03JL101310 Blue Ridge Manufacturing

CHAPTER 5
Activity-Based Costing and Management
Teaching Notes for Cases and Articles from the

Cases and Readings Manual
5-1 Blue Ridge Manufacturing (Activity-Based Costing for Marketing Channels)
Case Description:
Blue Ridge Manufacturing produces and sells towels for the U.S. sport towel market. A sport towel is a towel
that has the promotion of an event or a log printed on it. Most often they are used in connection with major sporting
events such as the Super Bowl.
Case Writers: Paul E. Juras and Paul A. Dierks, Wake Forest University; written for the IMA 1994 Student Case
Competition
Teaching Objectives:
The main teaching objective of the case is to illustrate, with an extensive numerical exercise, the use of
value chain analysis for profitability analysis. The analysis follows an ABC model, in which selling and
administrative costs are allocated to customer groups for the purpose of analyzing customer profitability.
Main Points:
Activity-Based Costing
Value Chain Analysis
Customer profitability analysis
Discussion Questions:
1. What is Blue Ridges competitive strategy?
The current strategy appears to be a combination of focus (on the southeast states) and cost leadership. The
manufacturing is in a modern plant with upgraded facilities, including the use of ABC costing for manufacturing
costs and the commitment to introducing advanced manufacturing techniques. This suggests a commitment to
efficiency and large volume production, which is characteristic of cost leadership firms. Because the product is
much like a commodity, unless Blue Ridge has exclusive rights from the sports teams, it is unlikely they are
competing on differentiation.
However, with the introduction of new ink that is non-toxic and wont wash out, the firm appears to be
moving to a differentiation strategy. Further evidence of this is the firm is going national, it will focus more on
quality, and is interested in identifying the least profitable customers. All this suggests efforts to differentiate the
firm from its competitors.
The case does not provide sufficient information for a thorough strategic analysis. However, the students
should be expected to identify strategic issues, as noted above, and also:
a) Is the new ink patented? How soon are competitors expected to meet this new innovation?
b) Are Blue Ridges licenses with the sports teams of unique value, or do competitors have the same access
as Blue Ridge?
c) How strong are Blue Ridges ties to its customers, especially the large customers? Are these ties
sufficiently strong to protect against competition for the next few years?
d) Has Blue Ridge integrated the marketing and manufacturing strategies, so that they are consistent?
Given the changes in both manufacturing (new ink) and marketing (going national, seeking more profitable
customers), the integration of these functions is important.
Blocher, Chen, Cokins, Lin: Cost Management: Cases and Readings, 3e 5-1 The McGraw-Hill Companies, Inc., 2005
2. What type of cost system does Blue Ridge use, and is it consistent with their strategy?
The ABC costing system in use is consistent with the cost leadership strategy. It will also assist the firm in
identifying the most profitable customers, as the firm moves to a differentiation strategy based on quality and
innovation.
3. What is Blue Ridge likely to gain from a value chain analysis? What are some of the opportunities for cost
reduction and for value added for the customers?
The value chain analysis can help Blue Ridge better understand its competitive advantage and to identify
opportunities for improving its competitive position.
Blue Ridge occupies the second, third and fourth value activities of a five-activity chain - knitting, ink-dye-
embroidery, and marketing-distribution:
A study of the value chain raises issues for possible cost reduction and value added.
Cost reduction:
- Can Blue Ridge obtain better terms or prices from its suppliers? Materials cost represents a large share of
total manufacturing cost.
- Use profitability analysis (as illustrated in the computer exercise below) to determine the full costs of
each product line and customer group as a basis for identifying and focusing on the most profitable product lines and
customers.
- Further analyses to identify the cost drivers in manufacturing, marketing and distribution:
- Customer service requirements
- Order frequency
- Delivery frequency
- Geographic location
- Technical support requirements
(Does Blue Ridge do design or other service for any of the customers, and if so are they properly charged to the
customer?)
Value Added for Customers

- Develop service links with the larger customers, as in the case of Proctor and Gamble and Wal-Mart; where the
retailer and manufacturer share data so that the manufacturer knows when, where and what to restock at the
retailers various locations
- Faster delivery, better coordination with all customers, especially the largest ones
- Identify new ways to improve customer satisfaction
- Identify new ways to boost demand at the retail level
Computer Assignment:
Develop a spreadsheet analysis, which can be used to assess the profitability of the three customer groups of Blue
Ridge -- large, medium and small customer account size. Use the information in Tables 1-4 to trace and allocate the
costs necessary for the analysis.
The solution is shown on the attached spreadsheet. The solution process involves three stages:
Stage 1: Allocate SG & A Costs to SG & A Activities.

1. Collect all SG & A costs incurred in each function (Shipping, Sales, Marketing) as showed in Table
4A of the case.
2. For each function, collect usage % for each activity (Entering P.O., Commissions, Shipping, Invoicing,
Making Sales Calls, Checking Credit, Samples & Catalog Information, Special Handling, Distribution
Management, Marketing by Customer Type, Advertising & Promotion, Marketing, Administrative
Office Support, and Licenses & Fees) as shown in 4A.
3. Then, allocate function costs to activities by usage %.
Stage 2: Allocate activity costs to Customer Type (Large, Medium, Small).
1. Identify cost drivers (as shown in Table 4) and their consumption statistics for each customer type (as
shown in Table 1).
2. Calculate cost driver consumption % for each customer type.
3. Allocate activity costs to customer type.
Stage 3: Customer Profitability Analysis.

1. Calculate revenues for each customer group (sales quantities from Table 1 and unit prices from Table
2).
2. Calculate manufacturing cost (Regular, Mid-size, Hand, Special), customizing cost (Inking,
Embroidery, Dyeing), SG & A cost and total costs for each customer group (using data from Tables 1
& 2).
3. Calculate customer profits ($102,661, $49,742, -$4,828) and profit per customer ($12,833, $323, -$6)
for each customer type.
Note that the analysis makes it clear the group of large customers provide most of the profits for Blue
Ridge. Show how the cost of purchase orders, shipping, the medium and small customer groups predominantly
cause credit checks, advertising, and marketing. The analysis shows clearly that these two groups, on a per
customer basis, are marginally profitable. This analysis indicates that Blue Ridge should concentrate on its largest
customers and/or determines how to make its smaller customers more profitable. This is especially important if the
firm is planning to go national and this may bring in an even larger portion of medium and smaller customers.
Blue Ridge Manufacturing
First Stage Allocation: Allocate SG&A Costs to SG&A Activities
First: SG&A Costs Total
Shipping Sales Marketing Other Assigned Source
Administration 17,000 37,400 20,400 56,100 130,900 Table 3
Selling 15,500 117,800 9,300 12,400 155,000 Table 3
$32,500 $155,200 $29,700 $68,500 $285,900
Percentage of...
Second: SG&A Shipping Sales Marketing Other
ACTIVITIES
Enter P.O. 55% 10% Table 3
Commissions 10% "
Shipping 65% 15% "
Invoicing 20% "
Sales Calls 30% 10% "
Check Credit 10% "
Samples... 5% 10% "
Sp Handling 5% 5% "
Distribution 10% 10% "
Marketing, Customer 5% "
Advertising 30% "
Marketing 15% 50% 5% "
Administrative 20% "
Licenses, fees 0% 5% "
TOTAL 100% 100% 100% 100% "
Third: Allocate Costs to Activities

Shipping Sales Marketing Other Total
ACTIVITIES Assigned
Enter P.O. 0 85,360 0 6,850 92,210
Commissions 0 15,520 0 0 15,520
Shipping 21,125 0 0 10,275 31,400
Invoicing 0 0 0 13,700 13,700
Sales Calls 0 46,560 0 6,850 53,410
Check Credit 0 0 0 6,850 6,850
Samples,... 1,625 0 2,970 0 4,595
Sp Handling 1,625 0 0 3,425 5,050
Distribution 3,250 0 2,970 0 6,220
Marketing, Cust 0 7,760 0 0 7,760
Advertising 0 0 8,910 0 8,910
Marketing 4,875 0 14,850 3,425 23,150
Administrative 0 0 0 13,700 13,700
Licenses, fees 0 0 0 3,425 3,425
TOTAL $ 32,500 $155,200 $29,700 $68,500 $285,900 Table 3
Second Stage Allocation: Allocates SA&A Activities to Customer Type (Large, Medium, Small)
First: Identify Cost Driver and Its Consumption Level or Amount
Customer Type...
COST DRIVER Large Medium Small Total
Units sold- w/o specials 99,770 55,118 116,812 271,700
Units sold-Total 100,250 58,544 117,406 276,200 Table 1
Units embroidered 5,959 6,490 29,394 41,843 "
Units dyed 20,536 9,935 12,328 42,799 "
Orders 133 845 5,130 6,108 "
Shipments 147 923 5,431 6,501 "
Invoices 112 754 4,737 5,603 "
%>60days 1 11 122 134 "
Revenues (Sales $308,762 $183,744 $318,024 $810,530 "
Value)
Customers 8 154 824 986 "
Second: Calculate Cost Driver Percentage for Each Customer Type

Units sold (excl. Special) 0.367 0.203 0.430 1.000 From above
Orders 0.022 0.138 0.840 1.000 From above
Shipments 0.023 0.142 0.835 1.000 From above
Invoices 0.020 0.135 0.845 1.000 From above
%>60days 0.007 0.082 0.910 1.000 From above
Revenues 0.381 0.227 0.392 1.000 From above
Customers 0.008 0.156 0.836 1.000 From above
Third: Allocate Activity Costs to Customer Type Cost Driver/ Allocation Base
ACTIVITIES Total Cost Large Medium Small (Table 4)
Enter P.O. 92,210 2,008 12,757 77,446 Orders
Commissions 15,520 15,520 Revenues (Medium Customers
Shipping 31,400 710 4,458 26,232 only)
Shipments
Invoicing 13,700 274 1,844 11,583 Invoices
Sales Calls 53,410 53,410 Revenues (Large
Check Credit 6,850 51 562 6,237 Customers only)
%>60days
Samples... 4,595 1,750 1,042 1,803 Revenues
Sp Handling 5,050 1,010 4,040 Estimate (20% M, 80% S)
Distribution 6,220 2,369 1,410 2,441 Revenues
Marketing, Cust 7,760 2,956 1,759 3,045 Revenues
Advertising 8,910 2,228 6,682 Estimate (25% M, 75% S)
Marketing 23,150 8,501 4,696 9,953 Units sold (Excluding Specials)
Administrative 13,700 5,031 2,779 5,890 Units sold (Excluding Specials)
Licenses, fees 3,425 3,425 Revenues (Medium Customers
TOTAL 285,900 77,060 53,490 155,350 only)
AA
Third Stage: Customer Profitability Analysis
First: Get Revenues by Customer Group
Unit Sales Large Medium Small
Regular 27,250 16,600 10,550 54,400 Table 1
Mid-size 36,640 18,552 10,308 65,500 "
Hand 35,880 19,966 95,954 151,800 "
Special 480 3,426 594 4,500 "
Total 100,250 58,544 117,406 276,200
Revenue Price Large Medium Small

Regular $ 3.60 98,100 59,760 37,980 195,840 Table 2
Mid-size $ 3.20 117,248 59,366 32,986 209,600 "
Hand $ 2.55 91,494 50,913 244,683 387,090 "
Special $ 4.00 1,920 13,704 2,376 18,000 "
Total Revenue $308,762 $183,744 $318,024 $810,530 BB
Second: Calculate Manufacturing Cost --

(1) Unit Cost
Regular $ 1.19 32,428 19,754 12,554 64,736 Table 2 x Table 1
Mid-size $ 1.03 37,739 19,109 10,617 67,465 "
Hand $ 0.89 31,933 17,770 85,399 135,102 "
Special $ 1.44 691 4,933 855 6,480 "
Total $102,791 $61,566 $109,426 $273,783 CC
Direct Cost of Unit Cost

Customizing
Inking (Units x 2) $ 0.0817 16,381 9,566 19,184 45,131 Table 2 x Table 1
Embroidery $ 1.2770 7,610 8,288 37,536 53,434
Dyeing $ 0.1100 2,259 1,093 1,356 4,708
$26,249 $18,947 $58,076 $103,272 DD
(2) Total Cost

Mfg Cost $102,791 $61,566 $109,426 $273,783 From CC above
Customizing $26,249 $18,947 $58,076 $103,272 From DD above
SG&A 77,060 53,490 155,350 $285,900 From AA above
Total Cost $206,101 $134,002 $322,853 $662,955 EE
Third: Calculate Customer Profit --

(1) Total
$102,661 $49,742 $(4,828) $147,575 BB-EE
(2) Per Customer $12,833 $323 $(6) $150
5-2 Blue Ridge Manufacturing (Using SAS Activity-Based Costing Software)
Overview of the Case
Case 5-2 is based on the same case material as in case 5-1, and has the same solution. The difference is
that the students using Case 5-2 have the experience of using a comprehensive software system (SAS Institutes
Oros Quick ABC software) to obtain the solution, in contrast to the Excel-based approach in Case 5-1. Cases 5-1
and 5-2 can be assigned together to provide the opportunity for the students to compare and contrast the two solution
approaches and to verify that they produce the same answer.
The instructor can download the files shown in TN-1 that are pertinent to the case from the McGraw-
Hill/Irwin textbook website (www.mhhe.com/blocher3e), under Instructor Center: Solutions to ABC cases.
These files include: A Word files of the teaching note as it appears in this Guide. The Excel file is the Excel solution
for the case that is used in case 5-1 and can also be used as a benchmark for the solution for case 5-2. The rest of the
files those used to solve the case using Oros Quick, so they collectively represent the Oros solution. We
recommend that you download all of these files into a specific folder for the case, and access the Excel and Oros
solutions from this subdirectory. The folder on my computer is labeled Blue Ridge Manufacturing as seen in TN-
1.
The actual Oros Quick Software and Oros Quick Tutorial are downloaded separately from the McGraw-
Hill/Irwin website (www.mhhe.com/blocher3e), under Premium Content. Students and instructors can download
the software and tutorial here as well as a Word file of the case as it appears in the Cases and Readings Manual.
(For clarity, the system, tutorial, and solutions files are downloaded separately. For example, the next Case 5-3:
Sunny View Dairy Farm is also an Oros case, and it will have a similar set of files to those discussed above for the
Blue Ridge Manufacturing case. The Sunny View Dairy Farm files will be in a separate link to be downloaded to a
separate folder. As further Oros cases are added to the web site in the coming months, they will be set up in the
same format.)
The organization of downloads is as follows. The web site will have the following links:
Under Premium Content (students will have access to this section with a passcode packaged with their text):
1. A link to download the Oros Quick Software (a 9,095KB Winzip file; Quick 551)
2. A link to download the Oros tutorial (a 1,833 KB Adobe Acrobat file; Oros Tutorial)
3. A link to the Word file of the Blue Ridge case for use with Oros Quick
Under the Instructor Center (password protected):
1. A link to download the Blue Ridge Manufacturing Case Solution files (these files are shown in TN-1)the
teaching note, Excel solution file, and Oros solutions files
TN-1 Solutions Files for the Blue Ridge Manufacturing Case
Approach to Teaching the Case
The goal of case 5-2 is to show students how to use a software system for calculating costs using ABC
costing. The use of the Oros system from SAS Software (formerly ABC Technologies Inc) provides the student an
experience using an ABC software system that is used in practice by firms implementing ABC costing. It is one of
the most well-known and widely used systems of this type. The Oros system used here (Oros Quick) is a
demonstration version which limits the number of accounts and other elements of the model, but the structure of the
model is the same as that used in practice.
A student who has the experience using an actual software system will have a better understanding of the
complexities involved in implanting such systems. They should also have a better appreciation of what these
systems can accomplish in the real world, since they are not working with the complexities inherent in
comprehensive systems. For example, most textbook problems and cases in ABC costing simplify the application
greatly. It is very uncommon, for example, to see a problem or case that requires the use of resource consumption
cost drivers. Generally, the problems and cases available today focus on the process of assigning activity cost pools
to cost objects, thereby ignoring the first half of the ABC Cross, the consumption of resources by activities.
The Blue Ridge Manufacturing case is one of the few cases that allows a consideration of both resources
and activities, and is therefore an excellent example to use in studying ABC costing. It is also a useful case for
illustrating the application of software such as the Oros system, since Oros, like other real-world ABC systems
incorporate all the elements of the ABC Cross (see the cost assignment view of the ABC Cross on page 6 of the
Oros tutorial).
There are a variety of ways the case can be used, from a relatively short exercise to a fairly extensive and
comprehensive case assignment. My suggestions below begin with the short and easy and progress to the most
extensive and demanding.
1. Perhaps the simplest is to assign students to read the Oros tutorial. Then, the tutorial could be discussed in class
period or part thereof. In the class discussion of the tutorial, the instructor can bring out the key elements of the
model (centers, accounts, assignments, etc) and relate these to the Blue Ridge case or to other ABC-based problems
that the instructor might be covering. For example, the instructor could ask how certain information in a problem
assigned from the textbook would be included in the Oros model. For the Blue Ridge case, the instructor might ask,
what are the Oros accounts (or drivers or activities, etc) that you would use to build an Oros model?
This approach would clearly highlight for example, whether the problem has resources and resource cost
drivers or not, and would reveal the degree of complexity in the activity cost assignment process (do some activities
serve only some of the cost objects, are does each activity serve all cost objects?). Information from the tutorial
could also be used on an exam, for example, by asking What are the default cost drivers included in Oros? or,
What is the difference between a cost center, and account, and an activity, in Oros?
2. A more challenging use of the Oros system would be to provide the students a solution for the Blue Ridge case
(for example, the Excel solution to Case 5-1; see TN-2) and then require them to use the tutorial and the Oros
system to solve the problem using Oros. The students would have the solution as a guide to building the model and
to checking the accuracy of their work. This would be a substantially more extensive experience for the students
and would acquaint them with the details of using a system such as Oros. We would suggest the student should
budget about two hours for reviewing the tutorial prior to doing the case, and then another two hours, approximately,
for completing the case with the solution in hand. These times could be reduced somewhat if you assign the
students to do the work in teams.
Another variation on this approach would be to build a partial Oros solution by for example entering the
accounts, activities, drivers, and cost objects, so that the student would only have to add the cost driver quantities
and assignments to complete the model. See the explanation of the use of the tutorial in the answer to assignment
question 5 below to get an idea of the various phases to completing the Oros model as a basis for choosing how
much or how little of the model to prepare for the students. With this approach, the time to complete the model
could be reduced to an hour or less.
Yet another variation on this approach would be to have the students build the entire Oros model but
provide some helpful hints about how to complete each step, for example, by including the steps outlined in the
solution key for assignment question 5 below. This should allow the students (or teams) to complete the project in
less than 2 hours.
3. The most extensive use of the Oros model, the one that we prefer, is to have the student complete the Oros
solution for the case without the aid of the solution key. We assign the students to teams to do this assignment
because of the amount of work involved. A reasonable time for the student to budget for this exercise would be
two hours for the tutorial and 3 hours for the solution of the case, when working as teams. Somewhat more time
will be required if working alone.
Teaching Notes for Assignments
1. Students should download and install the Oros Quick ABC/M program (WinZip file).
The link for this download is on the McGraw-Hill/Irwin text website: www.mhhe.com/blocher3e
under Premium Content. This will require the user to have the WinZip program. WinZip can be obtained at
https://secure.safesite.com/cgi-bin/wzc1?PWR for a single user fee of $29 or there is a link on the site for a free
trial version of WinZip as well.
2. Students should download the Oros Quick Tutorial (Adobe Acrobat file)
The link for this download is on the McGraw-Hill/Irwin website: www.mhhe.com/blocher3e
under Premium Content. This will require Adobe Acrobat Reader. Reader can be obtained free at
http://www.adobe.com/products/acrobat/readstep2.html
3. Work through the Oros Tutorial (you can skip the sections on attributes and on the balanced scorecard)
The student should expect to spend about 2 hours on this. A student could skim through it rather
quickly or spend several hours. We think the most benefit would be obtained by planning to spend about 1 to 2
hours, and then go to steps 4 and 5 below.
4. Create a folder on your computer labeled Blue Ridge.

This step is added simply to reduce clutter on the students computer and to keep the files in a
single convenient location for later reference.
5. Use the information in the Blue Ridge Manufacturing Company Case (Case Number 5-1) and in the tutorial
to complete an ABC costing application using Oros; determine the ABC-based unit costs for Blue Ridges
three customer groups.
The students should allow approximately 3 hours for this step working in teams, or a little longer
if working alone. The best way to complete the step is to print out the tutorial and to follow the tutorial page by
page in entering the relevant information from the case, replacing the Tyler case information in the tutorial with the
Blue Ridge Manufacturing information. Some suggestion for using the tutorial follow (tutorial pages are show in
parenthesis):
Page 24 of the tutorial has a good overview of the structure of the Oros model
Under Building Resources (pp19-22)
o Under resources, there is only one center in the Blue Ridge case, that is,
General and Administrative Costs
o There are four accounts in this center: shipping, sales, marketing, and other
Under Building the Activity Structure (pp 23):
o There are 14 activities in the model, from Enter Purchase Order to Licenses and Fees
Under Creating Cost Objects (pp24-25):
o There are three cost objects; small, medium and large customers
Building Drivers (29-31):
o There are two types of drivers in any ABC application and in the Oros system: resource
consumption cost drivers and activity consumption drivers
o There are two default drivers already in the Oros system evenly assigned and percentage.
The resource consumption cost drivers for the Blue Ridge case will use the percentage cost
driver.
o You will need to add six additional activity consumption cost drivers for the Blue Ridge case:
Number of units sold, orders, shipments, invoices, accounts > 60 days, and revenues
Creating Assignment Paths (pp 32-43)
o Each resource is linked to the activities that receive costs from that resource
o Each activity is linked to the cost objects that receive costs from that activity
Tutorial pp 43- 69. Can skip
Entering Data (pp 70-80):
o This section is used to show you how to enter the costs for each of the resource accounts and the
quantities for the resource drivers; this information is in Table 4A of the case
o Next you enter the activity cost driver quantities, from Table 1 of the case
o Finally, you enter the cost object (output) quantities from Table 1 of the case
Calculating the Model (pp 81-86):
o This section shows how the model is calculate
o Note that the cost object multi-level view now shows the final allocation of resource costs to
activities and then from the activities to the three cost objects, the large, medium, and small
customer groups.
o The assignment question asks for unit costs which is not automatically included in the cost object
multi-level view. This can be added easily by clicking on the command line that shows Name,
ReferenceNumber, and Cost, and then use the dialog box to add the additional columns:
UserOutputQty, and Unit Cost. The cost analysis is now complete
Tutorial pages 87- end; not needed for the Blue Ridge Case.
6. Create and print a unit cost report for Blue Ridge, using the Oros system.
The student prepares a unit cost report. The unit cost report is obtained from the file menu under
Generate Reports. You must select Unit Cost Report under Module Reports and Cost Objects under Select
Data.
Some Screens from the Oros Solution of the Blue Ridge Manufacturing Case are as follows. These screens are
included here as a guide to the instructor as to how the development of the solutions will look on the computer
screen. One teaching strategy for the instructor is to copy and hand out to the students some of these screens to
assist them in the development of their solutions. Note also that the tutorial has screens to assist in the development
of the solution. The difference here is that the screens in the tutorial are for the case used in the tutorial, while the
screens shown below are specific to the Blue Ridge case.
TN-2: Excel Solution for Blue Ridge

TN-3: List of Resources
TN-4: List of Activities Showing Costs after Model is Calculated
TN-5: Resource Driver Assignments to Activities
TN-6: Activity Driver Assignments to Cost Objects
TN-7: Resource Costs
TN-8: Resource Driver Quantities
TN-9: Activity Driver Quantities
TN-10: Cost Object Quantities
TN-11: Cost Allocation to Cost Objects after Model is Calculated, Showing Unit Costs
TN-12: Unit Cost Report
TN-2 Excel Solution for the Blue Ridge Manufacturing Case
First Stage Allocation: Allocate SG&A Costs (Resources) to SG&A Activities
First: SG&A Costs Total
Shipping Sales Marketing Other Assigned
Administration 17,000 37,400 20,400 56,100 130,900
Selling 15,500 117,800 9,300 12,400 155,000
$ 32,500 $ 155,200 $ 29,700 $ 68,500 $ 285,900
Second: Resource Drivers

Percentage of
Shipping Sales Marketing Other
ACTIVITIES
Enter P.O. 55 10
Commissions 10
Shipping 65 15
Invoicing 20
Sales Calls 30 10
Check Credit 10
Samples,... 5 10
Sp Handling 5 5
Distribution 10 10
Marketing, Cust 5
Advertising 30
Marketing 15 50 5
Administrative 20
Licenses,fees 0 5
TOTAL 100 100 100 100
Third: Allocate Costs to Activities

Shipping Sales Marketing Other Total
ACTIVITIES
Enter P.O. - 85,360 - 6,850 92,210
Commissions - 15,520 - - 15,520
Shipping 21,125 - - 10,275 31,400
Invoicing - - - 13,700 13,700
Sales Calls - 46,560 - 6,850 53,410
Check Credit - - - 6,850 6,850
Samples,... 1,625 - 2,970 - 4,595
Sp Handling 1,625 - - 3,425 5,050
Distribution 3,250 - 2,970 - 6,220
Marketing, Cust - 7,760 - - 7,760
Advertising - - 8,910 - 8,910
Marketing 4,875 - 14,850 3,425 23,150
Administrative - - - 13,700 13,700
Licenses,fees - - - 3,425 3,425
TOTAL $ 32,500 $ 155,200 $ 29,700 $ 68,500 $ 285,900
Second Stage Allocation: AllocateSA&A Activites to Custmer Type

COST DRIVER Large Medium Small Total
Units -total 100,250 58,544 117,406 276,200
Units - w/o spec 99,770 55,118 116,812 271,700
Units embroidered 5,959 6,490 29,394 41,843
Units dyed 20,536 9,935 12,328 42,799
Orders 133 845 5,130 6,108
Shipments 147 923 5,431 6,501
Invoices 112 754 4,737 5,603
%>60days 1 11 122 134
Revenues $ 308,762 $ 183,744 $ 318,024 $ 810,530
Customers 8 154 824 986
Second: Allocate Activity Costs to Customer Type Alloc. Base

ACTIVITIES Total Cost Large Medium Small (Table 4B)
Enter P.O. 92,210 2,008 12,757 77,446 orders
Commissions 15,520 15,520 direct
Shipping 31,400 710 4,458 26,232 shipments
Invoicing 13,700 274 1,844 11,583 invoices
Sales Calls 53,410 53,410 direct
Check Credit 6,850 51 562 6,237 #>60days
Samples,... 4,595 1,750 1,042 1,803 revenues
Sp Handling 5,050 1,010 4,040 estimate
Distribution 6,220 2,369 1,410 2,441 revenues
Marketing, Cust 7,760 2,956 1,759 3,045 revenues
Advertising 8,910 2,228 6,683 estimate
Marketing 23,150 8,403 4,907 9,841 units
Administrative 13,700 4,973 2,904 5,824 units
Licenses,fees 3,425 3,425 direct
TOTAL 285,900 76,904 53,825 155,171
Total Units 100,250 58,544 117,406
Unit Cost $ 0.767 $ 0.919 $ 1.322
TN-3 List of Resources
TN-4 List of Activities, Showing Costs after Model is Calculated
TN-5 Resource Driver Assignments to Activities
TN-6 Activity Driver Assignments to Cost Objects
TN-7 Resource Costs
TN-8 Resource Driver Quantities
TN-9 Activity Cost Driver Quantities
TN-10 Cost Object Quantities
TN-11 Cost Allocation to Cost Objects after Model is Calculated
TN-12 Unit Cost Report for Blue Ridge Manufacturing
5-3 Implementation of Activity Based Costing for Sunny View Dairy Farm Using SAS
Activity-Based Costing Software
Overview of the Case
Case 5-3 is based on a hypothetical dairy farm that produces a variety of dairy products. The case involves
both resources and activities, and related resource consumption drivers and activity drivers.
The instructor can download the files shown in TN-1 which are pertinent to the case from the McGraw-
Hill/Irwin text website (www.mhhe.com/blocher3e), under Instructor Center: Solutions to ABC cases. These
files include a Word file for the teaching note as it appears in the Guide. The Excel file is the Excel solution for the
case. The remaining files are the files that are created to solve the case using Oros Quick, so they collectively
represent the Oros solution. We recommend that you download all of these files into a specific folder for the case,
and access the Excel and Oros solutions from this subdirectory. The folder on my computer is labeled Sunny View
Diary Farm Case as seen in TN-1.
The actual Oros Quick Software and Oros Quick Tutorial are downloaded separately from the McGraw-
Hill/Irwin website (www.mhhe.com/blocher3e), under Premium Content. Students and instructors can download
the software and tutorial here as well as a Word file of the case as it appears in the Cases and Readings Manual.
(For clarity, the system, tutorial, and solutions files are downloaded separately. For example, the previous Case 5-2:
Blue Ridge Manufacturing is also an Oros case, and it will have a similar set of files to those discussed for the
Sunny View Dairy Farm case. The Blue Ridge Manufacturing files will be in a separate link to be downloaded to a
separate folder. As further Oros cases are added to the web site in the coming months, they will be set up the same
format.)
The organization of downloads is thus as follows. The web site will have the following links:
Under Premium Content (students will have access to this section with a passcode packaged with their text):
3. A link to download the Oros Quick Software (a 9,095KB Winzip file; Quick 551)
4. A link to download the Oros tutorial (a 1,833 KB Adobe Acrobat file; Oros Tutorial)
3. A link to the Word file of the Sunny View Dairy Farm case for use with Quick
Under the Instructor Center (password protected):
1. A link to download the Sunny View Dairy Farm Case Solution files (these files are shown in TN-1)the
teaching note, Excel solution file, and Oros solutions files
TN-1 Solutions Files for the Sunny View Dairy Farm Case
Approach to Teaching the Case
Goals for Teaching the Case
The goals of case 5-3 (Sunny View) are the same as that for Case 5-2 (Blue Ridge). Please see the
discussion of Goals under the Teaching note for Case 5-2.
Teaching Notes for Assignments
1. Download and install the Oros Quick ABC/M program (WinZip file).
The link for this download is on the McGraw-Hill/Irwin text website: www.mhhe.com/blocher3e,
Premium Content). This will require the user to have the WinZip program. WinZip can be obtained at
https://secure.safesite.com/cgi-bin/wzc1?PWR for a single user fee of $29 or there is a link on the site for a free trial
version of WinZip as well.
2. Students should download the Oros Quick Tutorial (Adobe Acrobat file)
The link for this download is on the McGraw-Hill/Irwin website: www.mhhe.com/blocher3e
under Premium Content. This will require Adobe Acrobat Reader. Reader can be obtained free at
http://www.adobe.com/products/acrobat/readstep2.html
3. Work through the Oros tutorial (you can skip the sections on attributes and on the balanced scorecard)
The student should expect to spend about 2 hours on this. A student could skim through it rather
quickly or spend several hours. We think the most benefit would be obtained by planning to spend about 1 to 2
hours, and then go to steps 4 and 5 below.
4. Create a folder on your computer labeled Sunny View. This step is added simply to reduce clutter
on the students computer and to keep the files in a convenient location for later reference.
5. Use the information in the Sunny View Dairy Farm Case and in the tutorial to complete an ABC
costing application using Oros; determine the ABC-based unit costs for the Farms products
The students should require approximately 3 hours for this step working in teams, or a little longer
working alone. The best way to complete the step is to print out the tutorial and to follow the tutorial page by page
in entering the relevant information from the case, replacing the Tyler case information in the tutorial with the
Sunny View information. Some suggestion for using the tutorial follow (tutorial pages are show in parenthesis):
Page 24 of the tutorial has a good overview of the structure of the Oros model
Under Building Resources (pp19-22)
o Under resources, there are four centers in the Sunny View case, that is,
Processing, Materials, G&A, and Facilities
o The accounts in each center are shown in TN-3
Under Building the Activity Structure (pp 23):
o There are 8 activities in the model, shown in TN-4
Under Creating Cost Objects (pp24-25):
o There are five cost objects; whole milk, low-fat milk, skim milk, chocolate milk, and eggnog
Building Drivers (29-31):
o There are two types of drivers in any ABC application and in the Oros system: resource
consumption cost drivers and activity consumption drivers
o There are two default drivers already in the Oros system evenly assigned and percentage.
The resource consumption cost drivers for the Sunny View case will use the percentage cost
driver.
o You will need to add eight additional activity consumption cost drivers for the Sunny View case:
See the right hand panel of TN-5
Creating Assignment Paths (pp 32-43)
o Each resource is linked to the activities that receive costs from that resource (TN-5)
o Each activity is linked to the cost objects that receive costs from that activity (TN-6)
Tutorial pp 43- 61. Can skip
Adding Bills of Costs (pp 62-69)
o The Sunny View Case incorporates direct costs (the tutorial calls them external costs) in
addition to the activity-based costs; these costs include, for example, the cost of chocolate used in
chocolate milk; TN-7)
Entering Data (pp 70-80):
o This section is used to show you how to enter the costs for each of the resource accounts and the
quantities for the resource drivers (TN-8, TN-9)
o Next you enter the activity cost driver quantities the case (TN-10)
o Finally, you enter the cost object (output) quantities from the case (TN-11)
Calculating the Model (pp 81-86):
o This section shows how the model is calculated
o Note that the cost object multi-level view now shows the final allocation of resource costs to
activities and then from the activities to the cost objects.
o The assignment question asks for unit cost which is not automatically included in the cost object
multi-level view. This can be added easily by clicking on the command line that shows Name,
ReferenceNumber, and Cost, and then use the dialog box to add the additional columns:
UserOutputQty, and Unit Cost. The cost analysis is now complete (TN-12)
Tutorial pages 87 and beyond are not needed for the Sunny View Case.
6. Create and print a unit cost report for Blue Ridge, using the Oros system.
The student prepares a unit cost report. The unit cost report is obtained from the file menu under
Generate Reports. You must select Unit Cost Report under Module Reports and Cost Objects under Select
Data. This report can be saved to a text file or shown on the screen. (TN-13)
Select Screens from the Oros Solution of the Blue Ridge Manufacturing Case:
Some Screens from the Oros Solution of the Sunny View Dairy Farm Case are as follows. These screens are
included here as a guide to the instructor as to how the development of the solutions will look on the computer
screen. One teaching strategy for the instructor is to copy and hand out to the students some of these screens to
assist them in the development of their solutions. Note also that the tutorial has screens to assist in the development
of the solution. The difference here is that the screens in the tutorial are for the case used in the tutorial, while the
screens shown below are specific to the Sunny View Dairy Farm case.
TN-2: Excel Solution for Sunny View

TN-3: List of Resources
TN-4: List of Activities Showing Costs after Model is Calculated
TN-5: Resource Driver Assignments to Activities
TN-6: Activity Driver Assignments to Cost Objects
TN-7 Entering Direct Costs (Bills of Costs)
TN-8: Resource Costs
TN-9: Resource Driver Quantities
TN-10: Activity Driver Quantities
TN-11: Cost Object Quantities
TN-12: Cost Allocation to Cost Objects after Model is Calculated, Showing Unit Costs
TN-13: Unit Cost Report
TN-2 Excel Solution for Sunny View Case
Sunny View Dairy Farm

First Stage Allocation: Allocate Resources to Activities Total
Materials Facilities Processing G&A Assigned
$ 1,528,620 $ 105,385 $ 468,331 $ 128,993 $ 2,231,329
First: Resource Consumption Drivers
Machine Facilities Processing G&A
ACTIVITIES
Milking 10,000.00 30
Separating/Past 2,000.00 15
Mixing 1,000.00 15
Bottling 90 1,500.00 25
Warehousing 12,500.00 10
General and Administrative 2,000.00 100
Receiving and Inspecting 10
Cleaning and Repairs 1,000.00 5
TOTAL 100 30,000.00 100 100
Cost Driver % Square Feet % %
Second: Allocate Resources to Activities Using Drivers

Machine Facilities Processing G&A Total
ACTIVITIES
Milking - 35,128 140,499 175,628
Separating/Past - 7,026 70,250 77,275
Mixing 3,513 70,250 73,762
Bottling 1,375,758 5,269 117,083 1,498,110
Warehousing - 43,910 46,833 90,744
General and Administrative - 7,026 - 128,993 136,019
Receiving and Inspecting 152,862 152,862
Cleaning and Repairs 3,513 23,417 26,929
TOTAL $ 1,528,620 $ 105,385 $ 468,331 $ 128,993 $ 2,231,329
Second Stage Allocation: AllocateSA&A Activites to Custmer Type

COST DRIVER Whole Milk Low Fat Milk Skim Milk Choc. Milk Eggnog Total
Number of Purchase Orders 373 933 653 280 280 2,519
Machine Hours Separating 162 406 284 122 122 1,096
Machine Hours Mixing 0 - - 365 365 730
Labor Hours Bottling 189 473 331 142 142 1,277
Labor Hours Warehousing 135 338 237 101 101 912
Number of Invoices 270 676 473 203 203 1,825
Ounces of Ingredients 0 - - 65,700 76,650 142,350
Labor Hours Repairs 108 270 189 81 81 729
Cost Driver Percentage of Total for each Customer Type

Number of Purchase Orders 0.15 0.37 0.26 0.11 0.11 1.00
Machine Hours Separating 0.15 0.37 0.26 0.11 0.11 1.00
Machine Hours Mixing - - - 0.50 0.50 1.00
Labor Hours Bottling 0.15 0.37 0.26 0.11 0.11 1.00
Labor Hours Warehousing 0.15 0.37 0.26 0.11 0.11 1.00
Number of Invoices 0.15 0.37 0.26 0.11 0.11 1.00
Ounces of Ingredients - - - 0.46 0.54 1.00
Labor Hours Repairs 0.15 0.37 0.26 0.11 0.11 1.00
Second: Allocate Activity Costs to Products

ACTIVITIES Whole Milk Low Fat Milk Skim Milk Choc. Milk Eggnog Total
Milking 26,006 65,050 45,528 19,522 19,522 175,628
Separating/Past 11,422 28,626 20,024 8,602 8,602 77,275
Mixing - - - 36,881 36,881 73,762
Bottling 221,725 554,899 388,312 166,587 166,587 1,498,110
Warehousing 13,432 33,631 23,581 10,049 10,049 90,744
General and Administrative 20,123 50,383 35,253 15,130 15,130 136,019
Receiving and Inspecting - - - 70,552 82,310 152,862
Cleaning and Repairs 3,990 9,974 6,982 2,992 2,992 26,929
TOTAL 296,698 742,562 519,680 330,315 342,074 2,231,329
Number of Units produced 292,000 730,000 511,000 219,000 219,000 1,971,000
Plus: Purchases from External Suppliers

Bottles @ $.75 $ 219,000 $ 547,500 $ 383,250 $ 164,250 $ 164,250 $ 1,478,250
Cocoa @ $.05 10,950.00 $ 10,950
Sugar @ $.05 10,950.00 10,950.00 $ 21,900
Spices @ $.08 17,520.00 $ 17,520
Total External Cost $ 219,000 $ 547,500 $ 383,250 $ 186,150 $ 192,720 $ 1,528,620
Total Cost for Each Product $ 515,698 $ 1,290,062 $ 902,930 $ 516,465 $ 534,794 $ 3,759,949
Total Cost per bottle $ 1.766 $ 1.767 $ 1.767 $ 2.358 $ 2.442
TN-3 List of Resources and Accounts
TN-4 List of Activities, Showing Costs after Model is Calculated
TN-5 Resource Driver Assignments to Activities
TN-6 Activity Driver Assignments to Cost Objects
TN-7 Entering Direct Costs (Bills of Costs)
TN-8 Entering Resource Costs
TN-9 Entering Resource Driver Quantities
TN-10 Entering Activity Cost Driver Quantities
TN-11 Entering Cost Object Quantities
TN-12 Cost Allocation to Cost Objects after Model is Calculated
TN-13 Unit Cost Report for Sunny View Dairy Farm
5-4 and 5-5 Wilson Electronics (A) and (B)
Abstract: This case is designed to provide students with an activity-based costing (ABC) capstone experience that
addresses the following topics: (1) applying resource usage and resource spending concepts to support "what-if"
decision making; (2) using ABC product cost information to support strategic product mix decision making; (3)
using ABC process cost information to support process improvement decision making; and (4) using ABC
information in conjunction with the theory of constraints (TOC) to support revenue growth-oriented modes of
analysis when making decisions. The case is partitioned into (A) and (B) versions to enable greater flexibility from a
teaching perspective. More specifically, the (A) case focuses on the resource usage vs. resource spending portion of
the analysis. The (B) case expands the analysis to address the full range of topics mentioned above.
Case Overview
The Wilson Electronics case is designed to provide for students an ABC "capstone" experience that draws upon
ABC product costing, process costing, and "what-if" cost-modeling concepts. The (A) version of the case focuses on
the application of resource usage and resource spending concepts to quantify the cost savings associated with a
product redesign proposal. The resource usage approach is a long-run perspective because it assumes that future
changes in capacity costs will occur as individual proposals are combined with other similar proposals that will
materialize in the future. Conversely, the resource spending approach focuses on the identification of tangible
changes in spending that will materialize from individual proposals in the short-run.
The (B) version of the case expands the analysis from (A) to include issues such as product mix strategy,
process cost management, and revenue growth as an alternative mode of ABC analysis that can be contrasted to the
usual focus on cost reduction. The (A) and (B) versions provide the instructor with the flexibility either to limit
his/her usage of the case to the resource usage vs. resource spending issue that is the focus of the discussion
questions in (A), or to expand the analysis to include the broader range of topics explicitly discussed in the (B) case.
The case is predicated on the assumption that a capacity-based ABC system is a prerequisite to analyzing
business decisions from a resource-usage perspective. This assumption is embedded into the case through the former
controller, Mike Foster, who made the decision to design Wilson's ABC system using a capacity-based approach. In
fact, Foster makes the statement in the case that a capacity-based approach to designing an ABC system is "essential
to managing the business from an activity-oriented perspective." Foster's statement is consistent with the resource
usage model as explained by Cooper and Kaplan (1992) who distinguish between the cost of used and unused
capacity in their article entitled "Activity-Based Systems: Measuring the Cost of Resource Usage." The benefits of
distinguishing between the cost of used and unused capacity include: (1) enabling more competitive pricing when
significant idle capacity exists, (2) providing fairness to current customers who are not responsible for idle capacity,
and (3) putting pressure on management to react to the presence of idle capacity by either reducing spending or
increasing sales.
The (A) Case

In the (A) version of the case, the president of Wilson Electronics, Bill Simms, has asked his controller, Alice
Johnson, to defend the value of Wilson's ABC system. Simms is concerned that Wilson has yet to realize any
benefits from the ABC system that his company has spent a substantial amount of time and money developing.
Simms informs Johnson that she has three weeks until the next management team meeting to organize a presentation
that will explain the merits of ABC in terms of its ability to support management decision making. The outcome of
Johnson's presentation will determine whether Wilson continues to support its ABC system.
Alice Johnson decides to narrow the scope of her presentation to a cost-reduction proposal that calls for the
redesign of the A12 junction box. A competitor has recently announced a $0.40 per unit price reduction on this
product line, thereby necessitating a response from Wilson. The reengineering proposal, prepared by the product
engineering department, calls for reducing the number of different types of parts in the A12 junction box from ten
down to eight, while reducing the total number of parts per unit from 26 to 21. Interestingly, the raw material cost
would increase $1.00 per unit as a result of the product redesign. Johnson believes that she can demonstrate the
potential value of ABC by showing how it can be used to help quantify the savings that Wilson would realize due to
the activity reductions that are associated with this cost-cutting proposal. Johnson is relatively new to the company
and does not have an intimate knowledge and understanding of Wilson's ABC system; therefore, she decides to
solicit the advice and recommendations of her staff and a representative of the industrial engineering department.
Johnson calls a meeting on August 30th that includes Ed Branson from Industrial Engineering, as well as
Sally Jones and Phil Markley from the Finance Department. The purpose of this meeting is to determine how to use
ABC data to quantify the cost-savings opportunity associated with the A12 redesign. Johnson is hoping that a
consensus emerges from this meeting that will give her the confidence in making her presentation to the
management team. However, such a consensus does not emerge from the meeting. The difference of opinion
between Sally Jones, the cost accounting manager, and Ed Branson, the head of industrial engineering, provides the
platform for a discussion of the merits of the resource-usage and resource-spending points of view. Sally supports
the resource-usage approach for estimating the cost savings associated with the A12 redesign, while Ed is a
proponent of the resource-spending point of view. According to the resource-usage-based analysis, the A12 redesign
proposal offers a savings of $0.47 per unit, net of the increase in material cost. However, the resource spending
analysis suggests that the redesign proposal is not cost-beneficial to Wilson.
The (B) Case

The (B) case begins where the (A) case ends. In other words, the (B) case cannot be used as a stand-alone case. In
the (B) case, Johnson's presentation to the management team is fast approaching. She is confident that the $0.47 per
unit savings identified by the ABC system (per the resource-usage approach) will provide Wilson with the
information the team needs to respond to its competitor's price reduction of $0.40 per unit. She believes that this
"proof-of-concept" will be sufficient to sustain the ABC system. However, a few days before the management team
meeting another of Wilson's competitors announces a price reduction of $2.50 per unit on this product line. Alice
becomes keenly aware that her presentation is destined for failure if she remains focused on using ABC to identify a
$0.47 per unit cost reduction on a product being threatened by a $2.50 price reduction.
In need of some advice, she seeks the counsel of Mike Foster, who was the controller whom she replaced.
Foster convinces Johnson that she needs to expand the scope of her presentation beyond the resource-
usage/resource-spending analysis associated with the A12 redesign. Foster's comments provide a platform for
students to consider ABC's role from a product-mix strategy perspective as well as a process cost management point
of view. These applications of ABC are prevalent in practice, as evidenced by the case studies discussed in Player
and Lacerda (1999); therefore, it is beneficial for students to expand the analysis of Wilson to consider these issues.
In addition, Foster offers comments that raise the topic of applying ABC data to decisions from a revenue
growth perspective as compared to the usual cost reduction perspective. Given that Wilson is operating at its
practical capacity, this presents the opportunity to introduce Theory of Constraint (TOC) concepts into the case
(Ruhl 2000).
Suggested Teaching Procedure

This case can be taught to a broad range of audiences. For example, the case is used in the junior-year management
accounting course at Miami University. To the authors' knowledge, the case has also been used in the junior-year
cost accounting course by a professor at the University of Texas at Austin. At the graduate level, the case has been
used in the M.ACC. program by a professor at the University of Virginia and at the M.B.A.-level by a professor at
Wake Forest University.
Background Knowledge
To teach the (A) case effectively, students should have sufficient background in three areas. First, students should be
exposed to at least four weeks of traditional vs. ABC. For example, at Miami we spend two weeks discussing
traditional cost allocation methods. We examine the conceptual underpinnings of traditional cost systems and we
solve practice problems similar to what would be found in undergraduate cost accounting textbooks. We also
analyze case studies, such as Seligram: Electronic Testing Operations (Turney and Ittner 1988) and Camelback
Communications (Cooper 1985), that deal with traditional cost allocation. Similarly, we discuss the conceptual
foundation of ABC and discuss ABC from a design perspective. We solve ABC problems comparable to what
would be found in an undergraduate textbook. In addition, we analyze case studies, such as Siemens Electric Motor
Works (A) (Cooper and Wruck 1990) and Classic Pen Company: Developing an ABC Model (Kaplan 1998), that
deal with ABC from a design and/or a decision-making perspective.
Second, students should have some background in capacity costing. At Miami, we discuss the conceptual
underpinnings of capacity-based denominator volumes and we solve problems comparable to what would be found
in textbooks (for example, see Horngren et al. 1997, problem 14-33). We also analyze the Schulze Waxed
Containers, Inc. (Bernier and Cooper 1988) case study that deals with capacity-based costing. Third, students need
to have familiarity with resource-usage vs. resource-spending concepts. To support a conceptual discussion about
resource usage vs. resource-spending, we solve problems similar to 11-7, 11-13, and 11-14 in Hansen and Mowen
(1997) that highlight the differences between these two terms.
To teach the (B) case, students need a modest background in four areas. From a product-mix-strategy
perspective, students need to understand the sources of product diversity that create cost distortion in traditional
volume-based cost systems. This topic can be covered as part of the background to prepare for the (A) case. From a
process-cost-management perspective, students need a basic understanding of a manufacturing cell and how cellular
manufacturing would eliminate many of the non-value-added activities that are currently a part of Wilson's
manufacturing process. From a revenue-growth perspective, students need a basic understanding of production
bottlenecks, so that they can identify the Assembly Department as the bottleneck in the Wilson case. Finally,
students need a basic understanding of NPV concepts in order to extend the analysis of the A12 proposal into a
multi-period setting.
In addition to the background information already provided, this Teaching Note includes an annotated
bibliography of literature citations that could be assigned to students as supplemental reading.
Teaching Methods
The case can be taught in numerous ways. One approach is to teach the (A) case in one 75-minute class period and
the (B) case in a second 75-minute class period (perhaps separated by one or more weeks). With this approach, the
professor needs to manage the direction of the conversation so that the issues earmarked for the (B) case do not
begin to dominate the discussion during coverage of the (A) case. The professor can explicitly ask the students to
adopt Alice's mindset, which is narrowly focused on analyzing the A12 junction box proposal, as a means of
ensuring that the discussion remains focused on the resource-usage vs. resource-spending debate.
A second method for teaching this case is to teach the (A) case in class and then assign the (B) case as an
outside-of-class group assignment to be handed in for grading at a later date. A third approach is to teach the (A)
case in class and then have groups of students prepare the (B) case and make oral presentations to the class to
explain how they would make their presentation to Wilson's management team if they were Alice Johnson. In
addition, it may be possible, depending upon the background of the students, to teach only the (A) case and rely
upon the students to identify the issues that are explicitly introduced in the (B) case without actually assigning it. For
example, if graduate students have a substantial amount of knowledge of ABM, manufacturing processes, and the
Theory of Constraints, they may be capable of identifying some of the issues implicitly from the (A) case that are
explicitly alluded to in the (B) case.
Wilson Electronics (A) Discussion Questions

The following discussion questions provide a foundation for teaching the (A) case. We have found that discussing
the questions in sequence works well. The most important "time management" issue in the (A) case is allowing
students enough time to complete the resource-spending-based calculations (Question 2). Depending upon the
preference of the professor, it is possible to manage the time students need to commit to the resource spending
calculations. For example, the professor can narrow the scope of the calculations by focusing exclusively on the
"wages and fringes" resource category. Another time-management tactic would be to walk the students through
the "wages and fringes" calculations in the Purchasing Department. Then let the students duplicate the same
methodology in the remaining departments. A final option would be to provide students with a template (similar to
Exhibit TN-3) that includes the appropriate headings to guide their thought process.
Question 1
Sally Jones supports the "what-if" output from Wilson's ABC model, which implies that a long-run-oriented
resource-usage perspective be adopted when analyzing the A12 redesign proposal. The resource usage view is
predicated on the logic that the A12 product redesign proposal is one in a stream of related proposals that will
continue to materialize in the future.
For example, activity #8, "move parts to Assembly," is expected to have a driver count reduction of 533
moves (per Exhibit 7). Since each of these moves requires a standard time of 25 minutes (per Exhibit 3), the activity
reduction will save 222 hours (533 moves at 25 minutes per move). While this results in freed-up material-handling
capacity in the short run, it does not generate enough idle capacity by itself to justify reducing employee headcount,
since each employee provides a capacity of 1,571 hours (per Exhibit 2). However, Sally Jones is contending that a
series of projects implemented over time may provide a substantial release of capacity in activities such as material
handling. This cumulative effect would allow the firm to reduce capacity and spending over time. Thus, each
proposal by itself has the potential to contribute to cost savings in the long run. In other words, if the cumulative
impact of three separate proposals reduced the hours needed to perform activity #8, "move parts to assembly," by
more than 1,571 hours, Wilson could release one of its forklift drivers and eliminate one forklift truck. This decision
to reduce capacity would provide savings in terms of wages, benefits, supplies, utilities, and equipment.
Under the resource-usage approach, the contribution of each proposal to cost savings is measured by the
reduction in activity frequency multiplied by the applicable activity rate for each affected activity. Granted, during
the first several months after activity demands decline, Wilson may realize nothing more than the presence of
additional idle time. However, as the benefits of subsequent improvement projects are realized, management will
eventually be able to react to the creation of excess time by reducing activity capacity or finding new uses for such
freed-up capacity.
Exhibit TN-1 presents a new bill of activities for the revised version of the A12 junction box. The revised per
unit cost is $82.24. Given the original cost of the A12 junction box ($82.72), this represents a per unit savings (net
of the material cost increase) of $0.48. Students can verify the accuracy of their revised bill of activities by
comparing their numbers to the estimated cost savings shown in Exhibit 7 of $147,231, less the material cost
increase of $100,000, for a net savings of $47,231 or $0.47 per unit (the $0.01 difference in estimated savings is due
to rounding).
The capacity-based approach enables the measurement of changes in resource usage because it distinguishes
between the cost of used and unused capacity. This approach to accounting for the cost of resources supplied ensures
that the cost of resources used in production is not confounded by the cost of unused capacity.
Question 2
Ed Branson supports a resource-spending point of view. The resource-spending model is based on the assumption
that management decisions to implement organizational or product changes should be judged as to whether the end
results of such decisions improve the "bottom-line" in the short run. This view recognizes that the majority of the
costs in ABC cost pools are salaries and wages, equipment and space costs. In the short run, these costs are primarily
fixed and represent planned investments in the creation and maintenance of activity capacities. For example, assume
that a material-handling cost pool represents a planned investment in forklift capacity of 2,000 moves. Whether the
actual resource usage is 1,700 moves or 1,800 moves during the year, there will be no difference in the wages and
equipment costs in the pool-at least in the short run. Changes in the cost pool occur only when management
increases or decreases the activity capacity by making changes in future employment levels, or making changes in
the amount of investment in equipment and space allotted to the activity. According to the resource-spending model,
cost changes occur as a result of specific management decisions to hire or fire employees and to buy or sell assets.
Activity reductions within specific departments, if significant, can support staffing change decisions and real cost
savings.
The resource-spending viewpoint looks at a single cost-reduction proposal in isolation from other similar
proposals reviewed over time. The single proposal must generate enough activity reduction to lead to employee
headcount reduction if cost savings are to be attributed to the proposal. Usually, some variable cost savings for items
such as supplies and utilities will be realized as a result of activity frequency reductions. However, with respect to
short-term fixed costs such as personnel, activity reductions are often insufficient to create an opportunity to reduce
these larger, step-fixed costs.
In summary, the three major differences between the resource-usage and resource-spending points of view
are: (1) resource usage is more long-run oriented and resource spending is more short-run oriented; (2) resource
usage views each decision within the larger context of an ongoing set of business decisions, while resource spending
views each decision and its cost savings potential in isolation; and (3) resource usage relies upon ABC rates to
estimate cost savings, while resource spending relies on resource-spending profiles in conjunction with estimates
of current idle capacity as the basis for estimating cost savings.
In answering this question, professors can narrow the scope of analysis to focus solely on labor expenses, or
they can expand the scope to consider all the resource categories included in the ABC model. The discussion below
considers all the resource categories in the ABC model. Providing a comprehensive answer to this question requires
labeling the four types of resources shown in Exhibit 4 as variable, step-fixed, or committed-fixed. These resources
are supplies and utilities, wages and fringes, supervision, and equipment. Each is discussed below.
The "supplies and utilities" are variable resources because they can be supplied as needed. The "wages and
fringes" are step-fixed resources that pertain to nonsupervisory labor, such as forklift drivers or assemblers.
Assuming that Wilson does not employ temporary workers, their laborers are employed for 40 hours a week and
their wages are a fairly stable expense for the company. Only long-term, substantial changes in output or activity
driver counts would cause the firm to expand or contract the number of employees hired. Shorter-term fluctuations
in output or driver counts are either handled by overtime or represent idle activity capacity. The cost of
"supervision" is also a step-fixed resource. This category changes with adjustments in number of shifts and large
changes in number of employees. The "equipment" may be a step-fixed cost, when equipment is specific to an
employee, such as a forklift truck driven by a specific driver. When releasing a driver, the expectation would be that
the firm would sell off the forklift truck driven by that employee. Equipment may also be a committed-fixed cost in
cases when: (1) it represents high investment cost; (2) its deployment is essentially permanent; and (3) it is operated
by work crews, compared to individuals. Committed fixed costs do not play a role in quantifying the spending
reduction opportunity associated with the A12 redesign.
Regarding the specific calculations, the instructor can walk the class through the analysis one resource
category at a time. First, calculate the $2,542 of cost savings associated with "supplies and utilities" resources. This
cost savings is estimated by isolating the "supplies and utilities" portion of each ABC rate and multiplying it by the
respective decreases in activity frequency, as shown below:
"Supplies/Utilities" Change in Estimated

Activity # ABC rate Activity Frequency Spending Reduction
3 $0.35 -600 $210
4 0.28 -600 168
5b 0.06 -3,200 192
6b 0.05 -3,200 160
8 0.62 -533 330
13 0.33 -1,550 512
15 0.00034 -500,000 170
16 0.0016 -500,000 800
Total savings $2,542
Second, calculate the $89,973 of cost savings associated with "wages and fringes" resources. This cost savings
is estimated by following a four-step process as shown in Exhibit TN-2. In the first step, calculate idle capacity
existing in each department stated in terms of idle employee hours. The information needed for this calculation is
given in Exhibit 2 and in the text of the case. For example, the Purchasing Manager estimated an idle time for the
department of 0.75 FTE. Multiplying 0.75 FTE by the average capacity of 1,537 hours provided by each Purchasing
employee results in an idle time estimate of 1,153 hours annually. In the second step, estimate the impact of the A12
redesign on idle time. This is added to the pre-existing idle time to provide the projected total idle time available if
the proposal is implemented. The detailed calculation of A12's impact on idle time, on a department-by-department
basis, is shown in Exhibit TN-3. For example, the Purchasing Department would have an estimated savings of 500
hours from the redesign. Since employees perform multiple activities within a department, determining payroll
savings from employee reduction must be done at the department level rather than the activity level. In the third
step, the total idle capacity in each department is translated into potential full-time equivalent (FTE) reductions. For
example, purchasing would have a total idle capacity of 1,653 hours annually if the proposal is implemented. A
typical employee in that department adds 1,537 hours of capacity each year. Therefore, reducing the number of
employees by one would still leave sufficient capacity to handle the demand for purchasing activities. In the fourth
step, translate the reduction in FTEs to dollar savings by multiplying the average annual wages and fringes per
employee, as given in Exhibit 2, by the FTE reduction.
The next consideration is the cost of supervisors. It appears that there is only one supervisor in purchasing,
stores, and crane/forklift operations (this observation is based on the supervision dollars shown in Exhibit 4);
therefore, there are no spending reduction opportunities in these departments. Exhibit TN-2 shows that the
Fabrication Department will not be able to reduce nonsupervisory headcount as a result of the A12 redesign;
therefore, it is reasonable to assume that no spending reduction opportunity exists with respect to fabrication
supervision.
Finally, it appears as though there are approximately seven supervisors in the assembly department. This
estimate is calculated by taking $370,800 of Assembly supervision salary and fringes from Exhibit 4 and dividing it
by an approximated average supervisor's salary and benefits of $50,000 (this approximation is reasonable given the
$52,000 of supervision in Purchasing, $48,800 in Stores, $37,938 in Material Handling, and $56,000 [$112,000/2]
average supervision in Fabrication per Exhibit 4). At seven supervisors, the span of control is about 15 employees,
which appears to be consistent with the other departments at Wilson. With a span of control of 15 employees, a
headcount reduction of two employees would not provide a spending reduction opportunity in supervision.
Equipment is the final resource cost. Under the resource-spending viewpoint, equipment is generally considered a
sunk fixed cost and not subject to cost savings in the short run. In the case of material handling, elimination of a
forklift driver would also provide the opportunity to eliminate equipment costs by selling or retiring a forklift truck.
Since the A12 redesign did not eliminate a driver, we assume that no equipment savings are available. In the other
departments, the equipment is assumed to be common to all employees and therefore a sunk cost.
In summary, the resource-spending-based cost savings associated with the A12 redesign total $92,515, as
shown below. Of course, in the first year these savings would be reduced by the $15,000 in severance pay for the
three eliminated workers.
Resource Category Spending Reduction

Supplies and Utilities $ 2,542
Wages and Fringes 89,973
Supervision 0
Equipment 0
Total Spending Reduction Opportunity $92,515
Given that the annual savings of $92,515 is less than the annual $100,000 increase in direct materials, the
resource spending view suggests that the A12 redesign would result in an annual net loss of $7,485.
Question 3
At this point, the objective is to generate significant class discussion and debate on the usage vs. spending issue. The
goal of the discussion is to have students identify the strengths and weaknesses of each approach. Many students
initially see the resource-usage-based estimate of long-run cost savings as vague because no specific timetable has
been established for realizing the proclaimed savings in step-fixed and committed-fixed resources. In fact, it is
possible that these savings may never materialize. Conversely, there is strong appeal among many students for the
specific and tangible nature of savings under the resource-spending viewpoint.
To extend the discussion, we present the class with two hypothetical cost-reduction proposals. Each proposal
assumes two departments-Purchasing and Material Handling-with one activity in each department and no idle
capacity. Exhibit TN-4 (Panel A) summarizes the first proposal that was prepared during the month of February and
has an implementation cost of $5,000. The proposal does not produce sufficient capacity reductions in either
department to generate any immediate savings under the resource-spending viewpoint. Students are then asked
whether they would accept or reject the proposal. The majority of students undoubtedly reject the proposal since it
loses money on its own merits. In other words, the proposal merely creates additional idle capacity while costing the
organization $5,000.
Exhibit TN-4 (Panel B) depicts the second cost-reduction proposal, involving the same two departments,
which is assumed to be evaluated two months later. The second proposal has higher costs and again insufficient
activity reduction by itself to generate any headcount reduction and cost savings. Again, we ask the students what
they would do-accept or reject? Applying the resource-spending point of view, students may support rejecting the
second proposal as well because it does not generate any costs savings on its merits. However, some students will
see that we should accept the combined proposals (see Exhibit TN-4, Panel C). The instructor should explain that
when analyzing the first proposal, the decision maker cannot be assured of when the second proposal will be
submitted or how much activity reduction it will generate. The only way to accept the first proposal is to use the
resource-usage method, which places a value on the benefits of any activity reduction and idle capacity creation. The
expectation would exist that future proposals would add to idle capacity sufficiently to support eventual activity
capacity reduction and true cost savings.
Exhibit TN-5 (Panels A and B) shows the resource-usage analysis for each proposal that includes multiplying
the reduction in activity driver counts in the two departments by the appropriate ABC rates. The estimated cost
savings for the first proposal would be a net of $24,500, while the estimated cost savings of the second proposal
would be $25,000. The combined benefits are $49,500, yet the resource-spending model suggests rejecting the
proposals one at a time. Notice, the estimated savings per the resource-usage model of $49,500 exceed the $37,000
of savings due to headcount reductions shown in Exhibit TN-4, Panel C. This is caused by the fact that the ABC rate
would appropriately include other resources besides labor (e.g., equipment, supplies, etc.).
Question 4
From a resource-usage perspective, the A12 redesign proposal does provide enough savings ($0.47 per unit) to
enable Wilson to respond to its competitor's price reduction of $0.40 per unit. In terms of advice, Alice should
mention the following five issues. First, she should emphasize that the ability of the ABC system to link engineering
design changes to the profitability of a product line provides Wilson with an important competitive advantage. The
lessons learned on the A12 product line can be transferred to other product lines. Wilson's management team does
not need to merely react to the actions of its competitors, but rather Wilson's engineers could proactively embark
upon a continuous process of re-evaluating product designs and proposing changes that would reduce unit costs and
increase profit margins.
Second, Alice should emphasize that the resource-usage-based savings are long-run estimates; therefore, the
projected savings of $0.47 per unit will not be realized in next month's income statement. Wilson will need to take
actions in the future that either translate the usage-based savings into spending reductions or sales growth. Third, she
should acknowledge that, while resource usage is broadly applicable in decision contexts where it makes sense to
distinguish between the costs of used and unused capacity, resource-spending analysis has its practical applications
as well. For example, from an operational budgeting perspective, the resource-spending mode of analysis can be
used to make informed resource-planning decisions. Also, if management needs highly certain and targeted cost
savings in the short run, the resource-spending-based measures may be more appropriate than the resource-usage
measures. Fourth, Alice should emphasize that both the resource-usage and resource-spending modes of analysis
offer higher quality information that the estimates provided by the standard-cost system. Finally, she should
acknowledge that the ABC data being relied upon for the cost-savings estimates is more than one year old. To the
extent manufacturing methods have changed or the combination/quantity of resources supplied have changed, the
ABC rates may be subject to some amount of error.
Of course, there are numerous other pieces of advice that would benefit Alice in her ultimate goal of making a
presentation that fully explains the potential applications of ABC to Wilson's business. However, these additional
points are reserved for discussion in the (B) case portion of the teaching notes.
President Simms' response to Alice Johnson's presentation is likely to be positive. Since the ABC system has
shown that the design change will save Wilson $0.47 per unit on a product that is in need of a $0.40 per unit cost
reduction, Simms will likely give his approval to Johnson's request to update the ABC system. However, there is a
strong likelihood that the ABC project will not be successful in the long run. The case points out that Wilson's ABC
project was spearheaded by Mike Foster. With Foster gone, the project stagnated. The implication is clear that the
ABC project did not have strong cross-functional top-management support. Research has shown that ABC
implementations driven by the finance function and unsupported by top-level nonaccounting managers are likely to
fail (Shields 1995). Therefore, it is probable that managers outside the accounting department will never use the
ABC system to support decision making in a meaningful and consistent manner.
Wilson Electronics (B) Discussion Questions

Part A
The ABC cross model illustrates that, generally speaking, ABC adds values from three perspectives-the cost
assignment view, the process view, and the "what-if" cost-modeling view. The conclusions that students reach in
this case may differ, but these three applications of ABC should be apparent to all students.
The purpose of asking students this question is to provide them with an overarching framework for organizing
their presentation. The term "product costing" relates to the cost assignment view of the ABC cross model, whereby
resource costs are assigned to activities and activity costs are assigned to products (Player and Lacerda 1999; Turney
1992). The term "process costing" refers to the process view of the ABC cross model that focuses on costing
activities and processes and identifying their root-cause drivers and performance measures (Player and Lacerda
1999; Turney 1992). The term "cost modeling," in this context, refers to the "what-if" analysis perspective of ABC.
The cost-modeling perspective inverts the cost assignment view in the sense that it estimates the impact of a change
in product mix, product design, or process design on activity demands and resource costs (Brewer and Linderman
1998; Greenwood and Reeve 1994).
The (A) version of the case focuses on the "what-if" cost-modeling perspective. The A12 junction box has
been redesigned and the task at hand is to estimate the potential cost savings. The resource-usage view uses ABC
rates to estimate the long-term impact on resource costs. The resource-spending view uses resource-spending
profiles to estimate the short-run impact on resource costs. The (B) version of the case incorporates the product-
costing and process-costing perspectives of the ABC cross model. It also asks the students to explore the
interrelationship between ABC and TOC.
Part B
At the conclusion of the (B) case, students should have been alerted to Alice's concern that the resource-usage-based
savings of $0.47 per unit is well below the recently announced price reduction of $2.50 per unit. When students are
asked if they are concerned about this $2.03 shortfall, the immediate answer is "yes." However, Wilson's current
view of A12's product cost and profitability is predicated on its direct labor (DL)-based cost accounting system.
Therefore, this question provides students an opportunity to examine the product cost distortion inherent in the DL-
based system and relate the amount of the distortion to the $2.50 price reduction.
Exhibit TN-6 (Panel A) provides an estimated income statement for the current version of the A12 junction
box using the DL-based standard cost system. The estimated DL charge of $416,896 is a function of the number of
labor hours spent on activities #12 and #16 and the average wage rate in the fabrication and assembly departments.
Exhibit 5 shows the 23,333 DL hours in assembly. The 10,000 DL hours in fabrication is found by dividing the
100,000 units produced by the activity time standard of six minutes per unit. Finally, Exhibit 2 shows the average
wage rates of $12.42 and $12.71 per hour for activities 12 and 16, respectively.
The overhead charge is estimated by calculating an overhead rate based on DL hours. The overhead rate is
computed by taking the $7,140,000 of overhead from Exhibit 1 and dividing it by the total labor hours allocated to
activities #12 and #16 of 135,032 (see Exhibit 3), thereby yielding an overhead rate of $52.876 per DL hour.
Multiplying this rate by the DL hours worked of 33,333 results in estimated overhead assigned to A12 of
$1,762,527.
Exhibit TN-6 (Panel B) provides an estimated income statement for the current version of A12 using the ABC
system. Notice that in the ABC system, DL is lumped in together with the overhead. The ABC charges and other
overhead charges come from Exhibit 6. The bottom of Exhibit TN-6 summarizes the decrease in cost of $3.08 per
unit that results from the ABC data.
This new piece of information usually draws three types of reactions from students. First, some students
contend that Wilson can match the price reduction easily. These students argue that, thanks to ABC, Wilson can
meet the price reduction and increase the A12 profit margins at the same time. At this point, ask students what the
income statement will look like for the coming period if Wilson matches the $2.50 price reduction and does nothing
else. The answer is that profits will shrink by $250,000. Revenue will shrink and the expenses reported on the
income statement will remain unchanged. This quickly gets students to realize that cost reduction must accompany a
$2.50 price cut or else profits will decrease.
The second reaction from students is to cut prices more than $2.50 in an attempt to gain market share. If
indeed Wilson's competitors could not match a price reduction greater than $2.50, this argument may have some
merit. However, if Wilson's competitors match any price reduction that it may introduce into the marketplace, it may
not make sense to fuel a price war where nobody gains share and everybody's margins shrink.
Third, some students will suggest that A12 should not be the focus of Wilson's cost reduction efforts. These
students will contend that ABC data should be used to identify the products that are truly unprofitable. The cost
reduction efforts should be directed toward products that are not price- or cost-competitive. These students believe
that the A12 product line seems to be doing okay. Furthermore, they think that Wilson needs to be looking at the
low-volume, complex, custom business that has been growing in recent years. This observation leads to the next
question.
Part C
This question is designed to help students identify the product cost cross-subsidization that results from Wilson's
standard cost system. The average overhead per unit for the custom product lines of $15.94 is calculated by dividing
the total overhead assigned to the custom lines, of $1,092,000 (Exhibit 1) by the 68,500 units produced (found in the
[A] case text). The average overhead per unit for the A12 junction box of $17.63 is calculated by dividing the
overhead assigned to A12 from Exhibit TN-6 of $1,762,527 by the 100,000 units produced. These rates should strike
the students as counter-intuitive. A high-volume product, such as the A12 junction box that is not very complex in
its design, should have a lower overhead rate per unit than custom products that are manufactured in lower volumes
to meet detailed customer specifications.
The primary conclusion inferred from these rates is that the standard cost system is undercosting the custom
business and over-costing the high-volume business. The cross-subsidization problem is probably contributing to
flawed decision making that has in turn resulted in declining profits. Exhibit 1 provides support for this assertion.
First, sales have increased each of the last three years, yet after-tax profits have declined each of the last three years.
Second, sales of the custom lines has increased substantially over the last three years. Third, total overhead has
increased each of the last three years despite what appears to be an effort to reduce DL costs. Fourth, S,G&A
expenses have increased each of the last three years. Although S,G&A was not included in the ABC analysis, it is
reasonable to conclude that the increase in custom sales to buyers outside the normal distribution channels has
probably been a major driving force behind the increase in S,G&A.
This mode of analysis raises the question as to whether the A12 junction box should be the focus of Wilson's
product-cost-reduction efforts. Perhaps Wilson's management should be focusing its attention on reassessing its
long-run product-mix strategy. If the custom business is viewed as supportive of Wilson's strategy, the management
team should revisit its custom business pricing strategy or reduce the costs incurred to serve the custom segment.
One question that Wilson should consider is: where is the competition in the custom niche? If Wilson believes that
the custom niche is highly profitable, why have competitors not challenged this segment of the business? Having
what appears to be a highly profitable niche without the presence of competition is a classic sign of an obsolete cost
system (Cooper 1987).
The $2.50 market-driven price reduction in the A12 line is a genuine issue that warrants a response.
Therefore, the engineers' efforts to reduce costs on this product line are well intended and, indeed, cost reduction of
some sort is a necessity. However, the intent of the (B) case is to alert students to some "bigger picture" issues of
which Wilson should be aware beyond the $0.47 price reduction. If Wilson's engineers can engage in an A12
junction box target-costing effort that eventually matches the $2.50 price cut, that is good. However, assuming that
Wilson's engineers are constrained by limited time and money, they may want to channel their intellectual capital to
larger profit improvement opportunities. One such opportunity is to consider the product-mix strategy issue and the
impact of the low-volume custom business on overhead and S,G&A costs. Another issue relates to process cost
management, which is the subject of the next question.
Part D
This question should lead into a discussion of value-added vs. non-value-added activities and the process cost view
of ABC. It should raise the students' awareness that the bill of activities for A12 contains numerous charges for
activities that may best be labeled "non-value-added." At a minimum, activities #4-11 and #13-15 could be so
labeled. The activity charges for the A12 junction box that emanate from activities #4-11 and #13-15 total $444,623,
or $4.45 on a per unit basis.
The $0.47 per unit long-run cost savings associated with the A12 redesign is well short of the $2.50 per unit
price reduction announced by one of Wilson's competitors. On the other hand, if Wilson felt that 100,000 units of
A12 were a sufficient volume to warrant creating a manufacturing cell, in the long run Wilson may be able to
eliminate the activity charges associated with activities #4-11 and #13-15, which total $4.45 per unit. These savings
more than offset the competitor's price reduction of $2.50 per unit. Given Wilson's resource constraints, it may make
sense to focus its improvement efforts on a process redesign initiative whereby the payback of $4.45 per unit is more
than nine times greater than the $0.47 per unit savings associated with the product redesign initiative. Exhibit TN-7
shows one approach for estimating an ABC income statement for the original version of A12 in a cellular
environment. This income statement suggests that the A12 profit margin could approach 6.3 percent if Wilson
created a manufacturing cell.
Students could also look at the non-value-added ABC costs in total as opposed to focusing solely on the A12
line. For example, assuming that activities #4-11 and #13-15 are labeled non-value-added, the total dollar value of
resources being committed to support these activities would equal $2,583,202. Stated another way, only 62 percent
of the dollars being committed to the materials procurement and manufacturing processes are adding value.
Part E
The resource-usage analysis vs. resource-spending analysis relates to the "what-if" cost-modeling aspect of the ABC
cross model. The analysis that was the focus of the (A) case definitely should be incorporated into the presentation
because it addresses the role that ABC can play in answering "what-if" questions. The resource-usage and resource-
spending-based savings estimates associated with the A12 proposal should be presented as examples of long-run and
short-run modes of analysis that can be used in particular contexts to support "what-if" decision making. The "what-
if" mode of ABC analysis is more proactive in nature in the sense that it feeds information forward into the
decisionmaking process before the decision has been made.
If the professor so desires, the resource-usage and resource-spending analyses can be expanded by extending
the decision time frame beyond one year and including the up-front costs mentioned in the (A) case. Exhibit TN-8
shows one potential net present value (NPV) analysis that relates to the resource-spending view. The NPV analysis
takes into account the up-front costs associated with the redesign, the increase in raw material costs, and the labor
savings over a three-year time horizon. The NPV is a negative $51,880.
An NPV analysis for the resource-usage view is somewhat more perplexing. The resource-usage view is
meant to provide an estimate of long-term cost savings; however, the translation of these savings to cash flows is not
guaranteed. Given that the value of a firm is measured by the discounted present value of its future cash flows, this
raises the question of how should the $147,231 of resource- usage-based, long-run savings be incorporated into an
NPV analysis? Exhibits TN-9 and TN-10 show two possible solutions that students might suggest. First, Exhibit
TN-9 is based on the most optimistic assumption that all the long-run cost savings will materialize in year one,
thereby resulting in an NPV of $75,170. This is an unlikely scenario. Second, Exhibit TN-10 includes only $92,515
of savings in year one and then phases in the rest of the savings at years two and three. Using a three-year time
horizon, the NPV is a positive $27,099. If the time horizon is extended to five years, the NPV becomes $79,596.
Of course, these two solutions are predicated on the assumption that all of the potential savings will truly be realized
at some point in the future, which is a debatable point.
Part F
The resource-usage vs. resource-spending debate that was the focus of the (A) case was predicated upon the
assumption that the answers to "what-if" questions need to be presented within the context of "cost reduction
potential" as the decision criterion. However, the freed-up capacity that would result from the A12 redesign does not
have to be translated into spending reductions. Certainly, cost reduction is one way to increase profits; however,
revenue and contribution growth is another way. Therefore, an alternative mode of thinking with respect to the A12
redesign is to analyze the impact of the redesign on the potential for revenue growth.
The (A) case indicates that Wilson is operating at its practical capacity. Furthermore, it mentions that the
constraining resource is the labor hours available in the assembly department. From a constrained optimization
perspective, the (A) case indicates that, on average for Wilson, 59 of each sales dollar is raw material cost and 6
of each sales dollar is paid out in commissions. This implies that the throughput earned by Wilson in 1996 is 35 per
sales dollar or $21,000,000 in total. The throughput per assembly labor hour is $21,000,000/157,220 = $133.57.
Given that the A12 redesign frees up 3,466 labor hours in assembly, a revenue-oriented "what-if" analysis would
suggest that the redesign provides Wilson with the opportunity to earn $462,954 of additional throughput without
having to invest in more people. From this perspective, the A12 redesign appears to be much more appealing than
the cost-reduction point of view.
EXHIBIT TN-1
Bill of Activities for Redesigned Version of A12 Junction Box
Quantity of Activity Total Activity Volume of Activity

Activity# Activity Driver Rate Charge Production Charge/unit
1 300 batches $20.51 $ 6,153 100,000 units $ 0.06
2 300 batches 19.61 5,883 100,000 units 0.06
3 2,400 unique parts 7.67 18,408 100,000 units 0.18
4 2,400 unique parts 11.74 28,176 100,000 units 0.28
5a 1,500 bundles 7.23 10,845 100,000 units 0.11
5b 16,800 containers 1.88 31,584 100,000 units 0.32
6a 1,500 bundles 3.26 4,890 100,000 units 0.05
6b 16,800 containers 0.86 14,448 100,000 units 0.14
7 600 crane moves 38.95 23,370 100,000 units 0.23
8 2,800 forklift moves 10.70 29,960 100,000 units 0.30
11 300 setups 84.72 25,416 100,000 units 0.25
12 100,000 housing units 2.46 246,000 100,000 units 2.46
13 3,000 hours 7.17 21,510 100,000 units 0.22
14 100,000 housing units 0.63 63,000 100,000 units 0.63
15 2,100,000 parts 0.04 84,000 100,000 units 0.84
16 2,100,000 parts 0.18 378,000 100,000 units 3.78
17 100,000 finished units 0.90 90,000 100,000 units 0.90
18 100,000 finished units 0.67 67,000 100,000 units 0.67
Total Activity Charges $1,203,438 $12.03
Overhead from departments not included in ABC study 520,661 5.21
Total Material Costs 6,500,000 65.00
Total Product Cost $8,224,099 $82.24
EXHIBIT TN-2
Resource Spending View of A12 Junction Box Redesign Proposal
Step 1-Transform FTE Idle Capacities from the Text of the Case to Hours
Current Practical
Idle Capacity x Capacity/FTE = Idle Capacity
Purchasing 0.75 persons 1,537 hours 1,153 hours
Stores 0.25 persons 1,490 hours 373 hours
Crane Operators 0.25 persons 1,615 hours 404 hours
Forklift Operators 0.50 persons 1,571 hours 786 hours
Fabrication 0.50 persons 1,590 hours 795 hours
Assembly 0.00 persons 1,526 hours 0 hours
Step 2-Compute Revised Idle Capacity as a Result of Product Redesign
Idle Capacity Decrease Due Revised

in Hours + to Redesign = Idle Capacity
Purchasing 1,153 hours 500 hours 1,653 hours
Stores 373 hours 374 hours 747 hours
Crane Operators 404 hours 0 hours 404 hours
Forklift Operators 786 hours 222 hours 1,008 hours
Fabrication 7 95 hours 258 hours 1,053 hours
Assembly 0 hours 3,466 hours 3,466 hours
Step 3-Quantify Potential Reduction in Terms of FTEs
Revised Practical Potential FTE

Idle Capacity Capacity/FTE = Reduction
Purchasing 1,653 hours 1,537 hours 1 FTE
Stores 747 hours 1,490 hours 0 FTE
Crane Operators 404 hours 1,615 hours 0 FTE
Forklift Operators 1,008 hours 1,571 hours 0 FTE
Fabrication 1,053 hours 1,590 hours 0 FTE
Assembly 3,466 hours 1,526 hours 2 FTE
Step 4-Translate Potential FTE Reduction to Dollar Savings
Potential FTE Average Wage and Dollar

Reduction x Fringe/Employee = Savings
Purchasing 1 FTE $30,373 $30,373
Stores 0 FTE 24,042 0
Crane Operators 0 FTE 27,300 0
Forklift Operators 0 FTE 18,262 0
Fabrication 0 FTE 24,022 0
Assembly 2 FTE 29,800 59,600
Total Spending Reduction $89,973
EXHIBIT TN-3
The Impact of the A12 Redesign on Idle Timea
Change from
Original Revised Change in Activity Original
Activity Activity Activity Time Activity Time
Activity Activity Driver Frequency Frequency Frequency Standards Forecast (hours)
Process #1: Materials Procurement
Purchasing Department
3. Issue purchase orders for parts # unique parts/batch 3,000 2,400 -600 20 min./count -200
4. Expedite open parts orders # unique parts/batch 3,000 2,400 -600 30 min./count -300
-500
Stores
5. Unload materials and put in stores
b. assembly-parts # parts containers 20,000 16,800 -3,200 5 min./container -267
6. Process material requisitions
b. assembly-parts # parts containers 20,000 16,800 -3,200 2 min./container -107
-374
Process #2: Manufacturing

Material Handling
8. Move parts to Assembly # forklift moves 3,333 2,800 -533 25 min./forklift
move -222
-222
Fabrication
13. Rework defective units # of rework hours 4,550 3,000 -1,550 10 min./unit -258
-258
Assembly
15. Unload parts and hold # parts used 2,600,000 2,100,000 -500,000 0.10 min./part -833
16. Assemble finished products # parts used 2,600,000 2,100,000 -500,000 see Exhibit 5 -2,633
-3,466
a
Activity #7 relates to Crane Operators. The A12 redesign has no effect on this activity.
EXHIBIT TN-4
Illustration of Usage vs. Spending Concepts
Panel A: Cost Reduction Proposal #1 Submitted in February 19xx
Assumptions
Average employee wages = $25,000
Implementation costs = $5,000
No idle capacity exists
Activity Activity Time

Frequency Time Savings Employee Headcount
Activity Reduction Activity Driver Standard (in hours) Capacity Reduction
Purchasing 1,600 # purchase orders 30 min. 800 1,500 hours 0
Material moves 1,800 # moves 25 min. 750 1,500 hours 0
According to the resource spending view, what are the potential cost savings?
Panel B: Cost Reduction Proposal #2 Submitted in April 19xx
Assumptions

Purchasing 1,800 # purchase orders 30 min. 900 1,500 hours 0
Material moves 2,000 # moves 25 min. 833 1,500 hours 0
According to the resource spending view, what are the potential cost savings?
Panel C: Impact of the Combined Proposals on Spending Reduction

Purchasing 3,400 # purchase orders 30 min. 1,700 1,500 hours 1
Material moves 3,800 # moves 25 min. 1,583 1,500 hours 1
Potential savings opportunity = $50,000 - $13,000 = $37,000.
EXHIBIT TN-5
Illustration of Usage vs. Spending Concepts
Panel A: Resource Usage View of Cost Reduction Proposal #1 Submitted in February 19xx
Assumptions
Activity
Frequency Activity ABC
Activity Reduction Activity Driver Rate Cost Savings
Purchasing 1,600 # purchase orders $10.00 $16,000
Material moves 1,800 # moves $7.50 13,500
Estimated Savings $29,500
Less: Implementation costs 5,000
Net Cost Savings $24,500
Panel B: Resource Usage View of Cost Reduction Proposal #2 Submitted in April 19xx
Assumptions
Activity
Frequency Activity ABC
Activity Reduction Activity Driver Rate Cost Savings
Purchasing 1,800 # purchase orders $10.00 $18,000
Material moves 2,000 # moves $7.50 15,000
Estimated Savings $33,000
Less: Implementation costs 8,000
Net Cost Savings $25,000
EXHIBIT TN-6
Comparative Income Statements for the Current Version of the A12 Junction Box
Panel A: Estimated Income Statement for the Current Version of the A12 Junction Box
(Using the Direct-Labor-Based Standard Cost System)
1999
Sales (60,000,000 ??0.185) $11,100,000
Direct materials (see Exhibit 5) 6,400,000
Direct labor (23,333 ??12.42) + (10,000 ??12.71)* 416,896
Overhead (7,140,000/135,032 ??33,333)** 1,762,527
Gross margin $ 2,520,577
S, G & A (11,100,000 ??0.19) 2,109,000
Profit before tax $ 411,577
Tax expense (411,577 ??0.4) 164,631
Profit after tax $ 246,946
Profit margin 2.2%
Panel B: Estimated Income Statement for the Current Version of the A12 Junction Box
(Using the Activity-Based Costing System)
1999
Sales $11,100,000
Direct materials (see Exhibit 5) 6,400,000
ABC charges (includes direct labor) (see Exhibit 6) 1,350,669
Other overhead unrelated to ABC project (see Exhibit 6) 520,661
S, G & A (11,100,000 ??0.19) 2,109,000
Profit before tax $ 719,670
Tax expense (719,670 ??0.4) 287,868
Profit after tax $ 431,802
Profit margin 3.9%
Cost Difference between Standard Cost System and ABC
Standard cost Direct labor + overhead $2,179,423

ABC charges (including direct labor) + other overhead 1,871,330
Difference in cost assigned $ 308,093
Number of units produced 100,000
Decrease in cost on a per-unit basis $3.08
* The estimates of direct labor hours (23,333 and 10,000) are based on the hours spent performing activities
12 and 16.
** Overhead can also be estimated by taking direct labor dollars of 416,896 ??4.2 = 1, 750,963.
Either estimate provides a result that approximates the 2.2 percent return reported in the case.
EXHIBIT TN-7
ABC Income Statement for the A12 Junction Box
(Original Version of A12 Junction Box in a Cellular Environment)
1999
Sales ($60,000,000 ??0.185) $11,100,000
DM (see Exhibit 5) 6,400,000
ABC charges (1,350,669 - 444,623) 906,046
Other overhead (see Exhibit 6) 520,661
S, G & A 2,109,000
Net income before tax $ 1,164,293
Tax expense 465,717
Net income after tax $ 698,576
Profit margin 6.3%
Key Assumptions
1. This income statement assumes that the $444,623 of resources attributable to activities #4-11 and #13-15 could be
productively redeployed and charged to other product lines or, that the resources could be released, thereby
resulting in genuine savings. If a manufacturing cell was created, but the freed-up resources relating to activities
#4-11 and #13-15 remained permanently idle, there would be no savings for Wilson as suggested by the income
statement above.
2. The "Other overhead" of $520,661 is assumed to be unaffected by the switch to cellular production.
EXHIBIT TN-8
Resource Spending View-Discounted Cash Flow Analysis
Discount rate = 14%
0 1 2 3
Product Engineering $ (10,000)
Process Engineering ( 9,500)
Severance Pay (15,000)
Raw Material purchases (232,200) $(100,000) $(100,000) $(100,000)
Cost Savings 214,820 $92,515 $92,515 $92,515
Net Present Value $ (51,880)
Key Assumption
1. This analysis assumes that raw material prices remain constant over the three-year time horizon. Likewise, it
assumes that the savings generated by the redesign ($92,515) remains constant over the three-year time horizon.
The analysis would become more complex if expected increases in raw material prices and average wage rates
were factored into the calculation.
EXHIBIT TN-9
Resource Usage View-Discounted Cash Flow Analysis
Discount rate = 14%
0 1 2 3
Process Engineering ( 9,500)
Cost Savings $ 341,870 $ 147,231 $ 147,231 $ 147,231
Net Present Value $ 75,170
Key Assumption
assumes that the savings generated by the redesign ($147,231) remains constant over the three-year time horizon.
The analysis would become more complex if expected increases in raw material prices and average resource costs
EXHIBIT TN-10
Resource Usage View-Discounted Cash Flow Analysis
Discount rate = 14%
0 1 2 3
Process Engineering (9,500)
Cost Savings 293,799 $92,515 $147,231 $147,231
Net Present Value $ 27,099
NPV for five-year time horizon $ 79,596
Key Assumption
assumes that the savings generated by the redesign ($147,231) remains constant over years 2 through 5. The
analysis would become more complex if expected increases in raw material prices and average resource costs
ANNOTATED BIBLIOGRAPHY
Brewer, P., and P. Linderman, 1998. From cost accounting to cost management. Journal of Engineering Valuation
and Cost Analysis 1: 265-276.
This article is a good background reading for the case because it discusses the uses of ABC
from product costing, process costing, and "what-if" cost-modeling perspectives. It relies on
a simple numerical example to illustrate these three applications of ABC. This article
would work best if assigned before the (B) case.
Cooper, R., and R. Kaplan. 1992. Activity-based systems: Measuring the cost of resource usage. Accounting
Horizons (September): 1-13.
This article is good background reading for the case because it explains how ABC systems
are designed to measure the cost of resource usage. It introduces the fundamental equation:
the cost of resources supplied = the cost of resources used + the cost of unused capacity.
Gantt, H. L. 2000. The relation between production and costs. In Readings and Issues in Cost Management, edited
by J. Reeve. Cincinnati, OH: South-Western College Publishing.
This article discusses the merits of capacity costing. It explains how cost-per-unit information
can be dramatically influenced in traditional cost systems by the amount of capacity
being utilized in production. It has some conceptual overlap with the Cooper and Kaplan
(1992) article entitled "Activity-Based Systems: Measuring the Cost of Resource Usage";
however, this article is shorter in length so it provides an attractive alternative if time or
student work load are of concern.
Greenwood, T., and J. Reeve. 1994. Process cost management. Journal of Cost Management (Winter): 4-19.
This reading discusses the concept of resource-spending profiles and explains their role in
estimating the impact of changes in product and process cost drivers on resource spending.
The article provides a useful illustration for demonstrating how changes in product cost
drivers can be linked to their impact on activity demands and resource spending.
Kaplan, R. 1997. Using Activity-Based Costing with Budgeted Expenses and Practical Capacity. Boston, MA:
Harvard Business School Publishing Case No. 9-197-083, 1-12.
This article discusses the use of practical capacity as a basis for calculating denominator
volumes. It also discusses the role capacity-based denominator volumes play in enabling
the accurate measurement of the cost of resources used in production. It introduces the
idea of responding to the presence of unused capacity by either reducing spending or increasing
output.
King, A. 1993. Green dollars and blue dollars: The paradox of cost reduction. Journal of Cost Management (Fall):
44-52.
This article can be used to contrast the notions of resource usage and resource spending.
The author refers to changes in the level of resource usage as "blue-dollar" savings and
changes in the level of spending as "green-dollar" savings.
Ruhl, J. 2000. An introduction to the theory of constraints. In Readings and Issues in Cost Management, edited by J.
Reeve, Cincinnati, OH: South-Western College Publishing.
This article is a basic introduction to the Theory of Constraints. It is good background reading
for the (B) case given that this portion of the case focuses on the A12 redesign proposal
from not only a cost management perspective, but also a revenue growth perspective.
Turney, P. 1992. What an activity-based cost model looks like. Journal of Cost Management (Winter): 54-60.
This article can be used to introduce students to the ABC Cross model. It serves as a good
foundation for organizing the analysis of the (B) case. The visual image of the cross model
enables students to conceptualize the three primary applications of ABC, namely, the product
costing, the process costing, and the "what-if" cost modeling perspectives.
REFERENCES
Bernier, M., and R. Cooper. 1988. Schulze Waxed Containers, Inc. Boston, MA: Harvard Business School
Publishing Case No: 9-188-134, 1-22.
Brewer, P., and P. Linderman. 1998. From cost accounting to cost management. Journal of Engineering Valuation
and Cost Analysis 1: 265-276.
Cooper, R. 1985. Camelback Communications. Boston, MA: Harvard Business School Publishing Case No. 9-185-
179, 1-5.
---. 1987. Does your company need a new cost system? Journal of Cost Management (Spring): 45-49.
---, and K. Wruck. 1990. Siemens Electric Motor Works (A). Boston, MA: Harvard Business School Publishing Case
No. 9-191-006, 1-8.
---, and R. Kaplan. 1992. Activity-based systems: Measuring the cost of resource usage. Accounting Horizons
(September): 1-13.
Greenwood, T., and J. Reeve. 1994. Process cost management. Journal of Cost Management (Winter): 4-19.
Hansen, D., and M. Mowen. 1997. Cost Management: Accounting and Control. Cincinnati, OH: South-Western
College Publishing.
Horngren, C., G. Foster, and S. Datar. 1997. Cost Accounting: A Managerial Emphasis. Upper Saddle River, NJ:
Prentice Hall, Inc.
Kaplan, R., 1998. Classic Pen Company: Developing an ABC Model. Boston, MA: Harvard Business School
Publishing Case No. 9-198-117, 1-4.
Player, S., and R. Lacerda. 1999. Arthur Andersen's Global Lessons in Activity-Based Management. New York, NY:
John Wiley & Sons, Inc.
Ruhl, J. 2000. An introduction to the theory of constraints. In Readings and Issues in Cost Management, edited by J.
Reeve. Cincinnati, OH: South-Western College Publishing.
Shields, M. 1995. An empirical analysis of firms' implementation experiences with activity-based costing. Journal
of Management Accounting Research 7: 148-166.
Turney, P., and C. Ittner. 1988. Seligram Inc.: Electronic Testing Operations. Boston, MA: Harvard Business
School Publishing Case No. 9-189-084, 1-11.
---. 1992. What an activity-based cost model looks like. Journal of Cost Management (Winter): 54-60.
5-6 Pecos Products (Complexity into the Study of Activity-Based Costing)
ABSTRACT: This case is designed to help students gain a more thorough understanding of activity-based
costing (ABC) than is usually obtained in introductory managerial accounting courses. If you have taken
such a course, you have probably seen, in general, simple examples of activity-based costing. However,
ABC can be more complex than these examples indicate for three reasons: (1) the mechanics of ABC are
far more complex than these simple examples indicate; (2) many of the design choices required in an ABC
system, which are critical to the cost-benefit decision, are omitted from the simple examples; and (3)
without adequate detail, it is hard to see how economic consequences arise from the choice of costing
systems.
The Pecos Products ABC Design Project (the project) addresses these issues by providing a
hypothetical company with a detailed business scenario and asking you to help with the cost-system-design
decision. To accomplish this, you will have to think about traditional cost system and ABC design issues,
delve deeply into the cost system mechanics, and evaluate the benefits (economic consequences) of an
ABC system in light of the cost and effort required to create it.
TEACHING NOTES Learning Objectives and Target Audience

Accounting students are generally introduced to ABC using simple examples, where the data provided force a
one-to-one mapping of pre-pooled costs with cost drivers (see, for example, Hilton [1999, 155169] and Horngren et
al. [2000, 140 150]). In this highly abstracted setting, students learn the absorption-costing mechanics of the
technique, are confronted with the fact that reported costs can differ substantially between different cost-allocation
5
systems, and are presented with an example of the economic consequences of these differences in reported costs.
We have found these simple examples to be an effective introduction to the topic of ABC, but inadequate to provide
a full understanding of the topic for three reasons:
(1) the mechanics of ABC are far more complex than these simple examples indi-cate; (2) the design choices
required in an ABC system, which are critical to the cost-benefit decision, are omitted from the simple examples;
and (3) in our experience, the notion of economic consequences remains too highly abstract for students to
understand and retain.
We believe that the learning objectives for a professional accounting student should incorporate these issues.
We use the traditional term professional accounting student to indicate that the project is targeted at accounting
majors or others who may view themselves as future professionals in business measurement, and not at all
undergraduate business students (as in an introductory management accounting course) or at M.B.A. students (where
6
the information-user perspective is generally emphasized and mechanics de-emphasized).
Our project promotes discussion of the benefits (economic consequences) of the ABC system in light of the
costs (here, effort) required to create such a system, and it supports the following four ABC learning objectives,
consistent with the discussion above:
1. Students will understand the importance of associating cost-system design with economic consequences for the
firm and will know the likely economic consequences of a change in cost reporting.
2. Students will learn in detail how ABC systems work by following the flow of costs from resource costs recorded
in the general ledger, through association of resource costs with activities, pooling of activity costs, selection of
pool allocation bases from a broad set of potential cost drivers, and allocation of activity pool costs to cost
objects.
5
Some ABC advocates refer to ABC as a cost assignment system. As this project reinforces for students, a practical
(i.e., cost effective) implementation of ABC remains substantively a cost allocation system, though ideally a less
noisy one than is traditionally observed.
6
We designed this project to fill a perceived gap in the curriculum (and in available teaching materials) for a junior-
level undergraduate cost accounting and cost management course that is required of all students who have been
accepted into our five-year combined bachelors/masters degree (150-hour) program in accounting.
3. Students will realize that ABC system design is an imprecise process and not one of idealized measurement (as in
the simple introductory examples).
4. Students will gain intuition about the measurement and reporting costs associated with cost-system-design
choices leading to the realization that increases in cost-system accuracy must be weighed against increased
system operating costs.
The next section of this teaching note distinguishes this project from available Harvard teaching cases. The
following two sections discuss our experiences teaching the project and the main design issues that arise in the
project. The final section discusses the project assignments, and commonly encountered issues.
Published ABC Cases

This project provides an intensive learning experience that addresses ABC issues in a manner different from
that of other cases available to educators. We summarize in Exhibit TN-1 a number of the readily available Harvard
7
Business School cases related to ABC. A comparison of the Pecos project to the other cases points out two primary
ways in which the case makes an incremental contribution.
First, Pecos is the only case to place a major focus on mechanics. While the Schrader Bellows case series
provides more practice in the mechanics of an ABC cost system than the other Harvard cases, a number of factors
distinguish the Pecos project from Schrader Bellows. For example, Schrader Bellows focuses entirely on support-
department costs, whereas Pecos provides an all-inclusive exercise in product costing, including calculations of
direct materials, direct labor, and total overhead. Also, while students are required to design their own allocation
routines in the Schrader Bellows case, a computer module performs the laborious calculations associated with
product costing. On the other hand, the data provided in the Pecos project are complex enough to provide a rich and
realistic setting but simplified enough to allow students to go through the detailed product-costing calculations.
A second contribution of the Pecos project is its breadth of scope. This project provides some level of coverage
of most of the seven topics listed in Exhibit TN-1, beginning with ABC theory and culminating in decision making.
Implementation Guidelines
Integration with Course Content
By design, the Pecos project is an immersion experience that requires a significant investment of time by
8, 9
students. We teach the project over a four-week period corresponding to the course time dedicated to teaching
ABC and activity-based management (ABM). The project is introduced as the transition from discussing cost system
design and traditional single-pool, volume-based absorption-costing
7
Given the wide usage of the Harvard Business School cases, we elected to review these cases as representative of
the general population of business cases available. While other extensive ABC projects may exist, especially
among consulting firms, we are aware of no other readily available cases or projects similar to this one.
8
As discussed in this section and throughout these teaching notes, this project is designed to be an intensive
experience of long duration. Complexity is its raison dtre. Accordingly, we do not recommend that it be used
simply as the basis for a one-class discussion or a one-time student presentation. If it were necessary to use the
case in this way, we would advise (1) concentrating on Assignment 3; (2) providing students with the ABC
system design and cost/profit results (Exhibits TN-3 and TN-4); (3) asking students to explain and critique the
design; and (4) focusing discussion on questions [3(c) to 3(f)].
9
Students have reported spending 4050 hours per student (in teams of four to five students) over the course of this
project. While we cannot vouch for the accuracy of this estimate, we find it credible: it took us six hours, working
together, the first time we designed the ABC system and computed ABC-based costs and profits. We had the
advantage of knowing exactly how to approach the problem we had constructed, and this six hours did not include
downloading and exploring the data, developing traditional costing systems, preparing and delivering the in-class
presentation, developing answers to the decision-making questions, or writing the papers for Assignments 2 and 3.
EXHIBIT TN-1 Comparison of Pecos Products and Harvard Business School ABC Cases
Examples of topics covered in each of the categories:
ABC Theory/Conceptual The basic concepts that distinguish ABC from traditional volume-based costing
Design Choice of cost pools (including tradeoffs between accuracy & system costs) Choice
of cost drivers (including correlation and regression using historical data) System
design for strategic vs. operational decision making
Integration of financial and managerial cost systems
Measurement Issues involved in measuring costs of activities
Use of general ledger (resource costs) to infer activity costs
Interviewing strategies
Mechanics Actual calculation of cost driver volumes/cost pool rates/product costs
Aggregation issues (e.g., multiple cost centers)
Outcomes Comparison of ABC results to results from traditional volume-based system
Analysis of factors leading to differences in costs between different systems
Economic Consequences
Product mix Pricing
& Decision Making
Product design Strategy development
Customer focus
Activity-Based
Analysis of activities
Management
Continuous improvement
Performance measurement
Other Variance analysis
Implementation issues
Behavioral consequences
Legend: Topic is a major focus of case. Topic is covered in some substantial manner.
systems into generalized multiple-pool, or ABC, systems. The project and its assignments support this multiweek
teaching model. Students begin by designing a traditional costing system for Pecos. They then design and defend
an ABC system and conclude by analyzing the new systems economic consequences and cost-benefit issues.
In addition to allowing adequate time for students to work through the complexities of the project, the staged
approach also provides opportunities for the instructor to provide feedback as the project progresses. For example,
during the first iteration of ABC system design many students will create designs that fail to allocate all costs
(notwithstanding the warning included in the case questions). Not only does this provide an opportunity to correct a
fundamental conceptual misunderstanding for those students, but the problem also must be corrected in order for the
students to draw valid inferences from the systems reported costs during the next stage of the project.
Use of Teams
This project provides an excellent opportunity to give students experience working in teams, as well as an
opportunity to instruct students about the difficult issues of group dynamics that can arise. We divide the class into
teams of four or five students each. The team members must achieve consensus on and present a solution to the
project. All team members receive the same grade for the project, but they are warned in advance that individual
grades may be modified after peer evaluations.
Because the project is intended to serve as a learning supplement for several weeks of course material, students
will be expected to continue concurrently with their normal course preparation, i.e., reading the text, doing
problems, and preparing for class discussions. Allowing students to work on the project in teams keeps the workload
during this period from being overwhelming and overshadowing the interesting aspects of the project.
Student Outputs and the Pedagogical Process

To provide opportunities for the development of communication skills by our undergraduate students, we
require written and oral team presentations in the Pecos project.
One week prior to submitting their final project report, the student teams present their preliminary ABC system
designs to the rest of the class, justifying their choice of cost pools and cost drivers. At this presentation, we
encourage teams to assess their design solutions against those of their classmates and to ask questions about design
choices. The teams are encouraged to adopt features of other teams designs for their final written design and report.
Other than asking a number of focusing questions during the design presentations, we do not publicly evaluate the
designs until the end of the project so that teams will not be swayed in their continuing exploration to a final design.
The final written project report is submitted one week later, documenting and supporting a final cost-system
design. We ask the students to respond to the case assignments as if they were preparing a written report for the
controller of the CAMP-1 facility. This provides an opportunity to give feedback on business writing skills and to
emphasize succinct analysis.
Use of Technology
The project also provides practice in using technology. First, students must develop and use spreadsheet skills
to perform their analyses. The skills needed are not particularly advanced (e.g., no macro writing is required), but a
great deal of formula writing and manipulation of fairly extensive spreadsheet data is required, since an efficient
10
solution is best achieved by linking spreadsheets across worksheets and workbooks. Second, the project provides
practice in the use of electronic communication skills. Data are distributed to students using the Internet, following
the download instructions given in the case, and part of the solution is submitted via email.
10
It is worth pointing out to the students that their results in this project are achieved using a relatively modest
approach to technologyonly the simplest of computers and software are requiredand that such low-tech
approaches can often provide powerful results.
ASSIGNMENTSRECOMMENDED SOLUTIONS
The assignments listed at the end of the case reinforce the learning objectives listed above. Exhibit TN-2 links
various aspects of the assignments with the learning objectives they most closely support. We discuss below several
of the main points relating to ABC that can be taught and reinforced through the project.
EXHIBIT TN-2 Mapping Pecos Products Learning Objectives to Project Assignments

Project Learning Objectives
Project Requirementsa 1 2 3 4
Assignment 2: Volume-Based System Design
Assignment 2: Questions 2(a) to 2(c)
Assignment 3: ABC System Design
Assignment 3: Questions 3(a) to 3(f)
Assignment 3: Questions 3(g) to 3(i)
Summary of Project Learning Objectives

1. Students will understand the importance of associating cost system design with economic consequences for the
firm and will know the likely economic consequences of a change in cost reporting.
2. Students will learn in detail how ABC systems work, by following the flow of costs from resource costs recorded
in the general ledger, through association of resource costs with activities, pooling of activity costs, selection of
pool allocation bases from a broad set of potential cost drivers, and allocation of activity pool costs to cost
objects.
3. Students will realize that ABC system design is an imprecise process and not one of idealized measurement (as
in the simple introductory examples).
4. Students will gain intuition about the measurement and reporting costs associated with cost system design
choices and will realize that increases in cost system accuracy must be weighed against increased system
operating costs.
a
Note that Assignment 1 (Download and Exploration) serves primarily to familiarize students with the project data,
in preparation for Assignments 2 and 3.
Assignment 1: Download and Exploration

Assignment 1 simply asks students to download and review the project data. As part of this orientation, the
instructor may wish to assign supplemental questions to force exploration. Such questions can ask students to look
for trends in the data, assess seasonality, or explore and speculate on issues of causality. Above all, however, the
purpose of this assignment is to make students familiar with the data included in the project so that the second and
third assignments can proceed smoothly.
Assignment 2: Volume-Based Costing Systems

Assignment 2 asks students to design two traditional (single overhead pool) costing systems, each with a
different volume-based cost driver. This serves as an introduction to the case and requires straightforward cost-
allocation computations (total overhead divided by total allocation base). These systems also provide benchmarks
that will later be used to assess the ABC design.
Through this exercise, students are generally challenged to think across multiple cost centers and multiple
products in a way they probably have not encountered before. (For example, a student commented that Before this
project I never realized that machine hours meant combining hours from different kinds of machines. The
problems usually just have one machine. This led her to further insights about the concept of cost-driver
correlation. One of the benefits of complex projects is the possibility of generating such teachable moments.)
There is only one possible solution to the assignment (for each of the given volume-based cost drivers) and it is
given in the Volume-Based Costing Systems columns of Exhibit TN-4.
In writing a paper that addresses questions 2(a), 2(b), and 2(c), students are forced to focus on the effects of
reported costs on managerial decision making and economic consequences. In addition to reinforcing the economic
perspective, the students conclusions about product pricing and profitability become benchmark references for
subsequent comparison with ABC results in Assignment 3.
Assignment 3: ABC System
Design Process
Assignment 3 requires students to design an ABC system for Pecos and then guides them through the complex
mechanics of ABC. As a first step in the design process, students must assign the costs of resources (general ledger
11
categories) to pre-defined activities. This step requires a great familiarity with all the case workbooks, as well as
the use of educated judgments and intuition. Students are often quite uncomfortable with this process, commenting
that their choices are arbitrary. We emphasize that good intuition is not arbitrary, and is likely to be highly
consistent from group to group. This point is reinforced when teams present their preliminary solutions: the cost by
activity is usually similar across teams.
The general ledger resources vary in the amount of judgment required for the activity-assignment process.
Indirect salaries, wages, and benefits can be based almost entirely on the detailed information (how indirect time is
spent) in the CCINFO workbook. Indirect materials and supplies require a bit more judgment. The CCINFO
workbook lists the main supplies used. Students must judge which activities are most likely to use those supplies
and in what proportions. For example:
Much of the cost of Office Supplies would logically go to the supervising activity, but some might also be
assigned to other support activities, and very little would go to the main production activities. The exact
apportioning would be subjective (but not, as the students say, arbitrary).
Safety Equipment costs are usually allocated mainly to the primary activity of the cost center (e.g., cutting in the
Cutting cost center), with much smaller amounts allocated to reworking, training, and moving materials.
Repairs and Maintenance and Depreciation are related to machines; hence these costs are allocated to all activities
that require machines, with most of the costs going to the primary activity of the cost center. (In Receiving, Lo-
gistics, and Shipping there are no machine hours, but these cost centers are likely to have a number of forklifts,
and these are the machines to which Repairs and Maintenance and Depreciation are related for these cost centers.)
In assigning Scrap Disposal costs, students are encouraged to infer which activities are most likely to produce
scrap. Most costs should be assigned to the primary activity of the cost center, but with significant amounts to re-
working and setting up.
There are a number of general ledger categories for headquarters allocations (e.g., lease, insurance, etc.). These
facility-level costs are particularly difficult to assign, and we feel the most appropriate solution is to assign them
based on the average of all other resource assignments. As we point out to the students, even in ABC we cannot
entirely escape the need for allocation.
11
As discussed in the case, activity identification is a major step in the system design process, which in this case has
already been performed for the students. This provides a certain degree of standardization, which facilitates
classroom discussions and eases the grading burden. To provide the students with some experience in this task
(albeit quite limited), we encourage students to suggest improvements to the activity list.
Design Challenges
In providing guidance to students working in the ABC design phase of the project, our primary goal is to help
them fully analyze the implications of their design choices. In their preliminary designs, students often make
decisions that sound reasonable on the surface, but are found to be flawed under a more thorough analysis. For ex-
ample, students often decide to combine the pad-pressing activity with other activities in one cost pool. They note
(correctly) that the cost of the pad-pressing activity is quite low, and suggest that the increased accuracy would not
be worth the cost of maintaining a separate cost pool for this activity. However, this logic fails to recognize that
costs of this activity ideally should be allocated entirely to sleeping pads. While the costs of the activity are not
significant for the plant as a whole, they are highly significant for the sleeping pad product line. Because this is a
low-volume product, the choice to allocate these costs to all the products instead of just sleeping pads can seriously
underestimate the cost of sleeping pads.
Another common preliminary design that is subtly flawed combines all labor intensive activities into one
cost pool and allocates this cost pool to products based on their direct-labor hours. Once again, on the surface this
seems a reasonable approach. However, the flaw with this approach is that it assumes that direct labor and labor
intensive overhead are consumed by products in the same proportions. For example, students often include the
costs of the seam-sealing activity in this labor-driven cost pool, because seam-sealing is a labor-intensive process.
This choice is usually indicative of a fundamental misunderstanding of the distinction between direct and indirect
costs that needs to be corrected. Students who make this design mistake are reminded that any direct labor
associated with seam-sealing is a direct cost and not included in overhead. The primary indirect costs associated
with seam sealing are indirect materials (sealant) and the cost of keeping the machines running. When students are
reminded of this fact, they usually conclude that a better cost driver for the seam-sealing activity is seam-sealing
machine hours.
To confirm their hypotheses about the relationships between activities and potential cost drivers, students are
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encouraged to perform regressions using the historical data provided in the project spreadsheets. Through this
process, students are able to refine their reasoning, and gain a deeper understanding of ABC fundamentals.
Good Designs
For this project, the best designs generally include between six and eight cost pools. While utilization of more
cost pools would certainly improve the accuracy of the solution, we find that the differences in results are minimal,
suggesting that the costs of more cost pools may outweigh the benefits. We propose that a good solution will include
at least one cost pool in each of the following categories:
Labor-related costs: Includes supervising and training, which both vary with the number of employees.
Machine-related costs: Cutting, sewing, and reworking. It is generally preferable to keep these each in a
separate cost pool. The main product affected by the choice to combine these activities is sleeping pads, which
are not sewn at all. Batch-related costs: Setting up, scheduling, and inspecting. A case can be made for putting
setups into a separate cost pool, because setup time depends on the product. Similarly, inspecting can be put
into a separate pool, allocated based on number of inspection batches. Students are encouraged to do sensitivity
analysis to analyze the implications of these choices. Seam-sealing: Discussed above. Pad-pressing: Discussed
above. Material-related costs: Tracking inventory, packing, and moving materials.
Building on these groupings, our reference (preferred) design solution is included as Exhibit TN-3. Note the
role of the Cooper hierarchy of costs in this solution. Most of the cost pools consist of volume-based costs, with
batch-level costs also represented in the solution. No product-level costs are present, and the facil-ity-level costs are
included among the general ledger costs that are mapped to the activities using percentage allocations (as described
in the first step of the ABC design guidelines in Assignment 3). There are three important lessons in this for
students. First, volume-based costs and their associated cost drivers are not evil. They will still play a very
important role in any costing-system design. Second,
12
As discussed earlier, some information (how indirect labor time was spent and use of indirect materials/
supplies) is provided as a yearly average instead of on a quarterly basis. For this reason, we suggest that
regressions be run on yearly data only.
EXHIBIT TN-3 Pecos Products Reference SolutionABC System Design
Cost Pool Pooled Activities Cost Driver

1 Cutting Cutting Machine Hours
2 Sewing Sewing Machine Hours
3 Pad Pressing Number of Pads (units)
4 Seam Sealing Sealing Machine Hours
Scheduling
5 Inspecting Number of Batches
Setting Up
Moving Materials
6 Tracking Inventory Pounds of Assembled Product
Packing
7 Reworking Total Machine Hours (all machines)
Training
8 Direct Labor Hours
Supervising
the benefit of an ABC system does not depend entirely on the use of non-volume-based cost drivers. Several of the
cost pools identified above are essentially volume-based, but they are constructed from activity-cost data provided
only by the ABC system. Third, facility-level costs can be significant, but they must still be allocated if full-costing
of products is desired.
Design Costs of ABC Systems

In a closed-end teaching exercise it is very challenging to convey a sense of the costs of gathering and
maintaining data in an ongoing cost system. As noted above, we discuss this topic in class with the intention of
sensitizing students to the importance of focusing their efforts only where the potential increase in the return to
management will exceed the costs. And as noted in the ABC design instructions in Assignment 3 (particularly the
third step), we expect students to be aware of and sensitive to the costs of collecting and updating data.
However, the value of the Pecos project in support of Learning Objective #4 (Students will gain intuition about
the measurement and reporting costs associated with cost system design choices) comes from the effort required
of students to manage and manipulate the extensive project data (in contrast to that required for the traditional
system). The students thus become aware of the burdens of complexity. We find that their efforts make the cost-of-
data concept resonate strongly (to the point that on a recent final examination essay, almost every student in the
class raised and discussed [unsolicited] the issue of cost-benefit).
We reinforce the idea that data measurement is expensive and itself a potential non-value-adding cost by
informing students that we will be explicitly weighing their proposed ABC systems ability to represent the
consumption of resources by products in light of its costs. We compare their proposed ABC systems with the
reference solution presented in Exhibit TN-3. In comparison to the reference solution, systems that require greater
data costs by proposing more cost pools and/or more complicated cost drivers generally do not result in significantly
different reported costs, and hence are strictly inferior to it.
More interesting are the solutions that employ fewer and/or simpler cost pools and drivers, while still reporting
product costs that do not deviate too far from those of the reference solution. These require more careful review and
some solutions may in fact be quite satisfactory. However, we generally find the intuition or logic behind the cost-
pool groupings or the chosen cost drivers to be inferior to the reference solution. For example, students will
sometimes combine the cutting and sewing activities into one cost pool and use combined cutting/sewing machine
hours as the cost driver. This results in a less costly system whose reported product costs are not very different from
the reference solution. The drawback of such a solution, however, is that these are both very large activities and
demand for them is not necessarily correlated (for example, sleeping pads require cutting but no sewing), so we do
not have great confidence that such a design will continue to provide accurate costs into the future.
Questions
In questions 3(a) through 3(f) students are asked to consider the economic consequences of using their ABC
system rather than a traditional system, revisiting the questions asked about the traditional systems in Assignment 2
13
and extending to a consideration of strategic issues. A comparison of the cost- and profit-per-unit results for our
14
reference ABC system and two of the possible traditional systems is included as Exhibit TN-4.
Several interesting points derive from this comparison. First, costs and profitability differ quite dramatically
among the three cost systems. Indirect costs reported by product for the direct-labor-based system differ from those
of the ABC solution by (in absolute value) between 1 percent and 60 percent, and for the machine-hours based
system this range increases to 19 percent and 1093 percent. Questions 3(a) to 3(f) force students to interpret these
swings in terms of their economic effects and the effects that the associated changes in profitability might have on
managers decisions and Pecos strategy. Examples of economic consequences reported by students in response to
the case questions have included:
13
Even greater economic consequences are likely to arise from using the activity data to perform ABM. This is a
logical extension of this project and will be addressed in the future. As presently written, the case supports the
analysis needed for ABC, but does not provide the detailed information about processes and activities that will be
required to effectively address ABM.
14
Using the ABC system design from Exhibit TN-3, the instructor should have little difficulty approximat
ing our ABC systems reported costs. However, an exact replication would require using the same percent
ages in the allocation of general ledger accounts to activities. The complete Excel workbook containing the
percentages and the results of our solution is available on request via email from the authors. Because a
percentage allocation of general ledger costs to activities is required for each of the six cost centers, the
complete solution is too long to be incorporated into these teaching notes.
EXHIBIT TN-4 Comparison of Pecos Products Costs Reference Solution (TN-3) vs. Traditional Costing
a
Systems
Volume-Based Costing Systems
ABC System Direct Labor Hours Machine Hours

Computed Computed % Computed %
Product Cost Cost from Cost from ABC
ABC
Tents
Price per Unit $112.00 $112.00 $112.00
Direct Material 44.80 44.80 44.80
Direct Labor 5.17 5.17 5.17
Indirect Costs 39.07 32.11 18 46.49 19
Cost per Unit 89.04 82.08 8 96.46 8
Profit per Unit $ 22.96 $ 29.92 30 $ 15.54 32
Backpacks
Price per Unit $58.00 $58.00 $58.00
Indirect Costs 29.54 29.19 1 4.81 84
Cost per Unit 50.96 50.61 1 26.23 49
Profit per Unit $ 7.04 $ 7.39 5 $31.77 351
Sleeping Bags
Price per Unit $53.00 $53.00 $53.00
Indirect Costs 25.64 27.24 6 33.25 30
Cost per Unit 38.54 40.14 4 46.15 20
Profit per Unit $14.46 $12.86 11 $ 6.85 53
Sleeping Pads
Price per Unit $25.00 $25.00 $25.00
Indirect Costs 14.55 23.35 60 1.22 1093
Cost per Unit 30.76 39.56 29 17.43 43
Profit per Unit ($5.74) ($14.56) 153 $ 7.57 232
a
The ABC System solution reflects the design shown in Exhibit TN-3. As discussed in the section entitled Good
Designs, this is only one of many possible ABC solutions. The Volume-Based Costing System solutions are
unique for the given volume-based cost drivers.
Resource allocation example: Should we continue investing in sleeping pads? The $5.74-per-unit loss reported by
ABC is sobering in comparison with the $7.57 profit reported by the machine-hours system, but is considerably
more palatable in the short run for a new product than the $14.56 loss reported by the direct-labor system.
Pricing example: Are we pricing sleeping bags at their optimal level, given elasticity of demand? Although we dont
know the demand elasticity, the fact that profit is understated (relative to ABC) by almost $2/unit in the direct-labor
system and by more than $7.50/unit in the machine-hours system hints at opportunities for more aggressive pricing
and different special-order decisions. Production example: Should we continue to outsource production of stuff
sacks? Under the ABC system, we know the cost of the cutting and sewing activities, so we can use this information
to make an effective make-or-buy decision.
A second point relating to the costing results in Exhibit TN-4 can help to instill a deeper understanding of cost-
pool/cost-driver relationships. We can observe that although several of the ABC systems cost drivers comprise
various measures of machine hours, using machine hours as the sole cost driver in a traditional system provides a
poor measure of product costs (if ABC is accepted as the standard). We similarly observe that although direct labor
serves as the cost driver for only one (relatively unimportant) ABC cost pool, the direct-labor-hour traditional
system reports results much closer to the ABC systems results. The only way to make sense of this result is to
understand the role of product cross-subsidization in volume-based costing.
Cross-subsidization (which occurs when one product is assigned costs actually caused by activities incurred in
support of another product) is most easily seen in the case of sleeping pads. This product is machine-intensive, so we
might expect the ABC system, with its many machine-related pools, to report costs similar to those of the machine-
hours-based system. However, the ABC methodology allows us to associate the costs of the pad-pressing machines
exclusively with the pad-pressing activity, all costs of which are assigned to sleeping pads. In contrast, in the
machine-hour system the pad-pressing machine costs are combined with all other indirect costs in the single
overhead cost pool and then divided among all machine hours, including sewing, cutting, and seam-sealing
machines, so that much of the pad-pressing machine cost ends up absorbed by the tents, backpacks, and sleeping
bags that dominate the cutting, sewing, and seam-sealing activities.
A third point regarding the economic consequences of ABC relates to the magnitude of the changes in indirect
cost allocation between costing systems in Exhibit TN-4. The difference between costing systems is likely to be
understated if we consider only the change in indirect-cost allocation, as students are prone to do. Rather, it is the
change in the perceived profitability of different cost objects that is likely to cause a change in managerial behavior.
Any change in indirect costs assigned to a product as a result of changing cost-allocation systems flows directly to
the profit line, because direct costs will not vary between costing systems.
Nevertheless, students are likely to express concern or disappointment at the similarity in
product costs between the direct-labor and ABC systems because they are so primed by this point in
the course for a big ABC message. This concern provides the motivation for a great discussion
about the effects of costing. Generally, there are three aspects of this discussion:
1. Why are costs between the ABC and direct-labor systems so similar?
While the reported cost differences between these systems may not be as dramatic as students are
accustomed to seeing in the textbook examples, a change in costs of a few percent is a highly significant event
in the real world. As discussed above, this is especially true for a change in overhead allocation where the full
effect flows straight to the bottom line.
2. Because the costs are similar now, does it mean they will remain that way in the future?
We lead a discussion on the differences in the systems and how changes in resource costs would flow
differently to products. We also emphasize the need to monitor system design in the future, and how having a
well-designed system will direct our attention more effectively to changes in the relationships among
resources, activities, and products. Finally, we point out that we didnt really know ahead of time that the
direct-labor-based system was giving us cost data similar to that produced by the ABC system.
3. Why, when there is so much machine time in this process, are machine-hours-based costs so different
from ABC-based costs?
We point out that the total machine hours are composed of hours from four different types of machines. The
products do not use proportional amounts of machine time from the four machine types. Further, the costs
associated with each of the machine types differ greatly. Therefore, it is not surprising that the ABC solution is
not similar to the machine hours solution.
Project requirements 3(g) to 3(i) provide a larger context for the question of cost system design, raising
issues of implementation and the role of the cost system.
Questions 3(g) and 3(h) ask about alternative approaches for obtaining and organizing expenditure data. If
an ABC system were integral to the general ledger, then expenditures theoretically could be charged to accounts
that would reflect the activity center as well as the expenditure type. In this case, the first ABC design step in
Assignment 3 would be unnecessary and activity costs could be totaled directly from the general ledger.
In reality, of course, ABC systems are quite structurally complex (see, for example, Cokins 1999) and, despite
calls for full integration of ABC systems (IMA 1998; Keegan and Eiler 1994), most systems remain as stand-alone
analysis tools (Krumweide 1998). These stand-alone models generally begin with resource-based, not activity-
based, data fed from the general ledger system, so this projects design (beginning with percentage allocations of
general ledger accounts to activities) represents a reasonable approach to teaching the ABC design process.
Question 3(i) asks students to discuss issues of ABC system implementation. This allows students to
summarize the costs associated with complex costing systems, including issues of data collection, project
management, and sponsorship, all of which are quite complex for an ABC system.
REFERENCES
Cokins, G. 1999. Avoiding ABC implementation mistakes. In Handbook of Cost Management, 1999 edition, edited
by J. B. Edwards, Section B9. New York, NY: RIA Group/WG&L.
Hilton, R. W. 1999. Managerial Accounting. Fourth edition. Boston, MA: Irwin McGraw-Hill.
Horngren, C. T., G. Foster, and S. M. Datar. 2000. Cost Accounting: A Managerial Emphasis. Tenth edition. Upper
Saddle River, NJ: Prentice Hall.
Institute of Management Accountants (IMA). 1998. Practices and Techniques: Implementing Activity-Based
Management: Avoiding the Pitfalls. Statement on Management Accounting No. 4CC. Montvale, NJ: IMA and
Arthur Andersen LLP.
Keegan, D. P., and R. G. Eiler. 1994. Lets reengineer cost accounting. Management Accounting (August): 2631.
Krumweide, K. R. 1998. The implementation stages of activity-based costing and the impact of contextual and
organizational factors. Journal of Management Accounting Research 10: 239277.
5-7 The Buckeye National Bank (Activity-Based Costing in the Service Sector)
ABSTRACT: The U.S. Bureau of the Census projects that by 2006, the service sector will employ 74 percent of the
workforce. This case illustrates why a major segment of the service sectorbanksneeds accurate cost information to
make strategic decisions, and how more refined accounting systems help fulfill this need.
Buckeye National Bank is a hypothetical bank that has suffered falling profits despite a shift in customer base
toward retail customers, which the current information system reports are more profitable than business customers.
Following a step-by-step approach, you will develop the Banks average cost of serving a retail customer account and a
business customer account, under (1) the Banks traditional single allocation base system, and (2) a (pilot test) activity-
based costing system. You will analyze these results to determine how and why costs reported by the activity-based
system differ from the costs reported by the traditional system, and what this difference means for the Banks business
strategy. Finally, you will consider how the Banks managers can use the new, more refined activity-based cost data in
strategic decision making, including controlling costs and developing more profitable business strategies.
TEACHING NOTES
Background and Purpose

Textbook illustrations and pedagogical cases on activity-based costing (ABC) typically focus on manufacturing
applications.1 However, the U.S. Bureau of the Census projects approximately 74 percent of the workforce will be
employed in the service sector by 2006 (U.S. Bureau of the Census 1999). Furthermore, ABC and customer costing are
increasingly popular among service organizations such as financial institutions and health care organizations.
This structured case uses a customer-costing context to help instructors introduce ABC to undergraduate
students in the initial sophomore- or junior-level management accounting or cost accounting course (although we have
also successfully used adaptations of the case in introductory M.B.A. courses). First, the case presents a structured and
straightforward ABC illustration that is more comprehensive than examples found in most undergraduate texts.
Structured cases like Buckeye National Bank (BNB) provide an educational bridge between textbook problems and
more in-depth and intentionally ill-structured Harvard Business School-style cases that students may encounter later in
their educational experiences. Second, this case integrates the conceptual advantages of ABC over traditional allocation
systems with the computational steps necessary to implement ABC, and also requires students to consider how
managers use ABC and customer cost information in making strategic decisions (activity-based management). Finally,
the BNB case illustrates ABC and customer costing in a nonmanufacuring environment, focusing on an important
industry in the service sectorbanking.
The case provides students with the opportunity to apply their (cost allocation) accounting knowledge to
address real-world problems. The Accounting Education Change Commissions (AECC) Position Statement Number
One (AECC 1990) lists the ability to apply accounting knowledge in realistic situations as one of the capabilities
accounting students must acquire. Assigning parts or all of the case as group work provides opportunities to apply
problem-solving skills, to work with others, and to better understand how changes evolve in an organization. These
educational opportunities help students develop intellectual, interpersonal, and general business skills (AECC 1990).
The structured flow of the BNB case requirements leads the student through the cost-allocation process, first
under a traditional system, then under ABC. This explicit contrast helps students understand how these two costing
approaches affect strategic corporate decisions, and reinforces the importance of accurate cost information in a
competitive industry. The banking scenario and banking activities are designed to be familiar even to introductory
accounting students.
This case assumes the introduction to ABC occurs early in the cost/managerial course following job costing.
Many students will not have covered capacity considerations at this point. Consequently, the case avoids capacity issues
by stipulating that actual activity levels approximate practical capacity. 2 In addition, because the case focuses on
1
Pedagogical ABC cases set in the manufacturing sector include Adams (1997), Albright et al. (1992), Tabor and
Stanwick (1996), Wisner and Roth (1998), Brewer et al. (2000), and Platt and Towry (2001).
2
Cooper and Kaplan (1992) and Kaplan and Cooper (1997) discuss the importance of capacity in ABC. In their
teaching note, Kaplan and Cooper (1997) describe ABC systems as resource usage models in which:
Activity Availability = Activity Usage + Unused Capacity
The left-hand term measures the resources acquired by the firm. The first right-hand term measures the
firms usage of its available resources. The difference between resources acquired and resources used is
Blocher, Chen, Corkin, Lin: Cost Management: Cases and Readings, 3e 5-21 The McGraw-Hill Companies, Inc., 2005
introducing ABC, consideration of activity-based management (ABM) occurs near the end of the cases requirements,
in conjunction with a discussion of how managers can use ABC data to make strategic business decisions.
Suggested Teaching Strategy

The BNB case is quite flexible. It can be used as an in-class lecture exercise, as an out-of-class individual or group
assignment, or some combination of these. Table 1 classifies requirements 112 by teaching objective. Instructors may
choose to assign only a subset of requirements 712, depending on the desired emphasis. The teaching notes for
requirements 2 and 712 are intended to facilitate class discussion. Our experience suggests that undergraduate
students responses to items 2 and 712 are less developed than responses of graduate students (enrolled in introductory
management accounting courses) who have the benefit of work experience. However, these requirements prompt
students at all levels to consider how managers actually use accounting information in making strategic business
decisions.
TABLE 1
Case Requirements Classified by Selected Teaching Objectives
Case Traditional ABC Step-by-Step Conceptual Group Limited

Requirement Costing Implementation Requirements Discussion Class Timea
1 X X P
2 X X X
3 X
4 X
5 X
6 X
7 X X X
8 X X A
9 X X A
10 X X A
11 X X A
12 X X A
a
P = completed prior to class; A = completed after class.
To spark student interest in why banks would use ABC, we suggest assigning the Wall Street Journal article by
Brooks (1999), reprinted as an Appendix to this case, prior to covering the BNB case. The article explains that, in an
effort to attract and retain profitable customers, banks are providing extra services and benefits targeted specifically to
their most profitable customers. However, to identify which customers provide the bank the most profit, the bank must
first assign costs to customers based on their usage of bank services. The BNB case illustrates how banks can design
ABC systems to provide such customer cost information.
The BNB case is specifically designed for undergraduate students early in their accounting education. It has
been used in a number of educational venues, including undergraduate introductory management accounting, junior-
level cost/ managerial accounting, and even introductory M.B.A. management accounting courses. The case has been
used by instructors at four different institutions, ranging from a small private university to large state universities. We
have used the case as an in-class exercise, as an out-of-class assignment, and as part of an examination. Most recently,
we used the case in a junior-level cost/management accounting course as an out-of-class assignment that we then
discussed in class. A survey of the students indicated that they believed the case met its learning objectives. Following
are the mean responses of 81 students on a five-point Likert scale where 1 = strongly disagree, 2 = disagree, 3 = neither
agree nor disagree, 4 = agree, and 5 = strongly agree: The case helped me understand how a service firm would
implement and then use ABC (4.2); The case helped me understand how to compute ABC costs (4.1); The case
helped me understand why costs reported by an ABC system may differ substantially from costs reported by traditional
single-allocation base systems (4.1); The case helped me understand why service firms need accurate cost
unused capacity. Kaplan and Cooper (1997) suggest that firms set the denominators of activity-cost allocation
rates to activity availability (i.e., the firms practical capacity). Since these rates are multiplied by
actual usage, the cost of unused capacity is not assigned to products and customers. This approach highlights
unused capacity costs for future management action (for example, future elimination of unused
capacity or putting the capacity to productive use).
information (4.2); and The case helped me understand how managers can use ABC information to control costs and to
develop more profitable business strategies (4.1). Students also agreed that the case was realistic (3.9).
Other instructors who have used this case indicate that it is more comprehensive than examples in the assigned
textbooks, while the students enjoy the realistic scenario. One instructor commented that the case helped students to
understand that activities could be interpreted broadly and that ABC applies to service institutions. It also helped them
to see that customers have costs, and that organizations can form strategy around the services they offer and the type of
customers they try to attract.These customer cost and strategy issues are seldom discussed in initial accounting
classes, even though they figure significantly in strategy or marketing. So I think this case helped students tie in the
ABC decision effects to issues they considered in other classes.
The case is designed to efficiently illustrate ABC and customer costing, and their strategic decision
implications, to accounting (and nonaccounting) students who are not sophisticated users of accounting information.
When we use the case in M.B.A. and Executive M.B.A. (introductory) management accounting courses, we typically
make the case less structured and thus more challenging by replacing requirements 1 and 38 with the following simple
instruction:
Compute the profit (loss) per account for: (1) the retail customer line and (2) the business customer line, under
both (a) the original cost system and (b) the ABC system.
The discussion can then rapidly focus on how business decisions depend on accurate cost information and the
advantages of implementing ABM. 3
RECOMMENDED SOLUTIONS
Requirement 1
Requirement 1 reviews indirect cost allocation in a conventional costing system. Students must understand a single
allocation-base system before attempting ABC. Requirement 1 shows students how the original, single-cost-pool system
allocates indirect costs to the retail and business customer lines. The results provide a basis for comparison with the
ABC system in Requirement 3.
A) The indirect cost allocation rate:
$2,850 total indirect costs = $0.03 per dollar processed.

$95,000 total value of checks processed
B) The total indirect cost assigned to (i) the retail customer line, and (ii) the business customer line:
(i) Retail Line (ii) Business Line Total

$ value of checks processed $9,500 $85,500 $95,000
Cost per $ processed 0.03 0.03 0.03
Total indirect cost $285 $2,565 $2,850
These allocations are driven by the dollar value of the checks processed.
C) The proportion of the total indirect cost assigned to: (i) the retail customer line, and (ii) the business customer
line:
(i) Retail line $ 285 10%
(ii) Business line 2,565 90%
Total indirect cost $2,850
The original system assumed that indirect costs are incurred in direct proportion to the dollar value of the checks
processed. Since retail customers wrote only 10 percent of the dollar value of the checks ($9,500/$95,000), the
original cost system assigned the retail line only 10 percent of the total indirect costs tabulated in Exhibit B.
Similarly, the original system allocated 90 percent of the indirect costs to the business customer line because
3
We have also modified the case by adding additional activities (such as ATM transactions and processing
returned checks), and by adding additional cost line items to Exhibit B that require students to split the
cost across activity cost pools. For example, salaries of check-processing personnel might be split across
the paying checks activity and a new activity for processing returned checks.
business customers wrote 90 percent of the dollar value of the checks processed. This allocation is
approximately accurate only if the indirect costs in Exhibit B are incurred in direct proportion to the dollar value
of the checks each customer line writes.
D) The annual indirect cost per (i) retail account, and (ii) business account:
(i) Retail (ii) Business

Total indirect cost $285 $2,565
Number of accounts 150 50
Indirect cost per account $1.90 $51.30
E) The average annual profit per account for retail customers and for business customers:
Retail Business
Revenue per account $ 10.00 $ 40.00
Cost per account ($ 1.90) ($51.30)
Profit (loss) per account $ 8.10 ($11.30)
The original cost system suggests retail customers are profitable, but business customers are not. This suggests
BNB should pursue a strategy of increasing the retail-customer base (e.g., awarding bonuses for attracting and
retaining new retail customers, pampering retail customers). BNB also should try to make business customers
more profitable, perhaps by increasing fees for services, requiring businesses to hold higher account balances (to
increase the interest revenue the bank earns from the business accounts), or increasing the interest spread on
business accounts. This interest spread (as explained in case note 3) is a major source of banks profits.
Figure 1 summarizes how the original cost system assigns costs to the retail and business customer
lines. We suggest reproducing Figure 1 on an overhead transparency, handout, or PowerPoint slide, and then
using its visual structure as a benchmark for comparison to the subsequent ABC analysis.
Requirement 2
Broken cars and computers simply stop running. In contrast, broken or outdated cost systems continue spewing out
(potentially misleading) costs. Consequently, managers need to recognize clues that the cost system needs refinement.
The original cost system was developed when the bank primarily served business customers. BNB then shifted
its focus to increasing its retail customer base. This shift significantly changed the relative proportions of total bank
resources expended on the two types of customers, with retail customers consuming relatively more resources, and
business customers consuming relatively less. For example, the bank established a customer account inquiry call center,
a service used primarily by retail customers. However, despite the significant change in BNBs customer mix,
the original cost system remained intact.
Other symptoms that BNBs original cost system may be broken include:
Profits are declining even though the bank is serving more customers. Use the Income Statement in Exhibit A to
illustrate this point. Although net interest income is growing at a modest rate as a result of the expanding retail
customer base, noninterest expense (largely the indirect costs on which the case focuses) is growing more
rapidly. This is one reason that net income declines from 20x3 to 20x5.
The original cost system (Requirement 1) suggests retail customers are more profitable than business customers,
but profits are declining despite a shift in the mix of customers toward retail customers. The cost system is an
old (1985), single-allocation-base system.
The cost system has not changed since BNB added the new customer account inquiry call center. Retail
customers are more likely than business customers to use the account inquiry call center, so establishment of this
center suggests that BNBs cost of serving its two customer lines may have changed significantly.
The manager (Erik Larsen) does not trust the accounting systems numbers.
CEO Rob Garrison does not understand the results.
Cooper (1987) provides a straightforward discussion of the symptoms of a broken cost system; this reading
can be assigned to advanced undergraduate or graduate classes. However, keep in mind that although the above bulleted
points are often symptoms that the cost system needs refinement, they are not rigid guidelines. For example, profits
could decline even though the number of customers is increasing if the business environment is becoming increasingly
competitive. While none of the symptoms provides conclusive evidence that the cost system is to blame, the pattern of
several symptoms suggests that BNB should consider whether its cost system would benefit from refinement.
Requirements 3 and 4
To help students see the big picture, we suggest walking through the case in class to explicitly relate your textbooks
steps in performing ABC to the BNB case. You can easily adapt the following steps to match those in your textbook.
If time is short, simply focus on steps 5 and 7 (computing the indirect cost allocation rates for Requirement 3 and
allocating the costs for Requirement 4).
Step 1: In ABC, the first step is identifying the activities. BNBs ABC team identified three activities:
1. Paying checks
2. Providing teller services
3. Responding to customer account inquiries
Step 2: The second step in ABC is estimating the aggregate costs, or cost pool, associated with each
activity. The ABC team used activity analysis as explained in the case to identify the personnel,
equipment, and other costs of each of the three activities:
1. Paying checks: $700 + $440 = $1,140
2. Providing teller services: $1,000 + $200 = $1,200
3. Responding to customer account inquiries: $450 + $60 = $510
Steps 3 and 4: The third step in ABC is identifying the cost driver for each activity that will link the cost of that
activity with the customers who use the activity. The fourth step is estimating the total quantity of
each cost driver. The ABC team identified the following cost drivers and estimated quantities for
each of the three activities:4
Activity Activity Cost Driver Total # Units of Cost Driver

Paying checks Checks processed 2,850
Providing teller services Teller transactions 200
Responding to customer Account inquiry calls to customer service
account inquiries call center 100
Because the pilot study is based on last years actual data, step 4 uses the total actual number of units of each cost
driver. In the future, however, BNBs ABC team has decided that the calculation in step 4 will use estimated (budgeted)
activity-level information, so that the activity cost allocation rates can reflect expected changes in each activity (see
Kaplan and Cooper 1997).
Step 5: The fifth step is computing the indirect cost allocation rate for each activity. (Divide activity costs in
step 2 by the quantity of activity cost driver in step 4.)
Paying checks: $700 + $440 = $1,140 = $0.40 per check processed

2,850 2,850
4
In more advanced classes, you may want to link BNBs pilot ABC study to the activity-cost hierarchy. Horngren et al.
(1999) describe the following four-level hierarchy:
1. Unit-level activities are performed for each unit of product or service. Erik Larsen considers paying checks and
providing teller services as unit-level activities.
2. Batch-level activities are performed for groups of products or services rather than for individual units. For
example, setting up machines to produce a batch of a specific product is a batch-level activity. For simplicity,
BNBs ABC pilot study does not identify any batch-level costs. Thus you may want to provide examples of batch-
level activities from manufacturing (e.g., setups, material handling), and ask whether students would expect to find
more or fewer batch-level activities in service firms (especially where each service represents a unique demand on
resources, such as in this case) or in manufacturing.
3. Product-sustaining activities, service-sustaining activities, and customer-sustaining activities support individual
products, services, or customers. Erik considers responding to customer account inquiries at the customer service
call center to be a customer-sustaining activity.
4. Facility-sustaining activities are general activities that support the organization as a whole, but that cannot be
traced to individual products or services, such as the CEOs activities. Because it is not possible to identify cost
drivers for facility-sustaining costs, many ABC systems exclude these costs, or allocate them using a general
allocation base. For simplicity, the BNB ABC team excluded this type of activity from the pilot study.
Providing teller services: $1,000 + $200 = $6 per teller transaction
200
Customer account inquiry: $450 + $60 = $510 = $5.10 per account inquiry call
100 100
Step 6: The sixth step in ABC is obtaining the actual quantity of the cost driver each cost object uses in
order to estimate the resource demands of each cost object. In this case, the two cost objects are the
retail customer line and the business customer line. The ABC team estimates that each customer
line will use the following quantities of the cost drivers: 5
# of Units of Activity Cost # of Units of Activity Cost Driver Total # Units

Activity Cost Driver Driver Used by Retail Customers Used by Business Customers of Cost Driver
Checks processed 570 2,280 2,850
Teller transactions 160 40 200
Account inquiry calls to
customer service call center 95 5 100
Step 7: The seventh step in ABC is allocating the cost of each activity to the cost object. BNB allocates the
costs to the retail and business customer lines, by multiplying the activitys indirect cost allocation
rate from step 5 by the number of units of the activitys cost driver in step 6:
Total Indirect Cost Assigned Total Indirect Cost Assigned

Activity to Retail Customer Line to Business Customer Line
Paying checks [$0.40 (570; 2,280)] $ 228.00 $ 912.00
Providing teller services [$6 (160; 40)] 960.00 240.00
Responding to customer account inquiries
[$5.10 (95; 5)] 484.50 25.50
Total indirect costs $1,672.50 $1,177.50
Figure 2 summarizes how the ABC system assigns costs to the retail and business customer lines.
Compare the visual structure of the ABC system in Figure 2 with the original system in Figure 1.
The ABC team uses the activity analysis described in the case to identify the cost of personnel,
equipment, and other resources required for each of these activities. BNB then assigns the costs of
each activity, for example the paying checks activity, to the retail and business customer lines,
based on how much of the paying checks activity the customer line actually used. Thus, each
customer line receives three indirect cost allocations, based on its actual usage of each of the three
activities. We use transparencies, handouts, or PowerPoint slides of Figure 2 to trace the flow of
resources to the activities, and then on to the customer line cost objects.
5
Students may ask whether step 4 is out of order, in that the total quantity of the cost driver is used in step 4, while its
components by customer class are used in step 6. The pilot study is based on historical data, so total costs and
quantities of the cost drivers are already available. If the pilot study succeeds and BNB implements ABC firm-wide,
then BNBs ABC team has decided that the calculation in step 4 will use data that are budgeted (and therefore
available at the beginning of the period). The advantage of budgeted rates is that they can reflect expected changes in
the costs or activity levels associated with each activity (see Kaplan and Cooper [1997] for a discussion of the use of
budgeted rates in ABC). Step 6 will continue to use the actual amounts of each cost driver consumed by the two
customer classes, which is not known until after the activity has occurred. Therefore, for this particular example, the
two steps are in the proper sequence.
Requirement 5
The proportion of each activity that is attributable to: (i) the retail customer line, and (ii) the business customer line:
Requirement 6
The ABC annual indirect cost per retail and business customer account is:
Requirement 7
Use Requirements 1C and 5 to illustrate why costs shifted as they did. The original cost system allocated all indirect
costs based on the dollar value of the checks processed. Retail customers wrote 10 percent of the value of checks
processed and business customers wrote 90 percent of the dollar value of checks processed. Thus, the original cost
system allocated 10 percent of the indirect costs to retail customers and 90 percent to business customers. We use
overhead transparencies, handouts, or PowerPoint slides of Figure 3 to help students visualize the allocation under the
original system.
The ABC analysis shows that retail customers use much more than 10 percent of the three activities: (1) paying
checks, (2) teller services, and (3) responding to customer account inquiry calls. The solution to Requirement 5 shows
that retail customers wrote 20 percent of the (number of) checks processed, made 80 percent of the teller transactions,
and 95 percent of the account inquiry calls to the customer service call center. Whereas the original costing system
suggested that retail customers consumed only 10 percent of these resources, the ABC analysis clearly shows that retail
customers consumed significantly more than 10 percent of these three activities. The new ABC system allocates the
indirect costs to the retail and business customers based on the proportion of each activitys resources that the customer
line consumed. Because retail customers wrote 20 percent of the checks processed, the ABC system considers these
customers as consuming 20 percent of the banks check paying resources, so they are allocated 20 percent of the costs
associated with the paying checks activity. Retail customers make 80 percent of the teller transactions, so they are
assigned 80 percent of the costs associated with the teller services activity. Retail customers are assigned 95 percent of
the customer account inquiry costs because they make 95 percent of the account inquiry calls. We use overhead
transparencies, handouts, or PowerPoint slides of Figure 4 to show how this more refined assignment of these activities
costs allocates 59 percent ($1,672.50/$2,850) of the total indirect costs to retail customers and only 41 percent
($1,177.50/$2,850) to business customers.
Comparing Figures 3 and 4 helps students see why ABC shifts costs out of the business customer line and into
the retail customer line. This shift arises because retail customers use a much greater proportion of the teller transactions
(80 percent) and customer account inquiry (95 percent) activities than of the dollar value of checks processed (10
percent). The original system that allocated all the indirect costs based on the dollar value of checks processed assigned
too little cost to the retail customers (failing to recognize that they make 80 percent of the teller transactions and 95
percent of the calls), and too much cost to the business customers, who write 90 percent of the dollar value of the
checks, but make only 20 percent of the teller transactions and only 5 percent of the customer account inquiry calls. The
more refined ABC system more accurately estimates the costs of serving each type of customer, based on the
customers use of BNBs resources.
Requirement 8
Using the ABC data, the average annual profit per account for retail and business customers is:
Retail Business
Revenue per account $10.00 $ 40.00
ABC cost per account (11.15) (23.55)
ABC profit (loss) per account $(1.15) $ 16.45
Original systems profit (loss) per account $ 8.10 $(11.30)
The ABC customer cost data suggest business customers are profitable, but retail customers are not, which is exactly
opposite the conclusion reached using the original cost data. This example illustrates how ABC can significantly affect
managements strategy. The ABC data suggest BNB should emphasize business customers (e.g., awarding managers
bonuses for attracting and retaining business customers, pampering business customers). The bank can also try to make
retail customers more profitable, perhaps by increasing fees for services, requiring retail customers to maintain higher
account balances, or increasing the interest spread on retail accounts.
Requirement 9
The ABC customer cost data suggest that managements strategy to increase the retail customer base rather than the
business customer base was unwise. Management made this decision based on the assumption that the banks original
cost system provided accurate cost information. Unfortunately, the ABC data show that the retail customers are not
currently profitable for BNB. Given the existing revenue and cost structure (and assuming the largely labor-related
indirect costs are mostly variable), BNB may want to provide a bonus for attracting and retaining new business
customers only. For retail customers, the bank should consider changing the revenue structure (e.g., increasing the
required minimum balance for retail checking accounts) or the cost structure (e.g., developing methods that deliver the
same level of service at a lower cost, such as encouraging retail customers to use ATMs or online banking rather than
expensive teller services, or possibly cutting back service at the customer account inquiry center).
Requirement 10
ABC provides more accurate cost information that managers can use in making important business decisions. Activity-
based management (ABM) refers to using ABC information to make decisions that increase profits while satisfying
customer needs. Managers use ABC information in making pricing and product or customer mix decisions, in
identifying opportunities to cut costs, and in routine planning and control.
ABC customer cost data can help BNBs managers develop more effective marketing strategies by more
appropriately pricing their services and assessing the profitability of different mixes of customers and/or services. For
example, after recognizing that attracting and retaining business accounts is the key to profitability (given the existing
cost and revenue structure), BNB may want to add special services for business customers. In a recent Wall Street
Journal article, reprinted as an Appendix to this case, Brooks (1999) highlights new services that banks provide to
retain their most profitable customersfrom special expedited toll-free phone lines to waiving certain fees. In contrast,
BNB should be wary of encouraging retail customer growth unless it increases the revenues or reduces the costs of
serving retail customers.
BNBs managers can also use ABC data to pinpoint opportunities to improve production (or service) processes
and trim costs by reducing: (1) the cost per unit of the activities, or (2) customers consumption of the activities. For
example, highlighting the costs of each activity may help BNB find ways to trim the indirect cost per unit of the cost
driver. The bank may train customer account inquiry representatives to handle more calls per hour. This can reduce the
cost per call if the bank can then handle the call load with fewer customer service representatives. To cut the per-check
cost of paying checks, BNB might purchase more efficient check-processing systems. ABM can also help the bank
reduce customers consumption of activities that drive costs (while maintaining their business). For example, teller
services, a relatively high-cost activity, provides a promising starting point for managers looking for significant cost
savings. Management may be able to develop creative lower-cost alternatives to reduce customers use of expensive
teller services, such as encouraging customers to use Automatic Teller Machines (ATMs) or to switch to Internet
banking. The bank may also develop a web-based account information site that allows customers to access their
accounts through the Internet, thereby answering many of their own questions, and reducing the number of inquiries to
the customer service call center.
Requirement 11
For BNB, the benefits are likely to outweigh the costs of ABC. First, BNB operates in a highly competitive
environment. In competitive industries, accurate cost information is essential for setting competitive prices that still
allow the company to earn a profit. Competitors will capitalize on a companys mispricing, especially by cherry-picking
high-volume profitable products, services, or customers that the company overprices. In this case, BNB is vulnerable to
losing its business customers, whose costs are far less than the revenues they provide BNB. In addition, ABC can
pinpoint opportunities for cost savings, which increase the banks profit or are passed on to customers in lower sale
prices (for example in this context, by reducing the amount of the minimum required account balances). Second, most
of BNBs costs are indirect. ABC is most valuable to companies with high indirect costs, because if indirect costs are
low, it does not matter how they are allocated. Third, ABC has a material effect when different customers/products/
services use different amounts of the companys resources. At BNB, retail and business customer lines use different
amounts of the banks resources for paying checks, teller services, and customer account inquiry services. Finally, costs
of ABC include information technology and accounting expertise to implement the system and to record cost driver
data. Given the magnitude of the data processing requirements, banks typically possess advanced information
technology and accounting expertise. All these factors suggest that for BNB, the benefits of ABC are likely to outweigh
the costs.
Requirement 12
ABC is not just an accounting exercise. Managers outside the financial function need to understand ABC so that they
can use the resulting cost information when making important decisions such as setting prices, analyzing product and
customer profitability, and identifying opportunities to trim costs. As requirement 10 briefly discusses, managers
engaged in ABM use ABC information to guide strategic product emphasis, process improvement, and cost-reduction
decisions. Finally, nonaccounting managers need to understand ABC because they often serve on ABC teams. These
cross-functional teams typically include managers actively engaged in the firms core operations, in addition to
accountants.

03JL101310 Blue Ridge Manufacturing

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03JL101310 Blue Ridge Manufacturing

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CHAPTER 5

Activity-Based Costing and Management

Teaching Notes for Cases and Articles from the

5-1 Blue Ridge Manufacturing (Activity-Based Costing for Marketing Channels)

Value Added for Customers

Stage 1: Allocate SG & A Costs to SG & A Activities.

Stage 2: Allocate activity costs to Customer Type (Large, Medium, Small).

Stage 3: Customer Profitability Analysis.

Third: Allocate Costs to Activities

Second: Calculate Cost Driver Percentage for Each Customer Type

Revenue Price Large Medium Small

Second: Calculate Manufacturing Cost --

Direct Cost of Unit Cost

(2) Total Cost

Third: Calculate Customer Profit --

Overview of the Case

Teaching Notes for Assignments

4. Create a folder on your computer labeled Blue Ridge.

TN-2: Excel Solution for Blue Ridge

Second: Resource Drivers

Third: Allocate Costs to Activities

Second Stage Allocation: AllocateSA&A Activites to Custmer Type

Second: Allocate Activity Costs to Customer Type Alloc. Base

Teaching Notes for Assignments

TN-2: Excel Solution for Sunny View

Sunny View Dairy Farm

Second: Allocate Resources to Activities Using Drivers

Second Stage Allocation: AllocateSA&A Activites to Custmer Type

Cost Driver Percentage of Total for each Customer Type

Second: Allocate Activity Costs to Products

Number of Units produced 292,000 730,000 511,000 219,000 219,000 1,971,000

Plus: Purchases from External Suppliers

Total Cost per bottle $ 1.766 $ 1.767 $ 1.767 $ 2.358 $ 2.442

The (A) Case

The (B) Case

Suggested Teaching Procedure

Wilson Electronics (A) Discussion Questions

"Supplies/Utilities" Change in Estimated

Resource Category Spending Reduction

Wilson Electronics (B) Discussion Questions

Quantity of Activity Total Activity Volume of Activity

Step 2-Compute Revised Idle Capacity as a Result of Product Redesign

Idle Capacity Decrease Due Revised

Step 3-Quantify Potential Reduction in Terms of FTEs

Revised Practical Potential FTE

Step 4-Translate Potential FTE Reduction to Dollar Savings

Potential FTE Average Wage and Dollar

Process #2: Manufacturing

Panel A: Cost Reduction Proposal #1 Submitted in February 19xx

Activity Activity Time

Panel B: Cost Reduction Proposal #2 Submitted in April 19xx

Activity Activity Time

Panel C: Impact of the Combined Proposals on Spending Reduction

Activity Activity Time

Potential savings opportunity = $50,000 - $13,000 = $37,000.

Cost Difference between Standard Cost System and ABC

Standard cost Direct labor + overhead $2,179,423

Discount rate = 14%

Discount rate = 14%

Discount rate = 14%

TEACHING NOTES Learning Objectives and Target Audience

Published ABC Cases

Examples of topics covered in each of the categories:

Student Outputs and the Pedagogical Process