1. For each cost in case Exhibit 3, indicate whether the cost is a direct cost or indirect cost.

Cost category Classification as direct or indirect

Direct material Direct
Direct labor Direct
Rent Indirect
Depreciation Indirect
Electricity Indirect
Other manufacturing Indirect
Selling Indirect
Sales commission Direct
Administrative * Indirect
Other * Indirect

2. Currently, the company uses a traditional overhead allocation system, where overhead
(both manufacturing and nonmanufacturing overhead) is allocated based on number of units.
Determine the cost of the basic and custom models using this costing system.
a. What proportion of the total overhead costs of $73,500 will be allocated to basic gym
bags? Custom gym bags?
Basic: 2,000 units / 2,500 units = 80%
Custom: 500 units / 2,500 units = 20%
b. Calculate the overhead rates per unit:
Total manufacturing overhead costs $43,500 = $17.40 per unit Total units
2,500
Total nonmanufacturing overhead costs $30,000 = $12.00 per unit Total units
2,500
c. Use those rates to allocate manufacturing and nonmanufacturing overhead cost to each
unit. Complete the table below:

Basic Custom
Direct material 30.00 35.00
Direct labor 15.00 20.00
Manufacturing overhead ($17.40 per unit) 17.40 17.40
Total manufacturing costs 62.40 72.40
Sales commissions 10.00 12.00
Nonmanufacturing overhead ($12.00 per unit) 12.00 12.00
Total nonmanufacturing costs 22.00 24.00
Total costs 84.40 96.40
3. Jones and West are conducting an analysis to see if an activity-based-costing system
will lead to different estimates of the costs of the basic and custom gym bags. Case Exhibit 5
provides costs for each overhead category, and data on activities assumed to drive each of those
costs. Using that cost and activity data, allocate overhead costs to basic and custom products using
an activity-based-costing approach. Complete the table below:

Basic Custom
Direct material $ 30.00 $ 35.00
Direct labor 15.00 20.00
Manufacturing overhead
Rent 2.45 4.20

Depreciation 1.60 1.60

Electricity 3.60 3.60
Other manufacturing overhead 7.05 18.80
Total 14.70 28.20
Total manufacturing costs 59.70 83.20
Sales commissions 10.00 12.00
Nonmanufacturing overhead
Sales 3.125 12.50

Administrative 3.00 8.00

Other 3.00 3.00
Total 9.125 23.50
Total nonmanufacturing costs 19.125 35.50
Total costs 78.825 118.70

Allocation of overhead costs:

Overhead Cost Category Cost Cost Use of cost driver Use of cost driver
driver by Basic by Custom

Rent $7,000 Square 70000 30000

footage 2000 500
Depreciation $4,000 Units

Electricity $9,000 Units 2000 500

Other manufacturing overhead $23,500 Orders 30 20
Selling $12,500 Sales 20 20
visits 30 20
Administrative $10,000 Orders

Other $7,500 Units 2000 500

 4. Why is there such a difference between the costs per unit between the traditional- and activity-based- costing syste
Under the traditional system, basic gym bags were being allocated most of the overhead (80%) because they use most o
Under the activity-based system, custom gym bags are allocated a larger proportion of overhead than under the traditio
account for 30% of square footage, 40% of orders, and 50% of sales visits. Notice that the overhead cost categories tha
driven by batch-related activities, and custom gym bags are processed in small batch sizes (fewer bags made per o
they are being allocated overhead in proportion to their use of these resources.
Proportion of allocation base used by basic and custom gym bags:

5. Based on the product costs data from the activity-based cost system, what actions do you recommend that Jones
and West consider next?
 Reconsider the price on the custom gym bags. It is only slightly above the total cost of making the bag:

Basic Custom
Price $100.00 $120.00
Total product cost 78.825 118.70

 Explore options to increase the order size associated with custom bags, because 29% of the custom bag’s product cost is dri
 Consider adjusting the relative sales commission for basic and custom bags. After considering the cost of the batch-related activities by
sales commission is higher on the custom bags ($12.00 compared to $10.00 on basic bags), cre

 Explore the potential benefits of making basic bags to stock in inventory, then adding the logo to make it a custom bag once an order i
increase inventory-carrying costs (because some basic bags will sit in inventory until a custom bag order is received). Thus the b
 Total % of cost % of $ allocated to Basic $ $ per $ per
Amount driveer Cost allocated basic bag Custom
of Cost used by driver to (at 2000 bag (at
driver basic used by Custom units) 500
Custom units)

100000 70% 30% 4,900 2,100 2.45 4.20

2500 3,200 800 1.60 1.60
80% 20%

2500 80% 20% 7,200 1,800 3.60 3.60

50 60% 40% 14,100 9,400 7.05 18.80
40 50% 50% 6,250 6,250 3.13 12.50
50 6,000 4,000 3.00 8.00
60% 40%

2500 80% 20% 6,000 1,500 3.00 3.00

23.825 51.700

Direct material 30 35
Direct labor 15 20
Sales commissions 10.00 12.00

Total Cost 78.825 118.700

nd activity-based- costing system?
(80%) because they use most of the allocation base (80%).
verhead than under the traditional system because they use a larger proportion of the allocation base for several cost categories than they di
he overhead cost categories that are driven by orders and sales visits are the three largest overhead costs—other manufacturing overhead, se
h sizes (fewer bags made per order and fewer bags sold per sales visit). So, much of the work being done that causes these overhead costs t

ommend that Jones

ng the bag:

e custom bag’s product cost is driven by orders ($26.80) or sales visits ($8.00).
t of the batch-related activities by using an activity-based-costing system, it is apparent that the basic bags are more profitable than the custom bags. Yet t
d to $10.00 on basic bags), creating an incentive for the sales representative to focus on selling custom bags.

ke it a custom bag once an order is received. This could decrease the amount of batch-related overhead costs incurred in making the bags. However, it wil
g order is received). Thus the benefits of lower order-related overhead costs must be weighed against the additional costs of carrying some inventory.
al cost categories than they did under the traditional system. For example, they
r manufacturing overhead, selling, and administrative. These costs are
causes these overhead costs to be incurred are related to the custom bags, so

able than the custom bags. Yet the

making the bags. However, it will

sts of carrying some inventory.