CHAPTER 4
Activity-based costing
Discussion Questions
4-1
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accessible website, in whole or in part.
1. A predetermined overhead rate is simply an estimate of the overhead used per unit of driver. It is calculated using budgeted overhead and budgeted levels of the associated driver. Predetermined rates are used because actual overhead may be incurred nonuniformly throughout the year.
2. Under- and overapplied overhead are mea- sures of the difference between the actual and applied overhead assigned to production. Underapplied overhead means too little was applied, and overapplied means too much was applied.
3. Plantwide overhead rates assign overhead to products in proportion to the amount used of the unit-based driver. If all products consume overhead in proportion to this unit-based driver, no distortion will occur. Cost distortion can occur if the products consume some overhead activities in different proportions than those
assigned by the unit-based driver (the product diversity factor). No significant distortion will occur unless the activities that are consumed in different proportions make up a significant proportion of the total overhead costs. Thus, two key factors are product diversity and significant non-unit-level overhead costs.
4. Non-unit-related overhead activities are those overhead activities that are not highly correlated with production volume mea-sures. Examples include setups, materials handling, and inspection. Non-unit-based cost drivers are causal factors that explain the consumption of non-unit-related overhead. Examples include setup hours, number of moves, and hours of inspection.
5. An overhead consumption ratio measures the proportion of an overhead activity consumed by a product.
6. Agree. Prime costs can be assigned using direct tracing and therefore do not cause cost distortions. Overhead costs, however, are not directly traceable and can cause distortions. For example, using unit-based drivers to trace non-unit-based overhead costs would cause distortions.
7. Activity-based product costing is a costing approach that first assigns costs to activities and then to products. The assignment is made possible through the identification of activities, their costs, and the use of cost drivers.
8. The six steps are: (1) identify, define, and classify activities and key attributes; (2) assign the cost of resources to activities; (3) assign the cost of secondary activities to primary activities; (4) identify cost objects and specify the amount of each activity consumed by specific cost objects; (5) calculate primary activity rates; and (6) assign activity costs to cost objects.
9. The cost of resources is assigned to activities using direct tracing and resource drivers. Resource drivers such as effort expended and material usage trace costs to activities using causal relationships. Assigning costs to activities requires unbundling the general ledger. General ledger accounts accumulate costs by department and by account—not by activity. Thus, the costs in the general ledger account must be reassigned to activities—this is what unbundling means.
10. A bill of activities specifies the product, expected product quantity, activities, and amount of each activity expected to be consumed by each product.
11. Two types of activity drivers are transaction drivers and duration drivers. Transaction drivers measure the demands placed on an activity using the number of times an activity is performed. Duration drivers measure demands by the time it takes to perform an activity.
12. Unit-level activities are those that occur each time a unit of product is produced. Batch-level activities are those that are performed each time a batch of products is produced. Product-level or sustaining activities are those that are performed as needed to support the various products produced by a company. Facility-level activities are those that sustain a factory’s general manufacturing process.
13. TDABC simplifies ABC by eliminating the need to do detailed interviews and surveys to assess activity costs. By using objectively determined capacity cost rates, activity rates can be calculated directly.
14. Updating a TDABC model is easy because activity rates are updated simply by updating the capacity cost rate. Most changes in operating conditions are reflected by changes in either resource costs or system time. These changes are reflected in the capacity cost rate which is then used to update the activity rate.
15. Reduced systems can be achieved by applying the Pareto principle (or 80/20 rule) to activity cost or a series of simultaneous equations based on consumption ratios. The Pareto principle approach creates an approximately relevant ABC system. The simultaneous equation approach creates a reduced system that duplicates the accuracy. The Pareto approach is easy to understand and implement. The simultaneous equation approach creates a system that duplicates the accuracy of the more complex system, and it may be even smaller in size than the Pareto approach. Preserving accuracy probably produces the most benefit and thus has the most merit of the two approaches.
4-1
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accessible website, in whole or in part.
Cornerstone Exercises
Cornerstone Exercise 4.1
1. Plantwide rate = $2,000,000/50,000 = $40.00 per hour
Applied overhead:
Deluxe Regular
$40.00 × 10,000 $400,000
$40.00 × 40,000 $1,600,000
2. Overhead per unit (deluxe) = $400,000/20,000 = $20
Overhead per unit (regular) = $1,600,000/200,000 = $8
3. There would be an increase of $400,000 ($40 × 10,000) of overhead assigned to the deluxe speakers and so profitability for this product line would decrease by this amount. Overhead assignments affect product cost and profitability and thus can affect many decisions (e.g., pricing). This conclusion, in turn, implies that the way overhead is assigned is important.
Cornerstone Exercise 4.2
1. Overhead variance = $470,000 – $500,000 = $30,000 overapplied
Overhead Control 30,000
Cost of Goods Sold 30,000
2. Proration: (0.40 × $30,000; 0.2 × $30,000; 0.4 × $30,000)
Overhead Control 30,000
Cost of Goods Sold 12,000
Work-in-Process Inventory 6,000
Finished Goods Inventory 12,000
Prorated
Unadjusted Overapplied Adjusted
Balance Overhead Balance
Work-in-Process Inventory $100,000 $ 6,000 $94,000
Finished Goods Inventory 200,000 12,000 188,000
Cost of Goods Sold 200,000 12,000 188,000
Cornerstone Exercise 4.2 (Concluded)
3.
Cost of Goods Sold 30,000
Overhead Control 30,000
Cost of Goods Sold 12,000
Work-in-Process Inventory 6,000
Finished Goods Inventory 12,000
Overhead Control 30,000
Cornerstone Exercise 4.3
1. Molding: $400,000/5,000 = $80 per machine hour
Polishing: $80,000/20,000 = $4 per direct labor hour
2. Overhead assignment:
Form A Form B
($80 × 3,500) + ($4 × 5,000) $300,000
($80 × 1,500) + ($4 × 15,000) $180,000
Total applied overhead $300,000 $180,000
Units of production ÷ 30,000 ÷ 50,000
Unit overhead cost $ 10.00 $ 3.60
Plantwide rate = $480,000/25,000 = $19.20 per direct labor hour
Form A unit overhead cost: $19.20 × 6,000/30,000 = $3.84
Form B unit overhead cost: $19.20 × 19,000/50,000 = $7.30 (rounded)
Relative to the plantwide rate, the cost increased dramatically for Form A (from $3.84 to $10.00) and decreased significantly for Form B (from $7.30 to $3.60).
3. Overhead assignment:
Form A Form B
($80 × 1,200) + ($4 × 5,000) $116,000
($80 × 3,800) + ($4 × 15,000) $364,000
Total applied overhead $116,000 $364,000
Units of production ÷ 30,000 ÷ 50,000
Unit overhead cost $ 3.87 $ 7.28
Cornerstone Exercise 4.3 (Concluded)
Compared to the plantwide unit overhead costs, the cost is $0.03 more for Form A and $0.02 less for Form B. The message is that departmental rates may not necessarily cause a significant change in the assignments. It depends on the complexity of each product and how the resource demands are made in each department.
Cornerstone Exercise 4.4
1.
Consumption Ratios
Overhead Activity Part X12 Part YK7 Activity Driver
Machining 0.14a 0.86a Machine hours
Setups 0.33b 0.67b Number of setups
Inspecting products 0.10c 0.90c Testing hours
Purchasing 0.13d 0.87d Purchase orders
a50,000/350,000 (Part X12) and 300,000/350,000 (Part YK7)
b40/120 (Part X12) and 80/120 (Part YK7)
c1,000/10,000 (Part X12) and 9,000/10,000 (Part YK7)
d500/4,000 (Part X12) and 3,500/4,000 (Part YK7)
2.
Consumption Ratios
Overhead Activity Part X12 Part YK7 Activity Driver
Plantwide:
Manufacturing 0.30a 0.70a Direct labor hours
a30,000/100,000 (Part X12) and 70,000/100,000 (Part YK7)
When compared with the consumption ratios, it appears that the plantwide rate is undercosting Part YK7 and overcosting Part X12 (0.30 is more than all but one activity consumption ratio for X12).
3.
Consumption Ratios
Overhead Activity Part X12 Part YK7 Activity Driver
Plantwide:
Manufacturing 0.14a 0.86a Machine hours
a50,000/350,000 (Part X12) and 300,000/350,000 (Part YK7)
Cornerstone Exercise 4.4 (Concluded)
The plantwide rate using machine hours may make the assignments better—all but one of Part X12’s activities has a consumption ratio close to 0.14. If the activity costs were about equal, then we could say that the cost assignment with machine hours would definitely be more accurate.
Cornerstone Exercise 4.5
1. Machining rate: $6,000,000/600,000 = $10per machine hour
Engineering rate: $2,000,000/4,000 = $500 per hour
Receiving rate: $560,000/1,600 = $350 per order
Inspecting rate: $360,000/2,400 = $150 per hour
2.
Basic Advanced
Prime costs $8,000,000 $ 30,000,000
Overhead costs:
Machining:
$10 × 100,000 1,000,000
$10 × 500,000 5,000,000
Engineering:
$500 × 400 200,000
$500 × 3,600 1,800,000
Receiving:
$350 × 400 140,000
$350 × 1,200 420,000
Inspecting products:
$150 × 800 120,000
$150 × 1,600 240,000
Total manufacturing costs $ 9,460,000 $ 37,460,000
Units of production ÷ 100,000 ÷ 300,000
Unit cost $ 94.60 $ 124.87
Prime cost per unit:
Basic = $8,000,000 ÷ 100,000 = $80.00
Advanced = $30,000,000 ÷ 300,000 = $100.00
Overhead cost per unit: Basic: $94.60 − $80.00 = $14.60; YK7: $124.87 − $100.00 = $24.87
Cornerstone Exercise 4.5 (Concluded)
3. Using consumption ratios will yield exactly the same overhead assignments as activity rates, if the actual activity usage is the same as the expected usage (assuming no rounding error for the ratios). For inspecting, the consumption ratio is 800/2,400 = 1/3 for Basic and 2/3 for Advanced. Thus, the assignment is (1/3) × $360,000 = $120,000 (Basic) and (2/3) × $360,000 = $240,000 (Advanced), which is the same assignment obtained using activity rates.
Cornerstone Exercise 4.6
1.
Percentage of Time on Each Activity
Activity Supervisor Clerks Supporting Calculation
Supervising clerks 100% 0% (2,000/2,000)
Processing accounts 0 40 (10,000/25,000)
Issuing statements 0 20 (5,000/25,000)
Processing transactions 0 28 (7,000/25,000)
Answering customer inquiries 0 12 (3,000/25,000)
2.
Activity Phonea Salariesb Computerc Total
Supervising clerks $ 9,000 $ 70,000 $ 79,000
Processing accounts 9,000 110,000 119,000
Issuing statements 9,000 55,000 $ 7,500 71,500
Processing transactions 9,000 77,000 17,500 103,500
Answering customer inquiries 54,000 33,000 87,000
a0.60 × $90,000 for customer inquiries; 0.10 × $90,000 for other activities
b1.0 × $70,000; 0.40 × $275,000; 0.20 × $275,000; 0.28 × $275,000; 0.12 × $275,000
c0.30 × $25,000; 0.70 × $25,000
Cornerstone Exercise 4.6 (Concluded)
3. Supervising is a secondary activity and its costs are consumed by primary activities (assigned in proportion to the labor content of each activity).
Processing accounts $150,600a
Issuing statements 87,300b
Processing transactions 125,620c
Answering customer inquiries 96,480d
a$119,000 + (0.40 × $79,000)
b$71,500 + (0.20 × $79,000)
c$103,500 + (0.28 × $79,000)
d$87,000 + (0.12 × $79,000)
Cornerstone Exercise 4.7
1. Capacity cost rate = $460,000/25,000 = $18.40 per hour
2. Rates:
Processing accounts: 0.20 × $18.40 = $3.68 per account
Issuing statements: 0.10 × $18.40 = $1.84 per statement
Processing transactions: 0.05 × $18.40 = $0.92 per transaction
Answering inquiries: 0.15 × $18.40 = $2.76 per inquiry
Activity Cost:
Issuing statements: $1.84 × 20,000 = $36,800
3. Capacity cost rate = $450,000/22,500* = $20 per hour
*25,000 – 0.10(25,000)
Updated rates:
Processing accounts: 0.20 × $20 = $4 per account
Issuing statements: 0.10 × $20 = $2 per statement
Processing transactions: 0.05 × $20 = $1 per transaction
Answering inquiries: 0.15 × $20 = $3 per inquiry
Cornerstone Exercise 4.8
1. Expected Consumption
Budgeted Activity Ratios
Activity Costa Wafer A Wafer B
3. Testing products $ 720,000 0.60 0.40
6. Handling wafer lots 360,000 0.45 0.55
7. Inserting dies 840,000 0.70 0.30
8. Purchasing materials 480,000 0.20 0.80
11. Moving materials 600,000 0.50 0.50
Total activity cost $3,000,000
Approximate ABC cost:b $1,578,000 $1,422,000
a Original activity cost plus share of the costs of the remaining “inexpensive” activities (allocated in proportion to the original costs of the expensive activities: $600,000 + [($600,000/$2,500,000) × $500,000] = $720,000
$300,000 + [($300,000/$2,500,000) × $500,000] = $360,000
$700,000 + [($700,000/$2,500,000) × $500,000] = $840,000
$400,000 + [($400,000/$2,500,000) × $500,000] = $480,000
$500,000 + [($500,000/$2,500,000) × $500,000] = $600,000
b Reduced system ABC assignment (using consumption ratios):
Wafer A: [(0.60 × $720,000) + (0.45 × $360,000) + (0.70 × $840,000) + (0.20 × $480,000) + (0.50 × $600,000)]
Wafer B: [(0.40 × $720,000) + (0.55 × $360,000) + (0.30 × $840,000) + (0.80 × $480,000) + (0.50 × $600,000)]
2. Relative error, Wafer A: ($1,578,000 – $1,500,000)/$1,500,000 = 0.052 (5.2%)
Relative error, Wafer B: ($1,422,000 – $1,500,000)/$1,500,000 = –0.052 (– 5.2%)
The maximum error is 5.2 percent compared to the ABC assignments. This is a good approximation indicating that the approach has merit.
3. Using consumption ratios, the ABC cost of Wafer A is $650,000(0.25 + 0.10 + 0.15 + 0.20) + $50,000(0.60 + 0.55 + 0.45 + 0.70 + 0.35 + 0.65 + 0.50 + 0.30) = $660,000. Since the cost is the same for each of the four most expensive activities, the reassigned cost for each of the four activities is $750,000[$650,000 + (0.25 × $400,000)]. Thus, using consumption ratios, the approximately relevant cost is $750,000(0.25 + 0.10 + 0.15 + 0.20) = $525,000. The difference between the ABC cost and the approximately relevant cost is $135,000 ($660,000 – $525,000) or a relative error of about –20.5% ($525,000 – $660,000)/$660,000. It appears that a significant error can occur even when the expensive activities account for about 87 percent of the total overhead. However, this is still a vast improvement over the plantwide rate assignment (which is $2,100,000 vs. $660,000—an error of over 218 percent).
Cornerstone Exercise 4.9
1. Global ratios:
Wafer A = 0.50 ($1,500,000/$3,000,000)
Wafer B = 0.50 ($1,500,000/$3,000,000)
Equations:
0.70w1 + 0.20w2 = 0.50 (Wafer A)
0.30w1 + 0.80w2 = 0.50 (Wafer B)