MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 11
SYSTEMS DESIGN: ACTIVITY-BASED COSTING
AND MANAGEMENT
I.

Questions
1. 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.
2. 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.
3. 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 low-volume
products.
4. 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 activity-based
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 nonvalue-added activities and thereby streamline operations and minimize
costs.
5. The four general levels of activities are:

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Chapter 11 Systems Design: Activity-Based Costing and Management

1. Unit-level activities, which are performed each time a unit is

produced.
2. Batch-level activities, which are performed each time a batch of goods
is handled or processed.
3. Product-level activities, which are performed as needed to support
specific products.
4. Facility-level activities, which simply sustain a facilitys general
manufacturing process.
6. 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 managers 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.
7. 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.
8. 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.
9. 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 firms resource
costs, namely factory overhead cost, to cost pools, and then to cost
objects.
12. Two major advantages of ABM are:

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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 firms competitive advantage.
II. True or False
1. True
2. True

3. False
4. True

5. False
6. False

7. True
8. True

III. Exercises
Exercise 1
Activity
a. Materials are moved
from the receiving
dock to product flow
lines by a materialhandling crew

Activity
Classification
Batch-level

Examples of
Traceable
Costs
Labor cost;
depreciation
of equipment;
space cost

Examples of
Cost
Drivers
Number of
receipts;
pounds handled

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

provided to all
employees in the
company

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Chapter 11 Systems Design: Activity-Based Costing and Management

f. Numerical control
(NC) machines are
used to cut and
shape materials

Unit-level

Power;
supplies used;
maintenance;
depreciation

Machinehours; number
of units

* 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.

Exercise 2
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

plantwide overhead rate

volume
two stage, stage, stage
Process value analysis
Unit-level
Batch-level
Product-level
Facility-level
high-volume, low-volume, low-volume
activity centers

IV. Problems
Problem 1
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
5 requisitions
18 parts

P 1,000
20,000
1,000
1,200
100
720
P24,020

Problem 2
Requirement 1
(a)
Total overhead = P200,000 + P32,000 + P100,000 + P120,000
= P452,000
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Systems Design: Activity-Based Costing and Management Chapter 11

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 10,000
Overhead applied
Total cost

P 6,000
9,040
P25,040

(c) Companys bid = Full manufacturing cost x 120% = P25,040 x 120%

= P30,048
Requirement 2
(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
Direct labor 10,000
Overhead applied
Total cost

P 6,000
5,620
P21,620

(c) Companys bid = Full manufacturing cost x 120% = P21,620 x 120%

= P25,944
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Chapter 11 Systems Design: Activity-Based Costing and Management

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
V. Multiple Choice Questions
1.
2.
3.
4.
5.
6.
7.
8.
9.
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

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P6,000
10,000
P5,000
240
80
300
5,620
P21,620
120%
P25,944