ACCT112 Management Accounting: WEEK 3 (Textbook Suggested Solution)

4.17

For decision-making, general and administrative costs should be assigned to goods

and services only if these costs can be avoided if the goods and services are
dropped (i.e. the costs are necessary for the goods and services). If the costs are
simply reallocated to other products when one product is eliminated, then allocating
general and administrative costs might be misleading for decision-making purposes.
(For example, perhaps a particular product would not have been dropped if general
and administrative costs were not part of the products profitability analysis.) If G&A
costs are too high, then analysts should apply ABC there, too.

4.25

(15 min) Identifying different levels of activities and resources

Resource
Production mgmt. (salaries & support)
Marketing research (salaries & support)
Labour (hourly)
Setup labour (personnel)
Utilities (electrical power)
Legal department (salaries & facilities)
Equipment
Materials
Supplies
Software

4.27

Activity Level
Facility
Facility
Unit
Batch
Batch
Customer
Product
Unit
Customer
Batch

(20 min) Matching activity levels and possible cost-driver bases to activities
(The possible cost-driver bases are suggestions, there is often more than one
correct answer).
Activity

Sales calls -- existing commercial customers

Possible cost-driver
base
No. of calls

Activity Level

Sales calls -- new commercial customers

No. of calls

Commercial loan negotiation

No. of applications

Unit

Commercial loan review

No. of applications

Unit or Batch

Customer file maintenance

No. of customers

Community involvement

Hours of time

Facility

Employee relations

No. of employees

Facility

Customer
Customer

Customer

Commercial loan customer service

No. of commercial
customers
No. of consumer
customers
No. of applications

Consumer loan customer service

Consumer loan review
Consumer deposit/withdrawal processing
Commercial deposit/withdrawal processing
Advertising particular products

4.35

No. of
deposits/withdrawals
No. of
deposits/withdrawals
No. of products being
advertised

(40 min) Activity-based costing in a service environment

(a)
Hours worked
Overhead
Overhead rate
Charge per
hour

Commercial Residential
7,000
13,000

Revenue
Less
Direct labour
Overhead
Total profits
(b)
Revenue
Less
Direct labour
Overhead:
Transportation
Equipment use
Supplies
Total costs
Total profits

Rate

283.33c
6.00d
0.35e

Total
20,000
130,000
6.50

25

30

175,000

390,000

565,000

112,000
45,500
17,500

208,000
84,500
97,500

320,000
130,000
115,000

Commercial Residential
175,000
390,000

Total
565,000

112,000

208,000

320,000

4,250f
22,800g
49,000h
188,050
- 13,050

12,750
13,200
28,000
261,950
128,050

17,000
36,000
77,000
450,000
115,000

_______________
283.33 per client = 17,000 60 clients
6.00 per hour = 36,000 6,000 equipment hours
e 0.35 per square meter = 77,000 220,000 square meters
f 4,250 = 283.33 x 15 commercial clients
g 22,800 = 6.00 x 3,800 equipment-hours
h 49,000 = 0.35 x 140,000 square yards
c

Customer
Customer
Unit or Batch
Unit
Unit
Product or
Customer

The total overhead is the same whether using the traditional labour-hour based
overhead application or ABC. The choice between ABC and the traditional method
affects the division of the total overhead of 130,000 between the products. ABC
does not affect the amount of overhead incurred in the short run. It provides
information that can help cost managers to reduce overhead in the long run by
measuring cost rates for cost drivers and by identifying unprofitable products for
which managers should take action (e.g., drop the product, raise prices, outsource
production to reduce costs).
c. The recommendation is to consider dropping the commercial business but definitely
continue the residential business. Alternatively, the company could find a way to
make the Commercial business profitable. Some ideas include cutting costs,
outsourcing some of the work to cheaper subcontractors, and raising prices to
commercial customers. Note that the area for commercial clients is much larger
which explains the greater supplies costs assigned to commercial customers and
likely explains the greater equipment use.
We can explain the differences in profits under the two cost methods by explaining
that there is little correlation in costs between direct labour and the overhead costs.
4.38

(45 min) Limitations of traditional costing methods

a.
Activity
Order processing
Production setup
Materials handling
Machine deprec. & maint.
Quality control
Packing

Cost
Driver
# of orders
# of runs
kg. of mat.
mach. hrs.
# of insp.
# of units

Estimated
Costs
42,000 K
130,000
90,000
88,000
20,000
50,000
420,000 K

Driver
Units
200
50
75,000
8,000
50
250,000

Allocation
Rate
210 K
2,600
1.20
11
400
0.2

Predetermined rate = estimated overhead cost estimated allocation base activity level
= 420,000 K estimated overhead cost 4,000 direct labour hours
= 100 K per direct labour hour

b.

Description
Direct materials
Direct laboura
Indirect costsb
Total cost

Unleaded
12,000 K
2,400
15,750
30,150 K

Low-Lead
9,000 K
2,400
15,750
27,150 K

_______________
a
b

Number of direct labour hours x 16 K per hour

Number of direct labour hours x 105 K per hour

High-Lead
6,000 K
3,200
21,000
29,200 K

Total
27,000 K
8,000
52,500
87,500 K

c.

d.

Description
Unleaded
Low-Lead
Direct materials
12,000 K
9,000 K
Direct labour
2,400
2,400
Indirect Costs
Order proc.
1,050a
840
Prod. setup
2,600 b
5,200
Mat. handling
4,800 c
1,800
Mach. dep.
6,270 d
1,650
e
Quality con.
400
400
Packing
3,600f
1,500
Total Cost
33,120 K
22,790 K
_______________
a 1,050 K = 210 K per order x 5 orders
b 2,600 K = 2,600 K per run x 1 run
c 4,800 K = 1.20 K per pound x 4,000 pounds
d 5,800 K = 11 K per machine hour x 570 hours
e 400 K = 400 K per inspections x 1 inspection
f 3,600 K = 0.2 K per unit x 18,000 units

High-Lead
6,000 K
3,200

Total
27,000 K
8,000

630
5,200
1,200
990
400
560
18,180 K

2,520
13,000
8,400
8,910
1,200
5,660
74,090 K

The discrepancy between our product costs using direct-labour hours as the
allocation base versus activity-based costing is found in the way overhead costs are
allocated. Our traditional direct-labour cost method distorts our product costs
because there is little correlation between our direct-labour costs and overhead.
Activity-based costing is more accurate. It allocates the individual components of
our overhead to our products based upon the products use of that overhead
component.
With the more accurate product costs, we should begin to concentrate our efforts
upon reducing the costs of our more expensive overhead operations. As seen in the
activity-based costing report, a large share of our total overhead is comprised of
materials handling and production setup costs costs which were not visible under
the direct-labour approach. Reducing our materials handling and production setup
costs should be a new priority.
We recommend assessing the cost of using an activity-based system in our
company. We will proceed with activity-based costing if we find the cost of the new
system is less than the benefits of the more accurate information we will receive.