Assignment Material

Questions

1. 5-1. What is broad averaging, and what consequences can it have on costs?
2. 5-2. Why should managers worry about product overcosting or undercosting?
3. 5-3. What is costing system refinement? Describe three guidelines for refinement.
4. 5-4. What is an activity-based approach to designing a costing system?
5. 5-5. Describe four levels of a cost hierarchy.
6. 5-6. Why is it important to classify costs into a cost hierarchy?
7. 5-7. What are the key reasons for product cost differences between simple costing systems and ABC systems?
8. 5-8. Describe four decisions for which ABC information is useful.
9. 5-9. What are five behavioral issues to consider in implementing ABC systems?
10. 5-10. Describe four signs that help indicate when ABC systems are likely to provide the most benefits.
11. 5-11. What are the main costs and limitations of implementing ABC systems?
12. 5-12. “ABC systems only apply to manufacturing companies.” Do you agree? Explain.
13. 5-13. “Activity-based costing is the wave of the present and the future. All companies should adopt it.” Do you agree? Explain.
14. 5-14. “Increasing the number of indirect-cost pools is guaranteed to sizably increase the accuracy of product or service costs.” Do you agree? Why?
15. 5-15. The controller of a retail company has just had a $50,000 request to implement an ABC system quickly turned down. A senior vice president, in rejecting the request, noted, “Given a choice, I will always prefer a $50,000 investment in improving things a customer sees or experiences, such as our shelves or our store layout. How does a customer benefit by our spending $50,000 on a supposedly better accounting system?” How should the controller respond?

Multiple-Choice Questions

1. 5-16. Conroe Company is reviewing the data provided by its management accounting system. Which of the following statements is/are correct?
   1. I. A cost driver is a causal factor that increases the total cost of a cost object.
   2. II. Cost drivers may be volume based or activity based.
   3. III. Cost drivers are normally the largest cost in the manufacturing process.
   4. 1. I, II, and III are correct.
   5. 2. I and II only are correct.
   6. 3. I only is correct.
   7. 4. II and III only are correct.
2. 5-17. Nobis Company uses an ABC system. Which of the following statements is/are correct with respect to ABC?
   1. I. All cost allocation bases used in ABC systems are cost drivers.
   2. II. ABC systems are useful in manufacturing, but not in merchandising or service industries.
   3. III. ABC systems can eliminate cost distortions because ABC develops cost drivers that have a cause-and-effect relationship with the activities performed.
   4. 1. I, II, and III are correct.
   5. 2. II and III only are correct.
   6. 3. III only is correct.
   7. 4. None of the listed choices is correct.

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Exercises

1. 5-18. COST HIERARCHY. Roberta, Inc., manufactures elliptical machines for several well-known companies. The machines differ significantly in their complexity and their manufacturing batch sizes. The following costs were incurred in 2020:
   1. a. Indirect manufacturing labor costs such as supervision that supports direct manufacturing labor, $935,000
   2. b. Procurement costs of placing purchase orders, receiving materials, and paying suppliers related to the number of purchase orders placed, $650,000
   3. c. Cost of indirect materials, $234,000
   4. d. Costs incurred to set up machines each time a different product needs to be manufactured, $392,000
   5. e. Designing processes, drawing process charts, and making engineering process changes for products, $236,900
   6. f. Machine-related overhead costs such as depreciation, maintenance, and production engineering, $865,000 (These resources relate to the activity of running the machines.)
   7. g. Plant management, plant rent, and plant insurance, $498,000
   8. Required
   9. 1. Classify each of the preceding costs as output unit–level, batch-level, product sustaining, or facility sustaining. Explain each answer.
   10. 2. Consider two types of elliptical machines made by Roberta, Inc. One machine, designed for professional use, is complex to make and is produced in many batches. The other machine, designed for home use, is simple to make and is produced in few batches. Suppose that Roberta needs the same number of machine-hours to make each type of elliptical machine and that Roberta allocates all overhead costs using machine-hours as the only allocation base. How, if at all, would the machines be miscosted? Briefly explain why.
   11. 3. How is the cost hierarchy helpful to Roberta in managing its business?
2. 5-19. ABC, COST HIERARCHY, SERVICE. (CMA, adapted) Vineyard Test Laboratories does heat testing (HT) and stress testing (ST) on materials and operates at capacity. Under its current simple costing system, Vineyard aggregates all operating costs of $1,190,000 into a single overhead cost pool. Vineyard calculates a rate per test-hour of $17 ($1,190,000 ÷ 70,000 total test-hours). HT uses 40,000 test-hours, and ST uses 30,000 test-hours. Gary Celeste, Vineyard’s controller, believes that there is enough variation in test procedures and cost structures to establish separate costing and billing rates for HT and ST. The market for test services is becoming competitive. Without this information, any miscosting and mispricing of its services could cause Vineyard to lose business. Celeste divides Vineyard’s costs into four activity-cost categories.
   1. a. Direct-labor costs, $146,000. These costs can be directly traced to HT, $100,000, and ST, $46,000.
   2. b. Equipment-related costs (rent, maintenance, energy, and so on), $350,000. These costs are allocated to HT and ST on the basis of test-hours.
   3. c. Setup costs, $430,000. These costs are allocated to HT and ST on the basis of the number of setup-hours required. HT requires 13,600 setup-hours, and ST requires 3,600 setup-hours.
   4. d. Costs of designing tests, $264,000. These costs are allocated to HT and ST on the basis of the time required for designing the tests. HT requires 3,000 hours, and ST requires 1,400 hours.
   5. Required
   6. 1. Classify each activity cost as output unit–level, batch-level, product or service sustaining, or facility sustaining. Explain each answer.
   7. 2. Calculate the cost per test-hour for HT and ST. Explain briefly the reasons why these numbers differ from the $17 per test-hour that Vineyard calculated using its simple costing system.
   8. 3. Explain the accuracy of the product costs calculated using the simple costing system and the ABC system. How might Vineyard’s management use the cost hierarchy and ABC information to better manage its business?
3. 5-20. ALTERNATIVE ALLOCATION BASES FOR A PROFESSIONAL SERVICES FIRM. The Walliston Group (WG) provides tax advice to multinational firms. WG charges clients for (a) direct professional time (at an hourly rate) and (b) support services (at 30% of the direct professional costs billed). The three professionals in WG and their rates per professional hour are as follows:

1. WG has just prepared the May 2020 bills for two clients. The hours of professional time spent on each client are as follows:

1. 1. Required
   2. 1. What amounts did WG bill to San Antonio Dominion and Amsterdam Enterprises for May 2020?
   3. 2. Suppose support services were billed at $75 per professional labor-hour (instead of 30% of professional labor costs). How would this change affect the amounts WG billed to the two clients for May 2020? Comment on the differences between the amounts billed in requirements 1 and 2.
   4. 3. How would you determine whether professional labor costs or professional labor-hours is the more appropriate allocation base for WG’s support services?

1. 5-21. PLANTWIDE, DEPARTMENT, AND ABC INDIRECT COST RATES. Roadster Company (RC) designs and produces automotive parts. In 2020, actual variable manufacturing overhead is $280,000. RC’s simple costing system allocates variable manufacturing overhead to its three customers based on machine-hours and prices its contracts based on full costs. One of its customers has regularly complained of being charged noncompetitive prices, so RC’s controller Matthew Draper realizes that it is time to examine the consumption of overhead resources more closely. He knows that there are three main departments that consume overhead resources: design, production, and engineering. Interviews with the department personnel and examination of time records yield the following detailed information:

1. 1. Required
   2. 1. Compute the manufacturing overhead allocated to each customer in 2020 using the simple costing system that uses machine-hours as the allocation base.
   3. 2. Compute the manufacturing overhead allocated to each customer in 2020 using department-based manufacturing overhead rates.
   4. 3. Comment on your answers in requirements 1 and 2. Which customer do you think was complaining about being overcharged in the simple system? If the new department-based rates are used to price contracts, which customer(s) will be unhappy? How would you respond to these concerns?
   5. 4. How else might RC use the information available from its department-by-department analysis of manufacturing overhead costs?
   6. 5. RC’s managers are wondering if they should further refine the department-by-department costing system into an ABC system by identifying different activities within each department. Under what conditions would it not be worthwhile to further refine the department costing system into an ABC system?

1. 5-22. PLANTWIDE, DEPARTMENT, AND ACTIVITY-COST RATES. Trendy Inc. makes two styles of trophies, basic and deluxe, and operates at capacity. Trendy does large custom orders. Trendy budgets to produce 10,000 basic trophies and 5,000 deluxe trophies. Manufacturing takes place in two production departments: forming and assembly. In the forming department, indirect manufacturing costs are accumulated in two cost pools, setup and general overhead. In the assembly department, all indirect manufacturing costs are accumulated in one general overhead cost pool. The basic trophies are formed in batches of 200 but because of the more intricate detail of the deluxe trophies, they are formed in batches of 50.
2. The controller has asked you to compare plantwide, department, and activity-based cost allocation.

1. 1. Required
   2. 1. Calculate the budgeted unit cost of basic and deluxe trophies based on a single plantwide overhead rate, if total overhead is allocated based on total direct costs. (Don’t forget to include direct material and direct manufacturing labor cost in your unit cost calculation.)
   3. 2. Calculate the budgeted unit cost of basic and deluxe trophies based on departmental overhead rates, where forming department overhead costs are allocated based on direct manufacturing labor costs of the forming department and assembly department overhead costs are allocated based on total direct manufacturing labor costs of the assembly department.
   4. 3. Calculate the budgeted unit cost of basic and deluxe trophies if Trendy allocates overhead costs in each department using activity-based costing, where setup costs are allocated based on number of batches and general overhead costs for each department are allocated based on direct manufacturing labor costs of each department.
   5. 4. Explain briefly why plantwide, department, and activity-based costing systems show different costs for the basic and deluxe trophies. Which system would you recommend and why?

1. 5-23. ABC, PROCESS COSTING. Walsh Company produces mathematical and financial calculators and operates at capacity. Data related to the two products are presented here:

1. Total manufacturing overhead costs are as follows:

1. 1. Required
   2. 1. Choose a cost driver for each overhead cost pool and calculate the manufacturing overhead cost per unit for each product.
   3. 2. Compute the manufacturing cost per unit for each product.
   4. 3. How might Walsh’s managers use the new cost information from its activity-based costing system to better manage its business?

1. 5-24. DEPARTMENT COSTING, SERVICE COMPANY. DLN is an architectural firm that designs and builds buildings. It prices each job on a cost plus 20% basis. Overhead costs in 2020 are $8,100,000. DLN’s simple costing system allocates overhead costs to its jobs based on number of jobs. There were three jobs in 2020. One customer, Chandler, has complained that the cost and price of its building in Chicago was not competitive. As a result, the controller has initiated a detailed review of the overhead allocation to determine whether overhead costs should be charged to jobs in proportion to consumption of overhead resources by jobs. She gathers the following information:

1. 1. Required
   2. 1. Compute the overhead allocated to each project in 2020 using the simple costing system that allocates overhead costs to jobs based on the number of jobs.
   3. 2. Compute the overhead allocated to each project in 2020 using department overhead cost rates.
   4. 3. Do you think Chandler had a valid reason for dissatisfaction with the cost and price of its building? How does the allocation based on department rates change costs for each project?\

1. 5-25. ACTIVITY-BASED COSTING, SERVICE COMPANY. Aniline Corporation owns a small printing press that prints leaflets, brochures, and advertising materials. Aniline classifies its various printing jobs as standard jobs or special jobs. Aniline’s simple job-costing system has two direct-cost categories (direct materials and direct labor) and a single indirect-cost pool. Aniline operates at capacity and allocates all indirect costs using printing machine-hours as the allocation base.
2. Aniline is concerned about the accuracy of the costs assigned to standard and special jobs and therefore is planning to implement an activity-based costing system. Aniline’s ABC system would have the same direct-cost categories as its simple costing system. However, instead of a single indirect-cost pool, there would now be six categories for assigning indirect costs: design, purchasing, setup, printing machine operations, marketing, and administration. To see how activity-based costing would affect the costs of standard and special jobs, Aniline collects the following information for the fiscal year 2020 that just ended.

1. 1. Required
   2. 1. Calculate the cost of a standard job and a special job under the simple costing system.
   3. 2. Calculate the cost of a standard job and a special job under the activity-based costing system.
   4. 3. Compare the costs of a standard job and a special job in requirements 1 and 2. Why do the simple and activity-based costing systems differ in the cost of a standard job and a special job?
   5. 4. How might Aniline use the new cost information from its activity-based costing system to better manage its business?

1. 5-26. ACTIVITY-BASED COSTING, MANUFACTURING. Decorative Doors, Inc., produces two types of doors, interior and exterior. The company’s simple costing system has two direct-cost categories (materials and labor) and one indirect-cost pool. The simple costing system allocates indirect costs on the basis of machine-hours. Recently, the owners of Decorative Doors have been concerned about a decline in the market share for their interior doors, usually their biggest seller. Information related to Decorative Doors production for the most recent year follows:

1. The owners have heard of other companies in the industry that are now using an activity-based costing system and are curious how an ABC system would affect their product costing decisions. After analyzing the indirect-cost pool for Decorative Doors, the owners identify six activities as generating indirect costs: production scheduling, material handling, machine setup, assembly, inspection, and marketing. Decorative Doors collected the following data related to the indirect-cost activities:

1. Marketing costs were determined to be 3% of the sales revenue for each type of door.
   1. Required
   2. 1. Calculate the cost of an interior door and an exterior door under the existing simple costing system.
   3. 2. Calculate the cost of an interior door and an exterior door under an activity-based costing system.
   4. 3. Compare the costs of the doors in requirements 1 and 2. Why do the simple and activity-based costing systems differ in the cost of an interior door and an exterior door?
   5. 4. How might Decorative Doors, Inc., use the new cost information from its activity-based costing system to address the declining market share for interior doors?

1. 5-27. ABC, RETAIL PRODUCT-LINE PROFITABILITY. Fitzgerald Supermarkets operates at capacity and decides to apply ABC analysis to three product lines: baked goods, milk and fruit juice, and frozen foods. It identifies four activities and their activity-cost rates as follows:

1. The revenues, cost of goods sold, store support costs, activities that account for the store support costs, and activity-area usage of the three product lines are as follows:

1. Under its simple costing system, Fitzgerald Supermarkets allocated support costs to products at the rate of 30% of cost of goods sold.
   1. Required
   2. 1. Use the simple costing system to prepare a product-line profitability report for Fitzgerald Supermarkets.
   3. 2. Use the ABC system to prepare a product-line profitability report for Fitzgerald Supermarkets.
   4. 3. What new insights does the ABC system in requirement 2 provide to Fitzgerald Supermarkets managers?

1. 5-28. ABC, WHOLESALE, CUSTOMER PROFITABILITY. Ruiz Wholesalers operates at capacity and sells furniture items to four department-store chains (customers). Mr. Ruiz commented, “We apply ABC to determine product-line profitability. The same ideas apply to customer profitability, and we should find out our customer profitability as well.” Ruiz Wholesalers sends catalogs to corporate purchasing departments on a monthly basis. The customers are entitled to return unsold merchandise within a 6-month period from the purchase date and receive a full purchase price refund. The following data were collected from last year’s operations:

1. Ruiz has calculated the following activity rates:

1. Customers pay the transportation costs. The cost of goods sold averages 80% of net sales.
2. Required
3. Determine the contribution to profit from each customer last year. Comment on your solution.

1. 5-29. ACTIVITY-BASED COSTING. The job-costing system at Shirley’s Custom Framing has five indirect-cost pools (purchasing, material handling, machine maintenance, product inspection, and packaging). The company is in the process of bidding on two jobs: Job 215, an order of 16 intricate personalized frames, and Job 325, an order of six standard personalized frames. The controller wants you to compare overhead allocated under the current simple job-costing system and a newly designed activity-based job-costing system. Total budgeted costs in each indirect-cost pool and the budgeted quantity of each activity driver are as follows.

1. Information related to Job 215 and Job 325 follows. Job 215 incurs more batch-level costs because it uses more types of materials that need to be purchased, moved, and inspected relative to Job 325.

1. 1. Required
   2. 1. Compute the total overhead allocated to each job under a simple costing system, where overhead is allocated based on machine-hours.
   3. 2. Compute the total overhead allocated to each job under an activity-based costing system using the appropriate activity drivers.
   4. 3. Explain why Shirley’s Custom Framing might favor the ABC job-costing system over the simple job-costing system, especially in its bidding process.

1. 5-30. ABC, PRODUCT COSTING AT BANKS, CROSS-SUBSIDIZATION. United Savings Bank (USB) is examining the profitability of its Premier Account, a combined savings and checking account. Depositors receive a 2% annual interest rate on their average deposit. USB earns an interest rate spread of 3% (the difference between the rate at which it lends money and the rate it pays depositors) by lending money for home-loan purposes at 5%. Thus, USB would gain $60 on the interest spread if a depositor had an average Premier Account balance of $2,000 in 2020 $(\$\text{2,000}\times \mathrm{3\%}=\mathrm{\$60)}$.
2. The Premier Account allows depositors unlimited use of services such as deposits, withdrawals, checking accounts, and foreign currency drafts. Depositors with Premier Account balances of $1,000 or more receive unlimited free use of services. Depositors with minimum balances of less than $1,000 pay a $22-a-month service fee for their Premier Account.

1. USB recently conducted an activity-based costing study of its services. It assessed the following costs for six individual services. The use of these services in 2020 by three customers is as follows:

1. Assume Lindell and Colston always maintain a balance above $1,000, whereas Welker always has a balance below $1,000.
   1. Required
   2. 1. Compute the 2020 profitability of the Lindell, Welker, and Colston Premier Accounts at USB.
   3. 2. Why might USB worry about the profitability of individual customers if the Premier Account product offering is profitable as a whole?
   4. 3. What changes would you recommend for USB’s Premier Account?

Problems

1. 5-31. JOB COSTING WITH SINGLE DIRECT-COST CATEGORY, SINGLE INDIRECT-COST POOL, LAW FIRM. Timlin Associates is a recently formed law partnership. Rachel Hamilton, the managing partner of Timlin Associates, has just finished a tense phone call with Phil Lopez, president of Lopez Enterprises. Phil strongly complained about the price Timlin charged for some legal work done for his company.
2. Hamilton also received a phone call from Timlin’s only other client, Clinical Inc., which was very pleased with both the quality of the work and the price charged on its most recent job.
3. Timlin Associates operates at capacity and uses a cost-based approach to pricing (billing) each job. Currently it uses a simple costing system with a single direct-cost category (professional labor-hours) and a single indirect-cost pool (general support). Indirect costs are allocated to cases on the basis of professional labor-hours per case. The job files show the following:

1. Professional labor costs at Timlin Associates are $250 an hour. Indirect costs are allocated to cases at $125 an hour. Total indirect costs in the most recent period were $625,000.
   1. Required
   2. 1. Why is it important for Timlin Associates to understand the costs associated with individual jobs?
   3. 2. Compute the costs of the Lopez Enterprises and Clinical Inc. jobs using Timlin’s simple costing system.

1. 5-32. JOB COSTING WITH MULTIPLE DIRECT-COST CATEGORIES, SINGLE INDIRECT-COST POOL, LAW FIRM (CONTINUATION OF 5-31). Rachel Hamilton, the managing partner of Timlin Associates, asks her assistant to collect details on those costs included in the $625,000 indirect-cost pool that can be traced to each individual job. After analysis, Timlin is able to reclassify $450,000 of the $625,000 as direct costs:

1. Hamilton decides to calculate the costs of each job as if Timlin had used six direct-cost pools and a single indirect-cost pool. The single indirect-cost pool would have $175,000 of costs and would be allocated to each case using the professional labor-hours base.
   1. Required
   2. 1. Calculate the revised indirect-cost allocation rate per professional labor-hour for Timlin Associates when total indirect costs are $175,000.
   3. 2. Compute the costs of the Lopez Enterprises and Clinical Inc. jobs if Timlin Associates had used its refined costing system with multiple direct-cost categories and one indirect-cost pool.
   4. 3. Compare the costs of Lopez Enterprises and Clinical Inc. jobs in requirement 2 with those calculated using the simple costing system. Comment on the results.

1. 5-33. JOB COSTING WITH MULTIPLE DIRECT-COST CATEGORIES, MULTIPLE INDIRECT-COST POOLS, LAW FIRM (CONTINUATION OF 5-31 AND 5-32). Timlin has two classifications of professional staff: partners and associates. Hamilton asks her assistant to examine the relative use of partners and associates on the recent Lopez Enterprises and Clinical Inc. jobs. The Lopez Enterprises job used 1,400 partner-hours and 1,100 associate-hours. The Clinical Inc. job used 1,100 partner-hours and 1,400 associate-hours. Therefore, totals of the two jobs together were 2,500 partner-hours and 2,500 associate-hours. Hamilton decides to examine how using separate direct-cost rates for partners and associates and using separate indirect-cost pools for partners and associates would have affected the costs of the Lopez Enterprises and Clinical Inc. jobs. Indirect costs in each indirect-cost pool would be allocated on the basis of total hours of that category of professional labor. From the total indirect-cost pool of $175,000, $100,000 is attributable to the activities of partners and $75,000 is attributable to the activities of associates.
2. The rates per category of professional labor are as follows:

1. 1. Required
   2. 1. Compute the costs of the Lopez Enterprises and Clinical Inc. jobs using Timlin’s further refined system, with multiple direct-cost categories and multiple indirect-cost pools.
   3. 2. For what decisions might Timlin Associates find it more useful to use this job-costing approach rather than the approaches of a simple costing system or a refined costing system with multiple direct-cost categories and one indirect-cost pool?

1. 5-34. FIRST-STAGE ALLOCATION, TIME-DRIVEN ACTIVITY-BASED COSTING, MANUFACTURING SECTOR. Marshall Devices manufactures metal products and uses activity-based costing to allocate overhead costs to customer orders for pricing purposes. Many customer orders are won through competitive bidding based on costs. Direct material and direct manufacturing labor costs are traced directly to each order. Marshall’s direct manufacturing labor rate is $20 per hour. The company reports the following budgeted yearly overhead costs:

1. Marshall has established four activity-cost pools and the following budgeted activity for each cost pool:

1. Some customer orders require more complex designs, while others need simple designs. Marshall estimates that it will do 120 complex designs during a year, which will each take 11.75 hours for a total of 1,410 design-hours. It estimates it will do 180 simple designs, which will each take 6 hours for a total of 1,080 design-hours.
2. Paul Napoli, Marshall’s controller, has prepared the following estimates for distribution of the overhead costs across the four activity-cost pools:

1. Order 277100 consists of four different metal products. Three products require a complex design and one requires a simple design. Order 277100 requires $4,550 of direct materials and 80 direct manufacturing labor-hours.
   1. Required
   2. 1. Allocate the overhead costs to each activity-cost pool. Calculate the activity rate for each pool.
   3. 2. Determine the cost of Order 277100.
   4. 3. How does activity-based costing enhance Marshall’s ability to price its orders? Suppose Marshall used a simple costing system to allocate all overhead costs to orders on the basis of direct manufacturing labor-hours. How might this have affected Marshall’s pricing decision for Order 227100?
   5. 4. When designing its activity-based costing system, Marshall uses time-driven activity-based costing (TDABC) for its design department. What does this approach allow Marshall to do? How would the cost of Order 277100 have been different if Marshall had used the number of customer designs rather than the number of custom design-hours to allocate costs to different customer orders? Which cost driver do you prefer for design support? Why?

1. 5-35. FIRST-STAGE ALLOCATION, TIME-DRIVEN ACTIVITY-BASED COSTING, SERVICE SECTOR. LawnCare USA provides lawn care and landscaping services to commercial clients. LawnCare USA uses activity-based costing to bid on jobs and to evaluate their profitability. LawnCare USA reports the following budgeted annual costs:

1. John Gilroy, controller of LawnCare USA, has established four activity-cost pools and the following budgeted activity for each cost pool:

1. Gilroy estimates that LawnCare USA’s costs are distributed to the activity-cost pools as follows:

1. Sunset Office Park, a new development in a nearby community, has contacted LawnCare USA to provide an estimate on landscape design and annual lawn maintenance. The job is estimated to require a single landscape design requiring 40 design hours in total and 250 direct labor-hours annually. LawnCare USA has a policy of pricing estimates at 150% of cost.
   1. Required
   2. 1. Allocate LawnCare USA’s costs to the activity-cost pools and determine the activity rate for each pool.
   3. 2. Estimate total cost for the Sunset Office Park job. How much would LawnCare USA bid to perform the job?
   4. 3. LawnCare USA does 30 landscape designs for its customers each year. Estimate the total cost for the Sunset Office park job if LawnCare USA allocated costs of the Landscape Design activity based on the number of landscape designs rather than the number of landscape design-hours. How much would LawnCare USA bid to perform the job? Which cost driver do you prefer for the Landscape Design activity? Why?
   5. 4. Sunset Office Park asks LawnCare USA to give an estimate for providing its services for a 2-year period. What are the advantages and disadvantages for LawnCare USA to provide a 2-year estimate?

1. 5-36. DEPARTMENT AND ACTIVITY-COST RATES, SERVICE SECTOR. Raynham’s Radiology Center (RRC) performs X-rays, ultrasounds, computer tomography (CT) scans, and magnetic resonance imaging (MRI). RRC has developed a reputation as a top radiology center in the state. RRC has achieved this status because it constantly reexamines its processes and procedures. RRC has been using a single, facilitywide overhead allocation rate. The vice president of finance believes that RRC can make better process improvements if it uses more disaggregated cost information. She says, “We have state-of-the-art medical imaging technology. Can’t we have state-of-the-art accounting technology?”

1. RRC operates at capacity. The proposed allocation bases for overhead are:

1. 1. Required
   2. 1. Calculate the budgeted cost per service for X-rays, ultrasounds, CT scans, and MRI using direct technician labor costs as the allocation basis.
   3. 2. Calculate the budgeted cost per service of X-rays, ultrasounds, CT scans, and MRI if RRC allocated overhead costs using activity-based costing.
   4. 3. Explain how the disaggregation of information could be helpful to RRC’s intention to continuously improve its services.

1. 5-37. ACTIVITY-BASED COSTING, MERCHANDISING. Pharmassist, Inc., a distributor of special pharmaceutical products, operates at capacity and has three main market segments:
   1. a. General supermarket chains
   2. b. Drugstore chains
   3. c. Mom-and-pop single-store pharmacies
2. Rick Flair, the new controller of Pharmassist, reported the following data for 2020.

1. For many years, Pharmassist has used gross margin percentage to evaluate the relative profitability of its market segments. But Flair recently attended a seminar on activity-based costing and is considering using it at Pharmassist to analyze and allocate “other operating costs.” He meets with all the key managers and several of his operations and sales staff, and they agree that there are five key activities that drive other operating costs at Pharmassist:

1. Each customer order consists of one or more line items. A line item represents a single product (such as Extra-Strength Tylenol Tablets). Each product line item is delivered in one or more separate cartons. Each store delivery entails the delivery of one or more cartons of products to a customer. Pharmassist’s staff stacks cartons directly onto display shelves in customers’ stores. Currently, there is no additional charge to the customer for shelf stocking and not all customers use Pharmassist for this activity. The level of each activity in the three market segments and the total cost incurred for each activity in 2020 is as follows:

1. 1. Required
   2. 1. Compute the 2020 gross-margin percentage for each of Pharmassist’s three market segments.
   3. 2. Compute the cost driver rates for each of the five activity areas.
   4. 3. Use the activity-based costing information to allocate the $313,075 of “other operating costs” to each of the market segments. Compute the operating income for each market segment.
   5. 4. Comment on the results. What new insights are available with the activity-based costing information?

1. 5-38. CHOOSING COST DRIVERS, ACTIVITY-BASED COSTING, ACTIVITY-BASED MANAGEMENT. Pastel Bags (PB) is a designer of high-quality backpacks and purses. Each design is made in small batches. Each spring, PB comes out with new designs for the backpack and the purse. The company uses these designs for a year and then moves on to the next trend. The bags are all made on the same fabrication equipment that is expected to operate at capacity. The equipment must be switched over to a new design and set up to prepare for the production of each new batch of products. When completed, each batch of products is immediately shipped to a wholesaler. Shipping costs vary with the number of shipments. Budgeted information for the year is as follows:

1. Other budget information follows:

1. 1. Required
   2. 1. Identify the cost hierarchy level for each cost category.
   3. 2. Identify the most appropriate cost driver for each cost category. Explain briefly your choice of cost driver.
   4. 3. Calculate the budgeted cost per unit of cost driver for each cost category.
   5. 4. Calculate the budgeted total costs and cost per unit for each product line.
   6. 5. Explain how you could use the information in requirement 4 to reduce costs.

1. 5-39. ABC, HEALTH CARE. Phoenix Medical Associates operates a walk-in medical clinic in Tempe, Arizona. The clinic includes two different departments, Urgent Care, which serves patients with minor to moderate acute illnesses and injuries, and Living Well, which administers vaccines, school and work physicals, and conducts workshops on healthy living topics. The center’s budget for 2020 follows.

1. Anita Alvarez, the director of the clinic, is keen on determining the cost of each department. Alvarez compiles the following data describing employee allocations to individual departments:

1. Alvarez has recently become aware of activity-based costing as a method to refine costing systems. She asks her accountant, David Burke, how she should apply this technique. Burke obtains the following budgeted information for 2020:

1. 1. Required
   2. 1. 
      1. a. Selecting cost-allocation bases that you believe are the most appropriate for allocating indirect costs to departments, calculate the budgeted indirect cost rates for medical supplies, rent and clinic maintenance, laboratory services, and general overhead.
      2. b. Using an activity-based costing approach to cost analysis, calculate the budgeted cost of each department and the budgeted cost per patient visit of each department.
      3. c. What benefits can Phoenix Medical Associates obtain by implementing the ABC system?
   3. 2. What factors, other than cost, do you think Phoenix Medical Associates should consider in allocating resources to its departments?

1. 5-40. UNUSED CAPACITY, ACTIVITY-BASED COSTING, ACTIVITY-BASED MANAGEMENT. Zarson’s Netballs is a manufacturer of high-quality basketballs and volleyballs. Setup costs are driven by the number of setups. Equipment and maintenance costs increase with the number of machine-hours, and lease rent is paid per square foot. Capacity of the facility is 14,000 square feet, and Zarson is using only 80% of this capacity. Zarson records the cost of unused capacity as a separate line item and not as a product cost. The following is the budgeted information for Zarson:

1. Other budget information follows:

1. 1. Required
   2. 1. Calculate the budgeted cost per unit of cost driver for each indirect-cost pool.
   3. 2. What is the budgeted cost of unused capacity?
   4. 3. What is the budgeted total cost and the cost per unit of resources used to produce (a) basketballs and (b) volleyballs?2. What is the budgeted cost of unused capacity?
   5. 4. Why might excess capacity be beneficial for Zarson? What are some of the issues Zarson should consider before increasing production to use the space?

1. 5-41. [UNUSED CAPACITY, ACTIVITY-BASED COSTING, ACTIVITY-BASED MANAGEMENT. Huntington Boards manufactures two models of surfboards, Basic and Competition, in a facility in Southern California. In fabrication, machine setup costs are driven by the number of setups, and machine maintenance and utility costs increase with the number of machine hours, and indirect labor costs increase with direct labor hours. Facility rent and machine depreciation are fixed, and are the basis of manufacturing capacity. Fixed costs are allocated equally to each unit produced, regardless of model. Currently, Huntington uses 80% of its manufacturing capacity. The cost of unused capacity is not assigned to products, but is expensed as a separate line item. For 2020, Huntington has budgeted the following:

1. Other information:

1. 1. Required
   2. 1. Calculate the cost-allocation rate for each of the activity-cost pools for variable and fixed overhead costs.
   3. 2. Calculate the cost of unused capacity for the year.
   4. 3. Calculate the total cost for each model, and the cost per unit for each model.
   5. 4. Huntington has the opportunity to sublease the unused factory space to a startup company that will be manufacturing surf apparel. None of Huntington’s machinery will be used. Is there a minimum annual rent that Huntington should charge? Are there any other considerations that Huntington’s management should make prior to offering the space?

1. 5-42. ABC, IMPLEMENTATION, ETHICS. (CMA, adapted) Plum Electronics, a division of Berry Corporation, manufactures two large-screen television models: the Mammoth, which has been produced since 2016 and sells for $990, and the Maximum, a newer model introduced in early 2018 that sells for $1,254. Based on the following income statement for the year ended November 30, 2020, senior management at Berry have decided to concentrate Plum’s marketing resources on the Maximum model and to begin to phase out the Mammoth model because Maximum generates much higher operating income per unit.

1. Details for cost of goods sold for Mammoth and Maximum are as follows:

1. Plum’s controller, Steve Jacobs, is advocating the use of activity-based costing and activity-based management and has gathered the following information about the company’s manufacturing overhead costs for the year ended November 30, 2020.

1. After completing his analysis, Jacobs shows the results to Charles Clark, the Plum division president. Clark does not like what he sees. “If you show headquarters this analysis, they are going to ask us to phase out the Maximum line, which we have just introduced. This whole costing stuff has been a major problem for us. First Mammoth was not profitable and now Maximum isn’t.
2. “Looking at the ABC analysis, I see two problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. Second, you used number of setups and number of inspections as allocation bases. The numbers would be different had you used setup-hours and inspection-hours instead. I know that measurement problems precluded you from using these other cost-allocation bases, but I believe you ought to make some adjustments to our current numbers to compensate for these issues. I know you can do better. We can’t afford to phase out either product.”
3. Jacobs knows that his numbers are fairly accurate. As a quick check, he calculates the profitability of Maximum and Mammoth using more and different allocation bases. The set of activities and activity rates he had used results in numbers that closely approximate those based on more detailed analyses. He is confident that headquarters, knowing that Maximum was introduced only recently, will not ask Plum to phase it out. He is also aware that a sizable portion of Clark’s bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, he feels some pressure from Clark to do something.
   1. Required
   2. 1. Using activity-based costing, calculate the gross margin per unit of the Maximum and Mammoth models.
   3. 2. Explain briefly why these numbers differ from the gross margin per unit of the Maximum and Mammoth models calculated using Plum’s existing simple costing system.
   4. 3. Comment on Clark’s concerns about the accuracy and limitations of ABC.
   5. 4. How might Plum find the ABC information helpful in managing its business?
   6. 5. What should Steve Jacobs do in response to Clark’s comments?

1. 5-43. ACTIVITY-BASED COSTING, ACTIVITY-BASED MANAGEMENT, MERCHANDISING. Pet World operates a pet supply superstore in Atlanta with three main product lines: food, toys, and accessories. Pet World allocates common selling, general, and administration (SG&A) costs to each product line using the cost of merchandise of each product line. Department manager salaries, while considered SG&A, are direct and are assigned directly to each product line. The company wants to optimize the pricing and cost management of each product line and is wondering whether its accounting system is providing it with the best information for making such decisions. Store manager Jason Wu gathers the following information regarding the three product lines:

1. For 2020, Pet World budgets the following selling, general, and administration costs:

1. 1. Required
   2. 1. Prepare an income statement for Pet World, by product line and in total, allocating common SG&A expenses using cost of merchandise. Calculate the profit per square foot of store space for each product line.
   3. 2. Identify an improved method for allocating costs to the three product lines. Explain. Use the method for allocating SG&A costs that you propose to prepare new product-line income statements. Calculate the profit per square foot of store space for each product line. Compare your results to the results in requirement 1.
   4. 3. What recommendations would you make to the store manager based on the results of the activity-based costing analysis?