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					Exercise 7-1: ABC Cost Hierarchy

Given:

Classify each of the following activities as either a unit-level, a batch-level, a product-level, or an
organization-sustaining activity. These activities occur at Greenwich Corporation, a company that
manufactures a variety of products.

     Unit-level activities:     Activities that are performed each time a unit is produced.

     Batch-level activities:    Activities that are performed each time a batch of goods is handled or processed,
                                   regardless of how many units are in the batch. The amount of resource consumed
                                   depends on the number of batches run rather than on the number of units in the
                                   batch.

     Product-level activities: Activities that relate to specific products that must be carried out regardless of how
                                 many units are produced and sold or batches run.

     Customer-level activities: Activities that are carried out to support customers but that are not related to
                                any specific product.

     Organization-sustaining activities: Activities that are carried out regardless of which customers are served,
                                which products are produced, how many batches are run, or how many units are
                                made.

a. Various individuals manage the parts inventory.                                            Product-level


b. A clerk in the factory issues purchase orders for a job.                                   Batch-level


c. The personnel department trains new production workers                                     Organization-sustaining


d. The factory's general manager meets with other department heads such as                    Organization-sustaining
   marketing to coordinate plans.


e. Direct labor workers assemble products.                                                    Unit-level


f.   Engineers design new products.                                                           Product-level


g. The materials storekeeper issues raw materials to be used in jobs.                         Batch-level


h. The maintenance department performs periodic preventive maintenance on                     Organization-sustaining
   general-use equipment.
ource consumed
of units in the


ardless of how




ers are served,
many units are




ion-sustaining


ion-sustaining




ion-sustaining
Exercise 7-14: Cost Hierarchy

Given:

Green Glider Corporation makes golf carts that it sells directly to golf courses throughout the world.
Several basic models are available, which are modified to suit the needs of each particular golf course.
A golf course located in the Pacific Northwest, for example, would typically specify that its golf carts
come equipped with retractable rain-proof covers. In addition, each customer (i.e., golf course)
customizes its golf carts with its own color scheme and logo. The company typically makes all of the
golf carts for a customer before starting work on the next customer's golf carts.

Required:

Unit-level activities:       Activities that are performed each time a unit is produced.

Batch-level activities:     Activities that are performed each time a batch of goods is handled or processed,
                               regardless of how many units are in the batch. The amount of resource consumed
                               depends on the number of batches run rather than on the number of units in the
                               batch.

Product-level activities: Activities that relate to specific products that must be carried out regardless of how
                            many units are produced and sold or batches run.

Customer-level activities: Activities that are carried out to support customers but that are not related to
                             any specific product.

Organization-sustaining activities: Activities that are carried out regardless of which customers are served,
                            which products are produced, how many batches are run, or how many units are
                            made.

Classify each of the costs or activities below as unit-level, batch-level, product-level, customer-level, or
organization-sustaining. In this case, customers are golf courses, products are models of the golf cart,
a batch is a specific order from a customer, and units are individual golf carts.

a. The purchasing department orders the specific color of paint                   batch-level
   specified by the customer from the company's supplier.

b. A steering wheel is installed in a golf cart.                                  unit-level

c. An outside attorney draws up a new generic sales contract for the              organization-sustaining
   company limiting Green Glider's liability in case of accidents that
   involve its golf carts.

d. The company's paint shop makes a stencil for a customer's logo.                batch-level

e. A sales representative visits an old customer to check on how                  customer-level
   the company's golf carts are working out and to try to make a
   new sale.

f.   The accounts receivable department prepares the bill for a                   batch-level
     completed order.
g. Electricity is used to heat and light the factory and the           organization-sustaining
   administrative offices.

h. A golf cart is painted.                                             unit-level

i.   The company's engineer modifies the design of a model to          product-level
     eliminate a potential safety problem.

j.   The marketing department has a catalogue printed and then mails   customer-level
     copies to golf course managers.

k. Completed golf carts are individually tested on the company's       unit-level
   test track.

l.   A new model golf cart is shipped to the leading golfing trade     product-level
     magazine to be evaluated for the magazine's annual rating of
     golf carts.
onsumed
Problem 7-11: Comprehensive ABC Problem

Given:   Silicon Optics has supplied the following data for use in its ABC system:

   Overhead Costs
     Wages & salaries                                 $350,000
     Other overhead costs                              200,000
        Total overhead costs                          $550,000

   Activity Cost Pool              Activity Measure (Driver)                           Total Activity
      DL support                   Number of DL Hours                                  10,000 DLHs
      Order processing             Number of orders                                       500 Orders
      Customer support             Number of customers                                    100 Customers
      Other                        These costs are not allocated
                                   to products or customers
                                   These are organization-sustaining activities.

                                   Distribution of Resource Consumption Across Activity Cost Pools
                                        DL          Order      Customer
                                     Support      Processing    Support     Other         Total
      Wages & salaries                     30%            35%        25%         10%          100%
      Other overhead costs                 25%            15%        20%         40%          100%

   During the year, Silicon Optics completed an order for a special optical switch for a new customer, Indus
   Telecom. This customer did not order any other products during the year. Data concerning that order
   follow:

      Data Concerning the Indus Telecom Order
      Selling price                  $295 per unit
      Units ordered                    100 units
      Direct materials               $264 per unit
      Direct labor-hours              0.50 DLH per unit
      Direct labor rate                $25 per DLH

Required:

1. Prepare a report showing the first-stage allocations of overhead costs to the activity cost pools.
   (See Exhibit 7-5)
                                                    DL          Order       Customer
   Overhead Costs                   Totals       Support      Processing     Support        Other
      Wages & salaries             $350,000        $105,000     $122,500       $87,500       $35,000
      Other overhead costs           200,000         50,000       30,000        40,000         80,000
         Total overhead costs      $550,000        $155,000     $152,500      $127,500      $115,000

2. Compute the activity rates for the activity cost pools.
   (See Exhibit 7-6)
                                                     DL            Order           Customer
   Overhead Costs                   Totals        Support        Processing         Support      Other
   Total overhead costs             $550,000        $155,000       $152,500          $127,500    $115,000
   Total activity measures                            10,000            500               100     N/A
   Rate per activity cost pool                        $15.50        $305.00         $1,275.00
                                                  DLHs          Orders      Customers

3. Prepare a report showing the overhead costs for the order from Indus Telecom, including
   customer support costs.
                                                                 Indus Telecom
                                      Cost            Pool     Driver    ABC Costs
   Activity Cost Pool                 Driver          Rate     Usage      Assigned
      DL support                      DLHs              $15.50   50          $775.00
      Order processing                Orders           $305.00    1           305.00
      Customer support              Customers        $1,275.00    1         1,275.00
          Total support costs assigned to Indus Telecom                    $2,355.00

4. Prepare a report showing the customer margin for Indus Telecom. (See Exhibit 7-11.)

   ABC Analysis Customer Margin Report for Indus Telecom
     Sales (100 units X $295)                                                  $29,500
     Costs:
        Direct Costs Traced
        Direct materials ($264 per unit X 100 units)              $26,400
        Direct labor ($25 per DLH X .5 DLH X 100 units)            $1,250
        Indirect Support Costs Allocated Using ABC
         Break-even point: 400 persons,
        DL support                                                   $775             Total Expenses
                                                                                    Fixed Expenses
                                                                                  Total Sales
        Order processing                                             $305
        Customer support                                           $1,275
            Total Assigned Costs                                               $30,005
     Customer Margin                                                             ($505)

Exercise 7A-4 Comprehensive Activity-Based Costing Exercise

1. Prepare a report showing the first-stage allocations of overhead costs to the activity cost pools.
   (Same as E7-11)
                                                    DL          Order       Customer
   Overhead Costs                   Totals       Support      Processing     Support        Other
      Wages & salaries             $350,000        $105,000     $122,500       $87,500       $35,000
      Other overhead costs           200,000         50,000       30,000        40,000         80,000
         Total overhead costs      $550,000        $155,000     $152,500      $127,500      $115,000

2. Compute the activity rates for the activity cost pools.
   (Same as E7-11, but rates by Overhead costs within pools)
                                                     DL          Pool      Order            Pool    Customer
   Overhead Costs                   Totals        Support        Rate    Processing         Rate     Support
      Wages & salaries              $350,000        $105,000      $10.50   $122,500            $245   $87,500
      Other overhead costs           200,000          50,000       $5.00     30,000             $60    40,000
         Total overhead costs       $550,000        $155,000      $15.50   $152,500            $305 $127,500
                                                                 DLHs                      Orders

3. Prepare a report showing the overhead costs for the order from Ides Telecom including customer support.
                                                 DL            Order      Customer       Total
      Activity                                Support       Processing     Support     Support
      Expected measure of cost driver             50             1            1
      Wages & Salaries                                  $525           $245           $875         $1,645
      Other Overhead Costs                              $250            $60           $400           $710
      Total Costs                                       $775           $305         $1,275         $2,355

4. Prepare a report showing the customer margin for Indus Telecom

   ABC Analysis Customer Margin Report for Indus Telecom
     Sales (100 units X $295)                                                      $29,500
     Costs:
        Direct Costs Traced
        Direct materials ($264 per unit X 100 units)                $26,400
        Direct labor ($25 per DLH X .5 DLH X 100 units)              $1,250
        Indirect Support Costs Allocated Using ABC
         Break-even point: 400 persons,
        DL support                                                     $775
        Order processing                                               $305
        Customer support                                             $1,275
            Total Assigned Costs                                                   $30,005
     Customer Margin                                                                 ($505)

5. Prepare an action analysis report showing the customer margin for Indus Telecom. Direct materials should
   be coded as a Green cost, direct labor and wages and salaries as Yellow costs, and other overhead costs as
   Red costs.

   Definition of an Action analysis report:    A report showing what costs have been assigned to a cost object, such as a
                                              product or customer, and how difficult it would be to adjust the cost if there is
                                              a change in activity.

   Ease of Adjustment Codes:                  " Green " costs are those costs that would adjust more or less automatically
                                              to changes in activity without any action by managers.

                                              " Yellow " costs are those costs that could be adjusted in response to changes
                                              in activity, but such adjustments require management action; the adjustment
                                              is not automatic.

                                              " Red " costs are costs that could be adjusted to changes in activity only with
                                              a great deal of difficulty and the adjustment would require management action.

   ABC Analysis Customer Margin Report for Indus Telecom                                                      No Indus Telcom Bus
     Sales (100 units X $295)                                                      $29,500                             0
     Costs:
        Green costs:
        Direct materials ($264 per unit X 100 units)                                26,400                              0
        Green margin:                                                                $3,100
        Yellow costs:
        Direct labor ($25 per DLH X .5 DLH X 100 units)              $1,250                                            0
        Overhead: Wages and Salaries                                  1,645           2,895                      (1,645)
        Yellow margins:                                                                $205
        Red costs:
         Break-even costs
        Other overheadpoint: 400 persons,                                              710                         (710)
        Red margins:                                                                 ($505)                     ($2,355)
6. What action, if any, do you recommend as a result of the above analysis?

   While the company appears to have incurred a loss on its business with Indus Telecom, caution must be exercised.
   The Green margin on the business was $3,100. Silicon Optics really incurred a loss on this business only if at least
   $3,100 of the yellow and red costs ($2,895 + $710 = $3,605) would have been avoided if the Indus Telecom order
   had been rejected.

      For example, we don't know what specific costs are included in the "other overhead" category. If these costs are
      committed fixed costs that cannot be avoided in the short run, then the company would have been worse off if the
      Indus Telecom order had not been accepted.

   Suppose that Indus Telecom will be submitting a similar order every year. As a general policy, the company might
   consider turning down this business in the future. Costs that cannot be avoided in the short run, may be avoided in
   the long run through the budgeting process or in some other manner. However, if the Indus Telecom business is
   turned down, management must make sure that at least $3,100 of the yellow and red costs are really eliminated or the
   resources represented by those costs are really redeployed to the constraint. If these costs remain unchanged, then
   the company would be better off accepting rather than rejecting business from the Indus Telecom in the future.
  Pool                 Pool
  Rate       Other     Rate
     $875    $35,000    N/A
     $400     80,000    N/A
   $1,275   $115,000   N/A
Customers
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Exercise 7B-1:     Activity-Based Costing Product Costs for External Reports

Given:
Pryad Corporation makes ultra-lightweight backpacking tents. Data concerning the company's two
product lines appear below:
                                               Deluxe      Standard
   DM per unit                                  $60.00        $45.00
   DL per unit                                   $9.60         $7.20
   DL-hours per unit                               0.80          0.60
   Estimated annual production                  10,000        70,000

The company has a traditional costing system in which MOH is applied to units based on DL-hours.
Data concerning MOH and DL-hours for the upcoming year appear below:

   Estimated total MOH                        $290,000
   Estimated total DL-Hours                     50,000

Required:
1. Determine the unit product costs of Deluxe and Standard products under the company's
   traditional costing system
                                            Deluxe     Standard
   Direct Materials                           $60.00      $45.00
   Direct Labor                                $9.60       $7.20
   Applied MOH
       Predetermined MOH           $5.80
       DL-hours per unit            0.80       $4.64

       Predetermined MOH             $5.80
       DL-hours per unit              0.60                     $3.48
        Traditional Unit Cost                   $74.24        $55.68

2. The company is considering replacing its traditional costing system for determining unit
   product costs for external reports with an ABC system. The ABC system would have the
   following three activity cost pools:
                                                        Estimated
                                            Cost per    Overhead             Expected Activity
              Activities          Driver     Driver       Costs       Deluxe      Standard     Total
       Supporting DL               DLHs           $3     $150,000         8,000      42,000     50,000
       Batch setups               Setups        $240        60,000          200          50        250
       Safety testing              Tests        $800        80,000           80          20        100
          Total MOH Costs                                $290,000

   Determine the unit product costs of the Deluxe and Standard products under the ABC
   system.
                                                                                              Units
                                                                                       10,000       70,000
                                                                                       Deluxe      Standard
   Direct Materials                                                                      $60.00       $45.00
   Direct Labor                                                                             9.60        7.20
       Total Direct Costs per Unit                                                       $69.60       $52.20
                                                     Assigned MOH Costs
Applied MOH         Driver    Cost/Driver Deluxe     Standard     Total
Supporting DL       DLHs              $3   $24,000    $126,000   $150,000    $2.40    $1.80
Batch setups        Setups          $240    48,000      12,000     60,000     4.80     0.17
Safety testing      Tests           $800    64,000      16,000     80,000     6.40     0.23
Total MOH                                 $136,000    $154,000   $290,000
    Total Indirect Costs per Unit                                           $13.60    $2.20
Total Unit Product Costs -- ABC System                                      $83.20   $54.40
Problem 7B-4:      ABC as an Alternative to Traditional Product Costing

Given:
Erte, Inc., manufactures two models of high-pressure steam valves, the XR7 model and the ZD5
model. Data regarding the two products follow:

                      DLHs      Annual         Total
         Product     Per Unit Production       DLHs
          XR7              0.2   20,000          4,000
          ZD5              0.4   40,000         16,000

Additional information about the company follows:
a. Product XR7 requires $35 in direct materials per unit, and product ZD5 requires $25
b. The direct labor rate is $20 per hour
c. The company has always used DLHs as the base for applying MOH costs to products. MOH
   costs totals $1,480,000 per year.
d. Product XR7 is more complex to manufacture than product ZD5 and requires the use of a
   special milling machine.
e. Because of the special work required in (d) above, the company is considering the use of
   ABC to apply overhead cost to products. Three activity cost pools have been identified and
   the first-stage allocations have been completed. Data concerning these activity cost pools
   appear below:
                                            Estimated
                                  Cost per     MOH               Expected Total Activity
     Activity Pool     Driver      Driver      Costs         XR7          ZD5          Total
   Mach. Setups        Setups          $720   $180,000            150          100          250
   Special Milling      MHRs           $300     300,000         1,000            0        1,000
   General Factory      DLHs            $50  1,000,000          4,000       16,000       20,000
   Total MOH Costs                          $1,480,000

                                                              XR7           ZD5
      DM per unit                                              $35.00        $25.00
      DL per unit                                               $4.00         $8.00
      DL-hours per unit                                          0.20          0.40
      Total direct labor hours                                  4,000        16,000
      Estimated annual production                              20,000        40,000

Required:
1. Assume that the company continues to use DLHs as the base for applying overhead cost to
   products.
   a. Compute the predetermined overhead rate.

      Estimated total MOH Costs / Total DLHs = ($1,480,000 / (4,000 + 16,000) =         $74.00

   b. Determine the unit product cost of each product.

                                                              XR7           ZD5
      Direct Materials                                         $35.00        $25.00
      Direct Labor                                               4.00          8.00
      Applied MOH
                    Predetermined MOH            $74.00
                     DL-hours per unit                   0.20        14.80

                     Predetermined MOH                 $74.00
                     DL-hours per unit                   0.40                   29.60
                      Traditional Unit Cost                         $53.80     $62.60

2. Assume that the company decides to use ABC to apply overhead costs to products.
   a. Compute the activity rate for each activity cost pool. Also compute the amount of
      overhead cost that would be applied to each product. (See 2.b. below)

                                                                Estimated
                                                 Cost per         MOH            Expected Total Activity
            Activity Pool             Driver      Driver          Costs       XR7          ZD5
      Mach. Setups                    Setups          $720        $180,000        150          100
      Special Milling                 MHRs            $300         300,000      1,000            0
      General Factory                  DLHs            $50       1,000,000      4,000       16,000
          Total MOH Costs                                       $1,480,000

   b. Determine the unit product cost of each product.
                                                                                                Units
                                                                                          20,000
                                                                                           XR7
   Direct Materials                                                                          $35.00
   Direct Labor                                                                                4.00
       Total Direct Costs per Unit                                                           $39.00
                                                           Assigned MOH Costs
   Applied MOH         Driver    Cost/Driver          XR7         ZD5         Total
   Mach. Setups        Setups          $720          $108,000     $72,000    $180,000         $5.40
   Special Milling     MHRs            $300           300,000           0     300,000         15.00
   General Factory      DLHs            $50           200,000     800,000   1,000,000         10.00
   Total MOH Costs                                   $608,000    $872,000 $1,480,000
      Total Indirect Costs per Unit                                                         $30.40
    ABC System Unit Cost                                                                    $69.40
    Traditional Unit Cost                                                                   $53.80

3. Explain why overhead cost shifted from the high-volume product to the low-volume product
   under ABC.

   Note that even under the ABC system 68% of the company's overhead costs continue to be applied to
   products on the basis of DLHs. ($1,000,000/$1,480,000)             68%

   Thus, the shift in overhead cost from the high-volume product ZD5 to the low-volume product XR7
   occurred as a result of reassigning only 32% of the company's overhead costs.

   The increase in unit product cost for XR7 can be explained as follows:

   1. Special milling costs, which are traceable to XR7, have all been assigned to XR7.

                                                                  XR7         ZD5
          Allocated Special Milling costs (traced)               $300,000           $0
      Production volume                                        20,000       40,000
      Special milling costs per unit                           $15.00        $0.00

2. Machine setup costs per unit differ significantly by product
                                                           XR7             ZD5
     Allocated setup costs                                $108,000         $72,000
     Production volume                                      20,000          40,000
     Setup cost per unit                                     $5.40           $1.80

                                                              XR7          ZD5
      Setup costs per batch                                      $720         $720
      Production volume                                        20,000       40,000
      Number of setups                                            150          100
      Batch size                                               133.33          400
      Setup cost per unit                                       $5.40        $1.80

3. Consumption ratios differ by pool

                                                           Consumption               Consumption
         Traditional             Driver       XR7             Ratio        ZD5          Ratio
   Overhead Costs                DLHs           4,000             20%       16,000               80%

   Overhead cost are allocated 20% to XR7 and 80% to ZD5 under the traditional costing system.



                                                           Consumption               Consumption
       Activity-Based            Driver       XR7             Ratio        ZD5          Ratio
   Mach. Setups                  Setups           150             60%          100               40%
   Special Milling               MHRs           1,000            100%            0                0%
   General Factory                DLHs          4,000             20%       16,000               80%

   Overhead costs are allocated as follows:
   1. Setup costs -- 60% to XR7 and 40% to ZD5
   2. Milling costs -- 100% to XR7 and 0% to ZD5
   3. General Factory costs -- 20% to XR7 and 80% to ZD5




Modified Traditional Unit Cost                 20,000          40,000
   Traceable Costs                            XR7             ZD5
   Direct Materials                            $35.00          $25.00
   Direct Labor                                  4.00            8.00
   Special Milling             $300,000         15.00
   Non-traceable Costs
   Applied MOH
     Predetermined MOH           $59.00
     DL-hours per unit             0.20          11.80

    Predetermined MOH              $59.00
    DL-hours per unit                0.40                       23.60
   Total Unit Cost                             $65.80          $56.60
Traditional Unit Cost            $53.80   $62.60
Modified Traditional Unit Cost   $65.80   $56.60
ABC System Unit Cost             $69.40   $54.80
per DLH
 d Total Activity
                 Total
                     250
                   1,000
                  20,000




        Units
                 40,000
                  ZD5
                  $25.00
                     8.00
                  $33.00


                   $1.80
                    0.00
                   20.00

                  $21.80
                  $54.80
                  $62.60




 be applied to


ume product XR7
Total
 20,000




Total
    250
  1,000
 20,000

				
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