CHAPTER 11:  Activity-Based Costing

 

Chapter Contents:

-                     Background

-                     Apparel factory example of two-stage ABC allocations

-                     Cost hierarchy

-                     Milwood Mills

-                     ABC in the service sector

-                     ABC implementation issues

-                     Exercises and problems

 

Background:

Activity-based costing (ABC) is a better, more accurate way of allocating overhead.

 

Recall the steps to product costing:

 

  1. Identify the cost object;
  2. Identify the direct costs associated with the cost object;
  3. Identify overhead costs;
  4. Select the cost allocation base for assigning overhead costs to the cost object;
  5. Develop the overhead rate per unit for allocating overhead to the cost object.

 

Activity-based costing refines steps #3 and #4 by dividing large heterogeneous cost pools into multiple smaller, homogeneous cost pools. ABC then attempts to select, as the cost allocation base for each overhead cost pool, a cost driver that best captures the cause and effect relationship between the cost object and the incurrence of overhead costs. Often, the best cost driver is a nonfinancial variable.  

 

ABC can become quite elaborate. For example, it is often beneficial to employ a two-stage allocation process whereby overhead costs are allocated to intermediate cost pools in the first stage, and then allocated from these intermediate cost pools to products in the second stage. Why is this intermediate step useful? Because it allows the introduction of multiple cost drivers for a single overhead cost item. This two-stage allocation process is illustrated in the example of the apparel factory below.

 

ABC focuses on activities. A key assumption in activity-based costing is that overhead costs are caused by a variety of activities, and that different products utilize these activities in a non-homogeneous fashion. Usually, costing the activity is an intermediate step in the allocation of overhead costs to products, in order to obtain more accurate product cost information. Sometimes, however, the activity itself is the cost object of interest. For example, managers at Levi Strauss & Co. might want to know how much the company spends to acquire denim fabric, as input in a sourcing decision. The “activity” of acquiring fabric incurs costs associated with negotiating prices with suppliers, issuing purchase orders, receiving fabric, inspecting fabric, and processing payments and returns.

 

Apparel Factory Example of Two-Stage ABC Allocations:

Assume that an apparel factory uses forklifts in only two departments:

 

The first department is Receiving, where large rolls of fabric are unloaded from semi-trailers and moved into storage, and later moved from storage to the cutting room.

 

The second department is Shipping, where cartons of finished pants are staged and then loaded onto semi-trailers for shipment to the warehouse.

 

Costs associated with operating these forklifts consist of the following:

 

Forklift costs:

  Operator salaries

  Maintenance

  Depreciation expense

  Other

    Total forklift costs

All other overhead

Total overhead for the factory

 

$      80,000

8,000

7,500

2,500

$      98,000

1,400,000

$1,498,000

 

 

The factory operates two production lines. One line is for jeans, which are made from denim fabric. The other production line is for casual slacks, which are made from a cotton-twill fabric. Operational data for the month is as follows:

 

 

Jeans

Casual Slacks

Total

Units produced

Direct labor hours

Rolls of fabric

Cartons shipped

420,000

70,000

1,750

52,500

200,000

40,000

640

20,000

620,000

110,000

2,390

72,500

 

The factory ships product to the company’s warehouse, not directly to customers. Hence, to facilitate stocking at the warehouse, each carton is packed with jeans or casual slacks, but not both. An examination of the information in the above table reveals that a carton holds more slacks than jeans, and that fewer pants are cut from a roll of denim fabric than from a roll of cotton-twill. These operational statistics are driven by the fact that denim is a heavier-weight fabric than cotton-twill, and hence, it is bulkier. The data also indicate that more direct labor minutes are required for a pair of slacks than for a pair of jeans, which reflects greater automation on the jeans production line.

 

Traditional costing

Under a traditional costing system, forklift costs are pooled with all other overhead costs for the factory (electricity, property taxes, front office salaries, etc.), and then allocated to product based on direct labor hours (sewing operator time) for each product.

 

Overhead rate under traditional costing:

 

Total overhead costs

Quantity of allocation base (direct labor hours)

Overhead rate per direct labor hour

 

of which the following is due to forklift costs:

Forklift overhead

Quantity of allocation base (direct labor hours)

Overhead rate for forklift costs per direct labor hour

$ 1,498,000

 ÷ 110,000

$        13.62

 

 

$     98,000

÷ 110,000

$     0.8909

 

Forklift overhead applied to product using traditional costing:

 

 

Jeans

Slacks

Overhead rate

Quantity of allocation base (direct labor hours)

Forklift costs allocated

Units produced

Approximate cost per unit

$  0.8909

x 70,000

$  62,363

420,000

$0.15

$   0.8909

x 40,000

$   35,636

200,000

$0.18

 

Note that all forklift overhead is allocated: $62,363 + $35,636 = $97,999 (the difference due to rounding of the overhead rate).

 

If the casual slacks product manager asks why her product incurs more forklift costs on a per-unit basis than jeans, even though casual slacks use a lighter-weight fabric, the answer is that her product uses more direct labor per unit, which perhaps is not a very satisfying explanation from her perspective.   

 

Activity-based costing

An ABC system might first allocate forklift costs into two cost pools: one for the Receiving Department and one for the Shipping Department. Then costs from each of these two departments would be allocated to the two product lines.

 

ABC first-stage allocation

The first-stage allocation might use an estimate of the amount of time the forklifts spend in each department. A one-time study indicates that forklifts spend approximately 70% of their time in the Shipping Department and 30% of their time in the Receiving Department. An additional benefit of ABC is that if this information were collected periodically, the managers of these two departments might be more willing to share the forklifts with each other, since the reported costs of each department would then depend on the time the forklifts spend in that department. In any case, the 70/30 allocation results in the following first-stage allocation:

 

            30% of $98,000 = $29,400 is allocated to the Receiving Department

            70% of $98,000 = $68,600 is allocated to the Shipping Department

 

 

ABC second-stage allocation

 

Receiving

Shipping

Total costs

Quantity of allocation base

Overhead rate

 

Allocation to Jeans

  Overhead rate

  Quantity of allocation base

 

Allocation to Slacks

  Overhead rate

  Quantity of allocation base

$29,400

÷ 2,390 rolls

$12.30 per roll

 

 

$12.30 per roll

x 1,750 rolls

$21,525

 

$12.30 per roll

x 640 rolls

$7,872

$68,600

÷ 72,500 cartons

$0.946 per carton

 

 

$0.946 per carton

x 52,500 cartons

$49,665

 

$0.946 per carton

x 20,000 cartons

$18,920

 

Total forklift costs allocated to each product:

 

 

Jeans

Slacks

Total

From Receiving

$21,525

$  7,872

$29,397

From Shipping

49,665

18,920

68,585

Total

$71,190

$26,792

$97,982

Units Produced

420,000

200,000

 

Approximate Cost per unit

$0.17

$0.13

 

 

The $18 difference between total costs allocated of $97,982 and the original costs of $98,000 is due to rounding.

 

The first-stage allocation allows the second-stage to allocate forklift costs to product using rolls of fabric as the allocation base in Receiving, and cartons of pants as the allocation base in Shipping. Since there are no rolls of fabric in the shipping department, and no cartons in the Receiving Department, without the first stage allocation, there would be no obvious choice of an allocation base that would capture the cause-and-effect relationship between the costs of operating the forklifts, and the utilization of forklift resources by each product in the two departments.

 

Conclusion

The traditional costing method allocates more forklift costs to slacks than to jeans on a per-unit basis because casual slacks require more sewing effort. ABC allocates more forklift costs to jeans than to casual slacks, on a per-unit basis, which is intuitive because denim is a heavier-weight fabric than cotton twill.

 

Cost Hierarchy:

In ABC, cost pools are often established for each level in a hierarchy of costs. For manufacturing firms, the following cost hierarchy is commonly identified:

 

Unit-level costs: For any given product, these costs change in a more-or-less linear fashion with the number of units produced. For example, fabric and thread are unit-level costs for an apparel manufacturer: if the company wants to double production, it will need twice as much fabric and thread.

 

Batch-level costs: These costs change in a more-or-less linear fashion with the number of batches run. Machine setup costs are often batch-level costs. The time required to prepare a machine to run one batch of product is usually independent of the number of units in the batch: the same time is required to prepare the machine to run a batch of 100 units as a batch of 50 units. Hence, batch-level costs do not necessarily vary in a linear fashion with the number of units produced.

 

Product-level costs: These costs are usually fixed and direct with respect to a given product. An example is the salary of a product manager with responsibility for only one product. The product manager’s salary is a fixed cost to the company for a wide range of production volume levels. However, if the company drops the product entirely, the product manager is no longer needed.

 

Facility-level costs: These costs are usually fixed and direct with respect to the facility. An example is property taxes on the facility, or the salaries of front office personnel such as the receptionist and office manager.

 

One reason why ABC provides more accurate product cost information is that traditional costing systems frequently allocate all overhead, including batch-level, product-level, and facility-level overhead, using an allocation base that is appropriate only for unit-level costs. The better information obtained from explicitly incorporating the cost hierarchy is illustrated in the following example:

 

Milwood Mills:

Milwood Mills makes decorative woodcut prints for sale to restaurants. Its Billings, Montana factory makes two of the company’s more popular designs: Bull and Matador and Dogs Playing Poker. Following is selected information for a typical month:

 

 

Bull

Dogs

Total

Number of woodcuts produced

Direct materials costs

Direct labor costs

Number of batches

Total overhead

Batch setup costs (included in total overhead)

500

$2,500

$1,400

10

1,500

$3,300

$1,600

30

2,000

$5,800

$3,000

40

$42,000

$12,000

 

The traditional costing system allocates all overhead based on number of units produced. This method allocates overhead of $21 ($42,000 ÷ 2,000 units) to each Bull and Matador woodcut and to each Dogs Playing Poker woodcut, of which $6 ($12,000 ÷ 2,000 units) represents batch setup costs.

 

The manager of the Bull and Matador production line develops a technique for doubling the batch size on her line without incurring any additional costs. Hence, she can now make 500 woodcuts per month using only 5 setups. She thinks this should cut her batch setup costs in half. She reasons as follows:

 

What “drives” batch setup costs? It is the number of batches. The cost per batch is $300. ($300 per batch x 40 batches = $12,000, which agrees to the monthly information provided above.) Using the new batch size, the batch setup cost is still $300, but instead of spreading this $300 over 50 units, the $300 will be spread over 100 units, lowering my per-unit batch setup cost from $6 to $3, and lowering my total unit cost by $3.

 

However, the following month, after implementation of the manager’s increased batch size, reported costs are as follows: Total overhead drops by $1,500, which represents the cost savings from eliminating five batch setups for the Bull and Matador production line. Hence, total overhead drops from $42,000 to $40,500. The traditional costing system allocates this $40,500 to 2,000 units as $20.25 per unit. This new overhead rate represents a savings of $0.75 per unit for every woodcut: every Bull and Matador woodcut, and every Dogs Playing Poker woodcut. The manager of the Bull and Matador production line is disappointed. Her reported costs did not decrease by as much as she had anticipated, because most of the benefit from the reduction in batch setups has been allocated to the Dogs Playing Poker production line.

 

An ABC system that explicitly recognizes the cost hierarchy would correct this problem. Under the old production process, ABC would have allocated costs as follows: The cost pool for batch setup costs was previously $12,000, which would have been allocated to the two product lines based on the number of batches run by each line:

 

Overhead rate = total batch setup costs ÷ total number of batches

= $12,000 ÷ 40 batches = $300 per batch

 

Batch setup costs of $300 per batch

x 10 batches = $3,000 would have been allocated to Bull,

x 30 batches = $9,000 would have been allocated to Dogs.

 

In a second-stage allocation, the $3,000 allocated to the Bull and Matador production line would have been allocated to 500 units for a cost of $6 per woodcut. This allocation is the same as under the traditional costing system only because the batch size of 50 woodcuts per batch was originally the same on both production lines.

 

After the batch size is increased for Bull and Matador, production information is as follows:


 

 

Bull

Dogs

Total

Number of woodcuts produced

Direct materials costs

Direct labor costs

Number of batches

Total overhead

Batch setup costs (included in total overhead)

500

$2,500

$1,400

5

1,500

$3,300

$1,600

30

2,000

$5,800

$3,000

35

$40,500

$10,500

 

Now ABC would allocate costs as follows:

 

In the first stage: $10,500 ÷ 35 batches = $300 per batch (same as before).

 

$300 per batch x 5 batches = $1,500 to Bull and Matador (50% less than before),

$300 per batch x 30 batches = $9,000 to Dogs Playing Poker (same as before).

 

In the second stage, the $1,500 is allocated to the 500 Bull and Matador woodcuts, for $3 per woodcut. This $3 per woodcut reflects the cost savings originally anticipated by the manager of the Bull and Matador production line. The cost per woodcut for Dogs Playing Poker remains unchanged ($9,000 ÷ 1,500 units = $6), which is appropriate because nothing has changed on the Dogs Playing Poker production line.

 

ABC in the Service Sector:

ABC is as important to companies in the merchandising and service sectors as to manufacturing companies. In fact, although the origination of ABC is generally ascribed to manufacturing companies in the 1980s, by then hospitals were already allocating overhead costs to departments and then to patient services using methods similar to ABC. Hospitals were required to implement relatively sophisticated allocation processes in order to comply with Medicare reimbursement rules. After its inception in the 1960s, Medicare established detailed rules regarding how overhead costs should be grouped into cost pools, and the choice of appropriate allocation bases for allocating overhead costs to departments and then to patients. Within these rules, hospitals were able to maximize revenues by shifting costs from areas such as pediatrics, labor and delivery, and maternity (which have low rates of Medicare utilization) to the intensive care unit, the critical care unit, and surgery (which have higher rates of Medicare utilization). Other non-manufacturing industries that have benefited from ABC include financial services firms and retailers.

 

ABC Implementation Issues:

Another refinement in product costing that often accompanies implementation of ABC focuses on step #2 of the five-step product costing sequence: “identify the direct costs associated with the cost object.” The refinement involves the following. For a given cost object, the company attempts to identify costs currently treated as overhead that have not been—but can be—traced directly to the cost object. In other words, costs are moved from the overhead cost pool to the direct cost category. For example, an accounting firm might take certain office-support expenses formerly treated as overhead, such as printing and copying, and start tracking and assigning these costs to specific jobs (audits, tax engagements, etc.) for internal reporting and profitability analysis (but not necessarily for client billing purposes).

 

The successful implementation of ABC usually requires participation by managers from non-accounting functions, such as production and marketing. Because ABC focuses on activities, and activities often cut across departments and functional areas, implementing ABC can improve lines of communication and cooperation within the company. On the other hand, more accurate cost allocation does not, by itself, reduce costs. The initial move from a traditional costing system to ABC usually shifts overhead costs from some products to other products, with some managers “winning” and some “losing.” Some companies have found that hiring an outside consulting firm to assist with the ABC adoption facilitates obtaining “buy-in” by managers and employees throughout the company. Perhaps partly for this reason, ABC implementation has become an important consulting product for accounting firms and for many consulting firms.

 

Although ABC should provide the company more accurate information, it is not a panacea; some companies that invested time and money implementing ABC did not realize the benefits they expected. Some of these companies have reverted to simpler, more traditional costing systems.

 

Exercises and Problems

 

Discussion Question 11-1: Colorado Airlines is operating at capacity on its Denver to New York route, offering three flights each day on this route, using Boeing 737’s, each with a capacity of 120 passengers. Airline management wants to determine the least expensive way to increase daily capacity from 360 passengers to 480 passengers. One possibility is to add one more Boeing 737 per day. The other possibility is to replace the current equipment with Boeing 727’s, which hold 160 passengers each. In either case, management believes the planes will continue to operate at capacity. 

 

To ascertain the least expensive way to increase passenger capacity on the Denver-to-New York route, management has asked you to determine what “drives” the airline’s operating costs.

 

Required:

Consider the following cost drivers:

 

a)      Number of flights per day

b)      Number of miles flown per day

c)      Number of passengers served per day

d)      Number of passenger miles (miles flown per day multiplied by number of passengers)

 

For each of the following costs, identify the most appropriate cost driver from the above list.

 

1.                  Passenger meals

2.                  Airplane fuel

3.                  Ground personnel who refuel the plane, and mechanics on the ground

4.                  Ground personnel who serve passengers at the ticket counter and at the gate.

5.                  Cockpit crew salaries (Federal Aviation Administration regulations limit pilots to fly no more than a certain number of hours per month).

6.                  Flight attendant salaries (assume that Federal Aviation Administration regulations limit flight attendants to fly no more than a certain number of hours per month, and require one flight attendant for every 40 passengers).

7.                  Economic depreciation of the airplane (i.e., without regard to the depreciation method chosen for accounting purposes, choose the cost driver that best captures the wear and tear on the equipment, and determines the economic life of the plane).

8.                  Personnel who handle baggage

 

11-2: You are the Chief Financial Officer of a large New York hospital that has decided to implement activity-based costing. Which of the following would you choose as the allocation base for allocating the costs of the Linen and Laundry Department to the four patient wards that utilize linen and laundry services, if your objective is to generate the most accurate cost information possible? The four wards are: (1) surgery, (2) adolescent care, (3) maternity and nursery, and (4) pediatric care.

 

(A)       Patient occupancy rates (i.e., patient days) in each ward.

 

(B)       The number of washing machines in the Laundry and Linen Department

 

(C)       The number of Medicare patients in each ward.

 

(D)       The number of patient admissions to each ward.

 

11-3: In which of the following situations are the techniques of activity-based costing most likely to lead to improved production or marketing decisions.

 

(I)        The All-Direct Company, which incurs significant direct costs, but no overhead costs, to manufacture its extensive and ever-changing product line.

 

(II)       The One-Size-Fits-All Hat Company, which makes a single product that is sold to many different kinds of retailers, in varying volumes, through various marketing channels, in many different geographic regions.

 

(III)      The Iowa Wind Turbine Electric Cooperative, which has direct costs and fixed overhead, but no variable overhead.

 

(A)       (I) and (II), but not (III)           

 

(B)       (I) and (III), but not (II)

 

(C)       (I) only

 

(D)       (II) only

 

11-4: For a generic manufacturing facility (i.e., without being told what the factory makes):

 

A) Give two examples of overhead expenses for which direct labor hours is a more appropriate allocation base than machine time.

 

B) Give two examples of overhead expenses for which machine time is a more appropriate allocation base than direct labor hours.

 

11-5: The Silver City Mining Company mines copper and aluminum in Southwestern New Mexico. Traditionally, overhead costs were allocated to the two metals based on direct labor hours. Using this method in 2005, overhead costs per ton are $50 for aluminum and $60 for copper.

 

The company switched to activity-based costing, using multiple cost pools, and allocating each cost pool using an allocation base that more accurately captures the cause and effect relationship between the mining operations and overhead costs. Also, several overhead cost categories were reclassified as direct costs. The company had used an Actual Costing system prior to implementing ABC (i.e., overhead rates were calculated at the end of the year, when actual amounts were known), and continued to use Actual Costing after implementation of ABC. To study the effect of the new ABC system, it was retroactively applied to 2005, in order to compare the results to the old method. Which of the following outcomes under the new system suggests that an error was made in the calculation of overhead rates?

 

(A)       The new overhead rates were $45 per ton of aluminum and $62 per ton of copper.

 

(B)       The new overhead rates were $45 per ton of aluminum and $58 per ton of copper.

 

(C)       The new overhead rates were $55 per ton of aluminum and $58 per ton of copper.

 

(D)       The new overhead rates were $55 per ton of aluminum and $62 per ton of copper.

 

11-6: The Santa Cruz Candy Company makes five types of candies in its sole factory, including chocolate truffles and chocolate mints. Truffles are hand-dipped, so making truffles is labor-intensive, and furthermore, only the most experienced (and highest paid) employees can make truffles. Production of mints is highly automated: they don’t require much labor, but the machine operators are also highly-skilled and highly-paid. The manager of truffles production (Candy Lowenski) and the manager of mints production (Coco Hernandez) are discussing their preferences for how factory overhead should be allocated to their products. The three choices are direct labor dollars, direct labor hours, and machine hours. Of course, each manager would like to report the highest profits possible from her product line.

 

Required: In one, two or three (no more than three) complete sentences (each sentence must have a verb and a period, among other grammatical components), predict what position each manager will take with respect to her preferred allocation base, and explain your reasoning. 

 

11-7: The Braintree Furniture Company manufactures two lines of furniture: an upscale, handcrafted line called Richleau, which is produced in small quantities; and a mass-produced, inexpensive line called Particleboard. Both lines are made in the same factory. Richleau is very labor intensive relative to Particleboard. Braintree just switched from a traditional costing method that allocated overhead based on direct labor hours to an activity-based costing system. Under activity-based costing, the amount of overhead allocated to Richleau will be

 

(A)       higher than under the traditional costing method.

 

(B)       lower than under the traditional costing method.

 

(C)       either higher or lower than under the traditional costing method, depending on the underlying economics of the business.

 

(D)       lower than under traditional costing, as long as activity-based costing is implemented in a way that provides more accurate cost information.

 

11-8: The not-for-profit health clinic Shots-Я-Us provides various types of vaccinations and other shots, especially flu shots, to the public for free or for a nominal fee. The clinic is funded by several local governmental agencies as well as by a number of charitable organizations. Since different donors wish to fund different types of shots, the clinic determines the full cost of each type of shot, by adding overhead to the direct costs, and then provides this information to current and prospective donors.

 

Following are actual and budgeted costs for Shots-Я-Us for 2003:

 

 

Actual

Budgeted

Number of patient visits

Number of shots administered

 

Fixed overhead: salaries, rent for the facility, insurance, depreciation.

 

Variable overhead: nursing staff hoursly wages, utilities, disposable supplies.

 

Cost of hypodermics (a direct cost)

 

Cost of medications (a direct cost)

5,000

6,000

 

 

$94,000

 

 

$66,000

 

$1,000

 

$30,000

4,000

4,500

 

 

$110,000

 

 

$40,500

 

$750

 

$20,000

 

Which of the following is probably not a significant cost driver for variable overhead, and hence, would probably be a poor choice as the cost allocation base for allocating variable overhead?

 

(A)       The number of shots administered

 

(B)       The dollar value of the medication administered

 

(C)       The number of patient visits

 

(D)       The amount of nursing staff time spent administering each type of shot

 

11-9: Pink Ink, Inc. has two products and two overhead cost pools:

 

 

Product A

Product B

In Total

Units produced

Direct Costs (per unit):

    Materials

    Labor (paid $20 per hour)

Materials Handling cost pool

Everything Else cost pool

200

 

$10

$20

50

 

$20

$40

 

 

 

 

$24,000

$76,000

 

A)        Using direct labor hours as the allocation base, what is the overhead rate for Materials Handling overhead?

 

B)        What is the total cost to make each unit of Product B, if all overhead is allocated based on units produced?

 

C)        How much Everything Else overhead would be applied to each unit of product A, if this cost pool is allocated to product using direct materials dollars as the allocation base?

 

11-10: Following is information about Aztech Industries:

 

 

Model A

Model B

Model C

Total

Units produced

Direct materials (per unit)

Direct labor (per unit)

 

Cost driver information:

  number of parts (per unit)

  direct labor hours (per unit)

  square feet (in total for all units)

 

Overhead costs:

  Labor Support

  Materials Support

  Facility Cost

    Total overhead

300

$50

$20

 

 

20

3

400

 

 

500

$75

$50

 

 

42

4.60

600

 

 

 

200

$100

$40

 

 

30

4

1,000

 

1,000

 

 

 

 

 

 

 

 

 

$22,000

$33,000

$90,000

$145,000

 

Use activity-based costing to calculate the total cost for each Model C heater. Allocate Labor Support using direct labor hours, Materials Support using number of parts, and Facility Cost using square feet.

 

11-11: The Crouse Travel Company applies overhead to its international camping tours using activity-based costing. Following is information about the three overhead cost pools:

 

 

 

Total Costs

 

Allocation Base

Total Quantity of the Allocation Base Incurred

Administration

Operations

Marketing

$200,000

600,000

180,000

Number of tours

Tourist travel days*

Number of tourists

40

6,000

600

 

* For any given tour, the number of tourist travel days is the number of tourists multiplied by the number of days in the tour. For example, 10 tourists on a seven-day tour would constitute 70 tourist travel days.

 

A) Calculate the overhead rates.

 

B) Five of the 40 tours were 10-day trips to Patagonia. These tours averaged 12 tourists per trip. How much overhead would be applied to these five Patagonia tours?

 

11-12 (A continuation of 6-14): Sister Rachel recently attended a seminar on activity-based costing held in Las Vegas. The other sisters were somewhat skeptical about Sister Rachel’s attendance at this particular seminar, and she is eager to put to use what she learned there. She suggests that the orphanage implement a refined costing system, and she develops the following information.

 

Costs vary with the age of the children. The number and ages of children were as follows:

 

 

 

2000

 

2001

 

Pre-school

(ages 0 - 5)

 

 30

 

 15

 

Pre-teen

(ages 6 - 12)

 

 30

 

 32

 

Teenagers

(ages 13 - 18)

 

Total

 

 20

 

 

 80

 

 25

 

 

 72

 

Everyone agrees that 2000 was a very successful year for the Orphanage, so the 2001 budget was based on 2000 actual costs. The following information pertains to 2000:

 

          Food costs per meal were $4 for pre-schoolers, $5 for pre-teens, and $6.50 for teenagers.  3 meals are served per day, 365 days per year.

          The cost of clothing is twice as much (per child) for teenagers as for the other two age groups.

          Laundry and linen costs per child do not vary with the age of the child.  However, this category also includes the cost of a diaper service.  1/3 of pre-school children are in diapers, and the cost is $15 per week, 52 weeks per year.

          Educational costs do not apply to pre-school children.

          Only teenagers receive an allowance.  The allowance is $20 per week, 50 weeks per year.

 

Required:

A)        Identify the cost drivers for the following expenses:

            (A)       Diaper service

            (B)       Educational costs

            (C)       Allowances      

 

B)        Prepare a flexible budget for 2001, making use of the information compiled by Sister Rachel, as well as information about fixed costs from the original 2001 budget.

 

C)        Should Sister Sarah be satisfied with the orphanage’s financial results and efforts to control costs in 2001?  Briefly explain.

 

11-13: The 601 Blue Jean Company has decided to allocate the cost of its Warehouse and Distribution Center to its customers using activity-based costing, in order to better assess profitability by customer. The warehouse manager determines that the only costs that are economically feasible to trace directly to the customer are outbound freight costs. The manager then decides that the following overhead cost pools should be allocated to customers using the following cost drivers:

 

Overhead Cost Pool

Cost Driver (Allocation Base)

Order Processing Department

Order Filling Department

Quality Control Department

Shipping Department

Number of individual orders processed for that customer

Number of line items on all pull-tickets for that customer

Number of cartons shipped to that customer

Number of cartons shipped to that customer

 

Following are relevant data for each overhead cost pool:

 

Order Processing Department

Total costs for this department

Total number of orders processed

 

Order Filling Department

Total costs for this department

Total number of line-items on all pull tickets


Quality Control Department

Total costs for this department

Total number of cartons shipped

 

Shipping Department

Total costs for this department

Total number of cartons shipped

 

$3,000,000

200,000

 

 

$4,000,000

4,000,000

 

 

$500,000

2,000,000

 

 

$7,500,000

2,000,000

 

Following is information pertaining to two customers:

 

7-9-11 Stores:

Sales revenue for the year

Number of orders

Number of pull ticket line-items

Number of boxes

Outbound freight costs

 

Men’s Large and Big Stores:

Sales revenue for the year

Number of orders

Number of pull ticket line-items

Number of boxes

Outbound freight costs

 

$2,400,000

500

100,000

50,000

$75,000

 

 

$1,500,000

250

20,000

40,000

$56,000

 

Required:

A) Compute the overhead rates for each of the four overhead cost pools.

 

B) Calculate the amount of overhead that would be applied to 7-9-11 Stores

 

C) Calculate the amount of overhead that would be applied to Men’s Large & Big Stores

 

D) Explain (in one or two sentences) or show (by calculation) how your answers to Parts (B) and (C) would change if the company combined Quality Control and Shipping into one overhead cost pool, and allocated overhead for this cost pool to customers based on the number of cartons shipped to that customer.