Chapter 6

Chapter 6
ACTIVITY-BASED COSTING, CUSTOMER

PROFITABILITY
AND ACTIVITY-BASED MANAGEMENT
DISCUSSION QUESTIONS
Q6-1. The following two sentences summarize the concepts underlying activity-based
costing:
1. Activities performed to serve customer needs cost money.

2. The cost of resources consumed by activities should be assigned to cost
objectives on the basis of the units of activity consumed by the cost
objective.
Q6-2. Implementing the two-stage model requires:
1. Identifying activities.
2. Assigning costs to activities.
3. Determining the basis for assigning the cost of activities to cost objectives.
4. Determining the cost per unit of activity.
5. Reassigning costs from the activity to the cost objective on the basis of the
cost objective's consumption of activities.
Q6-3. An activity cost pool consists of the total costs identified that relate to a given
activity conducted as part of a process. An activity cost driver is the unit of
measurement of the activity level that causes costs to be incurred. Cost per
unit of activity is simply the total amount of the activity cost pool divided by the
level of the activity cost driver.
Cambridge Business Publishers, 2012

Solutions Manual, Chapter 6 6-1
Q6-4. Cost Pool Possible Cost Drivers
Maintenance Number of maintenance hours
Number of repair orders
Number of machine hours
Materials movement Number of movements

Weight or volume of material
Dollar value of material
Machine setup Number of setups

Number of setup hours
Number of production runs
Inspection Number of inspections

Number of inspection hours
Weight or volume of goods inspected
Materials purchases Number of purchase orders

Number of vendors
Dollar value of purchases
Customer service Number of customers

Dollar value of sales to customers
Number of customer service calls
Q6-5. Activity-based costing is based on the premise that activities drive costs and
that the cost of activities should be assigned to cost objectives on the basis of
the activities they consume.

6-2 Managerial Accounting, 6th Edition
Q6-6. Activity-based costing differs from traditional approaches to cost allocation in
terms of the number of cost pools used, the assignment of costs to pools based
on activities, the rejection of volume-based allocation that is not related to cost-
causing activities, the need to understand the production process, and the
frequent use of judgment.
Q6-7. ABC often reveals product cross-subsidization problems if it produces costs for
some products that are higher, and costs for other products that are lower, than
costs produced by traditional costing methods. ABC often reveals that some
products are undercosted and others are overcosted. This is referred to as
cross- subsidization.
Q6-8. Customers make varying demands on companies with some customers

requiring little support and others requiring substantial amounts of support.
Using ABC companies can determine the amount of its various customer
support activities, and their related costs that are incurred for the benefit of
each customer, thereby determining customer profitability after taking into
account these customer support costs.
Q6-9. Activity-Based Management (ABM) is the identification and selection of

activities to maximize the value of activities while minimizing their cost from the
perspective of the final consumer. Whereas activity-based costing (ABC) is
concerned with measuring the cost of activities used to produce a cost
objective (e.g., a product or service), ABM is concerned with how to efficiently
and effectively manage activities and processes to provide value to the final
consumer.

MINI EXERCISES
M6-10.
1. i 6. d
2. h 7. b*
3. f 8. c
4. a 9. e
5. j 10. g
* (Note: (d) cannot be used because it is the most logical answer to item 6, and each
answer can be used only once.)
M6-11.
There is no single correct answer to this exercise. The purposes of the exercise are
to develop skills in thinking about activities and to organize them sequentially.
1. Open cargo hatch.

2. Unload aircraft.
3. Move baggage to baggage sorting area.
4. Sort baggage by outgoing flight numbers and/or destination.
5. Move baggage for which hub is final destination to baggage claim area.
6. Accumulate baggage for each outgoing flight.
7. Move baggage to outgoing aircraft.
8. Load aircraft.
9. Secure baggage.
10. Close cargo hatch.
M6-12.
Introductory Graduate
Course Course
Assignment of salary:
$135,000 0.50 portion teaching 0.50 $33,750 $33,750
Annual enrollment:
Introductory course
50 students 2 semesters 100
Graduate course
30 students 2 semesters _____ 60
Cost of instruction per student $337.50 $562.50

M6-13.
The easiest way to solve this assignment is to classify each of the activities Brenda
performed as unit, batch, product, or facility level. Next, total the percentages in
each category. Finally, multiply the percentages by Brendas salary.
Assignment of
Salary
Unit level:
Supervising production 20 percent
Total 20 $26,400
Batch level:
Job scheduling 15 percent
Supervising setup 5 percent
First unit inspection 2 percent
Total 22 29,040
Product level:
Product design 12 percent
Preparing bills of materials 5 percent
Preparing operations lists 12 percent
Total 29 38,280
Facility level:
Employee training 18 percent
Facility maintenance 7 percent
Attending professional meetings 4 percent
Total 29 38,280
Grand total 100 $132,000

M6-14.
Sales revenue $122,200
Less:
Cost of goods sold $68,940
Customer relations ($100 25) 2,500
Selling expenses ($122,200 0.06) 7,332
Accounting (235 $5) 1,175
Warehousing (4,700 $0.50) 2,350
Packing (4,700 $0.25) 1,175
Shipping (70,500 $0.20) 14,100 (97,572)
Profitability of March 2012 sales in Massachusetts $ 24,628
M6-15.
Activity cost of converting raw materials into 40 fireplace inserts:
Setup $ 60
Movement:
Batch ($15 3 moves) $ 45
Weight
($0.10 50 units 150 lbs. 3 moves) 2,250 2,295
Inspection ($2 2 50) 200
Drilling ($3 5 50) 750
Welding ($4 80 50) 16,000
Shaping ($25 0.50 50) 625
Assembly ($18 1 50) 900
Total $20,830

M6-16.
Activity cost calculations:
Machine setup cost = $600,000 12,000 setup hours = $50 per setup hour
Material handling cost = $120,000 2,000 tons = $60 per ton of materials
Machine operation = $500,000 10,000 = $50 per machine hour
Product costs: C23 Cams U2 Shafts
Direct materials $30,000 $20,000

Direct labor 5,000 10,000
Manufacturing overhead:
Machine setups (3 setup hours $50) 150 (7 setup hours $50)350
Material handling (12.5 tons $60) 750 480
(8 tons $60)
Machine operation (4 hours $50) 200 (5 machine hours $50) 250
Total job costs $36,100 $31,080
Units produced 500 300
Cost per unit produced $ 72.20 $103.60
M6-17.
Activity cost calculations:
Machine setup cost = $950,000 2,500 setups = $380 per setup hour
Material handling cost = $820,000 5,000 = $164 per material move
Machine operation = $200,000 20,000 = $10 per machine hour
Product costs:
Mirlite Subdue

Manufacturing overhead:
Machine setups (15 setup hrs. $380) 5,700 (12 setup hrs. $380) 4,560
Material handling (60 moves $164) 9,840 (35 moves $164) 5,740
Machine operation (800 hours $10) 8,000 (250 hours $10) 2,500
Total cost per batch $383,540 $170,300
Gallons produced 50,000 30,000
Cost per gallon $ 7.67 $ 5.68

M6-18.
Activity Alpine Blue Ridge Pineola
Refinishes (@ $60) $ 4,800 $ 2,100 $ 2,520
Touchups (@ $100) 15,000 11,000 11,500
Communication (@ $40) 14,400 8,200 7,600
Total support costs 34,200 21,300 21,620

Gross Profit 100,000 100,000 100,000
Customer profits $ 65,800 $ 78,700 $ 78,380
The instructor may want to ask the students to comment on the usefulness of this
type analysis, and ask what reasonable actions HyStandard might take as a result of
this analysis (see discussion below).
This analysis is beneficial to HyStandard because it shows that the Alpine Company
is a definite outlier among the three builders in terms of support services required.
Alpine is a significantly larger consumer of activities for refinishes, touchups and
communication. Note that Alpine requires 360 communications (calls, emails, etc.)
for 230 refinishes and touchup procedures, or 1.57 communications per procedure;
whereas, the ratios for Blue Ridge and Pineola are 1.41 and 1.21, respectively.
HyStandard should consider sharing some of these data with the Alpine Company to
demonstrate to them that they are not in line with the other builder/customers in
terms of the level of support required. If Alpine cannot be brought in line,
HyStandard may consider replacing Alpine, possibly by seeking another builder as a
third customer. Of course, despite Alpines poor performance as a customer, it is still
quite profitable this analysis may simply serve to help make it more profitable.
Also, by determining the cost of each unit of activity for refinishes, touchups, and
communications, HyStandard should assess its cost management of these activities
and attempt to lower the cost per unit without reducing the level of effectiveness.

EXERCISES
E6-19.
a. Cost per Unit
Activity Cost Pools Cost Cost Drivers of Activity
Setup costs $ 56,000 350 setups = $160
Materials handling costs 12,800 640 material moves = $ 20
Machine operating costs 240,000 20,000 machine hours = $ 12
Packing costs 60,000 1,200 packing orders = $ 50
Total indirect
manufacturing costs $368,800
b. Manufacturing overhead cost of producing metal casements:
Number of setups 20 $160 = $ 3,200

Number of material moves 80 $20 = 1,600
Number of machine hours 1,900 $12 = 22,800
Number of packing orders 150 $50 = 7,500
Total manufacturing overhead cost $35,100
Casements produced 500
Cost per casement $ 70.20
The instructor may want to ask the students to comment on the adequacy of
Merlots cost system (see below).
Merlots cost system should provide an accurate measurement of manufacturing

overhead because it recognizes the activities that go into making a product, and
it assigns cost to the product based on the cost of performing the activities used
to produce it.

E6-20.
a. Plantwide manufacturing overhead = Total manufacturing overhead
Total allocation base activity
Plantwide overhead rate

based on machine hours = $464,000 / 12,000 machine hours
= $38.67 per machine hour
b. Plantwide manufacturing overhead

rate based on direct labor hours = $464,000 / 2,000 direct labor hours
= $232 per direct labor hour
c. Milling department overhead rate

based on machine hours = $344,000/10,000 machine hours
= $34.40 per Milling Dept. machine hour
Finishing department overhead rate

based direct labor hours = $120,000/1,000 direct labor hours
= $120 per Finishing Dept. direct labor

hour
d. Milling department overhead rate

based on direct labor hours = $344,000/1,000 direct labor hours
= $344 per Milling Dept. direct labor hour
Finishing department overhead rate

based on machine hours = $120,000/2,000 machine hours
= $60 per Finishing Dept. machine hour
e. Part c. allocation rates, which use machine hours as the allocation base in the
Milling Department and direct labor hours as the allocation base in the Finishing
Department, are probably the best of the four alternatives illustrated, because
they reflect the nature of the activity in the respective departments. The
processes in the Milling Department are machine-activity intensive whereas the
Finishing Department conducts processes that are direct-labor-activity intensive.

E6-21.
a. Activity cost calculations
Setup cost: $144,000/1,000 setup hours = $144 per setup hour
Production scheduling cost: $60,000/400 batches = $150 per batch
Production engineering cost: $120,000/60 change orders = $2,000 per change
Supervision cost: $56,000/2,000 direct labor hours = $28 per direct labor hour
Machine operating cost: $84,000/12,000 machine hrs. = $7 per machine hr.
b. Job 845
Direct materials cost $ 7,000
Direct labor cost 1,000
Manufacturing overhead costs:
Setup costs (5 hours $144) 720
Production scheduling (1 batch $150) 150
Production engineering (3 orders $2,000) 6,000
Supervision (40 direct labor hours $28) 1,120
Machine operations (30 machine hours $7) 210
Total Job 845 cost $16,200
c. Cost of Job 845 using a plantwide overhead rate based on machine hours
Job 845
Direct materials cost $7,000
Manufacturing overhead cost:
(30 machine hours $38.67)* 1,160
*$464,000/12,000 = $38.67 per machine hour
d. Cost of Job 845 using departmental overhead rates based on machine hours in
the Milling Department and direct labor hours in the Finishing Department
Job 845
Direct materials cost $ 7,000
Manufacturing overhead cost
Milling Department (25 machine hours $34.40) 860
Finishing Department (35 labor hours $120) 4,200
The instructor may want to ask the students what additional data management
will need for Job 845 to adequately evaluate its price and profitability. This
problem takes into account only manufacturing costs, which are all that are
allowed to be included in product costs for financial statement purposes;
however, for managerial purposes, management will want to know what
additional costs are incurred with respect to Job 845. This will include shipping,
distribution, as well as service to the customer after the sale and delivery of the
job.
E6-22.
a. Overhead rate per direct labor dollar: $83,000 $45,000 = 1.8444 or 184.44%
Gas Charcoal
Cooker Smoker Total
Direct materials $40,000 $100,000 $140,000

Direct labor 20,000 25,000 45,000
Overhead (1.8444 direct labor) 36,888 46,110 82,998
Total cost $96,888 $171,110 $267,998
Units 1,000 5,000
Unit cost $ 96.89 $ 34.22
b. Rate per unit of activity cost driver:

(a) (b) (a) (b)
Cost Driver
Activity Cost Cost driver Quantity Rate
Materials acquisition Direct Materials

and inspection $30,800 Cost $140,000 0.22 per DM$
Materials movement 16,200 Number of moves 100 $162 per move
Scheduling 36,000 Number of batches 60 $600 per batch
Gas Charcoal
Cooker Smoker Total
Total direct materials costs $ 40,000 $ 100,000 $140,000

Total direct labor costs 20,000 25,000 45,000
Overhead costs:
Materials acquisition
$40,000 & $100,000 @ 0.22/DM$ 8,800 22,000 30,800
Materials movement
80 & 20 @ $162/batch move 12,960 3,240 16,200
Scheduling 50 & 10 @ $600/batch 30,000 6,000 36,000
Total costs $111,760 $156,240 $268,000
Units produced 1,000 5,000
Unit cost $ 111.76 $ 31.25

E6-23.
a. The solution to (b) using activity-based costing is more accurate. If the solution
to (a) using traditional costing is followed, prices developed on the basis of costs
will be inaccurate and result in lost profits and lost profit opportunities.
In particular, the Gas Cooker, which is more complicated and produced in much
smaller batches, may be priced too low, resulting in lost revenues and profits in
the premium grill market. The Charcoal Smoker, which is less complicated and
can be produced in very large batches, may be priced too high, resulting in lost
sales and inability to compete in the discount market. Under traditional costing,
Charcoal Smokers are subsidizing the cost of Gas Cookers because part of the
cost of the Cookers is being assigned to the Smokers.
b. Subtracting product costs from revenues will yield the gross margin on the
products, but to determine the net profitability of Cookers and Smokers, the costs
incurred after the products are manufactured, for selling and distribution
activities, must be determined. Because all customer types may not be equally
profitable (due to variations in servicing demands), management may also want
to determine the profitability for the various categories of customers (e.g.,
discount stores, buying clubs, and specialty shops) that buy Smokers and
Cookers from Hickory Grill Company.
E6-24.
a. Overhead rate per direct labor hour: $204,000 8,000 DLH = $25.50
X301 Z205

Overhead ($25.50 500 hours each) 12,750 12,750
Total cost $40,250 $40,250
Units 1,000 1,000
Unit cost $40.25 $40.25
continued next page

E6-24. continued
b. Rate per unit of cost driver:
Driver
Activity Cost activity Rate
Assembly setups $ 45,000 1,500 $30/setup hour
Materials handling 15,000 300 $50/move
Assembly 120,000 12,000 $10/Assembly hr.
Maintenance 24,000 1,200 $20/maint. hr.
X301 Z205
Total direct materials costs $15,000 $ 15,000
Total direct labor costs 12,500 12,500
Overhead costs:
Assembly setup 50 & 100 hours
@ $30 per hour 1,500 3,000
Materials handling 25 & 50 moves
@ $50 per move 1,250 2,500
Assembly 800 & 800 assembly hours
@ $10 per assembly hour 8,000 8,000
Maintenance 10 & 40 maintenance
hours @ $20 per hour 200 800
Total costs $38,450 $41,800
Units produced 1,000 1,000
Unit cost $ 38.45 $ 41.80
c. In (a), X301 and Z205 had the same total manufacturing cost because they have
identical direct materials and direct labor costs, and because manufacturing
overhead is assigned based on direct labor hours, which were also identical.
However, in (b), using activity-based costing, the differences between the two
products and the activities required to produce them are reflected in the total
product costs. Z205 required more setup hours, more material moves, and more
maintenance hours than X301, thus causing Z205 to have $3.35 per unit more
cost than X301.
continued next page

E6-24. continued
d. A company like Panasonic operates in a highly competitive worldwide market that
often forces companies to price products at levels that result in very low profit
margins. In such cases, relying on product costs that include even small errors
can result in bad pricing and product mix decisions. By overcosting Model X301
and undercosting Model Z205, the Panasonic brand manager could possibly be
promoting the sale of the wrong product, or could even be considering dropping
Model X301 because the product could not compete profitably at the current
price the market would support. An error of $1.80 per unit could lead the
company to make the wrong decision about that product. On the other hand,
Panasonics brand manager may have the opposite assessments about Model
Z205. The current cost under traditional costing gives the impression that its cost
is $1.55 less than its activity cost. This could cause the manager to promote this
product, which actually may not be profitable at all at the products current market
price.
E6-25.
a. Total overhead costs:
Setup $ 936,000
Ordering 240,000
Maintenance 1,200,000
Power 120,000
$2,496,000
Direct labor hours 60,000
Overhead cost per direct labor hour $ 41.60
Job cost calculations: Job 201 Job 202

Overhead ($41.60 270) and ($41.60 330) 11,232 13,728
$43,857 $99,978
Units produced 1,125 915
Cost per unit $ 38.98 $109.27
continued next page

E6-25. continued
b. Calculation of activity costs:
Setup costs $936,000 7,200 setups = $130 per setup
Ordering costs $240,000 60,000 orders = $4 per order
Maintenance costs $1,200,000 80,000 mach. hours = $15 per mach. hr.
Power $120,000 600,000 kilowatt hours = $0.20 per kwh
Job cost calculations: Job 201 Job 202

Setup cost ($130 18) and ($130 22) 2,340 2,860
Ordering costs ($4 24) and ($4 45) 96 180
Maintenance costs ($15 540) & ($15 450) 8,100 6,750
Power ($0.20 270) and ($0.20 360) 54 72
Total job costs $43,215 $96,112
Units produced 1,125 915
Cost per unit $38.41 $105.04
c. In addition to the manufacturing cost information provided by ABC, management

will need to have additional information about non-manufacturing costs, such as
distribution and customer service.
d. The findings in the above requirements could have multiple implications for High
Country Outfitters. The manager should be pleased that both Jobs 201 and 202
had ABC costs less than their costs under traditional overhead costing.
However, what this also means is that traditional costing would have to be
undercosting some other jobs. While it may be encouraging that the two jobs in
this exercise are more profitable than previously thought, it should be of serious
concern that other jobs are not as profitable as management previously thought.
A full cost analysis of all jobs should be conducted before management can
assess the full impact of failing to account for the actual activities used in
producing the jobs.

E6-26.
E6-27.
a. Dropping the two customers that have losses totaling $362,000 will not likely
cause an immediate increase in profits of $362,000 because some of those costs
are not avoidable. For example some of those costs may be fixed costs that will
continue, even if the two customers to which some of the costs are assigned
cease to be customers. In the long run, the company should be able to use
those costs to help serve new, hopefully profitable, customers, or possibly
eliminate the costs.
b. The benefit of this type analysis is that it clearly focuses managements attention
on the fact that not all customers are equally profitable because the activities
consumed in serving customers are not equal for all customers. Without
customer profitability analysis, management may not even be aware that some
customers are unprofitable, and that the customers that produce the most sales
revenue may not be producing the most profits.

PROBLEMS
P6-28.
a. Budgeted Budgeted Cost per Unit
Cost Activity of Activity
Purchasing and materials handling $675,000 900,000 = $0.75
Setup $700,000 1,120 = $625.00
Machine operations $954,000 12,000 = $ 79.50
First unit inspection $ 50,000 1,000 = $ 50.00
Packaging $250,000 312,500 = $ 0.80
Standard Standard Specialty

Product A Product B Products
Direct materials $900,000 $600,000 $820,000
Purchasing and handling:
Product A ($0.75 400,000) 300,000
Product B ($0.75 300,000) 225,000
Specialty ($0.75 200,000) 150,000
Setup:
Product A ($625 300) 187,500
Product B ($625 160) 100,000
Specialty ($625 900) 562,500
Machine operations:
Product A ($79.50 6,000) 477,000
Product B ($79.50 3,000) 238,500
Specialty ($79.50 2,000) 159,000
First unit inspection:
Product A ($50 100) 5,000
Product B ($50 80) 4,000
Specialty ($50 600) 30,000
Packaging:
Product A ($0.80 150,000) 120,000
Product B ($0.80 100,000) 80,000
Specialty ($0.80 50,000) ________ ________ 40,000
Total $1,989,500 $1,247,500 $1,761,500
Units 150,000 100,000 50,000
Unit cost $ 13.263 $ 12.475 $ 35.23
continued next page

P6-28. continued
b. Although the unit materials cost of the specialty products is somewhat higher
than the average materials cost of the standard products, the primary cause of
the high unit cost of the specialty products is the small number of units in each
batch:
Standard Product A 150,000 units/100 batches = 1,500 units per batch

Standard Product B 100,000 units/80 batches = 1,250 units per batch
Specialty Products 50,000 units/600 batches = 83.33 units per batch
Consequently, setup costs and first unit inspection costs are averaged over a
smaller number of units.
P6-29.
Calculation of meals & residential cost per resident day:
Total cost of meals and residential space Annual resident days =
$1,642,500 21,900 = $75 cost per day
a. Total cost of medical services Annual assistance hours = Cost per hour
$2,500,000 90,000 = $27.78 per hour
ABC cost per resident day based on annual assistance hours

Cost per resident day (medical services cost plus food and residential cost):
Class A: $27.78 15,000 = $416,700 8,760 = $47.57 + $75 = $122.57
Class B: $27.78 20,000 = $555,600 6,570 = $84.57 + $75 = $159.57
Class C: $27.78 22,500 = $625,050 4,380 = $142.71 + $75 = $217.71
Class D: $27.78 32,500 = $902,850 2,190 = $412.26 + $75 = $487.26
b. Total cost of medical services No. of assistance contacts = Cost per contact
$2,500,000 216,000 = $11.57
ABC cost per resident day based on number of assistance contacts

Cost per resident day (medical services cost plus food and residential cost):
Class A: $11.57 60,000 = $694,200 8,760 = $79.25 + $75 = $154.25
Class B: $11.57 52,000 = $601,640 6,570 = $91.57 + $75 = $166.57
Class C: $11.57 52,000 = $601,640 4,380 = $137.36 + $75 = $212.36
Class D: $11.57 52,000 = $601,640 2,190 = $274.72 + $75 = $349.72
continued next page

P6-29. continued
c. Under the current costing system the cost per resident day is $189.16 (or
[$2,500,000 + $1,642,500] 21,900 days) per day for all resident classifications.
While classifications C and D account for the lowest number of resident days,
they account for the largest amount of assistance hours and almost the same
amount of assistance contacts as the other classifications. The best cost driver
is the driver that has the greatest influence on cost. Intuitively, both assistance
hours and contacts would seem to influence costs; however, since much of the
cost is probably related to staff time, annual assistance hours is probably a better
cost driver.
P6-30.
a. Activity cost per unit of activity
Taking applications: $300,000 12,000 hours = $25.00 per hour

Conducting credit investigations: $450,000 16,500 hours = $27.27 per hour
Underwriting: $525,000 10,000 hours = $52.50 per hour
Preparing loan packages: $200,000 8,000 hours = $25 per hour
Closing loans: $600,000 6,000 hours = $100 per hour
b. Loan # 5066
Taking applications ($25.00 per hour 1.5) $ 37.50
Investigations ($27.27 per hour 4.0) 109.08
Underwriting ($52.50 per hour 2.50) 131.25
Loan packages ($25 per hour 3.5) 87.50
Closing loans ($100 per hour 1.5) 150.00
$515.33
Loan # 5429
Taking applications ($25.00 per hour 2.75) $ 68.75
Investigations ($27.27 per hour 3.0) 81.81
Underwriting ($52.50 per hour 4.75) 249.38
Loan packages ($25 per hour 3.0) 75.00
Closing loans ($100 per hour 1.5) 150.00
$624.94
continued next page

P6-30. continued
c. Average cost per hour = $2,075,000 52,500 = $39.52
Cost of loan #5066 ($39.52 13 hours) = $513.76
Cost of loan #5429 ($39.52 15 hours) = $592.80
d. Both loan 5066 and loan 5429 are undercosted when using average cost
compared with ABC:
Loan #5066 Loan #5429

ABC cost $515.33 $624.94
Average cost -513.76 -592.80
Difference $ 1.57 $ 32.14
Since individual jobs use different mixes of the various categories of labor, ABC
accounts for these differences; whereas, the average method does not. ABC
recognizes the unique combination of the various activities used to process each
individual loan and provides a more accurate measure of cost.

P6-31.
a. Costs assigned to machines 7 and 8: $34,100 10 = $3,410
b. Activity costs:
Routine Maintenance
Trips Hour
Maintenance salaries ($1,800 2) $3,600.00

Cashiers' salaries:
Routine visits ($1,800 2 0.50) $1,800.00
Maintenance visits ($1,800 2 0.50) 1,800.00
Head cashier's salary and office space:
Routine visits
[($3,000 + {$2,300/2}*) 0.75] 3,112.50
Maintenance
[($3,000 + {$2,300/2}) 0.25] 1,037.50
Supervisor's salary and office space:
Routine visits
[($4,000 + {$2,300/2}) 0.20] 1,030.00
Supervising maintenance employees
[($4,000 +{$2,300/2}) 0.80 2/5] 1,648.00
Supervising head cashier:
[($4,000 + {$2,300/2}) 0.80 1/5 0.75] 618.00
[($4,000 + {$2,300/2}) 0.80 1/5 0.25] 206.00
Supervising cashiers:
[($4,000 + {$2,300/2}) 0.80 2/5 0.5] 824.00
[($4,000 + {$2,300/2}) 0.80 2/5 0.5] 824.00
Cashiers' service vehicle 1,200.00
Maintenance service vehicle ________ 1,400.00
Total cost 8,584.50 10,515.50
Total activity 720 160
Activity cost $ 11.92 $ 65.72
*One-half office costs.
continued next page

P6-31. continued
c. Cost assignments and reassignments:
Machine 7 Machine 8
Machine lease, space rent, and utilities $1,500.00 $1,500.00
Routine trips:
(90 $11.92) 1,072.80
(120 $11.92) 1,430.40
Maintenance:
(25 $65.72) 1,643.00
(5 $65.72) ________ 328.60
Total $4,215.80 $3,259.00
d. Although determining accurate cost information is one of the primary benefits of

activity-cost systems, the greatest potential benefit is the basis it provides for
evaluating the cost-benefit of activities performed. Often, when the true cost of
an activity is determined, management will conclude that it is either not worth the
cost to continue the activity, or possibly it is more cost-effective to outsource the
activity to another organization. Calculating ABC costs is simply the first step in
activity-based management, which should be the ultimate goal of any activity-
based cost system

P6-32.
a. $705,000 27,500 = $25.64 per direct labor hour
b. Overhead cost for shafts:

$25.64 25,000 hours = $641,000 50,000 units = $12.82 per unit
Overhead cost for gears:

$25.64 2,500 hours = $64,100 10,500 units = $6.10 per unit
c. Setup activity cost based on number of production runs:

$30,000 30 runs = $1,000 per production run
Machine activity cost based on number of machine hours:

$175,000 18,750 hours = $9.33 per machine hour
Purchasing and receiving activity cost based on number of orders processed:

$210,000 140 = $1,500 per order
Engineering activity cost based on number of engineering hours:

$200,000 10,000 hours = $20 per hour
Materials handling activity cost based on number of material moves:

$90,000 90 = $1,000 per move
Activity costs of shafts and gears: Shafts Gears

Setup (10 & 20 runs @ $1,000) $ 10,000 $ 20,000
Machine (12,750 & 6,000 hours @ $9.33) 118,958 55,980
Purchasing (40 & 100 @ $1,500) 60,000 150,000
Engineering (5,000 & 5,000 @ $20) 100,000 100,000
Materials Handling (50 & 40 @ $1,000) 50,000 40,000
Total ABC overhead cost 338,958 365,980

Number of units produced 50,000 10,500
ABC manufacturing overhead per unit $6.779 $34.855
d. Using a plantwide manufacturing overhead rate of $25.64 per hour, LaMesa

assigned $12.82 of overhead cost to each shaft and $6.10 of overhead cost to
each gear. By recognizing that shafts and gears make different demands on the
activities of the manufacturing process, ABC produces an overhead cost of
$6.779 for shafts and $34.855 for gears. This shows that LaMesa is over-
assigning costs to shafts by $6.041 per unit ($12.82 $6.779), and it is under-
assigning costs to gears by $28.755 per unit ($6.10 - $34.855). These cost
assignment errors clearly explain why the company is having difficulty competing
in the shafts market (because its product is overcosted by $6.041), and why it is
cornering the market in the gears market (because its product is undercosted by
$28.755).
P6-33.
a. Customer Customer Customer Customer Customer
#1 #2 #3 #4 #5
($ 000)
Sales $17,000 $12,000 $3,000 $4,000 $3,000
Cost of goods -13,600 -9,600 -2,400 -3,200 -2,400
Gross profit 3,400 2,400 600 800 600
Less expenses:
Sales commissions (@ 5%) 850.0 600.0 150.0 200.0 150.0
Sales visits (@1,200) 127.2 156.0 62.4 40.8 19.2
Product adjustments (@ 1,500) 34.5 54.0 15.0 9.0 7.5
Phone and other remote contacts (@ $150) 33.0 53.1 27.0 20.7 15.6
Promotion and entertainment (@ $1,500) 123.0 99.0 111.0 27.0 15.0
Corporate jet expense 19.2 28.8 4.0 0.0 4.8
Customer profitability $2,213.1 $1,409.1 $ 230.6 $502.5 $387.9
Net customer return on sales 13.02% 11.74% 7.69% 12.56% 12.93%
b. Customer Customer Customer Customer Customer

#1 #2 #3 #4 #5
($ 000)
Customer profitability (before G&A exp.) $2,213.10 $1,409.10 $230.60 $502.50 $387.90
Less G&A expense*:
17/39 [2,500 (19.2 + 28.8 + 4.0 + 4.8)] 1,064.98
12/39 [2,500 (19.2 + 28.8 + 4.0 + 4.8)] 751.75
3/39 [2,500 (19.2 + 28.8 + 4.0 + 4.8)] 187.94
4/39 [2,500 (19.2 + 28.8 + 4.0 + 4.8)] 250.58
3/39 [2,500 (19.2 + 28.8 + 4.0 + 4.8)] _______ _____ ______ _____ 187.95
Net customer profitability $1,148.12 $657.35 $ 42.66 $251.92 $ 199.95
Net customer return on sales 6.75% 5.48% 1.42% 6.30% 6.67%
*Corporate jet cost previously assigned to the customers is subtracted from total G&A overhead in
this calculation.
continued next page

P6-33. continued
c. The above analyses provide insight into how Rogers Aeronautics is using its
resources to generate sales and support customers. Although all five customers
appear to be profitable before assigning corporate G&A expense, there is a wide
variance in the percentage of customer profitability, ranging from 13.02% to
7.69%. This difference is attributable to differences in the amount of activity
costs incurred for the benefit of the customers, because cost of goods sold (@
80%) and sales commissions (@ 5%) are the same percentages for all
customers. Although Customers #3 & #5 have the same amount of sales
revenue, there is significantly more activity cost incurred for the benefit of
Customer 3 than for Customer 5. This should provide an opportunity for
management to assess the level of activity being expended for the benefit of
customer 3, which has the lowest return-on-sales percentage.
Management should be cautioned about placing too much reliance on the Net
Customer Profitability calculations since G&A expenses (except for the cost of
the corporate jet assigned to the customers) are allocated based on total sales,
not based on activity incurred for the customers. There may be a temptation to
conclude that Customer 3 is barely breaking even and that the company should
consider dropping the customer. However, unless the G&A costs allocated to
Customer 3 could be eliminated, the total profits of the company would decline
from such an action. On the other hand, the net profitability numbers provide
some insight into how well the various customers are bearing what may be
regarded as their reasonable share of corporate overhead. In that sense, one
could conclude that Customer 3 is covering its share of overhead, but adding
little additional profit to the company.

MANAGEMENT APPLICATIONS
MA6-34.
a. One of the most difficult tasks in implementing an ABC system is assigning
resource costs to the activity pools. This often involves significant subjective
judgments and estimation. In this case, the vast majority of overhead costs are
related to indirect labor, and these costs should readily be assignable to the four
activity cost pools by asking each of the employees to estimate the amount of
time they spend on each activity. For the membership manager and the
controller, this should be very easy since virtually all of their time is probably
spent, respectively, on maintaining the membership roster and maintaining the
financial records. The general manager and the assistant manager will have to
depend on best estimates of the use of their time. They may want to keep a log
of time spent on the four activities for a typical month, and then use the data from
that log as a basis for estimating the allocation of their time.
Computers and information systems maintenance could also be assigned to the

activity pools in the same proportion as the allocation of indirect labor cost, or
possibly the controller could determine the amount of the computer cost that is
related to supporting the financial system, and then allocate the remainder to the
other activities in proportion to the indirect labor assigned to those activities.
Postage is probably largely related to the activity of maintaining the membership
roster and communicating with members, with some smaller amount related to
the other activities. The controller should be able to use actual data to assign
these costs to the four key activities.
b. Some possible activity cost drivers are:

Recruiting and providing orientation for new members
Number of new members recruited during the year
Number of new member recruiting packages sent out during the year
Number of existing members
Maintaining the membership roster and communicating with members
Maximum number of members approved for each category
Planning, scheduling and managing Club events
Number of events for each category of members
Number of event days for each category of members
Total cost spent on events for each category of members
Maintaining the financial records and reporting for the Club

Maximum number of members approved for each category
continued next page

MA6-34. continued
c. The remaining overhead costs not mentioned in part a. fall into the category of
facility level costs, and they would be difficult to assign to the activity cost pools.
Generally these types of costs are either not assigned to the cost objectives (in
this case, the membership categories), or else they are assigned based on some
relationship that the costs have to the cost objectives. Here, the best way to
assign these costs to the three membership categories is probably on the basis
of either the number of members or the number of member visits. For example,
clubhouse maintenance and depreciation, liability insurance, and security could
be assigned based on the number of members in the three categories, and
utilities could be based on the number of visits to the Club.
d. A golf and country club seems to be a reasonable situation for applying ABC.
Even though it requires considerable judgment in determining the key activities,
assigning resource costs to activity pools, and selecting activity cost drivers, it
should provide results that are more reliable on some sort of direct cost allocation
of overhead costs to the three membership categories. To ensure that the results
are perceived by the members to be fair and reasonable, Dess Rosmond should
form an implementation committee of staff, and possibly Club members. Hiring
an ABC consultant who has worked on such implementations in various types of
service organizations may also lead to more successful results.
MA6-35.
Traditional cost accounting allocated $9,800,000 of ATI's total overhead cost of
$17,500,000 to "Published Advertising" and $7,700,000 to "Online, based on Direct
Labor Cost 56% of which must have been incurred by "Published" and 44% by
"Online ($9.8 million/$17.5 million = 56%, and $7.7 million/$17.5 million = 44%)."
The following analysis shows that ABC results in a very different cost allocation:
$14,825,000 to Published Advertising and only $2,675,000 to Online. The first step
in the ABC analysis assigns the $17.5 million total overhead cost to the primary
process activities related to the product lines. These were given in the problem:
Selling $7,500,000
Design 3,000,000
Creative services 5,000,000
Customer services 2,000,000
continued next page

MA6-35. continued
Next, we select an activity cost driver for each activity.
Activity: Cost Driver:

Selling Salesperson days
Design Art & design hours
Creative services Subcontract hours
Customer services No. of service calls
Calculations of activity costs per cost driver unit:
Selling: $7,500,000/37,500 days = $200 per day

Design: $3,000,000/40,000 hours = $75 per hour
Creative services: $5,000,000/125,000 hours = $40 per hour
Customer service: $2,000,000/80,000 calls = $25 per call
ABC cost assignments:
Selling: Published On-Line

Publishing 32,000 days $200 = $6,400,000
Online 5,500 days $200 = $1,100,000
Design:
Publishing 35,000 hours $75 = 2,625,000
Online 5,000 hours $75 = 375,000
Creative Services:
Publishing 100,000 hours $40 = 4,000,000
Online 25,000 hours $40 = 1,000,000
Customer Service:
Publishing 72,000 calls $25 = 1,800,000
Online 8,000 calls $25 = _________ 200,000
Total ABC cost assignments 14,825,000 2,675,000

Total production units 200,000 10,000,000
ABC unit cost assignment 74.125 0.2675
Traditional indirect cost assignments 49.000 0.7700
Difference $ 25.125 $ (0.5025)
Total ABC production costs:

Published ($105 direct + $74.125 ABC) $179.125
Online ($0.50 direct + $0.2675 ABC) $0.7675
Total Traditional Production Costs:

Publishing ($105 direct + $49) $154
Online ($0.50 direct + $0.77 indirect) $1.27
continued next page

MA6-35. continued
Questions:
Should ATI give up trying to compete in the "Online" market? Probably not. Using
ABC it costs only 76.75 per unit and not $1.27 per unit to produce a minute of
"Online" service. If it matches Tel-a-Ads price of $1 per minute it will still have a
profit margin of 23.25%; whereas, if it switches to Publishing, at its current price of
$200, its profit margin only 10.44%.
Does the charge of predatory pricing seem valid? No! Predatory pricing involves
selling below cost to try to drive the competition from the market. At a price of $1
per minute, Tel-a-Ad was probably making a profit almost 25%.
Why are customers willing to pay a higher price to get publishing services? At a
price of $200 per unit, there is not likely to be a great deal of competition because it
produces a margin of only 10%, compared to almost 25% in the "online" sector of
the market. The closer the selling price is to total cost, the more likely the market
will tolerate a price increase.
Do traditional costing and ABC lead to similar conclusions? Obviously not.

Inaccurate cost data will almost always lead a manager to incorrect conclusions. Of
course, the greater the error, the greater the likelihood that the error will lead to bad
decisions.

MA6-36.
a. When product costs are calculated using ABC, the costs are first assigned to the
activities causing the costs and then to the products based on the activities they
consume. The following illustrates how the factory overhead costs are assigned.
Purchasing Department
The activity driving the purchasing department costs is the number of purchase
orders. With 100 purchase orders and costs of $6,000, the cost per purchase
order is $60. The final assignment of costs to products is then made based on
the quantity of materials used in producing each product. For example, 10,000
sq. yds. of leather were used in producing standard briefcases and 1,250 sq. yds.
(0.5 2,500) were used in producing specialty briefcases. Using these quantities
assigns 88.9 percent (10,000 11,250) of the purchasing department costs for
leather to standard briefcases and 11.1 percent (1,250 11,250) to specialty. As
shown in the following, similar calculations are used for the other materials.
Standard Specialty
Leather (20 $60 .889) $1,067 (20 $60 .111) $ 133
Fabric (30 $60 .80) 1,440 (30 $60 .20) 360
Synthetic _____ (50 $60) 3,000
$2,507 $3,493
Receiving and Inspecting Materials

The activity driving the cost of receiving and inspecting materials is the number of
deliveries. The receiving and inspection cost per delivery is $50 ($7,500/150).
As with the purchasing department costs, the cost is then assigned to the
products based on the materials used. The assignment is as follows:
Standard Specialty
Leather (30 $50 .889) $1,333 (30 $50 .111) $ 167
Fabric (40 $50 .80) 1,600 (40 $50 .20) 400
Synthetic _____ (80 $50) 4,000
$2,933 $4,567
Setting Up Production Line

The costs of setting up the production line are assigned to products based on the
time spent performing the activity. Since there were 50 setups for the standard
product and each requires one hour, a total of 50 hours relate to standard
briefcases. Similarly, the 100 setups for the specialty briefcases each required
two hours for a total of 200 hours. Thus, the cost per setup hour is $40 ($10,000
250). This results in $2,000 (50 $40) assigned to the standard line and
$8,000 (200 $40) to the specialty line.
continued next page

MA6-36. a. continued
Inspecting Finished Goods
The costs of inspecting the final products are assigned directly to the products
based on the time spent on each product. The cost per hour is $20 ($8,000
400). Thus, the total inspection cost for the standard briefcases is $3,000 (150
$20) and for the specialty line, $5,000 (250 $20).
Equipment-Related Costs
Although the equipment-related costs are caused by the process rather than a
specific product, they must be allocated to determine the total costs for each
product. The cost per machine hours is $0.60 ($6,000 10,000), and the cost
assigned to each product is $3,000 (5,000 $0.60).
Plant-Related Costs
Plant related costs are also allocated on the basis of machine hours. The cost is
$1.30 ($13,000 10,000) per machine hour, and the cost assigned each product
is $6,500 (5,000 $1.30).
ABC Overhead Costs Summary

When costs are assigned to products using an ABC system, the factory overhead
costs for each product differ from those calculated using a direct labor hour
basis. The following summary shows the total manufacturing overhead assigned
to each product using activity-based costing:
Standard Specialty
Purchasing Department:
Leather $ 1,067 $ 133
Fabric 1,440 360
Synthetic _____ 3,000
2,507 3,493
Receiving & Inspecting Materials:
Leather 1,333 167
Fabric 1,600 400
Synthetic ______ 4,000
2,933 4,567
Other:
Setup activities 2,000 8,000
Inspecting final products 3,000 5,000
Machine-related costs 3,000 3,000
Plant-related costs 6,500 6,500
14,500 22,500
Total costs $19,940 $30,560
continued next page

MA6-36. continued
b. With overhead costs assigned on the basis of activities as far as practicable,
standard briefcases cost $27.99 per unit and specialty briefcases, $32.72:
Standard Specialty
Direct materials $20.00 $17.50
Direct labor 6.00 3.00
Overhead ($19,940 10,000) 1.99 ($30,560 2,500) 12.22
Total $27.99 $32.72
If these ABC costs are compared with the traditional systems product costs, the
standard briefcase shows a lower cost while the specialty briefcase shows a
higher cost. The differences in the unit costs using the two systems are:
Product Costs
Standard Specialty
Traditional $30.49 $22.75
ABC 27.99 32.72
Difference $ 2.50 $(9.97)
Difference as a percent of traditional cost 8.20% (43.82)%
c. With ABC costing, the standard briefcase line now shows a gross profit of $2.01
($30.00 $27.99) per unit while the specialty line shows a loss of $0.72 ($32.00
$32.72) per unit. Thus, CarryAll is really making a profit on the product which
shows the loss using a direct labor hour basis for allocating overhead and losing
on the specialty line which appears profitable using traditional allocation
procedures. The president was correct in being concerned about the profitability
of the products, but the problem is with the specialty product line, not with the
standard line. Traditional allocation using a volume-based measure results in the
high-volume product subsidizing the low-volume product, affecting the profitability
of each. When costs are traced to products based on the activity causing the
costs, better costing data are available for evaluating the profitability of the
various products.
d. It is certainly important for CarryAll to determine that its traditional cost system
was distorting the cost of its products; and this should lead to important strategic
changes regarding the companys product mix and efforts. However, a
potentially greater benefit is that it can now move to the next level of using ABC
to manage its activities better, and better control the cost of activities. By
measuring the cost of key activities, CarryAll can determine whether all activities
are adding value to the products and, if so, whether there may be ways to
improve its processes so that the activities can be performed more efficiently and
possibly more effectively. Alternatively, it may want to consider outsourcing some
of its key activities, if it is determined that outsourcing can lead to more cost-
effectiveness.


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Chapter 6

ACTIVITY-BASED COSTING, CUSTOMER

1. Activities performed to serve customer needs cost money.

Q6-2. Implementing the two-stage model requires:

Cambridge Business Publishers, 2012

Materials movement Number of movements

Machine setup Number of setups

Inspection Number of inspections

Materials purchases Number of purchase orders

Customer service Number of customers

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Q6-8. Customers make varying demands on companies with some customers

Q6-9. Activity-Based Management (ABM) is the identification and selection of

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1. Open cargo hatch.

Cost of instruction per student $337.50 $562.50

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Product costs: C23 Cams U2 Shafts

Direct materials $30,000 $20,000

Direct materials $350,000 $150,000

Cost per gallon $ 7.67 $ 5.68

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Total support costs 34,200 21,300 21,620

Customer profits $ 65,800 $ 78,700 $ 78,380

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b. Manufacturing overhead cost of producing metal casements:

Number of setups 20 $160 = $ 3,200

Merlots cost system should provide an accurate measurement of manufacturing

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Plantwide overhead rate

= $38.67 per machine hour

b. Plantwide manufacturing overhead

= $232 per direct labor hour

c. Milling department overhead rate

= $34.40 per Milling Dept. machine hour

Finishing department overhead rate

= $120 per Finishing Dept. direct labor

d. Milling department overhead rate

= $344 per Milling Dept. direct labor hour

Finishing department overhead rate

= $60 per Finishing Dept. machine hour

Cambridge Business Publishers, 2012

Direct materials $40,000 $100,000 $140,000

b. Rate per unit of activity cost driver:

Materials acquisition Direct Materials

Materials movement 16,200 Number of moves 100 $162 per move

Scheduling 36,000 Number of batches 60 $600 per batch

Total direct materials costs $ 40,000 $ 100,000 $140,000

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Direct materials $15,000 $15,000

continued next page

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continued next page

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Job cost calculations: Job 201 Job 202

continued next page

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Job cost calculations: Job 201 Job 202

c. In addition to the manufacturing cost information provided by ABC, management

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