' ..

r--- L Activity-Based Costing: Demonstration Problems and Practice Quiz _ _____' _ ___ ________
Demonstration Problem 1
ABC Manufacturing, Inc. produces three gadgets (Ace, Best, and Champ) in two departments, Machining and
Assembly. Each product requires one hour of direct labor for completion. The following table provides production
and cost data for the year.
Ace Best Total
Number of units 25,000 15,000 45,000
Machine hours . 2,500 1,500
@
Mit O.1/o-f1(-
b . f 1'1/1
Direct materials $1,000,000 $450,000
PoHr'L
Direct labor 375,000 225,000
Overhead
Machining
b avo /'A 11 ;.If2,.s;- jMIf
Assembly
(\)L.$
Total overhead
Tot costs
Required:
Use the plantwide allocation method to determin(tk unit cost for each produc})rhe allocation bases to
choose from are
1. Machine hours.
2. Direct labor costs.
1
----------------------
----------------------
Solution:
1. The overhead allocation rate when@achine hou!j)were used as the allocation base was $225 per machine
hour (= $1,350,000 + 6,000 machine hours). The unit cost report would show the following:
Ace Best Champ
Units produced 25,000 15,000 5,000
Machine hours per unit
r
1;
0.4
0.1 0.1
./ ~ - z , " "
)C
Direct materials )C -vv.> $40.0 $30.0
$55.0
Direct labor 15.0 15.0 15.0
C
Applied overhea@ 5 per machine hour}) 22.5 22.5 90.0
Unit cost $77.5 $67.5 $160.0
2. The overhead allocation rate whe direct hour costs ere used as the allocation base was 200% (=
$1,350,000 + $675,000). The unit cos report would show the following:
Ace Best Champ
Units produced 25,000 15,000 5,000
Direct materials $40.0 $30.0 $55.0
Direct labor
x ~ ( 15.0 )(. ~ < ; 15.0 ')(1..-( 15.0
Applied overhea (200% direct labor costs) -? 30.0 30.0 30.0
Unit cost $85.0 $75.0 $100.0
Please note that the same results can be obtained using the number of units produced as the allocation base
because each product requires one hour of direct labor for completion and the direct labor costs are in direct
proportion to the number of units produced. The overhead allocation rate would be $30 per unit (= $1,350,000 +
45,000 units) as shown above.
The department allocation method uses a separate cost pool for each department. Each department has
its own overhead allocation rate or set of rates. This is a variation of the two-stage allocation approach in
which the cost pools happen to be departments.
If the company manufactures products that are quite similar and all use the same set of resources, the
plantwide rate is probably sufficient.
If there are multiple products that require manufacturing facilities in many different ways, departmental
rates provide a better picture of the use of manufacturing resources by the different products.
The choice between a plantwide rate and departmental rates is based on the costs and benefits of the
information inherent in each system. Any incremental costs of additional information must be justified by
an increase in benefits from improved decisions.
2
Demonstration Problem 2
(Continued from Demonstration Problem 1)
Considering the nature of the production processes, the cost accountant of ABC Manufacturing decided to
experiment with the department-specific allocation approach and determined that the Machining Department can
use machine hours as the allocation base for overhead assignment while the Assembly Department can use direct
labor costs instead.
Required:
Use the department allocation method to determine the unit cost for each product.
MH
.:.
Units produced
Machine hours per unit
Direct materials
Direct labor
Applied overhead
Machining ( $,SO per machine hour)
Assembly ( 6{..1"t. of direct labor costs)
nit cost

( Ace
25,000
6' . I
'to


{O
1'g"O
t 5 rn:>
Best
15,000
0.1
10

t S
(
t- 7 D
2- 0'0"0
Champ
5,000
D.".


.be:>
to

2
Solution:
For the Machining Department, the overhead allocation rate would be $150 per machine hour (= $900,000 +
6,000 machine hours).
For the Assembly Department, the overhead allocation rate would be 66.67% (= $450,000 + $675,000).
Ace Best Champ
Units produced 25,000 15,000 5,000
Machine hours per unit 0.1 0.1 0.4
Direct materials $40.0 $30.0 $55.0
Direct labor 15.0 15.0 15.0
Applied overhead
Machining ($150 per machine hour) 15.0 15.0 60.0
Assembly (66.67% of direct labor costs) 10.0 10.0 10.0
Unit cost $80.0 $70.0 $140.0
4
Demonstration Problem 3 (Continued from Demonstration Problems 2 and 3)
The cost accountant of ABC Manufacturing attended aworkshop on activity-based costing and was impressed by the results.
After consulting with the production personnel, he prepared the following information on cost drivers and the estimated
volume for each driver.
Activity Cost driver Cost driver volume
Machining Ace Best Champ
Setup Number of setups 125 75 50 250
Machining Machine hours 2,500 1,500 2,000 6,000
Assembly
Assembly Direct labor hours 25,000 15,000 5,000 45,000
Inspection Number of inspections I 50 25 25 100
U z-< 67JP I .5.1f7fi) '. om:>
The cost accountant also determined how much costs were incurred in eacH of the four activities as follows:
Activity Overhead costs
Machining
Setup
$150,000 -: 'l01:>
Machining ____7---"5---'-0,'-'-00.;:....:0_-:- b,OIS1> M I+s -;. ( J.-S/ M Id-
Total Machining department overhead $900,000
Assembly
$360,000 tK, creo !)/Jk _ =- <t i"/pu-r
Assembly
Inspection
_ __ 1 !r'"'O ::- t1OAspec:t:
Total Assembly department overhead $450,000
Total overhead costs $1,350,000
Required:
1. Determine the cost driver rate for each activity cost pool.
2. Use the activity-based costing method to determine the unit cost for each product.
3. Summarize and comment the results.
5
Solution:
1.
Activity Cost drive rate
Machining
Setup
Machining
Assembly
Assembly
Inspection
2. In the following table, the total costs are divided by the number of units to arrive at the unit cost for each
product.
Ace Best Champ
Direct materials $1,000,000 $450,000 $275,000
Direct labor . 375,000 225,000 75,000
Applied overhead
Setup ($600 per setup) $75,000 $45,000 $30,000
Machining ($125 per machine hour) 312,500 187,500 250,000
Assembly ($8 per direct labor hour) 200,000 120,000 40,000
Inspection ($900 per inspection) 45,000 22,500 22,500
Total overhead costs $632,500 $375,000 $342,500
Total costs $2,007,500 $1,050,000 $692,500
Number of units
Unit cost
Iternativel he following table shows direct calculation of unit cost for each product based on consumption
c Ivities for each unit of the products.
Ace Best Champ
Units produced 25,000 15,000 5,000
Number of setups per unit 0.005 0.005 0.01
Machine hours per unit 0.1 0.1 0.4
Direct labor hours per unit 1 1 1
Number of inspections per unit 0.002 0.00167 0.005
Direct materials $40.0 $30.0 $55.0
Direct labor 15.0 15.0 15.0
Applied overhead
Setup ($600 per setup) 3.0 3.0 6.0
Machining ($125 per machine hour) 12.5 12.5 50.0
Assembly ($8 per direct labor hour) 8.0 8.0 8.0
Inspection ($900 per inspection) 1.8 1.5 4.5
Unit cost $80.3 $70.0 $138.5
6
3. In summary, a comparison of the methods used to calculate unit cost for each product is presented below.
Ace Best
Plantwide rate based on machine hours $77.5 $67.5
Plantwide rate based on direct labor costs ~ 85.0 75.0
Department rates 80.0 __~ 7 0 ~ . 0 ~ __~
Activity-based costing ~ 70.0
In this series of demonstration problem both of the lantwide allocation methods distort product costs Since
Champ uses four times as much machine hours as the ot er two pro ucts, it inevitably receives more cost
assignment from the plantwide method based on machine hours; the opposite is the case when direct labor
costs are used as the allocation base.
The department allocation method and activity-based costing produce comparable numbers that portray
consumption of resources closer to reality. Since it is less costly to implement the department allocation
method than the activity-based costing method, the managers of ABC Manufacturing should probably use the
department allocation method to handle overhead costs in the future.
7
Multiple Choice [c-Ml-sed Py
/"
1. Death spiral /'
Ci)Happens when managers try toyet higher prices to recove(fcreasing reported costV
b. Occurs when capacity is re..duted.
c. May happen when the market share is ga.tnm9.
d. Has to do with costs
2. In atwo-stage cost allocation system,
a. The first stage involves assigning overhead costs to cost pools.
b. The cost pools may be departments.
c. Each cost pool requires an allocation rate.
(12AII of the above.
3. One of the cost pools at Toylands Store is Personnel department that provides recruiting and training for Sales and
Administrative departments and has an estimated overhead of $45,000. Sales department has 12 employees and
Administrative department has 3. How much of the overhead cost of the Personnel department should be allocated to the
Sales department?
a. $9,000.
b. O.
:; 30lf0
c. $36,000.
$38,000.
"-- )l 1;).
The following information is for questions 4- 7.
The accountant of Toylands Manufacturing collected the following information:
Activity Overhead costs Cost driver Product X1 Product X2
Machining Dept.
Setup $200,000 Number of setups 200 50
Machining 700,000 Machine hours 20,000 15,000
Packaging Dept.
Assembly C3"9 irect labor hours 000
Inspection .<:JMOL Number of inspections 120
I
4. If Toylands Manufacturing uses'a plantwide rate based oE t labor hOU!)O allocate overhead costs, how much is
product X1's share of overhead? G )
a. $324,000. To-n.J..
b. $416,000. "t t
c. 638000. I, 3?1=; Ifl"O ru JJLJJ-
d. $552,000. ;: lJUV .,. 6 5Tf) )
(ron.P Pufs)
5. If the department allocation method is used, what is the overhead rate for thE achining hOU!V
as the allocation base? T -(?Q !1 f) opt 0 If ..
a. $39.43 per machine hour. 0
b. $13.71 per machine hour. ( I 00, IAfV -r VV'O, tNO) 7 I
c. $ ne - v ). }f'
$25.71 per machine hour. c-=-== "'\ - iLA M
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I 4
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6. When activity-based costing is used, what i Oduct of the kaging departmenj)verhead costs?
a. 270 000. d
is' "300( dlJ\) -=> t:":3 () L!f X bC? &ro =- (<lO, 67Jn
d. $380,000. ( 'kJ,IJ1iD+ bo, 6W "\ puts +

60 PI
'$ I g'ol.wo _ _) rt{(iTO L )( I;,,'i(" = : 9 61f1l
l)..o+bo
7. When activity-based costing is used, how much of the
:> pu
c. $950,000.
d. $670,000.
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8. Which of the following is true of activity-based 11. What are the steps required for
costing relative to !?ditional costing? in administration?
a. It requires detailed cost measures. a. Identify activities that consume resources. I
b. Accounting department ajPrf6'can handle.;n1the b. Identify cost drivers associated with

c. C tivity rate per cost driver. J --yo- )..
__
d. All of the above.
9. Activity-based costing can be beneficial to
12. Which of the following statements Wrrect?
a. Nowadays, labor is still a cost in T
a. Banks.
b. Nonprofit organizations.
many companies, especially service
zations.
c. Law firms
c'
b. When the labor is prudent to
All of the above. )
allocate overhead based on direct labor.
c. en tela 0 onen rops, the overhead
rate based on direct labor tends to increase T
substantially.
d. When all resources are used proportionally, __
allocation of overhead based on machine hours is I
acceptable.
d.
5
.
1. a L01
2. d L02
3. c L02
$45 000
, = $3,000 per employees.
12+3
$3,000)( 12 employees at Sales department =
$36,000.
4. d L02
$200,000 +$700,000 + $300,000 + $180,000 =
$1,380,000.
$1 380 000 .
" =$13.8 per direct labor hour.
40,000 + 60, 000
$13.8)( 40,000 direct labor hours =$552,000.
5. d L02
$700,000 +$200,000 =$900,000.
$900 000 .
, =$25.71 per machine hour.
20,000 + 15, 000
6. b L04, L05
$300 000 .
---'- - = $3 per direct labor hour.
40, 000 + 60,000
$180 000 . .
--' - =$1,000 per inspection.
120+60
$3 per direct labor )( 60,000 direct labor hours +
$1,000 per inspection )( 60 inspections =
$240,000.
Answers
7.
8.
9.
10.
11.
12.
b L04, L05
$200 000
--' - = $800 per setup.
200+ 50
$700 000 .
- - ~ ' - - =$20 per machine hour.
20, 000 + 15, 000
$800 per setup )( 200 setups + $20 per machine
hour)( 20,000 machine hours + $3 per direct labor
hour )( 40,000 direct labor hours + $t,OOO per
inspection )( 120 inspections = $800,000.
c L06
d L08
b L07
d L08
b L07
10