Solution manual managerial accounting 8e by hansen mowen ch 4

Next, an overhead rate is computed and used to assign overhead to products.. First stage: Overhead is assigned to produc-tion department pools using direct tracing, driver tracing, an

CHAPTER 4 ACTIVITY-BASED PRODUCT COSTING

QUESTIONS FOR WRITING AND DISCUSSION

1 Unit costs provide essential information

needed for inventory valuation and

prepara-tion of income statements Knowing unit

costs is also critical for many decisions such

as bidding decisions and accept-or-reject

special order decisions

2 Cost measurement is determining the dollar

amounts associated with resources used in

production Cost assignment is associating

the dollar amounts, once measured, with

units produced

3 An actual overhead rate is rarely used

be-cause of problems with accuracy and

timeli-ness Waiting until the end of the year to

en-sure accuracy is rejected because of the

need to have timely information Timeliness

of information based on actual overhead

costs runs into difficulty (accuracy problems)

because overhead is incurred nonuniformly

and because production also may be

non-uniform

4 For plantwide rates, overhead is first

col-lected in a plantwide pool, using direct

trac-ing Next, an overhead rate is computed and

used to assign overhead to products

5 First stage: Overhead is assigned to

produc-tion department pools using direct tracing,

driver tracing, and allocation Second stage:

Individual departmental rates are used to

assign overhead to products as they pass

through the departments

6 Departmental rates would be chosen over

plantwide rates whenever some

depart-ments are more overhead intensive than

others and if certain products spend more

time in some departments than they do in

others

7 Plantwide overhead rates assign overhead

to products in proportion to the amount of

the unit-level cost driver used If the

prod-ucts consume some overhead activities in

represent a significant proportion of total overhead costs

8 Low-volume products may consume

non-unit-level overhead activities in much greater proportions than indicated by a unit-level cost driver and vice versa for high-volume products If so, then the low-volume prod- ucts will receive too little overhead and the high-volume products too much

9 If some products are undercosted and

oth-ers are overcosted, a firm can make a ber of competitively bad decisions For ex- ample, the firm might select the wrong product mix or submit distorted bids

num-10 Nonunit-level overhead activities are those

overhead activities that are not highly lated with production volume measures Ex- amples include setups, material handling, and inspection Nonunit-level cost drivers are causal factors—factors that explain the consumption of nonunit-level overhead Ex- amples include setup hours, number of moves, and hours of inspection

corre-11 Product diversity is present whenever

prod-ucts have different consumption ratios for different overhead activities

12 An overhead consumption ratio measures

the proportion of an overhead activity sumed by a product

con-13 Departmental rates typically use unit-level

cost drivers If products consume level overhead activities in different propor- tions than those of unit-level measures, then

nonunit-it is possible for departmental rates to move even further away from the true consump- tion ratios, since the departmental unit-level ratios usually differ from the one used at the plant level

14 Agree Prime costs can be assigned using

direct tracing and so do not cause cost

dis-15 Activity-based product costing is an

over-head costing approach that first assigns

costs to activities and then to products The

assignment is made possible through the

identification of activities, their costs, and the

use of cost drivers

16 An activity dictionary is a list of activities

accompanied by information that describes

each activity (called attributes)

17 A primary activity is consumed by the final

cost objects such as products and

custom-ers, whereas secondary activities are

sumed by other activities (ultimately

con-sumed by primary activities)

18 Costs are assigned using direct tracing and

resource drivers

19 Unit-level activities are those that occur each

time a product is produced Batch-level

activi-ties are those that are performed each time a batch of products is produced Product-level

or sustaining activities are those that are performed as needed to support the various products produced by a company Facility- level activities are those that sustain a facto- ry’s general manufacturing process

20 Rates can be reduced by building a system

that approximates the cost assignments of a fully specified ABC system One way to do this is by using only the most expensive ac- tivities to assign costs If the most expensive activities represent a large percentage of the total costs, then most of the costs are as- signed using a cause-and-effect relation- ship, thus creating a good level of accuracy while reducing the complexity of the ABC system

EXERCISES 4–1

1

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total Units produced 400,000 160,000 80,000 560,000 1,200,000 Prime costs $8,000,000 $3,200,000 $1,600,000 $11,200,000 $24,000,000 Overhead costs $3,200,000 $2,400,000 $3,600,000 $2,800,000 $12,000,000 Unit cost:

3 First, calculate a predetermined rate:

OH rate = $11,640,000/1,200,000

= $9.70 per unit

This rate is used to assign overhead to the product throughout the year Since the driver is units produced, $9.70 would be assigned to each unit Add- ing this to the actual prime costs produces a unit cost under normal costing: Unit cost = $9.70 + $20.00 = $29.70

This cost is close to the actual annual cost of $30.00

4–5

1 Predetermined rates:

Drilling Department: Rate = $600,000/280,000 = $2.14* per MHr

Assembly Department: Rate = $392,000/200,000

3 Unit overhead cost = [($2.14 × 4,000) + ($1.96 × 1,600)]/8,000

*Rounded

2 The consumption ratios vary significantly from driver to driver Using, for ample, only machine hours to assign the overhead may create accuracy prob- lems Both setup hours and number of moves have markedly different consump- tion ratios

4–8

1 Rates:

Inspecting products: $2,000/200 = $10 per inspection hour

Setting up equipment: $2,500/100 = $25 per setup hour

Machining: $4,000/800 = $5 per machine hour

2 The consumption ratios for each (using machine hours and setup hours

as the activity drivers) are as follows:

Fina: (1.75 × $3,000)/3,000 = $1.75 per briefcase

Note: Overhead rate = $21,000/$12,000 = $1.75 per direct labor dollar

(or 175 percent of direct labor cost)

There are more machine and setup costs assigned to Elegant than Fina This is clearly a distortion because the production of Fina is automated and uses the machine resources much more than the handcrafted Ele- gant In fact, the consumption ratio for machining is 0.10 and 0.90 (us- ing machine hours as the measure of usage) Thus, Fina uses 9 times the machining resources as Elegant Setup costs are similarly dis- torted The products use an equal number of setup hours Yet if direct labor dollars are used, then the Elegant briefcase receives three times more machining costs than the Fina briefcase

4 Products tend to make different demands on overhead activities and this should be reflected in overhead cost assignments Usually this means the use of both unit and nonunit-level activity drivers In this ex- ample, there is a unit-level activity (machining) and a nonunit-level

activity (setting up equipment)

Machine rate: $18,000/5,000 = $3.60 per machine hour

Setup rate: $3,000/200 = $15 per setup hour

Costs assigned to each product:

4–12

Activity dictionary:

Providing nursing Satisfying patient Primary Nursing hours

Providing Therapy treatments Primary Hours of therapy physical directed by

Monitoring Using equipment to Primary Monitoring hours patients monitor patient

4–13

1 Cost of labor (0.40 × $50,000) $20,000

Forklift (direct tracing) 10,000

Total cost of receiving $30,000

2

Activity rates:

Receiving: $30,000/60,000 = $0.50 per part

Setup: $60,000/300 = $200 per setup

The error is small and so the approach may be desirable as it reduces the

complexity and size of the system, making it more likely to be accepted by

management

4–14

1 Unit-level activities: Machining

Batch-level activities: Setups and packing

Product-level activities: Receiving

Facility-level activities: None

2 Activity rates:

(1) Machining: $80,000/40,000 = $2 per MHr

(2) Setups: $32,000/400 = $80 per setup

(3) Receiving: $18,000/600 = $30 per receiving order

(4) Packing: $48,000/3,200 = $15 per packing order

consump-3 The two most expensive activities are the first and the combined 2 and 4 activities Each has $80,000 of cost Thus if the cost of activity 3 is allo- cated in proportion to the cost, each of the expensive activities would receive 50% of the $18,000 or $9,000 This yields the following pool rates:

Activity (pool 1) 1: ($80,000 + $9,000)/40,000 = $2.225 per machine hour Activities 2 and 4 (pool 2): ($80,000 + $9,000)/400 = $222.50 per setup

Special forces = ($66,750 - $72,000)/$72,000 = -.07 (rounded)

The error is less than 10% for both products Using machine hours would have produce a rate of $178,000/40,000 = $4.45 per Mhr and an assignment of $89,000 to each product ($4.45 × 20,000) The error for the plantwide rate would be

Infantry: ($89,000 - $106,000)/106,000 = 0.16 (rounded)

Special forces = ($89,000 - $72,000)/$72,000 = 0.24 (rounded)

Thus, the plantwide rate produces product costing errors that are more than three times the magnitude of the approximately relevant ABC as- signments Clearly, the approximation produces a more reasonable and useful outcome and is less complex than the full ABC system

4–15

1 Unit-level: Testing products, inserting dies

2 Batch-level: Setting up batches, handling wafer lots, purchasing

materials, receiving materials

3 Product-level: Developing test programs, making probe cards,

engineering design, paying suppliers

4 Facility-level: Providing utilities, providing space

PROBLEMS 4–16

1 Cost before addition of duffel bags:

$60,000/100,000 = $0.60 per unit

The assignment is accurate because all costs belong to one product

2 Activity-based cost assignment:

Backpacks: $60,000/100,000 = $0.60 per unit

Duffel bags: $60,000/25,000 = $2.40 per unit

3 Product cost assignment:

Overhead rates:

Patterns: $48,000/10,000 = $4.80 per direct labor hour

Finishing: $72,000/20,000 = $3.60 per direct labor hour

Unit cost computation:

Total per unit $1.20 $4.80

4 This problem allows us to see what the accounting cost per unit should

be by providing the ability to calculate the cost with and without the duffel bags With this perspective, it becomes easy to see the benefits

of the activity-based approach over those of the functional-based proach The activity-based approach provides the same cost per unit as the single-product setting The functional-based approach used trans- actions to allocate accounting costs to each producing department, and this allocation probably reflects quite well the consumption of ac- counting costs by each producing department The problem is the second-stage allocation Direct labor hours do not capture the con- sumption pattern of the individual products as they pass through the departments The distortion occurs, not in using transactions to assign accounting costs to departments, but in using direct labor hours to as- sign these costs to the two products

ap-In a single-product environment, ABC offers no improvement in uct-costing accuracy However, even in a single-product environment,

prod-it may be possible to increase the accuracy of cost assignments to

oth-er cost objects such as customoth-ers

4–17

1 Plantwide rate = $1,320,000/440,000 = $3.00 per DLH

Overhead cost per unit:

Model A: $3.00 × 140,000/30,000 = $14.00

Model B: $3.00 × 300,000/300,000 = $3.00

2 Calculation of activity rates:

Setup Prod runs $360,000/100 = $3,600 per run

Machining Mach Hours $320,000/220,000 = $1.454 per hr Maintenance Maint hours $360,000/100,000 =$3.60 per hr

machine-the plantwide rate) for both products Looking at Department 1, this partment’s costs are assigned at a 17:1 ratio which overcosts B and undercosts A in a big way This raises some doubt about the conven- tional wisdom regarding departmental rates

4–18

1 Labor and gasoline are driver tracing

Gasoline ($4.50 × 6,000 moves) 27,000 Moves = Resource driver

2 Plantwide rate = $660,000/20,000

= $33 per DLH Unit cost:

Maintenance $114,000/4,000 = $28.50 per maint hour

Material handling $180,000/6,000 = $30 per move

Purchasing $ 60,000/300 = $200 per requisition

Receiving $ 40,000/750 = $53.33 per order Paying suppliers $ 30,000/750 = $40 per invoice

Providing space $ 20,000/10,000 = $2.00 per machine hour

The ABC costs are more accurate (better tracing—closer tion of actual resource consumption) This shows that the basic model

representa-4-18 (continued)

4 Consumption ratios:

Maint Eng Mat H Setups Purch Receiving Pay Sup Space Basic 0.25 0.25 0.20 0.20 0.33 0.33 0.33 0.50 Delux 0.75 0.75 0.80 0.80 0.67 0.67 0.67 0.50

5 When products consume activities in the same proportion, the ties with the same proportions can be combined into one pool This is

activi-so because the pooled costs will be assigned in the same proportion as the individual activity costs Using these consumption ratios as a guide, we create four pools, reducing the number of rates from 8 to 4 Pool 1:

Note: Engineering hours could also be used as a driver The activities

are grouped together because they have the same consumption ratios: (0.25, 0.75)

Pool 2: Material handling $180,000

Total $276,000

Note: Material handling and setups have the same consumption ratios:

(0.20, 0.80) The number of setups could also be used as the pool

driv-er

Note: The three activities are all product-level activities and have the

same consumption ratios: (0.33, 0.67)

3 Unit-level costs ($120 × 30,000) $ 3,600,000

Batch-level costs ($80,000 × 30) 2,400,000

Batch-level costs increase as the number of batches changes, and the costs

of engineering support change as the number of orders change Thus, batches and orders increased, increasing the total cost of the model

4 Classifying costs by category allows their behavior to be better understood This, in turn, creates the ability to better manage costs and make decisions

4–20

1 The total cost of care is $1,950,000 plus a $50,000 share of the cost of vision [(25/150) × $300,000] The cost of supervision is computed as follows:

super-Salary of supervisor (direct) $ 70,000

Salary of secretary (direct) 22,000

Capital costs (direct) 100,000

Assistants (3 × 0.75 × $48,000) 108,000

Thus, the cost per patient day is computed as follows:

$2,000,000/10,000 = $200 per patient day

(The total cost of care divided by patient days.) Notice that every maternity patient—regardless of type—would pay the daily rate of $200

2 First, the cost of the secondary activity (supervision) must be assigned to the primary activities (various nursing care activities) that consume it (the driver

is the number of nurses):

Maternity nursing care assignment:

(25/150) × $300,000 = $50,000

Thus, the total cost of nursing care is $950,000 + $50,000 = $1,000,000

Next, calculate the activity rates for the two primary activities:

Occupancy and feeding: $1,000,000/10,000 = $100 per patient day

Nursing care: $1,000,000/50,000 = $20 per nursing hour