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Test Bank for Accounting for Decision Making and Control- 9th Edition -Zimmerman

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Test Bank for Accounting for Decision Making and Control- 9th Edition -Zimmerman

 

 

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Test Bank for Accounting for Decision Making and Control- 9th Edition -Zimmerman

SAMPLE
Chapter 11

Criticisms of Absorption Cost Systems: Inaccurate Product Costs

 

Multiple Choice Questions

1. When traditional absorption costing is employed, which of the following is false?

A. In a multi-product organization, product costs are properly reported for financial reporting purposes

B. In a single product organization, product costs are properly reported for financial reporting purposes

C. In a multi-product organization, product costs are accurately reported for decision-making purposes

D. In a single product organization, product costs are accurately reported for decision-making purposes

E. None of the above

2. Which of the following is a correct matching of terms?

A. Depreciation of equipment is a batch-level cost

B. Cutting a table leg is a unit-level cost

C. Insurance is a product-level cost

D. Package design is a production-sustaining cost

E. None of the above

3. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

For a Standard inkstone, which is true of the materials input needed (to 3 significant figures)?

A. Total weight is 2.279 pounds

B. Total weight is 2.213 pounds

C. Total weight is 2.140 pounds

D. Total weight is 1.875 pounds

E. None of the above

4. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

For a Masterpiece inkstone, which is true of the direct labor hours (DLH) needed (to 3 decimal places)?

A. Total DLH are 4.100

B. Total DLH are 4.401

C. Total DLH are 4.406

D. Total DLH are 4.450

E. None of the above

5. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

For a Standard inkstone, which is true of the machine hours (MH) needed (to 3 decimal places)?

A. Total MH are 1.188

B. Total MH are 1.305

C. Total MH are 1.338

D. Total MH are 1.397

E. None of the above

6. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor hours are used as the cost driver? (Allow a little for rounding errors).

A. $133.47

B. $106.47

C. $102.55

D. $96.10

E. None of the above

7. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Which is the full (absorption) cost of a Standard inkstone, if machine hours are used as the cost driver? (Allow a little for rounding errors).

A. $94.81

B. $101.89

C. $107.25

D. $107.88

E. None of the above

8. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor dollars are used as the cost driver? (Round overhead absorption rate to 3 decimal places).

A. $131.01

B. $134.15

C. $121.11

D. $127.87

E. None of the above

9. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Dehli Inkstone recently employed a cost analyst, who recommended the adoption of an ABC system to obtain a more accurate understanding of the costs of the Standard and Masterpiece products. She has classified the overheads into the following four cost pools and identified the appropriate cost drivers:

Cost Pool Dollars Cost Driver
Materials handling $121,000 Pounds of raw materials
Inspection $48,400 Inspections
Machine operation & maint. $163,350 Machine hours
Labor-related costs $254,650 Direct Labor dollars
$587,400
Independent of your answers above, assume total planned output is 25,595 units. What is the correct materials handling cost rate?

A. $2.209 per lb.

B. $2.521 per lb.

C. $2.136 per lb.

D. $2.572 per lb.

E. None of the above

10. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

What is true when ABC is used in Dehli Inkstone?

A. Machine operations costs run $5.025 per machine hour

B. Labor-related costs are $0.143 per direct labor dollar

C. Inspection costs are $1.891 per inspection

D. Labor-based overheads are 19.6% per direct labor dollar

E. None of the above

11. What is true when ABC is used?

A. The full cost of the Masterpiece is $132.96

B. Prime cost of the Standard is $50.75

C. The full cost of the Standard is $107.43

D. ABC overheads allocated to Masterpiece total $25.52

E. None of the above

12. For Dehli Inkstone, is it worth implementing a full-fledged ABC system, based upon the findings for these two products?

A. No, for Standard the cost difference between using machine hours and ABC is less than 30 cents per unit, so adoption of the ABC system is not cost-beneficial

B. Yes, all of the single-base allocation systems over cost the Masterpiece

C. No, for Masterpiece the cost difference between using labor hours and ABC is less than 40 cents per unit, so adoption of the ABC system is not cost-beneficial

D. No, the ABC system has failed to reduce total overheads

E. No, the proportions of the different inputs consumed by each product are not sufficiently different to make ABC worthwhile

 

Essay Questions

13. Honey Lake Summer Camp

For many years the Honey Lake Summer Camp had used the number of campers per week to estimate weekly costs. The summer camp is open for ten weeks during the summer with a different number of campers each week. July is busiest with June and the end of August least busy. Costs from the last week of summer camp in Year 1 are used to estimate costs for Year 2 for pricing purposes. The following costs occurred during the last week of Year 1 and the costs of each cost category are expected to be the same for Year 2:

Weekly Cost
Supervisor’s salary $400
Cook’s salary 300
Camp counselor salaries (1 for each occupied cabin, each of
which hold 10 campers) (5 counselors × $200/counselor) 1,000
Food (50 campers × $100/camper) 5,000
Supplies (50 campers × $20/camper) 1,000
Utilities (50 campers × $10/camper) 500
Insurance (50 campers × $20/camper) 1,000
Property tax ($10,000/10 weeks) 1,000
Weekly total $12,200
Cost per camper: $12,200/50 campers = $244/camper

The Honey Lake Summer Camp expects 75 campers during the second week of July.

Required:

a. What is the expected cost of that week using the average cost?
b. What is the expected cost of that week using ABC?

 

 

14. Different Overhead Allocation Bases

Step Up Inc. produces blue things and gray things. Blue things are in much greater demand in the market and the firm sells 120,000 blue things a year. Step Up Inc. sells 6,000 gray things per year in small boutiques. Things have a short shelf life. They must be distributed, sold, and consumed within two months of manufacture.
Both things use the identical production process and production facilities. Direct labor is $0.50 per thing and direct material is $0.50 per thing. Things are produced in batches. Blue things are produced in batches of 600 units and gray things in batches of 30. Each batch of things goes through the thingamajig, which is the machine that converts raw inputs into things. Each batch requires engineers to reset the machine for the next batch, calibrate settings, and test the first 10 things for product quality and conformity to standards. Even if sequential batches of the same things are made, setups must be performed for each new batch. All the overhead costs are incurred in setups. Indirect labor, indirect materials, and supplies consumed during setup cost $360,000 per year. The only costs of producing things are direct labor, direct materials, and the overhead of setups. The company is currently allocating setup costs to things based on direct labor cost.
The firm has been selling blue things for $4 per unit and gray things for $6 per unit. But foreign competition for blue things is starting to put pressure on the $4 price. Some competitors are selling blue things for as low as $3 per unit. Management is considering putting more emphasis on selling gray things, whose margins are higher. On the other hand, management worries that the current system for allocating overhead costs is misrepresenting the costs of the two products because direct labor costs are not representative of the time spent by each product on the thingamajig. Management is considering allocating setup costs using machine hours on the thingamajig. A batch of gray things requires one hour of machine time and a batch of blue things requires 20 hours of machine time.

Required:

Analyze the present situation. Is there anything wrong with the costing system? If so, should management change to the proposed allocation base of machine hours?

 

 

 

 

15. Describe ABC

Required:

a. What is activity-based costing and how does it differ from traditional absorption costing?
b. Describe the advantages and disadvantages of activity-based costing systems.

 

 

 

 

16. Decision Management vs. Decision Control of ABC

Critically discuss the following quotation:

“ABC (activity-based cost) information, by itself, does not invoke actions and decisions leading to improved profits and operating performance…. For ABC systems to be effective, everyone in the company—from top management to operating personnel—must view them as cost management tools rather than as accounting tools. To achieve this objective, the accounting or finance department must relinquish ownership of these systems to the users. If accounting or finance fails to understand this key point, then ABC is unlikely to succeed…. While traditional systems are the property of accounting and are used to support the financial accounting process, successful ABC systems are owned by the functions and are designed to support the needs of cost management, not financial accounting. The result is a reduction in the role of accounting in the management of costs. [M]ost companies that implement ABC systems run them in parallel to their financial accounting systems. Parallel systems remove the risk of compromising the cost management capabilities of ABC to accommodate financial accounting rules and regulations.” (Source: R. Cooper, “Look Out, Management Accountants,” Management Accounting, May 1996, pp. 20-21.)

 

 

 

 

17. ABC Systems Can Still Produce Inaccurate Product Costs

Accurate Cost Manufacturing, Inc., manufactures and sells large business equipment for the office and business markets. The primary function of Manufacturing is to provide components and subassemblies for the profit centers within the company. To maintain competitiveness, each profit center can purchase parts either from Manufacturing or from outside firms. Manufacturing operates as a cost center and charges the profit centers for the full cost of the parts. Costs are computed once a year using full absorption costing. The volume of parts used to calculate costs is provided by the profit centers to Manufacturing in August; the fiscal year begins in January. With these numbers, Manufacturing projects costs per part for the year. These cost estimates are then used throughout the year to charge the profit centers. Any over/under-absorbed overhead goes directly to the bottom line of the company, not to any of the profit centers.
Within Manufacturing there is a department called finishing. The finishing department provides a service to other Manufacturing departments and profit centers as well as generating some external sales. Types of finishing include painting and plating. The facility has large investments in fixed assets in both automation and environmental compliance for finishing. The finishing operation believes it provides value to customers through its high quality and its close location to the manufacturing departments.
During the past year, the profit centers have begun taking work away from Manufacturing and giving it to outside vendors with lower quoted costs. Manufacturing then has lower volumes and has to raise the prices on the products it is producing, causing the profit centers to send even more work out. Manufacturing feels it is caught in a death spiral.
The death spiral situation has affected finishing the most. The finishing department is currently operating at 30 percent of capacity and has facilities that are too large for the low volume of work. Table 1 summarizes the data pertaining to finishing. Fixed costs make up 71 percent of the current cost structure. Other manufacturing departments are beginning to tell finishing that they will be sending their work out to get plating and painting so as not to lose any work because of the high internal cost of finishing.
Finishing is trying to attract business from outside Accurate Cost Manufacturing. The external sales guidelines require a 35 percent profit margin applied to the full cost for all external work. With the current low level of work and high fixed costs, finishing cannot attract external sales due to cost.
In an effort to gain control of the true cost drivers of the business, the manager of the finishing operation has implemented activity-based costing. Tables 2 and 3 project the cost for products and volumes for one plating operation. The problem that the finishing manager now faces is that the manufacturing departments are about to send the 12-inch and 18-inch work to an outside shop due to lower costs.
In implementing activity-based costing, the manager thinks he has truly identified the proper system. The larger parts tend to run in smaller lot sizes and generate more paperwork. Smaller parts tend to be run in larger lot sizes and generate less paperwork.
In a recent meeting with the management of the manufacturing department and profit centers, it was stated that the installation of activity-based costing is in direct conflict with the change in the mix of work from small parts to large parts and the need to run smaller lot sizes. The manufacturing department and profit centers would like to pursue just-in-time manufacturing and further reduce the lot sizes for both small and large parts. During this meeting, the profit centers and manufacturing departments said the implementation of activity-based costing would force them to move their work out of the finishing department to outside shops.

Table 1
Finishing Annual Cost Structure
Annual Cost
Fixed asset depreciation $400,000 $4,000,000 machine purchased 2 years ago
Tank operations costs 250,000 Cost to operate tanks—fixed cost, not volume dependent
Tank material cost 50,000 Cost to operate tanks—$0.007575/inch
Variable labor cost 210,000 $10/hour × 21,000 hours of operation
Total $910,000

Table 2
Finishing Costs before and after Activity-Based Costing
Volume of Pieces per Year* Old Cost per Piece Activity-Based Cost per Piece Outside Cost per Piece
3″ parts 1,000,000 $0.50 $0.31 $0.30
6″ parts 200,000 1.00 1.00 1.10
12″ parts 50,000 1.20 2.00 0.90
18″ parts 100,000 1.50 3.00 1.20

Table 3
Forecasted Costs
Old Cost Activity-Based Cost Outside Cost
3″ parts $500,000 $310,000 $300,000
6″ parts 200,000 200,000 220,000
12″ parts 60,000 100,000 45,000
18″ parts 150,000 300,000 120,000
Total per year $910,000 $910,000 $685,000
Required:

a. Analyze the current situation in this company. What should be done?
b. Compare and comment on the costs before and after ABC is implemented.
c. Has finishing management made a mistake by installing activity-based costing?

 

 

 

 

18. ABC versus Traditional Absorption Costing

Last year CCB Medical Technologies (CCB) introduced a proprietary orthopedic surgical saw that is used in a variety of orthopedic applications. However, its largest demand is in hip replacement surgeries. The electric reciprocating saw’s patented technology (including the blade) reduces noise and vibration and increases precision cutting, thereby reducing postoperative complications. CCB manufactures and sells both the saw and blades. CCB blades are designed and engineered specifically for the CCB saw, and CCB saws are designed to only be used with CCB blades. When an orthopedic surgeon performs a surgery, each blade is dedicated to one particular patient and, once used, the blade is discarded. Surgeons often use two or three blades during surgery on a patient. CCB saws sell for $2,000 each and CCB blades sell for $450 per blade.
CCB manufactures both the saw and blades in the same factory. The following table summarizes the variable and direct costs of the saws and blades and the number of units of each product produced and sold last year.

Saws Blades
Units produced 330 12,000
Units sold 300 9,000
Beginning inventory 0 0
Direct labor per unit $54.00 $12.00
Direct materials per unit $185.00 $38.00
Variable manufacturing overhead per unit $22.00 $8.00
CCB uses an activity-based costing system to assign fixed manufacturing overhead to the saws and blades. There are three fixed manufacturing overhead cost pools in the ABC system: batch costs, product-line engineering costs, and other factory overhead. The following describes the ABC methodology:

• Batch costs ($173,000 last year): Batch costs are allocated to the two product lines based on the number of batches manufactured during the year. Saws are produced in batch sizes of 10 saws per batch and blades are manufactured in batch sizes of 500 blades per batch.
• Product-line engineering costs ($724,000 last year): Product-line engineering costs are assigned to the two product lines (saws and blades) after a survey of the engineers inquiring how they spent their time. Based on last year’s survey, $289,000 was assigned to saws and $435,000 was assigned to blades.
• Other factory overhead ($330,000): Other factory overhead consists of all other fixed manufacturing overhead not included in either batch costs or product-line engineering costs. These costs are allocated to the saws and blades based on direct labor cost.

Required:

a. Compute CCB’s unit manufacturing costs and operating margins (revenues less cost of goods sold) for last year for the saws and blades using the activity-based costing methodology described above.
b. Having seen the ABC income statements prepared in part (a), CCB management wants to see how the operating margins (revenues less cost of goods sold) for the saws and blades would look if traditional absorption costing is used where the total fixed factory overhead is allocated to the saws and blades using direct labor dollars.
c. Make a recommendation to management as to whether ABC (part a) or traditional absorption costing (part b) should be used. Justify your recommendation.

 

 

 

 

Chapter 11 Criticisms of Absorption Cost Systems: Inaccurate Product Costs Answer Key

Multiple Choice Questions

1. When traditional absorption costing is employed, which of the following is false?

A. In a multi-product organization, product costs are properly reported for financial reporting purposes

B. In a single product organization, product costs are properly reported for financial reporting purposes

C. In a multi-product organization, product costs are accurately reported for decision-making purposes

D. In a single product organization, product costs are accurately reported for decision-making purposes

E. None of the above
Where a company makes multiple products or offers a variety of services, simple full costing, which accumulates overheads in one cost pool and then allocates them to products utilizing one cost base (such as direct labor hours, or sometimes machine hours), rarely matches accurately costs generated to the products that caused them.

In a single product or single service organization, overhead allocation is irrelevant.

 

AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Topic: Inaccurate Product Costs

2. Which of the following is a correct matching of terms?

A. Depreciation of equipment is a batch-level cost

B. Cutting a table leg is a unit-level cost

C. Insurance is a product-level cost

D. Package design is a production-sustaining cost

E. None of the above
This activity can be traced directly to a unit of product, whether the activity is performed manually (i.e., direct labor) or by machine.

The correct matching of the other terms appears below:

Depreciation of equipment is a product-level cost. Depreciation of air-conditioning plant or buildings would be a production-sustaining cost. Insurance is production-sustaining. Package design is a product-level cost.

 

AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Topic: Choosing Cost Drivers

3. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

For a Standard inkstone, which is true of the materials input needed (to 3 significant figures)?

A. Total weight is 2.279 pounds

B. Total weight is 2.213 pounds

C. Total weight is 2.140 pounds

D. Total weight is 1.875 pounds

E. None of the above

‘Standard’ Quantities Materials
Bubble wrap, carton, lbs. 0.375
Materials, gross lbs. 1.838
Total inputs 2.213
When there is waste in the process, work backwards to find the inputs needed.
Gross up the last stage items first to find the needed input.

Packing is performed on 100% good units.
Package materials do not need adjustment.

Materials are wasted at both stages in the process, so they must be grossed up twice.

To get one good preliminary unit, 1.17647 units must be started (1 ÷ .85). To get a good standard you need to start with 1.2255 preliminary units (1.17647 ÷ .96). So the total materials used to get one good standard is 1.838 lbs. (1.2255 × 1 ½ lbs.).

 

AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs

4. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

For a Masterpiece inkstone, which is true of the direct labor hours (DLH) needed (to 3 decimal places)?

A. Total DLH are 4.100

B. Total DLH are 4.401

C. Total DLH are 4.406

D. Total DLH are 4.450

E. None of the above

‘Masterpiece’ Quantities DLH
Packaging labor 0.100
Craftsperson labor, gross DLH 3.125
Drilling, gross DLH 1.225
Total inputs 4.450
Using the same logic as in Q11-3, to get one good standard, you must drill 1.225 units (see Q11-3), which each requires 1 DL hour per unit. Each master craftsman wastes 4% of the units, so to get 1 good unit, they must start 1.0417 preliminary units (1.0417 × .96 = 1.00 units). Since each Masterpiece inkstone requires 3 hours, to produce one acceptable masterpiece requires 3.125 DLH (1.0417 × 3).

 

AACSB: Knowledge Application
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AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs

5. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

For a Standard inkstone, which is true of the machine hours (MH) needed (to 3 decimal places)?

A. Total MH are 1.188

B. Total MH are 1.305

C. Total MH are 1.338

D. Total MH are 1.397

E. None of the above

Standard Quantities MH
Craftsperson labor, gross MH 0.521
Drilling, gross MH 0.817
Total inputs 1.338
To get one good standard unit, you must drill 1.225 units (see Q11-3), which requires 2/3 machine hours per unit (2/3 × 1.225 = 0.817). Also, to finish a standard requires another half hour of machine time. Before waste of 4%, 1.0417 basic units must be finished which requires 0.521 MH (1.0417 × 0.5 MH).

 

AACSB: Knowledge Application
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Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs

6. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor hours are used as the cost driver? (Allow a little for rounding errors).

A. $133.47

B. $106.47

C. $102.55

D. $96.10

E. None of the above

Qty Cost Masterpiece
Materials, gross lb. 1.838 $20 $36.76
Bubble wrap, carton 0.375 $0.50 $0.50
Drilling, gross DLH 1.225 $10 $12.25
Craftsperson labor 3.125 $18 $56.25
Packaging time 1/10 $10 $1.00
Total DLH 4.450
Direct cost $106.77
Overheads applied, per DLH $6.00 $26.70
Full cost $133.47

OH Rate = Est. Overheads $587,400 = $6.00 per DLH
Est. DLH 97,900

AACSB: Knowledge Application
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Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs

7. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Which is the full (absorption) cost of a Standard inkstone, if machine hours are used as the cost driver? (Allow a little for rounding errors).

A. $94.81

B. $101.89

C. $107.25

D. $107.88

E. None of the above
The problem data did not provide the number of machine hours available, only budgeted labor hours and budgeted product output mix. The first step is to compute the units of product that can be made with the labor hours, split into the product mix and finally compute the total machine hours needed.

COMPUTATIONS
1. Standard craftsperson MH
Input = Output 0.521 1/2 MH
(1 -waste 2%) 96.00%
2. Masterpiece craftsperson MH
Input = Output 1.042 1 MH
(1 -waste 2%) 96.00%
3. Basic MH
Input = Output 0.817 2/3 MH
(1 -waste 1%) (1- waste 2%) 85.00% 96.00%

Standard Masterpiece
Output% 60% 40%
DLH 3.409 4.450
Product Weighted DLH 2.045 1.780 3.825
Available DLH 97,900 25,595 units of good output
Product Weighted DLH 3.825
Units of output (rounded up) 15,357 10,238 25,595
Standard, gross MH 0.521
Masterpiece, gross MH 1.042
Drilling, gross MH 0.817 0.817
Total MH input 1.338 1.859
Total MH needed 20,547.67 19,032.44 39,580.11
Once budgeted total machine hours are known, it is then possible to derive the overhead rate per machine hour ($14.841), which is multiplied by planned product machine hours to determine overheads applied.

Qty Cost Standard
Materials, gross lb. 1.838 $20 $36.76
Bubble wrap, carton 0.375 $0.50 $0.50
Drilling, gross DLH 1.225 $10 $12.25
Craftsperson labor, gross DLH 2.083 $18 $37.50
Packaging time 1/10 $10 $1.00
Total DLH 3.409
Direct cost $88.02
Gross MH 1.338
Overheads applied, per MH $14.84 $19.86
Full cost $107.88

OH Rate = Est. Overheads
Est. MH $587,400
39,580 = $14.841 per MH

AACSB: Knowledge Application
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Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs

8. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Which is the full (absorption) cost of a Masterpiece inkstone, if direct labor dollars are used as the cost driver? (Round overhead absorption rate to 3 decimal places).

A. $131.01

B. $134.15

C. $121.11

D. $127.87

E. None of the above

Qty Cost Masterpiece
Materials, gross lb. 1.838 $20 $36.76
Bubble wrap, carton 0.375 $0.50 $0.50
Drilling, gross DLH 1.225 $10 $12.25
Craftsperson labor 3.125 $18 $56.25
Packaging time 1/10 $10 $1.00
Total DLH, DL$ per unit 4.450 $69.50
Overheads applied, per DL$ $0.3940 $27.38
Full cost $134.15

COMPUTATIONS
OH Rate = Est. Overheads $587,400 = $0.394 per DL$
Est. DL$ $1,490,909
Standard Masterpiece Total
Units of output (rounded up) 15,357 10,238 25,595
* DL$ per unit $50.75 $69.50
Total DL$ $779,368 $711,541 $1,490,909

AACSB: Knowledge Application
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Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Inaccurate Product Costs

9. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

Dehli Inkstone recently employed a cost analyst, who recommended the adoption of an ABC system to obtain a more accurate understanding of the costs of the Standard and Masterpiece products. She has classified the overheads into the following four cost pools and identified the appropriate cost drivers:

Cost Pool Dollars Cost Driver
Materials handling $121,000 Pounds of raw materials
Inspection $48,400 Inspections
Machine operation & maint. $163,350 Machine hours
Labor-related costs $254,650 Direct Labor dollars
$587,400
Independent of your answers above, assume total planned output is 25,595 units. What is the correct materials handling cost rate?

A. $2.209 per lb.

B. $2.521 per lb.

C. $2.136 per lb.

D. $2.572 per lb.

E. None of the above

Overhead cost pools Cost Cost driver units OH$ per
Materials handling $121,000 56,641.7 Pounds $2.136

COMPUTATIONS
Materials Per unit Output units Total
Pounds 2.213 25,595 56,641.7
Weight
Bubble wrap, carton, lbs. 0.375
Materials, gross lb. 1.838
Total inputs 2.213

AACSB: Knowledge Application
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AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Choosing Cost Drivers

10. This is a comprehensive problem comparing absorption costing and ABC. It is suggested that as you progress through the problem, keep track of the correct solutions, because these values will be used again later in the problem set.

Dehli Inkstone specializes in inkstone creation. Each finished inkstone needs 1½ pounds of special materials which cost $20 a pound. (One pound contains 16 ounces.) Drilling requires 1 direct labor hours, for which workers are paid $10 per hour, and 40 minutes of machine time. The preliminary product (a ‘basic’) is inspected to ensure that it is sound. Fifteen percent of the basics are rejected. It is not possible to rework these, and they have no salvage value. Each approved stone is handed to a master craftsperson who spends two hours making a ‘Standard’ product or three hours creating a ‘Masterpiece’. Standards use half an hour of machine time and Masterpieces one hour. Finished inkstones are inspected again before packing. Four percent of finished products fail the final quality control assessment and are destroyed. Crafts persons are paid $18 per hour. It takes a ‘basic’ worker six minutes to package each inkstone in bubble wrap and a shipping carton, which cost 50 cents in materials and weigh 6 ounces in total.

Total overheads are estimated to be $587,400 per year and 97,900 direct labor hours are budgeted. Production plans for the year call for 60% of output to be Standard inkstones and the balance Masterpieces.

What is true when ABC is used in Dehli Inkstone?

A. Machine operations costs run $5.025 per machine hour

B. Labor-related costs are $0.143 per direct labor dollar

C. Inspection costs are $1.891 per inspection

D. Labor-based overheads are 19.6% per direct labor dollar

E. None of the above
All are false. The correct calculations are shown below.

Determination of Cost Driver Rates
Inspection $48,400 51,190.0 Inspections $0.945
Machine operation & maint. $163,350 39,580.1 Machine hours $4.127
Labor-related costs $254,650 $1,490,908.8 DL$ $0.171

Per unit Output units Total
Inspections 2 25,595 51,190.0
Machine operations Standard Masterpiece Total
Units of output (rounded up) 15,357 10,238 25,595
Standard, gross MH 0.521
Masterpiece, gross MH 1.042
Drilling, gross MH 0.817 0.817
Total MH input 1.338 1.859
Total MH needed 20547.67 19032.44 39580.11
Direct labor costs
Units of output 15,357 10,238
× DL$ per unit $50.750 $69.500
Total DL$ $779,368 $711,541 $1,490,909

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Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Choosing Cost Drivers

11. What is true when ABC is used?

A. The full cost of the Masterpiece is $132.96

B. Prime cost of the Standard is $50.75

C. The full cost of the Standard is $107.43

D. ABC overheads allocated to Masterpiece total $25.52

E. None of the above

Qty Cost Standard Masterpiece
Materials, gross lb 1.838 $20 $36.76 $36.76
Bubble wrap, carton 0.375 $0.50 $0.50 $0.50
Drilling, gross DLH 1.225 $10 $12.25 1.225 $12.25
craftsperson labor 2.083 $18 $37.50 3.125 $56.25
Packaging time 1/10 $10 $1.00 1/10 $1.00
Total DLH, DL$ per unit 3.409 $50.75 4.450 $69.50
Direct cost $88.02 $106.77

ABC Overheads applied
Overhead cost pools OH$ per
Materials handling, per lb $2.136 2.213 $4.73 2.213 $4.73
Inspection, per $0.945 2 $1.89 2 $1.89
Machine costs, per MH $4.217 1.305 $5.50 1.826 $7.70
Labor-related costs, per DLH $0.171 $50.75 $8.67 $69.50 $11.87
Total overheads $20.79 $26.19
Full cost $108.81 $132.96

AACSB: Knowledge Application
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Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Absorption versus Activity-Based Costing: An Example
Topic: Choosing Cost Drivers

12. For Dehli Inkstone, is it worth implementing a full-fledged ABC system, based upon the findings for these two products?

A. No, for Standard the cost difference between using machine hours and ABC is less than 30 cents per unit, so adoption of the ABC system is not cost-beneficial

B. Yes, all of the single-base allocation systems over cost the Masterpiece

C. No, for Masterpiece the cost difference between using labor hours and ABC is less than 40 cents per unit, so adoption of the ABC system is not cost-beneficial

D. No, the ABC system has failed to reduce total overheads

E. No, the proportions of the different inputs consumed by each product are not sufficiently different to make ABC worthwhile
All are false. The correct calculations are shown below.

In summary, ABC overheads charged to the Masterpiece were $26.19. Using DLH, the charge was $26.70, $27.38 for DL$ and $27.69 for MH. Thus B seems plausible.

However, as the exercise demonstrated, a substantial amount of calculation (and for the firm, considerable resources expended in investigation and implementation) were incurred for little benefit in this case. The panel below shows that each product’s weighted consumption of resources was relatively stable, and thus the difference between ABC costs and the other cost bases was between 50c and $1.50.

Standard Masterpiece Total
Output 15,357 60% 10,238 40% 25,595
Input
Materials 1.838 60% 1.838 40% 47,050
Packaging 0.375 60% 0.375 40% 9,598
Inspections 2 60% 2 40% 51,190
Machine hours 1.338 52% 1.859 48% 39,580
Labor hours 3.409 53% 4.450 47% 97,911
Labor dollars $50.75 52% $69.50 48% $1,490,909
ABC is probably not a good investment in this case. However, where utilization of resources differs dramatically (let’s say Standard used the vast majority of labor hours and Masterpiece used the vast majority of machine hours, etc.), then ABC is superior than the other costing approaches at matching costs to resources consumed.

 

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Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Topic: Absorption versus Activity-Based Costing: An Example
Topic: Benefits and Costs of Activity-Based Costing
Topic: Choosing Cost Drivers
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing

Essay Questions

13. Honey Lake Summer Camp

For many years the Honey Lake Summer Camp had used the number of campers per week to estimate weekly costs. The summer camp is open for ten weeks during the summer with a different number of campers each week. July is busiest with June and the end of August least busy. Costs from the last week of summer camp in Year 1 are used to estimate costs for Year 2 for pricing purposes. The following costs occurred during the last week of Year 1 and the costs of each cost category are expected to be the same for Year 2:

Weekly Cost
Supervisor’s salary $400
Cook’s salary 300
Camp counselor salaries (1 for each occupied cabin, each of
which hold 10 campers) (5 counselors × $200/counselor) 1,000
Food (50 campers × $100/camper) 5,000
Supplies (50 campers × $20/camper) 1,000
Utilities (50 campers × $10/camper) 500
Insurance (50 campers × $20/camper) 1,000
Property tax ($10,000/10 weeks) 1,000
Weekly total $12,200
Cost per camper: $12,200/50 campers = $244/camper

The Honey Lake Summer Camp expects 75 campers during the second week of July.

Required:

a. What is the expected cost of that week using the average cost?
b. What is the expected cost of that week using ABC?

a. The average cost per camper using last year’s last week of camp is $204/camper. The total expected cost using that average cost is:

(75 campers) ($204/camper) = $15,300

b. ABC recognizes how the costs would change with different uses of activities and changing numbers of campers. In particular:

Weekly Cost
Supervisor’s salary $400
Cook’s salary 300
Camp counselor salaries (1 for each occupied cabin, each of
which hold 10 campers) (8 counselors × $200/counselor) 1,600
Food (75 campers × $100/camper) 7,500
Supplies (75 campers × $20/camper) 1,500
Utilities (75 campers × $10/camper) 750
Insurance (75 campers × $20/camper) 1,500
Property tax ($10,000/10 weeks) 1,000
Weekly total $14,550

AACSB: Knowledge Application
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Blooms: Apply
Difficulty: 1 Easy
Difficulty: 3 Hard
Topic: Choosing Cost Drivers
Topic: Inaccurate Product Costs

14. Different Overhead Allocation Bases

Step Up Inc. produces blue things and gray things. Blue things are in much greater demand in the market and the firm sells 120,000 blue things a year. Step Up Inc. sells 6,000 gray things per year in small boutiques. Things have a short shelf life. They must be distributed, sold, and consumed within two months of manufacture.
Both things use the identical production process and production facilities. Direct labor is $0.50 per thing and direct material is $0.50 per thing. Things are produced in batches. Blue things are produced in batches of 600 units and gray things in batches of 30. Each batch of things goes through the thingamajig, which is the machine that converts raw inputs into things. Each batch requires engineers to reset the machine for the next batch, calibrate settings, and test the first 10 things for product quality and conformity to standards. Even if sequential batches of the same things are made, setups must be performed for each new batch. All the overhead costs are incurred in setups. Indirect labor, indirect materials, and supplies consumed during setup cost $360,000 per year. The only costs of producing things are direct labor, direct materials, and the overhead of setups. The company is currently allocating setup costs to things based on direct labor cost.
The firm has been selling blue things for $4 per unit and gray things for $6 per unit. But foreign competition for blue things is starting to put pressure on the $4 price. Some competitors are selling blue things for as low as $3 per unit. Management is considering putting more emphasis on selling gray things, whose margins are higher. On the other hand, management worries that the current system for allocating overhead costs is misrepresenting the costs of the two products because direct labor costs are not representative of the time spent by each product on the thingamajig. Management is considering allocating setup costs using machine hours on the thingamajig. A batch of gray things requires one hour of machine time and a batch of blue things requires 20 hours of machine time.

Required:

Analyze the present situation. Is there anything wrong with the costing system? If so, should management change to the proposed allocation base of machine hours?

In this problem, there are three possible overhead allocation bases: direct labor (present system), machine hours (the proposed system), and number of batches. First, calculate product costs under each of the three allocation schemes:

1. Direct labor cost as the allocation base (present system):

Bluethings Graythings Total
Number of units 120,000 6,000 126,000
Direct labor/unit .50 .50
Direct labor cost $60,000 $3,000 $63,000
% of total direct labor cost 95.238% 4.762%
Overhead allocated 342,857 17,143 360,000
Direct material cost 60,000 3,000 63,000
Total cost $462,857 $23,143 $486,000
Unit cost $3.857 $3.857
2. Machine hours as the allocation base (proposed system):

Bluethings Graythings Total
Number of units/year 120,000 6,000 126,000
÷ number of units/batch 600 30
Number of batches/year 200 200
× number of hours per batch 20 1
Number of machine hours/year 4000 200 4200
% of total machine hours 95.238% 4.762%
Overhead allocated $342,857 $17,143 $360,000
Direct labor cost 60,000 3,000 63,000
Direct material cost 60,000 3,000 63,000
Total cost $462,857 $23,143 $486,000
Unit cost $3.857 $3.857
3. Number of batches as the allocation base:

Bluethings Graythings Total
Number of units/year 120,000 6,000 126,000
÷ number of units/batch 600 30
Number of batches/year 200 200 400
% of total batches 50% 50%
Overhead allocated $180,000 $180,000 $360,000
Direct labor cost 60,000 3,000 63,000
Direct material cost 60,000 3,000 63,000
Total cost $300,000 $186,000 $486,000
Unit cost $2.50 $31.00
Notice that allocating overhead by either direct labor or machine hours produces identical product costs. Thus, the proposed system change will not affect decision making.
There are two cost drivers in Step Up Company. Unit volume drives direct materials and direct labor, but set-ups (number of batches) appear to drive overhead costs. Allocating overhead using direct labor gives an incorrect impression of how overhead costs vary and distorts product costs. Overhead costs are incurred in set-ups. While run times per unit of thing is the same for blues and grays, batch sizes vary considerably. In fact, bluethings and graythings each required 200 batches. Therefore, each product line (as opposed to each unit of product) should be allocated an equal dollar amount of overhead. If this is done, then graythings become massive losers and bluethings are seen to be profitable, even with market price of $3 per unit.
But these allocated costs using number of batches still do not necessarily represent opportunity costs. If the thing-a-majig and set-up crews are not operating at full capacity, then the opportunity cost of a batch of graythings is $30 (just variable cost). However, if the firm is reducing the number of bluethings it can produce to make graythings (production is at capacity), then the opportunity cost of a graything is the forgone margin on a batch of bluethings plus the variable costs of the graythings. Or,

Contribution margin on batch of bluethings ($4- 1) × 600 $1800
Plus: Variable cost of a batch of graythings ($1 × 30) 30 $1,830
÷ Units of graythings per batch 30
Opportunity cost of producing a graything $61
The decision to continue to make graythings depends on i) how overhead costs vary with batches and ii) whether additional bluethings can be sold if graythings are not produced. If the size and cost of the set-up crew is invariant to the number of batches, then direct labor is probably not too bad an allocation base. If more bluethings cannot be sold, again it is not optimum to drop graythings. Graythings are covering variable cost. Just because all overhead costs are incurred in set-ups does not make set-up costs variable with number of batches. Some of the overhead costs are sunk costs and do not vary with batches (e.g., depreciation of the “thing-a-majig”).

 

AACSB: Communication
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Blooms: Apply
Difficulty: 3 Hard
Topic: Absorption versus Activity-Based Costing: An Example
Topic: Benefits and Costs of Activity-Based Costing
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing

15. Describe ABC

Required:

a. What is activity-based costing and how does it differ from traditional absorption costing?
b. Describe the advantages and disadvantages of activity-based costing systems.

An ABC system provides a finer partitioning of indirect costs than absorption costs and a different way of assigning these costs to products. Indirect costs are broken into batch-level processes, product-line processes, and all others (production sustaining). These buckets are not allocated directly to units produced using a volume-related measure but rather are assigned using the cost driver most closely associated with how costs vary in each bucket (e.g., number of batches, number of products, number of part numbers). These costs may or may not be allocated to the unit level, but usually are. The distinction between ABC and absorption costing is that the latter allocates all costs using a unit-based volume measure. ABC allocates batch and product line costs using non-unit-based volume measures.

Advantages:

more accurate product costs for decision making
focus managers’ attention on the “true” cost drivers

Disadvantages:

costly to implement
costly to operate
organizational problems might increase if ABC systems provide less control

Since few firms use ABC for internal and external reporting one must question whether for the typical production setting the benefits exceed the costs (i.e., apply the parable of the marmots and the bears).

 

AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Blooms: Remember
Difficulty: 1 Easy
Topic: Activity-Based Costing
Topic: Benefits and Costs of Activity-Based Costing
Topic: Reasons for Implementing Activity-Based Costing

16. Decision Management vs. Decision Control of ABC

Critically discuss the following quotation:

“ABC (activity-based cost) information, by itself, does not invoke actions and decisions leading to improved profits and operating performance…. For ABC systems to be effective, everyone in the company—from top management to operating personnel—must view them as cost management tools rather than as accounting tools. To achieve this objective, the accounting or finance department must relinquish ownership of these systems to the users. If accounting or finance fails to understand this key point, then ABC is unlikely to succeed…. While traditional systems are the property of accounting and are used to support the financial accounting process, successful ABC systems are owned by the functions and are designed to support the needs of cost management, not financial accounting. The result is a reduction in the role of accounting in the management of costs. [M]ost companies that implement ABC systems run them in parallel to their financial accounting systems. Parallel systems remove the risk of compromising the cost management capabilities of ABC to accommodate financial accounting rules and regulations.” (Source: R. Cooper, “Look Out, Management Accountants,” Management Accounting, May 1996, pp. 20-21.)

The author of this quote, Robin Cooper, an early advocate of ABC, makes the following implicit points:

i. ABC will not replace traditional costing methods for financial accounting.
ii. ABC will be a supplemental source of information in most firms.
iii. Dual cost systems will be used.

The author fails to discuss which system (ABC or financial accounting) will be used for performance measurement. Just giving the users control over the ABC system does not change their incentives if they are still evaluated and rewarded based on the traditional financial accounting system that remains under the control of accounting and finance.
This quotation correctly points out that in most firms successful implementation of ABC requires the users to have the decision rights over system design, not the accounting department. The likely, unstated reason why the users have decision rights over designing ABC systems is they have better specialized knowledge of the underlying cost drivers than the accounting department. However, the author fails to discuss two critical issues:

i. Why will anyone pay attention to the ABC numbers if they are still evaluated and compensated based on the traditional financial accounting numbers?
ii. How large are the costs of having two accounting systems reporting costs for the same products? For example, how large are the reconciliation costs and influence costs if two systems are used?

The quote is typical of ABC proponents. They assume that cost systems serve primarily a decision management function and they ignore the decision control role served by traditional systems under the control of accounting departments.

 

AACSB: Communication
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Measurement
Blooms: Understand
Difficulty: 2 Medium
Topic: Acceptance of Activity-Based Costing
Topic: Benefits and Costs of Activity-Based Costing

17. ABC Systems Can Still Produce Inaccurate Product Costs

Accurate Cost Manufacturing, Inc., manufactures and sells large business equipment for the office and business markets. The primary function of Manufacturing is to provide components and subassemblies for the profit centers within the company. To maintain competitiveness, each profit center can purchase parts either from Manufacturing or from outside firms. Manufacturing operates as a cost center and charges the profit centers for the full cost of the parts. Costs are computed once a year using full absorption costing. The volume of parts used to calculate costs is provided by the profit centers to Manufacturing in August; the fiscal year begins in January. With these numbers, Manufacturing projects costs per part for the year. These cost estimates are then used throughout the year to charge the profit centers. Any over/under-absorbed overhead goes directly to the bottom line of the company, not to any of the profit centers.
Within Manufacturing there is a department called finishing. The finishing department provides a service to other Manufacturing departments and profit centers as well as generating some external sales. Types of finishing include painting and plating. The facility has large investments in fixed assets in both automation and environmental compliance for finishing. The finishing operation believes it provides value to customers through its high quality and its close location to the manufacturing departments.
During the past year, the profit centers have begun taking work away from Manufacturing and giving it to outside vendors with lower quoted costs. Manufacturing then has lower volumes and has to raise the prices on the products it is producing, causing the profit centers to send even more work out. Manufacturing feels it is caught in a death spiral.
The death spiral situation has affected finishing the most. The finishing department is currently operating at 30 percent of capacity and has facilities that are too large for the low volume of work. Table 1 summarizes the data pertaining to finishing. Fixed costs make up 71 percent of the current cost structure. Other manufacturing departments are beginning to tell finishing that they will be sending their work out to get plating and painting so as not to lose any work because of the high internal cost of finishing.
Finishing is trying to attract business from outside Accurate Cost Manufacturing. The external sales guidelines require a 35 percent profit margin applied to the full cost for all external work. With the current low level of work and high fixed costs, finishing cannot attract external sales due to cost.
In an effort to gain control of the true cost drivers of the business, the manager of the finishing operation has implemented activity-based costing. Tables 2 and 3 project the cost for products and volumes for one plating operation. The problem that the finishing manager now faces is that the manufacturing departments are about to send the 12-inch and 18-inch work to an outside shop due to lower costs.
In implementing activity-based costing, the manager thinks he has truly identified the proper system. The larger parts tend to run in smaller lot sizes and generate more paperwork. Smaller parts tend to be run in larger lot sizes and generate less paperwork.
In a recent meeting with the management of the manufacturing department and profit centers, it was stated that the installation of activity-based costing is in direct conflict with the change in the mix of work from small parts to large parts and the need to run smaller lot sizes. The manufacturing department and profit centers would like to pursue just-in-time manufacturing and further reduce the lot sizes for both small and large parts. During this meeting, the profit centers and manufacturing departments said the implementation of activity-based costing would force them to move their work out of the finishing department to outside shops.

Table 1
Finishing Annual Cost Structure
Annual Cost
Fixed asset depreciation $400,000 $4,000,000 machine purchased 2 years ago
Tank operations costs 250,000 Cost to operate tanks—fixed cost, not volume dependent
Tank material cost 50,000 Cost to operate tanks—$0.007575/inch
Variable labor cost 210,000 $10/hour × 21,000 hours of operation
Total $910,000

Table 2
Finishing Costs before and after Activity-Based Costing
Volume of Pieces per Year* Old Cost per Piece Activity-Based Cost per Piece Outside Cost per Piece
3″ parts 1,000,000 $0.50 $0.31 $0.30
6″ parts 200,000 1.00 1.00 1.10
12″ parts 50,000 1.20 2.00 0.90
18″ parts 100,000 1.50 3.00 1.20

Table 3
Forecasted Costs
Old Cost Activity-Based Cost Outside Cost
3″ parts $500,000 $310,000 $300,000
6″ parts 200,000 200,000 220,000
12″ parts 60,000 100,000 45,000
18″ parts 150,000 300,000 120,000
Total per year $910,000 $910,000 $685,000
Required:

a. Analyze the current situation in this company. What should be done?
b. Compare and comment on the costs before and after ABC is implemented.
c. Has finishing management made a mistake by installing activity-based costing?

This case study illustrates that poorly designed ABC systems trying to recover the cost of excess capacity can fail.

a. The problem is they are trying to recover a sunk cost — fixed asset depreciation of $400,000. Because volumes have fallen, the original decision to acquire this much capacity turns out to have been wrong. They should take a one-time charge to profits by writing off some or most of the $400,000 machine. This will then lower unit costs. Other issues include:

• The volume-related death spiral. When volume decreases you raise prices, volume decreases more, you raise prices more, etc.
• Is the accounting system broken? They are installing ABC to fix a broken accounting system but that is not the major problem. Allocating the historical cost of excess capacity is the problem.
• Unitized transfer price. Unitization of fixed costs provides the wrong decision information to management for short-run decision making such as pricing special orders. Beware of unitized costs.
• Both the old absorption and new ABC accounting systems are sending the wrong signal for short-run decisions. Both systems are signaling higher costs and thus the apparent necessity to raise prices. Given the high fixed costs and decreasing volume, this is an incorrect inference.
• Allocation of decision rights (decision management versus decision control). How should management change the allocation and what will the systems’ changes do to the focus of management? Are the benefits of the imperfect decentralized system outweighing the costs?

b. In reviewing the data provided in Table 2, the apparent cost drivers have been identified and “properly” allocated to the parts using ABC costing. What is not apparent is that the unitized costs are misleading in the first place. Unitizing the fixed costs will cause the apparent profitability of parts to vary with volume. This unitization is misleading and should be avoided. Since the firm has so much excess capacity, the opportunity cost of this capacity is close to zero. Thus, none of the depreciation on the plant should be charged to products.

The details of the cost drivers are not provided, although one can see shifts in parts costs of up to 100 percent. The question to be asked is what effect the changes in cost will have on the workload and whether the costs of these drivers should be reduced. If no action or effort is placed on using the data obtained from the ABC system to reduce the cost of the elements, then why incur the expense of implementing ABC? The cost and benefits of the system need to be evaluated.

c. If management is gaining a better understanding of the cost drivers of the business and implementing cost reduction activities, and the reductions outweigh the cost of ABC, then they have not made a mistake.
They may have made a mistake in the implementation process. The ABC costing system is aimed at decision management. However, the finishing department did not understand the implications of the signals that ABC costs send to the rest of the firm (decision control) for short-run decisions. If the department management operated the ABC system in parallel to the old system then they could have the information required to reduce costs and not send the misleading signals within the firm.

 

AACSB: Analytical Thinking
AACSB: Communication
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Decision Making
Blooms: Evaluate
Difficulty: 3 Hard
Topic: Absorption versus Activity-Based Costing: An Example
Topic: Acceptance of Activity-Based Costing
Topic: Benefits and Costs of Activity-Based Costing
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing

18. ABC versus Traditional Absorption Costing

Last year CCB Medical Technologies (CCB) introduced a proprietary orthopedic surgical saw that is used in a variety of orthopedic applications. However, its largest demand is in hip replacement surgeries. The electric reciprocating saw’s patented technology (including the blade) reduces noise and vibration and increases precision cutting, thereby reducing postoperative complications. CCB manufactures and sells both the saw and blades. CCB blades are designed and engineered specifically for the CCB saw, and CCB saws are designed to only be used with CCB blades. When an orthopedic surgeon performs a surgery, each blade is dedicated to one particular patient and, once used, the blade is discarded. Surgeons often use two or three blades during surgery on a patient. CCB saws sell for $2,000 each and CCB blades sell for $450 per blade.
CCB manufactures both the saw and blades in the same factory. The following table summarizes the variable and direct costs of the saws and blades and the number of units of each product produced and sold last year.

Saws Blades
Units produced 330 12,000
Units sold 300 9,000
Beginning inventory 0 0
Direct labor per unit $54.00 $12.00
Direct materials per unit $185.00 $38.00
Variable manufacturing overhead per unit $22.00 $8.00
CCB uses an activity-based costing system to assign fixed manufacturing overhead to the saws and blades. There are three fixed manufacturing overhead cost pools in the ABC system: batch costs, product-line engineering costs, and other factory overhead. The following describes the ABC methodology:

• Batch costs ($173,000 last year): Batch costs are allocated to the two product lines based on the number of batches manufactured during the year. Saws are produced in batch sizes of 10 saws per batch and blades are manufactured in batch sizes of 500 blades per batch.
• Product-line engineering costs ($724,000 last year): Product-line engineering costs are assigned to the two product lines (saws and blades) after a survey of the engineers inquiring how they spent their time. Based on last year’s survey, $289,000 was assigned to saws and $435,000 was assigned to blades.
• Other factory overhead ($330,000): Other factory overhead consists of all other fixed manufacturing overhead not included in either batch costs or product-line engineering costs. These costs are allocated to the saws and blades based on direct labor cost.

Required:

a. Compute CCB’s unit manufacturing costs and operating margins (revenues less cost of goods sold) for last year for the saws and blades using the activity-based costing methodology described above.
b. Having seen the ABC income statements prepared in part (a), CCB management wants to see how the operating margins (revenues less cost of goods sold) for the saws and blades would look if traditional absorption costing is used where the total fixed factory overhead is allocated to the saws and blades using direct labor dollars.
c. Make a recommendation to management as to whether ABC (part a) or traditional absorption costing (part b) should be used. Justify your recommendation.

a. ABC operating margins (revenues less cost of goods sold) of saws and blades:

Saws Blades Total
Direct labor per unit $54.00 $12.00
Direct materials per unit $185.00 $38.00
Variable overhead per unit $22.00 $8.00
Selling price $2,000.00 $450.00
Units produced 330 12,000
Units sold 300 9,000
Batch size 10 500
Number of batches 33 24 57
Batch costs $173,000
Cost per batch $3,035.09
Batch cost per unit manufactured $303.51 $6.07

Saws Blades Total
Product line engineering cost $289,000 $435,000 $724,000
Product line cost per unit manufactured $875.76 $36.25
Total direct labor $17,820 $144,000 $161,820
Other factory overhead $330,000
Other factory overhead per DL $ $2.0393
Other factory OH per unit $110.12 $24.47
Total ABC cost per unit manufactured $1,550.39 $124.79
ABC Operating margin:
Revenues $600,000.00 $4,050,000.00 $4,650,000.00
Cost of goods sold 465,116.61 1,123,126.30 1,588,242.91
Operating margin $134,883.39 $2,926,873.70 $3,061,757.09
b. Absorption costing operating margins (revenues less cost of goods sold) of saws and blades:

Saws Blades Total
Direct labor per unit $54.00 $12.00
Direct materials per unit $185.00 $38.00
Variable overhead per unit $22.00 $8.00
Selling price $2,000.00 $450.00
Units produced 330 12,000
Units sold 300 9,000
Absorption Costing:
Batch cost $173,000
Product line engineering cost $724,000
Other factory overhead $330,000
Total fixed manufacturing OH $1,227,000
Total direct labor $161,820
Fixed mfg OH per DL $ $7.5825
Allocated fixed mfg OH per unit $409.45 $90.99
Total cost per unit manufactured $670.4549 $148.9900
Operating margin $398,863.52 $2,709,090.10 $3,107,953.62
c. Management may prefer the absorption costing method because it increases operating margin by about $40,000. However, this is just a temporary artifact caused by the fact that some of the fixed costs ended up in inventory because more units of saws and blades were produced than sold. When these units are sold, these higher fixed costs in inventory will flow through to income. A better argument for using absorption costing is recognizing that absorption costing better supports the firm’s strategy of price discrimination. CCB sells a bundled product — saws and blades. CCB wants to sell saws at a “low” price in order to generate more blade sales. One way to do this is to “under cost” the saws and “over cost” blades. Absorption costing accomplishes this better than ABC.

 

AACSB: Analytical Thinking
AACSB: Knowledge Application
AICPA: BB Resource Management
AICPA: FN Decision Making
AICPA: FN Measurement
Blooms: Apply
Difficulty: 3 Hard
Topic: ABC Measures Costs, Not Benefits
Topic: Absorption versus Activity-Based Costing: An Example
Topic: Inaccurate Product Costs
Topic: Reasons for Implementing Activity-Based Costing