Solutions to Exercises assigned for Ch. 9: Activity-Based Costing

Exercise 9-23, part a

Exercise 9-23, part b Note that Dept SV has state-of-art machines, and the overhead is likely driven by machine use. Examples of costs? Department SV has an overhead allocation rate of $4.20 per machine-hour($105,840 ÷ 25,200 machine hours). Department C has an overhead allocation rate of $1.32 per DLH ($23,760 ÷ 18,000 labor-hours).

Exercise 9-23, part b We expect these to better reflect the OH costs of the three flavors.

Ex. 9-23, part e Charlene was correct that she was being allocated some of Department SV’s overhead. Plantwide allocation does not correctly allocate the overhead by department; it simply uses one allocation rate for all products in all departments. Under plantwide allocation, 1,000 gallons of chocolate cost $1,950. Once the overhead was reallocated into department cost pools, the cost of chocolate fell to $1,824. Although it requires more time and skill to collect and process the information, department allocation generally yields more accurate product cost information.

Solution to 9-24 (not assigned, but related to 9/25) Allocation based on separate pools for routine matters and transitions:

Pr. 9-25 First, note that the total to be allocated is $750,000 (= $200*1500 employees + $5625* 80 transitions). If we just compute the variable cost to be allocated to Ohio, the remainder will be allocated to Illinois. 50 transition * $2000 = $100,000 300 employees* $50 = $15,000 $115,000 So, Illinois gets $750,000 – 115,000 = $635,000

Would the allocation be fair? Reasonable? The reason it’s considered an allocation rather than a traced (direct) cost is that there are multiple ways to do it---no “correct” way! Allocations always are arbitrary (because there is no provably “correct” way). But there does exist a hierarchy of reasons, from strongest to weakest: Cause-and-effect Benefits Received Fairness Ability to bear

Criteria for Cost-Allocation Decisions Cause and Effect Variables are identified that cause resources to be consumed Most credible to operating managers Integral part of ABC Benefits Received The beneficiaries of the outputs of the cost object are charged with costs in proportion to the benefits received Copyright © 2007 Pearson Education Canada 14-4

Criteria for Cost-Allocation Decisions Fairness (Equity) The basis cited for establishing a price satisfactory to the government, customers and suppliers Cost allocation here is viewed as a “reasonable” or “fair” means of establishing a selling price Ability to Bear Costs are allocated in proportion to the cost object’s ability to bear them Generally, larger or more profitable objects receive proportionally more of the allocated costs Copyright © 2007 Pearson Education Canada 14-5

9-27: Activity-Based Costing in a Nonmanufacturing Environment: Cathy’s Catering

Per-guest charge to cover costs? If Cathy wants to cover her costs she should charge… $49 per guest for the picnic ($980 ÷ 20 guests) $80.00/guest for dinner ($1,600 ÷ 20 guests). Do we know the cost structure? What is her BEP?

9-29: ABC vs. Traditional c-$15 per machine-hour = $120,000 in production run costs ÷ 8,000 machine-hours. d-$3,500 per run = $70,000 in per-run (setup?) costs ÷ 20 total runs. e-$1,500 per inspection = $90,000 in inspn. costs ÷ 60 inspections.

9-29 cont’d: Allocated by DLH Vs. $28.33 and $130.00 for ABC Which product was “subsidizing” the other?

9-29 concluded By allocating overhead on the basis of direct labor, Doaktown Products has been understating the cost to manufacture M-123, thereby overstating the profits on M-123. Perhaps the basic reel was being charged too much of the overhead costs related to machinery that really is used for the fancy version.