CHAPTER 4

ACTIVITY-BASED COSTING

SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY

Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT
True-False Statements
1. 1 K 7. 4 C 13. 5 K 19. 6 K *25. 9 K
2. 1 K 8. 4 K 14. 5 C 20. 6 K *26. 9 K
3. 1 K 9. 4 C 15. 5 K 21. 6 C *27. 9 K
4. 1 C 10. 5 K 16. 6 K 22. 8 K *28. 9 C
5. 1 C 11. 5 K 17. 6 K 23. 8 K 29. 7 K
6. 2 K 12. 5 K 18. 6 K 24. 8 K 30. 7 K
Multiple Choice Questions
31. 1 K 42. 4 AP 53. 6 C *64. 9 K 75. 4 AP
32. 1 K 43. 4 AP 54. 6 C *65. 9 K 76. 4 AP
33. 1 K 44. 4 AP 55. 6 K 66. 7 C 77. 4 AP
34. 1 C 45. 5 K 56. 6 K 67. 7 C 78. 4 AP
35. 2 K 46. 5 C 57. 8 K 68. 7 C 79. 4 AP
36. 3 K 47. 5 K 58. 8 K 69. 7 C 80. 1 AP
37. 4 AP 48. 5 C 59. 8 K 70. 7 C 81. 4 AP
38. 4 AP 49. 5 K 60. 8 C 71. 4 AP
39. 4 C 50. 5 K *61. 9 K 72. 1 AP
40. 4 K 51. 5 C *62. 9 K 73. 4 AP
41. 4 AP 52. 6 C *63. 9 K 74. 4 AP
Brief Exercises
82. 4 AP 83. 4 AP 84. 4 AP 85. 6 AP 86. 4, 5
Exercises
87. 1, 4 AP 90. 4 C 93. 4 E 96. 6 C 99. 7 C
88. 1, 4 AP 91. 4 C 94. 4 AP 97. 6 C
89. 3 K 92. 4 AP 95. 4, 5 AP 98. 8 AP
Completion Statements
100. 1 K 103. 4 K 106. 6 K 109. 7 K
101. 1 K 104. 5 K 107. 9 K 110. 7 K
102. 2 K 105. 5 K 108. 9 K

* This topic is covered in an Appendix to the chapter.

4-2 Test Bank for Managerial Accounting, Third Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type
Study Objective 1
1. TF 4. TF 32. MC 72. MC 88. Ex
2. TF 5. TF 33. MC 80. MC 100. C
3. TF 31. MC 34. MC 87. Ex 101. C
Study Objective 2
6. TF 35. MC 102. C
Study Objective 3
36. MC 89. Ex
Study Objective 4
7. TF 39. MC 44. MC 76. MC 82. BE 88. Ex 94. Ex
8. TF 40. MC 71. MC 77. MC 83. BE 90. Ex 95. Ex
9. TF 41. MC 73. MC 78. MC 84. BE 91. Ex 103. C
37. MC 42. MC 74. MC 79. MC 86. BE 92. Ex
38. MC 43. MC 75. MC 81. MC 87. Ex 93. Ex
Study Objective 5
10. TF 13. TF 45. MC 48. MC 51. MC 104. C
11. TF 14. TF 46. MC 49. MC 86. BE 105. C
12. TF 15. TF 47. MC 50. MC 95. Ex
Study Objective 6
16. TF 19. TF 52. MC 55. MC 96. Ex
17. TF 20. TF 53. MC 56. MC 97. Ex
18. TF 21. TF 54. MC 85. BE 106. C
Study Objective 7
29. TF 66. MC 68. MC 70. MC 109. C
30. TF 67. MC 69. MC 99. Ex 110. C
Study Objective 8
22. TF 24. TF 58. MC 60. MC
23. TF 57. MC 59. MC 98. Ex
*Study Objective 9
*25. TF *27. TF *61. MC *63. MC *65. MC *108 C
*26. TF *28. TF *62. MC *64. MC *107 C

Note: TF = True-False C = Completion BE = Brief Exercise

MC = Multiple Choice Ex = Exercise

The chapter also contains one set of ten Matching questions and three Short-Answer Essay
questions.
 Activity-Based Costing 4-3

CHAPTER STUDY OBJECTIVES

1. Recognize the difference between traditional costing and activity-based costing. A
traditional costing system allocates unit-based overhead to products on the basis of
predetermined plantwide or department-wide volume of unit-based output rates such as
direct labor or machine hours. An ABC system allocates overhead to identified activity cost
pools, and costs are then assigned to products using related cost drivers that measure the
activities (resources) consumed.
2. Identify the steps in the development of an activity-based costing system. The
development of an activity-based costing system involves four steps: (1) Identify and classify
the major activities that pertain to the manufacture of specific products and allocate
overhead costs to the appropriate cost pools. (2) Identify the cost driver that has a strong
correlation to the costs accumulated in the activity cost pool. (3) Compute the activity-based
overhead rate per cost driver. (4) Assign overhead costs for each activity cost pool to
products or services using the cost drivers.
3. Know how companies identify the activity cost pools used in activity-based costing.
To identify activity cost pools, a company must perform an analysis of each operation or
process, documenting and timing every task, action, or transaction.
4. Know how companies identify and use the activity cost drivers in activity-based
costing. Cost drivers identified for assigning activity cost pools must (a) accurately measure
the actual consumption of the activity by the various products, and (b) have related data
easily available.
5. Understand the benefits and limitations of activity-based costing. What makes ABC a
more accurate product costing system is: (1) the increased number of cost pools used to
assign overhead, (2) the enhanced control over overhead costs, and (3) the better
management decisions. The limitations of ABC are: (1) the higher analysis and
measurement costs that accompany multiple activity centers and cost drivers, and (2) the
necessity still to allocate some costs arbitrarily.
6. Differentiate between value-added and nonvalue-added activities. Value-added activities
increase the worth of a product or service. Nonvalue-added activities simply add cost to, or
increase the time spent on, a product or service without increasing its market value.
Awareness of these classifications encourages managers to reduce or eliminate the time
spent on the nonvalue-added activities.
7. Understand the value of using activity levels in activity-based costing. Activities may
be classified as unit-level, batch-level, product-level, and facility-level. Unit-, batch-,
product-, and facility-level overhead costs are controlled by modifying unit-, batch-, product-,
and facility-level activities, respectively. Failure to recognize this hierarchy of levels can
result in distorted product costing.
8. Apply activity-based costing to service industries. The overall objective of using ABC in
service industries is no different than for manufacturing industries, that is, improved costing
of services provided (by job, service, contract, or customer). The general approach to
costing is the same: analyze operations, identify activities, accumulate overhead costs by
activity cost pools, and identify and use cost drivers to assign the cost pools to the services.
*9. Explain just-in-time (JIT) processing. JIT is a processing system that is dedicated to
having on hand the right products at the time they are needed, thereby reducing the amount
of inventory and the time inventory is held. One of the principal accounting effects is that
one account, Raw and In-Process Inventory, replaces both the raw materials and work-in-
process inventory accounts.
TRUE-FALSE STATEMENTS
1. Traditional costing systems use multiple predetermined overhead rates.

2. Traditionally, overhead is allocated based on direct labor cost or direct labor hours.

3. Current trends in manufacturing include less direct labor and more overhead.

4. Activity-based costing allocates overhead to multiple cost pools and assigns the cost
pools to products using cost drivers.

5. A cost driver does not generally have a direct cause-effect relationship with the resources
consumed.

6. The first step in activity-based costing is to assign overhead costs to products, using cost
drivers.
4-4 Test Bank for Managerial Accounting, Third Edition

7. To achieve accurate costing, a high degree of correlation must exist between the cost
driver and the actual consumption of the activity cost pool.

8. Low-volume products often require more special handling than high-volume products.

9. When overhead is properly assigned in ABC, it will usually decrease the unit cost of high-
volume products.

10. ABC leads to enhanced control over overhead costs.

11. ABC usually results in less appropriate management decisions.

12. ABC is generally more costly to implement than traditional costing.

13. ABC eliminates all arbitrary cost allocations.

14. ABC is particularly useful when product lines differ greatly in volume and manufacturing
complexity.

15. ABC is particularly useful when overhead costs are an insignificant portion of total costs.

16. Activity-based management focuses on reducing costs and improving processes.

17. Any activity that increases the cost of producing a product is a value-added activity.

18. Engineering design is a value-added activity.

19. Nonvalue-added activities increase the cost of a product but not its market value.

20. Machining is a nonvalue-added activity.

21. Not all activities labeled nonvalue-added are totally wasteful, nor can they be totally
eliminated.

22. The overall objective of installing ABC in service firms is no different than it is in a
manufacturing company.

23. What sometimes makes implementation of activity-based costing difficult in service

industries is that a smaller proportion of overhead costs are company-wide costs.

24. The general approach to identifying activities, activity cost pools, and cost drivers is used
by a service company in the same manner as a manufacturing company.

*25. Inventory storage costs are reduced in just-in-time processing.

*26. Rework costs typically increase in just-in-time processing.

*27. Just-in-time strives to eliminate inventories by using a pull approach.

*28. Quality control is less important in just-in-time than in traditional manufacturing

philosophies.

29. Plant management is a batch-level activity.

30. Painting is a product-level activity.

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. F 6. F 11. F 16. T 21. T 26. F
2. T 7. T 12. T 17. F 22. T 27. T
3. T 8. T 13. F 18. T 23. F 28. F
4. T 9. F 14. T 19. T 24. T 29. F
5. F 10. T 15. F 20. F 25. T 30. F
 Activity-Based Costing 4-5

MULTIPLE CHOICE QUESTIONS

31. Which of the following is not typical of traditional costing systems?
a. Use of a single predetermined overhead rate.
b. Use of direct labor hours or direct labor cost to assign overhead.
c. Assumption of correlation between direct labor and incurrence of overhead cost.
d. Use of multiple cost drivers to allocate overhead.

32. In traditional costing systems, overhead is generally applied based on

a. direct labor.
b. machine hours.
c. direct material dollars.
d. units of production.

33. An activity that has a direct cause-effect relationship with the resources consumed is a(n)
a. cost driver.
b. overhead rate.
c. cost pool.
d. product activity.

34. Which best describes the flow of overhead costs in an activity-based costing system?
a. Overhead costs  direct labor cost or hours  products
b. Overhead costs  products
c. Overhead costs  activity cost pools  cost drivers  products
d. Overhead costs  machine hours  products

35. The first step in activity-based costing is to

a. assign manufacturing overhead costs for each activity cost pool to products.
b. compute the activity-based overhead rate per cost driver.
c. identify and classify the major activities involved in the manufacture of specific
products.
d. identify the cost driver that has a strong correlation to the activity cost pool.

36. A well-designed activity-based costing system starts with

a. identifying the activity-cost pools.
b. computing the activity-based overhead rate.
c. assigning manufacturing overhead costs for each activity cost pool to products.
d. analyzing the activities performed to manufacture a product.

37. One of Astro Company's activity cost pools is machine setups, with estimated overhead of
$150,000. Astro produces sparklers (400 setups) and lighters (600 setups). How much of
the machine setup cost pool should be assigned to sparklers?
a. $150,000.
b. $60,000.
c. $75,000.
d. $90,000.

38. Which would be an appropriate cost driver for the ordering and receiving activity cost pool?
a. Machine setups
b. Purchase orders
c. Machine hours
d. Inspections
39. As compared to a high-volume product, a low-volume product
a. usually requires less special handling.
b. is usually responsible for more overhead costs per unit.
c. requires relatively fewer machine setups.
d. requires use of direct labor hours as the primary cost driver to ensure proper allocation
of overhead.

40. In Japan,
a. activity-based costing is used more than in the U.S.
b. companies prefer volume measures such as direct labor hours to assign overhead costs.
c. labor cost reduction is less of a priority.
d. developing more accurate product costs is more of a priority.

Use the following information to answer questions 41–44.

Poodle Company manufactures two products, Mini A and Maxi B. Poodle's overhead costs
consist of setting up machines, $800,000; machining, $1,800,000; and inspecting, $600,000.
Information on the two products is:
4-6 Test Bank for Managerial Accounting, Third Edition

Mini A Maxi B
Direct labor hours 15,000 25,000
Machine setups 600 400
Machine hours 24,000 26,000
Inspections 800 700

41. Overhead applied to Mini A using traditional costing using direct labor hours is
a. $1,200,000.
b. $1,536,000.
c. $1,670,000.
d. $1,920,000.

42. Overhead applied to Maxi B using traditional costing using direct labor hours is
a. $1,280,000.
b. $1,536,000.
c. $1,670,000.
d. $2,000,000.

43. Overhead applied to Mini A using activity-based costing is

a. $1,200,000.
b. $1,536,000.
c. $1,664,000.
d. $1,920,000.

44. Overhead applied to Maxi B using activity-based costing is

a. $1,280,000.
b. $1,536,000.
c. $1,664,000.
d. $2,000,000.

45. Which of the following is a limitation of activity-based costing?

a. More cost pools
b. Less control over overhead costs
c. Poorer management decisions
d. Some arbitrary allocations continue
46. Which of the following factors would suggest a switch to activity-based costing?
a. Product lines similar in volume and manufacturing complexity.
b. Overhead costs constitute a significant portion of total costs.
c. The manufacturing process has been stable.
d. Production managers use data provided by the existing system.

47. Which of the following is true of activity-based costing?

a. More cost pools
b. Same base as traditional costing
c. Less costly to use
d. Eliminates arbitrary allocations

48. The primary benefit of ABC is it provides

a. faster management decisions.
b. enhanced control over overhead costs.
c. more cost pools.
d. more accurate product costing.

49. Which of the following is not a benefit of activity-based costing?

a. More accurate product costing
b. Enhanced control over overhead costs
c. Better management decisions
d. Less costly to use

50. Each of the following is a limitation of activity-based costing except that

a. it can be expensive to use.
b. it is more complex than traditional costing.
c. more cost pools are used.
d. some arbitrary allocations continue.

51. The presence of any of the following factors would suggest a switch to ABC except when
a. product lines differ greatly in volume.
b. overhead costs constitute a minor portion of total costs.
c. the manufacturing process has changed significantly.
d. production managers are ignoring data provided by the existing system.
 Activity-Based Costing 4-7

52. Which of the following is a value-added activity?

a. Engineering design
b. Machinery repair
c. Inventory storage
d. Inspections

53. Which of the following is a nonvalue-added activity?

a. Engineering design
b. Machining
c. Inspection
d. Packaging

54. A nonvalue-added activity in a service enterprise is

a. taking appointments.
b. traveling.
c. advertising.
d. all of these.
55. Value-added activities
a. should be reduced or eliminated.
b. involve resource usage customers are willing to pay for.
c. add cost to a product without affecting selling price.
d. cannot be differentiated from nonvalue-added activities.

56. All of the following are examples of a value-added activity in a service company except
a. delivering packages by a delivery service.
b. ordering supplies.
c. performing surgery.
d. providing legal research for legal services.

57. Activity-based costing has been found to be useful in each of the following service
industries except
a. banks.
b. hospitals.
c. telephone companies.
d. ABC has been useful in any of these industries.

58. What sometimes makes implementation of activity-based costing difficult in service

industries is
a. the labeling of activities as value-added.
b. identifying activities, activity cost plus, and cost drivers.
c. that a larger proportion of overhead costs are company-wide costs.
d. attempting to reduce or eliminate nonvalue-added activities.

59. All of the following statements are correct except that

a. activity-based costing has been widely adopted in service industries.
b. the objective of installing ABC in service firms is different than it is in a manufacturing
firm.
c. a larger proportion of overhead costs are company-wide costs in service industries.
d. the general approach to identifying activities and activity cost pools is the same in a
service company as in a manufacturing company.

60. The use of activity-based costing in service industries

a. has the same objective as in manufacturing.
b. results in improved costing of services provided.
c. uses cost pools to assign overhead.
d. all of these.

*61. Just-in-time processing

a. is based on a just-in-case philosophy.
b. results in a push approach.
c. minimizes inventory storage and waiting time.
d. all of these.

*62. An element of just-in-time processing is

a. dependable suppliers who are willing to deliver on short notice.
b. a multi-skilled workforce.
c. a total quality control system.
d. all of these.
4-8 Test Bank for Managerial Accounting, Third Edition

*63. Which of the following is not a benefit of just-in-time processing?

a. Control of significant inventory balances
b. Enhanced product quality
c. Reduction of rework costs
d. Production cost savings

*64. Which account is used in just-in-time processing?

a. Raw materials inventory
b. Work-in-process inventory
c. Merchandise inventory
d. Raw and In-Process inventory

*65. Under just-in-time processing, all of the following are received or completed “just in time”
except
a. finished goods.
b. raw materials.
c. subassembly parts.
d. supplies.

66. Which of the following is not a facility-level activity?

a. Plant management
b. Product design
c. Personnel administration
d. Training

67. Which of the following is not a product-level activity?

a. Product design
b. Engineering changes
c. Inventory management
d. Equipment setups

68. Which of the following is not a batch-level activity?

a. Engineering changes
b. Equipment setups
c. Inspection
d. Materials handling

69. Which of the following is not a unit-level activity?

a. Purchase ordering
b. Assembling
c. Painting
d. Sewing

70. Which of the following is a batch-level activity?

a. Plant management
b. Product design
c. Equipment setups
d. Assembling

71. Veronica Co. produces 3 products, Products Rain, Snow, and Wind. Product Rain
requires 80 machine setups, Product Snow requires 60 setups, and Product Wind
requires 180 setups. Veronica has identified an activity cost pool with allocated overhead
of $384,000 for which the cost driver is machine setups. How much overhead is assigned
to each product?
Rain Snow Wind
a. $128,000 $128,000 $128,000
b. $80,000 $60,000 $180,000
c. $96,000 $72,000 $216,000
d. $72,000 $128,000 $184,000

72. GoFish Inc. has an overhead rate for machine setups of $200 per machine setup, for a
total of $56,000 of overhead. The company produces two products, Product Salamander
and Product Gold, which require 160 and 120 setups each, respectively. The overhead
assigned to each product is
Salamander Gold
a. $28,000 $28,000
b. $24,000 $32,000
 Activity-Based Costing 4-9

c. $30,000 $26,000
d. $32,000 $24,000

73. Hammock Company manufactures two models of its hammock, the Superior and the
Deluxe. The Superior model requires 10,000 direct labor hours and the Superior requires
40,000 direct labor hours. The company produces 4,000 units of the Superior model and
1,000 units of the Deluxe model each year. The company produces the Superior model in
batch sizes of 200, while it produces the Deluxe model in batch sizes of 100. The
company expects to incur $120,000 of total setup costs this year. How much of the setup
costs are allocated to the Superior model using ABC costing?

a. $80,000
b. $60,000
c. $24,000
d. $100,000

74. Jaime Inc. manufactures 2 products, sweaters and jackets. The company has estimated
its overhead in the order-processing department to be $180,000. The company produces
50,000 sweaters and 80,000 jackets each year. Sweater production requires 25,000
machine hours, jacket production requires 50,000 machine hours. The company places
raw materials orders 10 times per month, 2 times for raw materials for sweaters and the
remainder for raw materials for jackets. How much of the order processing overhead
should be allocated to jackets?
a.$90,000
b.$120,000
c.$110,770
d.$144,000
4-10 Test Bank for Managerial Accounting, Third Edition

75. Canterra Co. incurs $160,000 of overhead costs each year in its three main departments,
setup ($10,000), machining ($110,000), and packing ($40,000). The setup department
performs 40 setups per year, the machining department works 5,000 hours per year, and
the packing department packs 500 orders per year. Information about Canterra’s 2
products is as follows:
Product One Product Two
Number of setups 20 20
Machining hours 1,000 4,000
Orders packed 150 350

If machining hours are used as a base, how much overhead is assigned to Product One
each year?

a. $32,000
b. $80,000
c. $55,000
d. $48,000

76. Canterra Co. incurs $160,000 of overhead costs each year in its three main departments,
setup ($10,000), machining ($110,000), and packing ($40,000). The setup department
performs 40 setups per year, the machining department works 5,000 hours per year, and
the packing department packs 500 orders per year. Information about Canterra’s 2
products is as follows:
Product One Product Two
Number of setups 20 20
Machining hours 1,000 4,000
Orders packed 150 350

Using ABC, how much overhead is assigned to Product One each year?

a. $80,000
b. $121,000
c. $32,000
d. $39,000

77. Canterra Co. incurs $160,000 of overhead costs each year in its three main departments,
setup ($10,000), machining ($110,000), and packing ($40,000). The setup department
performs 40 setups per year, the machining department works 5,000 hours per year, and
the packing department packs 500 orders per year. Information about Canterra’s 2
products is as follows:
Product One Product Two
Number of setups 20 20
Machining hours 1,000 4,000
Orders packed 150 350
Number of products
Manufactured 600 400

Using ABC, how much overhead is assigned to Product Two each year?
a. $80,000
b. $64,000
c. $121,000
d. $128,000
78. A company incurs $1,200,000 of overhead each year in three departments, Processing,
Packaging, and Testing. The company performs 800 processing transactions, 200,000
packaging transactions, and 2,000 tests per year in producing 400,000 drums of Oil and
600,000 drums of Sludge. The following data are available:
Department Expected use of Driver Cost
Processing 800 $500,000
Packaging 200,000 500,000
Testing 2,000 200,000

Production information for Oil is as follows:

Department Expected use of Driver
Processing 300
Packaging 120,000
Testing 1,600

Compute the amount of overhead assigned to Oil.

 Activity-Based Costing 4-11

a. $600,000
b. $647,500
c. $552,500
d. $460,000

79. A company incurs $1,200,000 of overhead each year in three departments, Processing,
Packaging, and Testing. The company performs 800 processing transactions, 200,000
packaging transactions, and 2,000 tests per year in producing 400,000 drums of Oil and
600,000 drums of Sludge. The following data are available:
Department Expected use of Driver Cost
Processing 800 $500,000
Packaging 200,000 500,000
Testing 2,000 200,000

Production information for Sludge is as follows:

Department Expected use of Driver
Processing 500
Packaging 80,000
Testing 400

Compute the amount of overhead assigned to Sludge.

a. $600,000
b. $552,500
c. $647,500
d. $460,000

80. Sleep-Tight manufactures mattresses for the hotel industry. It has two products, Downy
and Firm and total overhead of $474,000. The company plans to manufacture 400
Downy mattresses and 100 Firm mattresses this year. In manufacturing the mattresses,
the company must perform 600 material moves for the Downy and 400 for the Firm; it
processes 900 purchase orders for the Downy and 700 for the Firm; and the company’s
employees work 1,400 direct labor hours on the Downy product and 3,400 on the Firm.
Sleep-Tight’s total material handling costs are $300,000 and its total purchasing costs
are $174,000. Under a traditional costing approach based on direct labor hours, how
much overhead would be assigned to the Downy product?

a. $138,250
b. $335,750
c.$237,000
d. $277,875

81. Sleep-Tight manufactures mattresses for the hotel industry. It has two products, Downy
and Firm and total overhead of $474,000. The company plans to manufacture 400 Downy
mattresses and 100 Firm mattresses this year. In manufacturing the mattresses, the
company must perform 600 material moves for the Downy and 400 for the Firm; it
processes 900 purchase orders for the Downy and 700 for the Firm; and the company’s
employees work 1,400 direct labor hours on the Downy product and 3,400 on the Firm.
Sleep-Tight’s total material handling costs are $300,000 and its total purchasing costs are
$174,000. Using ABC, how much overhead would be assigned to the Downy product?

a. $237,000
b. $277,875
c. $196,125
d. $335,750

Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
31. d 39. b 47. a 55. b 63. a 71. c 79. b
32. a 40. b 48. d 56. b 64. d 72. d 80. a
33. a 41. a 49. d 57. d 65. d 73. a 81. b
34. c 42. d 50. c 58. c 66. b 74. d
35. c 43. c 51. b 59. b 67. d 75. a
36. d 44. b 52. a 60. d 68. a 76. d
37. b 45. d 53. c 61. c 69. a 77. c
38. b 46. b 54. d 62. d 70. c 78. b
4-12 Test Bank for Managerial Accounting, Third Edition

BRIEF EXERCISES
Ex. 82
Sanchez Co. has three activities in its manufacturing process: machine setups, machining, and
inspections. Estimated annual overhead cost for each activity is $90,000, $162,500, and
$35,000, respectively. The expected annual use in each department is 1,000 setups, 12,500
machine hours, and 875 inspections.

Instructions
Compute the overhead rate for each activity.

Solution 82 (5 min.)
Machine setups $90,000 ÷  1,000 = $90 per setup
Machining $162,500 ÷ 12,500 = $13 per machine hour
Inspections $ 35,000 ÷  875 = $40 per inspection
Ex. 83
Boots and More, Inc. uses activity-based costing to assist management in setting prices for the
company’s 3 major product lines. The following information is available:

Activity Cost Pool Estimated Overhead Expected Use of Cost Driver

Per Activity
Cutting $ 900,000 24,000 labor hours
Stitching 8,000,000 320,000 machine hours
Inspections 2,800,000 160,000 labor hours
Packing 672,000 64,000 finished goods units

Instructions
Compute the activity-based overhead rates.

Solution 83 (5 min.)

Estimated Expected Use of Activity-Based

Activity Cost Pool Overhead ÷ Cost Drivers per Activity = Overhead Rates
Cutting $  900,000   24,000 Labor hours $37.50 per labor hour
Stitching  8,000,000 320,000 Machine hours $25.00 per machine hour
Inspections  2,800,000 160,000 Labor hours $17.50 per labor hour
Packing    672,000   64,000 Finished units $10.50 per finished unit

Ex. 84
Stereo City Co. manufactures speakers and receivers and uses activity-based costing. The
following information is available:

Activity Cost Pool Estimated Overhead Expected Use of Cost Driver

Per Activity
Ordering $180,000 24,000 orders
Soldering 192,000 64,000 machine hours
Inspecting 894,000 120,000 labor hours
Packing 873,600 56,000 boxes

Instructions
Compute the activity-based overhead rates.

Solution 84 (5 min.)

Estimated Expected Use of Activity-Based

Activity Cost Pool Overhead ÷ Cost Drivers per Activity = Overhead Rates
Ordering $ 180,000   24,000 Orders $ 7.50 per order
Soldering    192,000   64,000 Machine hours $ 3.00 per machine hour
Inspecting    894,000  120,000 Labor hours $ 7.45 per labor hour
Packing    873,600   56,000 Boxes $15.60 per box
 Activity-Based Costing 4-13

Ex. 85
Malt Co. manufactures several types of microbrew beers. Malt has identified the following
activities:
a. Inventory control
b. Purchasing
c. Receiving
d. Employee training
e. Machine setups
f. Brewing
g. Packing and shipping

Instructions
Classify each activity as value-added or nonvalue-added.

Solution 85 (5 min.)
Activity Classification
a. Inventory control Nonvalue-added
b. Purchasing Nonvalue-added
c. Receiving Nonvalue-added
d. Employee training Nonvalue-added
e. Machine setups Nonvalue-added
f. Brewing Value-added
g. Packing and shipping Value-added

Ex. 86
Plum Tired manufactures tires for dune buggies and has two different products, Nubby Tires and
Smooth Tires. The company produces 5,000 Nubby Tires and 10,000 Smooth Tires each year
and incurs $178,000 of overhead costs. The following information is available:

Activity Total Cost Cost Driver

Materials handling $70,000 Number of requisitions
Machine setups 54,000 Number of setups
Quality inspections 54,000 Number of inspections

For the Nubby Tires, the company has 400 requisitions, 200 setups, and 200 inspections. The
Smooth Tires requires 600 requisitions, 300 setups, and 400 inspections.

Instructions
Determine the overhead rate for each activity.

Solution 86 (5 – 10 min.)
The overhead rates are:
Expected Use
Activity Overhead of Cost Drivers Overhead Rate
Materials handling $70,000 1,000 $ 70
Machine setups  54,000   500  108
Quality inspections  54,000   600   90

EXERCISES
Ex. 87
All Wood Corporation manufactures dining chairs and tables. The following information is
available:
Dining Chairs Tables Total Cost
Machine setups 200 600 $32,000
Inspections 250 500 $54,000
Labor hours 2,600 2,400

All Wood is considering switching from one overhead rate based on labor hours to activity-based
costing.
4-14 Test Bank for Managerial Accounting, Third Edition

Instructions
Perform the following analyses for these two components of overhead:
a. Compute total machine setups and inspection costs assigned to each product, using a single
overhead rate.
b. Compute total machine setups and inspection costs assigned to each product, using activity-
based costing.
c. Comment on your findings.

Solution 87 (8–12 min.)

a. Single overhead rate
($32,000 + $54,000) ÷ 5,000 = $17.20 per labor hour

Dining chairs: 2,600 × $17.20 =$44,720

Tables: 2,400 x $17.20 = 41,280
$86,000

b. Activity-based costing
Machine setups: $32,000 ÷ 800 = $40 per setup

Inspections: $54,000 ÷ 750 = $72 per inspection

Dining chairs: (200 × $40) + (250 × $72) = $26,000

Tables: (600 × $40) + (500 × $72) = 60,000
$ 86,000

c. The use of activity-based costing resulted in the allocation of less cost to dining chairs and
more cost to tables. The change in cost allocation reflects a more accurate allocation based
on cause and effect.

Ex. 88
Vid-saver, Inc. has five activity cost pools and two products (a budget tape rewinder and a deluxe
tape rewinder). Information is presented below:

Cost Drivers by Product

Activity Cost Pool Cost Driver Est. Overhead Budget Deluxe
Ordering and Receiving Orders $ 120,000 600 400
Machine Setup Setups 297,000 500 400
Machining Machine hours 1,500,000 150,000 100,000
Assembly Parts 1,200,000 1,200,000 800,000
Inspection Inspections 300,000 550 450

Instructions
Compute the overhead cost per unit for each product. Production is 700,000 units of Budget and
200,000 units of Deluxe. Round your answer to the nearest cent.

Solution 88 (15–20 min.)

Activity Cost Pool Est. Overhead ÷ Total Est. Activity = Overhead Rate
Ordering & Receiving $ 120,000 1,000 orders $120/order
Machine Setup 297,000 900 setups $330/setup
Machining 1,500,000 250,000 mach. hours $6/machine hour
Assembly 1,200,000 2,000,000 parts $.60/part
Inspection 300,000 1,000 inspections $300/inspection

Budget Deluxe
Cost Cost Cost Cost
Activity Cost Pool Driver × Rate = Assigned Driver × Rate = Assigned
Ordering & Receiving 600 $120 $ 72,000 400 $120 $ 48,000
Machine Setup 500 330 165,000 400 330 132,000
Machining 150,000 6 900,000 100,000 6 600,000
Assembly 1,200,000 .60 720,000 800,000 .60 480,000
Inspection 550 300 165,000 450 300 135,000
$2,022,000 $1,395,000
÷ 700,000 ÷ 200,000
$2.89 per unit $6.98 per unit
Activity-Based Costing 4-15
4-16 Test Bank for Managerial Accounting, Third Edition

Ex. 89
Ami Reed owns a small department store in a metropolitan area. For twenty years, the
accountant has applied overhead to the various departments—Women's Apparel, Men's Apparel,
Cosmetics, Housewares, Shoes, and Electronics—based on the basis of employee hours
worked. Ami Reed's daughter, who is an accounting student at a local university, has suggested
her mother should consider using activity-based costing (ABC). In an attempt to implement ABC,
Ami Reed and her daughter have identified the following activities.

Instructions
Determine a cost driver for each of the activities listed below.
Cost Pool Cost Driver
a. Placing orders ______________________________
b. Stocking merchandise ______________________________
c. Waiting on customers ______________________________
d. Janitorial and Maintenance ______________________________
e. Training employees ______________________________
f. Administrative ______________________________
g. Advertising and Marketing ______________________________
h. Accounting and Legal Services ______________________________
i. Wrapping packages ______________________________

Solution 89 (6–9 min.)

Cost Pool Cost Driver
a. Placing orders number of orders; volume of individual orders
b. Stocking merchandise number of orders; dollar volume of orders; number of units
c. Waiting on customers number of customers; dollar volume of sales
d. Janitorial and Maintenance square feet occupied
e. Training employees total number of employees; number of new employees
f. Administrative number of employees; dollar volume of business
g. Advertising and Marketing number of ad campaigns
h. Accounting and Legal Services dollar volume of sales; hours worked
i. Wrapping packages number of packages
 Activity-Based Costing 4-17

Ex. 90
A list of possible cost drivers is presented below:

Code Code
A Engineering hours D Number of subassemblies
B Setups E Boxes
C Machine hours F Orders

Instructions
For each of the following activity cost pools, select the most appropriate cost driver:

Code Cost Pool

_____ 1. Machine setup

_____ 2. Ordering and receiving

_____ 3. Packaging and shipping

_____ 4. Engineering design

_____ 5. Machining

_____ 6. Assembly

Solution 90 (4–6 min.)

1. B 4. A
2. F 5. C
3. E 6. D

Ex. 91
Identify appropriate cost drivers for the following activity cost pools:
1. Human resources
2. Security
3. Receiving
4. Data processing

Solution 91 (3–5 min.)

1. Number of employees, number of hires
2. Square footage
3. Shipments received; pounds received
4. Lines printed, CPU minutes, storage units

Ex. 92
Two of the activity cost pools for Montana Company are (a) machining ($400,000) and (b)
inspections ($42,000). Possible cost drivers are direct labor hours (2,500), machine hours
(12,500), square footage (2,000), and number of inspections (150).

Instructions
Compute the overhead rate for each activity.

Solution 92 (4–6 min.)

$400,000
(a) Machining: —————————— = $32 per machine hour
12,500 machine hours

$42,000
(b) Inspections: ———————- = $280 per inspection
150 inspections
4-18 Test Bank for Managerial Accounting, Third Edition

Ex. 93
Tanner, Inc. produces two models of cameras, Standard and Luxury. They sell 100,000 Standard
cameras and 15,000 Luxury cameras annually. Tanner switched from traditional costing to
activity-based costing and discovered that the cost allocated to Luxury cameras increased so
dramatically that the Luxury was now only marginally profitable.

Instructions
Give a probable explanation for this shift.

Solution 93 (4–6 min.)

Low-volume products often require more special handling, such as more machine setups and
inspections, than high-volume products. Also, the overhead costs incurred by the low-volume
product are often disproportionate to a traditional allocation base such as direct labor hours.

Ex. 94
Compute activity-based costing rates from the following budgeted data for Tatum's Tools:

Activity Cost Pool Budgeted Cost Budgeted Cost Driver

Designing $2,550,000 75,000 labor hours
Machining 525,000 21,000 machine hours
Packing 465,000 31,000 labor hours
 Activity-Based Costing 4-19

Solution 94 (3–5 min.)

Designing ($2,550,000 ÷75,000) = $34 per labor hour
Machining ($525,000 ÷ 21,000) = $25 per machine hour
Packing ($465,000 ÷ 31,000) = $15 per labor hour

Ex. 95
Holiday Favorites manufactures a wide variety of holiday and seasonal decorative items.
Holiday's activity-based costing overhead rates are:
Purchasing $340 per order
Storing $2 per square foot/days
Machining $100 per machine hour
Supervision $4 per direct labor hour

The Haunted House Project involved three purchase orders, 4,000 square feet/days, 60 machine
hours, and 30 direct labor hours. The cost of direct materials on the job was $17,000 and the
direct labor rate is $30 per hour.

Instructions
Determine the total cost the Haunted House Project.

Solution 95 (5–7 min.)

Direct materials $ 17,000
Direct labor (30 × $30) 900
Factory overhead
Purchasing (3 × $340) $ 1,020
Storing (4,000 × $2) 8,000
Machining (60 × $100) 6,000
Supervision (30 × $4) 120 15,140
Total cost $33,040

Ex. 96
Label the following costs as value-adding (VA) or nonvalue-adding (NVA):
____ 1. Engineering design
____ 2. Machine repair
____ 3. Inventory storage
____ 4. Machining
____ 5. Assembly
____ 6. Painting
____ 7. Inspections
____ 8. Packaging

Solution 96 (3–5 min.)

1. VA 5. VA
2. NVA 6. VA
3. NVA 7. NVA
4. VA 8. VA

Ex. 97
Borke and Falvery is a law firm that uses activity-based costing. Classify these activities as value-
added or nonvalue-added:
_______________ 1. Taking appointments
_______________ 2. Reception
_______________ 3. Meeting with clients
4-20 Test Bank for Managerial Accounting, Third Edition

_______________ 4. Bookkeeping
_______________ 5. Court time
_______________ 6. Meeting with opposing attorneys
_______________ 7. Billing
_______________ 8. Advertising

Solution 97 (3–5 min.)

1. Nonvalue-added 5. Value-added
2. Nonvalue-added 6. Value-added
3. Value-added 7. Nonvalue-added
4. Nonvalue-added 8. Nonvalue-added

Ex. 98
Brewer & Carr, PSC is an architectural firm that uses activity-based costing. The three activity
cost pools used by Brewer & Carr are: Salaries and Wages, Travel Expense, and Plan
Reproduction Expense. The firm has provided the following information concerning activity and
costs:
Salaries and wages $360,000
Travel expense 80,000
Plan reproduction expense 120,000
Total $560,000
Activity Cost Pools
Project Business
Assignment Development Other
Salaries and wages 60% 30% 10%
Travel expense 40% 40% 20%
Plan reproduction expense 30% 40% 30%
Ex. 98 (cont.)
Instructions
Calculate the total cost to be allocated to the (a) Project Assignment, (b) Business Development,
and (c) Other activity cost pools.

Solution 98 (6–9 min.)

Activity Cost Pools
(a) (b) (c)
Project Business
Assignment Development Other Total
Salaries and wages $216,000 $108,000 $36,000 $360,000
Travel expense 32,000 32,000 16,000 80,000
Plan reproduction expense 36,000 48,000 36,000 120,000
Total $284,000 $188,000 $88,000 $560,000

Ex. 99
Tim Taylor Tool Company manufactures small tools. Classify each of the following activity costs
of the tool company as either unit level, batch level, product level, or facility level:
_______________ 1. Plant management
_______________ 2. Drilling
_______________ 3. Painting
_______________ 4. Machine setups
_______________ 5. Product design
_______________ 6. Cutting
_______________ 7. Inspection
 Activity-Based Costing 4-21

_______________ 8. Inventory management

Solution 99 (4–6 min.)

1. Facility 5. Product
2. Unit 6. Unit
3. Unit 7. Unit
4. Batch 8. Product
4-22 Test Bank for Managerial Accounting, Third Edition

COMPLETION STATEMENTS
100. In traditional costing systems, direct labor cost is often used for the assignment of all
____________________.

101. A __________________ is any activity that has a direct cause-effect relationship with the
resources consumed.

102. In activity-based costing, overhead costs are allocated to ____________________, then

assigned to products.

103. The number of ___________________ is an appropriate cost driver for the ordering and
receiving activity cost pool.

104. The primary benefit of activity-based costing is ___________________ product costing.

105. When product lines differ greatly in volume and manufacturing complexity, a switch from
traditional costing to ___________________ is indicated.

106. ______________________ increase the worth of a product or service to customers.

*107. A primary objective of __________________ processing is to eliminate all manufacturing

inventories.

*108. Dependable suppliers, a multi-skilled workforce, and a __________________________

are necessary elements of just-in-time processing.

109. In the hierarchy of activity levels, the four levels are __________, ___________,
____________, and _____________.

110. Equipment setups are a ______________-level activity.

Answers to Completion Statements

100. overhead costs
101. cost driver
102. activity cost pools
103. purchase orders
104. more accurate
105. activity-based costing
106. value-added activities
107. just-in-time
108. total quality control system
109. unit, batch, product, facility
110. batch
 Activity-Based Costing 4-23

MATCHING
111. Match the items in the two columns below by entering the appropriate code letter in the
space provided.

A. Pull approach F. Just-in-time processing

B. Cost driver G. Batch-level activity
C. Facility-level activity H. Product-level activity
D. Unit-level activity I. Nonvalue-added activity
E. Activity-based costing J. Value-added activity

_____ 1. Allocates overhead to multiple activity cost pools, then assigns the activity cost pools
to products.

_____ 2. An activity that has a direct cause-effect relationship with the resources consumed.

_____ 3. Increases the worth of a product or service to customers.

_____ 4. Should be eliminated or reduced.

_____ 5. Plant management.

_____ 6. Engineering changes.

_____ 7. Equipment setups.

_____ 8. Assembling.

_____ 9. Primary objective is to eliminate all manufacturing inventories.

_____ 10. Used to initiate manufacturing under JIT processing.

Answers to Matching
1. E 6. H
2. B 7. G
3. J 8. D
4. I 9. F
5. C 10. A
4-24 Test Bank for Managerial Accounting, Third Edition

SHORT-ANSWER ESSAY QUESTIONS

S-A E 112
Borg Corporation uses a traditional costing system. Management is considering switching to an
activity-based costing system. What steps must Borg take in initiating an activity-based costing
system?

Solution 112
Borg Corporation must first identify the major activities that pertain to the manufacture of specific
products, then allocate manufacturing overhead to activity cost pools. Next, Borg must identify
the cost drivers that accurately measure each activity's contribution to the finished product and
compute activity-level overhead rates for each pool. Finally, the manufacturing overhead costs
for each activity pool must be allocated to products, using the activity-based overhead rates.

S-A E 113
Seven Company produces phasers (sales of 200,000 units per year) and force field enhancers
(sales of 25,000 units per year). If Seven switches from traditional costing to activity-based
costing, what is the likely effect on overhead assigned to the two products?

Solution 113
When overhead is properly assigned in ABC, it will usually increase the unit cost of low-volume
products like the force field enhancers. This is because low-volume products often require more
special handling, such as machine setups and inspections, than high-volume products. Also,
overhead costs incurred by low-volume products often are disproportionate to a traditional
allocation base.

S-A E 114
What are the conditions that would indicate to the management of a firm that they should switch
from traditional costing to activity-based costing?

Solution 114
The presence of one or more of the following conditions indicates ABC as the superior costing
system:
1) Product lines differ greatly in volume and manufacturing complexity.
2) Product lines are numerous, diverse, and require differing degrees of support services.
3) Overhead costs constitute a significant portion of total costs.
4) The manufacturing process or the number of products has changed significantly.
5) Production or marketing managers are ignoring data provided by the existing system and are,
instead, using alternative data in decision-making.