MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 11

SYSTEMS DESIGN: ACTIVITY-BASED COSTING

AND MANAGEMENT

I. Questions
1. The three levels available are: Level 1, in which a company uses a
plantwide overhead rate; Level 2, in which a company uses departmental
overhead rates; and Level 3, in which a company uses activity-based
costing.
2. New approaches to costing are needed because events of the last few
decades have made drastic changes in many organizations. Automation
has greatly decreased the amount of direct labor required to manufacture
products; product diversity has increased in that companies are
manufacturing a wider range of products and these products differ
substantially in volume, lot size, and complexity of design; and total
overhead cost has increased to the point in some companies that a
correlation no longer exists between it and direct labor.
3. The departmental approach to assigning overhead cost to products relies
solely on volume as an assignment base. Where diversity exists between
products (that is, where products differ in terms of number of units
produced, lot size, or complexity of production), volume alone is not
adequate for overhead costing. Overhead costing based on volume will
systematically overcost high-volume products and undercost low-volume
products.
4. Process value analysis (PVA) is a systematic approach to gaining an
understanding of the steps associated with a product or service. It
identifies all resource-consuming activities involved in the production
process and labels these activities as being either value-added or non-
value-added. Thus, it is the beginning point in designing an activity-
based costing system since management must know what activities are
involved with each product before activity centers can be designated and
cost drivers established. Also, PVA helps management to eliminate any
non-value-added activities and thereby streamline operations and
minimize costs.

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5. The four general levels of activities are:

1. Unit-level activities, which are performed each time a unit is
produced.
2. Batch-level activities, which are performed each time a batch of
goods is handled or processed.
3. Product-level activities, which are performed as needed to support
specific products.
4. Facility-level activities, which simply sustain a facility’s general
manufacturing process.
6. First, activity-based costing increases the number of cost pools used to
accumulate overhead costs. Second, it changes the base used to assign
overhead costs to products. And third, it changes a manager’s
perception of many overhead costs in that costs that were formerly
thought to be indirect (such as depreciation or machine setup) are
identified with specific activities and thereby are recognized as being
traceable to individual products.
7. The two chief limitations are: First, the portion of overhead costs that
relate to facility-level activities are still usually allocated to products on
some arbitrary basis, such as machine-hours or direct labor-hours.
Critics of activity-based costing argue that facility-level activities
account for the bulk of all overhead costs in some companies. Second,
high measurement costs are involved in operating an activity-based
costing system. That is, the system requires the tracking of large
amounts of detail and the completion of many separate computations in
order to determine the cost of a unit or product.
8. Yes, activity-based costing can be used in service organizations. It has
been successfully implemented, for example, in railroads, hospitals,
banks and data service companies.
9. A resource driver is a measure of the quality of resources consumed by
an activity.
10. An activity driver is a measure of frequency and intensity of demands
placed on activities by cost objects.
11. Two-stage allocation is a procedure that first assigns a firm’s resource
costs, namely factory overhead cost, to cost pools, and then to cost
objects.

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12. Two major advantages of ABM are:

a. ABM measures the effectiveness of the key business processes and
activities, and identifies how they can be improved to reduce costs
and improve the customer value.
b. ABM improves the management focus by allocating resources to key
value-added activities, key customers, key products, and continuous
improvement methods to maintain the firm’s competitive advantage.

II. True or False

1. True 3. False 5. False 7. True

2. True 4. True 6. False 8. True

III. Exercises

Exercise 1
Examples of Examples of
Activity Traceable Cost
Activity Classification Costs Drivers
a. Materials are moved Batch-level Labor cost; Number of
from the receiving depreciation receipts;
dock to product of equipment; pounds
flow lines by a space cost handled
material-handling
crew
b. Direct labor Unit-level Direct labor Direct labor-
workers assemble cost; indirect hours
various products labor cost;
labor benefits
c. Ongoing training is Facility-level* Space cost; Hours of
provided to all training costs; training time;
employees in the administration number
company costs trained
d. A product is Product-level Space cost; Hours of
designed by a supplies used; design time;
specialized design depreciation of number of
team design engineering
equipment change orders

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e. Equipment setups Batch-level Labor cost; Number of

are performed on a supplies used; setups; hours
regular basis depreciation of or setup time
equipment
f. Numerical control Unit-level Power; Machine-
(NC) machines are supplies used; hours; number
used to cut and maintenance; of units
shape materials depreciation
* Personnel administration and training costs might be traceable in part to the
facility-level and in part to other activity centers at the unit-level, product-
level, and batch-level.

Exercise 2

1. plantwide overhead rate

2. volume
3. two stage, stage, stage
4. Process value analysis
5. Unit-level
6. Batch-level
7. Product-level
8. Facility-level
9. high-volume, low-volume, low-volume
10. activity centers

IV. Problems

Problem 1

Cost Pool Cost Driver Cost

Systems Rate Consumption Assignment
Traditional cost system 350% P10,000 P35,000
ABC system
Labor 10% P10,000 P 1,000
Machining P25/hour 800 hours 20,000
Setup P10/hour 100 hours 1,000
Production order P100/order 12 orders 1,200
Material handling P20/requisition 5 requisitions 100
Parts administration P40/part 18 parts 720

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P24,020
Problem 2

Requirement 1

(a)
Total overhead = P200,000 + P32,000 + P100,000 + P120,000
= P452,000

Overhead rate = P452,000 / 50,000 direct labor hours

= P9.04 per direct labor hour

Overhead assigned to proposed job = P9.04 x 1,000 direct labor hours

= P9,040

(b) Total cost of proposed job:

Direct materials P 6,000
Direct labor 10,000
Overhead applied 9,040
Total cost P25,040

(c) Company’s bid = Full manufacturing cost x 120% = P25,040 x 120%

= P30,048

Requirement 2

(a) Maintenance : P200,000 / 20,000 = P10 per machine hour

Materials handling: P32,000 / 1,600 = P20 per move
Setups: P100,000 / 2,500 = P40 per setup
Inspection: P120,000 / 4,000 = P30 per inspection

Overhead assigned to proposed job:

Maintenance (P10 x 500) P5,000
Material handling (P20 x 12) 240
Setups (P40 x 2) 80
Inspection (P30 x 10) 300
Total overhead assigned to job P5,620

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(b) Total cost of proposed project:

Direct materials P 6,000
Direct labor 10,000
Overhead applied 5,620
Total cost P21,620

(c) Company’s bid = Full manufacturing cost x 120% = P21,620 x 120%

= P25,944

The bid price of P25,944 was determined as follows:

Direct materials P6,000
Direct labor 10,000
Overhead assigned:
Maintenance (P10 x 500) P5,000
Material handling (P20 x 12) 240
Setups (P40 x 2) 80
Inspections (P30 x 10) 300
Total overhead assigned to job 5,620
Total cost P21,620
Markup 120%
Bid price P25,944

V. Multiple Choice Questions

1. A 11. B 21. D
2. D 12. D 22. A
3. C 13. C 23. B
4. B 14. A 24. A
5. A 15. C 25. B
6. D 16. D 26. D
7. A 17. D 27. B
8. B 18. C 28. C
9. D 19. B 29. A
10. C 20. A 30. C

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