Capitulo 8 Activity Based Costing - Compressed

Chapter 4
Activity-Based Costing
Solutions to Questions
4-1 The most common methods of assigning 4-5 Activity-based costing involves two
overhead costs to products are plantwide over- stages of overhead cost assignments. In the first
head rates, departmental overhead rates, and stage, costs are assigned to activity cost pools.
activity-based costing. In the second stage, costs are allocated from
the activity cost pools to products.
4-2 The assumption, implicit in conventional
costing systems, that overhead cost is propor- 4-6 In a conventional costing system, over-
tional to direct labor, is being increasingly ques- head costs are allocated to products using some
tioned. Automation has decreased the amount measure of volume such as direct labor-hours or
of direct labor, overhead costs have increased, machine-hours. Consequently, the high-volume
and companies now handle many more products products, which have the largest amount of di-
that differ substantially in volume, batch size, rect labor-hours or machine-hours, are allocated
and complexity. Activity-based costing attempts most of the overhead cost. In activity-based
to more accurately assign overhead costs to costing, some of the overhead costs are typically
products based on the activities required to allocated using batch-level or product-level allo-
make products and the resources consumed by cation bases. For example, if each product is
those activities. allocated a total of $10,000 in product-level cost
irrespective of its volume, then a high-volume
4-3 The departmental approach to assigning product will be allocated exactly the same total
overhead cost to products usually assumes that overhead as a low-volume product. In contrast,
overhead costs are proportional to direct labor- if a measure of volume like direct labor-hours or
hours or machine-hours. However, overhead machine-hours were used to allocate this cost,
costs are often driven by other factors, including the high-volume product would be allocated
the number of batches run and product com- more in total than the low-volume product.
plexity, that are only loosely related, if at all, to
volume. Activity-based costing attempts to more 4-7 Activity-based costing improves the ac-
accurately assign overhead costs to products curacy of product costs in three ways. First, ac-
based on the activities that they cause rather tivity-based costing increases the number of
than just on the direct labor-hours required to cost pools used to accumulate overhead costs.
make a unit. Rather than accumulating all overhead costs in a
single, plantwide pool, or accumulating them in
4-4 The hierarchical levels are: departmental pools, costs are accumulated for
1. Unit-level activities, which are performed each major activity. Second, the activity cost
each time a unit is produced. pools are more homogeneous than departmental
2. Batch-level activities, which are per- cost pools. In principle, all of the costs in an ac-
formed each time a batch is handled or proc- tivity cost pool pertain to a single activity. In
essed. contrast, departmental cost pools contain the
3. Product-level activities, which are per- costs of many different activities carried out in
formed to support specific products. the department. Third, activity-based costing
4. Facility-level activities, which sustain an changes the bases used to assign overhead
organization’s general capabilities. costs to products. Rather than assigning costs
on the basis of direct labor or some other meas-
ure of volume, costs are assigned on the basis
© The McGraw-Hill Companies, Inc., 2022. All rights reserved.

Solutions Manual, Chapter 4 1
of the activities that presumably cause overhead
costs.
4-8 While the product costs computed using

activity-based costing are almost certainly more
accurate than those computed using more con-
ventional costing methods, activity-based cost-
ing nevertheless rests on some questionable
assumptions about cost behavior. In particular,
activity-based costing assumes that costs are
proportional to activity. In reality, costs appear
to increase less than in proportion to increases
in activity. This implies that activity-based prod-
uct costs will be overstated for purposes of
making decisions. (The same criticism can be
leveled at conventional product costs.) Second,
the costs of implementing and maintaining an
activity-based costing system can be high and
its benefits may not justify this cost.

2 Introduction to Managerial Accounting, 9th edition
Chapter 4: Applying Excel
The completed worksheet is shown below.

Chapter 4: Applying Excel (continued)
The completed worksheet, with formulas displayed, is shown below.

1. When the direct labor requirement for the Deluxe model is reduced, the
result is:

a. The effect of reducing the direct labor requirement on the
predetermined overhead rate is shown below:
Original: Reduced:
5 DLHs 2 DLHs
Estimated total manufacturing
overhead (a) ........................... $550,000 $550,000
Estimated total amount of the
allocation base (b) ................... 50,000 44,000
Predetermined overhead rate
(a) ÷ (b) ................................ $11.00 $12.50
The predetermined overhead rate increased from $11.00 per direct
labor-hour to $12.50 per direct labor-hour when the direct labor hour
requirement decreased from 5 direct labor-hours to 2 direct-labor
hours per unit of the Deluxe model. This occurs because the total
amount of the allocation base (in this case, direct labor-hours) drops,
but the estimated total manufacturing overhead has not changed.
Unless the estimated total manufacturing overhead is strictly variable
with respect to direct labor-hours, the predetermined overhead rate
will increase when the total direct labor-hours drops.
b. The effects of reducing the direct labor requirement of the Deluxe

model on the unit product costs of the Tourist model appear below:
Traditional unit product cost for the Tourist model:
5 DLHs 2 DLHs
Direct materials ........................... $ 17.00 $ 17.00
Direct labor ................................. 48.00 48.00
Manufacturing overhead applied ... 44.00 50.00
Traditional unit product cost ......... $109.00 $115.00
ABC unit product cost for the Tourist model:
5 DLHs 2 DLHs
Direct labor ................................. 48.00 48.00
ABC overhead cost per unit .......... 35.15 36.02

This result may seem odd. There was no change in any cost (except
for the total labor cost of producing the Deluxe model) and there was
no change in any of the fundamental characteristics of the Tourist
model and yet under both costing methods, the unit product cost of
the Tourist model increased. Why should a decrease in the labor cost
of another product increase the overall unit product cost of the
Tourist model? Truthfully, it shouldn’t.
What happened? When the direct labor-hours required to produce
the Deluxe models decreases, the proportion of the total direct labor-
hours accounted for by the Tourist model increases. Therefore, if a
fixed overhead cost is allocated on the basis of direct labor-hours,
some of its cost will be shifted from the Tourist to the Deluxe model.
This anomalous result is less pronounced under activity-based costing
because less of the overhead is allocated on the basis of direct labor-
hours. For this and other reasons, activity-based costing is usually
better for decision-making than traditional costing systems based
solely on direct labor-hours.

2. With the changes in the data, the worksheet should look like this:

a. The traditional unit product costs are shown below:
Original traditional unit product costs:
Deluxe Tourist
Direct labor ................................. 60.00 48.00
Revised traditional unit product costs:
Deluxe Tourist
Direct labor ................................. 60.00 48.00
The change in the production order requirements for the two
products has no impact on the unit product costs under the
traditional costing method that is based entirely on direct labor-hours.
b. The activity-based unit product costs are shown below:

Original ABC unit product costs:
Deluxe Tourist
Direct labor ................................. 60.00 48.00
ABC overhead cost per unit .......... 99.25 35.15
Revised ABC unit product costs:
Deluxe Tourist
Direct labor ................................. 60.00 48.00
The change in the production order requirements does affect the unit
product costs under activity-based costing. The Deluxe model now
requires more production orders and the Tourist model requires fewer
production orders. Therefore, the Deluxe model should cost more and
the Tourist model should cost less.

c. The traditional costing method does not take into account any
changes in cost drivers such as the number of production orders. It is
based solely on direct labor-hours. Therefore, the traditional costing
method is ordinarily less accurate than activity-based costing.

3. The following worksheet reflects all of the changes in the data:

a. The traditional unit product costs for the two products are identical.
This occurs because they have the same direct materials cost, the
same direct labor cost, and the same direct labor-hour requirements.
Because all of the overhead is allocated on the basis of direct labor-
hours, their costs will be the same.
b. In contrast to the traditional costing method, the ABC unit product

costs for the two products are different. Even though the two
products have the same direct materials cost, the same direct labor
cost, and the same direct labor-hour requirements, they differ in the
activities they use. While the Deluxe model has 10% of the total unit
sales and 10% of the total direct labor-hours, it has 20% of the total
setups, 30% of the production orders, and 50% of the total machine-
hours. Therefore, the Deluxe model is allocated more of the machine
setup costs, production order costs, and general factory costs than
the Tourist model under activity-based costing.
c. Assuming that machine setup costs really do vary with the number of
machine setups, the production order costs do vary with the number
of production orders, and the general factory costs do vary with the
number of machine-hours, then the activity-based costing system will
provide more accurate costs than the traditional costing method.

The Foundational 15
1. The plantwide overhead rate is computed as follows:
Total estimated overhead cost (a) ............ $684,000
Total expected direct labor-hours (b)........ 12,000 DLHs
Predetermined overhead rate (a) ÷ (b)..... $57.00 per DLH
2. The overhead cost assignments to Products Y and Z are as follows:

Product Y Product Z
Total direct labor-hours (a) ...................... 9,000 3,000
Plantwide overhead rate per DLH (b) ........ $57.00 $57.00
Manufacturing overhead assigned (a) × (b) $513,000 $171,000
3-6.
The activity rates are computed as follows:
(a)
Estimated (b) (a) ÷ (b)
Overhead Expected Activity
Activity Cost Pool Cost Activity Rate
Machining ............... $200,000 10,000 MH $20 per MH
Machine setups ....... $100,000 200 setups $500 per setup
Product design ........ $84,000 2 products $42,000 per product
General factory ....... $300,000 12,000 DLHs $25 Per DLH
7. Machine setups is a batch-level activity. A setup is performed to run a

batch of units. The cost of the setup is determined by the resources
consumed performing the setup and it is not influenced by the number
of units processed once the setup is complete.
8. The product design activity is a product-level activity. The product

design cost is determined by the number of products supported and it is
not influenced by the number of batches or units processed.

The Foundational 15 (continued)
9-10. Using the ABC system, the total overhead assigned to Products Y and Z is computed as follows:
Product Y Product Z
Expected Expected
Activity Amount Activity Amount
Machining, at $20.00 per machine-hour .............. 8,000 $160,000 2,000 $ 40,000
Machine setups, at $500.00 per setup ................. 40 20,000 160 80,000
Product design, at $42,000 per product .............. 1 42,000 1 42,000
General factory, at $25.00 per direct labor-hour .. 9,000 225,000 3,000 75,000
Total overhead cost assigned ............................. $447,000 $237,000

11-15. The percentages of overhead assigned using the plantwide and ABC approaches are computed
as follows:
Product Y Product Z Total
(a) (a) ÷ (c) (b) (b) ÷ (c) (c)
Plantwide Approach Amount % Amount % Amount
Manufacturing overhead ........ $513,000 75.0% $171,000 25.0% $684,000
Activity-Based Costing System

Machining ............................ $160,000 80.0% $ 40,000 20.0% $200,000
Machine setups .................... 20,000 20.0% 80,000 80.0% 100,000
Product design ..................... 42,000 50.0% 42,000 50.0% 84,000
General factory ..................... 225,000 75.0% 75,000 25.0% 300,000
Total cost assigned to products $447,000 $237,000 $684,000
The Machining allocation percentages used in the ABC system are similar to the plantwide allocation
percentages because the Machining cost pool uses a unit-level activity measure (machine-hours).
Since the plantwide cost pool also uses a unit-level allocation base (direct labor-hours), it is
reasonable to expect these cost allocations percentages to be comparable.
Under the ABC system, 20% and 80% of the Machine Setups cost is allocated to Products Y and Z,
respectively, whereas the plantwide approach allocates 75% and 25% of all overhead costs to the
two products. These allocation percentages are different because Machine Setups is a batch-level
cost pool. Although Product Y is the high-volume product (14,000 units) and Product Z is the low-
volume product (6,000 units), Product Y only consumes 20% of the total machine setups and Product
Z consumes 80% of the total machine setups. The conventional system is allocating too much of the
machine setup costs to Product Y and too little of these costs to Product Z.
Under the ABC system, 50% of the Product Design cost is allocated to each
product, whereas the plantwide approach allocates 75% and 25% of all
overhead costs to Products Y and Z, respectively. These percentages are
different because Product Design is a product-level cost pool. Although
Product Y is the high-volume product (14,000 units) and Product Z is the
low-volume product (6,000 units), both products consume 50% of the
product design resources. The conventional system is allocating too much
of the product design costs to Product Y and too little of these costs to
Product Z.
Under the ABC system, the General Factory allocation percentages are the
same as the plantwide allocation percentages because the General Factory
cost pool is allocated to products using the same unit-level activity measure
(direct labor-hours) as the plantwide approach.

Exercise 4-1 (10 minutes)
a. Various individuals manage the parts inventories. Product-level

b. A clerk in the factory issues purchase orders for a
job. Batch-level
c. The personnel department trains new production
workers. Facility-level
d. The factory’s general manager meets with other
department heads to coordinate plans. Facility-level
e. Direct labor workers assemble products. Unit-level
f. Engineers design new products. Product-level
g. The materials storekeeper issues raw materials to
be used in jobs. Batch-level
h. The maintenance department performs periodic
preventative maintenance on general-use
equipment. Facility-level
Note: Some of these classifications are debatable and may depend on
the specific circumstances found in particular companies.

1. The activity rates are computed as follows:
(a)
Labor related .................... $ 52,000 8,000 DLHs $ 6.50 per DLH
Machine related................. 15,000 20,000 MHs 0.75 per MH
Machine setups ................. 42,000 1,000 setups 42.00 per setup
Production orders .............. 18,000 500 orders 36.00 per order
Product testing .................. 48,000 2,000 tests 24.00 per test
Packaging ......................... 75,000 5,000 packages 15.00 per package
General factory ................. 108,800 8,000 DLHs 13.60 per DLH
Total ................................ $358,800
2. The predetermined overhead rate based entirely on direct labor-hours would be computed as follows:
Total estimated overhead cost (a) ............ $358,800
Total expected direct labor-hours (b)........ 8,000 DLHs
Predetermined overhead rate (a) ÷ (b)..... $ 44.85 per DLH

The unit product costs for the products are a combination of direct materials, direct labor, and overhead
costs. The overhead costs assigned to each product would be computed as follows:
J78 B52
Expected Expected
Labor related, at $7.00 per direct labor-hour ....... 1,000 $ 7,000 40 $ 280
Machine related, at $3.00 per machine-hour ........ 3,200 9,600 30 90
Machine setups, at $40.00 per setup .................. 5 200 1 40
Production orders, at $160.00 per order .............. 5 800 1 160
Shipments, at $120.00 per shipment .................. 10 1,200 1 120
General factory, at $4.00 per direct labor-hour .... 1,000 4,000 40 160
Total overhead cost assigned (a) ........................ $22,800 $ 850
Number of units produced (b) ............................ 4,000 100
Overhead cost per unit (a) ÷ (b) ........................ $ 5.70 $8.50
The unit product costs combine direct materials, direct labor, and overhead costs as follows:
J78 B52
Direct materials ........................................... $ 6.50 $31.00
Direct labor ................................................. 3.75 6.00
Manufacturing overhead (see above) ............. 5.70 8.50
Unit product cost ......................................... $15.95 $45.50

1. Using the company's conventional costing system, the overhead costs applied to the products would
be computed as follows:
Product H Product L Total
Number of units produced (a) ........... 40,000 8,000
Direct labor-hours per unit (b) .......... 0.40 0.40
Total direct labor-hours (a) × (b) ...... 16,000 3,200 19,200
Total manufacturing overhead (a) ............. $1,632,000
Total direct labor-hours (b) ....................... 19,200 DLHs
Predetermined overhead rate (a) ÷ (b) ...... $ 85.00 per DLH
Manufacturing overhead applied per unit
0.40 DLH per unit × $85.00 per DLH ...... $ 34.00 $ 34.00
Number of units produced ....................... 40,000 8,000
Total manufacturing overhead applied ...... $1,360,000 $272,000 $1,632,000
2. Using the proposed ABC system, overhead costs would be assigned as follows:
Total manufacturing overhead assigned (a) ......... $816,000 $816,000 $1,632,000
Number of units produced (b) ............................ 40,000 8,000
Manufacturing overhead per unit (a) ÷ (b) .......... $ 20.40 $ 102.00

20 Introduction to Managerial Accounting, 8th Edition
Exercise 4-4 (continued)
3. Under the company’s old method of allocating overhead costs, the high-
volume product, Product H, was allocated most of the overhead cost.
This occurred simply because the high-volume product is responsible for
most of the direct labor-hours. When the overhead is split evenly
between the two products, $544,000 of overhead cost is shifted from
the high-volume product, Product H, to the low-volume product, Product
L. Consequently, the shift from direct labor-hours as an allocation base
to an even split of the overhead costs between the two products favors
the high-volume product, Product H, and penalizes the low-volume
product, Product L. Note that on a per unit basis, the impact is much
greater for the low-volume product, Product L, than for the high-volume
product, Product H.


(a)
Labor related .................... $ 156,000 26,000 DLHs $6.00 per DLH
Purchase orders ................ 11,000 220 orders $50.00 per order
Parts management ............ 80,000 100 part types $800.00 per setup
Board etching ................... 90,000 2,000 boards 45.00 per board
General factory ................. 180,000 20,000 MHs 9.00 per MH
Total ................................ $517,000

2. The overhead assigned to each product can be computed as follows:
Product A
(a) (b) (a) × (b)

Activity Cost Pool Activity Rate Actual Activity ABC Cost
Labor related .......... $6 per DLH 6,000 DLHs $ 36,000
Purchase orders ...... $50 per order 60 orders 3,000
Parts management .. $800 per part type 30 part types 24,000
Board etching ......... $45 per board 500 boards 22,500
General factory ....... $9 per MH 3,000 MHs 27,000
Total ..................... $112,500
Product B
(a) (b) (a) × (b)

Total ..................... $192,000
Product C
(a) (b) (a) × (b)

Total ..................... $112,000

Product D
(a) (b) (a) × (b)

Labor related ........... $6 per DLH 5,000 DLHs $ 30,000
Purchase orders ....... $50 per order 90 orders 4,500
Parts management ... $800 per part type 15 part types 12,000
Board etching .......... $45 per board 0 boards 0
General factory ........ $9 per MH 6,000 MHs 54,000
Total ...................... $100,500

1. & 2.
Activity Examples of Activity

Activity Classification Measures
a. Preventive maintenance is Not applicable; these
performed on general- costs probably should
Facility-level
purpose production not be assigned to
equipment. products or customers.
b. Products are assembled by Time spent assembling
Unit-level
hand. products.
c. A security guard patrols Not applicable; these
the company grounds after costs probably should
Facility-level
normal working hours. not be assigned to
products or customers.
d. Purchase orders are issued Number of purchase
for materials to be used in orders; time spent
Batch-level
production. preparing purchase
orders.
e. Modifications are made to Number of modifications
Product-
product designs. made; time spent
level
making modifications.
f. New employees are hired Not applicable; these
by the personnel office. costs probably should
Facility-level
not be assigned to
g. Machine settings are
Number of batch setups;
changed between batches Batch-level
time spent doing setups.
of different products.
h. Parts inventories are
Number of products;
maintained in the
Product- number of parts; time
storeroom. (Each product
level spent maintaining
requires its own unique
inventories of parts.
parts.)
i. Insurance costs are Not applicable; these
incurred on the company’s costs probably should
Facility-level
facilities. not be assigned to

1. The unit product costs under the company's conventional costing system
would be computed as follows:
Mercon Wurcon Total

Number of units produced (a) ..................... 10,000 40,000
Direct labor-hours per unit (b) .................... 0.20 0.25
Total direct labor-hours (a) × (b) ................ 2,000 10,000 12,000
Total manufacturing overhead (a) ............... $336,000

Total direct labor-hours (b) ......................... 12,000 DLHs
Predetermined overhead rate (a) ÷ (b) ........ $28.00 per DLH
Mercon Wurcon
Direct materials ......................................... $10.00 $ 8.00
Direct labor ............................................... 3.00 3.75
Manufacturing overhead applied:
0.20 DLH per unit × $28.00 per DLH ......... 5.60
0.25 DLH per unit × $28.00 per DLH ......... 7.00
Unit product cost ....................................... $18.60 $18.75

2. The unit product costs with the proposed ABC system can be computed as follows:

Activity Cost Pool Cost* Activity Rate
Labor related ............ $168,000 12,000 direct labor-hours $14.00 per direct labor-hour
Engineering design .... 168,000 8,000 engineering-hours $21.00 per engineering-hour
$336,000
*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 Wurcon
Expected Expected
Labor related, at $14.00 per direct labor-hour .......... 2,000 $ 28,000 10,000 $140,000
Engineering design, at $21.00 per engineering-hour . 4,000 84,000 4,000 84,000
Total overhead cost assigned (a) ............................ $112,000 $224,000
Number of units produced (b)................................. 10,000 40,000
Overhead cost per unit (a) ÷ (b) ............................. $11.20 $5.60

The unit product costs combine direct materials, direct labor, and
manufacturing overhead costs:
Mercon Wurcon
Direct materials ............................... $10.00 $ 8.00
Direct labor ..................................... 3.00 3.75
Manufacturing overhead (see above) . 11.20 5.60
Unit product cost ............................. $24.20 $17.35
3. 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 labor-hours. When the overhead was applied on the
basis of direct labor-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.

1. Activity rates can be computed as follows:

(a)
Estimated (b)
Overhead Expected (a) ÷ (b)
Activity Cost Pool Cost Activity Activity Rate
Machine setups ....... $21,600 180 setups $120 per setup
Special processing ... $180,000 4,000 MHs $45 per MH
General factory ....... $288,000 24,000 DLHs $12 per DLH
2. The unit product costs would be computed as follows, starting with the
computation of the manufacturing overhead:
Rims Posts
Machine setups:
$120 per setup × 100 setups ............ $ 12,000
$120 per setup × 80 setups .............. $ 9,600
Special processing:
$45 per MH × 4,000 MHs ................. 180,000
$45 per MH × 0 MHs ........................ 0
General factory:
$12 per DLH × 8,000 DLHs ............... 96,000
$12 per DLH × 16,000 DLHs ............. 192,000
Total overhead cost (a) ....................... $288,000 $201,600
Number of units produced (b).............. 20,000 80,000
Overhead cost per unit (a) ÷ (b) .......... $14.40 $2.52
Rims Posts
Direct materials .................................. $17.00 $10.00
Direct labor:
$16 per DLH × 0.40 DLHs ................. 6.40
$16 per DLH × 0.20 DLHs ................. 3.20
Manufacturing overhead (see above) .... 14.40 2.52
Unit product cost ................................ $37.80 $15.72

1. Activity Rates:
(a)
Estimated (b)
Customer deliveries ........... $400,000 5,000 deliveries $80.00 per delivery
Manual order processing .... $300,000 4,000 orders $75.00 per manual order
Electronic order processing . $200,000 12,500 orders $16.00 per electronic order
Line item picking ............... $500,000 400,000 line items $1.25 per line item picked

2. Activity costs are assigned to the two hospitals as follows:

City General:
(a) (b) (a) × (b)
Activity Cost Pool Activity Rate Activity ABC Cost
Customer deliveries........... $80.00 per delivery 10 deliveries $ 800
Manual order processing.... $75.00 per order 0 orders 0
Electronic order processing $16.00 per order 10 orders 160
Line item picking .............. $1.25 per line item 100 line items 125
Total activity costs ............ $1,085
County General:
(a) (b) (a) × (b)
Activity Cost Pool Activity Rate Activity ABC Cost
Customer deliveries............. $80.00 per delivery 20 deliveries $ 1,600
Manual order processing...... $75.00 per order 40 orders 3,000
Electronic order processing .. $16.00 per order 0 orders 0
Line item picking ................ $1.25 per line item 260 line items 325
Total activity costs .............. $4,925
3. Hospitals that require frequent deliveries, place a high volume of manual orders, and order many line
items are likely to be more expensive to serve.

1. Under the traditional direct labor-hour based costing system,
manufacturing overhead is applied to products using the predetermined
overhead rate computed as follows:
Predetermined = Estimated total manufacturing overhead cost

overhead rate Estimated total direct labor - hours
$2,200,000
= = $20.00 per DLH
110,000 DLHs *
*25,000 units of Xactive @ 1.4 DLH per unit + 75,000 units of the
Pathbreaker @ 1.0 DLH per unit = 35,000 DLHs + 75,000 DLHs =
110,000 DLHs
Consequently, the unit product costs using the traditional approach
would be computed as follows:
Xactive Pathbreaker
Direct materials ................... $1,620,000 $3,825,000
Direct labor ......................... 455,000 975,000
Manufacturing overhead
applied @ $20.00 per
direct labor-hour ............... 700,000 1,500,000
Total manufacturing cost (a) $2,775,000 $6,300,000
Number of units (b) ............. 25,000 75,000
Unit product cost (a) ÷ (b) ... $111.00 $84.00

(a)
Total (b) (a) ÷ (b)
Activity Cost Pools Cost Total Activity Activity Rate
Supporting direct
labor .................. $797,500 110,000 DLH $7.25 per DLH
Batch setups ......... $680,000 400 setups $1,700 per setup
Product sustaining . $650,000 2 products $325,000 per product
General factory $72,500 10,000 MHR $7.25 Per MHR
3. Under the activity-based costing system, the unit product costs would
Xactive Pathbreaker
Direct materials ................ $1,620,000 $3,825,000
Direct labor...................... 455,000 975,000
Supporting direct labor ..... 253,750 543,750
Batch setups .................... 425,000 255,000
Product sustaining ............ 325,000 325,000
General factory 18,125 54,375
Total cost (a) ................... $3,096,875 $5,978,125
Number of units (b) .......... 25,000 75,000
Unit product cost (a) ÷ (b) $123.88 $79.71
4. The traditional system uses one unit-level activity measure, direct labor
hours, to assign 31.8% ($700,000 ÷ $2,200,000) of all overhead to the
Xactive product line and 68.2% ($1,500,000 ÷ $2,200,000) of all
overhead to the Pathbreaker product line. The ABC system assigns
62.5% ($425,000 ÷ $680,000) of Batch setup costs (a batch-level
activity) to the Xactive product line and 37.5% ($255,000 ÷ $680,000)
to the Pathbreaker product line. The ABC system assigns 50%
($325,000 ÷ $650,000) of Product sustaining costs (a product-level
activity) to each product line.


(a)
Estimated (b)
Labor related ...... $18,000 2,000 DLHs $9.00 per DLH
Purchase orders .. $1,050 525 orders $2.00 per order
Product testing .... $3,500 350 tests $10.00 per test
Template etching. $700 28 templates $25.00 per template
General factory ... $50,000 10,000 MHs $5.00 per MH
2. a. Overhead cost is assigned to the products as follows:

Product A
(a) (b) (a) × (b)
Labor related ........ $9.00 per DLH 500 DLHs $ 4,500
Purchase orders .... $2.00 per order 80 orders 160
Product testing ...... $10.00 per test 200 tests 2,000
Template etching... $25.00 per template 0 templates 0
General factory ..... $5.00 per MH 3,400 MHs 17,000
Total .................... $23,660

Product B
(a) (b) (a) × (b)
Labor related ........ $9.00 per DLH 100 DLHs $ 900
Product testing ...... $10.00 per test 60 tests 600
Total .................... $13,060
Product C
(a) (b) (a) × (b)
Total .................... $15,910
Product D
(a) (b) (a) × (b)
Total .................... $20,620

3. The conventional system would assign 5% (100 DLH ÷ 2,000 DLH) of all
overhead costs to Product B. The ABC system would assign 20% (105
orders ÷ 525 orders) of the purchase order activity costs to Product B.
It would assign approximately 17% (60 tests ÷ 350 tests) of the
product testing activity costs to Product B, 50% (14 templates ÷ 28
templates) of the template etching costs to Product B, and 22% (2,200
machine-hours ÷ 10,000 machine-hours) of the general factory costs to
Product B. The conventional cost system would undercost Product B
relative to the ABC cost allocations.

Problem 4-12 (30 minutes)
1. Under the traditional direct labor-dollar based costing system,
manufacturing overhead is applied to products using the predetermined
overhead rate computed as follows:
Predetermined = Estimated total manufacturing overhead cost

overhead rate Estimated total direct labor dollars
$508,625
= = $3.13 per DL$
$162,500
The unit product costs using the conventional approach would be

computed as follows:
EX300 TX500
Direct materials .................. $366,325 $162,550
Direct labor ........................ 120,000 42,500
Manufacturing overhead
applied @ $3.13 per direct
labor-dollar ..................... 375,600 133,025
Total manufacturing cost (a) $861,925 $338,075
Number of units (b) ............ 60,000 12,500
Unit product cost (a) ÷ (b) .. $14.37 $27.05

Problem 4-12 (continued)
(a)
Total (b) (a) ÷ (b)
Activity Cost Pools Cost Total Activity Activity Rate
Machining ............. $198,250 152,500 MHR $1.30 per MHR
Setups .................. $150,000 375 setup hrs. $400 per setup hr.
Product-level ......... $100,250 2 products $50,125 per product
General factory ...... $60,125 162,500 DL$ $0.37 per DL$
Under the activity-based costing system, the unit product costs would
EX300 TX500
Direct materials ................ 366,325 162,550
Direct labor...................... 120,000 42,500
Machining ........................ 117,000 81,250
Setups ............................ 30,000 120,000
Product sustaining ............ 50,125 50,125
General factory ................ 44,400 15,725
Total cost (a) ................... 727,850 472,150
Number of units (b) .......... 60,000 12,500
Unit product cost (a) ÷ (b) $12.13 $37.77
3. The traditional system uses one unit-level activity measure, direct labor
dollars, to assign 73.8% ($375,600 ÷ $508,625) of all overhead costs to
the EX300 product line and 26.2% ($133,025 ÷ $508,625) of all
overhead costs to the TX500 product line. The ABC system assigns
59.0% ($117,000 ÷ $198,250) of Machining costs to the EX300 product
line and 41.0% ($81,250 ÷ $198,250) to the TX500 product line. It
assigns 20.0% ($30,000 ÷ $150,000) of Setup costs (a batch-level
activity) to the EX300 product line and 80.0% ($120,000 ÷ $150,000) to
the TX500 product line. It also assigns 50% ($50,125 ÷ $100,250) of
product-level costs to each product line.

Activity Level Possible Activity Measures

a. Milling machines are used to
Number of units processed;
make components for Unit
Machine-hours
products.
b. A percentage of all completed
Number of units inspected;
goods are inspected on a Unit
Inspection time
random basis.
c. Production orders are issued
Batch Number of production orders
for jobs.
d. The company’s grounds crew
maintains planted areas Facility Arbitrary*
surrounding the factory.
e. Employees are trained in Facility or
Arbitrary if factory-level*
general procedures. Product
f. The human resources
department screens and hires Facility Arbitrary*
new employees.
g. Purchase orders are issued for
materials required in Batch Number of purchase orders
production.
h. Material is received on the
Batch or
receiving dock and moved to Number of material moves
Unit
the production area.
i. The plant controller prepares
Facility Arbitrary*
periodic accounting reports.
j. The engineering department
makes modifications in the Product Engineering time
designs of products.
k. Machines are set up between
Batch Number of setups; Setup time
batches of different products.
l. The maintenance crew does
routine periodic maintenance
Facility Arbitrary*
on general-purpose
equipment.
*Facility-level costs are commonly allocated using an arbitrary
allocation base such as direct labor-hours.

1. The first step is to determine the activity rates:

Serving a Party Serving a Diner Serving Drinks
Total cost (a) ........................... $32,800 $211,200 $69,600
Total activity (b) ....................... 8,000 parties 32,000 diners 58,000 drinks
Cost per unit of activity (a)÷(b) . $4.10 per party $6.60 per diner $1.20 per drink
2. According to the ABC system, the cost of serving each of the parties can be computed as follows:
Serving a Party Serving a Diner Serving Drinks
Cost per unit of activity . $4.10 per party $6.60 per diner $1.20 per drink
a. A party of four diners who order three drinks:

1 4 3
party diners drinks
Cost ............................ $4.10 $26.40 $3.60 $34.10
b. A party of two diners who order no drinks:

1 2 0
party diners drinks
Cost ............................ $4.10 $13.20 $0.00 $17.30
c. A lone diner who orders two drinks:

1 1 2
party diner drinks
Cost ............................ $4.10 $6.60 $2.40 $13.10
3. The average cost per diner for each party can be computed by dividing
the total cost of the party by the number of diners in the party as
follows:
a. $34.10 ÷ 4 diners = $8.53 per diner
b. $17.30 ÷ 2 diners = $8.65 per diner
c. $13.10 ÷ 1 diner = $13.10 per diner
4. The average cost per diner differs from party to party under the activity-
based costing system for two reasons. First, the cost of serving a party
($4.10) does not depend on the number of diners in the party.
Therefore, the average cost per diner of this activity decreases as the
number of diners in the party increases. With only one diner, the cost is
$4.10. With two diners, the average cost per diner is cut in half to
$2.05. With four diners, the average cost per diner would be
approximately $1.03. And so on. Second, the average cost per diner
differs also because of the differences in the number of drinks ordered
by the diners. If a party does not order any drinks, as was the case with
the party of two, no costs of serving drinks are assigned to the party.
The average cost per diner differs from the overall average cost of
$9.80 per diner because the $9.80 per diner figure does not recognize
differences in the diners’ demands on resources. It does not recognize
that some diners order more drinks than others nor does it recognize
that there are some economies of scale in serving larger parties. (The
batch-level costs of serving a party can be spread over more diners if
the party is larger.)
We should note that the activity-based costing system itself does not
recognize all of the differences in diners’ demands on resources. For
example, there are undoubtedly differences in the costs of preparing the
various meals on the menu. It may or may not be worth the effort to
build a more detailed activity-based costing system that would consider
such nuances.

1. The company’s estimated total direct labor-hours for the year can be
computed as follows:
Flexible model: 1,000 units × 2.0 DLH per unit .... 2,000
Rigid model: 10,000 units × 1.0 DLH per unit ...... 10,000
Total direct labor-hours ..................................... 12,000
Using direct labor-hours as the allocation base, the predetermined
overhead rate would be:
Predetermined = Total manufacturing overhead
overhead rate Total direct labor-hours
$600,000
= = $50.00 per DLH
12,000 DLHs
The unit product costs are computed as follows:
Flexible Rigid
Direct materials ....................... $110.00 $ 80.00
Direct labor ............................. 30.00 15.00
Manufacturing overhead:
$50.00 per DLH × 2.0 DLHs ... 100.00
$50.00 per DLH × 1.0 DLHs ... 50.00
Unit product cost ..................... $240.00 $145.00

(a)
Estimated (b)
Purchase orders .. $20,000 400 orders $50.00 per order
Rework requests . $10,000 200 requests $50.00 per request
Product testing .... $210,000 2,100 tests $100.00 per test
Machine related ... $360,000 4,000 MHs $90.00 per MH

3. a. Flexible Rigid
Expected Expected
Purchase orders, at $50.00 per order......... 100 $ 5,000 300 $ 15,000
Rework requests, at $50.00 per request..... 60 3,000 140 7,000
Product testing, at $100.00 per test .......... 900 90,000 1,200 120,000
Machine related, at $90.00 per MH ............ 1,500 135,000 2,500 225,000
Total overhead cost assigned (a) .............. $233,000 $367,000
Number of units produced (b) ................... 1,000 10,000
Overhead cost per unit (a) ÷ (b) ............... $233.00 $36.70
b. Using activity-based costing, the unit product costs would be:

Flexible Rigid
Direct materials ................ $110.00 $ 80.00
Direct labor ...................... 30.00 15.00
Manufacturing overhead .... 233.00 36.70
Unit product cost .............. $373.00 $131.70

4. Unit product costs are distorted as a result of using direct labor-hours as

the base for applying overhead costs to products. Although the flexible
model requires twice as much labor as the rigid model, it still is not
being assigned enough overhead cost according to the activity-based
costing system.
According to the activity-based costing system, the flexible model is
more expensive to manufacture than the company thought. Note that
the flexible model accounts for 37.5% of the machine-hours worked,
although it represents a small part of the company’s total output. Also, it
consumes a disproportionately large amount of the other activities.
When activity-based costing is used in place of direct labor-hours as the
basis for assigning overhead cost to products, the unit product cost of
the flexible model jumps up from $240.00 to $373.00. If the $240.00
figure is being used as the basis for pricing, then the selling price may
be too low for the flexible model. This may be the reason why profits
have been declining for the last several years. It may also be the reason
why sales of the flexible model have been increasing rapidly.

1. The company expects to work 40,000 direct labor-hours, computed as

follows:
LEC 40: 60,000 units × 0.40 DLH per unit ............. 24,000 DLHs
LEC 90: 20,000 units × 0.80 DLH per unit ............. 16,000 DLHs
Total direct labor-hours ....................................... 40,000 DLHs
Using direct labor-hours as the base, the predetermined manufacturing
overhead rate would be:
$912,000
= = $22.80 per DLH
40,000 DLHs
The unit product cost of each product would be:
LEC 40 LEC 90
Direct materials .......................... $30.00 $50.00
Direct labor ................................ 6.00 12.00
$22.80 per DLH × 0.40 DLHs .... 9.12
$22.80 per DLH × 0.80 DLHs .... 18.24
Unit product cost ........................ $45.12 $80.24


(a)
Estimated
Overhead (b) (a) ÷ (b)
Activity Cost Pool Cost Expected Activity Activity Rate
Maintaining inventory ............. $225,000 1,500 part types $150.00 per part type
Processing purchase orders .... $182,000 2,800 orders $65.00 per order
Quality control....................... $45,000 2,250 tests $20.00 per test
Machine-related .................... $460,000 10,000 MHs $46.00 per MH
3 a.
LEC 40 LEC 90
Expected Expected
Maintaining parts inventory, at $150.00 per part type .. 600 $ 90,000 900 $135,000
Processing purchase orders, at $65.00 per order ......... 2,000 130,000 800 52,000
Quality control, at $20.00 per test .............................. 500 10,000 1,750 35,000
Machine-related, at $46.00 per MH ............................ 1,600 73,600 8,400 386,400
Total manufacturing overhead cost ............................ $303,600 $608,400
Units produced ......................................................... 60,000 20,000
Manufacturing overhead per unit ............................... $5.06 $30.42

b. Using activity-based costing, the unit product costs would be:

LEC 40 LEC 90
Direct materials ................................. $30.00 $50.00
Direct labor ....................................... 6.00 12.00
Manufacturing overhead (see above) ... 5.06 30.42
Unit product cost ............................... $41.06 $92.42
4. Although the LEC 90 accounts for only 25% of the company’s total
production, it is responsible for 60% of the part types carried in
inventory and 84% of the machine-hours worked. It is also responsible
for 78% of the tests needed for quality control. These factors have been
concealed as a result of using direct labor-hours as the base for
assigning overhead cost to products. Since the LEC 90 is responsible for
a majority of the activity, under activity-based costing it is assigned a
larger amount of overhead cost.
The LEC 90 may not be as profitable as management believes, and this
may be the reason for the company’s declining profits. Note that from
part (1), the unit product cost of the LEC 90 is $80.24. In part (3),
however, the activity-based costing system sets the unit product cost of
the LEC 90 at $92.42. This is a difference of $12.18 per unit. If
management bases the LEC 90’s selling price on the lower figure of
$80.24, it is possible that the company may actually be losing money on
this product. This could explain declining profits and the apparent
popularity of the LEC 90.

1. a. When direct labor-hours are used to apply overhead costs to

products, other factors affecting the incurrence of overhead costs are
ignored. The company’s predetermined overhead rate would be:
$1,785,000
= = $85.00 per DLH
21,000 DLHs
b. The unit product costs are computed as follows:

Model N Model N
800 XL 500
Direct materials ...................... $ 75.00 $ 25.00
Direct labor:
$18.00 per DLH × 3.0 DLHs .. 54.00
$18.00 per DLH × 1.0 DLHs .. 18.00
$85.00 per DLH × 3.0 DLHs .. 255.00
$85.00 per DLH × 1.0 DLHs .. 85.00
Unit product cost .................... $384.00 $128.00
2. a. Activity rates can be computed as follows:

(a)
Estimated (b)
Machine setups ...... $360,000 300 setups $1,200.00 per setup
Special processing .. $165,000 16,500 MHs $10.00 per MH
General factory ...... $1,260,000 21,000 DLHs $60.00 per DLH

b. The unit product costs would now be computed as follows, starting

with the computation of the manufacturing overhead:
Model N 800 Model N

XL 500
Machine setups:
$1,200.00 per setup × 100 setups .... $120,000
$1,200.00 per setup × 200 setups .... $240,000
Special processing:
$10.00 per MH × 16,500 MHs .......... 165,000
$10.00 per MH × 0 MHs .................. 0
General factory:
$60.00 per DLH × 9,000 DLHs ......... 540,000
$60.00 per DLH × 12,000 DLHs ........ 720,000
Total overhead cost (a) ...................... $825,000 $960,000
Number of units produced (b) ............. 3,000 12,000
Overhead cost per unit (a) ÷ (b) ......... $275.00 $80.00
Model N 800 Model N

XL 500
Direct materials .................................. $ 75.00 $25.00
Direct labor:
$18.00 per DLH × 3.0 DLHs .............. 54.00
$18.00 per DLH × 1.0 DLHs .............. 18.00
Manufacturing overhead (see above) .... 275.00 80.00
Unit product cost ................................ $404.00 $123.00
3. It is important to note that, even under activity-based costing, 71% of

the company’s overhead costs continue to be assigned to products on
the basis of direct labor-hours:
Machine setups (number of setups) ..... $ 360,000 20 %
Special processing (machine-hours)..... 165,000 9
General factory (direct labor-hours) ..... 1,260,000 71
Total ................................................ $1,785,000 100 %

Thus, the shift in overhead cost from the high-volume product Model N
500 to the low-volume product Model N 800 XL occurred as a result of
reassigning only 29% of the company’s overhead costs.
The increase in unit cost of Model N 800 XL can be explained as follows:
First, where possible, overhead costs have been traced to the products
rather than being lumped together and spread uniformly over all units.
Therefore, special processing costs, which are all due to processing
Model N 800 XL, have been assigned to Model N 800 XL and none to
Model N 500 under the activity-based costing approach.
Second, the costs associated with the batch-level activity (machine
setups) have been assigned on the basis of setups rather than direct
labor-hours. Each setup, regardless of the batch size, is assigned the
same amount of machine setup cost. Some products are produced in
large batches and some are produced in small batches. The smaller the
batch, the higher unit cost. In this example, the data can be analyzed as
follows:
Model N 800 XL:
Machine setup cost from ABC system (a) . $1,200 per setup
Average number of units per setup
3,000 units ÷ 100 setups (b) ............... 30 units per setup
Average setup cost per unit (a) ÷ (b) ...... $40.00 per unit
Model N 500:
Machine setup cost from ABC system (a) . $1,200 per setup
Average number of units per setup
12,000 units ÷ 200 setups (b) ............. 60 units per setup
Average setup cost per unit (a) ÷ (b) ...... $20.00 per unit
Thus, the average setup cost per unit is 2.0 times as great for Model N
800 XL as for Model N 500. Such cost differences are obscured when
direct labor-hours (or any similar measure of volume) is used as the
basis for applying overhead costs to products.

(a)
Estimated (b)
Labor related ......... $35,000 7,000 DLHs $5 per DLH
Production orders ... $4,000 2,000 orders $2 per order
Material receipts ..... $10,450 950 receipts $11 per receipt
Relay assembly ...... $7,000 1,000 relays $7 per relay
General factory ...... $240,000 40,000 MHs $6 per MH
2. Overhead cost is assigned to the products as follows:

Product A
(a) (b)
Activity Actual (a) × (b)
Activity Cost Pool Rate Activity ABC Cost
Labor related ............ $5 per DLH 2,400 DLHs $12,000
Production orders ...... $2 per order 100 orders 200
Material receipts ........ $11 per receipt 400 receipts 4,400
Relay assembly ......... $7 per relay 170 relays 1,190
General factory ......... $6 per MH 12,000 MHs 72,000
Total ........................ $89,790
Product B
(a) (b)
Labor related ............ $5 per DLH 500 DLHs $ 2,500
Production orders ...... $2 per order 350 orders 700
Total ........................ $48,678

Product C
(a) (b)
Labor related ............ $5 per DLH 3,500 DLHs $17,500
Production orders ...... $2 per order 800 orders 1,600
Total ........................ $72,962
Product D
(a) (b)
Labor related ............ $5 per DLH 600 DLHs $ 3,000
Production orders ...... $2 per order 750 orders 1,500
Material receipts ........ $11 per receipt 0 receipts 0
Total ........................ $85,020
3. The conventional system would assign 20% (8,000 MHs ÷ 40,000 MHs)
of all overhead costs to Product C. The ABC system would assign 50%
(3,500 DLHs ÷ 7,000 DLHs) of the labor related activity costs to Product
C. It would assign approximately 40% (800 orders ÷ 2,000 orders) of
the production orders activity costs to Product C, 36% (342 receipts ÷
950 receipts) of the material receipts activity costs to Product C, and
30% (300 relays ÷ 1,000 relays) of the relay assembly costs to Product
C. The conventional cost system would undercost Product C relative to
the ABC cost allocations.

Communicating in Practice (30 minutes)
Date: Current Date

To: Maria Graham
From: Student’s Name
Subject: Overhead Allocation
I understand that you are thinking about purchasing a small manufacturing
company that assembles and packages its many products by hand. The
company currently uses direct labor hours to allocate overhead to its
products, but you plan to introduce automation. You have asked me to
comment on whether this technique should be continued.
Direct labor is an appropriate allocation base for overhead when overhead
is highly correlated with direct labor and direct labor “drives” overhead
costs. This may have been true when the assembly process was largely
manual, but after automation you may find that the relation between direct
labor and overhead is far weaker. When a factory is automated, direct
labor tends to decrease while overhead costs increase. Direct labor costs
decrease because machines replace direct laborers. Overhead costs
increase as a result of additional depreciation, power costs, insurance, and
other related costs. This suggests that there will no longer be a direct
relationship between overhead and direct labor (that is, when direct labor
costs increase there is not a related increase in overhead costs). Hence,
direct labor will no longer be an appropriate way to allocate overhead costs
to products.
Activity-based costing may be the best alternative. In activity-based
costing, overhead costs are allocated based on the activities required to
make the products and the resources that are consumed by these
activities. This technique is more complex than the approach the company
is currently using. Activity-based costing is costly to implement and to
maintain, but you may find that the benefits of having more accurate
product costs will outweigh these costs—particularly if you intend to rely on
product costs for pricing and other decisions.

Teamwork in Action
Student answers will vary depending on the operations they observe at the
restaurant they visit and on how they define a unit and products. The
following are only suggestive of the answers that might be offered for a
fast food restaurant that sells hamburgers and beverages:
a. Unit-level activities Grilling a burger, assembling a hamburger,

and costs making a milkshake, costs of ingredients,
costs of containers, etc.
b. Customer-level Taking an order, assembling ordered items,
activities and costs bagging order, taking payment, etc.
c. Product-level activities Cost of soft ice cream maker, cost of deep
and costs fat fryer, cost of soda dispenser, etc.
d. Facility-level activities Cost of building rent, cost of manager’s
and costs salary, heating and lighting the building,
etc.

Ethics Challenge (15 minutes)
Most people would probably feel that the most equitable way to divide the
dinner bill among a group of friends is for each person to pay for the cost
of what he or she individually consumed. However, it would be easier to
split the bill equally among the individuals.
This relates to material in the chapter because the method of dividing up
the bill according to what each individual order is similar to ABC and the
method of simply dividing the bill by the number of individuals is similar to
traditional costing methods. Figuring out the cost of what each individual
consumes properly allocates costs to the individuals who incurred them.
However, it sometimes is difficult to trace some costs to individuals. For
example, some dishes may be shared. This is also similar to ABC in that
some costs are easier to trace than others.

Case (150 minutes)
1. a. The predetermined overhead rate would be computed as follows:

Expected manufacturing overhead cost $3,000,000
=
Estimated direct labor-hours 50,000 DLHs
=$60 per DLH
b. The unit product cost per pound, using the company’s present costing
system, would be:
Mona Loa Malaysian
Direct materials (given) ........... $4.20 $3.20
Direct labor (given) ................. 0.30 0.30
0.025 DLH × $60 per DLH ..... 1.50 1.50
Total unit product cost ............ $6.00 $5.00
2. a. Overhead rates by activity:

(a)
Estimated (b)
Activity Center Costs Activity Activity Rate
Purchasing .......... $513,000 1,710 orders $300 per order
Material handling . $720,000 1,800 setups $400 per setup
Quality control ..... $144,000 600 batches $240 per batch
Roasting .............. $961,000 96,100 hours $10 per hour
Blending .............. $402,000 33,500 hours $12 per hour
Packaging ............ $260,000 26,000 hours $10 per hour

Case (continued)
Before we can determine the amount of overhead cost to assign to

the products, we must first determine the activity for each of the
products in the six activity centers. The necessary computations
follow:
Number of purchase orders:
Mona Loa: 100,000 pounds ÷ 20,000 pounds per order = 5 orders
Malaysian: 2,000 pounds ÷ 500 pounds per order = 4 orders
Number of batches:
Mona Loa: 100,000 pounds ÷ 10,000 pounds per batch = 10 batches
Malaysian: 2,000 pounds ÷ 500 pounds per batch = 4 batches
Number of setups:
Mona Loa: 10 batches × 3 setups per batch = 30 setups
Malaysian: 4 batches × 3 setups per batch = 12 setups
Roasting hours:
Mona Loa: 1 hour × (100,000 pounds ÷ 100 pounds) = 1,000 hours
Malaysian: 1 hour × (2,000 pounds ÷ 100 pounds) = 20 hours
Blending hours:
Mona Loa: 0.5 hour × (100,000 pounds ÷ 100 pounds) = 500 hours
Malaysian: 0.5 hour × (2,000 pounds ÷ 100 pounds) = 10 hours
Packaging hours:
Mona Loa: 0.1 hour × (100,000 pounds ÷ 100 pounds) = 100 hours
Malaysian: 0.1 hour × (2,000 pounds ÷ 100 pounds) = 2 hours

Case (continued)
Using the activity figures, manufacturing overhead costs can be

assigned to the two products as follows:
Mona Loa Malaysian
Expected Expected
Purchasing, at $300 per
order ........................ 5 orders $ 1,500 4 orders $1,200
Material handling, at
$400 per setup .......... 30 setups 12,000 12 setups 4,800
Quality control, at $240
per batch .................. 10 batches 2,400 4 batches 960
Roasting, at $10 per
roasting hour............. 1,000 hours 10,000 20 hours 200
Blending, at $12 per
blending hour ............ 500 hours 6,000 10 hours 120
Packaging, at $10 per
packaging hour .......... 100 hours 1,000 2 hours 20
Total overhead cost ...... $32,900 $7,300
b. According to the activity-based costing system, the manufacturing

overhead cost per pound is:
Mona Loa Malaysian
Total overhead cost assigned (above) (a) ... $32,900 $7,300
Number of pounds manufactured (b) ......... 100,000 2,000
Cost per pound (a) ÷ (b) .......................... $0.33 $3.65
c. The unit product costs according to the activity-based costing system

are:
Mona Loa Malaysian
Direct materials (given) ........... $4.20 $3.20
Direct labor (given) ................. 0.30 0.30
Manufacturing overhead .......... 0.33 3.65
Total unit product cost ............ $4.83 $7.15

Case (continued)
3. MEMO TO THE PRESIDENT: Analysis of CBI’s data shows that several
activities other than direct labor drive the company’s manufacturing
overhead costs. These activities include purchase orders issued, number
of setups for material processing, and number of batches processed.
The company’s present costing system, which relies on direct labor time
as the sole basis for assigning overhead cost to products, significantly
undercosts low-volume products, such as the Malaysian coffee, and
significantly overcosts high-volume products, such as our Mona Loa
coffee.

Case (continued)
ALTERNATIVE SOLUTION:
Most students will compute the manufacturing overhead cost per pound
of the two coffees as shown above. However, the cost per pound can
also be computed as shown below. This alternative approach provides
additional insight into the data and facilitates emphasis of some points
made in the chapter.
Mona Loa Malaysian
Per Pound Per Pound
Total (÷ 100,000) Total (÷ 2,000)
Purchasing ........... $ 1,500 $0.015 $1,200 $0.600
Material handling .. 12,000 0.120 4,800 2.400
Quality control ...... 2,400 0.024 960 0.480
Roasting .............. 10,000 0.100 200 0.100
Blending .............. 6,000 0.060 120 0.060
Packaging ............ 1,000 0.010 20 0.010
Total ................... $32,900 $0.329 $7,300 $3.650
Note particularly how batch size impacts unit cost data. For example,
the cost to the company to process a purchase order is $300, regardless
of how many pounds of coffee are contained in the order. Twenty
thousand pounds of the Mona Loa coffee are purchased per order (with
five orders per year), and just 500 pounds of the Malaysian coffee are
purchased per order (with four orders per year). Thus, the purchase
order cost per pound for the Mona Loa coffee is just 1.5 cents, whereas
the purchase order cost per pound for the Malaysian coffee is 40 times
as much, or 60 cents. As stated in the text, this is one reason why unit
costs of low-volume products, such as the Malaysian coffee, increase so
dramatically when activity-based costing is used.

Analytical Thinking (150 minutes)
1. (a)
Estimated
Overhead (b) (a) ÷ (b)
Costs Expected Activity Activity Rate
Purchasing ........................ $15,000 300 orders1 $50 per order
Material handling ............... 16,000 400 receipts2 $40 per receipt
Production orders and
setups ............................ 6,000 60 setup-hours3 $100 per setup-hour
Inspection ......................... 18,000 600 inspection-hours $30 per inspection-hour
Frame assembly ................. 12,000 1,500 assembly-hours $8 per assembly-hour
Machine related ................. 32,000 8,000 machine-hours4 $4 per machine-hour
1
60 + 90 + 150 = 300
2
80 + 105 + 215 = 400
3
Standard: 10 setups × 1 hour per setup ........ 10 hours
Specialty: 25 setups × 2 hours per setup ....... 50 hours
Total setup hours ........................................ 60 hours
4
Standard: 10,000 units × 0.5 hours per unit... 5,000 hours
Specialty: 2,500 units × 1.2 hours unit .......... 3,000 hours
Total machine-hours .................................... 8,000 hours

Analytical Thinking (continued)
Overhead cost charged to each product:
Standard Specialty
Purchasing, at $50 per order:
Leather ................................... 50 $ 2,500 10 $ 500
Fabric ..................................... 70 3,500 20 1,000
Synthetic ................................. 0 0 150 7,500
Material handling, at $40 per receipt:
Leather ................................... 70 2,800 10 400
Fabric ..................................... 85 3,400 20 800
Synthetic ................................. 0 0 215 8,600
Production orders and setups, at
$100 per hour ......................... 10 1,000 50 5,000
Inspection, at $30 per hour ......... 200 6,000 400 12,000
Frame assembly, at $8 per hour... 700 5,600 800 6,400
Machine related, at $4 per hour ... 5,000 20,000 3,000 12,000
Total manufacturing overhead
cost ........................................ $44,800 $54,200
Manufacturing overhead cost per unit of product:
Standard: $44,800 ÷ 10,000 units = $4.48 per unit
Specialty: $54,200 ÷ 2,500 units = $21.68 per unit

2. The unit product cost of each product under activity-based costing is
given below. For comparison, the costs computed by the company’s
accounting department using conventional costing are also provided.
Activity-Based Direct Labor-Hour
Costing Base
Standard Specialty Standard Specialty
Direct materials .............. $10.00 $20.00 $10.00 $20.00
Direct labor .................... 6.00 4.80 6.00 4.80
Manufacturing overhead .. 4.48 21.68 8.25 6.60
Total unit product cost .... $20.48 $46.48 $24.25 $31.40
3. The president was probably correct in being concerned about the

profitability of the products, but the problem is apparently with the
specialty product rather than the standard. Traditional overhead cost
assignment using a volume-based measure has resulted in the high-
volume product subsidizing the low-volume product. Thus, unit costs for
both products are badly distorted. These distorted costs have had a
major impact on management’s pricing policies and on management’s
perception of the margin being realized on each product. The specialty
briefcases are apparently being sold at a loss even without considering
nonmanufacturing costs:
Standard Specialty
Briefcases Briefcases
Selling price per unit ............................ $26.25 $42.50
Unit product cost ................................. 20.48 46.48
Gross margin (loss) per unit ................. $ 5.77 $(3.98)
Based on these data, the company should not shift its resources entirely
to the production of specialty briefcases. Whether or not the specialty
briefcases can be made profitable depends on a number of factors
including the sensitivity of the market to an increase in the selling price
of the specialty briefcase.

Note to the Instructor: You may wish to mention to your class that
before any decision can be made regarding dropping a product line, a
careful analysis will have to be made of the potential avoidable costs.
The unit product costs probably include some idle capacity costs and
facility-level costs that are not relevant in such a decision.
4. Perhaps the competition hasn’t been able to touch FirstLine Cases’ price
because the company has been selling its specialty briefcases at a price
that is below its cost. Thus, rather than “gouging” its customers,
FirstLine Cases’ competitor is probably just pricing its specialty items at
a normal markup over their cost. Indeed, according to the activity-based
costing system, if FirstLine Cases is to realize a profit on its specialty
items it may need to charge a price more in line with its competitor’s
price (over $50 per unit).
When a company sells a product at a price substantially below that of its
competitors, the company’s management should take a careful look at
the costing system to be sure that the product is being assigned all the
costs that it causes.


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Chapter 4

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4-8 While the product costs computed using

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b. The effects of reducing the direct labor requirement of the Deluxe

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b. The activity-based unit product costs are shown below:

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b. In contrast to the traditional costing method, the ABC unit product

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2. The overhead cost assignments to Products Y and Z are as follows:

7. Machine setups is a batch-level activity. A setup is performed to run a

8. The product design activity is a product-level activity. The product

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Activity-Based Costing System

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a. Various individuals manage the parts inventories. Product-level

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1. The activity rates are computed as follows:

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1. The activity rates are computed as follows:

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2. The overhead assigned to each product can be computed as follows:

(a) (b) (a) × (b)

(a) (b) (a) × (b)

(a) (b) (a) × (b)

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(a) (b) (a) × (b)

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Activity Examples of Activity

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Mercon Wurcon Total

Total manufacturing overhead (a) ............... $336,000

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Estimated (b) (a) ÷ (b)

Manufacturing overhead is assigned to the two products as follows:

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3. The unit product cost of the high-volume product, Wurcon, declines

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1. Activity rates can be computed as follows:

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2. Activity costs are assigned to the two hospitals as follows:

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Predetermined = Estimated total manufacturing overhead cost

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1. The activity rates are computed as follows: