity Rates an Assign to a Cost Object [LO2, LO3] Brooksie Property Management is a property management service company for small shopping malls that uses ABC to estimate costs for pricing an other purposes. The owner of the company believes that costs are riven primarily by the area of outoor maintenance (parking lots, siewalks, an garens), the area of inoor

11 11 of 34 6/9/ :35 PM tenant space in the shopping mall, the istance to travel to the shopping mall, an the number of shopping malls manage. In aition, the costs of managing the inoor tenant space epen on whether the tenants are locate on the main level or other levels of the mall. Accoringly, the company uses the five activity cost pools liste below: Page 282 The company has alreay carrie out its first-stage allocations of costs. The company s annual costs an activities are summarize as follows: Parker Hills Shopping Mall is one of Brooksie s olest clients. Details concerning the mall s layout, outoor space, an istance from Brooksie s hea office are as follows: Require: 1. Compute the activity rate for each of the activity cost pools. 2. Determine the total overhea cost that woul be assigne to the Parker Hills Shopping Mall using the ABC system.

12 12 of 34 6/9/ :35 PM EXERCISE 7-6 Secon-Stage Allocation [LO3] Larner Corporation is a iversifie manufacturer of inustrial goos. The company s ABC system contains the following six activity cost pools an activity rates: Activity ata have been supplie for the following proucts: Page 283 Require: Determine the total overhea cost that woul be assigne to each of the proucts liste above in the ABC system. EXERCISE 7-7 Prouct an Customer Profitability Analysis [LO3, LO4] PWC Systems Inc. makes personal watercraft for sale through specialty sporting goos stores. The company has a stanar moel but also makes custom-esigne moels. Management has esigne an ABC system with the following activity cost pools an activity rates: Management woul like an analysis of the profitability of a particular customer, WaveRier, which has

13 13 of 34 6/9/ :35 PM orere the following proucts over the last 12 months: The company s irect labour rate is $24 per hour. Require: Using the company s ABC system, compute the customer margin of WaveRier. EXERCISE 7-8 Activity Measures [LO1] Various activities at Husang Corporation, a manufacturing company, are liste below: Require: 1. Classify each activity as unit-level, batch-level, prouct-level, customer-level, or organizationsustaining. 2. For each activity, provie an example of one transaction river an one uration river that might be use in Husang Corporation s ABC system. EXERCISE 7-9 Computing Activity-Base Costing Prouct Costs [LO2, LO3] Exercise 7-9: Help Me Solve It Tutorial Click here to view a transcript of this vieo High-Calibre Proucts Corporation makes two proucts: titanium rims an posts. Data regaring the two proucts follow:

14 14 of 34 6/9/ :35 PM Page 284 Aitional information about the company follows: 1. Rims require $17 in irect materials per unit, an posts require $ The irect labour wage rate is $16 per hour. 3. Rims are more complex to manufacture than posts, an they require special equipment. 4. The ABC system has the following activity cost pools: Require: 1. Compute the activity rate for each activity cost pool. 2. Determine the unit cost of each prouct accoring to the ABC system, incluing irect materials an irect labour. EXERCISE 7-10 First-Stage Allocations [LO2] The operations vice-presient of the Regal Bank of Canaa, Kristin Wu, has been intereste in investigating the efficiency of the bank s operations. She has been particularly concerne about the costs of hanling routine transactions at the bank an woul like to compare these costs at the bank s various branches. If the branches with the most efficient operations can be ientifie, their methos can be stuie an then replicate elsewhere. While the bank maintains meticulous recors of wages an other costs, there has been no attempt thus far to show how those costs are relate to the various services provie by the bank. Wu has aske for your help in conucting an ABC stuy of bank operations. In particular, she woul like to know the cost of opening an account, the cost of processing eposits an withrawals, an the cost of processing other customer transactions. The Winsor branch of the Regal Bank of Canaa submitte the following cost ata for last year:

15 15 of 34 6/9/ :35 PM Virtually all of the other costs of the branch rent, epreciation, utilities, an so on are organizationsustaining costs that cannot be meaningfully assigne to iniviual customer transactions, such as epositing cheques. In aition to the cost ata above, the employees of the Winsor branch have been interviewe concerning how their time was istribute last year across the activities inclue in the ABC stuy. The results of those interviews appear below: Page 285 Require: Prepare the first-stage allocation for Wu as illustrate in Exhibit 7-7. EXERCISE 7-11 Computing an Interpreting Activity Rates [LO3] (This exercise is a continuation of Exercise 7-10; it shoul be assigne only if Exercise 7-10 is also assigne.) The manager of the Winsor branch of the Regal Bank of Canaa has provie the following ata concerning the transactions of the branch uring the past year: The lowest costs reporte by other branches for these activities are isplaye below:

16 16 of 34 6/9/ :35 PM Require: 1. Using the first-stage allocation from Exercise 7-10 an the above ata, compute the activity rates for the ABC system. (Use Exhibit 7-8 as a guie.) Roun all computations to the nearest whole cent. 2. What o these results suggest to you concerning operations at the Winsor branch? EXERCISE 7-12 Secon-Stage Allocation to an Orer [LO3] Transvaal Mining Tools Lt. of South Africa makes specialty tools use in the mining inustry. The company uses an ABC system for internal ecision making. The company has four activity cost pools, as liste below. The currency in South Africa is the ran, enote here by R: The managing irector of the company woul like information concerning the cost of a recently complete orer for har-rock rills. The orer require 150 irect labour-hours, 18 hours of prouct testing, an three sales calls. Require: Prepare a report showing the overhea cost of the orer for har-rock rills accoring to the ABC system. What is the total overhea cost assigne to the orer? EXERCISE 7-13 Cost Hierarchy [LO1] Green Glier Corporation makes golf carts that it sells irectly to golf courses throughout the worl. Several basic moels are available, which are moifie to suit the nees of each particular golf course. A golf course locate in British Columbia, for example, woul typically specify that its golf carts come equippe with retractable rain-proof covers. In aition, each customer (i.e., golf course) customizes its golf carts with its own colour scheme an logo. The company typically makes all of the golf carts for a customer before starting work on the next customer s golf carts. Below are liste a number of activities an costs at Green Glier Corporation: 1. The purchasing epartment orers the colour of paint specifie by the customer from the company s supplier.

17 17 of 34 6/9/ :35 PM 2. A steering wheel is installe in a golf cart. 3. An outsie lawyer raws up a new generic sales contract for the company, limiting Green Glier s liability in case of accients that involve its golf carts. Page The company s paint shop makes a stencil for a customer s logo. 5. A sales representative visits a previous customer to check on how the company s golf carts are working out an to try to make a new sale. 6. The accounts receivable epartment prepares the bill for a complete orer. 7. Electricity is use to heat an light the factory an the aministrative offices. 8. A golf cart is painte. 9. The company s engineer moifies the esign of a moel to eliminate a potential safety problem. 10. The marketing epartment has a catalogue printe an then mails copies to golf course managers. 11. Complete golf carts are iniviually teste on the company s test track. 12. A new moel golf cart is shippe to the leaing golfing trae magazine to be evaluate for the magazine s annual rating of golf carts. Require: Classify each of the costs or activities above as unit-level, batch-level, prouct-level, customer-level, or organization-sustaining. In this case, customers are golf courses, proucts are the various moels of the golf cart, a batch is a specific orer from a customer, an units are iniviual golf carts. EXERCISE 7-14 Secon-Stage Allocation an Margin Calculations [LO3, LO4] Roll Boar Inc. manufactures several moels of high-quality skateboars. The company s ABC system has four activity cost pools, which are liste below along with their activity measures an activity rates: The company just complete a single orer from SkateCo for 3,200 entry-level skateboars. The orer was prouce in 27 batches. Each skateboar require 0.7 irect labour-hours. The selling price was $125 per skateboar, the irect materials cost was $77.50 per skateboar, an the irect labour cost was $17.50 per skateboar. This was the only orer from SkateCo for the year. Require:

18 18 of 34 6/9/ :35 PM Using Exhibit 7-13 as a guie, prepare a report showing the customer margin on sales to SkateCo for the year. EXERCISE 7-15 Cost Hierarchy an Activity Measures [LO1] Various activities at Companhia e Textils S.A., a manufacturing company locate in Brazil, are liste below. The company makes a variety of proucts. 1. Preventive maintenance is performe on general-purpose prouction equipment. 2. Proucts are assemble by han. 3. Reminer notices are sent to customers who are late in making payments. 4. Purchase orers are issue for materials to be use in prouction. 5. Moifications are mae to prouct esigns. 6. New employees are hire by the personnel office. 7. Machine settings are change between batches of ifferent proucts. 8. Parts inventories are maintaine in the storeroom. (Each prouct requires its own unique parts.) 9. Insurance costs are incurre on the company s facilities. Require: 1. Classify each of the activities as unit-level, batch-level, prouct-level, customer-level, or organizationsustaining. 2. Where possible, name one or more activity measures that coul be use to assign costs generate by the activity to proucts or customers. EXERCISE 7-16 Comprehensive Activity-Base Costing Exercise [LO2, LO3, LO4] Cancico Communications has supplie the following ata for use in its ABC system:

19 19 of 34 6/9/ :35 PM Page 287 During the year, Cancico Communications complete an orer for special telephone equipment for a new customer, HurnTel. This customer i not orer any other proucts uring the year. Data concerning that orer follow: Require: 1. Using Exhibit 7-7 as a guie, prepare a report showing the first-stage allocations of overhea costs to the activity cost pools. 2. Using Exhibit 7-8 as a guie, compute the activity rates for the activity cost pools. 3. Prepare a report showing the overhea costs for the orer from HurnTel, incluing customer support costs. 4. Using Exhibit 7-13 as a guie, prepare a report showing the customer margin for HurnTel. EXERCISE 7-17 Calculating an Interpreting Activity-Base Costing Data [LO2, LO3] Jane s Cookhouse is a popular restaurant locate in a scenic setting. The owner of the restaurant has been trying to better unerstan costs at the restaurant an has hire a stuent intern to conuct an ABC stuy. The intern, in consultation with the owner, ientifie three major activities. The intern then complete the first-stage allocations of costs to the activity cost pools, using ata from last month s operations. The results appear below:

20 20 of 34 6/9/ :35 PM The above costs inclue all of the costs of the restaurant except for organization-sustaining costs such as rent, property taxes, an top-management salaries. A group of iners who ask to sit at the same table are counte as a party. Some costs, such as the costs of cleaning linen, are the same whether one person is at a table or the table is full. Other costs, such as washing ishes, epen on the number of iners serve. Page 288 Prior to the ABC stuy, the owner knew very little about the costs of the restaurant. She knew that the total cost for the month (incluing organization-sustaining costs) was $180,000 an that 12,000 iners ha been serve. Therefore, the average cost per iner was $15. Require: 1. Accoring to the ABC system, what is the total cost of serving each of the following parties of iners? A party of four iners that orers three rinks in total. 2. A party of two iners that oes not orer any rinks. 3. A lone iner who orers two rinks. Convert the total costs you compute in (1) above to costs per iner. In other wors, what is the average cost per iner for serving each of the following parties? 1. A party of four iners that orers three rinks in total. 2. A party of two iners that oes not orer any rinks. 3. A lone iner who orers two rinks. 3. Why o the costs per iner for the three ifferent parties iffer from each other an from the overall average cost of $15.00 per iner? EXERCISE 7-18 Customer Profitability Analysis [LO3, LO4, LO5] Me Max istributes meical supplies to octors offices an clinics throughout Alberta. Me Max sets its prices by marking up its cost of goos sol by 5%. For example, if Me Max pai $100 to buy supplies from manufacturers, Me Max woul charge its customers $105 to purchase these supplies. For years, Me Max believe that the 5% markup covere its selling an aministrative expenses an provie a reasonable profit. However, in the face of eclining profits, Me Max ecie to implement an ABC system to help improve its unerstaning of customer profitability. The company broke its selling an aministrative expenses into five activities, as shown below:

21 21 of 34 6/9/ :35 PM Me Max gathere the ata below for two of the many clinics that it serves City Clinic an County Clinic (both clinics purchase a total quantity of meical supplies that ha cost Me Max $30,000 to buy from its manufacturers): Require: 1. Compute the total revenue that Me Max woul receive from City Clinic an County Clinic. 2. Compute the activity rate for each activity cost pool. 3. Compute the total activity costs that woul be assigne to City Clinic an County Clinic. 4. Compute Me Max s customer margin for City Clinic an County Clinic. (Hint: Do not overlook the $30,000 cost of goos sol that Me Max incurre serving each clinic.) 5. Describe the purchasing behaviours that are likely to characterize Me Max s least profitable customers. Page 289 PROBLEMS PROBLEM 7-19 Evaluating the Profitability of Services [LO2, LO3, LO4] Problem 7-19: Excel Template Kenosha Winter Services is a small family-owne snow-removal business. For its services, the company has

22 22 of 34 6/9/ :35 PM always charge a flat fee per hunre square metres of snow removal. The current fee is $12.75 per hunre square metres. However, there is some question about whether the company is actually making any money on jobs for some customers particularly those locate on more remote properties that require consierable travel time. The owner s aughter, home from school for the summer, has suggeste investigating this question using ABC. After some iscussion, a simple system consisting of four activity cost pools seeme to be aequate. The activity cost pools an their activity measures appear below: The total cost of operating the company for the year is $390,000, which inclues the following costs: Resource consumption is istribute across the activities as follows: Job support consists of receiving calls from potential customers at the home office, scheuling jobs, billing, resolving issues, an so on. Require: 1. Using Exhibit 7-7 as a guie, prepare the first-stage allocation of costs to the activity cost pools.

23 23 of 34 6/9/ :35 PM 2. Using Exhibit 7-8 as a guie, compute the activity rates for the activity cost pools. 3. The company recently complete a 3,500-square-metre snow removal job at Hometown Harware a 75-kilometre roun-trip journey from Kenosha s offices. Compute the cost of this job using the ABC system. Page The revenue from the Hometown Harware job was $ (3,500 square metres at $12.75 per hunre square metres). Using Exhibit 7-13 as a guie, prepare a report showing the margin from this job. 5. What o you conclue concerning the profitability of the Hometown Harware job? Explain. 6. What avice woul you give the presient concerning pricing jobs in the future? PROBLEM 7-20 Activity-Base Costing an Biing on Jobs [LO2, LO3] Problem 7-20: Excel Template Problem 7-20: Connect Animation Click here to view the Transcript Vance Asbestos Removal Company removes potentially toxic asbestos insulation an relate proucts from builings. The company s estimator has been involve in a long-simmering ispute with the on-site work supervisors. The on-site supervisors claim that the estimator oes not aequately istinguish between routine work, such as removal of asbestos insulation aroun heating pipes in oler homes, an non-routine work, such as removing asbestos-contaminate ceiling plaster in inustrial builings. The on-site supervisors believe that non-routine work is far more expensive than routine work an shoul bear higher customer charges. The estimator sums up his position in this way: My job is to measure the area to be cleare of asbestos. As irecte by top management, I simply multiply the square metres by $4,000 per thousan square metres to etermine the bi price. Since our average cost is only $3,000 per thousan square metres, that leaves enough cushion to take care of the aitional costs of non-routine work that shows up. Besies, it is ifficult to know what is routine or not routine until you actually start tearing things apart. To she light on this controversy, the company initiate an ABC stuy of all of its costs. Data from the ABC system follow:

24 24 of 34 6/9/ :35 PM Page 291 Require: 1. Using Exhibit 7-7 as a guie, perform the first-stage allocation of costs to the activity cost pools. 2. Using Exhibit 7-8 as a guie, compute the activity rates for the activity cost pools. 3. Using the activity rates you have compute, etermine the total cost an the average cost per thousan square metres of each of the following jobs accoring to the ABC system: 1. A routine 2,000-square-metre asbestos removal job. 2. A routine 4,000-square-metre asbestos removal job. 3. A non-routine 2,000-square-metre asbestos removal job. 4. Given the results you obtaine in (3) above, o you agree with the estimator that the company s present policy for biing on jobs is aequate? PROBLEM 7-21 Secon-Stage Allocations an Prouct Margins [LO3, LO4] AnimPix Inc. is a small company that creates computer-generate animations for films an television. Much of the company s work consists of short commercials for television, but the company also oes realistic

25 25 of 34 6/9/ :35 PM computer animations for special effects in movies. The young founers of the company have become increasingly concerne with the economics of the business particularly since many competitors have sprung up recently in the local area. To help unerstan the company s cost structure, an ABC system has been esigne. Three major activities are carrie out in the company: animation concept, animation prouction, an contract aministration. The animation concept activity is carrie out at the contract proposal stage when the company bis on projects. This is an intensive activity that involves iniviuals from all parts of the company in creating storyboars an prototype stills to be shown to the prospective client. After the client has accepte a project, the animation goes into prouction an contract aministration begins. Technical staff o almost all of the work involve in animation prouction, whereas aministrative staff are largely responsible for contract aministration. The activity cost pools an their activity measures an rates are liste below: These activity rates inclue all of the costs of the company, except for the costs of ile capacity an organization-sustaining costs. There are no irect labour or irect materials costs. Preliminary analysis using these activity rates has inicate that the local commercials segment of the market may be unprofitable. This segment is highly competitive. Proucers of local commercials may ask several companies like AnimPix to bi, which results in an unusually low ratio of accepte contracts to bis. Furthermore, the animation sequences ten to be much shorter for local commercials than for other work. Since animation work is bille at stanar rates accoring to the running time of the complete animation, the revenues from these short projects ten to be below average. Data concerning activity in the local commercials market appear below: The total sales for local commercials amounte to $240,000. Require: 1. Determine the cost of the local commercials market. (Think of the local commercials market as a prouct.) 2. Prepare a report showing the prouct margin of the local commercials market. (Remember, this company has no irect materials or irect labour costs.) 3. What woul you recommen to management concerning the local commercials market?

26 26 of 34 6/9/ :35 PM Page 292 PROBLEM 7-22 Activity Rates an Activity-Base Management [LO2, LO3] Onassis Catering is a Greek company that provies passenger an crew meals to airlines operating out of two international airports in Athens an Corfu. The operations at the two airports are manage separately, an top management believes that there may be benefits to greater sharing of information between the two operations. To better compare the two operations, an ABC system has been esigne with the active participation of the managers at both airports. The ABC system is base on the following activity cost pools an activity measures: The operation at Athens International Airport (AIA) serves 1 million meals annually on 5,000 flights for 10 ifferent airlines. (Each airline is consiere one customer.) The annual cost of running the AIA airport operation, excluing only the costs of raw materials for meals, totals 3,675,000. Note: The currency in Greece is the euro, enote by To help etermine the activity rates, employees were interviewe an aske how they ivie their time among the four major activities. The results of employee interviews at AIA are isplaye below:

27 27 of 34 6/9/ :35 PM Require: 1. Perform the first-stage allocation of costs to the activity cost pools. (Use Exhibit 7-7 as a guie.) 2. Compute the activity rates for the activity cost pools. (Use Exhibit 7-8 as a guie.) Do not roun off. Page The Corfu operation has alreay conclue its ABC stuy an has reporte the following activity rates: 2.48 per meal for meal preparation; per flight for flight-relate activities; an 12,000 for customer service. Comparing the activity rates for the AIA operation you compute in (2) above to the activity rates for Corfu, o you have any suggestions for the top management of Onassis Catering? PROBLEM 7-23 Comparing Traitional an Activity-Base Costing Prouct Margins [LO1, LO3, LO4] Moern Tools makes two types of chain saws High Grae an Professional. Data concerning these two prouct lines appear below: The company has a traitional costing system in which manufacturing overhea is applie to units base on irect labour-hours. Data concerning manufacturing overhea an irect labour-hours for the upcoming year appear below:

28 28 of 34 6/9/ :35 PM Require: 1. Using Exhibit 7-14 as a guie, compute the prouct margins for the High Grae an the Professional proucts uner the company s traitional costing system. 2. The company is consiering replacing its traitional costing system with an ABC system that woul assign its manufacturing overhea to the following four activity cost pools (the Other cost pool inclues organization-sustaining costs an ile capacity costs): Using Exhibit 7-12 as a guie, compute the prouct margins for the High Grae an Professional proucts uner the ABC system. 3. Explain why an how the traitional an activity-base cost assignments iffer. CASES CASE 7-24 Comprehensive Activity-Base Costing [LO2, LO3, LO5] Kolbec Community College (KCC) has 4,000 full-time stuents an offers a variety of acaemic programs in three areas: professional stuies, arts, an technology. The professional stuies programs prepare stuents for aministrative an clerical jobs in a variety of professional settings, incluing accounting, meicine, an law. The arts program s offerings are wie ranging an inclue graphic esign, igital animation, culinary arts, cosmetology, an music arts. The technology programs are also varie, incluing information technology, meical laboratory technology, electrical engineering technology, pharmacy technology, an natural resources technology. Page 294 The chief financial officer of KCC, Lynn Jones, has consistently emphasize to other members of the senior management team the importance of unerstaning the costs of elivering the various acaemic programs. To that en, the costing system use at KCC tracks the irect costs of each program, which are shown below on

29 29 of 34 6/9/ :35 PM an annual basis, along with the number of full-time stuents: It is very important to unerstan the overhea costs consume by each acaemic program at KCC in etermining the full cost of operating the programs. Central aministration at KCC allocates financial resources to acaemic programs base on the estimate full cost per stuent of elivering the program. The overhea costs at KCC are significant, totalling over 60% of irect costs. Total annual overhea costs at KCC are as follows: Traitionally, KCC has allocate overhea costs to acaemic programs on the basis of the number of full-time stuents in each program. This approach was eeme appropriate since Jones reasone that increasing the number of stuents at KCC woul result in higher overhea costs (e.g., more facilities woul be neee, more inirect support costs woul be incurre, etc.). However, Jones is beginning to question the accuracy of the traitional approach since it results in a similar full cost per stuent for the arts an technology programs, which she feels oesn t make sense. Base on her knowlege of the programs, Jones feels that the technology program is probably more expensive to eliver than the arts program, but this oes not come through in the traitional costing approach. Jones recently attene a seminar on management techniques being use by leaing eucational institutions that, among other topics, covere the basics of the ABC approach. She likes the iea of being able to assign inirect costs to acaemic programs on the basis of how much of the support activity resources are consume by each program. If Jones s instincts are correct in that some programs consume more resources of certain activities than others, this coul have a significant impact on the overhea costs assigne to each uner the ABC approach. Upon returning to KCC, Jones ecies to implement ABC. She, along with Assistant CFO James West, begins by ientifying the key activities use to support the teaching programs. Rather than getting too etaile with respect to ientifying activities in the initial implementation, Jones ecies to keep the process manageable an comes up with six key activities. Next, base on a series of interviews with various KCC employees who work in the epartments covere by the ientifie activities, Jones an West estimate the percentage of the

30 30 of 34 6/9/ :35 PM total aministrative, facility, an office expense resources consume by each activity. Again, to keep the process efficient, Jones rouns all percentages to the nearest 5%, figuring that a close enough approach will suffice for this initial implementation an recognizing that the estimates are subjective to begin with. The results are shown below: Page 295 Working with key personnel from each of the six activities shown above, Jones an West then ientify the activity measure an the quantity of that measure use for each teaching program. Fortunately, KCC implemente an enterprise resource planning system a few years ago, which is alreay tracking much of the information neee regaring the activity measures an the specific quantities for each acaemic program: Require: 1. Using the traitional approach to assigning overhea costs to acaemic programs: 1. Calculate the preetermine overhea rate. 2. Assign the overhea costs to each acaemic program using the preetermine rate. 3. Calculate the total cost per stuent (irect costs plus overhea) of operating each acaemic program. 2. Using ABC, complete the following requirements: 1. Using Exhibit 7-7 as a guie, complete the first-stage allocation of overhea costs to acaemic programs.

31 31 of 34 6/9/ :35 PM 2. Using Exhibit 7-8 as a guie, calculate the activity rates for each of the activity cost pools. 3. Using the activity rates calculate in (b), complete the secon-stage allocation of overhea to acaemic programs. 3. Base on the results of (2), calculate the total cost per stuent (irect costs plus overhea) of operating each acaemic program. 4. Draft a memo to Jones explaining the key reasons for ifferences in the total cost per stuent of operating each acaemic program that arise between the traitional costing approach an ABC. CASE 7-25 Activity-Base Costing an Pricing [LO2, LO3, LO4, LO5] Oxfor Concrete Inc. (OCI) processes an istributes various types of cement. The company buys quarrie local rock, limestone, an clay from aroun the worl an mixes, blens, an packages the processe cement for resale. OCI offers a large variety of cement types that it sells in one-kilogram bags to local retailers for small o-it-yourself jobs. The major cost of the cement is raw materials. However, the company s preominantly automate mixing, blening, an packaging processes require a substantial amount of manufacturing overhea. The company uses relatively little irect labour. Some of OCI s cement mixtures are very popular an sell in large volumes, while a few of the recently introuce cement mixtures sell in very low volumes. OCI prices its cements at manufacturing cost plus a 25% markup, with some ajustments mae to keep the company s prices competitive. Page 296 For the coming year, OCI s buget inclues estimate manufacturing overhea cost of $4,400,000. OCI assigns manufacturing overhea to proucts on the basis of irect labour-hours. The expecte irect labour cost totals $1,200,000, which represents 100,000 hours of irect labour time. Base on the sales buget an expecte raw materials costs, the company will purchase an use $10,000,000 of raw materials (mostly quarrie rock, limestone, an clay) uring the year. The expecte costs for irect materials an irect labour for one-kilogram bags of two of the company s cement proucts appear below: OCI s controller believes that the company s traitional costing system may be proviing misleaing cost information. To etermine whether this is the case, the controller has prepare an analysis of the year s expecte manufacturing overhea costs, as shown in the following table:

32 32 of 34 6/9/ :35 PM Data regaring the expecte prouction of Normal Portlan an High Sulphate Resistance cement mixes are presente below: Require: 1. Using irect labour-hours as the base for assigning manufacturing overhea cost to proucts, o the following: 1. Determine the preetermine overhea rate that will be use uring the year. 2. Determine the unit prouct cost of one kilogram of the Normal Portlan cement an one kilogram of the High Sulphate Resistance cement. 2. Using ABC as the basis for assigning manufacturing overhea cost to proucts, o the following: 1. Determine the total amount of manufacturing overhea cost assigne to the Normal Portlan cement an to the High Sulphate Resistance cement for the year. Page Using the ata evelope in 2(a) above, compute the amount of manufacturing overhea cost per kilogram of the Normal Portlan cement an the High Sulphate Resistance cement. Roun all computations to the nearest whole cent. 3. Determine the unit prouct cost of one kilogram of the Normal Portlan cement an one kilogram of the High Sulphate Resistance cement.

33 33 of 34 6/9/ :35 PM 3. Write a brief memo to the presient of OCI explaining what you foun in (1) an (2) above, an iscuss the implications to the company of using irect labour as the base for assigning manufacturing overhea cost to proucts. INSTANT QUIZ SOLUTIONS 7-1 The four main ifferences between traitional costing an ABC are (1) both manufacturing an non-manufacturing costs may be assigne to proucts on a cause-an-effect basis uner ABC but not traitional prouct costing; (2) some manufacturing costs that woul be inclue in the preetermine overhea rate uner traitional costing woul not be applie to cost objects uner ABC because they o not rive the cost of that cost object; (3) while epartmental or plantwie overhea rates are use in traitional costing, ABC uses many ifferent cost pools that are base on activities that rive cost, not epartmental organization; an (4) activity rates are often calculate base on activity at capacity, while uner traitional costing, bugete levels of activity are use in the enominator of preetermine overhea rates. 7-2 One goo example is a company that prouces an sells flat-screen TVs. A unit-level activity is installing the igital receiver in each TV prouce. A batch-level activity is orering stans in three ifferent colours to use for each of three ifferent moels of TVs prouce. A prouct-level activity is the esign of a new moel of TV with next-generation electronics. A customer-level activity is a salesperson visiting a customer to ensure he or she is please with the prouct quality an elivery specifications. An organization-sustaining activity is seeking outsie legal avice on the terms of the top manager s employment contracts. 7-3 Total overhea costs relate to orer processing = $25,200; a total of 350 orers were processe in the year; therefore, the activity rate to assign orer processing costs to the customer orers cost object is $25, = $72 per orer. 7-4 Total overhea applie to Prouct Q43 = (120 DLH $7 per DLH) + (43 MH $2 per MH) + (4 setups $63 per setup) + (5 shipments $12 per shipment) = $1, Customer margin for Mitchell Harware is as follows:

34 34 of 34 6/9/ :35 PM For more information on the resources available from McGraw-Hill Ryerson, go to /solutions.