UNSW Business School

ACCT2522 Management Accounting 1

Term 1, 2019

Topic 1: Understanding Processes and Value Creation, and

Managing Costs I – Overhead Costs
Week 2: Tutorial Questions

Overall Theme of this Tutorial

The aim of this tutorial is twofold. First, we introduce a central theme that permeates this course –
process improvement. Students will learn to understand processes and their underlying activities,
evaluate processes, and hence, take steps to improve processes in order to reduce costs and create
value. Second, this tutorial continues with last week’s tutorial and completes the topic on assigning
costs to products using traditional costing systems. Our focus is on allocating manufacturing overhead
costs to products using departmental overhead rates. Students will first learn to allocate support
department costs to manufacturing department using different methods (from Topic 1), and then
practice allocating overhead costs from manufacturing departments to products (from Topic 0).

Desired Learning Outcomes and Essential Reading for this Topic

• Langfield-Smith, K., D. Smith, P. Andon, R. W. Hilton and H. Thorne (2018). Management

Accounting: Information for Managing and Creating Value, 8th ed, McGraw-Hill Australia Pty Ltd.
(Hereafter referred to as LS)
• Chapter 16 p. 761-769
• Chapter 7 p. 307-318

• BDMM Chapter 2 (extract)

• Available on Moodle

After completing this topic, you should be able to:

Part I: Understanding Processes and Value Creation

1. Understand processes
2. Understand the purpose of Activity-Based Management (ABM) and what it involves
3. Understand Business Process Re-engineering (BPR) and what it involves
Part II: Managing Cost I – Overhead Costs
4. Discuss the general principles and reasons for allocating indirect costs to responsibility centres
5. Allocate support department costs to production departments

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 Part I: Understanding Processes – The Ozy Lollipop Pty Ltd Case

Ozy Lollipop Pty Ltd (“Ozy”) is an Australian, family owned, manufacturing company that specializes in making
boutique lollipops. Ozy manufactures three types of lollipops in its factory with its best seller being Fizzy
Lemon. Ozy’s lollipops are well-known for their quality and for being hand-made in the old-fashioned way.
However, there has been increasing customer complaints about the lack of consistency in the taste and
texture of the lollipops, and the tightness of the lollipop wrappers (e.g., some lollipops have become half-
unwrapped because they were loosely wrapped and some are wrapped so tightly that the wrappers have to
be cut off).
In order to address these issues, John, the owner, visited the factory with his accountant to understand the
manufacturing process. 1 The list of activities identified are as follows:
(Note: All activities are performed by workers unless the activity is explicitly stated to be automated.
Also, the activities are the same for all types of lollipops except that different flavours are added.)
• Sugar, which is delivered by suppliers, is stored in the warehouse.
• When production starts, sugar is transported in trucks from the warehouse to the factory about 15mins
away and poured into a heated tank filled with water at 82°C.
• The sugar is left in the heated tank for about nine hours to dissolve.
• The sugary water is moved into a pre-cooker.
• Corn syrup delivered by suppliers is directly pumped into the pre-cooker.
• The mixture in the pre-cooker is heated to around 109°C to form a heated syrup.
• The heated syrup is poured into the final cooker.
• In the final cooker, the syrup is cooked under a vacuum for about four minutes to a temperate of 143°C.
The vacuum is necessary as it removes moisture and heat from the candy.
• After the candy is cooked, the candy is moved to the automated mixer.
• Pre-measured colour, flavour, and citric acid or malic acid are added to the candy in the automated mixer.
(One flavour of lollipop is made per batch.)
• The flavoured and coloured candy batch is thoroughly mixed using the automated mixer. Mixing not only
thoroughly distributes flavour and colour but reduces temperature and removes air bubbles produced from
cooking and mixing.
• The candy mixture is tested for (i) flavour and (ii) colour.
• Any candy that fails the flavour test or colour test is, respectively, re-flavoured or recoloured.
• Workers conduct a texture test using clean gloves to ensure that the candy is at the right consistency. Any
candy that fails the texture test is discarded.
• The cooling candy is moved onto metal tables.
• The workers cut the candy into the desired shape and insert a paper stick. (Each batch of candy is only cut
in one shape.) Any leftover candy is reheated before the workers remix the candy batch.
• The lollipops are then cooled in an electric cooling drum that rotates slowly while the lollipops are exposed
to cool air.
• The cooled lollipops are moved from the drum to the wrapping machine.
• The wrapping machine wraps the lollipops.
• The wrapped lollipops are moved to packing stations.
• The lollipops are packed into boxes or sealed into bags. The workers would randomly inspect the lollipops
by skimming through them during this process. Any poorly wrapped lollipops would be rewrapped.

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The process of manufacturing lollipops is adapted from http://www.madehow.com/Volume-6/Lollipop.html
and https://www.johnsonsconfectionery.com.au/about.

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• Boxes and bags of lollipops are randomly inspected for defects (e.g., torn boxes or plastic bags, and boxes
and bags that are not sealed properly). The lollipops are removed before the defective boxes or plastic
bags are discarded for repacking.
• The boxes and bags of lollipops are placed in crates and then trucked to the warehouse for storage.

Required:

Please note: these questions should be attempted after the self-study questions. All of the self-study
questions were selected to help you successfully complete this one!

1. Select two activities from the list of activities provided and suggest one (1) effectiveness measure and one
(1) efficiency measure for each of them. Explain your answer.

2. Identify two (2) non-value added activities. Explain why the activities are value-added or non-value added.

3. Suggest root-causes for the non-value added activities identified in Part (2).

4. Provide two recommendations to improve the lollipop manufacturing process. You need to classify each
recommendation:
a) Under one of the four ways of reducing activity costs e.g., activity elimination / reduction / selection /
sharing), and
b) As either business process re-engineering (BPR) or continuous improvement (CI).
Explain your classifications.

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 Part II: Managing Costs I – Advanced Electronics Ltd Case

Advanced Electronics Ltd manufactures two electronic devices - notebooks and tablets. Advanced
Electronics has two manufacturing departments: The Parts Department manufactures the various
components of the electronic devices, and the Assembly Department assembles the electronic
devices. Advanced Electronics uses machine hours as the cost driver for its Parts Department and
direct labour hours as the cost driver for its Assembly Department. The Parts Department has 30
machines, and each machine is budgeted to run for 2,000 hours per year. The Assembly Department
has 40 employees. Each employee is budgeted to work for 2,000 hours per year. The budgeted
overhead costs for the Parts and Assembly departments are as follows:

Budgeted Overhead Costs($)

Parts Department 600,000
Assembly Department 800,000

Advanced Electronics has two support departments: Materials Handling department (Materials) and
Power-generating department (Power). The budgeted costs for the Materials and Power departments
are as follows:

Budgeted Costs($)
Materials Handling Department 100,000
Power-generating Department 200,000

The manufacturing departments’ overhead rates cannot be determined until the support departments’
costs are allocated. The following schedule reflects the budgeted use of the Materials Department’s
and Power Department’s output by the various departments.

Used By
Supplied by Materials Power Parts Assembly
Materials (direct labour hours) - 300 250 50
Power (kilowatt-hours) 400 - 400 200

Required:

1. Assume that Advanced Electronics allocates the costs of support departments to manufacturing
departments using the reciprocal method.
a. Calculate the manufacturing overhead rates for the Parts and Assembly departments.
b. Calculate the manufacturing overhead costs allocated to notebooks and tablets given the
following additional information:

Notebooks Tablets
Actual MHs provided by Parts 26,400 39,600

Actual DHLs provided by Assembly 43,200 28,800

2. Assume that Advanced Electronics allocates the costs of supports department to manufacturing
departments using the step-down method. Calculate the support department costs allocated to
each manufacturing department.

3. The table on the next page provides the total budgeted overhead cost of the manufacturing
departments after costs of support departments were allocated to the manufacturing departments
using the step-down method. Compare the figures in the table with your answer in Part (1). Is the
reciprocal or step-down method preferable for allocating the costs of support departments to
manufacturing departments? Why?

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 Parts Assembly
Total budgeted OH cost $830,000 $870,000
Overhead rate per cost driver $13.83 per MH $10.88 per DLH

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 Self Study Questions and Solutions (complete in your own time)
Note: These questions will assist you with the tutorial questions for this week.

1. LS, Chapter 16, Exercise E16.23 Part (1) and (2) only.

2. Question 2

Required:
For each component, identify the type of improvement (i.e., activity elimination, reduction, selection,
or sharing).

3. Question 3

Suggest two effectiveness measure and two efficiency measures for each of the following processes:

(i) Airline reservation

(ii) Meals-on-wheels delivery
(iii) Bar tending

4. LS, Chapter 7, Self-Study Problems 1 and 2.

Solutions are on p. 320-322.

5. Extension of Self-Study Problem 1

Please use information from Self-Study Problem 1 and assume that the Engineering Department
provides 10% of its services to the Computing Services Department. Calculate the support
department costs that would be allocated from each of the support departments if the reciprocal
service method is used to allocate support department cost.

6. LS P7.39: Support department cost allocation: manufacturer

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Solutions:

1. LS, Chapter 16, Exercise E16.23 Part (1) and (2) only.

Non-value added activities Possible root-cause cost drivers

Store material No JIT system; suppliers unable to deliver at
short notice; unable to predict production
requirements accurately.

Move raw materials to production Factory layout, inadequate material movement

equipment; no JIT system

Set up extruding machine 2 Production scheduling, lack of training,

equipment that is difficult to set up.

Move product to assembly area Factory design

Inspect and test helmet Poor quality control in production area, poor
quality materials, lack of employee training

Move finished helmet to shipping Factory layout, inadequate material movement

equipment

2. Question 2

(a) Either activity reduction or selection

(b) Activity elimination (inspection) and reduction (less rework)
(c) Activity sharing

3. Question 3

(i) Airline reservation (sample answers)

• Effective: number of correct reservations, customer satisfaction ratings with regard to having their
queries addressed.
• Efficient: number of minutes taken on average for one reservation, number of calls taken per hour

(ii) Meals-on-wheels delivery (sample answers)

• Effective: number of incorrect meals delivered, number of cold meals delivered (assuming hot
meals are delivered)
• Efficient: number of meals delivered per hour, number of meals cooked per hour

(iii) Bar tending (sample answers)

• Effective: number of incorrect drinks served, tips relative to average tip takings
• Efficient: number of customers served per hour, number of litres of alcohol spilled (again both of
these best used against benchmarks)

2 Alternatively, students may choose to argue that the setting up of the extruding machine is a value-added

activity because the set-up is necessary before production can commence, even if it does not directly add to the
value of the product. In this case, the students can argue that excessive time and resources are incurred in the
setting up of the extruding machine. Thus, the root-cause cost drivers refer to the reason for the inefficiency.

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4. LS, Chapter 7, Self-Study Problems 1 and 2.

Solutions are on p. 320-322.

5. Extension of Self-Study Problem 1

Please use information from Self-Study Problem 1 and assume that the Engineering Department
provides 10% of its services to the Computing Services Department. Calculate the support
department costs that would be allocated from each of the support departments if the reciprocal
service method is used to allocate support department cost.

Stage 1: Let E = Total costs of Engineering Department

C = Total costs of Computing Services Department
(1) E = 600,000 + 0.2C
(2) C = 240,000 + 0.1E

Stage 2: Substituting (1) into (2) C = 240,000 + 0.1 (600,000 + 0.2C)

C = 240,000 + 60,000 + 0.02C
0.98C = 300,000
C = $306,122 (ANS) ... ... (3)

Substituting (3) into (1) E = 600,000 +0.2 (306,122)

E = 661,224 (ANS)

6. LS P7.39: Support department cost allocation: manufacturer

1 Direct method:
Production department
Machining Finishing
Cost to
be Proportio
Provider of service allocated Proportion Amount n Amount
HR $300 (3/9) $100 (6/9) $200
000 000 000
Maintenance 250 000 (6/15) 100 000* (9/15) 150 000*
Design 350 000 (5/8) 218 750 (3/8) 131 250
Total support department costs $418 $481
allocated 750 250
Overhead costs traceable to
production departments 800 000 500 000
$1 218 $981
Total overhead cost 750 250
Budgeted machine hours (MH) for
Machining Department 30 000
Budgeted direct labour hours
(DLH) for Finishing Department 15 000
Overhead rate per hour (total
overhead ÷ MH and DLH) $40.63* $65.42*
* Rounded

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2 Sequence for step-down method:
1st: HR (serves 2 other service departments)
2nd: Maintenance (serves 1 other service department)
3rd: Design (serves no other service departments)

3 Step-down method:
Service departments Production departments
HR Maintenance Design Machining Finishing
Costs prior to
allocation $300 000 $250 000 $350 000
Allocation of HR (30/100 (60/100
Department costs $300 000 15 000 (5/100) 15 000 (5/100) $90 000 ) $180 000 )
Allocation of
Maintenance 149
Department costs 265 000 16 562.50* (5/80) 99 375* (30/80) 062.50 (45/80)
Allocation of Design 381 143
Department costs 562.50 238 476.60 (50/80) 085.90 (30/80)
Total cost allocated 472
to each department 427 851.60 148.40
Overhead costs traceable to production departments 800 000 500 000
1 227 972
Total overhead cost
851.60 148.40
Budgeted machine hours (MH) for Machining Department 30 000
Budgeted direct labour hours (DLH) for Finishing Department 15 000
Overhead rate per hour (total overhead ÷ MH and DLH) $40.93* $64.81*
* Rounded