Solution manual managerial accounting concept and applications by cabrera chapter 11 answer

Automation has greatly decreased the amount of direct labor required to manufacture products; product diversity has increased in that companies are manufacturing a wider range of product

CHAPTER 11

SYSTEMS DESIGN: ACTIVITY-BASED COSTING

AND MANAGEMENT

I Questions

1 The three levels available are: Level 1, in which a company uses a plantwide overhead rate; Level 2, in which a company uses departmental overhead rates; and Level 3, in which a company uses activity-based costing

2 New approaches to costing are needed because events of the last few decades have made drastic changes in many organizations Automation has greatly decreased the amount of direct labor required to manufacture products; product diversity has increased in that companies are manufacturing a wider range of products and these products differ substantially in volume, lot size, and complexity of design; and total overhead cost has increased to the point in some companies that a correlation no longer exists between it and direct labor

3 The departmental approach to assigning overhead cost to products relies solely on volume as an assignment base Where diversity exists between products (that is, where products differ in terms of number of units produced, lot size, or complexity of production), volume alone is not adequate for overhead costing Overhead costing based on volume will systematically overcost high-volume products and undercost low-volume products

4 Process value analysis (PVA) is a systematic approach to gaining an understanding of the steps associated with a product or service It identifies all resource-consuming activities involved in the production process and labels these activities as being either value-added or non-value-added Thus, it is the beginning point in designing an activity-based costing system since management must know what activities are involved with each product before activity centers can be designated and cost drivers established Also, PVA helps management to eliminate any non-value-added activities and thereby streamline operations and minimize costs

5 The four general levels of activities are:

1 Unit-level activities, which are performed each time a unit is produced

2 Batch-level activities, which are performed each time a batch of goods is handled or processed

3 Product-level activities, which are performed as needed to support specific products

4 Facility-level activities, which simply sustain a facility’s general manufacturing process

6 First, activity-based costing increases the number of cost pools used to accumulate overhead costs Second, it changes the base used to assign overhead costs to products And third, it changes a manager’s perception of many overhead costs in that costs that were formerly thought to be indirect (such as depreciation or machine setup) are identified with specific activities and thereby are recognized as being traceable to individual products

7 The two chief limitations are: First, the portion of overhead costs that relate to facility-level activities are still usually allocated to products

on some arbitrary basis, such as machine-hours or direct labor-hours Critics of activity-based costing argue that facility-level activities account for the bulk of all overhead costs in some companies Second, high measurement costs are involved in operating an activity-based costing system That is, the system requires the tracking of large amounts of detail and the completion of many separate computations in order to determine the cost of a unit or product

8 Yes, activity-based costing can be used in service organizations It has been successfully implemented, for example, in railroads, hospitals, banks and data service companies

9 A resource driver is a measure of the quality of resources consumed by

an activity

10 An activity driver is a measure of frequency and intensity of demands placed on activities by cost objects

11 Two-stage allocation is a procedure that first assigns a firm’s resource costs, namely factory overhead cost, to cost pools, and then to cost objects

12 Two major advantages of ABM are:

a ABM measures the effectiveness of the key business processes and activities, and identifies how they can be improved to reduce costs and improve the customer value

b ABM improves the management focus by allocating resources to key value-added activities, key customers, key products, and continuous improvement methods to maintain the firm’s competitive advantage

13 When direct labor is used as an allocation base for overhead, it is implicitly assumed that overhead cost is directly proportional to direct labor When cost systems were originally developed in the 1800s, this assumption may have been reasonably accurate However, direct labor has declined in importance over the years while overhead has been increasing This suggests that there is no longer a direct link between the level of direct labor and overhead Indeed, when a company automates, direct labor is replaced by machines; a decrease in direct labor is accompanied by an increase in overhead This violates the assumption that overhead cost is directly proportional to direct labor Overhead cost appears to be driven by factors such as product diversity and complexity as well as by volume, for which direct labor has served

as a convenient measure

14 Employees may resist activity-based costing because it changes the

“rules of the game.” ABC changes some of the key measures, such as product costs, used in making decisions and may affect how individuals are evaluated Without top management support, employees may have little interest in making these changes In addition, if top managers continue to make decisions based on the numbers generated by the traditional costing system, subordinates will quickly conclude that the activity-based costing system can be ignored

15 Unit-level activities are performed for each unit that is produced Batch-level activities are performed for each batch regardless of how many units are in the batch Product-level activities must be carried out

to support a product regardless of how many batches are run or units produced Customer-level activities must be carried out to support customers regardless of what products or services they buy Organization-sustaining activities are carried out regardless of the company’s precise product mix or mix of customers

16 Organization-sustaining costs, customer-level costs, and the costs of idle capacity should not be assigned to products These costs represent resources that are not consumed by the products

II True or False

III Exercises

Exercise 1

Activity

Activity Classification

Examples of Traceable Costs

Examples of Cost Drivers

a Materials are

moved from the

receiving dock to

product flow lines

by a

material-handling crew

Batch-level Labor cost;

depreciation

of equipment;

space cost

Number of receipts; pounds handled

b Direct labor

workers assemble

various products

Unit-level Direct labor

cost; indirect labor cost;

labor benefits

Direct labor-hours

c Ongoing training is

provided to all

employees in the

company

Facility-level* Space cost;

training costs;

administration costs

Hours of training time; number trained

d A product is

designed by a

specialized design

team

Product-level Space cost;

supplies used;

depreciation

of design equipment

Hours of design time; number of engineering change orders

e Equipment setups

are performed on a

regular basis

Batch-level Labor cost;

supplies used;

depreciation

of equipment

Number of setups; hours

or setup time

f Numerical control

(NC) machines are

used to cut and

shape materials

Unit-level Power;

supplies used;

maintenance;

depreciation

Machine-hours; number

of units

* Personnel administration and training costs might be traceable in part to the facility-level and in part to other activity centers at the unit-level, product-level, and batch-level

Exercise 2

Exercise 3

department heads such as marketing to

preventative maintenance on general-use

equipment

Organization-sustaining Note: Some of these classifications are debatable and may depend on the specific circumstances found in particular companies

Exercise 4

Sales (P1,650 per standard model glider × 10 standard

model gliders + P2,300 per custom designed glider ×

2 custom designed gliders) P21,100 Costs:

Direct materials (P462 per standard model glider × 10

standard model gliders + P576 per custom

designed glider × 2 custom designed gliders) P5,772 Direct labor (P19 per direct labor-hour × 28.5 direct

labor-hours per standard model glider × 10 standard 6,631

model gliders + P19 per direct labor-hour × 32

direct labor-hours per custom designed glider × 2

custom designed gliders) Supporting manufacturing (P18 per direct labor-hour ×

28.5 direct labor-hours per standard model glider ×

10 standard model gliders + P18 per direct

labor-hour × 32 direct labor-labor-hours per custom designed

glider × 2 custom designed gliders) 6,282 Order processing (P192 per order × 3 orders) 576 Custom designing (P261 per custom design × 2

custom designs) 522 Customer service (P426 per customer ×

1 customer) 426 20,209 Customer margin P 891

Exercise 5

Requirement 1

The predetermined overhead rate is computed as follows:

The unit product costs under the company’s traditional costing system are computed as follows:

Special Regular

Direct materials P60.00 P45.00 Direct labor 9.60 7.20 Manufacturing overhead (0.8 DLH × P5.80 per DLH;

0.6 DLH × P5.80 per DLH) 4.64 3.48 Unit product cost P74.24 P55.68

Requirement 2

The activity rates are computed as follows:

(a) Estimated (b)

Activities Cost Expected Activity Activity Rate

Supporting direct labor P150,000 50,000 DLHs P3 per DLH

Batch setups P60,000 250 setups P240 per setup Safety testing P80,000 100 tests P800 per test

Manufacturing overhead is assigned to the two products as follows:

Predetermined

overhead rate = 50,000 DLHsP290,000 = P5.80 per DLH

Special Product:

Activity Cost Pool Activity Rate (a) Activity (b) ABC Cost (a) × (b)

Supporting direct labor P3 per DLH 8,000 DLHs P24,000 Batch setups P240 per setup 200 setups 48,000 Safety testing P800 per test 80 tests 64,000

Regular Product:

Activity Cost Pool Activity Rate (a) Activity (b) ABC Cost (a) × (b)

Supporting direct labor P3 per DLH 42,000 DLHs P126,000 Batch setups P240 per setup 50 setups 12,000 Safety testing P800 per test 20 tests 16,000

Activity-based costing unit product costs are computed as follows:

Special Regular

Direct materials P60.00 P45.00 Direct labor 9.60 7.20 Manufacturing overhead (P136,000 ÷ 10,000 units; P154,000 ÷

70,000 units) 13.60 2.20 Unit product cost P83.20 P54.40

IV Problems

Problem 1

Cost

Systems Pool Rate Consumption Cost Driver Assignment Cost

ABC system

Material handling P20/requisition 5 requisitions 100 Parts administration P40/part 18 parts 720

P24,020

Problem 2

Requirement 1

(a)

Total overhead = P200,000 + P32,000 + P100,000 + P120,000

= P452,000 Overhead rate = P452,000 / 50,000 direct labor hours

= P9.04 per direct labor hour Overhead assigned to proposed job = P9.04 x 1,000 direct labor hours

= P9,040 (b) Total cost of proposed job:

(c) Company’s bid = Full manufacturing cost x 120% = P25,040 x 120%

= P30,048

Requirement 2

Overhead assigned to proposed job:

(b) Total cost of proposed project:

Direct labor 10,000

(c) Company’s bid = Full manufacturing cost x 120% = P21,620 x 120%

= P25,944 The bid price of P25,944 was determined as follows:

Overhead assigned:

Problem 3 (Activity-Based Costing)

Requirement 1

The first-stage allocation of costs to the activity cost pools appears below:

Activity Cost Pools Assemblin

g Units Processing Orders Supporting Customers Other Total

Manufacturing

Selling and

administrative

Requirement 2

The activity rates for the cost pools are:

Total Cost Total Activity Activity Rate

Requirement 3

The overhead cost attributable to Lucky Sale would be computed as follows:

Activity Cost Pools Activity Rate (a) Activity (b) ABC Cost (a) x (b)

Requirement 4

The customer margin can be computed as follows:

Costs:

Problem 4 (Activity-Based Costing as an Alternative to Traditional Product Costing)

Requirement 1

a When direct labor-hours are used to apply overhead cost to products, the company’s predetermined overhead rate would be:

b Model

Direct materials P35.00 P25.00 Direct labor:

P20 per hour × 0.2 DLH, 0.4 DLH 4.00 8.00 Manufacturing overhead:

P74 per hour × 0.2 DLH, 0.4 DLH 14.80 29.60 Total unit product cost P53.80 P62.60

Requirement 2

a Predetermined overhead rates for the activity cost pools:

Activity Cost Pool

(a) Estimated Total Cost

(b) Estimated Total Activity Activity Rate (a) ÷ (b)

The overhead applied to each product can be determined as follows:

Model HY5

Activity Cost Pool

(a) Predetermined Overhead Rate Activity (b)

(a) × (b) Overhead Applied

Machine setups P720 per setup 150 setups P108,000 Special milling P300 per MH 1,000 MHs 300,000 General factory P50 per DLH 4,000 DLHs 200,000 Total manufacturing overhead cost (a) P608,000 Number of units produced (b) 20,000 Overhead cost per unit (a) ÷ (b) P30.40

Predetermined

overhead rate

= 20,000 DLHsP1,480,000 = P74 per DLH

= Manufacturing overhead costDirect labor hours

Model AS2

Activity Cost Pool

(a) Predetermined Overhead Rate Activity (b)

(a) × (b) Overhead Applied

Machine setups P720 per setup 100 setups P 72,000 Special milling P300 per MH 0 MHs 0 General factory P50 per DLH 16,000 DLHs 800,000 Total manufacturing overhead cost (a) P872,000 Number of units produced (b) 40,000 Overhead cost per unit (a) ÷ (b) P21.80

b The unit product cost of each model under activity-based costing would

be computed as follows:

Model

Direct materials P35.00 P25.00 Direct labor (P20 per DLH × 0.2 DLH; P20 per DLH × 04.DLH) 4.00 8.00 Manufacturing overhead (above) 30.40 21.80 Total unit product cost P69.40 P54.80 Comparing these unit cost figures with the unit costs in Part 1(b), we find that the unit product cost for Model HY5 has increased from P53.80 to P69.40, and the unit product cost for Model AS2 has decreased from P62.60 to P54.80

Requirement 3

It is especially important to note that, even under activity-based costing, 68% of the company’s overhead costs continue to be applied to products on the basis of direct labor-hours:

Machine setups (number of setups) P  180,000 12%

Special milling (machine-hours) 300,000 20

General factory (direct labor-hours) 1,000,000 68

Total overhead cost P1,480,000 100%

Thus, the shift in overhead cost from the high-volume product (Model AS2)

to the low-volume product (Model HY5) occurred as a result of reassigning