ACCT 130 – Principles of Management Accounting

Fall 2023, S5 & S6

Practice Sheet 7 – Chapter 7 Activity Based Costing

MCQs:
1. Guerra Electronics manufactures a variety of electronic gadgets for use in the home. Which of
the following would probably be the most accurate measure of activity to use for allocating the
costs of inspecting the finished products at Guerra?
A) Machine-hours
B) Direct labor-hours
C) Inspection time
D) Number of inspections

2. Would the following activities at a manufacturer of canned soup be best classified as unit-
level, batch-level, product-level, or organization-sustaining activities?

Researching new recipes Shipping orders to grocery stores

A) unit unit
B) batch batch
C) product unit
D) product batch

3. Linden, Inc. uses a 5,000 square foot factory space that it rents for $2,500 a month for all its
manufacturing activities. Linden has decided to switch to an activity-based costing system and
has identified its activities as follows: Preparation and Setup, Machining, Finishing, and Quality
Control. 500 square feet of the factory are used for machining, while 2,000 square feet (each) are
used for Preparation and Setup and Quality Control. Finishing uses 500 square feet.

When assigning indirect costs to each activity, how much factory rent should be assigned to the
Preparation and Setup cost pool?
A. $250
B. $500
C. $1,000
D. $2,000

Short Computational:
1. Mccaskey Corporation uses an activity-based costing system with the following three activity
cost pools:

Activity Cost Pool Total Activity

Fabrication 40,000 machine hours
Order processing 500 orders
Other Not applicable

The Other activity cost pool is used to accumulate costs of idle capacity and organization-
sustaining costs. The company has provided the following data concerning its costs:

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Wages and salaries $420,000
Depreciation $100,000
Occupancy $120,000
Total $640,000

The distribution of resource consumption across activity cost pools is given below:

Activity Cost pools

Fabrication Order Processing Other Total
Wages and salaries 5% 80% 15% 100%
Depreciation 15% 45% 40% 100%
Occupancy 25% 50% 25% 100%

Required:
a. What is the activity rate for the Fabrication activity cost pool?
b. What is the costs of idle capacity and sustaining the organization?

Solution:
a. Fabrication Cost pool (first stage allocation) = 5% * $420,000 +15% * $100,000 + 25%
*$120,000 = $66,000
Activity rate = $66,000/40,000 machine hours = $1.65 per machine hour

b. Other cost pool (first stage allocation) = 15% * $420,000 +40% * $100,000 + 25% *$120,000
= $133,000

2. Spendlove Corporation has provided the following data from its activity-based costing system:

Activity Cost Pool Total Cost Total Activity

Assembly $1,114,920 57,000 machine-hour
Processing orders $47,016 1,800 orders
Inspection $107,328 1,560 inspection-hour

The company makes 430 units of product S78N a year, requiring a total of 1,120 machine-hours,
40 orders, and 30 inspection-hours per year. The product's direct materials cost is $49.81 per unit
and its direct labor cost is $12.34 per unit. The product sells for $129.90 per unit.

Required:
a. What is the product margin according to the activity-based costing system?

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Solution:
a.
Activity rates
Assembly ($1,114,920/57,000) $19.56
Processing orders ($47,016/1,800) $26.12
Inspection ($107,328/1,560) $68.80

Sales $55,857.00

COGS:
DM ($49.81*430) $21,418.30
DL ($12.34*430) $5,306.20
Overheads ($20*1,120+$26*40+$69*30) $25,016.00
$51,740.50
Product Margin $4,116.50

3. Parker Woodworks manufactures baseball bats and wooden tops. In the current month, Parker
made 5,000 baseball bats. Each bat uses $1.00 in direct materials and $0.50 in direct labor.
Parker uses two activities in manufacturing the baseball bats: Cutting and Finishing. The cost
associated with Cutting is $7,500 a month, allocated based on direct labor hours. The cost
associated with Finishing is $12,000 a month, allocated based on batches. Usage of the activity
drivers are as follows:
Baseball Bats Wooden Tops
Direct Labour hours 100 200
Batches 4 6

Required:
a. What is the total manufacturing cost for one baseball bat?

Solution:
Total Product Cost = $1.00 + $0.5 + $7,500 (100/300) + $12,000 *(4/10) = $2.96 per unit

4. Delphi incurs $160,000 of overhead costs each year in its three main departments, setup
($10,000), machining ($110,000), and packing ($40,000). The setup department performs 40
setups per year, the machining department works 5,000 hours per year, and the packing
department packs 500 orders per year. Information about Delphi's 2 products is as follows:
Product 1 Product 2
Number of setups 20 20
Machining hours 1,000 4,000
Orders packed 150 350
No. of product manufactured 600 400

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Required:
a. Using ABC, how much overhead is assigned to Product 2 each year?

Solution:
Overhead assignment = ($10,000 x 20 / 40) + ($110,000 x 4,000 / 5,000) + ($40,000 x 350 / 500)
= $121,000

Long form Problems:

Question 1:

Tissot Inc. has recently implemented an activity-based costing system with three activity cost
pools: Processing, Set ups and Other. Data concerning the two products and the company's costs
and activity-based costing system appear below:

Activity cost pools

Machining ($) Setting up ($) Other ($) Total ($)
Equipment depreciation 54,000 9,000 27,000 90,000
Indirect labor 300 2,100 600 3,000
Total 54,300 11,100 27,600 93,000

Allocation bases Machine hours No. of batches NA

Machine hours Batches

Product M8 4,700 300
Product K3 5,300 1,700
Total 10,000 2,000

Product M8 ($) Product K3 ($)

Sales 220,500 318,900
Direct materials 109,000 130,300
Direct labor 76,100 141,200

Required:
a. Compute the activity rates for each cost pool.
b. Calculate the overhead to be allocated to each product.
c. Calculate the product margins for each product.
d. Previously Tissot allocated the $93,000 overhead using machine hours. Discuss how are the
activity-based cost allocations different to the traditional ones? Calculations are not required.

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Solution:
a. Activity rates for each cost pool are as follows:

Activity Cost Pool Total Activity Activity Rates

Machining $54,300 10,000 machine $5.43/machine hour
hours
Setting up $11,100 2,000 batches $5.55/ batch

b. Overhead allocation to each product would be as follows:

Product M8 Activity rate Activity level Overhead

allocated
Machining $5.43 / MH 4,700 MH $ 25,521
Setting up $5.55 / batch 300 batches $ 1,665
Total $ 27,186

Product K3 Activity rate Activity level Overhead

allocated
Machining $5.43 / MH 5,300 MH $ 28,779
Setting up $5.55 / batch 1,700 batches $ 9,435
Total $ 38,214

c. Product Margin of each product would be as follows:

Product M8 Product K3
Sales $ 220,500 $ 318,900
Less: COGS
Direct materials $ 109,000 $ 130,300
Direct labor $ 76,100 $ 141,200
Overhead Allocation $ 27,186 $ 38,214
Product Margin $ 8,214 $ 9,186

d. Overhead allocation based on machine hours would result in over-costing both products as the
$27,600 of the overhead which relates to idle capacity and organization sustaining costs would
be allocated to the products under traditional costing method. This will cause both products to
appear unprofitable, see calculation below.

Product M8 Product K3
Sales $ 220,500 $ 318,900
Less: COGS
Direct materials $ 109,000 $ 130,300
Direct labor $ 76,100 $ 141,200
Overhead Allocation $ 43,710 $ 49,290
Product Margin $ (8,310) $ (1,890)

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Question 2:
Cabalo Company manufactures two products, Product C and Product D. The company estimated
it would incur $130,890 in manufacturing overhead costs during the current period. Overhead
currently is applied to the products on the basis of direct labor hours.

Data concerning the current period's operations appear below:

Product C Product D
Estimated units produced and sold .............. 400 units 1,200 units
Selling price per unit $100 $135
Direct labor hours per unit ................... 0.70 hour 1.20 hours
Direct materials cost per unit ............... $10.70 $16.70
Direct labor cost per unit ..................... $11.20 $19.20

The company is considering using an activity-based costing system to compute unit product
costs instead of its traditional system based on direct labor hours. The activity-based costing
system would use three activity cost pools. Data relating to these activities for the current period
are given below:
Estimated
Overhead Expected Activity
Activity Cost Pool Costs Product C Product D Total
Machine setups ............ $13,570 100 130 230
Purchase orders ............ $91,520 810 1,270 2,080
General factory ............ $25,800 280 1,440 1,720
$130,890
Required:
a. Calculate the overhead absorption rate using the traditional costing system.
b. Calculate the cost per unit for each product using traditional costing system.
c. Calculate the activity rates for each activity cost pool using the activity-based costing
approach.
d. Calculate the cost assignment (overhead cost) per unit of each product for the current period
using the activity-based costing approach.
e. Calculate the unit product cost of each product for the current period using the activity-based
costing approach.
f. Discuss how the unit cost would change under the new system and reasons for difference.
g. Calculate the product margin per unit of Product C and Product D under both costing systems.
h. Discuss the viability of current selling prices of each Product C and Product D.

Solution:
a. The expected total direct labor hours during the period are computed as follows:
Product C: 400 units × 0.7 hours per unit ....... 280 hours
Product D: 1,200 units × 1.2 hours per unit .... 1,440 hours
Total direct labor hours ................................... 1,720 hours

Using these hours as a base, the overhead absorption rate using direct labor hours would be:
Estimated overhead cost, $130,890 ÷ Estimated direct labor hours, 1,720
= $76.10/DLH

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b. Using this overhead rate, the unit product costs are:
Product C Product D
Direct materials ............................. $10.70 $ 16.70
Direct labor .................................... 11.20 19.20
Manufacturing overhead ................ 53.27 91.32
Total unit product cost ................... $75.17 $127.22

c. The overhead rates for each activity cost pool are as follows:

Estimated
Overhead Expected Overhead
Costs Activity Rate
Machine setups ............ $13,570 230 $59.00
Purchase orders ............ $91,520 2,080 $44.00
General factory ............ $25,800 1,720 $15.00

d. The cost assignment / overhead cost charged to each product is:

Product C Product D
Activity Amount Activity Amount
Machine setups ............ 100 $5,900 130 $ 7,670
Purchase orders ............ 810 35,640 1,270 55,880
General factory ............ 280 4,200 1,440 21,600
Total overhead cost ..... $45,740 $85,150

Overhead cost per unit:

Product C: $45,740 ÷ 400 units = $114.35 per unit
Product D: $85,150 ÷ 1,200 units = $70.96 per unit

e. Using activity-based costing, the unit product cost of each product would be:
Product C Product D
Direct materials .................... $ 10.70 $ 16.70
Direct labor ........................... 11.20 19.20
Manufacturing overhead ....... 114.35 70.96
Total unit product cost .......... $136.25 $106.86

f. The traditional absorption costing system under-costs Product C and over-costs Product D.
This is because the traditional costing allocates manufacturing overhead costs using a volume-
related allocation base (direct labor hour), and Product D uses 83.7% of the total direct labor
hours.

g. Using traditional costing, the product margin per unit of each product would be:
Product C Product D
Selling Price $100 $135
Less: COGS ($75.17) ($127.22)
Product Margin $24.83 $7.78

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Using activity-based costing, the product margin per unit of each product would be:
Product C Product D
Selling Price $100 $135
Less: COGS ($136.25) ($106.86)
Product Margin ($36.25) $28.14

h. If the company plans to adopt the activity-based costing system, it will need to revise the
selling prices for the next period as Product C would not yield a profit at $100. However, the
company may need to consider if increasing the selling price of Product C will keep it
competitive in the market. Product D’s selling price is viable as the unit cost would be less than
$135, in fact it would yield a higher margin per unit as compared to the traditional system.