ACTIVITY BASED COSTING

PROBLEM 1 TRUE-FALSE STATEMENTS

​ 1.​ Traditional costing systems use multiple predetermined overhead rates.
​ 2.​ Traditionally, overhead is allocated based on direct labor cost or direct labor hours.
​ 3.​ Current trends in manufacturing include less direct labor and more overhead.
​ 4.​ Activity-based costing allocates overhead to multiple cost pools and assigns the cost
pools to products using cost drivers.
​ 5.​ A cost driver does not generally have a direct cause-effect relationship with the
resources consumed.
​ 6.​ The first step in activity-based costing is to assign overhead costs to products, using
cost drivers.
​ 7.​ To achieve accurate costing, a high degree of correlation must exist between the
cost driver and the actual consumption of the activity cost pool.
​ 8.​ Low-volume products often require more special handling than high-volume
products.
​ 9.​ When overhead is properly assigned in ABC, it will usually decrease the unit cost of
high-volume products.
​ 10.​ABC leads to enhanced control over overhead costs.
​ 11.​ABC usually results in less appropriate management decisions.
​ 12.​ABC is generally more costly to implement than traditional costing.
​ 13.​ABC eliminates all arbitrary cost allocations.
​ 14.​ABC is particularly useful when product lines differ greatly in volume and
manufacturing complexity.
​ 15.​ABC is particularly useful when overhead costs are an insignificant portion of total
costs.
​ 16.​Activity-based management focuses on reducing costs and improving processes.
​ 17.​Any activity that increases the cost of producing a product is a value-added activity.
​ 18.​Engineering design is a value-added activity.
​ 19.​Non-value-added activities increase the cost of a product but not its market value.
​ 20.​Machining is a non-value-added activity.
​ 21.​Not all activities labeled non-value-added are totally wasteful, nor can they be totally
eliminated.
​ 22.​The overall objective of installing ABC in service firms is no different than it is in a
manufacturing company.
​ 23.​What sometimes makes implementation of activity-based costing difficult in service
industries is that a smaller proportion of overhead costs are company-wide costs.
​ 24.​The general approach to identifying activities, activity cost pools, and cost drivers is
used by a service company in the same manner as a manufacturing company.
​ 25.​Plant management is a batch-level activity.
​ 26.​Painting is a product-level activity.
a
27.​ Just-in-time strives to eliminate inventories by using a pull approach.
a
​ 28.​ Quality control is less important in just-in-time than in traditional manufacturing
philosophies.
a
​ 29.​ Inventory storage costs are reduced in just-in-time processing.
a
30.​ Rework costs typically increase in just-in-time processing

PROBLEM 2
Boots and More, Inc. uses activity-based costing to assist management in setting prices for the
company’s three major product lines. The following information is available:
​ ​ Expected Use of
Activity Cost Pool​ Estimated Overhead​ Cost Driver per Activity
Cutting​ $ 900,000​ 25,000 labor hours
Stitching​ 8,000,000​ 320,000 machine hours
Inspections​ 2,800,000​ 160,000 labor hours
Packing​ 800,000​ 64,000 finished goods units

Instructions
Compute the activity-based overhead rates.
PROBLEM 3
Stereo City Co. manufacturers speakers and receivers and uses activity-based costing. The
following information is available:
​ ​ Expected Use of
Activity Cost Pool​ Estimated Overhead​ Cost Driver per Activity
Ordering​ $180,000​ 24,000 orders
Soldering​ 192,000​ 64,000 machine hours
Inspecting​ 930,000​ 120,000 labor hours
Packing​ 840,000​ 56,000 boxes

Instructions
Compute the activity-based overhead rates.

PROBLEM 4
Plum Tired manufactures tires for dune buggies and has two different products, nubby tires and
smooth tires. The company produces 5,000 nubby tires and 10,000 smooth tires each year and
incurs $171,000 of overhead costs. The following information is available:
​ Activity​ ​ Total Cost​ ​ Cost Driver​
Materials handling​ $60,000​ Number of requisitions
Machine setups​ 54,000​ Number of setups
Quality inspections​ 57,000​ Number of inspections

For the nubby tires, the company has 400 requisitions, 200 setups, and 200 inspections. The
smooth tires require 600 requisitions, 300 setups, and 400 inspections.
Instructions
Determine the overhead rate for each activity.

PROBLEM 5
Malt Co. manufactures several types of microbrew beers. Malt has identified the following
activities:
a.​ Inventory control​ e.​ Machine setups
b.​ Purchasing​ f.​ Brewing
c.​ Receiving​ g.​ Packing and shipping
d.​ Employee training

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

EXERCISES
Ex. 1
All Wood Corporation manufactures dining chairs and tables. The following information is
available:
​ Dining Chairs​ Tables​ Total Cost
​ Machine setups​ 200​ 600​ $36,000
​ Inspections​ 250​ 470​ $54,000
​ Labor hours​ 2,600​ 2,400

All Wood is considering switching from one overhead rate based on labor hours to
activity-based costing.

Instructions
Perform the following analyses for these two components of overhead:
a.​ Compute total machine setups and inspection costs assigned to each product, using a
single overhead rate.
b.​ Compute total machine setups and inspection costs assigned to each product, using
activity-based costing.
c.​ Comment on your findings.
Ex. 2
Vid-saver, Inc. has five activity cost pools and two products (a budget tape rewinder and a
deluxe tape rewinder). Information is presented below:
​
Cost Drivers by Product
Activity Cost Pool​ Cost Driver​ Est. Overhead​ Budget​ ​ Deluxe​
Ordering and Receiving​ Orders​ $ 110,000​ 600​ 400
Machine Setup​ Setups​ 297,000​ 500​ 400
Machining​ Machine hours​ 1,000,000​ 150,000​ 100,000
Assembly​ Parts​ 1,200,000​ 1,200,000​ 800,000
Inspection​ Inspections​ 300,000​ 550​ 450

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

Ex. 3
Ami Reed owns a small department store in a metropolitan area. For twenty years, the
accountant has applied overhead to the various departments—Women's Apparel, Men's
Apparel, Cosmetics, Housewares, Shoes, and Electronics—based on the basis of employee
hours worked. Ami Reed 's daughter, who is an accounting student at a local university, has
suggested her mother should consider using activity-based costing (ABC). In an attempt to
implement ABC, Ami Reed and her daughter have identified the following activities.

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

Ex. 4
A list of possible cost drivers is presented below:

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

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

​ Code​ Cost Pool

_____​ 1.​ Machine setup

_____​ 2.​ Ordering and receiving

_____​ 3.​ Packaging and shipping

_____​ 4.​ Engineering design

_____​ 5.​ Machining

_____​ 6.​ Assembly

Ex. 5
Identify appropriate cost drivers for the following activity cost pools:
1.​ Human resources
2.​ Security
3.​ Receiving
4.​ Data processing

Ex. 6
Holiday Favorites manufactures a wide variety of holiday and seasonal decorative items.
Holiday’s activity-based costing overhead rates are:
​ Purchasing​ $350 per order
​ Storing​ $2 per square foot/days
​ Machining​ $100 per machine hour
​ Supervision​ $5 per direct labor hour

The Haunted House project involved three purchase orders, 4,000 square feet/days, 60
machine hours, and 30 direct labor hours. The cost of direct materials on the job was $19,000
and the direct labor rate is $30 per hour.

Instructions
Determine the total cost of the Haunted House project.

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

Ex. 8
Borke and Falvery is a law firm that uses activity-based costing. Classify these activities as
value-added or non-value-added:
​ ​ 1.​ Taking appointments
​ ​ 2.​ Reception
​ ​ 3.​ Meeting with clients
​ ​ 4.​ Bookkeeping
​ ​ 5.​ Court time
​ ​ 6.​ Meeting with opposing attorneys
​ ​ 7.​ Billing
​ ​ 8.​ Advertising

Ex. 9
Tim Taylor Tool Company manufactures small tools. Classify each of the following activity costs
of the tool company as either unit level, batch level, product level, or facility level:
​ ​ 1.​ Plant management
​ ​ 2.​ Drilling
​ ​ 3.​ Painting
​ ​ 4.​ Machine setups
​ ​ 5.​ Product design
​ ​ 6.​ Cutting
​ ​ 7.​ Inspection
​ ​ 8.​ Inventory management

Ex. 10
Brewer & Carr, PSC is an architectural firm that uses activity-based costing. The three activity
cost pools used by Brewer & Carr are: Salaries and Wages, Travel Expense, and Plan
Reproduction Expense. The firm has provided the following information concerning activity and
costs:
​ Salaries and wages​ $360,000
​ Travel expense​ 100,000
​ Plan reproduction expense​ 120,000
​ Total​ $580,000
​ ​ ​ Activity Cost Pools​
​ ​ Project​ Business
​ ​ Assignment​ Development​ Other
​ Salaries and wages​ 60%​ 30%​ 10%
​ Travel expense​ 40%​ 40%​ 20%
​ Plan reproduction expense​ 35%​ 40%​ 25%

Instructions
Calculate the total cost to be allocated to the (a) Project Assignment, (b) Business
Development, and (c) Other activity cost pools.