Solution manual managerial accounting concept and applications by cabrera chapter 11 answer

MANAGEMENT ACCOUNTING- Solutions Manual CHAPTER 11 SYSTEMS DESIGN: ACTIVITY-BASED COSTING AND MANAGEMENT I Questions 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 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 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 lowvolume products 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 nonvalue-added Thus, it is the beginning point in designing an activitybased 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 The four general levels of activities are: 11-1 Chapter 11 Systems Design: Activity-Based Costing and Management Unit-level activities, which are performed each time a unit is produced Batch-level activities, which are performed each time a batch of goods is handled or processed Product-level activities, which are performed as needed to support specific products Facility-level activities, which simply sustain a facility’s general manufacturing process 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 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 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 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 12 Two major advantages of ABM are: 11-2 Systems Design: Activity-Based Costing and Management Chapter 11 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 13 When direct labor is used as an allocation base for overhead, it is implicitly assumed that overhead cost is directly proportional to direct labor When cost systems were originally developed in the 1800s, this assumption may have been reasonably accurate However, direct labor has declined in importance over the years while overhead has been increasing This suggests that there is no longer a direct link between the level of direct labor and overhead Indeed, when a company automates, direct labor is replaced by machines; a decrease in direct labor is accompanied by an increase in overhead This violates the assumption that overhead cost is directly proportional to direct labor Overhead cost appears to be driven by factors such as product diversity and complexity as well as by volume, for which direct labor has served as a convenient measure 14 Employees may resist activity-based costing because it changes the “rules of the game.” ABC changes some of the key measures, such as product costs, used in making decisions and may affect how individuals are evaluated Without top management support, employees may have little interest in making these changes In addition, if top managers continue to make decisions based on the numbers generated by the traditional costing system, subordinates will quickly conclude that the activity-based costing system can be ignored 15 Unit-level activities are performed for each unit that is produced Batch-level activities are performed for each batch regardless of how many units are in the batch Product-level activities must be carried out to support a product regardless of how many batches are run or units produced Customer-level activities must be carried out to support customers regardless of what products or services they buy Organization-sustaining activities are carried out regardless of the company’s precise product mix or mix of customers 16 Organization-sustaining costs, customer-level costs, and the costs of idle capacity should not be assigned to products These costs represent resources that are not consumed by the products 11-3 Chapter 11 Systems Design: Activity-Based Costing and Management II True or False True True False True False False True True III Exercises Exercise Activity Activity Classification Examples of Traceable Costs Labor cost; depreciation Examples of Cost Drivers a Materials are moved from the receiving dock to product flow lines by a materialhandling crew Batch-level b Direct labor workers assemble various products Unit-level Direct labor cost; indirect labor cost; labor benefits Direct laborhours c Ongoing training is Facility-level* Space cost; training costs; administration costs Hours of training time; number trained d A product is designed by a specialized design team Product-level Space cost; supplies used; depreciation of design equipment Hours of design time; number of engineering change orders e Equipment setups are performed on a regular basis Batch-level Labor cost; supplies used; depreciation of equipment Number of setups; hours or setup time f Numerical control (NC) machines are used to cut and shape materials Unit-level Power; supplies used; maintenance; depreciation Machinehours; number of units of equipment; space cost provided to all employees in the company Number of receipts; pounds handled * 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, productlevel, and batch-level 11-4 Systems Design: Activity-Based Costing and Management Chapter 11 Exercise 2 plantwide overhead rate volume two stage, stage, stage Process value analysis Unit-level 10 Batch-level Product-level Facility-level high-volume, low-volume, low-volume activity centers Exercise a b c d e g h Various individuals manage the parts inventories A clerk in the factory issues purchase orders for a job The personnel department trains new production workers The factory’s general manager meets with other department heads such as marketing to coordinate plans Direct labor workers assemble products Engineers design new products The materials storekeeper issues raw materials to be used in jobs The maintenance department performs periodic preventative maintenance on general-use equipment Product-level Batch-level Organizationsustaining Organizationsustaining Unit-level Product-level Batch-level Organizationsustaining Note: Some of these classifications are debatable and may depend on the specific circumstances found in particular companies Exercise Sales (P1,650 per standard model glider × 10 standard model gliders + P2,300 per custom designed glider × custom designed gliders) P21,100 Costs: Direct materials (P462 per standard model glider × 10 standard model gliders + P576 per custom designed glider × custom designed gliders) P5,772 Direct labor (P19 per direct labor-hour × 28.5 direct 6,631 labor-hours per standard model glider × 10 standard 11-5 Chapter 11 Systems Design: Activity-Based Costing and Management model gliders + P19 per direct labor-hour × 32 direct labor-hours per custom designed glider × custom designed gliders) Supporting manufacturing (P18 per direct labor-hour × 28.5 direct labor-hours per standard model glider × 10 standard model gliders + P18 per direct laborhour × 32 direct labor-hours per custom designed glider × custom designed gliders) 6,282 Order processing (P192 per order × orders) 576 Custom designing (P261 per custom design × custom designs) 522 Customer service (P426 per customer × customer) 426 20,209 Customer margin P 891 Exercise Requirement The predetermined overhead rate is computed as follows: Predetermined overhead rate = P290,000 50,000 DLHs = P5.80 per DLH The unit product costs under the company’s traditional costing system are computed as follows: Special Regular Direct materials P60.00 P45.00 Direct labor 9.60 7.20 Manufacturing overhead (0.8 DLH × P5.80 per DLH; 0.6 DLH × P5.80 per DLH) 4.64 3.48 Unit product cost P74.24 P55.68 Requirement The activity rates are computed as follows: (a) Estimated Overhead Activities Cost Supporting direct labor P150,000 Batch setups P60,000 Safety testing P80,000 (b) Total Expected Activity 50,000 DLHs 250 setups 100 tests (a) ÷ (b) Activity Rate P3 per DLH P240 per setup P800 per test Manufacturing overhead is assigned to the two products as follows: 11-6 Systems Design: Activity-Based Costing and Management Chapter 11 Special Product: (a) Activity Cost Pool Activity Rate Supporting direct labor P3 per DLH Batch setups P240 per setup Safety testing P800 per test Total (b) Activity 8,000 DLHs 200 setups 80 tests (a) × (b) ABC Cost P24,000 48,000 64,000 P136,000 (b) Activity 42,000 DLHs 50 setups 20 tests (a) × (b) ABC Cost P126,000 12,000 16,000 P154,000 Regular Product: (a) Activity Cost Pool Activity Rate Supporting direct labor P3 per DLH Batch setups P240 per setup Safety testing P800 per test Total Activity-based costing unit product costs are computed as follows: Special Direct materials P60.00 Direct labor 9.60 Manufacturing overhead (P136,000 ÷ 10,000 units; P154,000 ÷ 70,000 units) 13.60 Unit product cost P83.20 Regular P45.00 7.20 2.20 P54.40 IV Problems Problem Cost Systems Traditional cost system ABC system Labor Machining Setup Production order Material handling Parts administration Pool Rate 350% Cost Driver Consumption P10,000 Cost Assignment P35,000 10% P25/hour P10/hour P100/order P20/requisition P40/part P10,000 800 hours 100 hours 12 orders requisitions 18 parts P 1,000 20,000 1,000 1,200 100 720 P24,020 11-7 Chapter 11 Systems Design: Activity-Based Costing and Management Problem Requirement (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 Direct labor Overhead applied Total cost P 6,000 10,000 9,040 P25,040 (c) Company’s bid = Full manufacturing cost x 120% = P25,040 x 120% = P30,048 Requirement (a) Maintenance : P200,000 / 20,000 Materials handling: P32,000 / 1,600 = Setups: P100,000 / 2,500 = Inspection: P120,000 / 4,000 = = P10 per machine hour P20 per move P40 per setup P30 per inspection Overhead assigned to proposed job: Maintenance (P10 x 500) Material handling (P20 x 12) Setups (P40 x 2) Inspection (P30 x 10) Total overhead assigned to job P5,000 240 80 300 P5,620 (b) Total cost of proposed project: Direct materials P 6,000 11-8 Systems Design: Activity-Based Costing and Management Chapter 11 Direct labor Overhead applied Total cost 10,000 5,620 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 Direct labor Overhead assigned: Maintenance (P10 x 500) Material handling (P20 x 12) Setups (P40 x 2) Inspections (P30 x 10) Total overhead assigned to job Total cost Markup Bid price P6,000 10,000 P5,000 240 80 300 5,620 P21,620 120% P25,944 Problem (Activity-Based Costing) Requirement The first-stage allocation of costs to the activity cost pools appears below: Assemblin g Units Manufacturing overhead Selling and administrative overhead Total cost Activity Cost Pools Processing Supporting Orders Customers Other Total P250,000 P175,000 P25,000 P50,000 P500,000 30,000 P280,000 135,000 P310,000 75,000 P100,000 60,000 P110,000 300,000 P800,000 Requirement The activity rates for the cost pools are: (a) 11-9 (b) (a) ÷ (b) Chapter 11 Systems Design: Activity-Based Costing and Management Assembling units Processing orders Supporting customers Total Cost P280,000 P310,000 P100,000 Total Activity 1,000 units 250 orders 100 customers Activity Rate P280 per unit P1,240 per order P1,000 per customer Requirement The overhead cost attributable to Lucky Sale would be computed as follows: Activity Cost Pools Assembling units Processing orders Supporting customers (a) Activity Rate P280 per unit P1,240 per order P1,000 per customer (b) Activity 80 units orders customer (a) x (b) ABC Cost P22,400 P4,960 P1,000 Requirement The customer margin can be computed as follows: Sales (P595 per unit x 80 units) Costs: Direct materials (P180 per unit x 80 units) Direct labor (P50 per unit x 80 units) Unit-related overhead (above) Order-related overhead (above) Customer-related overhead (above) Customer margin P47,600 P14,400 4,000 22,400 4,960 1,000 P 46,760 840 Problem (Activity-Based Costing as an Alternative to Traditional Product Costing) Requirement a When direct labor-hours are used to apply overhead cost to products, the company’s predetermined overhead rate would be: 11-10 Systems Design: Activity-Based Costing and Management Chapter 11 Predetermined overhead rate = = b Manufacturing overhead cost Direct labor hours P1,480,000 20,000 DLHs = P74 per DLH Model HY5 AS2 Direct materials P35.00 P25.00 Direct labor: P20 per hour × 0.2 DLH, 0.4 DLH 4.00 8.00 Manufacturing overhead: P74 per hour × 0.2 DLH, 0.4 DLH 14.80 29.60 Total unit product cost P53.80 P62.60 Requirement a Predetermined overhead rates for the activity cost pools: (a) Estimated Activity Cost Pool Total Cost Machine setups P180,000 Special milling .P300,000 General factory P1,000,000 (b) Estimated Total Activity 250 setups 1,000 MHs 20,000 DLHs (a) ÷ (b) Activity Rate P720 per setup P300 per MH P50 per DLH The overhead applied to each product can be determined as follows: Model HY5 (a) Predetermined Activity Cost Pool Overhead Rate Machine setups P720 per setup Special milling P300 per MH General factory P50 per DLH Total manufacturing overhead cost (a) Number of units produced (b) Overhead cost per unit (a) ÷ (b) 11-11 (b) Activity 150 setups 1,000 MHs 4,000 DLHs (a) × (b) Overhead Applied P108,000 300,000 200,000 P608,000 20,000 P30.40 Chapter 11 Systems Design: Activity-Based Costing and Management Model AS2 (a) Predetermined (b) Activity Cost Pool Overhead Rate Activity Machine setups P720 per setup 100 setups Special milling P300 per MH MHs General factory P50 per DLH 16,000 DLHs Total manufacturing overhead cost (a) Number of units produced (b) Overhead cost per unit (a) ÷ (b) (a) × (b) Overhead Applied P 72,000 800,000 P872,000 40,000 P21.80 b The unit product cost of each model under activity-based costing would be computed as follows: Model HY5 AS2 Direct materials P35.00 P25.00 Direct labor (P20 per DLH × 0.2 DLH; P20 per DLH × 04.DLH) 4.00 8.00 Manufacturing overhead (above) 30.40 21.80 Total unit product cost P69.40 P54.80 Comparing these unit cost figures with the unit costs in Part 1(b), we find that the unit product cost for Model HY5 has increased from P53.80 to P69.40, and the unit product cost for Model AS2 has decreased from P62.60 to P54.80 Requirement It is especially important to note that, even under activity-based costing, 68% of the company’s overhead costs continue to be applied to products on the basis of direct labor-hours: Machine setups (number of setups) P  180,000 Special milling (machine-hours) 300,000 General factory (direct labor-hours) 1,000,000 Total overhead cost P1,480,000 12% 20 68 100% Thus, the shift in overhead cost from the high-volume product (Model AS2) to the low-volume product (Model HY5) occurred as a result of reassigning 11-12 Systems Design: Activity-Based Costing and Management Chapter 11 only 32% of the company’s overhead costs The increase in unit product cost for Model HY5 can be explained as follows: First, where possible, overhead costs have been traced to the products rather than being lumped together and spread uniformly over production Therefore, the special milling costs, which are traceable to Model HY5, have all been assigned to Model HY5 and none assigned to Model AS2 under the activity-based costing approach It is common in industry to have some products that require special handling or special milling of some type This is especially true in modern factories that produce a variety of products Activity-based costing provides a vehicle for assigning these costs to the appropriate products Second, the costs associated with the batch-level activity (machine setups) have also been assigned to the specific products to which they relate These costs have been assigned according to the number of setups completed for each product However, since a batch-level activity is involved, another factor affecting unit costs comes into play That factor is batch size Some products are produced in large batches and some are produced in small batches The smaller the batch, the higher the cost per unit of the batch activity In the case at hand, the data can be analyzed as shown below Model HY5: Cost to complete one setup [see 2(a)] P720 Number of units processed per setup (20,000 units ÷ 150 setups) 133.33 Setup cost per unit (a) ÷ (b) P5.40 Model AS2: Cost to complete one setup (above) P720 Number of units processed per setup (40,000 units ÷ 100 setups) 400 Setup cost per unit (a) ÷ (b) P1.80 (a) (b) (a) (b) Thus, the cost per unit for setups is three times as great for Model HY5, the low-volume product, as it is for Model AS2, the high-volume product Such differences in cost are obscured when direct labor-hours (or any other volume measure) is used as the basis for applying overhead cost to products In sum, overhead cost has shifted from the high-volume product to the low-volume product as a result of more appropriately assigning some costs to the products on the basis of the activities involved, rather than on 11-13 Chapter 11 Systems Design: Activity-Based Costing and Management the basis of direct labor-hours V Multiple Choice Questions 10 A D C B A D A B D C 11 12 13 14 15 16 17 18 19 20 B D C A C D D C B A 21 21 22 23 24 25 26 27 28 29 D A B A B D B C A C 11-14 ... advantages of ABM are: 11- 2 Systems Design: Activity-Based Costing and Management Chapter 11 a ABM measures the effectiveness of the key business processes and activities, and identifies how they... direct labor-hour × 28.5 direct 6,631 labor-hours per standard model glider × 10 standard 11- 5 Chapter 11 Systems Design: Activity-Based Costing and Management model gliders + P19 per direct labor-hour... handled * 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, productlevel, and batch-level 11- 4