SOLUTIONS TO EXERCISES ASSIGNED FOR CH. 9: ACTIVITYBASED COSTING EXERCISE 9-23, PART A EXERCISE 9-23, PART B • Note that Dept SV has state-of-art machines, and the overhead is likely driven by machine use. • Examples of costs? • Department SV has an overhead allocation rate of $4.20 per machine-hour($105,840 ÷ 25,200 machine hours). • Department C has an overhead allocation rate • of $1.32 per DLH ($23,760 ÷ 18,000 labor-hours). EXERCISE 9-23, PART B We expect these to better reflect the OH costs of the three flavors. EX. 9-23, PART E • Charlene was correct that she was being allocated some of Department SV’s overhead. • Plantwide allocation does not correctly allocate the overhead by department; it simply uses one allocation rate for all products in all departments. • Under plantwide allocation, 1,000 gallons of chocolate cost $1,950. Once the overhead was reallocated into department cost pools, the cost of chocolate fell to $1,824. • Although it requires more time and skill to collect and process the information, department allocation generally yields more accurate product cost information. SOLUTION TO 9-24 (NOT ASSIGNED, BUT RELATED TO 9/25) Allocation based on separate pools for routine matters and transitions: PR. 9-25 • First, note that the total to be allocated is $750,000 (= $200*1500 employees + $5625* 80 transitions). • If we just compute the variable cost to be allocated to Ohio, the remainder will be allocated to Illinois. • 50 transition * $2000 = $100,000 • 300 employees* $50 = $15,000 $115,000 • So, Illinois gets $750,000 – 115,000 = $635,000 WOULD THE ALLOCATION BE FAIR? REASONABLE? • The reason it’s considered an allocation rather than a traced (direct) cost is that there are multiple ways to do it---no “correct” way! • Allocations always are arbitrary (because there is no provably “correct” way). • But there does exist a hierarchy of reasons, from strongest to weakest: • • • • Cause-and-effect Benefits Received Fairness Ability to bear CRITERIA FOR COST-ALLOCATION DECISIONS • Cause and Effect • Variables are identified that cause resources to be consumed • Most credible to operating managers • Integral part of ABC • Benefits Received • The beneficiaries of the outputs of the cost object are charged with costs in proportion to the benefits received Copyright © 2007 Pearson Education Canada 14-4 CRITERIA FOR COST-ALLOCATION DECISIONS • Fairness (Equity) • The basis cited for establishing a price satisfactory to the government, customers and suppliers • Cost allocation here is viewed as a “reasonable” or “fair” means of establishing a selling price • Ability to Bear • Costs are allocated in proportion to the cost object’s ability to bear them • Generally, larger or more profitable objects receive proportionally more of the allocated costs Copyright © 2007 Pearson Education Canada 14-5 9-27: ACTIVITY-BASED COSTING IN A NONMANUFACTURING ENVIRONMENT: CATHY’S CATERING PER-GUEST CHARGE TO COVER COSTS? • If Cathy wants to cover her costs she should charge… $49 per guest for the picnic ($980 ÷ 20 guests) $80.00/guest for dinner ($1,600 ÷ 20 guests). • Do we know the cost structure? What is her BEP? 9-29: ABC VS. TRADITIONAL c-$15 per machine-hour = $120,000 in production run costs ÷ 8,000 machine-hours. d-$3,500 per run = $70,000 in per-run (setup?) costs ÷ 20 total runs. e-$1,500 per inspection = $90,000 in inspn. costs ÷ 60 inspections. 9-29 CONT’D: ALLOCATED BY DLH Vs. $28.33 ABC and $130.00 for Which product was “subsidizing” the other? 9-29 CONCLUDED • By allocating overhead on the basis of direct labor, Doaktown Products has been understating the cost to manufacture M-123, thereby overstating the profits on M-123. • Perhaps the basic reel was being charged too much of the overhead costs related to machinery that really is used for the fancy version.