1. Traditional activity-based costs, VG Company has identified the following cost pools and cost drivers:
Cost PoolsActivity costsCost driver
Machine setup$360,0006,000 setup hours
Materials handling100,00050,000 pounds of material
Electric power40,00080,000 kilowatt-hours
The following information pertains to the production of V203 and G179
Item V203G179
Number of units produced5,00015,000
Direct materials cost25,00033,000
Direct labor cost14,00016,000
Number of setup hours120150
Pounds of material used5,00010,000
Kilowatt-hours 2,0003,000
Determine the unit cost for each of the two products using activity-based costing.
pool / Activity
Costs / Cost
Drivers / Cost Driver
Rate
Machine setups / $360,000 / 6,000 setup hours / $60 per setup hour
Material handling / 100,000 / 50,000 pounds of materials / $2 per pound
Electric power / 40,000 / 80,000 kilowatt hours / $0.5 per kilowatt hour
V203 / G179
Direct material
cost / $25,000.00 / $33,000.00
Direct labor cost / 14,000.00 / 16,000.00
Support costs:
Machine setups / $60 ´ 120 =7,200.00 / $60 ´ 150 =$9,000.00
Materials handling / $2 ´ 5,000 =10,000.00 / $2 ´ 10,000 =20,000.00
Electric power / $0.5 ´ 2,000 =1,000.00 / $0.5 ´ 3,000 =1,500.00
Total manufacturing costs / $57,200.00 / $79,500.00
Number of units produced / 5,000.00 / 15,000.00
Unit cost / $11.44 / $5.30
2. Traditional activity costs driver rates, Creathon Company’s plant in Columbus Ohio, manufactures two products: BR12 and BR15. Product BR15 has more complex design and requires more setup time than BR12. Setups for BR12 require 2 hours average setups for BR15 require 3 hours. Creathon’s setup department employs 10 workers whose average wages is $10 per hour fringe benefits cost 38% of wages. Other costs for setup activities amount to $25 per setup. Creathon plans to use all 10 workers for 40 hours each for the first 3 weeks of the winter quarter. The number of setups for these 3 weeks follows:
Number of SetupsNumber of Setup
WeekBR12BR15
18575
29070
38080
a. Determine the actual setup activity cost driver rate for each week based on (1) the number of setups and (2) the number of setup hours.
1) Based on number of setups:
Week 1 / Week 2 / Week 3Direct labor costs / $5,520.00 / * / $5,520.00 / $5,520.00
Other costs / $4,000.00 / ** / $4,000.00 / $4,000.00
Total setup costs / $9,520.00 / $9,520.00 / $9,520.00
Number of setups / 160 / 160 / 160
Cost driver rate / $59.50 / $59.50 / $59.50
* $10 per hour ´ 10 workers ´ 40 hours ´ 1.38
** $25 ´ 160 setups
2) Based on number of setup hours:
Week 1 / Week 2 / Week 3Direct labor costs / $5,520.00 / $5,520.00 / $5,520.00
Other costs / $4,000.00 / $4,000.00 / $4,000.00
Total setup costs / $9,520.00 / $9,520.00 / $9,520.00
Number of setup hours / 395* / 390** / 400***
Cost driver rate / $24.10 / $24.41 / $23.80
* (2´85) + (3´75) = 395
** (2´90) + (3´70) = 390
*** (2´80) + (3´80) = 400
b. Is either of the two activity cost driver rates or some other rate appropriate in this case? Why?
If only one cost driver can be used, then it may be preferable to base the cost
driver rate on the number of setup hours because the setup time is different
for these two products. However, both cost drivers are required in this case
because some costs ($25 per setup) depend on the number of setups and
some ($13.80 per setup hour) depend on setup hours.
3.Assigning marketing, distribution, and selling expenses to customers, Tetra Company’s cost system assigns marketing, distribution, and selling expenses to customers using a rate of 33% of sales revenue. The new controller has discovered that Tetra’s customers differ greatly in their ordering patterns and interaction with Tetra’s sales force. Because the controller believes Tetra’s cost system does not accurately assign marketing, distribution, and selling expenses to customers, she developed an activity-based costing system to assign these expenses to customers. She then identified the following marketing, distribution, and selling costs for two customers, Ashton and Brown:
Ashton Brown
Sales representative travel$9,000$42,000
Service customers15,000110,000
Handle customer orders1,00012,000
24,00072,000
The following additional information is available:
Ashton Brown
Sales $430,000$350,000
Cost of gold sold220,000155,000
a. Using the current cost system’s approach of assigning marketing, distributions, and selling expenses to customers using a rate of 33% of sales revenue, determine the operating profit associated with Ashton and with Brown.
b. Using the activity-based costing information provided, determine the operating profit associated with Ashton and with Brown.
c. Which of the two methods produces more accurate assignments of marketing, distributions, and selling expenses to customers? Explain.
Sales / $430,000 / $350,000
Cost of goods sold / $220,000 / $155,000
Gross margin / $210,000 / $195,000
Marketing, distribution, and selling
expenses @ 33% of sales / $141,900 / $115,500
Operating profit / $68,100 / $79,500
Operating profit/Sales / 15.84% / 22.71%
-
(b) / Sales / $430,000 / $350,000
Cost of goods sold / $220,000 / $155,000
Gross margin / $210,000 / $195,000
Marketing, distribution, and selling
expenses
Sales representative travel / $9,000 / $42,000
Service customers / 15,000 / 110,000
Handle customer orders / 1,000 / 12,000
Ship to customers / 24,000 / 72,000
Total activity expenses / $49,000 / $236,000
Operating profit / $161,000 / –$41,000
Operating profit/Sales / 37.44% / –11.71%
(c) / The activity-based costing method provides more accurate assignments of marketing, distribution, and selling expenses by identifying activities consumed by each customer and assigning costs to customers based on their activity usage. In this example, Brown places smaller orders, orders more frequently, and requires more after-sales support (travel and service support) than Ashton does.
4. Cost distortions, At its manufacturing plant in Duluth, Minnesota, Endo Electronics Company manufactures two products, X21 and Y37. For many years, the company has used a simple plantwide manufacturing support cost rate base on direct labor hours. A new plant accountant suggested that the company maybe able to assign support costs to products more accurately by using an activity-based costing system that relies on a separate rate for each manufacturing activity that causes support costs. After studying the plant’s manufacturing activities and costs, the plant accountant has collected the following data for last year:
Item X21Y37
Units produced and sold50,000100,000
Direct labor hours used100,000300,000
Direct labor cost1,000,0004,500,000
Number of times handled40,00020,000
Number of parts12,0008,000
Number of design changes2,0001,000
Number of product setups8,0006,000
The accountant has also determined that actual manufacturing support costs incurred last year were as follows:
Cost poolActivity costs
Handling $3,000,000
Number of parts2,400,000
Design changes3,300,000
Setups 2,800,000
Total 11,500,000
The direct materials cost for product X21 is $120 per unit, while for product Y37 it is $140 per unit.
a. Determine the unit cost of each product using direct labor hours to allocate all manufacturing support costs.
b. Determine the unit cost of each product using activity-based costing.
c. Which of the two methods produces more accurate estimates of job costs? Explain
d. Suppose Endo has been setting its product prices by adding a 25% markup to its reported product cost. Compute the product prices on the basic of the costs computed in parts (a) and (b) what do you recommend to Endo regarding its pricing?
e. what product-level changes do you suggest on the basic of the activity-based cost analysis? Who would be involved in bringing about your suggested changes?
4-30 (a) Manufacturing support cost driver rate
Costs Per Unit / Product X21 / Product Y37Direct materials cost / $120.00 / $140.00
Direct labor cost
2 ´ $(1,000,000¸100,000) / 20.00
3 ´ $(4,500,000¸300,000) / 45.00
Manufacturing support cost
$28.75 ´ (100,000¸50,000) / 57.50
$28.75 ´ (300,000¸100,000) / 86.25
Unit cost / $197.50 / $271.25
(b) / Cost / Cost / Costs Allocated to Products
Activity / Activity Costs / Driver Quantity / Driver Rate / X21 / Y37
Handling / $3,000,000 / 60,000 / 50 / 50 ´ 40,000 / 50 ´ 20,000
Number
of parts / 2,400,000 / 20,000 / 120 / 120 ´ 12,000 / 120 ´ 8,000
Design
changes / 3,300,000 / 3,000 / 1,100 / 1,100 ´ 2,000 / 1,100 ´ 1,000
Setups / 2,800,000 / 14,000 / 200 / 200 ´ 8,000 / 200 ´ 6,000
Total / $11,500,000 / $7,240,000 / $4,260,000
Costs Per Unit / X21 / Y37
Direct materials cost / $120.00 / $140.00
Direct labor cost / 20.00 / 45.00
Manufacturing support cost
$7,240,000 ¸ 50,000 / 144.80
$4,260,000 ¸ 100,000 / 42.60
Unit cost / $284.80 / $227.60
(c) Activity-based costing produces more accurate estimates of job costs because it takes into account the cost drivers that give rise to support costs.
(d) / Cost-based Prices / Product X21 / Product Y37Traditional costing
1.25 × unit costs in part (a) / $246.88 / $339.06
Activity-based costing
1.25 × unit costs in part (b) / $356.00 / $284.50
If Endo plans to continue to use cost-based pricing, it should use activity-
based costs as the basis for its markups. Note X21’s current price is not even
covering its manufacturing costs as determined using activity-based costing.
Conversely, Y37 may be overpriced. Endo should consider raising X21’s
price and could consider lowering Y37’s price if competitors are selling the
same product for a lower price.
e)
The company sells half as many X21’s as Y37’s, but X21 has twice as many design changes and 50% more parts. These facts suggest that the company can explore ways to reduce the number of design changes and the number of parts. Management accountants would be involved in developing and communicating the cost of design changes and parts proliferation; design engineers would be directly involved in studying different designs and trying to reduce the number of parts. In addition, sales staff who communicate with customers could make greater efforts to understand customer needs and convey this information to the design engineers.
5. Customer profitability analysis, Kronecker Company, a growing mail-order clothing and accessory company, is concerned about its growing marketing, distribution, selling, and administration expenses. It therefore examined its customer ordering patterns for the past year and identified four different types of customers, as illustrated in the following table. Kronecker sends catalog and flyers to all its customers several times a year. Orders are taken by mail or over the phone. Kronecker maintains a toll-free number for customers to use when placing orders over the phone. Kronecker prides itself on the personal attention it provides shoppers who order over the phone. All purchases are paid for by check or credit card. Kronecker has very generous return policy if customers are not satisfied with the merchandise received. Customers must pay return shipping charges, but their purchase price is then fully refunded.
Customer 1Customer 2Customer 3Customer 4
Initial sales$1,000$1,000$2,500$3,000
Number of item retuned04224
Dollar value of items returned0$200$500$1,500
Number of orders per year16412
Number of phone orders per year10012
Time spend on the phone placing orders0.25 hours001 hour
Number of overnight deliveries10012
Number of regular deliveries0640
Prices are set so that cost of goods sold is on average about 75% of the sales price. Customers pay actual shipping charges, but extra processing is required for overnight deliveries. Kronecker has developed the following activity cost driver rates for its support costs:
Activity Activity cost driver rate
Process mail order$5 per order
Process phone order$80 per hour
Process returns$5 per item returned
Process overnight delivery requests$4 per request
Maintain customer relations(send catalogs and respond to customer comments or complaints)$50 per year
a. Using activity-based costing, determine the yearly profit associated with each of the four customers described.
b. Comment on which customers are most profitable and why.
c. What advice do you have for Kronecker regarding managing customer relationships with the different types of customers represented?
4
Sales / $1,000 / $1,000 / $2,500 / $3,000
Less returns / 0 / 200 / 500 / 1,500
Net sales / $1,000 / $800 / $2,000 / $1,500
Cost of goods sold,
75% of sales / 750 / 600 / 1,500 / 1,125
Processing mail orders,
$5 per nonphone order / 0 / 30 / 20 / 0
Process phone orders,
$80 per hour / 20 / 0 / 0 / 80
Process returns,
$5 per item returned / 0 / 20 / 10 / 120
Process overnight
delivery requests,
$4 per request / 4 / 0 / 0 / 48
Maintain customer
relations / 50 / 50 / 50 / 50
Profit / $176 / $100 / $420 / $77
Profit ¸ Sales / 0.18 / 0.10 / 0.17 / 0.03
b)
Although customer 4 has the highest sales, it has the highest dollar returns and the lowest
profit. Customer 3 is by far the most profitable, even though its sales are less than
customer 4’s (but customer 3’s net sales exceed customer 4’s). Customers 1 and 2 are
more profitable than customer 4 in total dollars and in percent of sales. Customer 1
returns the highest profit as a percent of sales, slightly above customer 3’s ratio. Cost of
goods sold represents 75% of sales revenue, so the remaining costs as a percent of sales
pertain to each customer’s interaction with the company. Customer 4 is the most
expensive to service because it orders frequently, places orders in a costly manner (one
hour on the phone), returns many items, and requests overnight deliveries. Customer 1 is
fairly low-cost to serve in spite of ordering by phone and requesting overnight delivery
because the customer orders only once a year and does not return merchandise. Aside
from returns, customers 2 and 3 are fairly low-cost to serve because they order via mail
and request regular delivery rather than overnight delivery.
c)
Kronecker can seek to reduce the service activity usage or improve efficiency to reduce
the cost of providing services. For example, Kronecker might ask customers the reason
for returns, and follow up with ways to reduce problems that caused the returns. The
company might also explore ways to make phone ordering more efficient, to reduce the
time spent on the phone. Kronecker may also charge fees to handle overnight delivery
requests.