In Class #5.1 Required 1

In Class #5.1
Required 1:
Prepare a report showing the first stage allocations of overhead costs to the activity cost pools.
Distribution of Resource Consumption
Across Activity Cost Pools
Direct Labour
Order
Customer
Support
Processing
Support
Wages and salaries.......................
30%
35%
25%
Other overhead costs ...................
25%
15%
20%
Other
10%
40%
Totals
100%
100%
Direct Labour
Support
Wages and salaries.......................
$105,000
Other overhead costs ...................
50,000
Total cost .....................................
$155,000
Other
$ 35,000
80,000
$115,000
Totals
$350,000
200,000
$550,000
Order
Processing
$122,500
30,000
$152,500
Customer
Support
$ 87,500
40,000
$127,500
Example: 30% of $350,000 is $105,000.
Required 2:
Compute the activity rates for the activity cost pools.
Activity Cost Pools
Direct labour support ..................
Order processing .........................
Customer support ........................
(a)
Total Cost
$155,000
$152,500
$127,500
(b)
Total Activity
10,000 DLHs
500 orders
100 customers
(a) ÷ (b)
Activity Rate
$15.50 per DLH
$305 per order
$1,275 per customer
Required 3:
Prepare a report showing the overhead costs for the order from Indus Telecom, including customer support costs.
Activity Cost Pool
Direct labour support ...
Order processing ..........
Customer support .........
Total .............................
(a)
Activity Rate
$15.50 per DLH
$305 per order
$1,275 per customer
(b)
Activity
50 DLHs*
1 orders
1 customer
(a) × (b)
ABC Cost
$ 775
305
1,275
$2,355
*0.5 DLH per unit × 100 units = 50 DLHs
Required 4:
Prepare a report showing the customer margin for Indus Telecom.
Customer Margin—ABC Analysis
Sales (100 units × $295 per unit) .......................................
Costs:
Direct materials ($264 per unit × 100 units) .........................
Direct labour ($25 per DLH × 0.5 DLH per unit × 100
units) ...............................................................................
Direct labour support overhead (see part 3 above) ............
Order processing overhead (see part 3 above) ...................
Customer support overhead (see part 3 above) ..................
Customer margin ...................................................................
$29,500
$26,400
1,250
775
305
1,275
30,005
$ (505)
In Class #5.2 – Compute Activity Rates
Required:
Compute the activity rate for each of the activity cost pools.
Activity Cost Pool
Caring for lawn
Caring for garden beds–
low maintenance
Caring for garden beds–
high maintenance
Travel to jobs
Customer billing and service
Estimated
Overhead
Cost
$77,400
$30,000
$57,600
$4,200
$8,700
Expected Activity
Activity Rate
180,000
24,000
18,000
15,000
30
square metres of lawn
square metres of low
maintenance beds
square feet of high
maintenance beds
kilometres
customers
$0.43
$1.25
$3.20
$0.28
$290
per square metre of lawn
per square metre of low
maintenance beds
per square metre of high
maintenance beds
per kilometre
per customer
The activity rate for each activity cost pool is computed by dividing its estimated overhead cost by its expected activity.
In Class #5.3 – Product and Customer Profitability Analysis
Required:
Using the company’s activity-based costing system, compute the customer margin of Eagle
Wings.
Sales ($1,650 per standard model glider x 10 standard model gliders +
$2,300 per custom designed glider x 2 custom designed gliders) ...
Costs:
Direct materials ($462 per standard model glider x 10 standard model
gliders + $576 per custom
designed glider x 2 custom designed gliders) ..............................
Direct labour ($19 per direct labour-hour × 28.5 direct labour-hours
per standard model glider x 10 standard model gliders + $19 per
direct labour-hour × 32 direct labour-hours per custom designed
glider x 2 custom designed gliders) .............................................
Supporting manufacturing ($18 per direct labour-hour × 28.5 direct
labour-hours per standard model glider x 10 standard model gliders
+ $18 per direct labour-hour × 32 direct labour-hours per custom
designed glider x 2 custom designed gliders) ..............................
Order processing ($192 per order × 3 orders) .................................
Custom designing ($261 per custom design × 2 custom designs) ....
Customer service ($426 per customer ×
1 customer)...................................................................................
Customer margin .................................................................................
$21,100
$5,772
6,631
6,282
576
522
426
20,209
$ 891
In Class #5.4 – Activity-Based Costing Product Costs for External Reports
Required 1:
The company’s manufacturing overhead costs for the year are expected to be $336,000. Using
the company’s traditional costing system compute the unit product costs for the two products.
Number of units produced (a) ..........................................
Direct labour-hours per unit (b) .......................................
Total direct labour-hours (a) × (b) ...................................
Total manufacturing overhead (a) ....................................
Total direct labour-hours (b) ............................................
Predetermined overhead rate (a) ÷ (b) .............................
Direct materials ................................................................
Direct labour ....................................................................
Manufacturing overhead applied:
0.20 DLH per unit × $28.00 per DLH ..........................
0.25 DLH per unit × $28.00 per DLH ..........................
Unit product cost ..............................................................
Mercon
10,000
0.20
2,000
Wurcon
40,000
0.25
10,000
$336,000
12,000 DLHs
$28.00 per DLH
Mercon
$10.00
3.00
Wurcon
$ 8.00
3.75
5.60
$18.60
7.00
$18.75
Total
12,000
Required 2:
Management is considering an activity-based costing system in which half of the overhead would continue to be allocated on the basis of
direct labour-hours and half would be allocated on the basis of engineering design time. The Mercon product is expected to need 4,000
engineering design hours and the Wurcon project is also expected to need 4,000 engineering design hours. Compute the unit product
costs for the two products using the proposed ABC system.
Activity Cost Pool
Labour related ....................
Engineering design ............
Estimated
Overhead
Cost*
$168,000
168,000
$336,000
(b)
Expected
Activity
direct labour-hours
12,000
8,000 engineering-hours
(a) ÷ (b)
Activity
Rate
$14 per direct labour-hour
$21 per engineering-hour
*The total manufacturing overhead cost is split evenly between the two activity cost pools.
Manufacturing overhead is assigned to the two products as follows:
Mercon:
Activity Cost Pool
Labour related .................
Engineering design ..........
Total ................................
(a)
Activity Rate
$14 per DLH
$21 per engineering-hour
(b)
Activity
2,000 DLHs
4,000 engineering-hours
(a) × (b)
ABC Cost
$28,000
84,000
$112,000
(a)
Activity Rate
$14 per DLH
$21 per engineering-hour
(b)
Activity
10,000 DLHs
4,000 engineering-hours
(a) × (b)
ABC Cost
$140,000
84,000
Wurcon:
Activity Cost Pool
Labour related .................
Engineering design ..........
Total ................................
$224,000
The unit product costs combine direct materials, direct labour, and manufacturing overhead costs:
Direct materials .....................................................................
Direct labour ..........................................................................
Manufacturing overhead ($112,000 ÷ 10,000 units;
$224,000 ÷ 40,000 units) ...................................................
Unit product cost ...................................................................
Mercon
$10.00
3.00
Wurcon
$ 8.00
3.75
11.20
$24.20
5.60
$17.35
Required 3:
Explain why the unit product costs differ between the two systems.
The unit product cost of the high-volume product, Wurcon, declines under the activity-based costing system, whereas the unit product
cost of the low-volume product, Mercon, increases. This occurs because half of the overhead is applied on the basis of engineering design
hours instead of direct labour-hours. When the overhead was applied on the basis of direct labour-hours, most of the overhead was
applied to the high-volume product. However, when the overhead is applied on the basis of engineering-hours, more of the overhead cost
is shifted over to the low-volume product. Engineering design is a product-level activity, so the higher the volume, the lower the unit cost
and the lower the volume, the higher the unit cost.
In Class #5.5 – Activity-Based Costing as an Alternative to Traditional Product Costing
Required 1:
Using direct labour-hours as the base for assigning manufacturing overhead cost to products,
compute the predetermined overhead rate. Using this rate and other data from the problem,
determine the unit product cost of each model.
The company’s estimated direct labour-hours (DLHs) can be computed as follows:
Deluxe model: 15,000 units × 1.6 DLH per unit ...........................
Regular model: 120,000 units × 0.8 DLH per unit ........................
Total direct labour-hours ...............................................................
24,000
96,000
120,000
Using direct labour-hours as the base, the predetermined overhead rate would be:
$6,000,000 ÷ 120,000 = $50 per direct labour hour
The unit product cost of each model using the company’s traditional costing system would
be:
Direct materials ...............................
Direct labour....................................
Manufacturing overhead:
$50 per DLH × 1.6 DLHs ............
$50 per DLH × 0.8 DLHs ............
Total unit product cost ....................
Deluxe
$154
16
Regular
$112
8
80
40
$160
$250
Required 2:
Management is considering an activity-based costing to apply manufacturing overhead costs to
products for external financial reports. The activity-based costing system would have the
following four activity cost pools:
Activity Cost Pool
Purchase orders
Scrap/rework orders
Product testing
Machine related
Total overhead costs
Activity Measure
Number of purchase orders
Number of scrap/rework orders
Number of tests
Machine-hours
Number of purchase orders
Number of scrap/rework orders
Number of tests
Machine-hours
Overhead costs
$252,000
$648,000
$1,350,000
$3,750,000
$6,000,000
Expected Activity
Deluxe
Regular
400
800
500
400
6,000
9,000
20,000
30,000
Total
1,200
900
15,000
50,000
Compute the predetermined overhead rates (i.e. activity rates) for each of the four activity cost
pools.
Predetermined overhead rates are computed below:
(a)
(b)
(a) ÷ (b)
Estimated
Expected
Predetermined
Activity Cost Pool
Overhead Cost
Activity
Overhead Rate
Purchase orders ....................
$252,000 1,200 purchase orders $210 per purchase order
Scrap/rework orders .............
$648,000
900 scrap/rework $720 per scrap/ rework
orders
order
Product testing......................
$1,350,000
15,000 tests
$90 per test
Machine related ....................
$3,750,000
50,000 MHs
$75 per MH
Required 3:
Using the predetermined overhead rates computed in required 2 above, do the following:
a. Compute the total amount of manufacturing overhead cost that would be applied to each
model using the activity-based costing system. After these totals have been computed,
determine the amount of manufacturing overhead cost per unit for each model.
b. Compute the unit product cost of each model (materials, labour, and manufacturing
overhead).
a. The overhead applied to each product can be determined as follows:
The Deluxe Model
Activity Cost Pool
Purchase orders ...................................................
Scrap/rework orders ............................................
Product testing ....................................................
Machine related ..................................................
Total overhead cost (a) .......................................
Number of units produced (b) ............................
Overhead cost per unit (a) ÷ (b) ..........................
(a)
Predetermined
Overhead Rate
$210 per PO
$720 per order
$90 per test
$75 per MH
(b)
Activity
400 POs
500 orders
6,000 tests
20,000 MHs
(a) × (b)
Overhead
Applied
$ 84,000
360,000
540,000
1,500,000
$2,484,000
15,000
$165.60
The Regular Model
Activity Cost Pool
Purchase orders ...................................................
Scrap/rework orders ............................................
Product testing ....................................................
Machine related ..................................................
Total overhead cost (a) .......................................
Number of units produced (b) ............................
Overhead cost per unit (a) ÷ (b) ..........................
(a)
Predetermined
Overhead Rate
$210 per PO
$720 per order
$90 per test
$75 per MH
(b)
Activity
800 POs
400 orders
9,000 tests
30,000 MHs
(a) × (b)
Overhead
Applied
$ 168,000
288,000
810,000
2,250,000
$3,516,000
120,000
$29.30
b. Using activity-based costing, the unit product cost of each model would be:
Direct materials ..............................................
Direct labour...................................................
Manufacturing overhead (above) ...................
Total unit product cost ...................................
Deluxe
$154.00
16.00
165.60
$335.60
Regular
$112.00
8.00
29.30
$149.30
Required 4:
From the data you have developed in required 1 through 3 above, identify factors that may
account for the company’s declining profits.
It is risky to draw any definite conclusions based on the above analysis. The activity-based
costing system used in this company is not completely suitable for making decisions. Product
costs probably include the costs of idle capacity and organization-sustaining costs. They also
exclude non-manufacturing costs that may be caused by the products. Nevertheless, the above
analysis is suggestive. Unit costs appear to be distorted as a result of using direct labour-hours as
the base for assigning overhead cost to products. Although the deluxe model requires twice as
much labour time as the regular model, it still is not being assigned enough overhead cost, as
shown in the analysis in part 3(a).
When the company’s overhead costs are analyzed on an activities basis, it appears that the deluxe
model is more expensive to manufacture than the company realizes. Note that the deluxe model
accounts for 40% of the machine-hours, although it represents a small part of the company’s total
production. Also, it consumes a disproportionately large amount of the activities.
When activity-based costing is used in place of direct labour as the basis for assigning overhead
cost to products, the unit product cost of the deluxe model jumps from $250 to $335.60. If the
$250 cost figure is being used as the basis for pricing, then the selling price for the deluxe model
may be too low. This may be one reason why profits have been declining over the last several
years. It may also be the reason why sales of the deluxe model have been increasing rapidly.

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