Kimmel SM Cp17 VPDF

CHAPTER 17
Activity-Based Costing
ASSIGNMENT CLASSIFICATION TABLE
Brief
Exercises
Study Objectives
Questions
*1.
Recognize the difference

between traditional costing
and activity-based costing.
1, 2, 3,
4, 5
*2.
Identify the steps in the

development of an activitybased costing system.
*3.
Know how companies

identify the activity
cost pools used in
activity-based costing.
*4.
Know how companies

identify and use cost
drivers in activity-based
costing.
6, 10, 11,
12
*5.
Understand the benefits and limitations of

13, 14, 15
*6.
Differentiate between
value-added and nonvalue-added activities.
8, 16, 17
8, 9
12, 13, 14,

15, 16
*7.
Understand the value of

using activity levels in
19
10, 11, 12
17, 18
*8.
Apply activity-based costing

to service industries.
18
9, 10
16
*9.
Explain just-in-time
(JIT) processing.
20
1, 2
Exercises
1, 2, 3, 4, 5,
6, 12, 13
A
Problems
B
Problems
1A, 3A,
4A, 5A
1B, 3B,
4B, 5B
1A, 2A,
3A,
4A, 5A
1B, 2B, 3B,

4B, 5B
1A, 5A
1B, 5B
5A
5B
7, 8
3, 4, 5, 6,
7, 12
1, 3, 4, 5, 6,
8, 9, 10, 11,
12, 13
11
*Note:All asterisked Questions, Exercises, and Problems relate to material contained in the
appendix*to the chapter.
17-1
ASSIGNMENT CHARACTERISTICS TABLE

Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
1A
Assign overhead using traditional costing and ABC;

compute unit costs; classify activities as value- or
non-value-added.
Moderate
3545
2A
Assign overhead to products using ABC and evaluate

decision.
Moderate
2535
3A
Assign overhead costs using traditional costing and ABC;

compare results.
Moderate
3545
4A

compare results.
Moderate
4050
5A
Assign overhead costs to services using traditional

costing and ABC; compute overhead rates and unit costs;
compare results.
Moderate
3545
1B
Assign overhead using traditional costing and ABC;

compute unit costs; classify activities as value- or
non-value-added.
Moderate
3545
2B
Assign overhead to products using ABC and evaluate

decision.
Moderate
2535
3B

compare results.
Moderate
3545
4B

compare results.
Moderate
4050
5B
Assign overhead costs to services using traditional

costing and ABC; compute overhead rates and unit costs;
compare results.
Moderate
3545
17-2
BLOOMS TAXONOMY TABLE
17-3
ANSWERS TO QUESTIONS
1.
Direct labor is a valid basis for allocating overhead when: (a) direct labor constitutes a significant
part of total product cost, and (b) there is a high correlation between direct labor and changes in
the amount of overhead costs.
2.
The amount of direct labor in many industries has greatly decreased, due to advances in
computerized systems, technological innovation, global competition and automation.
Total overhead costs resulting from depreciation on expensive equipment and machinery, utilities,
repairs, and maintenance have significantly increased. Many companies now use machine hours
as the basis on which to allocate overhead in an automated manufacturing environment.
3.
In many automated manufacturing environments, machine hours is a more relevant basis on

which to allocate overhead.
4.
Under a traditional volume-based costing system where overhead cost is allocated on the basis
of units of output, the high-volume product will undoubtedly absorb more overhead than the lowvolume product.
5.
(a) The principal differences are:

(1) Primary focus
(2) Bases of allocation
(3) Total product costs
Activity-Based Costing
Activities performed in making
products
Multiple cost drivers
Sum of costs of activities
consumed in making
product
Traditional Costing
Units of production
Single unit-level base
Direct materials plus direct labor
plus manufacturing overhead
(b) There are two assumptions that must be met in using ABC:
(1) All overhead costs related to the activity must be driven by the cost driver used to assign
costs to products.
(2) All overhead costs related to the activity should respond proportionally to changes in
the activity level of the cost driver.
6.
Activity-based overhead rates are computed using the following formula:

Estimated Overhead per Activity
Expected Use of Cost Drivers per Activity
7.
The four steps involved in developing an ABC system are:

(1) Identify and classify the major activities involved in the manufacture of specific products, and
allocate manufacturing overhead costs to appropriate cost pools.
(2) Identify the cost driver that has a strong correlation to the costs accumulated in the cost
pool.
(3) Compute the overhead rate per cost driver.
(4) Assign manufacturing overhead costs for each cost pool to products, using the overhead
rates (cost per driver).
17-4
Questions Chapter 17 (Continued)

8.
A value-added/non-value-added activity flowchart is based on a systematic analysis of all the

activities (resource-consuming actions and transactions) performed to manufacture a product or
render a service. The flowchart documents each activity and the time involved in each activity.
The flow chart also documents managements proposed reengineering of the manufacturing
process.
9.
An activity cost pool is the accumulated overhead cost attributed to a distinct type of activity.
10.
A cost driver is any factor or activity that has a direct cause-effect relationship with the resources
consumed. A cost driver should be an accurate and appropriate measure of an activity consumed
or performed in manufacturing a product or rendering a service.
11.
A cost driver is accurate and appropriate if it measures the actual consumption of specific activities
in manufacturing a product or rendering a service and the data relating to the cost driver is
available and easily obtained.
12.
The formula for assigning activity cost pools to products is:

Activity-based overhead rate X Number of cost drivers expected to be used per product
13.
The primary benefit of ABC is more accurate product costing. This results from using more cost
pools and enhanced control over overhead costs, and leads to better management decisions.
14.
The limitations of ABC are: (a) higher analysis and measurement costs that accompany multipleactivity cost pools and cost drivers and (b) the necessity still to allocate some costs arbitrarily.
15.
ABC is the superior costing system when: (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; and (5) data from
the
existing system is being ignored.
16.
Basic ABC has been enhanced by identifying activities as value-added and non-value-added.
17.
Identifying non-value-added activities highlights for managers the activities that should be
reduced or eliminated because they add no value to the product.
18.
The overall objective of using ABC in service industries is no different than for manufacturing
industries; that is, improved costing of services rendered (by job, service, contract, or customer).
The general approach to costing is the sameanalyze operations, identify activities, assign
overhead costs to activity cost pools, and identify and use cost drivers to assign the cost pools to
the services.
17-5
Questions Chapter 17 (Continued)

19.
Greater accuracy in cost allocation is achieved by recognizing the four levels of activity. Some
activities are affected (driven) by changes in the number of units produced, while other activities
are affected only by changes in the number of batches or the number of products, and some,
facility-level activities, are unaffected by changes in either units, batches, or products produced.
*20. (a) Just-in-time processing has a just-in-time philosophy and a demand-pull approach to eliminate
inventory. It is dedicated to having the right amount of materials, parts, or products at the
time they are needed.
(b) There are three important elements in JIT processing:
(1) A company must have dependable suppliers who are willing to deliver on short notice
exact quantities of raw materials according to precise quality specifications.
(2) A multiskilled workforce must be developed.
(3) A total quality control system must be established.
17-6
SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 17-1
(a)
Estimated annual overhead costs

= Predetermined overhead rate
Expected annual operating activity
$1,000,000
= $10 per direct labor hour
100,000
(b) 90,000 direct labor hours $10 = $900,000 overhead applied

(c) If the manufacturing process is complex, then multiple allocation
bases can result in more accurate product-cost computations. In
such situations, managers need to consider a new overhead cost
allocation method that uses multiple bases. That method is activitybased costing.
BRIEF EXERCISE 17-2
Under ABC, overhead costs are shifted from the high-volume products to
the low-volume products. This shift results in more accurate costing for
two reasons:
1.
2.
Low-volume products often require more special handling, such

as more machine setups and inspections, than high-volume
products. Thus, the low-volume product frequently is responsible
for more overhead costs per unit than is a high-volume product.
Assigning overhead using ABC will usually increase the cost per
unit for low-volume products. Therefore, a traditional overhead
allocation such as direct labor hours is usually a poor cost driver
for assigning overhead costs to low-volume products.
As a result, for Sassafras, one of the products (Product RX3) may have been
low volume and therefore may have more overhead costs assigned to it
under an ABC system.
17-7
BRIEF EXERCISE 17-3

An appropriate cost driver for each activity is:
Activity
Materials handling
Machine setups
Factory machine maintenance
Factory supervision
Quality control
Cost Driver
Number of requisitions
Number of setups
Machine hours used
Number of employees
Number of inspections
BRIEF EXERCISE 17-4

(a)
(b)
(c)
(d)
(e)
(f)
(g)
Number of parts or assemblies

Number of setups
Number of employees
Number of inspections
Number of purchase orders
Machine hours
Square footage occupied
BRIEF EXERCISE 17-5

Machine setups
Machining
Inspections
$180,000 2,500 = $72 per setup

$325,000 25,000 = $13 per machine hour
$87,500 1,750 = $50 per inspection
BRIEF EXERCISE 17-6

Activity Cost Pool
Designing
Sizing and cutting
Stitching and trimming
Wrapping and packing
Estimated
Expected Use of
Overhead Cost Drivers per Activity =
$ 450,000
4,000,000
1,440,000
336,000
12,000 Designer hours

160,000 Machine hours
80,000 Labor hours
32,000 Finished units
17-8
Activity-Based
Overhead Rates
$37.50 per designer hour
$25.00 per machine hour
$18.00 per labor hour
$10.50 per finished unit
BRIEF EXERCISE 17-7

Estimated
Expected Use of
Overhead Cost Drivers per Activity =
Activity Cost Pool

Ordering and receiving
Etching
Soldering
$ 90,000
480,000
1,760,000
Cost Drivers
11,000 orders
50,000 machine hours
500,000 labor hours
15,000 Orders
440,000 Labor hours
Activity-Based
Overhead Rates
$6.00 per order
$8.00 per machine hour
$4.00 per labor hour
Overhead
Total overhead
Rates
=
applied
$6
$ 66,000
$8
400,000
$4
2,000,000
$2,466,000
BRIEF EXERCISE 17-8

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Non-value-added
Non-value-added
Value-added
Non-value-added
Non-value-added
Non-value-added
Non-value-added
Value-added
BRIEF EXERCISE 17-9

Value-added Activities
(1) Designing and drafting
(3) On-site supervision
(5) Consultation with client
Hours
3.0
2.0
1.5
6.5
Non-value-added Activities
(2) Staff meetings
(4) Lunch
(6) Entertaining a prospective client
Hours
1
1
2
4
17-9
BRIEF EXERCISE 17-10

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Batch- or unit-level
Unit-level
Unit-level
Batch- or unit-level
Facility-level
Batch- or product-level
Batch- or product-level
Unit-level
Facility-level
Batch-level

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Facility-level
Unit-level
Product-level
Unit-level
Batch-level
Batch-level
Product-level
Facility-level

(a) Product design
$50,000
= $5,000 per product change
10
Machining
$300,000
= $2 per machine hour
150,000
Material handling
$100,000
= $1,000 per set up
100
(b) Product designproduct level

Machiningunit level
Material handlingbatch level
17-10
17-11
SOLUTIONS TO EXERCISES
EXERCISE 17-1
(a)
Estimated overhead
= Predetermined overhead rate
Direct labor costs
$300,000
= 200% of direct labor cost
$50,000 + $100,000
(b)
Activity cost pools

Machining
Machine setup
Cost drivers
Machine hours
Set up hours
Estimated overhead
$200,000
100,000
Activity-based overhead rates

Machining:
Machine setup:
$200,000
$100,000
= $100 per machine hour
= $200 per setup hour
1,000 + 1,000
500
(c)
Traditional costing
$50,000 X 200%
$100,000 X 200%
Standard
$100,000
$100,000
Custom
$200,000
$200,000
Activity-based costing
Machining:
1,000 X $100
1,000 X $100
$100,000
Machine setup:
100 X $200
400 X $200
20,000
$120,000
17-12
$100,000
80,000
$180,000
EXERCISE 17-2
(a)
Traditional costing system

Product 540X
Product 249S
Sales
$200,000
$160,000
$80,000
Costs
55,000
50,000
15,000
$145,000
$110,000
$65,000
Operating income
(b)
Product 137Y
Activity-based costing system

Product 540X
Product 137Y
Product 249S
Sales
$200,000
$160,000
$80,000
Costs
50,000
35,000
35,000
$150,000
$125,000
$45,000
Operating income
(c) Product 540X:
($150,000 $145,000) $145,000 = 3.45%
Product 137Y
($125,000 $110,000) $110,000 = 13.64%
Product 249S
($45,000 $65,000) $65,000 = (30.77%)
(d) These costs are similar probably because the cost drivers are
essentially the same; that is, they are based on a unit volume
concept.
17-13
EXERCISE 17-3
(a)
Activity cost pools

Cutting
Design
Cost drivers
Machine hours
Number of setups
Estimated overhead
$300,000
600,000
Activity-based overhead rates

Cutting
$300,000
= $1.50 per machine hour
200,000
Activity-based costing
Cutting
100,000 X $1.50
100,000 X $1.50
Design
1,000 X $400
500 X $400
Total cost allocated
(b)
Design
$600,000
= $400 per setup
1,500
Wool
Cotton
$150,000
$150,000
400,000
200,000
$350,000
$550,000
Estimated overhead
$900,000
=
Direct labors hours
450,000
Traditional costing
225,000 X $2
225,000 X $2
Wool
$450,000
Cotton
$450,000
The wool product line is allocated $100,000 ($550,000 $450,000) more

overhead cost when an activity-based costing system is used. As a result,
the cotton product line is allocated $100,000 ($450,000 $350,000) less.
17-14
EXERCISE 17-4
(a)
Direct labor hours for car wheels
(40,000 X 1) = 40,000
Direct labor hours for truck wheels (10,000 X 3) = 30,000

Total direct labor hours
70,000
$700,000 ( total estimated overhead)
70,000 (total direct labor hours)
Overhead assigned
Car wheels
(40,000 X $10)
Truck wheels
(30,000 X $10)
Total overhead
(b)
= $400,000
= 300,000
$700,000
Activity Cost Pool
Estimated
Overhead
Setting up machines
Assembling
Inspection
$180,000
280,000
240,000
(c)
Activity Cost Pools
Setting up machines
Assembling
Inspection
Total cost assigned
= $10 per direct labor hour.
Expected
Use of
Cost Drivers
ABC
Overhead
Rate
1,000
70,000
1,200
Car Wheels
Expected Use Activity-Based
of Cost Driver
Overhead
per Product
Rates
200
40,000
100
17-15
$180
$ 4
$200
$180
$4
$200
Cost
Assigned
$ 36,000
$160,000
$ 20,000
$216,000
EXERCISE 17-4 (Continued)

(c)
Activity Cost Pools
Setting up machines
Assembling
Inspection
Total cost assigned
(d)
Truck Wheels
Expected use Activity-Based
of Cost Driver
Overhead
per Product
Rates
800
30,000
1,100
$180
$ 4
$200
Cost
Assigned
$144,000
$120,000
$220,000
$484,000
Assuming that the cost drivers are a reasonable representation of

what is occurring in the two product lines, it seems appropriate to
switch to activity-based costing. By using this system, more accurate
cost information is developed which should lead to better allocation
of resources and pricing decisions in the future.
17-16
EXERCISE 17-5
(a)
Activity Cost Pools

Estimated Overhead
$90,000
$70,000
$40,000
Scheduling and travel

Setup time
Supervision
Expected use
of Cost Drivers
1,500
700
$400,000*
ABC Overhead Rates

$ 60.00
$100.00
$
.10
*$100,000 + $300,000
Activity Cost Pools

Setup time
Supervision
Total assigned costs
Activity Cost Pools

Setup time
Supervision
Total assigned costs
Commercial
Expected use of Cost
Drivers per Product
ABC Overhead Rates
1,000
$ 60.00
450
$100.00
$100,000
$
.10
Residential
Expected use of Cost
Drivers per Product
ABC Overhead Rates
500
$ 60.00
250
$100.00
$300,000
$
.10
(b)
Revenues
Direct material costs
Direct labor costs
Overhead costs
Operating income (loss)
(c)
Commercial
$300,000
$ 30,000
100,000
115,000
245,000
$ 55,000
Cost Assigned
$ 60,000
45,000
10,000
$115,000
Cost Assigned
$30,000
25,000
30,000
$85,000
Residential
$480,000
$ 50,000
300,000
85,000
435,000
$ 45,000
Assuming that the cost drivers are a reasonable representation of what is occurring in the
two product lines, it seems appropriate to switch to activity-based costing. By using this
system, more accurate cost information is developed which should lead to better
allocations of resources and more informative pricing decisions in the future.
17-17
EXERCISE 17-6
(a) Traditional costing:
$235,000 2,500 (800 + 1,700) hours
(1) One mobile safe:
800 hours X $94 = $75,200
$75,200 200 = $376 each
(2) One walk-in safe:
1,700 hours X $94 = $159,800
$159,800 50 = $3,196 each
(b) Activity-based costing:
(1) Material handling costs
$150,000 500 (300 + 200) moves = $300 per move
(a) One mobile safe:
300 moves X $300 = $90,000
$90,000 200 = $450 each
(b) One walk-in safe:
200 moves X $300 = $60,000
$60,000 50 = $1,200 each
(2) Purchasing activity costs
$85,000 800 (450 + 350) orders = $106.25 per order
(a) One mobile safe:
450 orders X $106.25 = $47,812.50
$47,812.50 200 = $239.0625 each
(b) One walk-in safe:
350 orders X $106.25 = $37,187.50
$37,187.50 50 = $743.75 each
17-18

(c) The total amount of overhead allocated to each unit of the two products
under the two allocation approaches is:
Mobile safe
Walk-in safe
Traditional
Costing
$ 376
$3,196
Activity-Based
Costing
**$689.0625**
$ 1,943.75**
**$450 + $239.0625
**$1,200 + $743.75
EXERCISE 17-7
The following activities might be identified at Quik Prints Company from
your analysis of its operations and a discussion with the owner-manager,
Damon Hastings.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Hiring and training personnel

Purchasing supplies and materials
Selling, promoting, and marketing
Billing and collecting
Designing
Offset printing
Copying
Faxing
Collating
Cutting and folding
17-19
11.
12.
13.
Maintenance and repairs

Delivery
Accounting
EXERCISE 17-8
Budgeted Costs
Activity Cost Pool
Cost Driver
Engineering design
Engineering prototypes
Engineering
Engineering hours
Depreciation, machinery
Electricity, machinery
Machinery
Machine hours
Machine setup
Number of setups
Inspections
Tests
Quality control
Number of tests or
inspections
Depreciation, plant
Insurance, plant
Property taxes
Oil, heating
Electricity, plant lighting
Factory utilities
Square feet
Machine hours
Custodial wages
Maintenance
Machine setup, indirect labor

Machine setup, indirect
materials
Number of
machines
Machine hours
EXERCISE 17-9
The following cost drivers might be used to assign overhead:
1.
2.
3.
4.
5.
6.
7.
8.
Labor hours
Labor hours
Labor hours
Gallons of chemicals
Number of cartfuls or
labor hours
Number of cartfuls
Gallons of juice
Gallons of juice
9.
10.
11.
12.
13.
14.
15.
Gallons of wine or months of aging

Number of bottles
Number of bottles
Number of boxes
Number of shipments
Number of gallons processed
Number of gallons processed
17-20
EXERCISE 17-10
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Number of engineering change orders; hours of designing

Number of orders processed
Number of parts in stock
Weight of material; number of boxes or cartons
Employee turnover; number of employees hired
Machine hours; direct labor hours
Number of employees; number of parts; direct labor
Number of employees
Book or market value of assets
Cost of goods manufactured, direct labor hours; number of
employees
Machine hours; number of machines
Gallons of paint; number of appliances
EXERCISE 17-11
(a) The overhead rates are:
Activity Cost Pools
Materials handling
Machine setups
Quality inspections
Expected Use
Estimated of Cost Drivers Activity-Based
Overhead per Activity = Overhead Rates
$35,000
1,000
$35
27,500
500
55
27,000
600
45
(b) The assignment of the overhead costs to products is as follows:

Cost Driver
Materials handling
($35)
Machine setups ($55)
Quality inspections
($45)
Total costs
assigned (a)
Units produced (b)
Instruments
Number
Cost
Gauges
Number
Cost
Cost
Assigned
400
200
$14,000
11,000
600
300
$21,000
16,500
$35,000
27,500
200
9,000
400
18,000
27,000
$34,000
$55,500
$89,500
50
300
Overhead cost per

17-21
unit (a) (b)
$680
17-22
$185

(c)
MEMO
To:
President, Fontillas Instrument, Inc.
From:
Student
Re:
Benefits of activity-based costing (ABC)
ABC focuses on the activities performed in producing a product.

Overhead costs are assigned to products based on cost drivers that
measure the activities performed on the product.
The primary benefit of ABC is more accurate and meaningful product
costing. This improved cost data can lead to reduced costs as managers
become more aware of the underlying causes of cost incurrence. Thus,
control over costs is enhanced.
The improved cost data should also lead to better management
decisions. More accurate product costing should contribute to setting
selling prices which will help achieve desired profitability levels. In
addition, it should be helpful in deciding whether to make or buy a
product part or component, and sometimes even whether to eliminate
a product.
17-23
EXERCISE 17-12
(a) (1) Traditional product costing system:
$400,000 X .70 = $280,000 Selling costs assigned in March to the
high intensity product line.
(2) Activity-based costing system:
Activity Cost Pools

Sales commissions
AdvertisingTV/Radio
AdvertisingNewspaper
Catalogs
Cost of catalog sales
Credit and collection
Total assigned cost for March
ActivityBased
Cost Drivers
Overhead
Overhead Cost
Used
X
Rates =
Assigned
$930,000
250
2,000
60,000
9,000
$930,000
$.05
$300
$10
$2.50
$1.00
$.03
$46,500
75,000
20,000
150,000
9,000
27,900
$328,400
(b) As compared to ABC, traditional costing grossly undercosts the selling

costs assigned to the high intensity product line. The difference of
$48,400 ($328,400 $280,000) in the month of March is a 14.7%
understatement.
(c) All six activities, as selling activities, are non-value-added activities.
17-24
EXERCISE 17-13
(a) (1) Traditional product costing system:
$55,000 X .17 = $9,350 Quality-control overhead costs assigned in
June to the low-calorie dessert line are $9,350 ($55,000 X .17).
(2) Activity-based costing system:
Activity Cost Pools

Inspections of material received
In-process inspections
FDA certification
Total assigned cost for June
ActivityBased
Cost Drivers
Overhead
Overhead Cost
Used
X
Rate
=
Assigned
6,000
10,000
420
$.60
$.33
$12.00
$3,600
3,300
5,040
$11,940
(b) As compared to ABC, the traditional costing system undercosts the

quality-control overhead cost assigned to the low-calorie dessert
product line by $2,590 ($11,940 $9,350) in the month of June. That is
a 21.7% understatement.
(c) All three activities, as quality-control related activities, are non-valueadded activities.
EXERCISE 17-14
1.
2.
3.
4.
5.
6.
7.
8.
Value-added. It is assumed that any activity which directly enhances or

improves the quality or quantity of the vines, grapes, or wine is a
value-added activity.
Non-value-added
9. Value-added
Value-added
10. Value-added
Value-added
11. Non-value-added
Non-value-added
12. Non-value-added
Value-added
13. Non-value-added
Value-added
14. Non-value-added
Value-added
15. Non-value-added
17-25
EXERCISE 17-15
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Value-added
Non-value-added
Non-value-added
Non-value-added
Non-value-added
Value-added
Value-added
Non-value-added
Non-value-added
Non-value-added
Non-value-added
Value-added
EXERCISE 17-16
Value-Added Activities
Writing contracts and letters
Taking depositions
Contemplating legal strategy
Litigating a case in court
Hours
1.0
1.0
1.0
2.5
5.5
Non-value-Added Activities
Attending staff meetings
Doing research
Traveling to/from court
Eating lunch
Entertaining a prospective client
Hours
0.5
1.0
1.0
1.0
2.0
5.5
Questionable Classifications
Writing contracts is value-added; writing letters may be value-added if
related to a specific case or it may be non-value-added if it is billing a client
or collecting receivables. Research may be value-added if it is unique,
related to a specific case, and is billable. Research may be nonvalue-added
if it is something the attorney should already have known and is not billable
to the client.
17-26
EXERCISE 17-17
Activity Cost Pools
Engineering
Machinery
Machine setup
Quality control
Factory utilities
Maintenance
Activity Level
Product-level
Unit-level
Batch-level
Depends on frequency. Could be unit batch
or product-level
Facility-level
Facility-level
EXERCISE 17-18
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Facility-level activity
Product-level activity
Batch-level activity
Batch-level activity
Facility-level activity
Batch-level or unit-level activity
Unit-level activity
Unit-level activity
17-27
SOLUTIONS TO PROBLEMS
PROBLEM 17-1A
(a) Computation of unit coststraditional costing.
Products
Manufacturing Costs
Direct materials
Direct labor
Overhead
Total unit cost
Home Model
Commercial Model
$18.50
19.00
*23.40*
$60.90
$26.50
19.00
*23.40*
$68.90
*$15.60 X 1.5 = $23.40
(b)
Estimated
Overhead
Activity Cost Pool

Receiving
Forming
Assembling
Testing
Painting
Packing and shipping
$ 70,350
150,500
390,600
51,000
52,580
787,250
$1,502,280
Expected
Use of Cost Drivers
Activity-Based
Overhead Rate
335,000 Pounds
217,000 Parts
25,500 Tests
5,258 Gallons
335,000 Pounds
$ .21 per pound

$ 4.30 per machine hour
$ 1.80 per part
$ 2.00 per test
$10.00 per gallon
$ 2.35 per pound
(c)
Home Model
ActivityExpected
Based
Use of
Overhead
Cost
Drivers X Rates = Assigned
Activity Cost Pool

Receiving
Forming
Assembling
Testing
Painting
Total costs assigned (a)
Units produced
215,000
27,000
165,000
15,500
3,680
215,000
$ .21
$ 4.30
$ 1.80
$ 2.00
$10.00
$ 2.35
(b)
Overhead cost per unit [(a) (b)]
17-28
$ 45,150
116,100
297,000
31,000
36,800
505,250
$1,031,300
Commercial Model
ActivityExpected
Based
Use of
Overhead
Cost
120,000
8,000
52,000
10,000
1,578
120,000
$ .21
$ 4.30
$ 1.80
$ 2.00
$10.00
$ 2.35
$25,200
34,400
93,600
20,000
15,780
282,000
$470,980
54,000
10,200
$19.10
$46.17
PROBLEM 17-1A (Continued)

(d)
ABC Manufacturing Costs
Direct materials
Direct labor
Overhead
Total cost per unit
Home Model
$18.50
19.00
19.10
$56.60
Commercial Model
$26.50
19.00
46.17
$91.67
(e)
Activity
Receiving
Forming
Assembling
Testing
Painting
Value- vs. Non-value-Added

Non-value-added
Value added
Value-added
Non-value-added
Value-added
Value-added
(f)
(1) Activity-based costing shows the commercial model absorbs

nearly 21/2 ($46.17 $19.10) times as much overhead per unit as
the home model.
(2) The comparison of ABC and traditional costing shows that the
proper amount of overhead assigned to the two products is not
equal at $23.40 but rather $19.10 for the home model and $46.17
for the commercial model. Under traditional costing, the margin of
error on the commercial model was almost 100%, an
understatement of $22.77 on an assignment of $23.40. These
distorted overhead assignments have likely led to overpricing the
home model and underpricing the commercial model.
17-29
PROBLEM 17-2A
(a) The allocation of total manufacturing overhead using activity-based
costing is as follows:
Overhead Rate
Purchase orders @ $30
Machine setups @ $50
Machine hours @ $40
Inspections @ $25
Total assigned costs (a)
Royale
Drivers
Cost
Used
Assigned
Majestic
Drivers
Cost
Used
Assigned
15,000
5,000
75,000
9,000
25,000
13,000
45,000
19,000
$ 450,000
250,000
3,000,000
225,000
$3,925,000
$ 750,000
650,000
1,800,000
475,000
$3,675,000
Units produced (b)
25,000
10,000
Cost per unit (a) (b)
$157
$367.50
Total
Overhead
$1,200,000
900,000
4,800,000
700,000
$7,600,000
(b) The cost per unit and gross profit of each model under ABC costing
were:
Direct materials
Direct labor
Manufacturing overhead
Total cost per unit
Royale
$ 700
120
157
$ 977
Majestic
$ 420.00
100.00
367.50
$ 887.50
Sales price per unit

Cost per unit
Gross profit
$1,600
977
$ 623
$1,300.00
887.50
$ 412.50
(c) Managements future plans for the two television models are not
sound. Under ABC costing, the Royale model is $210.50 ($623.00
$412.50) per unit more profitable than the Majestic model. If any product
should be phased out, it is the Majestic. But, by applying ABC and
activity-based management analysis, Jacobson may determine how to
reduce the costs of producing the Majestic model.
17-30
PROBLEM 17-3A
(a) Predetermined overhead rate using machine hours:
$830,000 100,000 hrs. = $8.30 per machine hour
(b) Manufacturing cost per stair under traditional costing:
Direct materials................................................................
Direct labor.......................................................................
Overhead (14,500 X $8.30)...............................................
Total cost of 280 stairs.............................................
$103,600
112,000
120,350
$335,950
Cost per stair ($335,950 280).......................................
$1,199.82
(c) Manufacturing cost per stair under activity-based costing:

Computation of Activity-Based Overhead Rate
Activity Cost Pools
Purchasing
Handling materials
Production
Setting up machines
Inspecting
Inventory control
Utilities
Estimated Expected Use of Cost

Overhead Drivers per Activity =
$57,000
82,000
210,000
85,000
90,000
126,000
180,000
$830,000
600 Orders
8,000 Moves
100,000 D/L Hours
1,250 Setups
6,000 Inspections
168,000 Components
90,000 Sq. ft.
Activity-Based
Overhead Rate
$95 per order
$10.25 per move
$2.10 per D/L hour
$68 per setup
$15 per inspection
$.75 per component
$2.00 per sq. ft.
Assignment of Overhead to Order of 280 Stairs

Activity Cost Pools
Expected Use of
Cost Drivers
Purchasing
60 Orders
Handling materials
800 Moves
Production
5,000 D/L Hours
Setting up machines 100 Setups
Inspecting
450 Inspections
Inventory control
16,000 Components
Utilities
8,000 Sq. ft.
Total overhead assigned
17-31
Activity-Based
X Overhead Rates = Cost Assigned
$95
$10.25
$2.10
$68
$15
$.75
$2.00
$5,700
8,200
10,500
6,800
6,750
12,000
16,000
$65,950

Total manufacturing cost per stair under ABC:
Direct materials.......................................................................
Direct labor..............................................................................
Overhead..................................................................................
Total cost of 280 stairs....................................................
$ 103,600
112,000
65,950
$ 281,550
Total cost per stair ($281,550 280)......................................
$1,005.54
(d) The difference between the traditional cost and the activity-based cost
per unit, $1,199.82 versus $1,005.54, is not great in amount but $194.28
or ($1,199.82 $1,005.54) is 19.3% of the more correct ABC cost per
unit. Activity-based costing is the preferable costing system for setting
prices because the real costs are more accurately reflected. The
greater accuracy is a result of multiple, more relevant activity cost
drivers under ABC than the single cost driver used with the traditional
volume-based system.
17-32
PROBLEM 17-4A
(a) Computation of unit coststraditional costing
Overhead cost per labor hour is $1,241,660 (120,000 + 25,000) =
$8.563
Manufacturing Costs
Direct materials
Direct labor
Overhead
CoolDay
$0.400
0.250
0.428*
$1.078
Products
LiteMist
$1.200
0.500
0.771**
$2.471
*$8.563 X .05 **$8.563 X .09

(b)
Activity Cost Pools

Grape processing
Aging
Bottling and corking
Labeling and boxing
Maintain and inspect
equipment
(c)
Activity Cost Pools

Grape processing
Aging
Labeling and boxing
equipment
Liters produced
Estimated
Overhead
Expected Use
of Cost Drivers
Activity-Based
Overhead Rate
$ 145,860
396,000
270,000
189,000
6,600
6,600,000
900,000
900,000
$22.10 per cart

$0.06 per month
$0.30 per bottle
$0.21 per bottle
240,800
$1,241,660
800
$301 per inspection
CoolDay
LiteMist
Expected
ActivityUse of
Based
Cost
Overhead
Cost
Expected
ActivityUse of
Based
Cost
Overhead =
Cost
Drivers X Rates
Assigned
6,000
3,000,000
600,000
600,000
$22.10
$0.06
$0.30
$0.21
$132,600
180,000
180,000
126,000
600
3,600,000
300,000
300,000
$22.10
$0.06
$0.30
$0.21
$13,260
216,000
90,000
63,000
350
$301
105,350
$723,950
450
$301
135,450
$517,710
(b)
Overhead cost per

liter
[(a) (b)]
17-33
3,000,000
300,000
$0.241
$1.726

(d)
Products
CoolDay
LiteMist
$0.400
$1.200
0.250
0.500
0.241
1.726
$0.891
$3.426
Manufacturing Costs
Direct materials
Direct labor
Overhead
(e) To:
Mr. Tyler Silva
From:
Student
Subject:
Product costs using traditional approach versus ABC
The memorandum covers the following points:

a.
ABC allocates overhead costs as a function of each products use

of cost drivers. Thus, ABC results in overhead allocation that
more closely approximates each products generation of overhead
costs.
b.
Traditional approaches that allocate costs as a function of volume

tend to be biased toward allocating too much overhead to high
volume, simple products, and too little to low volume, complex
products. This is because the actual incurrence of overhead costs
is rarely correlated with labor costs.
c.
In the case of the Mendocino Wine Company, the LiteMist product

required the company to begin using more complex methods and
equipment. Overhead costs increased substantially. When
overhead costs were allocated using labor rates, too much
overhead was allocated to the high volume CoolDay product. This
reduced the apparent profitability of this product.
d.
The total cost of the two products under the two approaches was
as follows:
17-34

Traditional approach
ABC
CoolDay
$1.078
LiteMist
$2.471
$0.891
$3.426
Therefore, the relative profitability of the two products should be

determined using ABC costing.
17-35
PROBLEM 17-5A
(a) Computation of assigned overhead under traditional costing (direct
labor dollars appears in the first line of the schedule of overhead
data):
Predetermined overhead rate X direct labor dollars
Overhead assigned to audit:
Overhead assigned to tax:
.40 X $1,000,000 = $400,000

.40 X $800,000 = $320,000
(b) (1) Computation of activity-based overhead rate:

Activity Cost Pools
Employee training
Typing and secretarial
Computing
Facility rental
Travel
Estimated
Overhead
$216,000
76,200
204,000
142,500
81,300
$720,000
Expected Use of
Cost Drivers per Activity
Activity-Based
Overhead Rates
$1,800,000 Direct labor dollars

2,500 Reports/forms
60,000 Minutes
40 Employees
Direct
$.12 per DL dollar

$30.48 per report/form
$3.40 per minute
$3,562.50 per employee
Direct
(2) Assignment of overhead to audit and tax services:
Activity Cost Pools

Employee training
Computing
Facility rental
Travel
Overhead costs
assigned
Expected
Use of
Cost
Driver
Audit
ActivityBased
Overhead
Rate
$1,000,000
600
25,000
22
56,000
$.12
$30.48
$3.40
$3,562.50
Direct
Cost
Assigned
Expected
Use of
Cost
Driver
Tax
ActivityBased
Overhead
Rate
Cost
Assigned
$120,000
18,288
85,000
78,375
56,000
$800,000
1,900
35,000
18
25,300
$.12
$30.48
$3.40
$3,562.50
Direct
$96,000
57,912
119,000
64,125
25,300
$357,663
17-36
$362,337

(c)
Activity
Employee training
Computing
Facility rental
Travel
Value-Added vs. Nonvalue-Added

Nonvalue-added
Value-added
Value-added
Nonvalue-added
Nonvalue-added
(d) Overhead is assigned to the two service lines as follows:

Audit
$400,000
357,663
$42,337
Traditional costing
ABC
Difference
Tax
$320,000
362,337
$42,337
The $42,337 difference for audits is 10.6% lower under ABC costing,
while the $42,337 difference for tax is 13.2% higher under ABC costing.
Clearly, ABC costing should be used to determine the relative
profitability of each service.
17-37
PROBLEM 17-1B
(a) Computation of unit coststraditional costing.
Manufacturing Costs
Curler
Direct materials
Direct labor
Overhead ($438,000 120,000 hours)
Total unit cost
$5.25
8.00
3.65
$16.90
Products
Dryer
$9.75
8.00
3.65*
$21.40
(b)
Activity Cost Pools
Purchasing
Receiving
Assembling
Testing
Finishing
Estimated
Total Expected
Activity-Based
Overhead Use of Cost Drivers = Overhead Rates
$57,500
42,000
166,000
52,000
60,000
60,500
$438,000
500 Orders
140,000 Pounds
830,000 Parts
130,000 Tests
120,000 Units
12,100 Cartons
$ 115 per order

$.30 per pound
$.20 per part
$.40 per test
$.50 per unit
$5.00 per carton
(c)
Activity Cost Pools

Purchasing
Receiving
Assembling
Testing
Finishing
Curler
ActivityExpected
Based
Use of
Overhead
Cost
170
58,000
415,000
82,000
80,000
8,040
$115.00
$.30
$.20
$.40
$.50
$5.00
$19,550
17,400
83,000
32,800
40,000
40,200
$232,950
Dryer
ActivityExpected
Based
Use of
Overhead
Cost
330
82,000
415,000
48,000
40,000
4,060
$115.00
$.30
$.20
$.40
$.50
$5.00
$37,950
24,600
83,000
19,200
20,000
20,300
$205,050
Units produced (b)
80,000
40,000
Overhead cost per unit [(a) (b)]
$2.91
$5.13
17-38
PROBLEM 17-1B (Continued)

(d)
ABC Manufacturing Costs
Direct materials
Direct labor
Overhead
Total cost per unit
Curler
$5.25
8.00
2.91
$16.16
Dryer
$9.75
8.00
5.13
$22.88
(e)
Activity
Purchasing
Receiving
Assembling
Testing
Finishing
Value- vs. Nonvalue-Added

Nonvalue-added
Nonvalue-added
Value-added
Nonvalue-added
Value-added
Value-added
(f)
(1) Activity-based costing shows the blow dryer will absorb 76 percent
more overhead per unit, $5.13 versus $2.91, than the hair curler.
(2) A comparison of ABC and traditional costing shows that the
proper amount of overhead assigned to the two products is not
equal as under traditional costing at $3.65 per unit; rather it is $2.91
per curler unit and $5.13 per blower unit. Under traditional costing,
the margin of error on the curlers is 74 cents per unit, an
overstatement of 25%, and on the blowers it is $1.48 per unit, an
understatement of 29%. These distorted overhead assignments
have likely led to overpricing the curlers and underpricing the
blowers.
17-39
PROBLEM 17-2B
(a) The allocation of total manufacturing overhead using activity-based
costing is as follows:
Activity-Based Overhead Rate
Purchase orders @ $40
Machine setups @ $250
Machine hours @ $4
Tests and inspections @ $20
Ice House
Drivers
Cost
Used
Assigned
2,500
480
60,000
5,000
$100,000
120,000
240,000
100,000
$560,000
Cool Chest
Drivers
Cost
Used
Assigned
Total
Overhead
$79,000
75,000
80,000
60,000
$294,000
$179,000
195,000
320,000
160,000
$854,000
1,975
300
20,000
3,000
Units produced (b)
50,000
20,000
Cost per unit (a) (b)
$11.20
$14.70
(b) The cost per unit and the gross profit of each product under ABC
costing were:
Direct materials
Direct labor
Manufacturing overhead
Total cost per unit
Sales price per unit
Cost per unit
Gross profit (loss)
Ice House
$9.50
8.00
11.20
$28.70
Cool Chest
$6.00
5.00
14.70
$25.80
$35.00
28.70
$6.30
$24.00
25.70
($ (1.70)
(c) Activity-based costing reveals a very different situation than traditional

costing. Management must be stunned to learn that the Cool Chest
is unprofitable, losing $1.70 per unit while its other product, Ice
House, earns gross profit of $6.30 per unit. Obviously, management
must revise its marketing and selling efforts as well as its pricing, and
maybe its production, of the Cool Chest.
17-40
PROBLEM 17-3B
(a) Predetermined overhead rate using machine hours:
$1,750,000 100,000 hrs. = $17.50 per machine hour
(b) Manufacturing cost per kitchen under traditional costing:
Direct materials.....................................................................
Direct labor............................................................................
Overhead (15,000 X $17.50).................................................
Total cost of 50 kitchens..............................................
$180,000
200,000
262,500
$642,500
Cost per kitchen ($642,500 50).........................................
$12,850
(c) Manufacturing cost per kitchen under activity-based costing:

Computation of Activity-Based Overhead Rates
Activity Cost Pools

Purchasing
Handling materials
Production
Setting up machines
Inspecting
Inventory control
Utilities
Estimated
Overhead
$ 114,400
164,320
500,000
174,480
184,800
252,000
360,000
$1,750,000
Expected Use of
Cost Drivers per
Activity
650 Orders
8,000 Moves
100,000 D/L Hours
1,200 Setups
6,000 Inspections
36,000 Components
90,000 Sq. ft.
Activity-Based
Overhead Rates
$176 per order
$20.54 per move
$5 per D/L hour
$145.40 per setup
$30.80 per inspection
$7 per component
$4 per sq. ft.
Assignment of Overhead to Order of 50 Kitchens

Activity Cost Pools
Expected Use of
Cost Drivers
Purchasing
50 Orders
Handling materials
800 Moves
Production
12,000 D/L Hours
Setting up machines 100 Setups
Inspecting
450 Inspections
Inventory control
3,000 Components
Utilities
8,000 Sq. ft.
17-41
Activity-Based
X Overhead Rates = Cost Assigned
$176
$20.54
$5
$145.40
$30.80
$7
$4
$8,800
16,432
60,000
14,540
13,860
21,000
32,000
$166,632

Total manufacturing cost per kitchen under ABC:
Direct materials.....................................................................
Direct labor............................................................................
Overhead...............................................................................
Total cost of 50 kitchens...............................................
$ 180,000
200,000
166,632
$ 546,632
Total cost per kitchen ($546,632 50).................................
$10,932.64
(d) The difference between the traditional cost and the activity-based cost
per unit of $1,917.36 ($12,850 vs. $10,932.64) is significant17.5%
($1,917.36 $10,932.64). The traditional costing did not take into
account the mass production of 50 identical kitchens rather than
building custom-made, one-of-a-kind, kitchens. ABC allowed for the
savings in fewer orders, fewer material moves, fewer setups, fewer labor
hours, and fewer inspections when producing 50 identical units. The
greater accuracy of ABC over traditional costing, which used only one
cost driver (machine hours), results from the identification of multiple
activities and their relevant cost drivers.
17-42
PROBLEM 17-4B
(a) Computation of unit coststraditional costing
Overhead cost per labor hour is $1,485,000 (60,000 + 30,000) = $16.50
Manufacturing Costs
Direct materials
Direct labor
Overhead
*$16.50 X .075
**$16.50 X .15
(b)
Activity Cost Pools
Grape processing
Aging
Labeling and boxing
equipment
(c)
StarDew
$1.100
.500
1.238*
$2.838
Products
VineRose
$2.400
1.000
2.475**
$5.875
Estimated
Overhead
Expected Use
of Cost Drivers
per Activity
$189,000
416,000
360,000
240,000
10,000
10,400,000
1,600,000
1,600,000
$18.90 per cart

$0.040 per month
$0.225 per bottle
$0.15 per bottle
280,000
$1,485,000
560
$500 per inspection
StarDew
Expected
ActivityUse of
Based
Cost
Overhead
Cost
8,000
$18.90
$151,200
800,000
$0.04
32,000
800,000
$0.225
180,000
800,000
$0.15
120,000
Activity Cost Pools

Grape processing
Aging
Labeling and boxing
Equipment
160
Total cost assigned (a)
$500
80,000
$563,200
Activity-Based
Overhead Rates
VineRose
Expected
ActivityUse of
Based
Cost
Overhead
Cost
Drivers X
Rates
= Assigned
2,000
$18.90
$37,800
9,600,000
$0.040
384,000
800,000
$0.225
180,000
800,000
$0.15
120,000
400
$500
200,000
$921,800
Gallons produced (b)
800,000
200,000
Overhead cost per

Gallon [(a) (b)]
$0.704
$4.609
17-43

(d)
Products
StarDew
VineRose
$1.100
$2.400
.500
1.000
0.704
4.609
$2.304
$8.009
Manufacturing Costs
Direct materials
Direct labor
Overhead
(e) To:
Mr. Jorge Rojo
From:
Student
Subject:
Product costs using traditional approach versus ABC
The students memorandum should cover the following points:

(1) ABC allocates overhead costs as a function of each products use
of cost drivers. Thus, ABC results in overhead allocation that
more closely approximates each products generation of overhead
costs.
(2) Traditional approaches that allocate costs as a function of volume
tend to be biased toward allocating too much overhead to high
volume, simple products, and too little to low volume, complex
products. This is because the actual incurrence of overhead costs
is rarely correlated with labor costs.
(3) In the case of the Vino Verite Corporation, the VineRose product
required the company to begin using more complex methods and
equipment. Overhead costs increased substantially. When
overhead costs were allocated using labor rates, too much
overhead was allocated to the high volume StarDew product. This
reduced the apparent profitability of this product.
(4) The total cost of the two products under the two approaches was
as follows:
17-44

Traditional approach
ABC
StarDew
$2.8380
VineRose
$5.875
$2.304
$8.009
Therefore, the relative profitability of the two products should be

determined using ABC costing.
17-45
PROBLEM 17-5B
(a) Computation of total overhead cost using direct labor hours:
Total overhead
$265,000
=
= $53 per D/L hour
Total direct labor hours
5,000
Overhead assigned to farm animals:
Overhead assigned to pets:
$53 X 2,000 = $106,000

$53 X 3,000 = $159,000
(b) (1) Computation of activity-based overhead rates:

Farm and Home Veterinary Clinic
Activity Cost Pools

Drug treatment
Surgery
Travel
Consultation
Accounting/Office
Boarding/Grooming
Expected Use of
Cost Drivers
per Activity
Estimated
Overhead
$64,000
70,000
28,000
33,000
30,000
40,000
$265,000
4,000 treatments
800 operations
28,000 miles
3,000 appointments
5,000 D/L hours
(Pets only)
Activity-Based
Overhead Rates
$16 per treatment
$87.50 per operation
$1 per mile
$11 per appointment
$6 per D/L hour
(2) Assignment of activity cost pools to services:

Farm and Home Veterinary Clinic
Activity Cost Pools
Expected
Use of
Cost
Drivers
Drug treatment
1,700
Surgery
200
Travel
26,000
Consultation
600
Accounting/Office
2,000
Boarding/Grooming
Farm Animals
ActivityBased
Overhead
Cost
Rates
Assigned
$16
$87.50
$1
$11
$6
$27,200
17,500
26,000
6,600
12,000
000,000
$89,300
Expected
Use of
Drivers
2,300
600
2,000
2,400
3,000
(Direct)
Pets
ActivityBased
Overhead
Rate
$16
$87.50
$1
$11
$6
Cost
Assigned
$36,800
52,500
2,000
26,400
18,000
40,000
$175,700
(c) Value-added activities:Drug treatment, surgery, consultation,

boarding/grooming. Non-value-added activities:Travel, accounting/
office.
17-46

(d) Comparison of overhead assigned:
Traditional costing:
Farm animals
Pets
Total
$106,000
159,000
$265,000
40%
60%
$89,300
175,700
$265,000
34%
66%
ABC:
Farm animals
Pets
Total
The difference in the overhead assigned is significant.
17-47
BYP 17-1
GROUP DECISION CASE
The following activities and cost drivers might be submitted:

(a)
Activities
Laundering
Housekeeping
Dietary
Computing information
technology
Nursing care
Surgery
Clinical lab
Imaging (X-ray, etc.)
Pharmacy
Emergency room
Maintenance
Billing and collecting
(b)
Cost Drivers
Pounds of linen
Square footage; number of beds
Number of meals
Minutes of computer usage; or number of
work stations
Number of patients
Number of procedures or operations
Number of tests
Number of images
Number of prescriptions
Number of cases or patients
Square footage
Number of invoices
17-48
BYP 17-2
MANAGERIAL ANALYSIS
(a) Computation of activity-based overhead rate:
Activity Cost Pools

Market analysis
Product design
Product development
Prototype testing
Total
Estimated
Overhead
Expected Use of
Cost Drivers
Per Activity
$1,050,000
2,280,000
3,600,000
1,400,000
15,000 Hours
2,500 Designs
90 Products
700 Tests
Activity-Based
Overhead Rates
$70 per hour

$912 per design
$40,000 per product
$2,000 per test
(b) Charges to in-house manufacturing department:

In-House Manufacturing Department
Activity Cost Pools
Cost Drivers Used
Market analysis
1,800 Hours
Product design
280 Designs
Product development
10 Products
Prototype testing
92 Tests
Activity-Based
Overhead Rates
$70
$912
$40,000
$2,000
Cost Assigned
$126,000
255,360
400,000
184,000
$965,360
(c) Charges to outside R & D contractor:

Outside Contract Costs
Activity Cost Pools
Cost Drivers Used
Market analysis
800 Hours
Product design
178 Designs
Product development
3 Products
Prototype testing
70 Tests
17-49
Activity-Based
Overhead Rates
$70
$912
$40,000
$2,000
Cost Assigned
$56,000
162,336
120,000
140,000
$478,336
BYP 17-2 (Continued)

(d) Activity-based costing permits the company to identify its R & D costs
by the activities that cause the costs; that is, ABC allows closer scrutiny
of the causes for cost incurrences; hence, greater control. By charging
in-house manufacturing departments for their fair share of the
companys R & D costs, these departments may exert their own control
over such costs. Activity-based costing allows Ideal to compile realistic
costs for bidding and charging outside users of its R & D departments
services.
17-50
BYP 17-3
REAL-WORLD FOCUS
(a) 1.
Too many drivers.At the Colorado Springs Division, participants

attempted to select a cost driver for just about every activity in a
process rather than picking drivers for just the top two or three
critical activities of a particular process. Extending 20+ cost drivers
over numerous processes created too large of an information matrix.
2.
No proper administration.The Division tracked, documented, and

explained all the driver differences just like material usage variance,
purchase part price variance, and all other variances. It drove an
overhead structure in the administrative area that it could not and
should not have supported. Explaining driver variances over a short
period of time does not provide value-added benefits to a cost
structure that is relatively fixed over that period of time.
3.
No follow-through.The Division had become so engulfed in

identifying and explaining monthly variances that it never quite
followed through with delivering a cost reduction.
4.
Too much emphasis on consensus .The Colorado Springs

Division spent too much time trying to achieve cost pool
consensus with other divisions within the Test Measurement
Group in order to provide comparable measurements across the
Groups divisions. Decentralized divisions should focus their ABC
implementation
efforts internally. Too much time was spent micro-managing the
drivers versus analyzing the impact at the manufacturing overhead
level, or better yet, the gross margin level.
(b) At Colorado Springs, ABC and its resultant development of cost drivers
constituted an excellent tool for understanding manufacturing processes, overhead consumption and manufacturing efficiencybut it did
not ascertain the real value of its product in the form of inventory.
Successful ABC implementation requires clear goals, simple tracking
methods, close internal and external collaboration, and consistent, as
well as persistent, follow-through.
17-51
BYP 17-4
EXPLORING THE WEB
(a) The definition provided by Cost Technology is: Activity-based costing

is a method of describing, measuring, analyzing, and communicating
business performance. The textbook defines activity based costing as
follows: An overhead cost allocation system that allocates overhead to
multiple activity cost pools and assigns the activity cost pools to
products or services by means of cost drivers that represent the
activities used. The definition used by Cost Technology is much broader
than the one provided in the textbook. The textbook definition is much
more specific about what is involved with activity based costing. The
Cost Technology definition is less technical and may be a good way of
attracting companies to use activity based costing.
(b) The ABC Assessment: Obtaining the Highest Value from Your
Implementation is described as follows:
In this seminar, Dr. Turney focuses on what you need prior to ABC
implementation to ensure success. He explains how to define
success before you begin, and to systematically plan for results
from your ABC implementation. Drawing on more than 16 years of
experience implementing ABC, Dr Turney uses actual examples to
illustrate the assessment process.
The Drivers of Successful ABC implementation is described as follows:
In this presentation, Dr. Turney identifies the drivers of successful
ABC implementation. He provides guidelines for action that will
help ensure management buy-in, establish proper leadership, lead to
project success, encourage management use of ABC information,
sustain the ABC initiative beyond the implementation phase, and in
other ways create results from the ABC implementation effort.
17-52
BYP 17-5
COMMUNICATION ACTIVITY
(a) The following unique strategies and tactics prompted sales to take off:
1.
Super Bakery targeted the school system segment of the

institutional food market.
2.
Super Bakery avoided the local market restrictions of most freshbaked goods by refrigerating the product, vacuum-sealing it, and
distributing it nationally.
3.
Super Bakery developed numerous ways of serving and supporting

its customers. They included: helping customers obtain lower
prices by acquiring government-supported commodities, cooperating
with noncompeting suppliers by providing complete prepackaged
meals to schools, and helping distributors reduce inventory carrying
costs and avoiding stockouts through reliable, just-in-time delivery.
4.
Super Bakery reduced capital investment and overhead expenses

by contracting out major functions of the businessit became a
virtual corporation.
(b) Super Bakerys management decided to install a detailed ABC system,

first, because it would allow management to track the profitability of
each customers account and, second, because it would allow
management to track the performance of outside contractors more
closely.
(c) One of the main differences between Super Bakerys ABC system and
other manufacturers ABC systems is that the main focus is placed on
capturing costs by customer order rather than by product.
17-53
BYP 17-6
RESEARCH ASSIGNMENT
(a) The 1996 survey conducted by The Cost Management Group of the
IMA found that 49% of all responding firms have adopted ABC (up from
41% a year earlier), that 25% of the nonadopting companies were
considering it, that 21% had not considered it, and that only 5%
seriously considered ABC and rejected it. The survey also showed that
for those companies that adopted ABC, 54% used ABC for decision
making not only for accounting purposes but used it for decision
making outside the accounting function.
(b) Krumwiedes survey attempted to determine if adoption of ABC is
associated with kinds of products and processes, quality and lean
production practices, and information technologies.
(c) The factors that appeared to separate those who adopted ABC from
those who didnt were: (1) potential for cost distortions, (2) decision
usefulness of cost information, (3) lack of system initiatives, and (4) the
size of organization.
(d) Professor Krumwiede
implementation tips:
recommends
the
following
basic
ABC
1.
Focus on critical needs.Before implementing an expensive

integrated information system or a more sophisticated costing
system, decide what are the organizations most important issues
or decisions and what types of information would help address
those issues.
2.
Get top management support.If you think ABC might be a useful

tool in your organization, be sure to get top managements support
first. With its help, identify critical information needs, and show
how an activity cost approach could provide valuable information.
Seek approval for small, relatively quick projects, such as a single
process or a pilot plant. If these are successful, management will
drive further implementation and help make it a priority for other
areas.
17-54
BYP 17-6 (Continued)

3.
The main cost system.If pilot projects are successful, try to

incorporate ABC methods into your organizations financial
reporting process. Successful implementers of ABC systems were
more than six times as likely to have integrated ABC into their
primary financial system and almost twice as likely to use ABC for
budgeting.
4.
Consider a separate model.If integrating ABC into the main cost

reporting system is not feasible, consider developing a separate PCbased ABC system that can be used on an infrequent basis for
strategic decision making. The model should be relatively simple
and can be updated with data that already are available or easily
collected. But even a relatively simple model can be far more
accurate than many traditional cost allocation methods.
5.
The existing information system.If you implement an ABC costing

system, make sure that the input requirements can be easily
supported by the existing information system. If not, either change
the model or install a more sophisticated integrated system.
6.
Smaller companies.Smaller companies need to be especially

creative to find reasonable activity cost drivers from their often
more limited data. Like one company using material cost as a proxy
for its weight, look for available drivers that have some correlation
with how resources are spent.
7.
The implementation team.Make sure the people who will be actual

users of the ABC information are represented on the implementation
team. A common mistake is putting managers on the team and not
getting enough input from the cost accountants or other analysts.
8.
The right software.Several respondents reported purchasing

expensive ABC software and having a fairly successful initial study,
but then having to use spreadsheets to generate the specific
reports that are needed. Complaints about maintaining ABC also
were common. Its wise to start simple. Early studies should be
high-level in order to get concepts across. Once you have created
interest, there will be a demand-pull for more information. Use
spreadsheets until you identify exactly what your needs are, and
then buy the software that meets your needs.
17-55
BYP 17-7
ETHICS CASE
(a) The stakeholders (parties affected by Marcuss and Rays actions) in

this case are:
Marcus as cost accountant.
Ray and all personnel employed in the production of the Supercut
Model of lawn tractor.
Hi-Power Mower management.
Hi-Power Mower owners (stockholders).
The stakeholder group may be expanded to include Hi-Power
Mowers suppliers and customers.
(b) The objective of cost accounting is to provide useful, accurate
information for decision making by managers. Ray is coercing Marcus
to massage the data to save the product line and, thus, Rays job. Ray
is advocating knowingly providing false data, deceiving management,
and jeopardizing Marcuss job.
(c) Marcus is a management accountant employed by Hi-Power Mower
Company. His first job responsibility is to his employer to: (1)
communicate information fairly and objectively and (2) disclose fully all
relevant information that could reasonably be expected to influence an
intended users understanding of the reports, comments, and
recommendations presented (see Appendix D, Standards of Ethical
Conduct for Management AccountantsObjectivity). Marcuss
obligation is to provide management with timely, truthful information.
17-56

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CHAPTER 17

Recognize the difference

Identify the steps in the

Know how companies

Know how companies

Understand the benefits and limitations of

12, 13, 14,

Understand the value of

Apply activity-based costing

1B, 2B, 3B,

ASSIGNMENT CHARACTERISTICS TABLE

Assign overhead using traditional costing and ABC;

Assign overhead to products using ABC and evaluate

Assign overhead costs using traditional costing and ABC;

Assign overhead costs using traditional costing and ABC;

Assign overhead costs to services using traditional

Assign overhead using traditional costing and ABC;

Assign overhead to products using ABC and evaluate

Assign overhead costs using traditional costing and ABC;

Assign overhead costs using traditional costing and ABC;

Assign overhead costs to services using traditional

BLOOMS TAXONOMY TABLE

In many automated manufacturing environments, machine hours is a more relevant basis on

(a) The principal differences are:

Activity-based overhead rates are computed using the following formula:

The four steps involved in developing an ABC system are:

Questions Chapter 17 (Continued)

A value-added/non-value-added activity flowchart is based on a systematic analysis of all the

The formula for assigning activity cost pools to products is:

Questions Chapter 17 (Continued)

SOLUTIONS TO BRIEF EXERCISES

Estimated annual overhead costs

(b) 90,000 direct labor hours $10 = $900,000 overhead applied

Low-volume products often require more special handling, such

BRIEF EXERCISE 17-3

BRIEF EXERCISE 17-4

Number of parts or assemblies

BRIEF EXERCISE 17-5

$180,000 2,500 = $72 per setup

BRIEF EXERCISE 17-6

12,000 Designer hours

BRIEF EXERCISE 17-7

Activity Cost Pool

BRIEF EXERCISE 17-8

BRIEF EXERCISE 17-9

BRIEF EXERCISE 17-10

BRIEF EXERCISE 17-11

BRIEF EXERCISE 17-12

(b) Product designproduct level

Activity cost pools

Activity-based overhead rates

Traditional costing system

Activity-based costing system

($150,000 $145,000) $145,000 = 3.45%

($125,000 $110,000) $110,000 = 13.64%

($45,000 $65,000) $65,000 = (30.77%)

Activity cost pools

Activity-based overhead rates

The wool product line is allocated $100,000 ($550,000 $450,000) more

Direct labor hours for car wheels

Direct labor hours for truck wheels (10,000 X 3) = 30,000

Activity Cost Pool