MBA 606 – MANAGERIAL ACCOUNTING

ACTIVITY # 2 - PROCESS COSTING, JOB-ORDER COSTING, ACTIVITY-BASED COSTING

INSTRUCTOR: MA. ROSALINA ARARAO-BESARIO, CPA, Ph.D.

Problem No. 1. High-Low Method; Method of Least Squares; Correlation

Livingston Company has gathered data on its overhead activities and associated costs for the
past 10 months. Brett Wilkinson, a member of the controller’s department, has convinced
management that overhead costs can be better estimated and controlled if the fixed and
variable components of each overhead activity are known. Brett has identified 150 different
activities and has grouped them into sets based on her belief that they share a common driver.
(This classification process has reduced the number of cost formulas needed from 150 to 25.)
For example, she has decided that processing sales orders, scheduling, and setups can be
grouped together (as a general order-filling activity) based on her belief that the costs of the
three related activities are all driven by the same driver, number of setups. To confirm her
activity classification and driver assignment, she has gathered 10 months of data on the cost of
filling sales orders and on the number of setups. Just in case the number of setups is not a
good driver, she also collected data on setup hours.

Required:

1. Using the high-low method, prepare a cost formula for the order filling activity using
number of setups as the driver.
2. Using the method of least squares, prepare a cost formula for the order filling activity
using number of setups as the driver. What does the coefficient of determination tell us
about the use of receiving orders as the independent variable?
3. Using the method of least squares, prepare a cost formula for the order filling activity
using setup hours as the driver. What does the coefficient of determination tell us about
the use of setup hours as the independent variable?
4. Run a multiple regression using both the number of setups and setup hours as the
independent variables. Which of the three regression equations do you think is best?
Why

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MBA 606 – MANAGERIAL ACCOUNTING
ACTIVITY # 2 - PROCESS COSTING, JOB-ORDER COSTING, ACTIVITY-BASED COSTING
INSTRUCTOR: MA. ROSALINA ARARAO-BESARIO, CPA, Ph.D.

Problem No. 2 - Functional Based versus Activity-Based Costing

Descout Company for years produced only one product: backpacks. Recently, the company
decided to add a line of duffel bags. With this addition, the company began assigning overhead
costs using departmental rates. (Prior to this, the company used a predetermined plantwide
rate based on units produced.) Departmental rates meant that overhead costs had to be
assigned to each producing department to create overhead pools so that predetermined
departmental rates could be calculated. Surprisingly, after the addition of the duffel-bag line and
the switch to departmental rates, the costs to produce the backpacks increased and their
profitability dropped. The marketing manager and the production manager both complained
about the increase in the production cost of backpacks. The marketing manager was concerned
because the increase in unit costs led to pressure to increase the unit price of backpacks. She
was resisting this pressure because she was certain that the increase would harm the
company’s market share. The production manager was receiving pressure to cut costs also, yet
he was convinced that nothing different was being done in the way the backpacks were
produced. He was also convinced that further efficiency in the manufacture of the backpacks
was unlikely. After some discussion, the two managers decided that the problem had to be
connected to the addition of the duffel-bag line.

Upon investigation, they were informed that the only real change in product-costing procedures
was in the way overhead costs are assigned. A two-stage procedure was now in use. First,
overhead costs are assigned to the two producing departments, patterns, and finishing. Some
overhead costs are assigned to the producing departments using direct tracing, and some are
assigned using driver tracing. For example, the salaries of the producing department’s
supervisors are assigned using direct tracing, whereas the costs of the factory’s accounting
department are assigned using driver tracing (the driver being the number of transactions
processed for each department). Second, the costs accumulated in the producing departments
are assigned to the two products using direct labor hours as a driver (the rate in each
department is based on direct labor hours). The managers were assured that great care was
taken to associate overhead costs with individual products. So that they could construct their
own example of overhead cost assignment, the controller provided information necessary to
show how accounting costs are assigned to products:

Department
Patterns Finishing Total

Accounting cost $48,000 $72,000 $120,000

Transactions processed 32,000 48,000 80,000
Total direct labor hours 10,000 20,000 30,000
Direct labor hours per backpack* 0.10 0.20 0.30
Direct labor hours per duffel bag* 0.40 0.80 1.20

*Hours required to produce one unit of each product

The controller remarked that the cost of operating the accounting department had doubled with
the addition of the new product line. The increase came because of the need to process
additional transactions, which had also doubled in number. During the first year of producing
duffel bags, the company produced and sold 100,000 backpacks and 25,000 duffel bags. The
100,000 backpacks matched the prior year’s output for that product.

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MBA 606 – MANAGERIAL ACCOUNTING
ACTIVITY # 2 - PROCESS COSTING, JOB-ORDER COSTING, ACTIVITY-BASED COSTING
INSTRUCTOR: MA. ROSALINA ARARAO-BESARIO, CPA, Ph.D.

Required
1. Compute the amount of accounting cost assigned to a backpack before the duffel-bag
line was added using a plantwide rate approach based on units produced. Is this
assignment accurate? Explain.
2. Suppose that the company decided to assign the accounting costs directly to the product
lines using the number of transactions as the activity driver. What is the accounting cost
per unit of backpacks? per unit of duffel bags?
3. Compute the amount of accounting cost assigned to each backpack and duffel bag using
departmental rates based on direct labor hours.
4. Which way of assigning overhead does the best job, the functional-based approach
using departmental rates or the activity-based approach using transactions processed
for each product? Explain. Discuss the value of activity-based costing before the duffel-
bag line was added.

Problem No. 3. Preparing a Cost of Production Report

Cocolots, Inc., manufactures chocolate syrup in three departments: Cooking, Mixing, and
Bottling. Cocolots uses the weighted average method. The following are cost and production
data for the Mixing Department for June (assume that units are measured in gallons):

Production:
Units in process, June 1, 60% complete 60,000
Units completed and transferred out 240,000
Units in process, June 30, 20% complete 40,000

Costs:
Work in process, June 1 $ 390,600
Costs added during June 1, 171,800

Required
1. Prepare a physical flow analysis for the Mixing Department for the month of June.
2. Calculate equivalent units of production for the Mixing Department for the month of June.
3. Calculate unit cost for the Mixing Department for the month of June.
4. Calculate the cost of units transferred out and the cost of ending work-in process inventory.
5. Prepare a cost reconciliation for the Mixing Department for the month of June.
6. Prepare a cost of production report for the Mixing Department for the month of June.

Problem 4. Equivalent Units— Weighted Average Method

The following data are for four independent process-costing departments:

A B C D
Beginning inventory 3,200 1,000 0 30,000
Percent completion 30% 40% 0% 75%
Units started 17,000 23,000 40,000 40,000
Ending inventory 4,000 0 9,000 10,000
Percent completion 25% 0% 10% 25%

Required
Compute the equivalent units of production for each of the above departments using the
weighted average method.

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MBA 606 – MANAGERIAL ACCOUNTING
ACTIVITY # 2 - PROCESS COSTING, JOB-ORDER COSTING, ACTIVITY-BASED COSTING
INSTRUCTOR: MA. ROSALINA ARARAO-BESARIO, CPA, Ph.D.

Problem 5. Journal Entries & T-Accounts

Lowder, Inc., builds custom conveyor systems for warehouses and distribution centers. During
the month of July, the following occurred:

a. Materials were purchased on account for $44,200.

b. Materials totaling $27,000 were requisitioned for use in production—$12,500 for Job
#703 and the remainder for Job #704.
c. Direct labor payroll for the month was $28,200, with an average wage of $15 per hour.
Job #703 required 780 direct labor hours; Job #704 required 1,100 direct labor hours.
d. Actual overhead of $19,950 was incurred and paid.
e. Overhead is charged to production at the rate of $10 per direct labor hour.
f. Job #703 was completed and transferred to finished goods.
g. Job #704, which was started during July, remained in process at the end of the month.
h. Job #700, which had been completed in May, was sold on account for cost plus 40
percent.

Beginning balances as of July 1 were as follows:

Materials $ 6,070
Work in Process (for Job #703) 13,000
Finished Goods (for Job #700) 6,240

Required

1. Prepare the journal entries for events (a) through (e) above.
2. Prepare simple job-order cost sheets for Jobs #703 and #704.
3. Prepare the journal entries for events (f) and (h) above.
4. Calculate the ending balances of:
a. Materials
b. Work in Process
c. Finished Goods

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MBA 606 – MANAGERIAL ACCOUNTING
ACTIVITY # 2 - PROCESS COSTING, JOB-ORDER COSTING, ACTIVITY-BASED COSTING
INSTRUCTOR: MA. ROSALINA ARARAO-BESARIO, CPA, Ph.D.

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MBA 606 – MANAGERIAL ACCOUNTING
ACTIVITY # 2 - PROCESS COSTING, JOB-ORDER COSTING, ACTIVITY-BASED COSTING
INSTRUCTOR: MA. ROSALINA ARARAO-BESARIO, CPA, Ph.D.

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MBA 606 – MANAGERIAL ACCOUNTING
ACTIVITY # 2 - PROCESS COSTING, JOB-ORDER COSTING, ACTIVITY-BASED COSTING
INSTRUCTOR: MA. ROSALINA ARARAO-BESARIO, CPA, Ph.D.

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