MANAGEMENT ACCOUNTING- Solutions Manual
CHAPTER 11 SYSTEMS DESIGN: ACTIVITY-BASED COSTING AND MANAGEMENT I.
Questions 1. The three levels available are: Level 1, in which a company uses a plantwide overhead rate; Level 2, in which a company uses departmental overhead rates; and Level 3, in which a company uses activity-based costing. 2. New approaches to costing are needed because events of the last few decades have made drastic changes in many organizations. Automation has greatly decreased the amount of direct labor required to manufacture products; product diversity has increased in that companies are manufacturing a wider range of products and these products differ substantially in volume, lot size, and complexity of design; and total overhead cost has increased to the point in some companies that a correlation no longer exists between it and direct labor. 3. The departmental approach to assigning overhead cost to products relies solely on volume as an assignment base. Where diversity exists between products (that is, where products differ in terms of number of units produced, lot size, or complexity of production), volume alone is not adequate for overhead costing. Overhead costing based on volume will systematically overcost high-volume products and undercost low-volume products. 4. Process value analysis (PVA) is a systematic approach to gaining an understanding of the steps associated with a product or service. It identifies all resource-consuming activities involved in the production process and labels these activities as being either value-added or nonvalue-added. Thus, it is the beginning point in designing an activity-based costing system since management must know what activities are involved with each product before activity centers can be designated and cost drivers established. Also, PVA helps management to eliminate any nonvalue-added activities and thereby streamline operations and minimize costs. 5. The four general levels of activities are:
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1. Unit-level activities, which are performed each time a unit is produced. 2. Batch-level activities, which are performed each time a batch of goods is handled or processed. 3. Product-level activities, which are performed as needed to support specific products. 4. Facility-level activities, which simply sustain a facility’s general manufacturing process. 6. First, activity-based costing increases the number of cost pools used to accumulate overhead costs. Second, it changes the base used to assign overhead costs to products. And third, it changes a manager’s perception of many overhead costs in that costs that were formerly thought to be indirect (such as depreciation or machine setup) are identified with specific activities and thereby are recognized as being traceable to individual products. 7. The two chief limitations are: First, the portion of overhead costs that relate to facility-level activities are still usually allocated to products on some arbitrary basis, such as machine-hours or direct labor-hours. Critics of activity-based costing argue that facility-level activities account for the bulk of all overhead costs in some companies. Second, high measurement costs are involved in operating an activity-based costing system. That is, the system requires the tracking of large amounts of detail and the completion of many separate computations in order to determine the cost of a unit or product. 8. Yes, activity-based costing can be used in service organizations. It has been successfully implemented, for example, in railroads, hospitals, banks and data service companies. 9. A resource driver is a measure of the quality of resources consumed by an activity. 10. An activity driver is a measure of frequency and intensity of demands placed on activities by cost objects. 11. Two-stage allocation is a procedure that first assigns a firm’s resource costs, namely factory overhead cost, to cost pools, and then to cost objects. 12. Two major advantages of ABM are:
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a. ABM measures the effectiveness of the key business processes and activities, and identifies how they can be improved to reduce costs and improve the customer value. b. ABM improves the management focus by allocating resources to key value-added activities, key customers, key products, and continuous improvement methods to maintain the firm’s competitive advantage. 13. When direct labor is used as an allocation base for overhead, it is implicitly assumed that overhead cost is directly proportional to direct labor. When cost systems were originally developed in the 1800s, this assumption may have been reasonably accurate. However, direct labor has declined in importance over the years while overhead has been increasing. This suggests that there is no longer a direct link between the level of direct labor and overhead. Indeed, when a company automates, direct labor is replaced by machines; a decrease in direct labor is accompanied by an increase in overhead. This violates the assumption that overhead cost is directly proportional to direct labor. Overhead cost appears to be driven by factors such as product diversity and complexity as well as by volume, for which direct labor has served as a convenient measure. 14. Employees may resist activity-based costing because it changes the “rules of the game.” ABC changes some of the key measures, such as product costs, used in making decisions and may affect how individuals are evaluated. Without top management support, employees may have little interest in making these changes. In addition, if top managers continue to make decisions based on the numbers generated by the traditional costing system, subordinates will quickly conclude that the activity-based costing system can be ignored. 15. Unit-level activities are performed for each unit that is produced. Batchlevel activities are performed for each batch regardless of how many units are in the batch. Product-level activities must be carried out to support a product regardless of how many batches are run or units produced. Customer-level activities must be carried out to support customers regardless of what products or services they buy. Organization-sustaining activities are carried out regardless of the company’s precise product mix or mix of customers. 16. Organization-sustaining costs, customer-level costs, and the costs of idle capacity should not be assigned to products. These costs represent resources that are not consumed by the products. II. True or False
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1. True 2. True
3. False 4. True
5. False 6. False
7. True 8. True
III. Exercises Exercise 1 Activity
Activity Classification
Examples of Traceable Costs Labor cost; depreciation
Examples of Cost Drivers
a. Materials are moved from the receiving dock to product flow lines by a materialhandling crew
Batch-level
b. Direct labor workers assemble various products
Unit-level
Direct labor cost; indirect labor cost; labor benefits
Direct laborhours
c. Ongoing training is
Facility-level*
Space cost; training costs; administration costs
Hours of training time; number trained
d. A product is designed by a specialized design team
Product-level
Space cost; supplies used; depreciation of design equipment
Hours of design time; number of engineering change orders
e. Equipment setups are performed on a regular basis
Batch-level
Labor cost; supplies used; depreciation of equipment
Number of setups; hours or setup time
f. Numerical control (NC) machines are used to cut and shape materials
Unit-level
Power; supplies used; maintenance; depreciation
Machinehours; number of units
of equipment; space cost
provided to all employees in the company
Number of receipts; pounds handled
* Personnel administration and training costs might be traceable in part to the facility-level and in part to other activity centers at the unit-level, productlevel, and batch-level.
Exercise 2 11-4
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1. 2. 3. 4. 5.
plantwide overhead rate volume two stage, stage, stage Process value analysis Unit-level
6. 7. 8. 9. 10.
Batch-level Product-level Facility-level high-volume, low-volume, low-volume activity centers
Exercise 3 a. b. c. d. e. f. g. h.
Various individuals manage the parts inventories. A clerk in the factory issues purchase orders for a job. The personnel department trains new production workers. The factory’s general manager meets with other department heads such as marketing to coordinate plans. Direct labor workers assemble products. Engineers design new products. The materials storekeeper issues raw materials to be used in jobs. The maintenance department performs periodic preventative maintenance on general-use equipment.
Product-level Batch-level Organizationsustaining Organizationsustaining Unit-level Product-level Batch-level Organizationsustaining
Note: Some of these classifications are debatable and may depend on the specific circumstances found in particular companies. Exercise 4 Sales (P1,650 per standard model glider × 10 standard model gliders + P2,300 per custom designed glider × 2 custom designed gliders)...................................................................................... P21,100 Costs: Direct materials (P462 per standard model glider × 10 standard model gliders + P576 per custom designed glider × 2 custom designed gliders)................................................. P5,772 Direct labor (P19 per direct labor-hour × 28.5 direct labor-hours per standard model glider × 10 standard model gliders + P19 per direct labor-hour × 32 direct labor-hours per custom designed glider × 2 custom designed gliders).............................................................................................. 6,631 Supporting manufacturing (P18 per direct labor-hour × 6,282 28.5 direct labor-hours per standard model glider × 11-5
Chapter 11 Systems Design: Activity-Based Costing and Management 10 standard model gliders + P18 per direct laborhour × 32 direct labor-hours per custom designed glider × 2 custom designed gliders)................................................................. Order processing (P192 per order × 3 orders)..................................................... 576 Custom designing (P261 per custom design × 2 custom designs)............................................................................................................ 522 Customer service (P426 per customer × 1 customer)....................................................................................................... 426 20,209 Customer margin...................................................................................................... P 891
Exercise 5 Requirement 1 The predetermined overhead rate is computed as follows: Predetermined overhead rate
=
P290,000 50,000 DLHs
=
P5.80 per DLH
The unit product costs under the company’s traditional costing system are computed as follows: Special Regular Direct materials................................................................................................................ P60.00 P45.00 Direct labor...................................................................................................................... 9.60 7.20 Manufacturing overhead (0.8 DLH × P5.80 per DLH; 0.6 DLH × P5.80 per DLH)........................................................................................ 4.64 3.48 Unit product cost.............................................................................................................. P74.24 P55.68
Requirement 2 The activity rates are computed as follows: (a) Estimated Overhead Activities Cost Supporting direct labor............................... P150,000 Batch setups............................................... P60,000 Safety testing.............................................. P80,000
(b) Total Expected Activity 50,000 DLHs 250 setups 100 tests
(a) ÷ (b) Activity Rate P3 per DLH P240 per setup P800 per test
Manufacturing overhead is assigned to the two products as follows: Special Product: (a) Activity Cost Pool Activity Rate Supporting direct labor.......................................................... P3 per DLH Batch setups.......................................................................... P240 per setup Safety testing......................................................................... P800 per test
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(b) Activity 8,000 DLHs 200 setups 80 tests
(a) × (b) ABC Cost P24,000 48,000 64,000
Systems Design: Activity-Based Costing and Management Chapter 11 Total
P136,000
Regular Product: (a) Activity Cost Pool Activity Rate Supporting direct labor.......................................................... P3 per DLH Batch setups.......................................................................... P240 per setup Safety testing......................................................................... P800 per test Total
(b) Activity 42,000 DLHs 50 setups 20 tests
(a) × (b) ABC Cost P126,000 12,000 16,000 P154,000
Activity-based costing unit product costs are computed as follows: Special Direct materials................................................................................................... P60.00 Direct labor......................................................................................................... 9.60 Manufacturing overhead (P136,000 ÷ 10,000 units; P154,000 ÷ 70,000 units).................................................................................................. 13.60 Unit product cost................................................................................................. P83.20
Regular P45.00 7.20 2.20 P54.40
IV. Problems Problem 1 Cost Systems Traditional cost system ABC system Labor Machining Setup Production order Material handling Parts administration
Pool Rate 350%
Cost Driver Consumption P10,000
Cost Assignment P35,000
10% P25/hour P10/hour P100/order P20/requisition P40/part
P10,000 800 hours 100 hours 12 orders 5 requisitions 18 parts
P 1,000 20,000 1,000 1,200 100 720 P24,020
Problem 2 Requirement 1 (a) 11-7
Chapter 11 Systems Design: Activity-Based Costing and Management
Total overhead
= P200,000 + P32,000 + P100,000 + P120,000 = P452,000
Overhead rate
= P452,000 / 50,000 direct labor hours = P9.04 per direct labor hour
Overhead assigned to proposed job = P9.04 x 1,000 direct labor hours = P9,040
(b) Total cost of proposed job: Direct materials Direct labor 10,000 Overhead applied Total cost
P 6,000 9,040 P25,040
(c) Company’s bid = Full manufacturing cost x 120% = P25,040 x 120% = P30,048
Requirement 2 (a) Maintenance : P200,000 / 20,000 Materials handling: P32,000 / 1,600 = Setups: P100,000 / 2,500 = Inspection: P120,000 / 4,000 =
= P10 per machine hour P20 per move P40 per setup P30 per inspection
Overhead assigned to proposed job: Maintenance (P10 x 500) Material handling (P20 x 12) Setups (P40 x 2) Inspection (P30 x 10) Total overhead assigned to job
P5,000 240 80 300 P5,620
(b) Total cost of proposed project: Direct materials Direct labor 10,000 Overhead applied Total cost
P 6,000 5,620 P21,620
(c) Company’s bid = Full manufacturing cost x 120% = P21,620 x 120% 11-8
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= P25,944 The bid price of P25,944 was determined as follows: Direct materials Direct labor Overhead assigned: Maintenance (P10 x 500) Material handling (P20 x 12) Setups (P40 x 2) Inspections (P30 x 10) Total overhead assigned to job Total cost Markup Bid price
P6,000 10,000 P5,000 240 80 300 5,620 P21,620 120% P25,944
Problem 3 (Activity-Based Costing) Requirement 1 The first-stage allocation of costs to the activity cost pools appears below: Activity Cost Pools Processing Supporting Orders Customers Other
Assemblin g Units Manufacturing overhead Selling and administrative overhead Total cost
Total
P250,000
P175,000
P25,000
P50,000
P500,000
30,000 P280,000
135,000 P310,000
75,000 P100,000
60,000 P110,000
300,000 P800,000
Requirement 2 The activity rates for the cost pools are:
Assembling units Processing orders Supporting customers
(a) Total Cost P280,000 P310,000 P100,000
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(b) Total Activity 1,000 units 250 orders 100 customers
(a) (b) Activity Rate P280 per unit P1,240 per order P1,000 per customer
Chapter 11 Systems Design: Activity-Based Costing and Management
Requirement 3 The overhead cost attributable to Lucky Sale would be computed as follows: (a) Activity Rate P280 per unit P1,240 per order P1,000 per customer
Activity Cost Pools Assembling units Processing orders Supporting customers
(b) Activity 80 units 4 orders 1 customer
(a) x (b) ABC Cost P22,400 P4,960 P1,000
Requirement 4 The customer margin can be computed as follows: Sales (P595 per unit x 80 units) Costs: Direct materials (P180 per unit x 80 units) Direct labor (P50 per unit x 80 units) Unit-related overhead (above) Order-related overhead (above) Customer-related overhead (above) Customer margin
P47,600 P14,400 4,000 22,400 4,960 1,000 P
46,760 840
Problem 4 (Activity-Based Costing as an Alternative to Traditional Product Costing) Requirement 1 a. When direct labor-hours are used to apply overhead cost to products, the company’s predetermined overhead rate would be: Predetermined overhead rate
= =
Manufacturing overhead cost Direct labor hours P1,480,000 20,000 DLHs 11-10
=
P74 per DLH
Systems Design: Activity-Based Costing and Management Chapter 11
b.
Model HY5 Direct materials...................................................................... P35.00 Direct labor: P20 per hour × 0.2 DLH, 0.4 DLH.................................... 4.00 Manufacturing overhead: P74 per hour × 0.2 DLH, 0.4 DLH.................................... 14.80 Total unit product cost............................................................ P53.80
AS2 P25.00 8.00 29.60 P62.60
Requirement 2 a. Predetermined overhead rates for the activity cost pools: (a) Estimated Activity Cost Pool Total Cost Machine setups.................P180,000 Special milling..................P300,000 General factory................. P1,000,000
(b) Estimated Total Activity 250 setups 1,000 MHs 20,000 DLHs
(a) ÷ (b) Activity Rate P720 per setup P300 per MH P50 per DLH
The overhead applied to each product can be determined as follows: Model HY5 (a) Predetermined Activity Cost Pool Overhead Rate Machine setups.................................................................................... P720 per setup Special milling..................................................................................... P300 per MH General factory.................................................................................... P50 per DLH Total manufacturing overhead cost (a)................................................. Number of units produced (b)............................................................. Overhead cost per unit (a) ÷ (b)..........................................................
(b) Activity 150 setups 1,000 MHs 4,000 DLHs
(a) × (b) Overhead Applied P108,000 300,000 200,000 P608,000 20,000 P30.40
Model AS2 Activity Cost Pool
(a) Predetermined Overhead Rate
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(b) Activity
(a) × (b) Overhead Applied
Chapter 11 Systems Design: Activity-Based Costing and Management Machine setups.................................................................................... P720 per setup 100 setups Special milling..................................................................................... P300 per MH 0 MHs General factory.................................................................................... P50 per DLH 16,000 DLHs Total manufacturing overhead cost (a)................................................. Number of units produced (b)............................................................. Overhead cost per unit (a) ÷ (b)..........................................................
P 72,000 0 800,000 P872,000 40,000 P21.80
b. The unit product cost of each model under activity-based costing would be computed as follows: Model HY5 AS2 Direct materials........................................................................................................ P35.00 P25.00 Direct labor (P20 per DLH × 0.2 DLH; P20 per DLH × 04.DLH)........................... 4.00 8.00 Manufacturing overhead (above).............................................................................. 30.40 21.80 Total unit product cost............................................................................................... P69.40 P54.80
Comparing these unit cost figures with the unit costs in Part 1(b), we find that the unit product cost for Model HY5 has increased from P53.80 to P69.40, and the unit product cost for Model AS2 has decreased from P62.60 to P54.80. Requirement 3 It is especially important to note that, even under activity-based costing, 68% of the company’s overhead costs continue to be applied to products on the basis of direct labor-hours: Machine setups (number of setups)............................P 180,000 Special milling (machine-hours)................................. 300,000 General factory (direct labor-hours)........................... 1,000,000 Total overhead cost.....................................................P1,480,000
12% 20 68 100%
Thus, the shift in overhead cost from the high-volume product (Model AS2) to the low-volume product (Model HY5) occurred as a result of reassigning only 32% of the company’s overhead costs. The increase in unit product cost for Model HY5 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 production. Therefore, 11-12
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the special milling costs, which are traceable to Model HY5, have all been assigned to Model HY5 and none assigned to Model AS2 under the activitybased costing approach. It is common in industry to have some products that require special handling or special milling of some type. This is especially true in modern factories that produce a variety of products. Activity-based costing provides a vehicle for assigning these costs to the appropriate products. Second, the costs associated with the batch-level activity (machine setups) have also been assigned to the specific products to which they relate. These costs have been assigned according to the number of setups completed for each product. However, since a batch-level activity is involved, another factor affecting unit costs comes into play. That factor is batch size. Some products are produced in large batches and some are produced in small batches. The smaller the batch, the higher the cost per unit of the batch activity. In the case at hand, the data can be analyzed as shown below. Model HY5: Cost to complete one setup [see 2(a)]......................................... P720 Number of units processed per setup (20,000 units ÷ 150 setups)...................................................133.33 Setup cost per unit (a) ÷ (b)....................................................... P5.40 Model AS2: Cost to complete one setup (above)............................................ P720 Number of units processed per setup (40,000 units ÷ 100 setups)................................................... 400 Setup cost per unit (a) ÷ (b)....................................................... P1.80
(a) (b)
(a) (b)
Thus, the cost per unit for setups is three times as great for Model HY5, the low-volume product, as it is for Model AS2, the high-volume product. Such differences in cost are obscured when direct labor-hours (or any other volume measure) is used as the basis for applying overhead cost to products. In sum, overhead cost has shifted from the high-volume product to the lowvolume product as a result of more appropriately assigning some costs to the products on the basis of the activities involved, rather than on the basis of direct labor-hours.
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V. Multiple Choice Questions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
A D C B A D A B D C
11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
B D C A C D D C B A
21. 21. 22. 23. 24. 25. 26. 27. 28. 29.
D A B A B D B C A C
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