Chapter 07

Activity-Based Costing: A Tool to Aid

Decision Making
Exercise 7-3 (10 minutes)

Activity Cost Pool

Caring for lawn
Caring for garden beds
low maintenance
Caring for garden beds
high maintenance
Travel to jobs
Customer billing and
service

Estimat
ed
Overhe
ad Cost
$77,40
0
$30,00
0
$57,60
0
$4,200
$8,700

Expected Activity
180,00 square feet of
0 lawn
24,000 square feet of
low
maintenance
beds
18,000 square feet of
high
maintenance
beds
15,000
miles
30
customers

7-1

$0.4
3
$1.2
5
$3.2
0
$0.2
8
$29
0

Activity Rate
per square foot of
lawn
per square foot of
low maintenance
beds
per square foot of
high maintenance
beds
per mile
per customer

The activity rate for each activity cost pool is computed by dividing its estimated overhead
cost by its expected activity.

7-2

Exercise 7-4 (10 minutes)

J78

Activity Cost Pool

Activity Rate

Supporting direct labor... .

$7

Machine processing..........

$3

Machine setups................
Production orders.............

$40
$16
0
$12
0
$80
0

Shipments........................
Product sustaining............
Total overhead cost..........
W52

Activity Cost Pool

per setup
per order
per shipment
per product

1,00
0
3,20
0
5
5
10
1

Activity Rate

Supporting direct labor... .

$7

Machine processing..........
Machine setups................
Production orders.............

$3
$40
$16
0
$12

Shipments........................

per direct laborhour

per machine-hour

Activity

per direct laborhour

per machine-hour
per setup
per order
per shipment
7-3

40
30
1
1
1

direct laborhours
machine-hours
setups
order
shipment

ABC
Cost
$ 7,00
0
9,600
200
800
1,200

product

80
0
$19,60
0

Activity

ABC
Cost
$ 280

direct laborhours
machine-hours
setups
orders
shipments

90
40
160
120

Product sustaining............
Total overhead cost..........

0
$80
0

per product

product

800
$1,490

7-4

Exercise 7-9 (30 minutes)

1. Total revenue received:

Cost of goods sold to the hospital (a)....

Markup percentage...............................
Markup in dollars (b).............................
Revenue received from hospitals (a) +
(b).......................................................

City
General
$30,000
5%
$1,500

County
General
$30,000
5%
$1,500

$31,500

$31,500

2. Activity Rates:

Activity Cost Pool

Customer deliveries.......
Manual order
processing...................
Electronic order
processing...................
Line item picking............

(a)
Estimat
ed
Overhea
d Cost
$400,00
0
$300,00
0
$200,00
0
$500,00
0

(b)
Expected
Activity
5,000 deliverie
s
4,000 orders
12,500

orders

400,00
0

line
items

(a) (
Activity
$80.0 per de
0
$75.0 per ma
0
$16.0 per ele
0 order
$1.25 per lin
picked

3. Activity costs are assigned to the two hospitals as follows:

City General:
(a)
Activity Cost Pool
Activity Rate
Customer deliveries....... $80.0 per
0 delivery
Manual order
$75.0 per order
processing...................
0
Electronic order
$16.0 per order
7-5

(b)
Activity
10 deliveries

(a)
(b)
ABC
Cost
$ 800

0 orders

10 orders

160

processing...................
0
Line item picking............ $1.25 per line
item
Total activity costs..........

100 line items

125
$1,085

County General:
Activity Cost Pool
Customer deliveries.......
Manual order
processing...................
Electronic order
processing...................
Line item picking............

(a)
Activity Rate
$80.0 per
0 delivery
$75.0 per order
0
$16.0 per order
0
$1.25 per line
item

(b)
Activity
20 deliverie
s
40 orders

(a) (b)
ABC
Cost
$1,600
3,000

0 orders
260 line
items

Total activity costs..........

0
325
$4,925

Exercise 7-9 (continued)

4. Customer margins for the two hospitals:

Sales.................................
Cost of goods sold.............
Gross margin.....................
Customer deliveries..........
Manual order processing. . .
Electronic order
processing......................
Line item picking...............
Total activity costs.............
Customer margin..............

City
General
$31,500
30,000
1,500
800
0
160

County
General
$31,500
30,000
1,500
1,600
3,000
0

125
1,085
$ 415

325
4,925
$(3,425)

5. Hospitals that require frequent deliveries, place a high volume

of manual orders, and order many line items are likely to be

7-6

unprofitable.
Exercise 7-13 (15 minutes)
Customer MarginABC Analysis
Sales (2,400 seats $137.95 per seat)....
Costs:
Direct materials ($112 per seat 2,400
seats)...................................................... $268,800
Direct labor ($14.40 per seat 2,400
seats)......................................................
34,560
Supporting direct labor ($12 per DLH
0.8 DLH per seat 2,400 seats).............
23,040
Batch processing ($96 per batch 4
batches)..................................................
384
Order processing ($284 per order 1
order)......................................................
284
Customer service overhead ($2,620 per
customer 1 customer).........................
2,620
Customer margin........................................

7-7

$331,080

329,688
$ 1,392

Problem 7-17 (45 minutes)

1. Under the traditional direct labor-dollar based costing system,
manufacturing overhead is applied to products using the
predetermined overhead rate computed as follows:

Predetermined = Estimated total manufacturing overhead cost

overhead rate
Estimated total direct labor dollars
=

$508,625
= $3.13 per DL$
$162,500

The product margins using the traditional approach would be

computed as follows:
Sales................................
Direct materials...............
Direct labor......................
Manufacturing overhead
applied @ $3.13 per
direct labor-dollar..........
Total manufacturing cost..
Product margin.................

EX300
$1,200,0
00
366,325
120,000
375,60
0
861,92
5
$ 338,07
5

TX500
$500,000
162,550
42,500

Total
$1,700,00
0
528,875
162,500

133,025

508,625

338,075

1,200,000

$161,925

$ 500,000

Note that all of the manufacturing overhead cost is applied to

the products under the companys traditional costing system.

7-8

Problem 7-17 (continued)

2. The first step is to determine the activity rates:
(a)
Activity Cost
Total
(b)
(a) (b)
Pools
Cost
Total Activity
Activity Rate
Machining.......... $198,25 152,500 MHRs
$1.30 per MHR
0
Setups................ $150,00
375 setup
$400 per setup
0
hrs.
hr.
Product
$100,00
2 products $50,00 per
sustaining........
0
0 product
*The Other activity cost pool is not shown above because it
includes organization-sustaining and idle capacity costs that
should not be assigned to products.
Under the activity-based costing system, the product margins
would be computed as follows:
EX300
TX500
Total
Sales.......................
$1,200,0 $500,000
$1,700,0
00
00
Direct materials......
366,325
162,550
528,875
Direct labor.............
120,000
42,500
162,500
Advertising expense
50,000
100,000
150,000
Machining...............
117,000
81,250
198,250
Setups.....................
30,000
120,000
150,000
Product sustaining...
50,00
100,00
0
50,000
0
Total cost.................
733,32
1,289,62
5
556,300
5
Product margin........
$ 466,67
$ 410,37
5
$(56,300)
5

7-9

Problem 7-17 (continued)

3. The quantitative comparison is as follows:
EX300
Traditional Cost System
Direct materials............................
Direct labor..................................
Manufacturing overhead..............
Total cost assigned to products....
Selling and administrative............

(a)
Amou
nt
$366,3
25
120,00
0
375,60
0
$861,9
25

TX500

(a) (c)
%
69.3%
73.8%

(b)
Amou
nt
$162,5
50
42,500

Total

(b) (c)
(c)
%
Amount
30.7% $ 528,87
5
26.2%
162,500

73.8%

133,02
5
$338,0
75

26.2%

69.3%

$162,5
50
42,500

30.7% $ 528,87
5
26.2%
162,500

100,00
0

66.7%

Total cost......................................
Activity-Based Costing System
Direct costs:
Direct materials.........................
Direct labor................................
Advertising expense..................

$366,3
25
120,00
0
50,000

7-10

73.8%
33.3%

508,62
5
1,200,00
0
550,00
0
$1,750,0
00

150,000

Indirect costs:
Machining..................................
Setups.......................................
Product sustaining.....................
Total cost assigned to products....
Costs not assigned to products:
Selling and administrative.........
Other.........................................

117,00
0
30,000

59.0%

81,250

41.0%

198,250

20.0%

80.0%

150,000

50,00
0
$733,3
25

50.0%

120,00
0
50,00
0
$556,3
00

50.0%

100,00
0
1,289,62
5
400,000
60,37
5
$1,750,0
00

Total cost......................................

7-11

Problem 7-17 (continued)

The traditional and activity-based cost assignments differ for
three reasons. First, the traditional system assigns all $508,625
of manufacturing overhead to products. The ABC system
assigns only $448,250 of manufacturing overhead to products.
The ABC system does not assign the $60,375 of Other activity
costs to products because they represent organizationsustaining costs. Second, the traditional system uses one unitlevel activity measure, direct labor dollars, to assign 73.9% of
all overhead to the EX300 product line and 26.1% of all
overhead to the TX500 product line. The ABC system assigns
59.0% of Machining costs to the EX300 product line and 41.0%
to the TX500 product line. The ABC system assigns 20.0% of
Setup costs (a batch-level activity) to the EX300 product line
and 80.0% to the TX500 product line. The ABC system assigns
50% of Product sustaining costs (a product-level activity) to
each product line. Third, the traditional system does not trace
any advertising expenses to the two products. The ABC system
traces $50,000 of advertising to the EX300 and $100,000 of
advertising to the TX500 product line.