Chapter05 E7

CHAPTER 5
Activity-Based Costing
ANSWERS TO REVIEW QUESTIONS

5-1 In a traditional, volume-based product-costing system,
only a single predetermined overhead rate is used. All
manufacturing-overhead costs are combined into one cost
pool, and they are applied to products on the basis of a
single cost driver that is closely related to production
volume. The most frequently used cost drivers in
traditional product-costing systems are direct-labor
hours, direct-labor dollars, machine hours, and units of
production.
5-2 Management was being misled by the traditional product-

costing system, because the high-volume product lines
were being overcosted and the low-volume product line
was being undercosted. The high-volume products
essentially were subsidizing the low-volume line. The
traditional product-costing system failed to show that the
low-volume products were driving more than their share
of overhead costs. As a result of these misleading costs,
the company's management was mispricing its products.
5-3 An activity-based costing system is a two-stage process of

assigning costs to products. In stage one, activity-cost
pools are established. In stage two a cost driver is
identified for each activity-cost pool. Then the costs in
each pool are assigned to each product line in proportion
to the amount of the cost driver consumed by each
product line.
5-4 A cost driver is a characteristic of an event or activity that

results in the incurrence of costs by that event or activity.
In activity-based costing systems, the most significant
cost drivers are identified. Then a database is created
that shows how these cost drivers are distributed across
products. This database is used to assign costs to the
various products depending on the extent to which they
use each cost driver.
McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.

Managerial Accounting, 7/e 5-1
5-5 The four broad categories of activities identified in an
activity-based costing system are as follows:
(a) Unit-level activities: Must be done for each unit of

production.
(b) Batch-level activities: Must be performed for each

batch of products.
(c) Product-sustaining activities: Needed to support

an entire product line.
(d) Facility-level (or general-operations-level)

activities: Required for the entire production process
to occur.
5-6 An activity-based costing system alleviated the problems

management was having under its traditional, volume-
based product-costing system by more accurately
assigning costs to products. Products were assigned costs
based on the extent to which they used various cost
drivers that were determined to be closely related to the
incurrence of a variety of overhead costs.
5-7 Product-costing systems based on a single, volume-based

cost driver tend to overcost high-volume products,
because all overhead costs are combined into one pool
and distributed across all products on the basis of only
one cost driver. This simple averaging process fails to
recognize the fact that a disproportionate amount of costs
often is associated with low-volume or complex products.
The result is that low-volume products are assigned less
than their share of manufacturing costs, and high-volume
products are assigned more than their share of the costs.
5-8 In traditional, volume-based costing systems, only direct

material and direct labor are considered direct costs. In
contrast, under an activity-based costing system, an
effort is made to account for as many costs as possible as
direct costs of production. Any cost that can possibly be
traced to a particular product line is treated as a direct
cost of that product.

5-2 Solutions Manual
5-9 The pool rate is calculated by dividing the budgeted
amount of an activity cost pool by the budgeted total
quantity of the associated cost driver. The pool rate is
the cost of a particular activity that is expected per unit
of the associated cost driver.
5-10 Two factors that tend to result in product cost distortion

under traditional, volume-based product-costing systems
are as follows:
(a) Non-unit level overhead costs: Many overhead costs

vary with cost drivers that are not unit-level activities.
Use of a unit-level cost driver to assign such costs
tends to result in cost distortion.
(b) Product diversity: When a manufacturer produces a

diverse set of products, which exhibit different
consumption ratios for overhead activities, use of a
single cost driver to assign costs results in cost
distortion.
5-11 Three important factors in selecting cost drivers for an

ABC system are as follows:
(a) Degree of correlation between consumption of an

activity and consumption of the cost driver.
(b) Cost of measurement of the cost driver.
(c) Behavioral effects, that is, how the cost driver

selected will affect the behavior of the individuals
involved in the activity related to the cost driver.
5-12 An activity dictionary lists all of the activities identified

and used in an activity-based costing analysis. The
activity dictionary provides for consistency in the
terminology and level of complexity in the ABC analysis in
the organization’s various subunits.
5-13 Designing and implementing an ABC system requires a

large amount of data from all facets of an organization's
operations. A multidisciplinary team will be more effective
in obtaining access to this data, and the result will be a
better ABC system. Moreover, a multidisciplinary team

typically helps in gaining acceptance of the new product-
costing system.
5-14 Indicators that a new product-costing system may be

needed include the following (eight required):
(a) Line managers do not believe the product costs

reported by the accounting department.
(b) Marketing personnel are unwilling to use reported

product costs in making pricing decisions.
(c) Complex products that are difficult to manufacture

are reported to be very profitable although they are not
priced at a premium.
(d) Product-line profit margins are difficult to explain.
(e) Sales are increasing, but profits are declining.
(f)Line managers suggest that apparently profitable

products be dropped.
(g) Marketing or production managers are using

"bootleg costing systems," which are informal systems
they designed, often on a personal computer.
(h) Some products that have reported high profit

margins are not sold by competitors.
(i) The firm seems to have captured a highly profitable

product niche all for itself.
(j) Overhead rates are very high, and increasing over time.
(k) Product lines are diverse.
(l) Direct labor is a small percentage of total costs.
(m) The results of bids are difficult to explain.
(n) Competitors' high-volume products seem to be priced

unrealistically low.

(o) The accounting department spends significant
amounts of time on special costing projects to support
bids or pricing decisions.
5-15 Line managers are close to the production process and

may realize that a complex product, which is difficult to
manufacture, is undercosted by a traditional, volume-
based costing system. Because of the cost distortion that
is common in such systems, the undercosted product may
appear to be profitable when it is really losing money.
Line managers may have a "gut feeling" for this situation,
even if the cost-accounting system suggests otherwise.
5-16 Diverse products typically consume support activities

(such as purchasing, material handling, engineering, and
inspection) in differing degrees. When there are
significant differences among product lines in the ways
that they consume support services (and thereby cause
overhead costs), a traditional, volume-based costing
system may distort product costs. Some products are
overcosted; others are undercosted. An ABC system can
eliminate (or at least alleviate) such cost distortion.
5-17 Activity-based costing is just as appropriate in the service

industry as in the manufacturing industry. Just as in
manufacturing firms, diverse services typically consume
support activities in varying degrees. ABC systems are
more accurate in tracking the usage of these support
activities to the services (products) that are produced
than are traditional, volume-based costing systems.
5-18 As indicated in the chapter, Pennsylvania Blue Shield, like

many manufacturers, classifies activities as unit level,
batch level, product-sustaining level, or facility level.
Maintenance of the medical-services provider network
(i.e., the physicians and hospitals that provide medical
care to claimants) is a product-sustaining-level activity
because it benefits an entire product line (service line, in
this case) of personal health insurance policies.
5-19 Management could use the ABC information about the

cost of various types of patient appointments for
determining charges for appointments, making

appointment staffing decisions (e.g., physician versus
nurse practitioner), and justifying reimbursements from
insurance companies or government agencies.
5-20 At Patio Grill Company, every unit of each product line

manufactured requires all eight of the support activities
covered by the ABC system. In contrast, at Delaware
Medical Center, each patient sees a physician, or a nurse
practitioner, or an intern, or a resident. Moreover, each
patient is either a new patient or a continuing patient, but
not both. Therefore, in determining the cost a patient
appointment, the cost analyst would include only the
relevant activity costs in the cost of a patient
appointment.

SOLUTIONS TO EXERCISES
EXERCISE 5-21 (15 MINUTES)
1 Material-handling cost per lens:

.
$50,000
× 200 = $1,000
[(25)(200)+ (25)(200)]*
*The total number of direct-labor hours.
An alternative calculation, since both types of product use

the same amount of the cost driver, is the following:
$50,000
= $1,000
50*
*The total number of units (of both types) produced.
2 Material-handling cost per mirror = $1,000. The analysis is

. identical to that given for requirement (1).
3 Material-handling cost per lens:

.
$50,000†
×5
(5+ 15)
*
= $500
25
*The total number of material moves.
†
The number of material moves for the lens product line.
4 Material-handling cost per mirror:

.
$50,000
× 15*
(5+ 15)
= $1,500
25
*The number of material moves for the mirror product line.

1 a. Quality-control costs assigned to the Satin Sheen line

. under the traditional system:
Quality-control = 14.5% × direct-labor cost

costs
Quality-control
costs assigned to
Satin Sheen line = 14.5% × $27,500
= $3,988 (rounded)
b. Quality-control costs assigned to the Satin Sheen line

under activity-based costing:
Quantity Assign
for ed
Activity Pool Rate Satin Cost
Sheen
Incoming material $11.50 per 12 types. $ 138
inspection.................. type
In-process inspection. . .14 per 17,500 2,450
unit units......
Product certification. . . 77.00 per 25 1,925
order orders....
Total quality-control costs assigned................... $4,513
2 The traditional product-costing system undercosts the Satin

. Sheen product line, with respect to quality-control costs, by
$525 ($4,513 – $3,988).
There is no single correct answer to this exercise. There are

many reasonable solutions.
Cost pool 1:
Raw materials and components.......................... 2,950,000

yen

Inspection of finished goods............................... 30,000
yen
Total.................................................................. 2,980,000
yen
Cost driver: raw-material cost

EXERCISE 5-23 (CONTINUED)
Cost pool 2:
Depreciation, machinery..................................... 1,400,000

yen
Electricity, machinery......................................... 120,000
yen
Equipment maintenance, wages.......................... 150,000
yen
Equipment maintenance, parts........................... 30,000
yen
Total.................................................................. 1,700,000
yen
Cost driver: number of units produced.
Cost pool 3:
Setup wages...................................................... 40,000

yen
Total.................................................................. 40,000
yen
Cost driver: number of production runs.
Cost pool 4:
Engineering design............................................. 610,000

yen
Total.................................................................. 610,000
yen
Cost driver: number of parts in a product.
Cost pool 5:
Depreciation, plant............................................. 700,00

0 yen
Insurance, plant................................................. 600,000
yen
Electricity, light.................................................. 60,000

yen
Custodial wages, plant....................................... 40,000
yen
Property taxes................................................... 120,000
yen
Natural gas, heating........................................... 30,000
yen
Total.................................................................. 1,550,000
yen
Cost driver: for costs allocated to support departments,

square footage; for costs assigned to products, number of
units produced.

Cost pool 1: unit-level

Cost pool 2: unit-level
Cost pool 3: batch-level
Cost pool 4: product-sustaining-level
Cost pool 5: facility-level
Answers will vary widely, depending on the web site chosen.

In general, though, activity-based costing could be a useful
tool in helping any governmental unit understand what its cost
drivers are for the various activities in which it engages.
Wheelco's product-costing system probably is providing

misleading cost information to management. A common
problem in a traditional, volume-based costing system is that
high-volume products are overcosted and low-volume products
are undercosted. There is evidence of this in the exercise,
since Wheelco's competitors are selling the high-volume A22
wheel at a price lower than Wheelco's reported manufacturing
cost. In contrast, Wheelco is selling its specialty D52 wheel at
a huge markup above the product's reported cost. An activity-
based costing system probably would report a lower product
cost for wheel A22 and a substantially higher cost for wheel
D52.
The president's strategy of pushing the firm's specialty

products probably will aggravate Wheelco's problem even
further. These products probably are not as profitable as the
firm's traditional product-costing system makes them appear.
Recommendation: Install an activity-based costing

system. If the new reported product costs shift as suggested in
the preceding comments, then lower the price on the high-
volume products, such as wheel A22. The prices of the
specialty wheels probably will need to be raised. It is possible
that Wheelco should discontinue low-volume products.

1 Key features of an activity-based costing system:

.
(a Two-stage procedure for cost assignment.

)
(b Stage one: Establish activity cost pools.

)
(c Stage two: Select cost drivers for each activity-cost

) pool. Then assign the costs in each cost pool to the
company's product lines in proportion to the amount of
the related cost driver used by each product line.
2 As described in the answer to the preceding exercise, the

. new system probably will reveal distortion in the firm's
reported product costs. In all likelihood, the high-volume
products are overcosted and the low-volume specialty
products are undercosted.
3 Strategic options:
.
(a Lower the prices on the firm's high-volume products to

) compete more effectively.
(b Increase the prices on low-volume specialty products.

)
(c Consider eliminating the specialty product lines. This

) option may not be desirable if there is a marketing need
to produce a full product line. Also, the specialty wheels
may give Wheelco prestige.

The activity of the Finger Lakes Winery may be classified as

follows:
U: Unit-level
B: Batch-level
P: Product-sustaining-level
F: Facility-level
Activity Classification Activity Classification

(1) P (11) B
(2) P (12) B
(3) P (13) U
(4) P (14) U
(5) P (15) U
(6) P (16) U
(7) P (17) B
(8) B (18) F
(9) B (19) F
(10) B
The definitions used by Carrier Corporation for each of the

activity levels are as follows:*
• Unit: This activity or cost occurs every time a unit is

produced. An example is the utility cost for production
equipment. This level of activity usually relates directly to
production volume.

________________
*Robert Adams and Ray Carter, "United Technologies' Activity-

Based Accounting Is a Catalyst for Success” As Easy as
ABC, 18, p.4. United Technologies uses the term structural-
level activity, instead of facility-level activity as we have
done.

• Batch: This activity is performed for each batch produced

or acquired. Examples include moving raw material
between the stock room and production line or setting up
a machine for a run.
• Product-sustaining: This activity is performed to maintain
product designs, processes, models, and parts. Examples
include expediting parts, maintaining the bill of materials,
or issuing orders for product changes. Sustaining
activities are required for supporting a key manufacturing
capability or process.
• Facility: These activities are performed to enable
production. They are fundamental to supporting the
business entity at the most basic level. Examples are
managing or cleaning the building.
These definitions are consistent with those given in the
chapter. An argument for the ABC project team's classification
would be that the activity or account in question was
characterized by the definition of the activity-level
classification given above. An argument against the team's
classification would be that the particular activity or account
did not satisfy the definition.
For example, moving materials is a batch-level activity

because a raw material must be moved to the product area
when a production run or batch is started. Depreciation is a
facility-level account because depreciation on plant and
equipment represents the cost of providing production
facilities in which manufacturing can take place.

1 REDWOOD COMPANY
. COMPUTATION OF SELLING COSTS
BY ORDER SIZE AND PER SKEIN WITHIN EACH ORDER SIZE
Order Size
Small Mediu Large Total
m
Sales commissionsa
(Unit cost:
$675,000/225,000 $ $135,0 $534,00 $
= $3.00 per box).... 6,000 00 0 675,000
box)........................
Catalogsb
(Unit cost:
$295,400/590,800 127,15 105,65 62,600 295,400
= $.50 per catalog) 0 0
catalog)..................
Costs of catalog salesc

(Unit cost:
$105,000/175,000 47,400 31,200 26,400 105,000
= $.60 per skein)...
skein).....................
Credit and collectiond

(Unit cost:
$60,000/6,000 4,850
= $10.00 per 24,150 31,000 60,000
order)........................
order).....................
Total cost for all

orders of a given $185,4 $296,0 $654,00 $1,135,
size size..................... 00 00 0 400
Units (skeins) solde.... 103,00 592,00 2,180,0

0 0 00

Unit cost per order of
a given sizef............... $1.80 $.50 $.30
a
Retail sales in boxes × unit cost:
Small, 2,000 × $3
Medium, 45,000 × $3
Large, 178,000 × $3
b
Catalogs distributed × unit cost
c
Catalog sales × unit cost
d
Number of retail orders × unit cost
e
Small: (2,000 × 12) + 79,000 = 103,000
Medium: (45,000 × 12) + 52,000 = 592,000
Large: (178,000 × 12) + 44,000 = 2,180,000
f
Total cost for all orders of a given size ÷ units sold
2. The analysis of selling costs shows that small orders cost

more than large orders. This fact could persuade
management to market large orders more aggressively
and/or offer discounts for them.

SOLUTIONS TO PROBLEMS
PROBLEM 5-31 (25 MINUTES)
1 a. Manufacturing overhead costs include all indirect

. manufacturing costs (all production costs except direct
material and direct labor). Typical overhead costs
include:
• Indirect labor (e.g., a lift-truck driver, maintenance

and inspection labor, engineering labor, and
supervisors).
• Indirect material.
• Other indirect manufacturing costs (e.g., building

maintenance, machine and tool maintenance,
property taxes, insurance, depreciation on plant and
equipment, rent, and utilities).
b. Companies develop overhead rates before production to

facilitate the costing of products as they are completed
and shipped, rather than waiting until actual costs are
accumulated for the period of production.
2. The increase in the overhead rate should not have a

negative impact on the company, because the increase
in indirect costs was offset by a decrease in direct
labor.
3. Rather than using a plantwide overhead rate, Borealis

Manufacturing could implement separate activity cost
pools. Examples are as follows:
• Separate costs into departmental overhead accounts

(or other relevant pools), with one account for each
production and service department. Each department
would allocate its overhead to products on the basis
that best reflects the use of these overhead services.
• Treat individual machines as separate cost centers,

with the machine costs collected and charged to the
products using machine hours.

4. An activity-based costing system might benefit Borealis
Manufacturing because it assigns costs to products
according to their usage of activities in the production
process. More accurate product costs are the result.

1. Predetermined overhead rate = budgeted overhead ÷

budgeted direct-labor hours
= $800,000 ÷ 25,000* = $32 per
direct labor hour
*25,000 budgeted direct-labor hours = (3,000 units of

Standard)(3 hrs./unit) +
(4,000 units of Enhanced)(4 hrs./unit)
Stand Enhanc
ard ed
Direct $ 25 $ 40
material…………….
Direct labor:
3 hours x 36
$12…………
4 hours x 48
$12…………
Manufacturing
overhead:
3 hours x 96
$32…………
4 hours x 128
$32…………
Total $157 $216
cost………………….
2. Activity-based overhead application rates:
Activity Applicati
Activity Cost Cost Driver on
Rate
Order $150,0 ÷ 500 orders = $300 per

processi 00 processed OP
ng (OP)
Machine 560,0 ÷ 40,000 = $14 per

processi 00 machine MH

ng hrs. (MH)
Product 90,0 ÷ 10,000 = $9 per

inspecti 00 inspection IH
on hrs. (IH)

PROBLEM 5-32 (CONTINUED)
Order processing, machine processing, and product

inspection costs of a Standard unit and an Enhanced unit:
Activity Stand Enhanc

ard ed
Order processing:
300 OP x $
$300……………... 90,00
0
200 OP x $
$300……………... 60,000
Machine processing:
18,000 MH x 252,
$14…………... 000
22,000 MH x 308,0
$14…………... 00
Product inspection:
2,000 IH x 18,
$9……………….. 000
8,000 IH x 72,0
$9………………. 00
Total $360, $440,0
000 00
Production volume 3,000 4,000
(units)
Cost per unit $120* $110**
* $360,000 ÷ 3,000 units = $120

** $440,000 ÷ 4,000 units = $110
The manufactured cost of a Standard unit is $181, and the

manufactured cost of an Enhanced unit is $198:
Stand Enhanc
ard ed
Direct $ 25 $ 40
material……………………………
….
Direct labor:

3 hours x 36
$12……………………………
4 hours x 48
$12……………………………
Order processing, machine
processing, and product 120 110
inspection………………..
Total $181 $198
cost…………………………………
….
3. a. The Enhanced product is overcosted by the

traditional product-costing system. The labor-hour
application base resulted in a $216 unit cost; in
contrast, the more accurate ABC approach yielded a
lower unit cost of $198. The opposite situation
occurs with the Standard product, which is
undercosted by the traditional approach ($157 vs.
$181 under ABC).

b. Yes, especially since the company’s selling prices are

based heavily on cost. An overcosted product will
result in an inflated selling price, which could prove
detrimental in a highly competitive marketplace.
Customers will be turned off and will go elsewhere,
which hurts profitability. With undercosted
products, selling prices may be too low to adequately
cover a product’s more accurate (higher) cost. This
situation is also troublesome and will result in a
lower income being reported for the company.
4. In the electronic version of the solutions manual, press

the CTRL key and click on the following link: Build a
Spreadsheet
1. The predetermined overhead rate is calculated as follows:
Predetermined overhead rate = Budgeted manufacturing

overhead/budgeted direct-labor hours =
$1,224,000/102,000* = $12 per hour
*Direct labor, budgeted hours:

REG: 5,000 units × 9 hours.......... 45,000 hours
ADV: 4,000 units × 11 hours........ 44,000 hours
SPE: 1,000 units × 13 hours........ 13,000 hours
Total direct-labor hours.......................102,000 hours

2. Activity-based-costing analysis:
Activi
Cost ty
Driver Activity Cost
Cost Quanti Cost Produc per
Activity Cost Driver ty for for t Line Unit of
Activit Cost Drive Quanti Pool Produ Produ Produc Prod. Produ
y Pool r ty Rate ct Line ct Line t Line Volume ct
Machi $310,50 Machi 115,00 $ $135,0 $27.00

ne 0 ne 0 2.70 REG 50,000 00 5,000
Relate 129, 32.40
d Hours ADV 48,000 600 4,000
GMT 17,000 45,900 1,000 45.90
Tota 115,00 $310,5
l 0 00
Materi 525. $ 4.20
al 52,500 Prod. 100 00 REG 40 21,000 5,000
Hand. Runs ADV 40 21,000 4,000 5.25
GMT 20 10,500 1,000 10.50
Tota $
l 100 52,500
Purch 250. $ 5.00
Purch. 75,000 . 300 00 REG 100 25,000 5,000
Order 6.00
s ADV 96 24,000 4,000
GMT 104 26,000 1,000 26.00
Tota $
l 300 75,000
850. $ 6.80
Setup 85,000 Prod. 100 00 REG 40 34,000 5,000
Runs ADV 40 34,000 4,000 8.50
GMT 20 17,000 1,000 17.00
Tota $
l 100 85,000
Inspec Inspe 25.0 $ 2.00
t. 27,500 ct. 1,100 0 REG 400 10,000 5,000
Hours ADV 400 10,000 4,000 2.50
GMT 300 7,500 1,000 7.50
Tota $
l 1,100 27,500
60.0 $ 6.00
Ship. 66,000 Ship. 1,100 0 REG 500 30,000 5,000
ADV 400 24,000 4,000 6.00
GMT 200 12,000 1,000 12.00
Tota $
l 1,100 66,000
50.0 $ 2.50
Eng. 32,500 Eng. 650 0 REG 250 12,500 5,000
Hours ADV 200 10,000 4,000 2.50
GMT 200 10,000 1,000 10.00
Tota 650 $

l 32,500
Machi 115,00 $250,0 50.00
Fac. 575,000 ne 0 5.00 REG 50,000 00 5,000
240,00 60.00
Hours ADV 48,000 0 4,000
GMT 17,000 85,000 1,000 85.00
Tota 115,00 $575,0
l 0 00
Grand
Tot $1,224, Grand $1,224,
al 000 Total 000

3. Calculation of new product costs under ABC.
REG ADV GMT

Direct material............ $129.00 $151.00 $203.00
Direct labor (not
including 171.00 (9 hr. @ 209.00 (11 hr. 247.00 (13 hr.
set-up time)............. $19) @ $19) @ $19)
Total direct costs per $300.00 $360.00 $450.00
unit.............................
Manufacturing overhead (based on ABC):

Machine-related....... $ 27.00 $ 32.40 $ 45.90
Setup....................... 4.20 5.25 10.50
Purchasing............... 5.00 6.00 26.00
Material handling..... 6.80 8.50 17.00
Quality assurance..... 2.00 2.50 7.50
Packing/shipping...... 6.00 6.00 12.00
Engineering design... 2.50 2.50 10.00
Facility..................... 50.00 60.00 85.00
Total ABC overhead
cost per unit............. $103.50 $123.15 $213.90
Total product cost per $403.50 $483.15 $663.90
unit.............................
McGraw-Hill/Irwin  2008 The McGraw-Hill Companies,

Inc.
4. Comparison of costs and target prices under two

alternative product-costing systems:
REG ADV GMT

Reported unit overhead cost:
Traditional, volume-based costing $108.0 $132.0 $156.0
system 0 0 0
...................................................
Activity-based costing system 103.50 123.15 213.90
...................................................
Reported unit product cost (direct
material, direct labor and
overhead):
Traditional, volume-based costing 408.00 492.00 606.00
system
...................................................
...................................................
Sales price data:
Original target price (130% of 530.40 639.60 787.80
product cost based on traditional,
volume-based costing system)
...................................................
New target price (130% of 524.55 628.10 863.07
product cost based activity-based
costing system)
...................................................
Actual current selling price............. 525.00 628.00 800.00
5. The REG and ADV products were overcosted by the

traditional system, and the GMT product was undercosted
by the traditional system
Reported unit product cost:

Traditional, volume-based costing $408.0 $492.0 $606.0
system 0 0 0
...................................................
................................................... 0 5 0
Cost distortion:
Inc.
REG and ADV overcosted by $ $
traditional system 4.50 8.85
...................................................
GMT undercosted by traditional ($
system 57.90)
...................................................
6. In the electronic version of the solutions manual, press

the CTRL key and click on the following link: Build a
Spreadsheet

Inc.
The information supplied by the ABC project team is in

columns A, B, C, D, F, G, and I.
Activ
ity
Cost Cost
Driver per
Quant Activit Produc Unit
Activ Cost ity for y Cost t Line
ity Driver Prod Produ for Produc of
Activi Cost Cost Quanti Pool uct ct Produ tion Prod
ty Pool Driver ty Rate Line Line ct Line Volume uct
Mater $52, Produc $525 $21,00 $

ial 500 tion 100 .00 REG 40 0 5,000 4.20
Handl 5.25
ing Runs ADV 40 21,000 4,000
10.5
GMT 20 10,500 1,000 0
To $52,50
tal 100 0
The results of the ABC calculations are in columns E, H and J.

The ABC calculations are as follows:
(1) Compute pool rate for material-handling activity:
Activity cost pool ÷ cost driver quantity = pool rate
$52,500 ÷ 100 = $525.00
(2) Compute total activity cost for each product line:

Cost
Driver
Quantity Activity Cost
Prod for = for Each
uct Pool Product
Line Rate x Line Product Line
R $525.0 x =
EG 0 40 $21,000
A x =
DV 525.00 40 21,000
G x =
MT 525.00 20 10,500

Inc.
(3) Compute product cost per unit for each product line:
Activi
Activity ty Cost
Cost for per
Each ÷ Product Line Unit
Prod Product Production = of
uct
Line Line Volume Product
R $21,00
EG 0 ÷ 5,000 = $ 4.20
A 21,00 ÷
DV 0 4,000 = 5.25
G 10,50 ÷
MT 0 1,000 = 10.50

Inc.
1. Type A manufacturing overhead cost:

16,000 machine hours x $80 = $1,280,000
$1,280,000 ÷ 8,000 units = $160 per unit
Type B manufacturing overhead cost:

22,500 machine hours x $80 = $1,800,000
$1,800,000 ÷ 15,000 units = $120 per unit
Type Type
A B
Direct $ 35 $ 60
material………………
.
Direct 20 20
labor…………………..
Manufacturing 160 120
overhead….
Unit $215 $200
cost…………………
2. Activity-based application rates:
Activity Applicatio
Activity Cost Driver n Rate
Manufactu $ ÷ 80 setups = $8,400

ring 672,00 (SU) per SU
setups 0
Machine 1,848, ÷ 38,500 = $48 per

processin 000 machine MH
g hours
(MH)
Product 560, ÷ 175 = $3,200

shipping 000 outgoing per OS
shipments
(OS)

Inc.
Manufacturing setup, machine processing, and product

shipping costs of a Type A unit and a Type B unit:
Activity Type A Type B
Manufacturing
setups:
50 SU x $
$8,400…………….. 420,00
0
30 SU x $
$8,400…………….. 252,00
0
Machine processing:
16,000 MH x 768,
$48…………... 000
22,500 MH x 1,080,
$48…………... 000
Product shipping:
100 OS x 320,
$3,200…………… 000
75 OS x 240,
$3,200…………….. 000
Total $1,508, $1,572,
……………………………. 000 000
Production volume 8,000 15,000

(units)….
Cost per $188.5 $104.8

unit………………….. 0* 0**
* $1,508,000 ÷ 8,000 units = $188.50

** $1,572,000 ÷ 15,000 units = $104.80
The manufactured cost of a Type A cabinet is $243.50,

and the manufactured cost of a Type B cabinet is $184.80.
The calculations follow:
Type Type

Inc.
A B
Direct $ $
material…………………………… 35.00 60.00
……
Direct 20. 20.
labor………………………………… 00 00
….
Manufacturing setup,
machine processing, and 188. 104.
outgoing shipments.. 50 80
Total $243. $184.
cost…………………………………… 50 80
….
3. Yes, the Type A storage cabinet is undercosted. The use

of machine hours produced a unit cost of $215; in
contrast, the more accurate activity-based-costing
approach shows a unit cost of $243.50. The difference
between these two amounts is $28.50.

Inc.
4. No, the discount is not advisable. The regular selling

price of $260, when compared against the more accurate
ABC cost figure, shows that each sale provides a profit to
the firm of $16.50 ($260.00 - $243.50). However, a $30
discount will actually produce a loss of $13.50 ($243.50 -
$230.00), and the more units that are sold, the larger the
loss. Notice that with the less-accurate, machine-hour-
based figure ($215), the marketing manager will be
misled, believing that each discounted unit sold would
boost income by $15 ($230 - $215).
1. Activity-based costing results in improved costing

accuracy for two reasons. First, companies that use ABC
are not limited to a single driver when allocating costs to
products and activities. Not all costs vary with units, and
ABC allows users to select a host of nonunit-level cost
drivers. Second, consumption ratios often differ greatly
among activities. No single cost driver will accurately
assign costs for all activities in this situation.
2. Allocation of administrative cost based on billable hours:
Information systems: 3,100 ÷ 5,000 = 62%;

$342,000 x 62% = $212,040
E-commerce consulting: 1,900 ÷ 5,000 = 38%;
$342,000 x 38% = $129,960
Information
Systems E-
Services Commerce
Consulting
Billings:
3,100 hours x $387,500
$125…………
1,900 hours x $237,500
$125…………
Less: Professional staff
cost:
Inc.
3,100 hours x (139,500)
$45…….
1,900 hours x (85,500)
$45…….
Administrative (212,040) (129,960)
cost…….
Income……………………… $ 35,960 $ 22,040
……
Income ÷ 9.28% 9.28%

billings……………….

Inc.
3. Activity-based application rates:
Activity Application
Activity Cost Driver Rate
Staff $180,0 ÷ 250 clients = $720 per

support 00 client
In-house 136,4 ÷ 4,400 = $31 per CH

computin 00 computer
g hours
(CH)
Miscellan 25,6 ÷ 1,000 client = $25.60 per

eous 00 transaction CT
office s (CT)
charges
Staff support, in-house computing, and miscellaneous

office charges of information systems services and e-
commerce consulting:
Informa
tion E-
Activity System Commerc
s e
Service Consultin
s g
Staff support:
200 clients x $144,00
$720…………... 0
50 clients x $ 36,000
$720…………….
In-house computing:
2,600 CH x 80,60
$31………………. 0
1,800 CH x 55,800
$31……………….
Miscellaneous office

Inc.
charges:
400 CT x 10,24
$25.60……………... 0
600 CT x 15,360
$25.60……………...
Total $234,84 $107,160
……………………………… 0
.

Inc.
Profitability of information systems services and e-commerce

consulting:
Informatio
n E-
Systems Commerce
Services Consulting
Billings:
3,100 hours x $387,500
$125………..
1,900 hours x $237,500
$125………..
Less: Professional
staff cost:
3,100 hours x (139,500
$45…… )
1,900 hours x (85,500)
$45……
Administrative (234,840 (107,160)
cost……. )
Income…………………… $ 13,160 $ 44,840
……..
Income ÷ 3.40% 18.88%

billings……………...
4. Yes, his attitude should change. Even though both

services are needed and professionals are paid the same
rate, the income percentages show that e-commerce
consulting provides a higher return per sales dollar than
information systems services (18.88% vs. 3.40%). Thus,
all other things being equal, professionals should spend
more time with e-commerce.
5. Probably not. Although both services produce an

attractive return, the firm is experiencing a very tight
labor market and will likely have trouble finding qualified
help. In addition, the professional staff is currently

Inc.
overworked, which would probably limit the services
available to new clients.

Inc.
ROBLEM 5-37 (40 MINUTES)
1. Overhead to be assigned to film development chemical

order:
Assign
Activity Cost Pool Level of ed
Pool Rate Cost Driver Overhe
ad
Cost
Machine setups $2,000 per × 5 setups $10,00
setup 0
Material $2 per pound × 10,000 20,000
handling pounds
Hazardous waste $5 per pound × 2,000 pounds 10,000
control
Quality control $75 per × 10 750
inspection inspections
Other overhead $10 per × 500 machine
costs machine hour hours 5,000
Total $45,75
0
2. Overhead 45,750
= $45.75
perbox
=
cost per 1,000
boxes
box of
chemicals
3. Predetermin total
budgeted cost $625,000
overhead
= =
ed total
budgeted
machine
hours 20,000
overhead
rate
= $31.25 per
machine hr.
4. Overhead to be assigned to film development chemical

order, given a single predetermined overhead rate:
a. Total overhead = $31.25 per machine hr. × 500

assigned machine hr.

Inc.
= $15,625
b. Overhead $15,625
= $15.625
perbox
=
cost per 1,000
boxes
box of
chemicals
5. The film development chemicals entail a relatively large

number of machine setups, a large amount of hazardous
materials, and several inspections. Thus, they are quite
costly in terms of driving overhead costs. Use of a single
predetermined overhead rate obscures this characteristic
of the production job. Underestimating the overhead cost
per box could have adverse consequences for the
company. For example, it could lead to poor decisions
about product pricing. The activity-based costing system
will serve management much better than the system based
on a single, predetermined overhead rate.
6. In the electronic version of the solutions manual, press the

CTRL key and click on the following link: BUILD A
SPREADSHEET
1. Unit cost calculation:
(a Overhead assigned to photographic plates:

)
Assign
Activity Cost Pool Level of ed
Pool Rate Cost Driver Overhe
ad
Cost
Machine setups $2,000 per × 3 setups $
setup 6,000
Material $2 per pound × 900 pounds 1,800
handling
Hazardous waste $5 per pound × 300 pounds 1,500

Inc.
control
Quality control $75 per × 3 inspections 225
inspection
Other overhead $10 per × 50 machine 50
costs machine hour hours 0
Total $10,02
5
$10,025
costperunit=
Overhead = $100.25
100plates
(b Unit cost per plate:

)
Direct material............ $120.00

Direct labor................. 40.00
Manufacturing 100.25
overhead....................
Total cost per plate..... $260.25

SPREADSHEET
1. An ABC system is a two-stage process of assigning costs

to products. In stage one, activity-cost pools are
established. In stage two a cost driver is identified for
each activity-cost pool. Then the costs in each pool are
assigned to each product line in proportion to the amount
of the cost driver consumed by each product line.

Inc.
2. Montreal Electronics should not continue with its plans to

emphasize the Royal model and phase out the Nova model.
As shown in the following activity-based costing analysis,
the Royal model has a contribution margin of less than 3
percent, while the Nova model generates a contribution
margin of nearly 43 percent.
Cost per event for each cost driver:
Soldering........ $ ÷ 1,570, = $ .60 per

942,000 000 solder joint
Shipments...... 860,000 ÷ 20,00 = 43.00 per
0 shipment
Quality control 1,240,0 ÷ 77,50 = 16.00 per
00 0 inspection
Purchase 950,400 ÷ 190,0 = 5.00 per order
orders............. 80
Machine power 57,600 ÷ 192,0 = .30 per
00 hour
Machine setups 750,000 ÷ 30,00 = 25.00 per
0 setup
Costs per model:
Roy Nova
al
Direct costs:
Materiala.................................... $2,336,000 $
4,576,0
00
Direct laborb............................... 168,000 396,000
Machine hoursc........................... 288,000
3,168,0
00
Total direct costs............................ $2,792,000 $
8,140,0
00
Assigned costs:
Solderingd.................................. $ 231,000 $
711,000
Inc.
Shipmentse................................. 163,400 696,600
Quality controlf........................... 340,800 899,200
Purchase ordersg........................ 549,900 400,500
Machine powerh.......................... 4,800 52,800
Machine setupsi.......................... 350,000
400,000
Total assigned costs........................ $1,639,900 $
3,160,1
00
Total cost....................................... $4,431,900 $11,300
,100
Calculations follow.

Inc.
Calculations:
Royal Nova
a
Material..................... 4,000 × 22,000 ×
$584 $208
b
Direct labor............... 4,000 × 22,000 ×
$42 $18
c
Machine hours........... 4,000 × 22,000 ×
$72 $144
d
Soldering................... 385,000 1,185,000 ×
× $.60 $.60
e
Shipments................. 3,800 × 16,200 ×
$43 $43
f
Quality control........... 21,300 × 56,200 ×
$16 $16
g
Purchase orders......... 109,980 80,100 ×
× $5 $5
h
Machine power.......... 16,000 × 176,000 ×
$.30 $.30
i
Machine setups.......... 14,000 × 16,000 ×
$25 $25
Profitability analysis:
Roy Nova Total

al
Sales................................... $4,560,0 $19,800 $24,360
00 ,000 ,000
Less: Cost of goods sold....... 15,732
4,431,90 11,300, ,000
0 100
Gross margin....................... $ $ $
128,100 8,499,9 8,628,0
00 00
Units sold............................ 4,000 22,000

Inc.
Per-unit calculations:
Selling price.................... $1,140.0 $900.00
0
Less: Cost of goods sold. . 513.64
1,107.98
Contribution margin........ $ 32.02 $386.36
Contribution margin 2.8% 42.
percentage.......................... a
9%b
a
$32.02/$1,140.00 =
2.8%
b
$386.36/$900.00 =
42.9%

Inc.
1. General advantages associated with activity-based costing

include the following:
• Provides management with a more thorough

understanding of complex product costs and product
profitability for improved resource management and
pricing decisions.
• Allows management to focus on value-added and non-

value-added activities, so that non-value-added
activities can be controlled or eliminated, thus
streamlining production processes.
• Highlights the relationship between activities and

identifies opportunities to reduce costs (i.e., designing
products with fewer parts in order to reduce the cost of
the manufacturing process).
• Provides a more appropriate means of charging

overhead costs to products.

Inc.
2. Using Manchester Technology’s unit cost data, the total

contribution margin expected from the PC board is
$2,360,000, calculated as follows:
Total
for
Per Unit 40,000
Units
Revenue............................................. $300 $12,000,0
00
Direct material................................... $140 $
5,600,000
Material-handling charge (10% of 14 560,000
material)............................................
Direct labor ($14 per hr. × 4 hr.)........ 56 2,240,000
Variable overhead ($4 per hr. × 4 hr.)* 16 640,000
Machine time ($10 per hr. × 1.5 hr.)... 15
600,000
Total cost....................................... $241 $
9,640,000
Unit contribution margin..................... $ 59
Total contribution margin $
(40,000 × $59).................................. 2,360,000
*Variable overhead rate: $1,120,000 ÷ 280,000 hr. = $4 per

hr.
The total contribution margin expected from the TV board

is $1,950,000, calculated as follows:
Total
for
Per Unit 65,000
Units
Revenue............................................. $150 $9,750,
000
Direct material................................... $ 80 $5,200,
000
Material-handling charge (10% of 8 520,000
material)............................................
Inc.
Direct labor ($14 per hr. × 1.5 hr.)..... 21 1,365,0
00
Variable overhead ($4 per hr. × 1.5 6 390,000
hr.)*...................................................
Machine time ($10 per hr. × .5 hr.). . . . 5
325,000
Total cost....................................... $120 $7,800,
000
Unit contribution margin..................... $ 30
Total contribution margin $1,950,
(65,000 × $30).................................. 000
*Variable-overhead rate: $1,120,000 ÷ 280,000

hr. = $4 per hr.

Inc.
3. The pool rates, which apply to both the PC board and the
TV board, are calculated as follows:
Procurement........... $400,000/4,00 = $.10 per part

0,000
Production $220,000/110, = $2.00 per board
scheduling.............. 000
Packaging and $440,000/110, = $4.00 per board
shipping................. 000
Machine setup......... $446,000/278, = $1.60 per setup
750
Hazardous waste $48,000/16,00 = $3.00 per lb.
disposal.................. 0
Quality control........ $560,000/160, = $3.50 per
000 inspection
General supplies..... $66,000/110,0 = $.60 per board
00
Machine insertion.... $1,200,000/3, = $.40 per part
000,000
Manual insertion..... $4,000,000/1, = $4.00 per part
000,000
Wave soldering....... $132,000/110, = $1.20 per board
000
Using activity-based costing, the total contribution margin

expected from the PC board is $1,594,000, calculated as
follows:
Total
for
Per Unit 40,000
Units
Revenue.............................................. $300. $12,000,0
00 00
Direct material.................................... $140. $
00 5,600,000
Procurement ($.10 per part × 55 5.50 220,000
parts)..................................................
Production scheduling......................... 2.00 80,000
Packaging and shipping....................... 4.00 160,000
Inc.
Machine setup ($1.60 per setup × 3 4.80 192,000
setups)................................................
Hazardous waste disposal ($3 per 1.05 42,000
lb. × .35 lb.).......................................
Quality control
($3.50 per inspection × 2 7.00 280,000
inspections)........................................
General supplies.................................. .60 24,000
Machine insertion ($.40 per part × 35 14.00 560,000
parts)..................................................
Manual insertion ($4 per part × 20 80.00 3,200,000
parts)..................................................
Wave soldering....................................
1.20 48,000
Total cost $ $10,406,0
260.1 00
5
Unit contribution margin $
39.85
Total contribution margin $
1,594,000

Inc.
Using activity-based costing, the total contribution margin

expected from the TV board is $2,557,100, calculated as
follows:
Total
for
Per Unit 65,000
Units
Revenue............................................. $ $9,750,
150.00 000
Direct material................................... $ $5,200,
80.00 000
Procurement ($.10 per part × 25 2.50 162,500
parts).................................................
Production scheduling........................ 2.00 130,000
Packaging and shipping...................... 4.00 260,000
Machine setups ($1.60 per setup × 2 3.20 208,000
setups)...............................................
Hazardous waste disposal ($3 per .06 3,900
lb. × .02 lb.)......................................
Quality control.................................... 3.50 227,500
General supplies................................. .60 39,000
Machine insertion ($.40 per part × 24 9.60 624,000
parts).................................................
Manual insertion................................. 4.00 260,000
Wave soldering................................... 1.20
78,000
Total cost........................................ $ $7,192,
110.66 900
Unit contribution margin..................... $
39.34
Total contribution margin................... $2,557,
100
4. The analysis using the previously reported costs shows

that the unit contribution of the PC board is almost double
that of the TV board. On this basis, management is likely to
accept the suggestion of the production manager and
concentrate promotional efforts on expanding the market

Inc.
for the PC boards.
However, the analysis using activity-based costing does

not support this decision. This analysis shows that the unit
dollar contribution from each of the boards is almost equal,
and the total contribution from the TV board exceeds that
of the PC board by almost $1,000,000. As a percentage of
selling price, the contribution from the TV board is double
that of the PC board (26 percent versus 13 percent).

Inc.
1 a. WGCC's predetermined overhead rate, using direct-

. labor cost as the single cost driver, is $5 per direct
labor dollar, calculated as follows:
totalmanufactur
ing-overheadcost
Overhead = budgeteddirect
-laborcost
rate
= $3,000,000/$600,000
= $5 per direct-labor dollar
b. The full product costs and selling prices of one pound of

Kona and one pound of Malaysian coffee are calculated
as follows:
Kona Malays
ian
Direct material................. $3.20 $4.20

Direct labor..................... .30 .30
Overhead (.30 × $5)........ 1.50 1.50
Full product cost.............. $5.00 $6.00
Markup (30%).................. 1.50 1.80
Selling price..................... $6.50 $7.80
2. A new product cost, under an activity-based costing

approach, is $7.46 per pound of Kona and $4.82 per pound
of Malaysian coffee, calculated as follows:
Budgete Budget
Activity Cost Driver d Activity ed Cost Unit
Cost
Purchasing Purchase 1,158 $579,0 $500
orders 00
Material Setups 1,800 720,00 400
handling 0
Quality Batches 720 144,00 200
control 0
Roasting Roasting hours 96,100 961,00 10
0
Blending Blending hours 33,600 336,00 10
Inc.
0
Packaging Packaging 26,000 260,00 10
hours 0

Inc.
Kona Coffee
Standard cost per pound:
Direct material.............................................. $3.20

Direct labor.................................................. .30
Purchasing (4 orders × $500/2,000 lb.).......... 1.00
Material handling (12 setups × $400/2,000 lb.) 2.40
Quality control (4 batches × $200/2,000 lb.). . .40
Roasting (20 hours × $10/2,000 lb.)............... .10
Blending (10 hours × $10/2,000 lb.)............... .05
Packaging (2 hours × $10/2,000 lb.).............. .01
Total cost..................................................... $7.46
Malaysian Coffee
Standard cost per pound:
Direct material.............................................. $4.20

Direct labor.................................................. .30
Purchasing (4* orders × $500/100,000 lb.)..... .02
Material handling (30 setups × $400/100,000 .12
lb.)...............................................................
Quality control (10 batches × $200/100,000 .02
lb.)...............................................................
Roasting (1,000 hours × $10/100,000 lb.)...... .10
Blending (500 hours × $10/100,000 lb.)......... .05
Packaging (100 hours × $10/100,000 lb.)....... .01
Total cost..................................................... $4.82
*Budgeted sales...........÷ purchase order size

100,000 lbs.......÷ 25,000 lbs. = 4 orders

Inc.
a. The ABC analysis indicates that several activities other

than direct labor drive overhead. The cost computations
show that the current system significantly undercosted
Kona coffee, the low-volume product, and overcosted
the high-volume product, Malaysian coffee.
b. The implication of the ABC analysis is that the low-

volume products are using resources but are not
covering their share of the cost of those resources. The
Kona blend is currently priced at $6.50 [see
requirement 1(b)], which is significantly below its
activity-based cost of $7.46. The company should set
long-run prices above cost. If there is excess capacity
and many of the costs are fixed, it may be acceptable to
price some products below full activity-based cost
temporarily in order to build demand for the product.
Otherwise, the high-volume, high-margin products are
subsidizing the low-volume, low-margin products.
1. Activity Cost Pool Type of Activity

I: Machine-related Unit-level
costs
II: Setup and inspection Batch-level
III Engineering Product-
: sustaining-level
IV Plant-related costs Facility-level
:

Inc.
2. Calculation of pool rates:
I: Machine-related
costs:
$450,000
9,000machinehrs. = $50 per machine hr.
II. Setup and

inspection:
$180,000
= $4,500 per run
40runs
III Engineering:
.
$90,000
100changeorders = $900 per change order
IV Plant-related
. costs:
$96,000
1,920sq. ft. = $50 per sq. ft.
3. Unit costs for odds and

ends:
I: Machine-related costs:
Odds: $50 per machine hr. × 4 = $200 per
machine hr. per unit unit
Ends: $50 per machine hr. × 1 = $50 per
machine hr. per unit unit
II: Setup and inspection:

Odds: $4,500 per run ÷ 50 = $90 per unit
units per run

Inc.
Ends: $4,500 per run ÷ 250 = $18 per unit
units per run

Inc.
III Engineering:
:
$900perchangeorder×100changeorders×75%
Odd
1,000
units
s:
$67,500
= 1,000units= $67.50 per unit
$900perchangeorder×100changeorders×25%
End
5,000
units
s:
$22,500
= 5,000
units
= $4.50 per unit
IV Plant-related costs:
.
$50per sq. ft.×1,920sq. ft.×80%
Odd
1,000units
s:
$76,800
= = $76.80 per unit
1,000
units
$50persq.ft.×1,920sq.ft.×20%
End
5,000units
s:
$19,200
= = $3.84 per unit
5,000
units

Inc.
4. New product cost per unit using the ABC system:
Odds Ends
Direct material..................... $ 40.00 $ 60.00
Direct labor.......................... 30.00 45.00
Manufacturing overhead:
Machine-related............... 200.00 50.00
Setup and inspection........ 90.00 18.00
Engineering...................... 67.50 4.50
Plant-related.................... 76.80 3.84
Total cost per unit................ $504.30 $181.3
4
5. New target prices:
Odds Ends
New product cost (ABC)........ $504.30 $181.3
4
Pricing policy........................ × 120% ×
120%
New target price................... $605.16 $217.6 (rounde
1 d)
6. Full assignment of overhead

costs:
Odds Ends
Manufacturing overhead
costs:
Machine-related............... $200.00
$50.00
Setup and inspection........ 90.00
18.00
Engineering...................... 67.50
4.50
Plant-related.................... 76.80

3.84
Total overhead cost per unit. $434.30 $76.34
× Production volume............. × 1,000 ×
5,000
Total overhead assigned....... $434,30 $381,7
0 00
Total = $816,000
Inc.
7. Cost distortion:
Odds Ends
Traditional volume-based costing
system:
reported product cost................... $ 166.00 $249.00
Activity-based costing system:
reported product cost................... 504.30 181.34
Amount of cost distortion per unit..... $(338.30) $ 67.66
Traditio Tradition
nal al
system system
underco overcost
sts s
odds by ends by
$338.30 $67.66
per unit per unit
Production volume........................... × × 5,000

1,000
Total amount of cost distortion for
entire
product line................................. $(338,30 $338,30
0) 0
Sum of these two

amounts is zero.

Inc.
1. Kara Lindley's predecessor at Northwest Aircraft Industries

(NAI) would have used a 10 percent material-handling rate,
calculated as follows:
Payroll................................................ $180,
000
Employee benefits.............................. 36,00
0
Telephone.......................................... 38,00
0
Other utilities..................................... 22,00
0
Materials and supplies........................ 6,000
Depreciation.......................................
6,000
Total Material-Handling Department costs $288,
000
totalMaterial
-Handling
Departmentcosts
Material- =
totaldirect
-material
costs
handling rate
$288,000
= $2,006,000
+$874,000
= 10%
2. a. The revised material-handling costs to be allocated on

a per-purchase-order basis is $1.00, calculated as
follows:
Total Material-Handling Department costs..... $288,00

0
Deduct: Direct costs:
Direct government payroll.......... $36,000
Fringe benefits (20% × $36,000) 7,200
Direct phone line....................... 2,800
46,000
Material-handling costs applicable to $242,00
purchase orders............................................ 0
÷ Total number of purchase orders ÷ 242,00
0
Material-handling cost per purchase $
Inc.
order 1.00
b. Purchase orders might be a more reliable cost driver

than is the dollar amount of direct material, because
resources are consumed in processing a purchase
order. The size of the order does not necessarily have
an impact on the consumption of resources.

Inc.
3. There is a $74,600 reduction in material-handling costs

allocated to government contracts by NAI as a result of the
new allocation method, calculated as follows:
Previous method:
Government material.......................... $2,006,

000
× Material-handling rate..................... ×
10%
Total (previous method)...................... $
200,600
New method:
Directly traceable material-handling

costs
[$36,000 + (20% × $36,000) + $
$2,800].............................................. 46,000
Purchase orders (80,000 × $1.00).......
80,000
Total (new method)............................ $126,00
0
Net reduction..................................... $
74,600

Inc.
4. A forecast of the cumulative dollar impact over a three-

year period from 20x1 through 20x3 of Kara Lindley's
recommended change for allocating Material-Handling
Department costs to the Government Contracts Unit is
$234,346, calculated as follows:
20x2 20x3
Calculation of forecasted variable material-handling costs:
Direct-material cost:
20x2 ($2,880,000 × 1.025)...... $2,952,0
00
20x3 ($2,952,000 × 1.025)...... _________ $
3,025,80
0
Material-handling rate (10%)....... $ $
295,200 302,580
Deduct: Direct traceable costs *....
46,000 46,000
Variable material-handling costs.. $ $
249,200 256,580
Calculation of forecasted
purchase orders:
20x2 (242,000 × 1.05)................. 254,100

20x3 (254,100 × 1.05)................. _________
266,805
Government purchase orders 88,046
(33% of total).............................. 83,853 (rounded)
Calculation of material-handling costs allocated to

government contracts:
Variable material-handling costs.. $ $

249,200 256,580
Purchase orders.......................... ÷ ÷
254,100 266,805
Variable material-handling costs

Inc.
per purchase
order (rounded)...................... $ . $ .
98 96
Government purchase orders....... × ×
83,853 88,046
Projected variable material-
handling
costs (rounded)...................... $ $
82,176 84,524
Fixed material-handling costs*..... 46,000
46,000
Total material-handling costs
allocated to
government contracts............. $ $
128,176 130,524
$36,000 + (20% × $36,000) + $2,800 =

*
$46,000

Inc.
Calculation of cumulative dollar

impact:
Government material at 70%.......... $2,066,4 $2,118,0

00b 60c
Material-handling at 10% (previous $ $
method)........................................ 206,640d 211,806e
Deduct: Material-handling costs
allocated to
government contracts (new 128, 130,
method)........................................ 176 524
Net reduction in government
contract
material-handling costs............. $ $
78,464 81,282
b
70% × $2,952,000 = $2,066,400
c
70% × $3,025,800 = $2,118,060
d
10% × $2,066,400 = $206,640
e
10% × $2,118,060 = $211,806
In summary, the cumulative dollar impact of the

recommended change in allocating Material-Handling
Department costs is $234,346, calculated as follows:
20x1 [from requirement $

(3)]..................................... 74,600
20x2............................... 78,464
20x3............................... 81,282
Total.............................. $234,34
6
5. a. Referring to the standards of ethical conduct for

management accountants, Kara Lindley faces the
following ethical issues:
Competence:
• Provide decision support information and

recommendations that are accurate, clear, concise,
Inc.
and timely.
Integrity:
• Refrain from engaging in any conduct that would

prejudice Lindley's ability to carry out her duties
ethically.
• Abstain from engaging in or supporting any activity

that would discredit Lindley's profession.

Inc.
Credibility:
• Disclose all relevant information that could

reasonably be expected to influence an intended
user’s understanding of the reports, analyses, or
recommendations. Lindley has information that Jay
Preston should see if he is going to make a reliable
judgment about the results of the Government
Contracts Unit.
b. The steps Kara Lindley could take to resolve this
ethical conflict are as follows:
• Lindley should first follow the established policies at

NAI.
• If this approach does not resolve the conflict or if

such policies do not exist, she should discuss the
problem with her immediate superior, except when it
appears that the superior is involved. If the
Government Contracts Unit manager, Paul Anderson,
is her superior, then she obviously cannot discuss
the problem with him. In this case she should go to
the next-higher managerial level and continue, up to
the audit committee of the board of directors, until
the conflict is resolved.
• She should also discuss the situation with an

objective advisor to clarify the issues involved and
obtain an understanding of possible courses of
action.
• If the ethical conflict still exists after exhausting all

levels of internal review, then she may have no
other course of action than to resign from the
company and submit an informative memorandum to
an appropriate representative of the company.

Inc.
1. a. The calculation of total budgeted costs for the

Manufacturing Department at Marconi Manufacturing
is as follows:
Direct material:
Tuff Stuff ($5.00 per $100,00
unit × 20,000 units)..................... 0
Ruff Stuff ($3.00 per
unit × 20,000 units)..................... 60,000
Total direct material..................... $
160,000
Direct labor.................................. 800,000
Overhead:
Indirect labor............................. $
24,000
Fringe benefits.......................... 5,000
Indirect material........................ 31,000
Power........................................ 180,000
Setup........................................ 75,000
Quality assurance...................... 10,000
Other utilities............................ 10,000
Depreciation..............................
15,000
Total overhead.............................
350,000
Total Manufacturing Department $1,310,
budgeted cost............................... 000
b. The unit costs of Tuff Stuff and Ruff Stuff, with

overhead assigned on the basis of direct-labor hours,
are calculated as follows:
Tuff Stuff:
Direct material........................... $ 5.00
Direct labor ($8.00 per hour × 2 16.00
hours)*.........................................
Overhead ($3.50 per hour × 2 7.00
hours)*.........................................
Tuff Stuff unit cost................. $28.00

Inc.
*Budgeted direct labor hours:
Tuff Stuff (20,000 units × 2 hours) 40,000
Ruff Stuff (20,000 units × 3 hours) 60,000
Total budgeted direct-labor hours. 100,000
Direct-labor rate: $800,000 per = $8.00 per hour

100,000 hours
Overhead rate: $350,000 per = $3.50 per hour
100,000 hours

Inc.
Ruff Stuff:
Direct material........................... $ 3.00
Direct labor ($8.00 per hour × 3 24.00
hours)*.........................................
Overhead ($3.50 per hour × 3 10.50
hours)*.........................................
Ruff Stuff unit cost................. $37.50
*Budgeted direct labor hours

Tuff Stuff (20,000 units × 2 hours) 40,000
Ruff Stuff (20,000 units × 3 hours) 60,000
Total budgeted direct-labor hours. 100,000
Direct-labor rate: $800,000 per = $8.00 per hour

100,000 hours
Overhead rate: $350,000 per = $3.50 per hour
100,000 hours
2. The total budgeted cost of the Fabricating and Assembly

Departments, after separation of overhead into the
activity cost pools, is calculated as follows:
Total Fabricating Assembly

Percen Dollars Percent Dollars
t
Direct material $ 100% $160,00
160,00 0
0
Direct labor.... 75% 25% $200,00
800,00 600,000 0
0
Overhead:
Indirect $ 75% $ 25% $
labor 24,000 18,000 6,000
Fringe 5,000 80% 4,000 20% 1,000
benefits
Indirect 31,000 20,000 11,000
material
Power 180,00 160,000 20,000
0
Inc.
Setup 75,000 5,000 70,000
Quality 10,000 80% 8,000 20% 2,000
assurance
Other 10,000 50% 5,000 50% 5,000
utilities
80% 20% 3,000
Depreciation 15,000 12,000

Total overhead $ $232,00 $118,00
350,00 0 0
0
Total cost $1,310, $992,00 $318,00
000 0 0

Inc.
3 The unit costs of the products using activity-based costing

. are calculated as follows:
Fabricating:
Total cost............................................. $992,00
0
Less: Direct material............................. 160,000
Less: Direct labor.................................
600,000
Pool overhead cost............................... $232,00
0
Hours: Tuff Stuff (4.4 hours × 20,000 88,000 hours

units)
Ruff Stuff (6.0 hours × 20,000 120,00 hours
units) 0
Total machine hours............ 208,00 hours
0
Pool rate per machine hour $1.12 per hour
($232,000/208,000).............................. (rounded)
Fabricating cost per unit:.......Tuff Stuff $4.93 per unit

($1.12 × 4.4 hours)............................... (rounded)
Ruff Stuff ($1.12 × $6.72 per unit
6.0 hours) (rounded)
Assembly:
Total cost............................................. $318,00
0
Less: Direct labor.................................
200,000
Pool overhead cost............................... $118,00
0
Setups: Tuff Stuff.................................

1,000
Ruff Stuff.................................
272
Total setups.......................
1,272
Pool rate per setup ($118,000/1,272).... $92.77 per setup
(rounded)
Inc.
Setup cost per unit:
Tuff Stuff ($92.77 per setup × 1,000 $4.64 per unit

set-ups) ÷ 20,000 units............................. (rounded)
Ruff Stuff ($92.77 per setup × 272 $1.26 per unit
set-ups) ÷ 20,000 units............................. (rounded)
Tuff Stuff unit cost:
Direct material..................................... $ 5.00

Direct labor (2 hours × $8 per hour)...... 16.00
Fabrication overhead............................ 4.93
Assembly overhead.............................. 4.64
Tuff Stuff unit cost.......................... $30.57

Inc.
Ruff Stuff unit cost:
Direct material.................................... $ 3.00

Direct labor (3 hours × $8 per hour)..... 24.00
Fabrication overhead........................... 6.72
Assembly overhead............................. 1.26
Ruff Stuff unit cost......................... $34.98
4. Ruff Stuff unit costs:
Cost with overhead assigned on basis of $37.50

direct-labor hours......................................
Cost using activity-based costing............... $34.98
The activity-based costing unit costs may lead the

company to decide to lower its price for Ruff Stuff in order
to be more competitive in the market and continue
production of the product. It now appears that Ruff Stuff
has lower unit costs and can afford lower prices. Using ABC
for assigning overhead costs generally leads to a more
accurate estimate of the costs incurred to produce a
product. Management should be able to make better
informed decisions regarding pricing and production of the
company’s products.
1
.
Standar Deluxe Heavy-
d Model Model Duty
Model
Product costs based on
traditional, volume-
based costing system......... $105.0 $215.0 $232.00
0 0
× 110%.................................. × × ×
110% 110% 110%
Target price........................... $115.5 $236.5 $255.20

Inc.
0 0

Inc.
2 Product costs based on activity-based

. costing system:
Reg Standa Deluxe

ular rd Model
Mo Model
del
Direct material....................... $10.00 $ 25.00 $ 42.00

Direct labor............................ 10.00 20.00 20.00
Machinery depreciation and 32.00 208.00 75.20
maintenancea.........................
Engineering, inspection and
repair of defectsb................ 17.04 43.50 34.08
Purchasing, receiving,
shipping, and
material handlingc.............. 15.28 52.00 29.25
Factory depreciation, taxes,
insurance,
and miscellaneous overhead 12.50 89.25 25.59
costsd....................................
Total...................................... $96.82 $437.75 $226.12
a
Pool I:
Depreciation, machinery........................... $1,480,
000
Maintenance, machinery...........................
120,000
Total........................................................ $1,600,
000
($1,600,000 ÷ 20,0 = $32.0

Standard: × 40%) 00 0
Deluxe: ($1,600,000 ÷ 1,00 = $208.
× 13%) 0 00
Heavy- ($1,600,000 ÷ 10,0 = $75.2
Duty: × 47%) 00 0
b
Pool II:

Inc.
Engineering.............................................. $350,00
0
Inspection and repair of defects................
375,000
Total........................................................ $725,00
0
($725,000 × ÷ 20,0 = $17.0

Standard: 47%) 00 4
Deluxe: ($725,000 ÷ 1,00 = $43.5
× 6%) 0 0
Heavy- ($725,000 × ÷ 10,0 = $34.0
Duty: 47%) 00 8

Inc.
c
Pool III:
Purchasing, receiving, and shipping.......... $250,00
0
Material handling.....................................
400,000
Total........................................................ $650,00
0
($650,000 × ÷ 20,0 = $15.2

Standard: 47%) 00 8
Deluxe: ($650,000 ÷ 1,00 = $52.0
× 8%) 0 0
Heavy- ($650,000 × ÷ 10,0 = $29.2
Duty: 45%) 00 5
d
Pool IV:
Depreciation, taxes, and insurance for $300,00
factory........................................................ 0
Miscellaneous manufacturing overhead.....
295,000
Total........................................................ $595,00
0
($595,000 × ÷ 20,0 = $12.5

Standard: 42%) 00 0
Deluxe: ($595,000 × ÷ 1,00 = $89.2
15%) 0 5
Heavy- ($595,000 × ÷ 10,0 = $25.5
Duty: 43%) 00 9
3
.
Stand Delux Heavy
ard e Duty
Model Model Model
Product costs based on activity-
based
costing system........................ $ $437. $226.12
96.82 75
× 110%........................................ × × × 110%
Inc.
110% 110%
New target price.......................... $106. $481. $248.73
50 53
The new target price of the standard model, $106.50, is

lower than the current actual selling price, $110.

Inc.
4 MEMORANDUM
.
Date: Today
To: President Morelli Electric Motor Corporation
From: I.M. Student
Subjec Product costing

t:
Based on the cost data from our traditional, volume-based

product-costing system, our standard model is not very
profitable. Its reported actual contribution margin is only
$5 ($110 – $105). However, the validity of this conclusion
depends on the accuracy of the product costs reported by
our product-costing system. Our competitors are selling
motors like our standard model for $106. This price
suggests that their product cost is substantially below our
previously reported cost of $105.
Our new activity-based-costing system reveals serious

product cost distortions stemming from our old costing
system. The new costing system shows that the standard
model costs only $96.82, which implies a target price of
$106.50. This price is lower than our current actual selling
price and consistent with the price our competitors are
charging.
In contrast, our new product-costing system reveals

that the deluxe model's product cost is $437.75 instead of
the previously reported cost of $215. The new product cost
suggests a target price of $481.53 for the deluxe model,
rather than $236.50, which was our previous target price
for the deluxe model.

Inc.
5. The company should adopt and maintain the activity-based

costing system. The price of the standard model should be
lowered to the $106. Lowering the price should enable the
firm to regain its competitive position in the market for the
standard model. Further price cuts should be considered if
marketing studies indicate such a move will increase
demand.
The price of the deluxe model should be set near the

target price of $481.53. If the deluxe model does not sell
at this price, management should consider discontinuing
the product line. Input from the marketing staff should be
sought before such an action is taken. An important
consideration is the extent to which sales in the standard
model and heavy-duty model markets depend on the firm's
offering a complete product line.
A slight price reduction should be considered for the

heavy-duty model (from $255.20 down to $248.73).
However, the product cost distortion from the old costing
system did not affect this model as seriously as it did the
other two.

Inc.
Stand Deluxe Heavy-

ard Model Duty
Model Model
Traditional, volume-based costing
system:
reported product cost............. $105. $21 $232.00
00 5.00
reported product cost............. 96.82 226.12
437.75
Amount of cost distortion per unit $ 8.18 $(222.75 $ 5.88
)
Traditi Tradito Traditi

onal nal onal
system system system
overco underco overco
sts sts sts
standar deluxe heavy-
d duty
model model model
by by by
$8.18 $222.75 $5.88
per per unit per
unit unit
Product volume.......................... × × ×

20,00 1,000 10,000
0
Total amount of cost distortion
for entire
product line............................ $163, $(222,75
600 0) $58,800

Inc.
Sum of these three
amounts is $(350). It
would be zero except for
the slight rounding errors
in the calculation of the
new product costs to the
nearest cent.

Inc.
1 The controller, Erin Jackson, has acted ethically up to this

. point. She correctly pointed out to the president that the
firm's traditional, volume-based product-costing system
was distorting the reported product cost for the
company's three products. She designed an activity-based
costing system to provide more accurate product-costing
data.
2 The production manager, Alan Tyler, is not acting

. ethically. Although we can sympathize with his plight, we
cannot condone his pressuring the controller to suppress
or alter the new product-costing data she has compiled.
What can Tyler do that is ethical and has the

potential for positive results? First, he could take a hard
look at the deluxe model's production process. Are there
non-value-added activities that could be reduced or
eliminated? Second, he could argue to the president that
the company should carry a full product line, if he has
reason to believe that is the firm's best strategy.
3 Jackson has an ethical obligation to the president, to the

. company, to her profession, and to herself to report
accurate product-costing data to the president. There is
nothing wrong with her offer to her friend to go over her
analysis again to verify its accuracy. However, she must
report what she finds with no suppression or alteration of
the data. Several of the ethical standards for managerial
accounting apply in this case. (See Chapter 1 for a listing
of these standards.) The standards that are most clearly
relevant include the following:
Integrity:
• Communicate unfavorable as well as favorable

information and professional judgments or opinions.
Objectivity:
• Communicate information fairly and objectively.

Inc.
• Disclose fully all relevant information that could
reasonably be expected to influence an intended user's
understanding of the reports, comments, and
recommendations presented.

Inc.
Jackson is in a tough spot. Her professional obligation to

report accurate product costs is clear. She cannot
ethically avoid this responsibility. Yet her friend Tyler is in
a tenuous position. What can Jackson ethically do for him?
First, she can be compassionate and understanding of his
concern, yet remain firm in meeting her professional
obligations. Second, she can assist the production
manager in finding ways to manufacture the deluxe model
electric motor more efficiently and at a lower cost. For
example, she can share her ABC analysis with Tyler to help
him identify non-value-added activities and costs.

Inc.
SOLUTIONS TO CASES
CASE 5-48 (60 MINUTES)
1. Based on the cost data from Gigabyte's traditional,

volume-based product-costing system, product G is the
firm's least profitable product. Its reported actual gross
margin is only $22.00, as compared with $84.75 and
$104.50 for products T and W, respectively. However, the
validity of this conclusion depends on the accuracy of the
product costs reported by Gigabyte's product-costing
system.
2. Again, based on the product costs reported by the firm's

traditional, volume-based product-costing system, product
W appears to be very profitable. As in requirement (1),
however, the validity of this assessment depends on the
accuracy of the reported product costs.
3. Gigabyte's competitors have moved aggressively into the

market for gismos (product G), but they have abandoned
the whatchamacallit (product W) market to Gigabyte.
These competing firms apparently believe they can

sell gismos at a much lower price than Gigabyte's
management feels is feasible. This evidence suggests that
Gigabyte's competitors may believe their product cost for
gismos is below Gigabyte's reported product cost. In
contrast, Gigabyte's competitors apparently believe that
they cannot afford to sell whatchamacallits at Gigabyte's
current price of $200. Perhaps the competing firms'
reported production costs for product W are higher than
the cost reported by Gigabyte's product-costing system.
The danger to Gigabyte is that the company will be

forced out of the market for its second largest selling
product. This could be disastrous to Gigabyte, Inc.
4. Percentages for raw-material costs:
Percentag
e
Annual of Total
Inc.
Raw- Annual Raw- Raw-
Material Material Material
Product Cost per Volume Cost Cost*
Unit
G $35.00 8,000 $ 280,000 25%
T 52.50 15,000 787,500 69%
W 17.50 4,000 70,000 6%
Total $1,137,500 100%
*Percentages rounded to nearest whole percent.

Inc.
CASE 5-48 (CONTINUED)
5. Product costs based on an activity-based costing system

(rounded):
Product Product Product

G T W
Direct material...................... $ 35.00 $ 52.50 $ 17.50

Direct labor........................... 16.00 12.00 8.00
Machine setupa..................... .13 .11 .66
Machineryb............................ 38.28 40.83 76.56
Inspectionc............................ 9.84 15.75 52.50
Material handlingd................. 27.34 40.25 13.13
Engineeringe......................... 15.08 2.30 47.40
Total..................................... $141.67 $163.74 $215.75
a
Machine setup:
Product ($5,250 × 20%) ÷ 8,000 = $ .13
G: units
Product ($5,250 × 30%) ÷ 15,000 = $ .11
T: units
Product ($5,250 × 50%) ÷ 4,000 = $ .66
W: units
b
Machinery
:
Product ($1,225,000 × ÷ 8,000 = $38.28
G: 25%) units
Product ($1,225,000 × ÷ 15,000 = $40.83
T: 50%) units
Product ($1,225,000 × ÷ 4,000 = $76.56
W: 25%) units
c
Inspection
:
Product ($525,000 × ÷ 8,000 = $ 9.84
G: 15%) units
Product ($525,000 × ÷ 15,000 = $15.75
T: 45%) units
Product ($525,000 × ÷ 4,000 = $52.50
W: 40%) units
d
Material handling:

Inc.
Product ($875,000 × ÷ 8,000 = $27.34
G: 25%) units
Product ($875,000 × ÷ 15,000 = $40.25
T: 69%) units
Product ($875,000 × ÷ 4,000 = $13.13
W: 6%) units
e
Engineeri
ng:
Product ($344,750 × ÷ 8,000 = $15.08
G: 35%) units
Product ($344,750 × ÷ 15,000 = $ 2.30
T: 10%) units
Product ($344,750 × ÷ 4,000 = $47.40
W: 55%) units

Inc.
6. Comparison of reported product costs, new target prices,
and actual selling prices:
Produc Product Product

t T W
G
Reported product costs:
Traditional, volume-based $191.0 $169.50 $ 95.50
costing system 0
Activity-based costing 141.67 163.74 215.75
system
Target price based on new
product costs
(150% × new product cost) 212.51 245.61 323.63
Current actual selling price 213.00 254.25 200.00

SPREADSHEET

MEMORANDUM
Date: Today
To: President, Gigabyte, Inc.
From: I.M. Student
Subje Gigabyte's competitive position
ct:

Inc.
Gigabyte's product-costing system has been providing
misleading product cost information. Our traditional, volume-
based costing system overcosted gismos and thingamajigs, but
it substantially undercosted whatchamacallits. As a result
Gigabyte has been overpricing gismos and underpricing
whatchamacallits. The company has been losing money on
every sale in the product W market. Our competitors have
taken advantage of our mispricing by moving aggressively into
the gismo market and abandoning the whatchamacallit market
to Gigabyte. As a result, our profitability has suffered.
I recommend the following courses of action:

1. Implement the new activity-based costing system and
revise its database frequently.
2. Lower the target price of gismos to $213, the current
actual selling price. This price yields our usual 50 percent
markup over product cost.
3. Consider lowering the price of thingamajigs to $246 in
order to increase demand. The lower price still yields
Gigabyte a 50 percent markup over product cost.

Inc.
4. Raise the price of whatchamacallits to $324. If the product

does not sell at that price, consider discontinuing the
product line.
Product Product Product

G T W
Traditional, volume-based costing

system:
reported product cost............. $191.00 $169.50 $ 95.50
reported product cost............. 141.67 163.74 215.75
Amount of cost distortion per unit $ 49.33 $ 5.76 $(120.25)
Traditi Tradito Traditio

onal nal nal
system system system
overco overcos underco
sts ts sts
produc product product
t
G by T by W by
$49.33 $5.76 $120.25
per per unit per unit
unit
Product volume.......................... × × ×

8,000 15,000 4,000
Total amount of cost distortion
for entire
product line........................... $394,6 $ $(481,00)
40 86,400 0

Inc.
Sum of these three
amounts is $40. It
would be zero except for
the slight rounding errors
in the calculation of the
new product costs to the
nearest cent.

Inc.
1. Activity-based costing (ABC) differs from traditional costing in

that it focuses on activities that consume resources as the
fundamental cost drivers. ABC is a two-stage cost assignment
process focused on causality and the determination of cost
drivers. It usually uses several different activities to assign
costs to products or services. Therefore, it is more detailed
and more accurate than traditional costing. It also helps
managers distinguish between value added and non-value
added activities.
2. Calculations of total activity cost pools and pool rates:
Machining...... ($424,528 × 1.06) ÷ (15,000 hours + 30,000

hours)
= $450,000* ÷ 45,000 hours = $10 per
machine hour
*Rounded
Assembly....... ($216,981 × 1.06) ÷ (6,000 hours + 5,500

hours)
= $230,000* ÷ 11,500 hours = $20 per
assembly hour
*Rounded
Material ($56,604 × 1.06) ÷ [(5 parts × 5,000 units) +

handling........ (10 parts × 5,000 units)]
= $60,000* ÷ (25,000 parts + 50,000 parts)
= $60,000 ÷ 75,000 parts = $.80 per part
*Rounded
Inspection...... ($117,925 × 1.06) ÷ (5,000 hours + 7,500

hours)
= $125,000* ÷ 12,500 hours = $10 per
inspection hour
*Rounded

Inc.
3.
JR-14 RM-13
Estimat Estimat
20x1 ed 20x1 ed
Cost 20x2 Cost 20x2
Data Produc Data Produc
t t
Cost Cost
Direct material:
No cost increase... $1,000, $1,750,
000 000
Direct labor:
Direct labor $185, $92,5
185 93
× 1.08 cost 200,00 (round 100,00 (round
increase................ 0 ed) 0 ed)
Machining:
Machining activity 15,00 30,00
in hours 0 0
× $10 per hour. . . 150,00 300,00
0 0
Assembly:
Assembly activity 6,000 5,500
in hours
× $20 per hour. . . 120,00 110,00
0 0
Material handling:
Number of parts 5 10
× units produced × ×
5,000 5,000
25,00 50,00
0 0
× $.80 per unit. . . 20,000 40,000
Inspection:
Inspection hours 5,000 7,500
× $10 per hour. . .
50,000 75,000
Total cost.............. $1,540, $2,375,
000 000

Inc.
4. WHITESTONE COMPANY
BUDGETED STATEMENT OF GROSS MARGIN FOR 20X2
JR-14 RM-13 Total
Sales revenue........................ $1,810, $2,229, $4,040,
500 500 000
Cost of goods manufactured
and sold:
Beginning finished-goods $ $ $
inventory............................... 240,000 300,000 540,000
Ad Direct material............... 1,000,0 1,750, 2,750,0
d: 00 000 00
Direct labor.................... 200,000 100, 300,000
000
Machining...................... 150,000 300, 450,000
000
Assembly....................... 120,000 110, 230,000
000
Material handling........... 20,000 40, 60,000
000
Inspection......................
50,000 75,000 125,000
Cost of goods available for $1,780, $2,675, $4,455,
sale....................................... 000 000 000
Les Ending finished-goods
s: inventory*..................... 215,600 332,500 548,100
Cost of goods sold................. $1,564, $2,342, $3,906,
400 500 900
Gross margin......................... $ $ $
246,100 (113,00 133,100
0)
*Ending finished-goods inventory = (total product cost ÷

units produced) × ending inventory in units:
JR-14: ($1,540,000 ÷ 5,000 units) × 700 units = $215,600
RM-13: ($2,375,000 ÷ 5,000 units) × 700 units = $332,500

Inc.
FOCUS ON ETHICS (See page 195 in the text.)
This scenario explores ethical issues surrounding activity-
based costing.
Among the potential ethical issues in this situation are the

following:
• How did the product proliferation problem at the

Charlotte plant come about? Were product-line managers
more concerned with maintaining their spheres of
influence than making product discontinuance decisions
that would be in the company’s best interest? At the very
least, the company seems to exhibit a lack of discipline
and focus. Products that have been dropped as a result
of sound analysis should not routinely creep back into the
product line.
• Why did top management refuse to adopt the

recommendations of the ABC analysis? It is sometimes
said that top managers are compensated and rewarded
with other perks in accordance with the size of the
business unit they manage. More product lines, more
departments, and more employees mean more prestige,
higher pay and bonuses, and greater prospects for
advancement in the company (or another company). Are
top managers putting their own well-being ahead of the
company’s?
• Alternatively, perhaps management is genuinely

concerned about the implications for their employees if a
large number of products are dropped. Is it ethical for
management to put the interests of their employees
ahead of those of the company’s shareholders?
• Was it ethical for Xavier’s top management to sell the

Engine Parts Division, probably suspecting that the
Charlotte plant would be closed and people would be laid
off?

Inc.

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What are the four broad categories of activities identified in an activity-based costing system?

What are the four broad categories of activities identified in an activity-based costing system?

What problems did the traditional, volume-based product-costing system cause for management?

What problems did the traditional, volume-based product-costing system cause for management?

CHAPTER 5

ANSWERS TO REVIEW QUESTIONS

5-2 Management was being misled by the traditional product-

5-3 An activity-based costing system is a two-stage process of

5-4 A cost driver is a characteristic of an event or activity that

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.

(a) Unit-level activities: Must be done for each unit of

(b) Batch-level activities: Must be performed for each

(c) Product-sustaining activities: Needed to support

(d) Facility-level (or general-operations-level)

5-6 An activity-based costing system alleviated the problems

5-7 Product-costing systems based on a single, volume-based

5-8 In traditional, volume-based costing systems, only direct

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.

5-10 Two factors that tend to result in product cost distortion

(a) Non-unit level overhead costs: Many overhead costs

(b) Product diversity: When a manufacturer produces a

5-11 Three important factors in selecting cost drivers for an

(a) Degree of correlation between consumption of an

(b) Cost of measurement of the cost driver.

(c) Behavioral effects, that is, how the cost driver

5-12 An activity dictionary lists all of the activities identified

5-13 Designing and implementing an ABC system requires a

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.

5-14 Indicators that a new product-costing system may be

(a) Line managers do not believe the product costs

(b) Marketing personnel are unwilling to use reported

(c) Complex products that are difficult to manufacture

(d) Product-line profit margins are difficult to explain.

(e) Sales are increasing, but profits are declining.

(f)Line managers suggest that apparently profitable

(g) Marketing or production managers are using

(h) Some products that have reported high profit

(i) The firm seems to have captured a highly profitable

(k) Product lines are diverse.

(l) Direct labor is a small percentage of total costs.

(m) The results of bids are difficult to explain.

(n) Competitors' high-volume products seem to be priced

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.

5-15 Line managers are close to the production process and

5-16 Diverse products typically consume support activities

5-17 Activity-based costing is just as appropriate in the service

5-18 As indicated in the chapter, Pennsylvania Blue Shield, like

5-19 Management could use the ABC information about the

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.

5-20 At Patio Grill Company, every unit of each product line

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.

1 Material-handling cost per lens:

*The total number of direct-labor hours.

An alternative calculation, since both types of product use

*The total number of units (of both types) produced.

2 Material-handling cost per mirror = $1,000. The analysis is

3 Material-handling cost per lens:

4 Material-handling cost per mirror:

*The number of material moves for the mirror product line.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.