Managerial Accounting 2.1.

4 Chapter 4 Solutions
Heisinger and Hoyle

Chapter 4 Solutions
Questions

1. Managers allocate costs to products for several reasons. Costs are allocated to:
1. provide information for decision making (for example, setting prices, eliminating
products, and assessing profitability);
2. promote efficient use of resources (for example, if repairing defective products is
a costly activity, managers will have an incentive to minimize this activity); and
3. comply with Generally Accepted Accounting Principles (GAAP require that all
manufacturing costs be allocated to products for external reporting).

2. Overhead costs can be allocated using one plantwide rate, department rates, or
activity rates (activity-based costing). The plantwide method uses one predetermined
overhead rate for the entire plant to allocate overhead costs. The department method
uses several predetermined overhead rates (one for each department) to allocate
overhead costs. Activity-based costing also uses several predetermined overhead
rates (one for each activity) to allocate overhead.
The plantwide method tends to be the least accurate. The department method is
better but still relies on the assumption that overhead costs are driven by direct labor
hours, direct labor costs, or machine hours (not necessarily a valid assumption).
Activity-based costing provides the best cost information, but can be costly to
implement and maintain.

3. A cost pool is a group of costs. Cost pools are used to form “buckets” of overhead
costs that are eventually allocated to products. Predetermined overhead rates are
established for each cost pool and used to assign overhead costs to products. The
plantwide method forms one cost pool for the entire plant. The department method
forms several cost pools–one for each department. ABC forms several cost pools–
one for each activity.

4. In the context of activity-based costing, an activity is any process or procedure that

consumes overhead resources. Setting up production machinery and performing
materials inspections are examples of activities that consume overhead resources. A
cost driver is the action that causes, or drives, the costs associated with the activity.
For example, the number of machine setups drives the cost of setting up production
machinery (the more setups, the higher the cost), and the number of inspection hours
drives the cost of inspecting materials (the more inspection hours, the higher the
cost).

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5. There are very few differences in cost flows between the two methods of allocating
overhead. The plantwide method uses one rate to allocate, or apply, overhead costs to
products, and ABC uses several overhead rates. Although more detailed calculations
are required using ABC, the entry to record applied overhead is the same–debit Work
in Process Inventory and credit Manufacturing Overhead. The disposition of
overapplied and underapplied overhead at the end of the reporting period, and all
other entries, are the same regardless of the allocation approach used.

6. The five steps to implement activity-based costing are:

1. Identify costly activities required to complete products. This includes identifying
all procedures in the production process that consume a significant amount of
overhead resources.
2. Assign overhead costs to the activities identified in step 1. Cost pools are formed
for each activity, and overhead costs are assigned to each cost pool.
3. Identify the cost driver for each activity. This involves identifying the action that
causes, or drives, the costs associated with the activity.
4. Calculate a predetermined overhead rate for each activity. The predetermined
overhead rate is calculated by dividing the estimated overhead costs by the
estimated level of cost driver activity.
5. Allocate overhead costs to products. Overhead costs are allocated to products by
multiplying the predetermined overhead rate for each activity times the level of
cost driver activity used by the product.

7. Activity-based costing systems provide more accurate product cost information than
traditional costing systems. Armed with more accurate information, managers are
able to make better decisions in areas such as product pricing and product line
changes. ABC systems also provide information to managers regarding costly
activities required to make products and the cost of these activities. Management can
use this information to make process improvements and reduce costs.

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8. Activity-based costing systems can be costly to implement. Personnel throughout the

company must be involved in identifying costly activities, and once an ABC system is
set up, cost driver activity must be tracked and journal entries made to assign
overhead costs to products.
Another disadvantage of ABC, and of plantwide and department allocation
approaches as well, is that fixed costs are unitized. That is, once all overhead costs
are allocated to products using different activity rates, a unit product cost is
established. Managers may think this is the true cost per unit, and that each
additional unit produced will cost the same amount. This is only accurate if all
overhead costs are variable, which is rarely the case. Managers must be made aware
of the existence of fixed costs, and the impact fixed costs have on unit product costs
at different levels of production.
A third disadvantage of ABC is that the benefits of implementing such a system
do not always outweigh the costs. Companies with simple production systems and
very few products may not benefit much from using ABC. Also, managers must be
willing to use the ABC information for decision-making and process improvement
purposes. If not, the implementation of ABC has no purpose.

9. Companies that used activity-based costing had (1) relatively higher overhead costs
as a percent of total product costs than those who did not use ABC; and (2) a
relatively higher level of automation resulting from complex production processes
and products than those who did not sue ABC.

10. Under Activity-based costing (ABC), several overhead rates to allocate overhead are
used. The entry to record these allocations is to debit Work in Process Inventory and
credit Manufacturing Overhead for the amount of overhead applied. The
Manufacturing Overhead account is closed to Cost of Goods Sold at the end of the
period.

11. The three steps to implement activity-based management are:

1. Identify activities required to complete products. This is similar to the first step
of activity-based costing. Key personnel throughout the company are interviewed
to identify the process and activities required to complete products.
2. Determine whether activities are value-added or nonvalue-added. Identify which
activities add to the product’s quality and performance (value-added) and which
do not add to the product’s quality and performance (nonvalue-added).
3. Continuously improve the value-added activities and minimize, or eliminate, the
nonvalue-added activities. The focus of this step is on improving the efficiency
of operations and reducing costs.

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12. Activity-based costing (ABC) focuses on providing accurate product cost

information, while activity-based management (ABM) uses this cost information to
improve the efficiency and profitability of operations. ABC requires five steps
resulting in the allocation of overhead costs to products. Although many who use
ABM are interested in product costs, the focus is on production activities. ABM
requires three steps leading to the elimination of nonvalue-added activities and
continued improvement of value-added activities. Some view ABM as an extension
of ABC. Others argue that ABM can be implemented regardless of whether the
organization uses ABC.

13. A value-added activity adds value to the product’s quality and performance. A
nonvalue-added activity does not add value to the product’s quality and performance.
Examples are as follows (answers will vary):
1. Fast-food restaurant
 Cashier waiting to take an order
 Moving boxes of supplies from one area of the restaurant to another
 Throwing away poor-quality ingredients
2. Clothing store
 Looking for a specific size for a customer, and discovering the item is out
of stock
 Cashier waiting for customers
 Sending back defective merchandise
3. College bookstore
 Customers waiting in line to pay the cashier
 Helping a customer locate a book, only to find that the book is out of stock
 Returning excess inventory (books) to suppliers

14. BuyGasCo Corporation was accused of selling its regular grade gasoline below cost
(called predatory pricing). BuyGasCo’s expert witness used activity-based costing
(ABC) to allocate costs for labor, kiosk, and gas dispensing to each of the three
grades of fuel. By using ABC, the expert witness (an accounting professor) was able
to show that regular gas had a lower cost than the plaintiff alleged; therefore proving
that regular gas was not being sold below cost.

15. The top two objectives for using ABC and ABM were (1) to provide product costing
information; and (2) to analyze processes.

16. Management’s primary concern was how to allocate administrative costs totaling
$588 million to the organization’s products and services. These costs represented 21
percent of the organization’s revenue. The allocation of these costs was vital to
improved product pricing and the efficient use of resources.

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17. Answers will vary, but should mention the fact that any cost can be allocated to
products for internal reporting purposes–it’s up to management to decide. Examples
of selling costs that can be allocated to products include sales commissions, shipping,
and advertising. Examples of general and administrative costs (most of which are
considered “service department” costs) that might be allocated to products include
accounting, human resources, and computer support.
Managers prefer to allocate many of these nonmanufacturing costs to products for
the same reasons manufacturing costs are assigned to products. More cost
information is provided to managers for decision-making purposes (for example,
should certain services be outsourced or maintained in-house?), and an incentive is
created for managers to be efficient in using service department resources.

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Brief Exercises

18. Product Costing at SailRite

a. SailRite’s owner was concerned about the affect of individual product profits on
overall company profits. She indicated that ever since the company introduced
the Deluxe model, overall company profits had steadily declined.

b. SailRite’s accountant calculated product costs using activity-based costing and

discovered that the Deluxe model was costing much more than expected. In fact,
each deluxe model sold resulted in a loss of $530 (as shown in Figure 3.7).

19. Calculating Plantwide Predetermined Overhead Rate

The plantwide predetermined overhead rate is calculated as follows:

Predetermined Estimated overhead costs
overhead rate Estimated activity in allocation base

a. Predetermined overhead rate based on direct labor hours:

$5,000,000 estimated overhead costs
100,000 direct labor hours
= $50 per direct labor hour

Products are charged $50 in overhead costs for each direct labor hour worked.
This rate is used across the company in all production departments.

b. Predetermined overhead rate based on machine hours:

$5,000,000 estimated overhead costs
40,000 machine hours
= $125 per machine hour

Products are charged $125 in overhead costs for each machine hour worked. This
rate is used across the company in all production departments.

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20. Calculating Department Predetermined Overhead Rates

a. The department rates are calculated using the same formula as one plantwide rate
as follows:
Predetermined Estimated overhead costs
overhead rate Estimated activity in allocation base
However, overhead costs and activity levels are estimated for each department
rather than for the entire company, and separate rates are used for each
department as shown below:
Assembly $200,000 $50 per machine hour
Department 4,000 machine hrs

Finishing $300,000 $10 per direct labor hour

Department 30,000 direct labor hrs

Products going through the Assembly Department are charged $50 in overhead
costs for each machine hour used. Products going through the Finishing
Department are charged $10 in overhead costs for each direct labor hour worked.
b. Different allocation bases are used for each department because different
activities drive overhead costs in each department. For example, the Assembly
Department uses machine hours because this department uses a high level of
equipment and machinery. The Finishing Department uses direct labor hours
because this is a labor intensive department. Thus, departmental overhead rates
are developed using the activity that drives the overhead costs in that department.

21. Identifying Cost Drivers

Only one answer is required for each activity and answers will vary. Possible
answers are:

1. Number of purchase orders processed, or units of material purchased (for

example, pounds of material purchased)
2. Number of inspections, or units of material inspected
3. Units of raw materials stored, or storage space consumed
4. Number of machine hours
5. Number of machine setups
6. Number of tests, or number of products tested

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22. Identifying Cost Drivers, Service Company

Only one answer is required for each activity and answers will vary. Possible
answers are:

1. Number of meetings, or hours of meeting time

2. Number of inspections
3. Hours spent meeting with contractors
4. Hours of equipment use
5. Number of customers, or number of billings (invoices)

23. Value-added and Nonvalue-added Activities

1. Nonvalue-added
2. Nonvalue-added
3. Value-added
4. Nonvalue-added
5. Value-added
6. Value-added
7. Nonvalue-added

24. Allocation Base for Service Departments

a. Answers will vary. Examples are provided below.

1. Hours of computer support used–Production departments requiring a high number
of computer support hours consume more Computer Technology Department
resources than production departments requiring little computer support.
2. Number of employees–Production departments with a high number of employees
consume more Personnel Department resources than production departments with
fewer employees.
3. Number of transactions or number of financial reports–Production departments
with a high number of transactions or financial reports consume more Accounting
Department resources than production departments with few transactions or fewer
financial reports.
4. Square feet of building space occupied–Production departments occupying large
areas consume more Maintenance Department resources than production
departments occupying small areas.
5. Hours of legal services used–Production departments using a high number of
legal service hours consume more Legal Department resources than production
departments using fewer hours.

b. No, the direct method does not allocate service department costs to other service
departments. Instead, service department costs are allocated directly to
production departments. Other, more complex methods allow for the allocation
of service departments to other service departments first, then to production
departments (these methods are discussed in advanced costing accounting texts).

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Exercises: Set A

25. Plantwide Versus Department Allocations of Overhead

a. The predetermined overhead rate using the plantwide method is:

Predetermined Estimated overhead costs
overhead rate Estimated activity in allocation base
$600,000
30,000 hrs
= $20 per direct labor hour

Products are charged $20 in overhead costs for each direct labor hour worked.
This rate is used across the company in all production departments.

b. The department rates are calculated using the same formula as the plantwide rate.
However, overhead costs and activity levels are estimated for each department
rather than for the entire company, and separate rates are used for each
department:
Cutting $100,000 $5 per machine hour
Department 20,000 machine hrs

Assembly $300,000 $12 per direct labor hour

Department 25,000 direct labor hrs

Finishing $200,000 $2 per $1 in direct labor cost

Department $100,000 direct labor costs (or 200% of direct labor costs)

Products going through the Cutting Department are charged $5 in overhead costs for
each machine hour used. Products going through the Assembly Department are
charged $12 in overhead costs for each direct labor hour worked. And products going
through the Finishing Department are charged 200 percent of direct labor costs
incurred.

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26. Computing Product Costs Using Activity-Based Costing

a. Predetermined overhead rates are shown in the far right column below:
(a) (b) (a) ÷ (b)
Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Production setups Number of production runs $ 60,000 100 runs $600 per production run
Materials handling Yards of material purchased 140,000 10,000 yards $14 per yard purchased
Quality control Number of inspections 80,000 800 inspections $100 per inspection
Total $280,000

b. Overhead is allocated to products for the month of July as follows:

MX1 MX2
Predetermined Cost Cost
Overhead Rate Driver Overhead Driver Overhead
(from part a) Activity Allocated* Activity Allocated*
$600 per production run 3 $ 1,800 6 $3,600
$14 per yard purchased 550 7,700 230 3,220
$100 per inspection 40 4,000 10 1,000
Total allocated $13,500 $7,820
_______________
* Overhead allocated equals the predetermined overhead rate times the cost driver activity for each product.

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26. (continued)

c. The overhead cost per unit for each product is calculated below:

MX1 product: $13,500 overhead allocated ÷ 1,000 units = $13.50 per unit
MX2 product: $7,820 overhead allocated ÷ 700 units = $11.17 per unit (rounded)

d. The product cost per unit for each product is calculated below:

MX1 MX2
Direct materials (given) $20.00 $30.00
Direct labor (given) 15.00 45.00
Overhead (from part c) 13.50 11.17
Total product cost $48.50 $86.17

27. Apply Overhead

For all three methods, the amount of overhead to be applied is calculated as:
Predetermined overhead rate x actual activity in allocation base

a. Using one plantwide rate, the calculation is:

120 percent x $80,000 actual direct labor cost = $96,000

b. Using department rates, the calculation is:

$55 per machine hour x 1,000 actual machine hours = $55,000
$35 per direct labor hour x 1,200 actual direct labor hours = 42,000
Total overhead applied $97,000

c. Using activity-based costing rates, the calculation is:

$15 per requisition x 900 actual requisitions = $ 13,500
$50 per setup x 1,300 actual setups = 65,000
$70 per inspection x 400 actual inspections = 28,000
Total overhead applied $106,500

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Exercises: Set B

28. Plantwide Versus Department Allocations of Overhead: Service Company

a. The predetermined overhead rate using the plantwide method is:

Predetermined Estimated overhead costs
overhead rate Estimated activity in allocation base
$1,000,000
$800,000
= $1.25 per $1 of direct labor cost (or 125% of direct labor cost)

Customers are charged overhead totaling 125 percent of direct labor costs. This
rate is used for both departments.

b. The department rates are calculated using the same formula as the plantwide rate.
However, overhead costs and activity levels are estimated for each department
rather than for the entire company, and separate rates are used for each
department:
Design $300,000 $0.60 per $1 in direct labor cost
Department $500,000 direct labor costs (or 60 % of direct labor costs)

Wetlands Maint. $700,000 $23.33 per direct labor hour

Department 30,000 direct labor hrs

Customers are assigned overhead equal to 60 percent of direct labor costs incurred
in the Design Department. Customers are assigned $23.33 in overhead costs for
each direct labor hour worked in the Wetlands Maintenance Department.

c. One interpretation is that overhead costs will be included in the costs used for
billing purposes. Thus, billing would be based on direct labor costs and overhead
costs plus a 30 percent markup.
Another interpretation is that overhead costs will not be included in the
costs used for billing purposes. Thus, billing would be based on direct labor costs
only plus a 30 percent markup.
Imagine the surprise if your auto mechanic quoted you a price of “cost
plus 20 percent markup,” only to find out that “cost” meant direct labor and
overhead. The point here is to make sure you understand what is meant by the
term “cost” when used for bidding purposes, regardless of whether you are the
provider of the goods and services or the customer.

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29. Computing Product Costs Using Activity-Based Costing

a. Predetermined overhead rates are shown in the far right column below:
(a) (b) (a) ÷ (b)
Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Ordering parts Number of purchase requisitions $ 400,000 5,000 reqs. $80 per purchase req.
Tracking inventory parts Number of parts purchased 560,000 80,000 parts $7 per part purchased
Running machines Machine hours 350,000 7,000 hours $50 per machine hour
Inspecting finished
products Inspection hours 200,000 1,000 hours $200 per insp. hour
Total $1,510,000

b. Overhead is allocated to products for the month of May as follows:

Z1 Z2 Z3
Predetermined Cost Cost Cost
Overhead Rate Driver Overhead Driver Overhead Driver Overhead
(from part a) Activity Allocated* Activity Allocated* Activity Allocated*
$80 per purchase requisition 50 $ 4,000 70 $ 5,600 100 $ 8,000
$7 per part purchased 4,000 28,000 3,300 23,100 3,600 25,200
$50 per machine hour 330 16,500 240 12,000 310 15,500
$200 per inspedtion hour 10 2,000 50 10,000 30 6,000
Total allocated $50,500 $50,700 $54,700
_______________
* Overhead allocated equals the predetermined overhead rate times the cost driver activity for each product.

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29. (continued)

c. The overhead cost per unit for each product is calculated below:

Z1 product: $50,500 overhead allocated ÷ 250 units = $202.00 per unit

Z2 product: $50,700 overhead allocated ÷ 500 units = $101.40 per unit
Z3 product: $54,700 overhead allocated ÷ 700 units = $78.14 per unit (rounded)

d. The product cost per unit for each product is calculated below:

Z1 Z2 Z3
Direct materials (given) $100.00 $ 75.00 $200.00
Direct labor (given) 35.00 25.00 70.00
Overhead (from part c) 202.00 101.40 78.14
Total product cost $337.00 $201.40 $348.14

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Problems

30. Activity-Based Costing Versus Traditional Approach

a. The cost per unit for direct materials is as follows:

Regular Monitor Premium Monitor

Total direct material costs (a) $1,908,000 $900,000
Units produced (b) 36,000 units 12,000 units
Direct material cost per unit (a) ÷ (b) $53 per unit $75 per unit

The cost per unit for direct labor is as follows:

Regular Monitor Premium Monitor
Total direct labor costs (c) $1,728,000 $1,200,000
Units produced (d) 36,000 units 12,000 units
Direct labor cost per unit (c) ÷ (d) $48 per unit $100 per unit

b. 1. The plantwide allocation used by Carson Company is based on direct labor

hours. The rate is calculated as:

Estimated overhead cost $3,675,000

Estimated activity in allocation base 105,000 hours

= $35 per direct labor hour

Since the regular monitor requires 1.75 direct labor hours to build and the
premium monitor takes 3.50 direct labor hours to build (both figures are
provided in the problem data), $61.25 in overhead is allocated to one unit of
the regular monitor (= $35 rate x 1.75 hours) and $122.50 in overhead is
allocated to one unit of the premium monitor ($35 rate x 3.50 direct labor
hours).

2. Per unit product costs are:

Regular Monitor Premium Monitor
Direct materials (from part a.) $ 53.00 $ 75.00
Direct labor (from part a.) 48.00 100.00
Overhead 61.25^ 122.50^^
Total product cost per unit $162.25 $297.50
_______________
^ $61.25 = 1.75 direct labor hours per unit x $35 rate
^^ $122.50 = 3.50 direct labor hours per unit x $35 rate

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30. (continued)
c.1.Predetermined overhead rates are calculated for each activity as follows:
(a) (b) (a) ÷ (b)
Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Purchase orders Number of purchase orders $1,200,000 1,000 orders $1,200.00 per order
Production setups Number of setups 1,125,000 150 setups $7,500.00 per setup
Quality inspections Inspection hours 750,000 12,000 hours $62.50 per inspection hour
Packaging and shipping Number of units shipped 600,000 48,000 units $12.50 per unit shipped
Total $3,675,000

2. Overhead costs are allocated below:

Regular Monitor Premium Monitor
Predetermined Cost Cost
Overhead Driver Overhead Driver Overhead
Activity Rate Activity Allocated* Activity Allocated*
Purchase orders $1,200.00 per order 400 $ 480,000 600 $ 720,000
Production setups $7,500.00 per setup 120 900,000 30 225,000
Quality inspections $62.50 per inspection 3,600 225,000 8,400 525,000
Packaging and shipping $12.50 per unit shipped 36,000 450,000 12,000 150,000
Total overhead costs allocated $2,055,000 $1,620,000

Total companywide overhead costs $3,675,000

Overhead cost per unit for each product (rounded)** $ 57 $ 135

_______________
* Overhead allocated equals the predetermined overhead rate times the cost driver activity.
** Overhead cost per unit for the regular monitor equals $2,055,000 (overhead allocated) ÷ 36,000 units produced, and for the premium
monitor, $1,620,000 ÷ 12,000 units produced. Amounts are rounded to the nearest dollar.

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30.c. (continued)

3. Per unit product costs are:

Regular Monitor Premium Monitor
Direct materials (from part a) $ 53 $ 75
Direct labor (from part a) 48 100
Overhead (from part c) 57 135
Total product cost per unit $158 $310

d. Traditional Costing (direct labor hours as the allocation base)

Regular Monitor Premium Monitor
Direct materials $ 53.00 $ 75.00
Direct labor 48.00 100.00
Overhead 61.25 122.50
Total product cost per unit (a) $162.25 $297.50
Sales price (b) $175.00 $300.00
Profit = (b) – (a) $ 12.75 $ 2.50

******************************************************************
Activity-Based Costing (several different allocation bases)

Regular Monitor Premium Monitor

Direct materials $ 53.00 $ 75.00
Direct labor 48.00 100.00
Overhead 57.00 135.00
Total product cost per unit (c) $158.00 $310.00
Sales price (d) $175.00 $300.00
Profit (loss) = (d) – (c) $ 17.00 $(10.00)
******************************************************************

e. Although unit product costs do not change significantly for the regular monitor
when activity-based costing is used (from $162.25 to $158.00), activity-based
costing results in a $4.25 increase in profit per unit (from $12.75 to $17.00).
Conversely, the premium monitor costs increase from $297.50 to $310.00 per unit
when using activity-based costing resulting in a loss of $10 per unit (versus a
profit of $2.50 using the traditional approach).
The shift in overhead costs to the premium monitor is primarily a result of the
premium monitor using 60 percent of the purchase order resources (= 600 flat
panel purchase orders ÷ 1,000 total purchase orders) and 70 percent of quality
inspection resources (= 8,400 flat panel inspections ÷ 12,000 total inspections).
Thus, 60 percent of the purchase order costs and 70 percent of the quality
inspection costs are assigned to the premium monitor. The plantwide rate
approach only assigned 40 percent of all overhead costs to the premium monitor
(= 42,000 premium monitor direct labor hours ÷ 105,000 total direct labor hours).

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31. Activity-Based Costing Versus Traditional Approach, Activity-Based

Management

a. The cost per unit for direct materials is as follows:

Desk Table
Total direct material costs (a) $1,575,000 $950,000
Units produced (b) 15,000 units 5,000 units
Direct material cost per unit (a) ÷ (b) $105 per unit $190 per unit

The cost per unit for direct labor is as follows:

Desk Table
Total direct labor costs (c) $1,200,000 $800,000
Units produced (d) 15,000 units 5,000 units
Direct labor cost per unit (c) ÷ (d) $80 per unit $160 per unit

b. 1. The plantwide allocation used by Fine Finishing, Inc., is based on direct labor
costs. The rate is calculated as:
Estimated overhead cost $6,000,000 estimated overhead
Estimated activity in allocation base $2,000,000 estimated DL costs

= 300 percent of direct labor costs (or 3 times direct labor cost)

Since the each desk costs $80 in direct labor to build and each table costs
$160 in direct labor to build (as shown in part a.), $240 in overhead is
allocated to one unit of the desk product (= 300% x $80) and $480 in
overhead is allocated to one unit of the table product (= 300% x $160).

2. Per unit product costs are:

Desk Table
Direct materials (from part a) $105 $190
Direct labor (from part a) 80 160
Overhead 240^ 480^^
Total product cost per unit $425 $830
_______________
^ $240 = 300 percent of direct labor cost x $80 direct labor cost per unit
^^ $480 = 300 percent of direct labor cost x $160 direct labor cost per unit

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31. (continued)
c. 1. Predetermined overhead rates are calculated for each activity as follows:
(a) (b) (a) ÷ (b)
Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Purchase orders Number of purchase orders $ 800,000 1,000 orders $800 per order
Machine setups Number of setups 1,600,000 500 setups $3,200 per setup
Machine maintenance Machine hours 2,400,000 60,000 hours $40 per hour
Quality inspections Number of inspections 1,200,000 20,000 inspection $60 per inspection
Total $6,000,000

2. Overhead costs are allocated below:

Desk Table
Predetermined Cost Cost
Overhead Driver Overhead Driver Overhead
Activity Rate Activity Allocated* Activity Allocated*
Purchase orders $800 per order 900 $ 720,000 100 $ 80,000
Machine setups $3,200 per setup 240 768,000 260 832,000
Machine maintenance $40 per machine hour 42,000 1,680,000 18,000 720,000
Quality inspections $60 per inspection 15,000 900,000 5,000 300,000
Total overhead costs allocated $4,068,000 $1,932,000

Total companywide overhead costs $6,000,000

Overhead cost per unit for each product (rounded)** $271 $386
_______________
* Overhead allocated equals the predetermined overhead rate times the cost driver activity.
** Overhead cost per unit for the desk equals $4,068,000 (overhead allocated) ÷ 15,000 units produced, and for the table, $1,932,000 ÷ 5,000
units produced. Amounts are rounded to the nearest dollar.

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31.c. (continued)

3. Per unit product costs are:

Desk Table
Direct materials (from part a) $105 $190
Direct labor (from part a) 80 160
Overhead (from part c) 271 386
Total product cost per unit $456 $736

d. Traditional Costing (direct labor cost as the allocation base)

Desk Table
Direct materials $105 $190
Direct labor 80 160
Overhead 240 480
Total product cost per unit (a) $425 $830
Sales price (b) $500 $900
Profit = (b) – (a) $ 75 $ 70

******************************************************************
Activity-Based Costing (several different allocation bases)

Desk Table
Direct materials $105 $190
Direct labor 80 160
Overhead 271 386
Total product cost per unit (c) $456 $736
Sales price (d) $500 $900
Profit (loss) = (d) – (c) $ 44 $164
******************************************************************

Activity-based costing results in a $31 decrease in per unit profit for the desk and
a $94 increase in profit for the table. This is a direct result of the desk product
cost increasing by $31 (from $425 to $456), and the table product cost decreasing
by $94 (from $830 to $736).

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31. (continued)

e. The percent calculations are as follows:

Desk Table
Purchase orders 90% 10%
Machine setups 48% 52%
Machine maintenance 70% 30%
Quality inspections 75% 25%

The shift in overhead costs to the desk product is primarily a result of the desk
product using 90 percent of the purchase order resources, 70 percent of machine
maintenance resources, and 75 percent of the quality inspection resources. Thus,
90 percent of the purchase order costs, 70 percent of the machine maintenance
costs, and 75 percent of quality inspection costs are assigned to the desk product.
The plantwide rate approach only assigned 60 percent of all overhead costs to the
desk product (= $1,200,000 desk direct labor costs ÷ $2,000,000 total direct labor
costs).

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32. Calculating and Recording Overhead Applied

a. Predetermined overhead rates are calculated for each activity as follows:
(a) (b) (a) ÷ (b)
Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Purchase orders Number of purchase orders $ 800,000 1,000 orders $800 per order
Machine setups Number of setups 1,600,000 500 setups $3,200 per setup
Machine maintenance Machine hours 2,400,000 60,000 hours $40 per hour
Quality inspections Number of inspections 1,200,000 20,000 inspection $60 per inspection

b. (a) (b) (a) x (b)

Desk Product Rate Amount of
Activity for the Month (from part a) Overhead Applied
40 purchase orders processed $800 per purchase order $ 32,000
22 machine setups $3,200 per setup 70,400
2,425 machine hours $40 per hour 97,000
890 quality inspections $60 per inspection 53,400
Total overhead applied for March $252,800

c. The activity of setting up machines is the most costly at $3,200 per setup. For each setup eliminated, the desk product would
be allocated $3,200 less in machine setup overhead costs. Thus, the manager of the desk product line would likely start with
improving efficiency associated with machine setups.

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33. Computing Product Costs using Activity-Based Costing, Service Company

a. Predetermined overhead rates are shown in the far right column below:

(a) (b) (a) ÷ (b)

Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Meeting with customers Hours of meeting time $400,000 20,000 hours $20 per hour
Reviewing applications Number of apps. reviewed 120,000 8,000 apps. $15 per application
Running credit reports Number of credit reports run 420,000 6,000 reports $70 per credit report
Total $940,000

b. Overhead is allocated to loan products for the month of August as follows:

Student Loans Auto Loans

Predetermined Cost Cost
Overhead Rate Driver Overhead Driver Overhead
(from part a) Activity Allocated* Activity Allocated*
$20 per hour 400 $ 8,000 350 $ 7,000
$15 per application 175 2,625 700 10,500
$70 per credit report 150 10,500 550 38,500
Total allocated $21,125 $56,000
_______________
* Overhead allocated equals the predetermined overhead rate times the cost driver activity for each product.

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33. (continued)

c. The overhead cost per loan for each loan product is calculated below:
Student loans: $21,125 overhead allocated ÷ 100 loans = $211.25 per loan
Auto loans: $56,000 overhead allocated ÷ 300 loans = $186.67 per loan
(rounded)

d. The total cost per loan for each loan product is calculated below:

Student Loans Auto Loans

Direct labor (given) $250.00 $150.00
Overhead (from part c) 211.25 186.67
Total cost per loan $461.25 $336.67

e. The activity of running credit reports is the most costly at $70 per report. For each
credit report that is not run, the auto loan product would be allocated $70 less in
credit report overhead costs. Thus, the manager of the auto loan product would likely
start by investigating if the number of credit reports run can be reduced. If not, the
next most expensive activity is meeting time with the customer, which has a rate of
$20 per hour. The manager would look for ways to improve efficiency with regards
to time spent meeting with customers.

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34. Activity-Based Costing Versus Traditional Approach: Service Company,

Activity-Based Management

a. (1) The plantwide allocation used by Orth and Associates is based on direct labor
costs. The rate is calculated as:

Estimated overhead cost $330,000

Estimated activity in allocation base $300,000 direct labor costs

= $1.10 per dollar in direct labor cost (or 110 percent of direct labor costs)

Total product costs are:

Residential Commercial
Direct labor (given) $120,000 $180,000
Overhead 132,000^ 198,000^^
Total product cost $252,000 $378,000
_______________
^ $132,000 = $120,000 direct labor cost x 110 percent rate
^^ $198,000 = $180,000 direct labor cost x 110 percent rate

(2) Residential Commercial

Direct labor (given) $120,000 $180,000
Overhead (from above) 132,000 198,000
Total product cost (a) $252,000 $378,000
Sales revenue (b) $450,000 $330,000
Profit (loss) (c) = (b) – (a) $198,000 ($ 48,000)
Profit (loss) as percent
of revenue (c) ÷ (b) 44.0% (14.5%) (rounded)

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34. (continued)

b. (1) Predetermined overhead rates are calculated for each activity as follows:

(a) (b) (a) ÷ (b)

Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Scheduling and data entry Direct labor hours $100,000 8,000 DL hours $12.50 per DL hour
Computer maintenance Number of computer hours 70,000 20,000 hours $3.50 per computer hour
Processing permit
applications Number of applications 160,000 800 applications $200.00 per application
Total $330,000

(2) Overhead costs are allocated below:

Residential Commercial
Predetermined Cost Cost
Overhead Driver Overhead Driver Overhead
Activity Rate Activity Allocated* Activity Allocated*
Scheduling and data entry $12.50 per DL hour 4,500 $ 56,250 3,500 $43,750
Computer maintenance $3.50 per computer hour 8,000 28,000 12,000 42,000
Processing permit apps. $200.00 per application 400 80,000 400 80,000
Total overhead costs allocated $164,250 $165,750

Total companywide overhead costs $330,000

_______________
* Overhead allocated equals the predetermined overhead rate times the cost driver activity.

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34.b. (continued)

(3)
Residential Commercial
Direct labor (given) $120,000 $180,000
Overhead (from b) 164,250 165,750
Total product cost (d) $284,250 $345,750
Sales revenue (e) $450,000 $330,000
Profit (loss) (f) = (e) – (d) $165,750 ($15,750)
Profit (loss) as percent
of revenue (f) ÷ (e) 36.8% (rounded) (4.8%) (rounded)

c. Activity-based costing results in an increase of overhead costs allocated to the

residential product and a decrease of overhead costs allocated to the commercial
product. The shift in overhead costs to the residential product is primarily a result
of the residential product using 56 percent of the scheduling and data entry
resources (= 4,500 residential direct labor hours ÷ 8,000 total direct labor hours),
and 50 percent of the permit processing resources (= 400 residential applications
÷ 800 total applications). Thus, 56 percent of the scheduling and data entry costs,
and 50 percent of permit processing costs, are assigned to the residential product.
The plantwide rate approach only assigned 40 percent of all overhead costs to the
residential product (= $120,000 residential direct labor costs ÷ $300,000 total
direct labor costs).
Although activity-based costing resulted in a smaller loss for the
commercial segment, additional work will be required to make the commercial
segment profitable, either through improved efficiency or through increased
revenues (or perhaps both). A starting point for management is to review costly
overhead activities to determine if improvements can be made that will reduce
costs. The most costly activity, processing permit applications, costs $200 per
application. Perhaps management can identify value added and nonvalue added
activities within this process, with the goal of eliminating nonvalue added
activities and improving the efficiency of value added activities.

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35. Calculating and Recording Overhead Applied: Service Company

a. Predetermined overhead rates are calculated for each activity as follows:

(a) (b) (a) ÷ (b)

Estimated Estimated Predetermined
Overhead Cost Driver Overhead
Activity Cost Driver Costs Activity Rate
Scheduling and data entry Direct labor hours $100,000 8,000 DL hours $12.50 per DL hour
Computer maintenance Number of computer hours 70,000 20,000 hours $3.50 per computer hour
Processing permit
applications Number of applications 160,000 800 applications $200.00 per application

b. (a) (b) (a) x (b)

Commercial Product Rate Amount of
Activity for the Month (from part a) Overhead Applied
350 direct labor hours $12.50 per DL hour $ 4,375
960 computer hours $3.50 per computer hour 3,360
50 applications $200.00 per application 10,000
Total overhead applied for September $17,735

c. The activity of processing permit applications is the most costly at $200 per application. This would be a reasonable starting
point since it is the most costly activity. It may be difficult to reduce the number of applications needed to complete a client
project. However, if managers in both departments focus on making efficiency improvements, over time the rate would
decrease thereby reducing overhead allocated to each department.

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36. Selecting an Allocation Base for Service Costs

a. Allocation percentages are:

Allocation Base Assembly Sanding Finishing

Number of employees 30%* 20% 50%
Square feet of space occupied 50%** 30% 20%

Allocation dollar amounts are:

Allocation Base Assembly Sanding Finishing
Number of employees $1,500,000^ $1,000,000 $2,500,000
Square feet of space occupied $2,500,000^^ $1,500,000 $1,000,000

_______________
* 30% = 30 assembly employees ÷ 100 total employees
** 50% = 25,000 square feet of space occupied by assembly ÷ 50,000 total square feet
occupied
^ $1,500,000 = $5,000,000 total personnel overhead cost x 30%
^^ $2,500,000 = $5,000,000 total personnel overhead cost x 50%

b. Managers prefer an allocation base that drives, or causes, personnel overhead costs to
occur. Since the personnel department is responsible for a variety of employee
related activities such as interviewing, maintaining records, and handling benefits, the
most reasonable allocation base is the number of employees in each production
department. The more employees a production department has, the higher the
demand for personnel department resources.
Although square feet of space occupied might be an indication of the number of
employees in the department, other factors might also cause departments to occupy
significant amounts of square footage, such as machinery and storage.

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