Exercise 7-1: ABC Cost Hierarchy Hierarchy Given: Classify each of the following activities as either a unit-level, a batch-level, a ro!uct-level, or an organi"ation-sustaining activity# activity# $hese activities ac tivities occur at Greenwich Cororation, a co%any that %anufactures a variety of ro!ucts# &nit-level activities:
Activities Activities that are performed each time a unit is produced.
Batch-level activities:
Activities that are performed each time a batch of goods is is handled or processed, regardless of how many units units are in the batch. The amount of resource consu depends on the number of batches run rather than on the number of units in t batch.
'ro!uct-level activities: Activities Activities that relate to specific products that must be carried out regardless of ho many units are produced and sold or batches run. Custo%er-level activities: Activities Activities that are carried out to support customers but that are not related to any specific product. (rgani"ation-sustaining activities: Activi Activities ties that that are carri carried ed out regardl regardless ess of which which customer customers s are serve serve which products are produced, how many batches are run, run, or how units are made.
a. Various individuals manage the parts inventory.
Product-level
b. A clerk in the factory issues purchase orders for a job.
atch-level
c. The personnel department trains new production workers
!rgani"ation-sustainin
d. The fac factor tory#s y#s gen gener eral al mana manag ger meet meets s wi with othe otherr dep depar arttment ment head heads s suc such h as as marketing to coordinate plans.
!rgan rganii"ati ation-s on-sus usttaini ainin n
e. $irect labor workers assemble products.
%nit-level
f.
Product-level
&ngineers design new products.
g. The materials storekeeper issues raw materials to be used in jobs.
atch-level
h. The The mai maint nten enan ance ce depa depart rtme ment nt perf perfor orms ms peri period odic ic prev preven enti tive ve main mainte tena nanc nce e on on general-use e'uipment.
!rga !rgani ni"a "ati tion on-s -sus usta tain inin in
med e
d, any
g
g
g
Exercise 7-1): Cost Hierarchy Given:
(reen (lider )orporation makes golf carts that it sells directly to golf courses throughout the world. *everal basic models are available, which are modified to suit the ne eds of each particular golf course. A golf course located in the Pacific +orthwest, for eample, would typically specify that its golf carts come e'uipped with retractable rain-proof covers. n addition, each customer i.e., golf course/ customi"es its golf carts with its own color scheme and logo. The company typically makes all of the golf carts for a customer before starting work on the net customer#s golf carts. *e+uire!: &nit-level activities:
Activities that are performed each time a unit is produced.
Batch-level activities:
Activities that are performed each time a batch of goods is handled or processed, regardless of how many units are in the batch. The amount of resource consume depends on the number of batches run rather than on the number of units in the batch.
'ro!uct-level activities: Activities that relate to specific products that must be carried out regardless of how many units are produced and sold or batches run. Custo%er-level activities: Activities that are carried out to support customers but that are not related to any specific product. (rgani"ation-sustaining activities: Activities that are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made. Classify each of the costs or activities below as unit-level, batch-level, ro!uct-level, custo%er-level, or organi"ation-sustaining# n this case, custo%ers are golf courses, ro!ucts are %o!els of the golf cart, a batch is a secific or!er fro% a custo%er, an! units are in!ivi!ual golf carts#
a. The purchasing department orders the specific color of paint specified by the customer from the company#s supplier.
batch-level
b. A steering wheel is installed in a golf cart.
unit-level
c. An outside attorney draws up a new generic sales contract for the company limiting (reen (lider#s liability in case of accidents that involve its golf carts.
organi"ation-sustaining
d. The company#s paint shop makes a stencil for a customer#s logo.
batch-level
e. A sales representative visits an old customer to check on how the company#s golf carts are working out and to try to make a new sale.
customer-level
f.
batch-level
The accounts receivable department prepares the bill for a
0 !r
completed order. g. &lectricity is used to heat and light the factory and the administrative offices.
organi"ation-sustaining
h. A golf cart is painted.
unit-level
i.
The company#s engineer modifies the design of a model to eliminate a potential safety problem.
product-level
j.
The marketing department has a catalogue printed and then mails copies to golf course managers.
customer-level
k. )ompleted golf carts are individually tested on the company#s test track.
unit-level
l.
product-level
A new model golf cart is shipped to the leading golfing trade maga"ine to be evaluated for the maga"ine#s annual rating of golf carts.
d
'roble% 7-11: Co%rehensive ABC 'roble% Given:
*ilicon !ptics has supplied the following data for use in its A) system1
Overhead Costs
./0,000 00,000 //0,000
2ages 3 salaries !ther overhead costs Total overhead costs Activity Cost Pool
$4 support !rder processing )ustomer support !ther
Activity Measure (Driver)
+umber of $4 5ours +umber of orders +umber of customers These costs are not allocated to products or customers These are organi"ation-sustaining activities.
Total Activity 10,000 $45s /00 !rders 100 )ustomers
Distribution of Resource Consumption Across Activity Cost Pools
2ages 3 salaries !ther overhead costs
$4 *upport .02 /2
!rder Processing ./2 1/2
)ustomer *upport /2 02
!ther 102 )02
Total 1002 1002
$uring the year, *ilicon !ptics completed an order for a special optical switch for a new customer, ndus Telecom. This customer did not order any other products during the year. $ata concerning that order follow1 Data Concerning the ndus Telecom Order 3/ per unit *elling price 100 units %nits ordered 4) per unit $irect materials 0#/0 $45 per unit $irect labor-hours / per $45 $irect labor rate
*e+uire!: 1# 'reare a reort showing the first-stage allocations of overhea! costs to the activity cost ools# 56ee Exhibit 7-/ D! Order Customer Overhead Costs Totals "upport Processing "upport Other ./0,000 2ages 3 salaries 6789,888 67::,988 6;<,988 6=9,888 00,000 !ther overhead costs 98,888 =8,888 >8,888 ;8,888 //0,000 1//,000 1/,/00 17,/00 11/,000 Total overhead costs # Co%ute the activity rates for the activity cost ools# 56ee Exhibit 7-4 D! Order Overhead Costs Totals "upport Processing //0,000 1//,000 1/,/00 Total overhead costs 10,000 /00 Total activity measures
Customer "upport 17,/00 100
Other 11/,000 89A
?ate per activity cost pool
679.98 ;Hs
6=89.88 (r!ers
67,:<9.88 Custo%ers
.# 'reare a reort showing the overhea! costs for the or!er fro% n!us $eleco%, inclu!ing custo%er suort costs# ndus Telecom Cost Pool Driver A#C Costs Activity Cost Pool Driver Rate $sage Assigned $4 support $45s 679.98 98 6<<9.88 !rder processing !rders 6=89.88 7 =89.88 )ustomer support )ustomers 67,:<9.88 7 7,:<9.88 Total support costs assigned to ndus Telecom 6:,=99.88 )# 'reare a reort showing the custo%er %argin for n!us $eleco%# 56ee Exhibit 7-11# ABC Analysis Custo%er
6:@,988
6:,>88 67,:98 6<<9 6=89 67,:<9 6=8,889 6989/
Exercise 7A-) Co%rehensive Activity-Base! Costing Exercise 1# 'reare a reort showing the first-stage allocations of overhea! costs to the activity cost ools# 56a%e as E7-11 D! Order Customer Overhead Costs Totals "upport Processing "upport Other ./0,000 2ages 3 salaries 6789,888 67::,988 6;<,988 6=9,888 00,000 !ther overhead costs 98,888 =8,888 >8,888 ;8,888 //0,000 1//,000 1/,/00 17,/00 11/,000 Total overhead costs # Co%ute the activity rates for the activity cost ools# a%e as - , ut rates y ver ea costs w t n oo s D! Overhead Costs Totals "upport ./0,000 2ages 3 salaries 6789,888 00,000 !ther overhead costs 98,888 //0,000 1//,000 Total overhead costs
Pool Rate
678.98 69.88 1/#/0 ;Hs
Order Processing
67::,988 =8,888 1/,/00
Pool Rate
6:>9 68 .0/ (r!ers
Customer "upport
6;<,988 >8,888 17,/00
.# 'reare a reort showing the overhea! costs for the or!er fro% !es $eleco% inclu!ing custo%er suort# D! Order Customer Total Activity "upport Processing "upport "upport
&pected measure of cost driver 2ages 3 *alaries !ther !verhead )osts Total )osts
%&
'
69:9 6:98 6<<9
'
6:>9 68 6=89
6;<9 6>88 67,:<9
67,>9 6<78 6:,=99
)# 'reare a reort showing the custo%er %argin for n!us $eleco% ABC Analysis Custo%er
6:@,988
6:,>88 67,:98 6<<9 6=89 67,:<9 6=8,889 6989/
/# 'reare an action analysis reort showing the custo%er %argin for n!us $eleco%# irect %aterials shoul! be co!e! as a Green cost, !irect labor an! wages an! salaries as >ellow costs, an! other overhea! costs as *e! costs# Definition of an Action analysis report
ase of Ad*ustment Codes
A report showing what costs have been assigned to a cost object, such product or customer, and how difficult it would be to adjust the cost if th a change in activit! " +reen" costs are those costs that would adjust more or less automatic to changes in activit without an action b managers! " ,ello- " costs are those costs that could be adjusted in response to ch in activit, but such adjustments re#uire management action$ the adjust is not automatic! " Red " costs are costs that could be adjusted to changes in activit onl a great deal of difficult and the adjustment would re#uire management
ABC Analysis Custo%er
6:@,988
:,>88 .,100 67,:98 7,>9
:,;@9 6:89
=4 +o ndus T 8
8
8 8
Red costs
!ther overhead costs Red margins
<78 6989/
Died
<78/ 6<78/ 6:89
4# ?hat action, if any, !o you reco%%en! as a result of the above analysis@
2hile the company appears to have incurred a loss on its business with ndus Telecom, caution must be eercised. The (reen margin on the business was 6=,788. *ilicon !ptics really incurred a loss on this business only if at least 6=,788 of the yellow and red costs 6:,;@9 E 6<78 F 6=,89/ would have been avoided if the ndus Telecom order had been rejected. Dor eample, we don#t know what specific costs are included in the Gother overheadG category. f these costs are committed fied costs that cannot be avoided in the short run, then the company would have been worse off if the ndus Telecom order had not been accepted. *uppose that ndus Telecom will be submitting a similar order every year. As a general policy, the company might consider turning down this business in the future. )osts that cannot be avoided in the short run, may be avoided in the long run through the budgeting process or in some other manner. 5owever, if the ndus Telecom business is turned down, management must make sure that at least 6=,788 of the yellow and red costs are really eliminated or th resources represented by those costs are really redeployed to the constraint. f these costs remain unchanged, then the company would be better off accepting rather than rejecting business from the ndus Telecom in the future.
Pool Rate
6;<9 6>88 1,7/ Custo%ers
Other
Pool Rate
6=9,888 ;8,888 11/,000
+HA +HA 89A
as a re is
ll
nges ent
ith action!
lcom us. 6:@,988/ (iven-up
:,>88 *aved
67,:98 *aved 7,>9 *aved
6:,;@9 4ess than 6=,788 of
)B given up 8 6:89/ +et $ecrease Adv. of T business
e
Exercise 7B-1:
Activity-Base! Costing 'ro!uct Costs for External *eorts
Given: Pryad )orporation makes ultra-lightweight backpacking tents. $ata concerning the company#s two product lines appear below1 $elue *tandard 40#00 )/#00 $B per unit 3#40 7#0 $4 per unit 0#0 0#40 $4-hours per unit 10,000 70,000 &stimated annual production
The company has a traditional costing system in which B!5 is applied to units based on $4-hours. $ata concerning B!5 and $4-hours for the upcoming year appear below1 &stimated total B!5 &stimated total $4-5ours
30,000 /0,000
69.;8 per $45
*e+uire!: 1# eter%ine the unit ro!uct costs of eluxe an! 6tan!ar! ro!ucts un!er the co%anys tra!itional costing syste% $elue *tandard 40#00 )/#00 $irect Baterials 3#40 7#0 $irect 4abor Applied B!5 Predetermined B!5 69.;8 0#0 $4-hours per unit 6>.>
Predetermined B!5 $4-hours per unit $ra!itional &nit Cost
69.;8 0#40 7)#)
6=.>; //#4
# $he co%any is consi!ering relacing its tra!itional costing syste% for !eter%ining unit ro!uct costs for external reorts with an ABC syste%# $he ABC syste% woul! have the following three activity cost ools: stimated Cost per Overhead .pected Activit Activities Driver Driver Costs Delu.e "tandard 1/0,000 ,000 ),000 *upporting $4 $45s 6= 40,000 00 /0 atch setups *etups 6:>8 0,000 0 0 *afety testing Tests 6;88 30,000 Total B!5 )osts eter%ine the unit ro!uct costs of the eluxe an! 6tan!ar! ro!ucts un!er the ABC syste%# $ni
Direct Materials Direct !abor
10,000 Delu.e 40#00 3#40
43#40
Total Direct Costs per $nit Applied MO/
Driver
Cost0Driver
*upporting $4 $45s atch setups *etups *afety testing Tests Total B!5 Total ndirect )osts per %nit
6= 6:>8 6;88
Total $nit Product Costs 11 A#C "ystem
Assigned MO/ Costs Delu.e "tandard Total 1/0,000 6:>,888 67:,888 40,000 >;,888 7:,888 0,000 >,888 7,888 30,000 67=,888 679>,888
6:.>8 >.;8 .>8 67=.8 .#0
Total /0,000 /0 100
s
70,000 "tandard )/#00 7#0
/#0
67.;8 8.7< 8.:= 6:.:8 /)#)0
'roble% 7B-):
ABC as an Alternative to $ra!itional 'ro!uct Costing
Given: Erte, nc#, %anufactures two %o!els of high-ressure stea% valves, the *7 %o!el an! the D/ %o!el# ata regar!ing the two ro!ucts follow:
Product C?< I$9
$45s Annual Per %nit Production 0# 0,000 0#) )0,000
Total $45s ),000 14,000
A!!itional infor%ation about the co%any follows: a# 'ro!uct *7 re+uires ./ in !irect %aterials er unit, an! ro!uct D/ re+uires / b# $he !irect labor rate is 0 er hour c# $he co%any has always use! ;Hs as the base for alying <(H costs to ro!ucts# <(H costs totals 1,)0,000 er year# !# 'ro!uct *7 is %ore co%lex to %anufacture than ro!uct D/ an! re+uires the use of a secial %illing %achine# e# Because of the secial wor re+uire! in 5! above, the co%any is consi!ering the use of ABC to aly overhea! cost to ro!ucts# $hree activity cost ools have been i!entifie! an! the first-stage allocations have been co%lete!# ata concerning these activity cost ools aear below: stimated Cost per MO/ .pected Total Activity Activity Pool Driver Driver Costs 2R3 4D% Total 10,000 1/0 100 /0 6<:8
$B per unit $4 per unit $4-hours per unit Total direct labor hours &stimated annual production
2R3 ./#00
4D% /#00
6>.88 0#0 ),000 0,000
6;.88 0#)0 14,000 )0,000
*e+uire!: 1# Assu%e that the co%any continues to use ;Hs as the base for alying overhea! cost to ro!ucts# a# Co%ute the re!eter%ine! overhea! rate#
&stimated total B!5 )osts H Total $45s F 67,>;8,888 H >,888 E 7,888/ F
6<>.88
b# eter%ine the unit ro!uct cost of each ro!uct#
$irect Baterials $irect 4abor Applied B!5
2R3 ./#00
4D% /#00
>.88
;.88
Predetermined B!5 $4-hours per unit
6<>.88 0#0
Predetermined B!5 $4-hours per unit $ra!itional &nit Cost
6<>.88 0#)0
7>.;8
/.#0
:@.8 4#40
# Assu%e that the co%any !eci!es to use ABC to aly overhea! costs to ro!ucts# a# Co%ute the activity rate for each activity cost ool# Also co%ute the a%ount of overhea! cost that woul! be alie! to each ro!uct# 56ee #b# below
Activity Pool
Driver
6etus
General Factory
;Hs
Cost per Driver
6<:8 6=88 698
$otal <(H Costs
stimated MO/ Costs 10,000 .00,000 1,000,000 1,)0,000
.pected Total Acti 2R3 4D% 1/0 100 1,000 0 ),000 14,000
b# eter%ine the unit ro!uct cost of each ro!uct# $ni
0,000 2R3 ./#00 >.88 .3#00
Direct Materials Direct !abor Total Direct Costs per $nit Applied MO/
Driver
Cost0Driver
6etus
6<:8 6=88 698
$otal <(H Costs
Assigned MO/ Costs 2R3 4D% Total 10,000 678;,888 6<:,888 .00,000 =88,888 8 1,000,000 :88,888 ;88,888 68;,888 6;<:,888 1,)0,000
Total ndirect )osts per %nit A#C "ystem $nit Cost Traditional $nit Cost
69.>8 79.88 78.88 6=8.>8 43#)0 69=.;8
.# Exlain why overhea! cost shifte! fro% the high-volu%e ro!uct to the low-volu%e ro!uct un!er ABC#
+ote that even under the A) system ;J of the company#s overhead costs continue to be applied t products on the basis of $45s. 67,888,888H1,)0,000/ ;J Thus5 the shift in overhead cost from the high1volume product 4D% to the lo-1volume product occurred as a result of reassigning only 678 of the company9s overhead costs:
The increase in unit product cost for C?< can be eplained as follows1 1# 6ecial %illing costs, which are traceable to *7, have all been assigne! to *7#
C?< .00,000 0,000 679.88
Allocated *pecial Billing costs traced/ Production volume *pecial milling costs per unit
I$9 68 )0,000 68.88
# 8
I$9 6<:,888 )0,000 67.;8
C?< 6<:8 0,000 1/0 7==.== 69.>8
I$9 6<:8 )0,000 100 >88 67.;8
*etup costs per batch Production volume +umber of setups atch si"e *etup cost per unit .# Consu%tion ratios !iffer by ool
Consumption
Traditional
Driver
(verhea! Costs
;Hs
2R3 ),000
Ratio
:8J
Consumption
4D% 14,000
Ratio
;8J
(verhea! cost are allocate! 02 to *7 an! 02 to D/ un!er the tra!itional costing syste%#
Consumption
Activity1#ased
Driver
6etus
General Factory
;Hs
2R3 1/0 1,000 ),000
Ratio
8J 788J :8J
(verhea! costs are allocate! as follows: 1# 6etu costs -- 402 to *7 an! )02 to D/ #
6=88,888
0,000 2R3 ./#00 >.88 79.88
69@.88 0#0
77.;8
Modified Traditional $nit Cost Traceable Costs
$irect Baterials $irect 4abor *pecial Billing ;on1traceable Costs
Applied B!5 Predetermined B!5 $4-hours per unit
)0,000 4D% /#00 ;.88
Consumption
4D% 100 0 14,000
Ratio
>8J 8J ;8J
Predetermined B!5 $4-hours per unit $otal &nit Cost
69@.88 0#)0
Traditional $nit Cost Modified Traditional $nit Cost A#C "ystem $nit Cost
4/#0
:=.8 /4#40
69=.;8 4/#0 43#)0
6:.8 /4#40 /)#0
per $45
vity Total /0 1,000 0,000
s
)0,000 4D% /#00 ;.88 ..#00
67.;8 8.88 :8.88 6:7.;8 /)#0 6:.8
o
2R3
Total 0,000
Total /0 1,000 0,000
