Professional Documents
Culture Documents
5-2
Aerotech Corporation's management was being misled by the traditional productcosting system, because the high-volume product lines were being overcosted and
the low-volume product line was being undercosted. The high-volume products
essentially were subsidizing the low-volume line. The traditional product-costing
system failed to show that the low-volume products were driving more than their
share of overhead costs. As a result of these misleading costs, the company's
management was mispricing its products.
5-3
5-4
5-5
(b)
(c)
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Managerial Accounting, 5/e
(d)
5-6
5-7
5-8
In traditional, volume-based costing systems, only direct material and direct labor
are considered direct costs. In contrast, under an activity-based costing system, an
effort is made to account for as many costs as possible as direct costs of
production. Any cost that can possibly be traced to a particular product line is
treated as a direct cost of that product.
5-9
McGraw-Hill/Irwin
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5-2
5-10
Non-value-added costs are the costs of activities that can be eliminated with no
deterioration of product quality, performance, or perceived value. Some examples of
potential non-value-added costs are as follows: time spent unnecessarily moving
raw materials, work in process, or finished goods between operations; unnecessary
time spent by raw materials or work in process waiting for the next operation;
storage of unnecessary inventories of raw materials, parts, or partially completed
products; costs incurred in repairing defective units when the defects could be
eliminated with better quality control systems.
5-11
Time is spent in a manufacturing process in the following five ways: process time,
inspection time, move time, waiting time, and storage time. There is the potential for
non-value-added costs in any of these five areas. Inefficient or unnecessary steps in
the production process may result in non-value-added costs. Other potential nonvalue-added activities include unnecessary inspections, unnecessary movement of
materials and goods between operations, unnecessary time spent waiting by
materials or partially completed goods, and excessive inventory in storage.
5-12
Two factors that tend to result in product cost distortion under traditional, volumebased product-costing systems are as follows:
(a) Non-unit level overhead costs: Many overhead costs vary with cost drivers that
are not unit-level activities. Use of a unit-level cost driver to assign such costs
tends to result in cost distortion.
(b) Product diversity: When a manufacturer produces a diverse set of products,
which exhibit different consumption ratios for overhead activities, use of a single
cost driver to assign costs results in cost distortion.
5-13
5-14
Three important factors in selecting cost drivers for an ABC system are as follows:
(a) Degree of correlation between consumption of an activity and consumption of
the cost driver.
(b) Cost of measurement of the cost driver.
(c) Behavioral effects, that is, how the cost driver selected will affect the behavior of
the individuals involved in the activity related to the cost driver.
5-15
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Managerial Accounting, 5/e
5-16
An activity dictionary lists all of the activities identified and used in an activity-based
costing analysis. The activity dictionary provides for consistency in the terminology
and level of complexity in the ABC analysis in the organizations various subunits.
5-17
Designing and implementing an ABC system requires a large amount of data from all
facets of an organization's operations. A multidisciplinary team will be more effective
in obtaining access to this data, and the result will be a better ABC system.
Moreover, a multidisciplinary team typically helps in gaining acceptance of the new
product-costing system.
5-18
Tipoffs that a new product-costing system may be needed include the following
(eight required):
(a) Line managers do not believe the product costs reported by the accounting
department.
(b) Marketing personnel are unwilling to use reported product costs in making
pricing decisions.
(c) Complex products that are difficult to manufacture are reported to be very
profitable although they are not priced at a premium.
(d) Product-line profit margins are difficult to explain.
(e) Sales are increasing, but profits are declining.
(f) Line managers suggest that apparently profitable products be dropped.
(g) Marketing or production managers are using "bootleg costing systems," which
are informal systems they designed, often on a personal computer.
(h) Some products that have reported high profit margins are not sold by
competitors.
(i) The firm seems to have captured a highly profitable product niche all for itself.
(j) Overhead rates are very high, and increasing over time.
(k) Product lines are diverse.
(l) Direct labor is a small percentage of total costs.
(m) The results of bids are difficult to explain.
(n) Competitors' high-volume products seem to be priced unrealistically low.
McGraw-Hill/Irwin
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5-4
Line mangers are close to the production process and may realize that a complex
product, which is difficult to manufacture, is undercosted by a traditional, volumebased costing system. Because of the cost distortion that is common in such
systems, the undercosted product may appear to be profitable when it is really
losing money. Line mangers may have a "gut feeling" for this situation, even if the
cost-accounting system suggests otherwise.
5-20
5-21
5-22
5-23
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Managerial Accounting, 5/e
SOLUTIONS TO EXERCISES
EXERCISE 5-24 (15 MINUTES)
1.
Material-handling cost per mirror = $1,000. The analysis is identical to that given for
requirement (1).
3.
$50,000
5
(5 15) *
$500
25
*The total number of material moves.
McGraw-Hill/Irwin
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5-6
a.
Quality-control costs assigned to the Satin Sheen line under the traditional system:
Quality-control costs = 14.5% direct-labor cost
Quality-control
costs assigned to
Satin Sheen line = 14.5% $27,500
= $3,988 (rounded)
b.
Quality-control costs assigned to the Satin Sheen line under activity-based costing:
Quantity for
Activity
Pool Rate
Satin Sheen
Incoming material inspection....... $11.50 per type..... 12 types.........
In-process inspection...................
.14 per unit...... 17,500 units...
Product certification...................... 77.00 per order.... 25 orders.......
Total quality-control costs assigned...........................................................
2.
Assigned
Cost
$ 138
2,450
1,925
$4,513
The traditional product-costing system undercosts the Satin Sheen product line, with
respect to quality-control costs, by $525 ($4,513 $3,988).
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Managerial Accounting, 5/e
40,000 yen
40,000 yen
610,000 yen
610,000 yen
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5-8
2.
The benefits of using multiple cost drivers stem from the increased accuracy in
product costs. This improved accuracy helps management to make better decisions
about pricing, bidding, product mix, and adding or dropping product lines.
3.
The costs of using multiple cost drivers include the time spent dividing overhead
costs into pools, selecting cost drivers, and measuring the amount of each cost
driver used by each product line; and increased data management requirements.
McGraw-Hill/Irwin
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Managerial Accounting, 5/e
2.
(b)
(c)
Stage two: Select cost drivers for each activity-cost pool. Then assign the costs
in each cost pool to the company's product lines in proportion to the amount of
the related cost driver used by each product line.
As described in the answer to the preceding exercise, the new system probably will
reveal distortion in the firm's reported product costs. In all likelihood, the high-volume
products are overcosted and the low-volume specialty products are undercosted.
McGraw-Hill/Irwin
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5-10
Strategic options:
(a)
Lower the prices on the firm's high-volume products to compete more effectively.
(b)
(c)
Consider eliminating the specialty product lines. This option may not be desirable
if there is a marketing need to produce a full product line. Also, the specialty
wheels may give Wheelco prestige.
Classification
P
P
P
P
P
P
P
B
B
B
McGraw-Hill/Irwin
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Managerial Accounting, 5/e
Activity
(11)
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
Classification
B
B
U
U
U
U
B
F
F
________________
*Robert Adams and Ray Carter, "United Technologies' Activity-Based Accounting Is a
Catalyst for Success As Easy as ABC, 18, p.4. United Technologies uses the term
structural-level activity, instead of facility-level activity as we have done.
McGraw-Hill/Irwin
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5-12
REDWOOD COMPANY
COMPUTATION OF SELLING COSTS
BY ORDER SIZE AND PER SKEIN WITHIN EACH ORDER SIZE
Small
Order Size
Medium
Large
Total
Sales commissions
(Unit cost: $675,000/225,000
= $3.00 per box.....................................................
$ 6,000
$135,000
box)...........................................................................
$534,000
$ 675,000
62,600
295,400
26,400
105,000
31,000
60,000
$654,000
$1,135,400
2,180,000
Catalogsb
(Unit cost: $295,400/590,800
= $.50 per catalog.................................................
127,150
105,650
catalog)....................................................................
Costs of catalog salesc
(Unit cost: $105,000/175,000
= $.60 per skein....................................................
47,400
31,200
skein)........................................................................
Credit and collectiond
(Unit cost: $60,000/6,000
= $10.00 per order................................................
4,850
24,150
order)........................................................................
$.30
The analysis of selling costs shows that small orders cost more than large orders.
This fact could persuade management to market large orders more aggressively
and/or offer discounts for them.
McGraw-Hill/Irwin
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5-14
SOLUTIONS TO PROBLEMS
PROBLEM 5-35 (25 MINUTES)
1.
a.
Indirect material.
Other indirect manufacturing costs (e.g., building maintenance, machine and
tool maintenance, property taxes, insurance, depreciation on plant and
equipment, rent, and utilities).
b.
2.
The increase in the overhead rate should not have a negative impact on the
company, because the increase in indirect costs was offset by a decrease in direct
labor.
3.
Separate costs into departmental overhead accounts (or other relevant pools),
with one account for each production and service department. Each
department would allocate its overhead to products on the basis that best
reflects the use of these overhead services.
Treat individual machines as separate cost centers, with the machine costs
collected and charged to the products using machine hours.
4.
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Direct material.
Direct labor:
3 hours x $12
4 hours x $12
Manufacturing overhead:
3 hours x $32
4 hours x $32
Total cost.
2.
Standard
Enhanced
$ 25
$ 40
36
48
96
$157
128
$216
McGraw-Hill/Irwin
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5-16
Cost
Activity Cost
Driver
Application
Rate
Order
processing
$150,000
500 orders
processed (OP)
= $300 per OP
Machine
processing
560,000
40,000 machine
hrs. (MH)
= $14 per MH
Product
inspection
90,000
10,000 inspection
hrs. (IH)
= $9 per IH
Standard
Enhanced
Order processing:
300 OP x $300... $ 90,000
200 OP x $300...
Machine processing:
18,000 MH x $14... 252,000
22,000 MH x $14...
Product inspection:
2,000 IH x $9..
18,000
8,000 IH x $9.
Total
$360,000
Production volume (units)
3,000
Cost per unit
$120*
$ 60,000
308,000
72,000
$440,000
4,000
$110**
Enhanced
$ 25
$ 40
Direct material.
Direct labor:
3 hours x $12
4 hours x $12
Order processing, machine processing,
and product inspection..
Total cost.
3.
a.
36
48
120
$181
110
$198
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Yes, especially since Petersons selling prices are based heavily on cost. An
overcosted product will result in an inflated selling price, which could prove
detrimental in a highly competitive marketplace. Customers will be turned off
and will go elsewhere, which hurts profitability. With undercosted products,
selling prices may be too low to adequately cover a products more accurate
(higher) cost. This situation is also troublesome and will result in a lower
income being reported for the company.
Type B
$ 35
20
160
$215
$ 60
20
120
$200
Direct material.
Direct labor..
Manufacturing overhead.
Unit cost
2.
Activity
Cost
Manufacturing
setups
$ 672,000
80 setups (SU)
= $8,400 per SU
1,848,000
38,500 machine
hours (MH)
= $48 per MH
Machine
processing
Product
shipping
McGraw-Hill/Irwin
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5-18
Activity
Driver
560,000
175 outgoing
= $3,200 per OS
shipments (OS)
Type A
Manufacturing setups:
50 SU x $8,400.. $ 420,000
30 SU x $8,400..
Machine processing:
16,000 MH x $48...
768,000
22,500 MH x $48...
Product shipping:
100 OS x $3,200
320,000
75 OS x $3,200..
Total . $1,508,000
Type B
$ 252,000
1,080,000
240,000
$1,572,000
8,000
15,000
$188.50*
$104.80**
Direct material
Direct labor.
Manufacturing setup, machine
processing, and outgoing shipments..
Total cost.
3.
Type A
Type B
$ 35.00
20.00
$ 60.00
20.00
188.50
$243.50
104.80
$184.80
Yes, the Type A storage cabinet is undercosted. The use of machine hours produced
a unit cost of $215; in contrast, the more accurate activity-based-costing approach
shows a unit cost of $243.50. The difference between these two amounts is $28.50.
McGraw-Hill/Irwin
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Managerial Accounting, 5/e
No, the discount is not advisable. The regular selling price of $260, when compared
against the more accurate ABC cost figure, shows that each sale provides a profit to
the firm of $16.50 ($260.00 - $243.50). However, a $30 discount will actually produce
a loss of $13.50 ($243.50 - $230.00), and the more units that are sold, the larger the
loss. Notice that with the less-accurate, machine-hour-based figure ($215), the
marketing manager will be misled, believing that each discounted unit sold would
boost income by $15 ($230 - $215).
Activity-based costing results in improved costing accuracy for two reasons. First,
companies that use ABC are not limited to a single driver when allocating costs to
products and activities. Not all costs vary with units, and ABC allows users to select
a host of nonunit-level cost drivers. Second, consumption ratios often differ greatly
among activities. No single cost driver will accurately assign costs for all activities
in this situation.
2.
McGraw-Hill/Irwin
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5-20
E-Commerce
Consulting
$387,500
212,040
$175,460
$237,500
129,960
$107,540
45.28%
45.28%
Activity
Driver
Cost
Staff support
In-house
computing
$180,000
136,400
Miscellaneous
office charges
25,600
Application
Rate
250 clients
4,400 computer
hours (CH)
$31 per CH
1,000 client
transactions (CT)
$25.60 per CT
Activity
Staff support:
200 clients x $720...
50 clients x $720.
In-house computing:
2,600 CH x $31.
1,800 CH x $31.
Miscellaneous office charges:
400 CT x $25.60...
600 CT x $25.60...
Total .
McGraw-Hill/Irwin
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Managerial Accounting, 5/e
Information
Systems
Services
E-Commerce
Consulting
$144,000
$ 36,000
80,600
55,800
10,240
$234,840
15,360
$107,160
E-Commerce
Consulting
$387,500
234,840
$152,660
$237,500
107,160
$130,340
39.40%
54.88%
4.
Yes, his attitude should change. Even though both services are needed and
professionals are paid the same rate, the income percentages show that e-commerce
consulting provides a higher return per sales dollar than information systems
services (54.88% vs. 39.40%). Thus, all other things being equal, professionals
should spend more time with e-commerce.
5.
Probably not. Although both services produce an attractive return for Simon and
Sloan, the firm is experiencing a very tight labor market and will likely have trouble
finding qualified help. In addition, the professional staff is currently overworked,
which would probably limit the services available to new clients.
Detroit Metal Works (DMW) is currently using a plantwide overhead rate that is applied
on the basis of direct-labor dollars. In general, a plantwide manufacturing-overhead
rate is acceptable only if a similar relationship between overhead and direct labor
exists in all departments or the company manufactures products that receive the same
proportional services from each department
In most cases, departmental overhead rates are preferable to plantwide
overhead rates because plantwide overhead rates do not provide the following:
McGraw-Hill/Irwin
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5-22
Because the company uses a plantwide overhead rate applied on the basis of directlabor dollars, the elimination of direct labor in the Drilling Department through the
introduction of robots may appear to reduce the overhead cost of the Drilling
Department to zero. However, this change will not reduce fixed manufacturing costs
such as depreciation and plant supervision. In reality, the use of robots is likely to
increase fixed costs because of increased depreciation. Under the current method of
allocating overhead costs, these costs merely will be absorbed by the remaining
departments.
3.
a.
In order to improve the allocation of overhead costs in the Cutting and Grinding
departments, management should move toward an activity-based costing system.
The firm should:
b.
Establish a separate overhead pool and rate for the Drilling Department.
Identify fixed and variable overhead costs and establish fixed and variable
overhead rates.
McGraw-Hill/Irwin
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Managerial Accounting, 5/e
Pool
Rate
$2,000 per setup
$2 per pound
$5 per pound
$75 per inspection
$10 per machine
hour
Level of
Cost Driver
5 setups
10,000 pounds
2,000 pounds
10 inspections
500 machine hours
Total
Assigned
Overhead
Cost
$10,000
20,000
10,000
750
5,000
$45,750
2.
45,750
$45.75 per box
1,000 boxes
3.
Predetermined
overhead rate
$625,000
total budgeted overhead cost
b.
5.
$15,625
$15.625 per box
1,000 boxes
The film development chemicals entail a relatively large number of machine setups, a
large amount of hazardous materials, and several inspections. Thus, they are quite
costly in terms of driving overhead costs. Use of a single predetermined overhead rate
obscures this characteristic of the production job. Underestimating the overhead cost
per box could have adverse consequences for Knoxville Photographic Supply
Company. For example, it could lead to poor decisions about product pricing. The
activity-based costing system will serve management much better than the system
based on a single, predetermined overhead rate.
McGraw-Hill/Irwin
Inc.
5-24
(b)
Level of
Cost Driver
3 setups
900 pounds
300 pounds
3 inspections
50 machine hours
Assigned
Overhead
Cost
$6,000
1,800
1,500
225
500
$10,025
$10,025
$100.25
100 plates
$120.00
40.00
100.25
$260.25
Quebec Electronics should not continue with its plans to emphasize the Royal model
and phase out the Nova model. As shown in the following activity-based costing
analysis, the Royal model has a contribution margin of less than 3 percent, while the
Nova model generates a contribution margin of nearly 43 percent.
Cost per event for each cost driver:
Soldering....................
Shipments...................
Quality control............
Purchase orders.........
Machine power...........
Machine setups..........
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$942,000
860,000
1,240,000
950,400
57,600
750,000
1,570,000 =
20,000 =
77,500 =
190,080 =
192,000 =
30,000 =
$.60
43.00
16.00
5.00
.30
25.00
Nova
Direct costs:
Materiala..........................................................................
Direct laborb...................................................................
Machine hoursc..............................................................
Total direct costs..................................................................
$2,336,000
168,000
288,000
$2,792,000
$ 4,576,000
396,000
3,168,000
$ 8,140,000
Assigned costs:
Solderingd.......................................................................
Shipmentse.....................................................................
Quality controlf...............................................................
Purchase ordersg...........................................................
Machine powerh.............................................................
Machine setupsi.............................................................
Total assigned costs.............................................................
Total cost...............................................................................
$ 231,000
163,400
340,800
549,900
4,800
350,000
$1,639,900
$4,431,900
$ 711,000
696,600
899,200
400,500
52,800
400,000
$ 3,160,100
$11,300,100
Calculations:
Royal
a
Material.........................................
Direct labor...................................
c
Machine hours..............................
d
Soldering......................................
e
Shipments.....................................
f
Quality control..............................
g
Purchase orders...........................
h
Machine power.............................
i
Machine setups.............................
b
McGraw-Hill/Irwin
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5-26
4,000 $584
4,000 $42
4,000 $72
385,000 $.60
3,800 $43
21,300 $16
109,980 $5
16,000 $.30
14,000 $25
Nova
22,000 $208
22,000 $18
22,000 $144
1,185,000 $.60
16,200 $43
56,200 $16
80,100 $5
176,000 $.30
16,000 $25
Royal
Nova
$4,560,000 $19,800,000
4,431,900 11,300,100
$ 128,100 $8,499,900
4,000
22,000
$1,140.00
1,107.98
$ 32.02
2.8%a
Total
$24,360,000
15,732,000
$ 8,628,000
$900.00
513.64
$386.36
42.9%b
$32.02/$1,140.00 = 2.8%
$386.36/$900.00 = 42.9%
2.
Activity-based management (ABM) is the use of information obtained from activitybased costing to improve operations in the firm. For example, a firm could revise
product prices on the basis of revised cost information. For the long term, activitybased costing can assist management in making decisions regarding the viability of
product lines, distribution channels, marketing strategies, and so on. ABM highlights
possible improvements, including reducing or eliminating non-value-added activities,
selecting lower cost activities, sharing activities with other products, and eliminating
waste. ABM is an integrated approach that focuses management's attention on
activities with the ultimate aim of continuous improvement. As a whole-company
philosophy, ABM focuses on strategic as well as tactical and operational activities of
the company.
McGraw-Hill/Irwin
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Managerial Accounting, 5/e
McGraw-Hill/Irwin
Inc.
5-28
Using Manchester Technologys unit cost data, the total contribution margin expected
from the PC board is $2,360,000, calculated as follows:
Revenue................................................................................
Direct material......................................................................
Material-handling charge (10% of material).......................
Direct labor ($14 per hr.4 hr.)..........................................
Variable overhead ($4 per hr.4 hr.)*................................
Machine time ($10 per hr.1.5 hr.)....................................
Total cost.......................................................................
Unit contribution margin.....................................................
Total contribution margin (40,000$59)...........................
Per Unit
$300
$140
14
56
16
15
$241
$59
Total for
40,000
Units
$12,000,000
$5,600,000
560,000
2,240,000
640,000
600,000
$9,640,000
$2,360,000
Revenue................................................................................
Direct material......................................................................
Material-handling charge (10% of material).......................
Direct labor ($14 per hr.1.5 hr.).......................................
Variable overhead ($4 per hr.1.5 hr.)*.............................
Machine time ($10 per hr..5 hr.)......................................
Total cost.......................................................................
Unit contribution margin.....................................................
Total contribution margin (65,000$30)...........................
Per Unit
$150
$ 80
8
21
6
5
$120
$30
Total for
65,000
Units
$9,750,000
$5,200,000
520,000
1,365,000
390,000
325,000
$7,800,000
$1,950,000
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Managerial Accounting, 5/e
The pool rates, which apply to both the PC board and the TV board, are calculated as
follows:
Procurement............................
$400,000/4,000,000 = $.10 per part
Production scheduling...........
$220,000/110,000 = $2.00 per board
Packaging and shipping.........
$440,000/110,000 = $4.00 per board
Machine setup.........................
$446,000/278,750 = $1.60 per setup
Hazardous waste disposal.....
$48,000/16,000 = $3.00 per lb.
Quality control.........................
$560,000/160,000 = $3.50 per inspection
General supplies.....................
$66,000/110,000 = $.60 per board
Machine insertion.................... $1,200,000/3,000,000 = $.40 per part
Manual insertion...................... $4,000,000/1,000,000 = $4.00 per part
Wave soldering........................
$132,000/110,000 = $1.20 per board
Using activity-based costing, the total contribution margin expected from the PC
board is $1,594,000, calculated as follows:
Revenue..................................................................................
Direct material........................................................................
Procurement ($.10 per part55 parts)...............................
Production scheduling..........................................................
Packaging and shipping........................................................
Machine setup ($1.60 per setup3 setups).......................
Hazardous waste disposal ($3 per lb..35 lb.)..................
Quality control
($3.50 per inspection2 inspections).........................
General supplies....................................................................
Machine insertion ($.40 per part35 parts).......................
Manual insertion ($4 per part20 parts)............................
Wave soldering......................................................................
Total cost
Unit contribution margin
Total contribution margin
McGraw-Hill/Irwin
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5-30
Per Unit
$300.00
$140.00
5.50
2.00
4.00
4.80
1.05
7.00
.60
14.00
80.00
1.20
$260.15
$39.85
Total for
40,000
Units
$12,000,000
$5,600,000
220,000
80,000
160,000
192,000
42,000
280,000
24,000
560,000
3,200,000
48,000
$10,406,000
$1,594,000
Revenue................................................................................
Direct material......................................................................
Procurement ($.10 per part25 parts)..............................
Production scheduling........................................................
Packaging and shipping......................................................
Machine setups ($1.60 per setup2 setups)....................
Hazardous waste disposal ($3 per lb..02 lb.)................
Quality control......................................................................
General supplies..................................................................
Machine insertion ($.40 per part24 parts).....................
Manual insertion...................................................................
Wave soldering.....................................................................
Total cost.........................................................................
Unit contribution margin.....................................................
Total contribution margin....................................................
4.
Per Unit
$ 150.00
$ 80.00
2.50
2.00
4.00
3.20
.06
3.50
.60
9.60
4.00
1.20
$110.66
$39.34
Total for
65,000
Units
$9,750,000
$5,200,000
162,500
130,000
260,000
208,000
3,900
227,500
39,000
624,000
260,000
78,000
$7,192,900
$2,557,100
The analysis using the previously reported costs shows that the unit contribution of
the PC board is almost double that of the TV board. On this basis, management is
likely to accept the suggestion of the production manager and concentrate
promotional efforts on expanding the market for the PC boards.
However, the analysis using activity-based costing does not support this
decision. This analysis shows that the unit dollar contribution from each of the boards
is almost equal, and the total contribution from the TV board exceeds that of the PC
board by almost $1,000,000. As a percentage of selling price, the contribution from the
TV board is double that of the PC board (26 percent versus 13 percent).
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
a.
WGCC's predetermined overhead rate, using direct-labor cost as the single cost
driver, is $5 per direct labor dollar, calculated as follows:
Overhead rate
= $3,000,000/$600,000
= $5 per direct-labor dollar
b.
The full product costs and selling prices of one pound of Kona and one pound of
Malaysian coffee are calculated as follows:
Kona
Direct material........................................
Direct labor.............................................
Overhead (.30$5)...............................
Full product cost...................................
Markup (30%).........................................
Selling price...........................................
2.
$3.20
.30
1.50
$5.00
1.50
$6.50
Malaysian
$4.20
.30
1.50
$6.00
1.80
$7.80
A new product cost, under an activity-based costing approach, is $7.46 per pound of
Kona and $4.82 per pound of Malaysian coffee, calculated as follows:
Activity
Purchasing
Material handling
Quality control
Roasting
Blending
Packaging
McGraw-Hill/Irwin
Inc.
5-32
Cost Driver
Purchase orders
Setups
Batches
Roasting hours
Blending hours
Packaging hours
Budgeted
Activity
1,158
1,800
720
96,100
33,600
26,000
Budgeted
Cost
$579,000
720,000
144,000
961,000
336,000
260,000
Unit Cost
$500
400
200
10
10
10
$3.20
.30
1.00
2.40
.40
.10
.05
.01
$7.46
Malaysian Coffee
Standard cost per pound:
Direct material.......................................................................................
Direct labor............................................................................................
Purchasing (4* orders $500/100,000 lb.)..........................................
Material handling (30 setups $400/100,000 lb.)...............................
Quality control (10 batches $200/100,000 lb.).................................
Roasting (1,000 hours $10/100,000 lb.)............................................
Blending (500 hours $10/100,000 lb.)...............................................
Packaging (100 hours $10/100,000 lb.)............................................
Total cost...............................................................................................
$4.20
.30
.02
.12
.02
.10
.05
.01
$4.82
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
The ABC analysis indicates that several activities other than direct labor drive
overhead. The cost computations show that the current system significantly
undercosted Kona coffee, the low-volume product, and overcosted the highvolume product, Malaysian coffee.
b.
The implication of the ABC analysis is that the low-volume products are using
resources but are not covering their share of the cost of those resources. The
Kona blend is currently priced at $6.50 [see requirement 1(b)], which is
significantly below its activity-based cost of $7.46. The company should set longrun prices above cost. If there is excess capacity and many of the costs are fixed,
it may be acceptable to price some products below full activity-based cost
temporarily in order to build demand for the product. Otherwise, the high-volume,
high-margin products are subsidizing the low-volume, low-margin products.
McGraw-Hill/Irwin
Inc.
5-34
Type of Activity
Unit-level
Batch-level
Product-sustaining-level
Facility-level
III. Engineering:
$90,000
100 change orders
3.
Ends: $4,500 per run 250 units per run = $18 per unit
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
$67,500
= $67.50 per unit
1,000 units
$900 per change order 100 change orders 25%
5,000 units
=
Ends:
$22,500
= $4.50 per unit
5,000 units
$76,800
= $76.80 per unit
1,000 units
$50 per sq. ft. 1,920 sq. ft. 20%
5,000 units
=
Ends:
McGraw-Hill/Irwin
Inc.
5-36
$19,200
= $3.84 per unit
5,000 units
5.
50.00
18.00
4.50
3.84
$181.34
6.
Ends
$ 60.00
45.00
Ends
$181.34
120%
$217.61 (rounded)
Ends
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
Cost distortion:
Odds
Traditional volume-based costing system:
reported product cost...................................................
Activity-based costing system:
reported product cost...................................................
Amount of cost distortion per unit......................................
Ends
$ 166.00
$249.00
504.30
$(338.30)
181.34
$ 67.66
Traditional
system
undercosts
odds by
$338.30
per unit
Production volume............................................................... 1,000
Total amount of cost distortion for entire
product line.................................................................... $(338,300)
Traditional
system
overcosts
ends by
$67.66
per unit
5,000
$338,300
McGraw-Hill/Irwin
Inc.
5-38
Kara Lindley's predecessor at Northwest Aircraft Industries (NAI) would have used a
10 percent material-handling rate, calculated as follows:
Payroll...................................................................................
Employee benefits................................................................
Telephone..............................................................................
Other utilities........................................................................
Materials and supplies.........................................................
Depreciation..........................................................................
Total Material-Handling Department costs.........................
Material-handling rate
$288,000
$2,006,000 $874,000
$180,000
36,000
38,000
22,000
6,000
6,000
$288,000
= 10%
2.
a.
b.
$288,000
46,000
$242,000
242,000
$ 1.00
Purchase orders might be a more reliable cost driver than is the dollar amount of
direct material, because resources are consumed in processing a purchase
order. The size of the order does not necessarily have an impact on the
consumption of resources.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
$ 2,006,000
10%
$200,600
New method:
Directly traceable material-handling costs
[$36,000 + (20% $36,000) + $2,800]...........................
Purchase orders (80,000 $1.00).......................................
Total (new method)...............................................................
$46,000
80,000
$126,000
Net reduction........................................................................
$74,600
McGraw-Hill/Irwin
Inc.
5-40
A forecast of the cumulative dollar impact over a three-year period from 20x1 through
20x3 of Kara Lindley's recommended change for allocating Material-Handling
Department costs to the Government Contracts Unit is $234,346, calculated as
follows:
20x2
20x3
$ 3,025,800
$302,580
46,000a
$256,580
$ 256,580
266,805
$ .96
88,046
$ 84,524
46,000a
$ 130,524
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
$2,118,060c
$ 211,806e
130,524
$ 81,282
a.
$ 74,600
78,464
81,282
$234,346
Refrain from engaging in any activity that would prejudice Lindley's ability to
carry out her duties ethically.
McGraw-Hill/Irwin
Inc.
5-42
The steps Kara Lindley could take to resolve this ethical conflict are as follows:
She should also discuss the situation with an objective advisor to clarify the
issues involved and obtain an understanding of possible courses of action.
If the ethical conflict still exists after exhausting all levels of internal review,
then she may have no other course of action than to resign from the
company and submit an informative memorandum to an appropriate
representative of the company.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
a.
b.
$100,000
60,000
$ 160,000
800,000
$ 24,000
5,000
31,000
180,000
75,000
10,000
10,000
15,000
350,000
$1,310,000
The unit costs of Tuff Stuff and Ruff Stuff, with overhead assigned on the basis
of direct-labor hours, are calculated as follows:
Tuff Stuff:
Direct material........................................................
Direct labor ($8.00 per hour2 hours)*..............
Overhead ($3.50 per hour2 hours)*.................
Tuff Stuff unit cost...........................................
$5.00
16.00
7.00
$28.00
40,000
60,000
100,000
McGraw-Hill/Irwin
Inc.
5-44
=
=
$ 3.00
24.00
10.50
$37.50
40,000
60,000
100,000
The total budgeted cost of the Fabricating and Assembly Departments, after
separation of overhead into the activity cost pools, is calculated as follows:
Total
Direct material...........
Direct labor...............
Overhead:
Indirect labor
Fringe benefits
Indirect material
Power
Setup
Quality assurance
Other utilities
Depreciation
Total overhead
Total cost
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
$160,000
800,000
$24,000
5,000
31,000
180,000
75,000
10,000
10,000
15,000
$ 350,000
$1,310,000
Fabricating
Percent
Dollars
100%
$160,000
75%
600,000
75%
80%
80%
50%
80%
$18,000
4,000
20,000
160,000
5,000
8,000
5,000
12,000
$232,000
$992,000
Assembly
Percent
Dollars
25%
$200,000
25%
20%
$6,000
1,000
11,000
20,000
70,000
2,000
5,000
3,000
$118,000
$318,000
20%
50%
20%
The unit costs of the products using activity-based costing are calculated as follows:
Fabricating:
Total cost..............................................................................................................
$992,000
Less: Direct material............................................................................................
160,000
Less: Direct labor................................................................................................
600,000
Pool overhead cost..............................................................................................
$232,000
88,000 hours
Tuff Stuff (4.4 hours 20,000 units).................................................
120,000 hours
Ruff Stuff (6.0 hours 20,000 units).................................................
Total machine hours................................................................
208,000 hours
Pool rate per machine hour ($232,000/208,000)................................................
$1.12 per hour (rounded)
Hours:
Tuff Stuff..........................................................................................
1,000
Ruff Stuff..........................................................................................
272
Total setups............................................................................
1,272
Pool rate per setup ($118,000/1,272)..................................................................
$92.77 per setup (rounded)
Setup cost per unit:
Tuff Stuff ($92.77 per setup 1,000 set-ups/20,000 units)
Ruff Stuff ($92.77 per setup 272 set-ups/20,000 units)
McGraw-Hill/Irwin
Inc.
5-46
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
Standard
Model
Deluxe
Model
$105.00
110%
$115.50
$215.00
110%
$236.50
Heavy-Duty
Model
$232.00
110%
$255.20
Direct material..................................................
Direct labor......................................................
Machinery depreciation and maintenancea. . .
Engineering, inspection and
repair of defectsb........................................
Purchasing, receiving, shipping, and
material handlingc......................................
Factory depreciation, taxes, insurance,
and miscellaneous overhead costsd........
Total..................................................................
Standard
Model
$10.00
10.00
32.00
Deluxe
Model
$25.00
20.00
208.00
Heavy-Duty
Model
$42.00
20.00
75.20
17.04
43.50
34.08
15.28
52.00
29.25
12.50
$96.82
89.25
$437.75
25.59
$226.12
Pool I:
Depreciation, machinery...............................................................
Maintenance, machinery...............................................................
Total................................................................................................
Standard:
$32.00
($1,600,00040%) 20,000 =
Deluxe:
($1,600,00013%) 1,000 = $208.00
Heavy-Duty:
$75.20
($1,600,00047%) 10,000 =
b
Pool II:
Engineering....................................................................................
Inspection and repair of defects..................................................
Total................................................................................................
Standard:
$17.04
($725,000 47%) 20,000 =
Deluxe:
$43.50
($725,000 6%) 1,000 =
Heavy-Duty:
$34.08
($725,000 47%) 10,000 =
c
Pool III:
Purchasing, receiving, and shipping...........................................
Material handling...........................................................................
Total................................................................................................
Standard:
$15.28
($650,000 47%) 20,000 =
Deluxe:
$52.00
($650,000 8%) 1,000 =
Heavy-Duty:
$29.25
($650,000 45%) 10,000 =
McGraw-Hill/Irwin
Inc.
5-48
$1,480,000
120,000
$1,600,000
$350,000
375,000
$725,000
$250,000
400,000
$650,000
Pool IV:
Depreciation, taxes, and insurance for factory...........................
Miscellaneous manufacturing overhead.....................................
Total................................................................................................
Standard:
$12.50
($595,000 42%) 20,000 =
Deluxe:
1,000 =
$89.25
($595,000 15%)
Heavy-Duty:
$25.59
($595,000 43%) 10,000 =
$300,000
295,000
$595,000
3.
Product costs based on activity-based
costing system..................................................
Markup percentage...................................................
New target price........................................................
Standard
Model
Deluxe
Model
$96.82
110%
$106.50
$437.75
110%
$481.53
Heavy Duty
Model
$226.12
110%
$248.73
The new target price of the standard model, $106.50, is lower than the current actual
selling price, $110.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
MEMORANDUM
Date:
Today
To:
From:
I.M. Student
Subject:
Product costing
Based on the cost data from our traditional, volume-based product-costing system,
our standard model is not very profitable. Its reported actual contribution margin is
only $5 ($110 $105). However, the validity of this conclusion depends on the
accuracy of the product costs reported by our product-costing system. Our
competitors are selling motors like our standard model for $106. This price suggests
that their product cost is substantially below our previously reported cost of $105.
Our new, activity-based costing system reveals serious product cost
distortions stemming from our old costing system. The new costing system shows
that the standard model costs only $96.82, which implies a target price of $106.50.
This price is lower than our current actual selling price and consistent with the price
our competitors are charging.
In contrast, our new product-costing system reveals that the deluxe model's
product cost is $437.75 instead of the previously reported cost of $215. The new
product cost suggests a target price of $481.53 for the deluxe model, rather than
$236.50, which was our previous target price for the deluxe model.
McGraw-Hill/Irwin
Inc.
5-50
The company should adopt and maintain the activity-based costing system. The price
of the standard model should be lowered to the $106. Lowering the price should
enable the firm to regain its competitive position in the market for the standard model.
Further price cuts should be considered if marketing studies indicate such a move
will increase demand.
The price of the deluxe model should be set near the target price of $481.53. If
the deluxe model does not sell at this price, management should consider
discontinuing the product line. Input from the marketing staff should be sought before
such an action is taken. An important consideration is the extent to which sales in the
standard model and heavy-duty model markets depend on the firm's offering a
complete product line.
A slight price reduction should be considered for the heavy-duty model (from
$255.20 down to $248.73). However, the product cost distortion from the old costing
system did not affect this model as seriously as it did the other two.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
Heavy-Duty
Model
$105.00
$215.00
$232.00
96.82
$8.18
437.75
$(222.75)
226.12
$5.88
Traditional
system
overcosts
standard
model by
$8.18
per unit
Product volume......................................................
Total amount of cost distortion for entire
product line........................................................
Deluxe
Model
Traditonal
system
undercosts
deluxe
model by
$222.75
per unit
Traditional
system
overcosts
heavy-duty
model by
$5.88
per unit
20,000
1,000
10,000
$163,600
$(222,750)
$58,800
McGraw-Hill/Irwin
Inc.
5-52
The controller, Erin Jackson, has acted ethically up to this point. She correctly
pointed out to the president that the firm's traditional, volume-based product-costing
system was distorting the reported product cost for the company's three products.
She designed an activity-based costing system to provide more accurate productcosting data.
2.
The production manager, Alan Tyler, is not acting ethically. Although we can
sympathize with his plight, we cannot condone his pressuring the controller to
suppress or alter the new product-costing data she has compiled.
What can Tyler do that is ethical and has the potential for positive results?
First, he could take a hard look at the deluxe model's production process. Are there
non-value-added activities that could be reduced or eliminated? Second, he could
argue to the president that the company should carry a full product line, if he has
reason to believe that is the firm's best strategy.
3.
Jackson has an ethical obligation to the president, to the company, to her profession,
and to herself to report accurate product-costing data to the president. There is
nothing wrong with her offer to her friend to go over her analysis again to verify its
accuracy. However, she must report what she finds with no suppression or alteration
of the data. Several of the ethical standards for managerial accounting apply in this
case. (See Chapter 1 for a listing of these standards.) The standards that are most
clearly relevant include the following:
Integrity:
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
McGraw-Hill/Irwin
Inc.
5-54
SOLUTIONS TO CASES
CASE 5-51 (60 MINUTES)
1.
2.
Again, based on the product costs reported by the firm's traditional, volume-based
product-costing system, product W appears to be very profitable. As in requirement
(1), however, the validity of this assessment depends on the accuracy of the reported
product costs.
3.
Gigabyte's competitors have moved aggressively into the market for gismos (product
G), but they have abandoned the whatchamacallit (product W) market to Gigabyte.
These competing firms apparently believe they can sell gismos at a much
lower price than Gigabyte's management feels is feasible. This evidence suggests that
Gigabyte's competitors may believe their product cost for gismos is below Gigabyte's
reported product cost. In contrast, Gigabyte's competitors apparently believe that
they cannot afford to sell whatchamacallits at Gigabyte's current price of $200.
Perhaps the competing firms' reported production costs for product W are higher than
the cost reported by Gigabyte's product-costing system.
The danger to Gigabyte is that the company will be forced out of the market for
its second largest selling product. This could be disastrous to Gigabyte, Inc.
4.
Product
G
T
W
Total
Raw-Material
Cost per Unit
$35.00
52.50
17.50
Annual
Volume
8,000
15,000
4,000
Annual
Raw-Material
Cost
$ 280,000
787,500
70,000
$1,137,500
Percentage
of Total
Raw-Material
Cost*
25%
69%
6%
100%
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
Direct material................................................
Direct labor.....................................................
Machine setupa...............................................
Machineryb......................................................
Inspectionc......................................................
Material handlingd..........................................
Engineeringe...................................................
Total................................................................
Product
T
Product
W
$52.50
12.00
.11
40.83
15.75
40.25
2.30
$163.74
$17.50
8.00
.66
76.56
52.50
13.13
47.40
$215.75
Machine setup:
Product G: ($5,250 20%)
Product T:
($5,250 30%)
Product W: ($5,250 50%)
b
Machinery:
Product G: ($1,225,000 25%)
Product T:
($1,225,000 50%)
Product W: ($1,225,000 25%)
c
Inspection:
Product G: ($525,000 15%)
Product T:
($525,000 45%)
Product W: ($525,000 40%)
d
Material handling:
Product G: ($875,000 25%)
Product T:
($875,000 69%)
Product W: ($875,000 6%)
e
Engineering:
Product G: ($344,750 35%)
Product T:
($344,750 10%)
Product W: ($344,750 55%)
McGraw-Hill/Irwin
Inc.
5-56
8,000 units =
15,000 units =
4,000 units =
$.13
$.11
$.66
8,000 units =
15,000 units =
4,000 units =
$38.28
$40.83
$76.56
8,000 units =
15,000 units =
4,000 units =
$9.84
$15.75
$52.50
8,000 units =
15,000 units =
4,000 units =
$27.34
$40.25
$13.13
8,000 units =
15,000 units =
4,000 units =
$15.08
$2.30
$47.40
Comparison of reported product costs, new target prices, and actual selling prices:
Product
G
Reported product costs:
Traditional, volume-based costing system
Activity-based costing system
Target price based on new product costs
(150%new product cost)
Current actual selling price
Product
T
Product
W
$191.00
141.67
$169.50
163.74
$95.50
215.75
212.51
213.00
245.61
254.25
323.63
200.00
Today
To:
From:
I.M. Student
Subject:
Implement the new activity-based costing system and revise its database frequently.
2.
Lower the target price of gismos to $213, the current actual selling price. This price
yields our usual 50 percent markup over product cost.
3.
Consider lowering the price of thingamajigs to $246 in order to increase demand. The
lower price still yields Gigabyte a 50 percent markup over product cost.
4.
Raise the price of whatchamacallits to $324. If the product does not sell at that price,
consider discontinuing the product line.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
Product volume......................................................
Total amount of cost distortion for entire
product line......................................................
Product
T
Product
W
$191.00
$169.50
$ 95.50
141.67
$49.33
163.74
$ 5.76
215.75
$(120.25)
Traditional
system
overcosts
product
G by
$49.33
per unit
Traditonal
system
overcosts
product
T by
$5.76
per unit
8,000
15,000
$394,640
$86,400
Traditional
system
undercosts
product
W by
$120.25
per unit
4,000
$(481,000)
McGraw-Hill/Irwin
Inc.
5-58
Activity-based costing (ABC) differs from traditional costing in that it focuses on activities
that consume resources as the fundamental cost drivers. ABC is a two-stage cost
assignment process focused on causality and the determination of cost drivers. It usually
uses several different activities to assign costs to products or services. Therefore, it is
more detailed and more accurate than traditional costing. It also helps managers
distinguish between value added and non-value added activities.
2.
Assembly..................
Material handling......
Inspection.................
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
McGraw-Hill/Irwin
Inc.
5-60
RM-13
Estimated
20x1
20x2
Cost
Product
Data
Cost
$1,000,000
$1,750,000
$92,593
200,000
(rounded)
100,000
(rounded)
30,000
150,000
300,000
5,500
120,000
110,000
10
5,000
50,000
20,000
40,000
7,500
50,000
$1,540,000
75,000
$2,375,000
WHITESTONE COMPANY
BUDGETED STATEMENT OF OPERATING MARGIN FOR 20X2
Sales revenue..................................................
Cost of goods manufactured and sold:
Beginning finished-goods inventory.............
Add: Direct material.....................................
Direct labor..........................................
Machining............................................
Assembly.............................................
Material handling.................................
Inspection............................................
Cost of goods available for sale....................
Less: Ending finished-goods inventory*....
Cost of goods sold.........................................
Operating margin............................................
JR-14
$1,810,500
RM-13
$2,229,500
Total
$4,040,000
$ 240,000
1,000,000
200,000
150,000
120,000
20,000
50,000
$1,780,000
215,600
$1,564,400
$ 246,100
$ 300,000
1,750,000
100,000
300,000
110,000
40,000
75,000
$2,675,000
332,500
$2,342,500
$ (113,000)
$ 540,000
2,750,000
300,000
450,000
230,000
60,000
125,000
$4,455,000
548,100
$3,906,900
$ 133,100
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e
ISSUE 5-56
"LEARNING TO LOVE ABC," JOURNAL OF ACCOUNTANCY, AUGUST 1999, GARY COKINS.
As the power of personal computers have grown and their prices have fallen, the
information for ABC systems has become more available and cost effective to obtain
and use. Moreover, several companies have found that simpler designs of ABC
generally produce higher levels of accuracy. Most important of all, those who have
successfully implemented ABC say that when gathering data for ABC, close enough is
not only good enough, it's often the key to its success. Therefore, simpler is better.
ISSUE 5-57
"MANUFACTURING MASTERS ITS ABCS," BUSINESS WEEK, AUGUST 7, 2000, HUGH
FILMAN.
Alcoa employed ABC to capture indirect costs such as machine setups, quality control,
packing and shipping. Managers can now determine if they want to produce a particular
product line or sell off certain assets. Smarter production decisions are being made, and
a new pricing structure has resulted.
McGraw-Hill/Irwin
Inc.
5-62
ISSUE 5-58
"YES, ABC IS FOR SMALL BUSINESS, TOO," JOURNAL OF ACCOUNTANCY, AUGUST 1999,
DOUGLAS T. HICKS.
Smaller organizations are beginning to see that ABC can work as effectively for them as
it does for large companies. The concept of activity-based costing is actually very
simple. An organization has to perform certain activities to provide the products and
services it sells, and those activities cost money. The cost of each of the activities is
measured and assigned only to those products and services requiring the activity, using
appropriate cost drivers. It is then possible to get an accurate picture of the real cost of
producing each product or providing each service. Non-activity costs such as direct
material or outsourced services do not need to be included because they are already
traceable to specific products or services. This process can work as effectively for
smaller organizations as it does for large companies.
ISSUE 5-59
"SUCCEEDING WITH 80/20," MANAGEMENT ACCOUNTING, FEBRUARY 1999, LAKSHMI U.
TATIKONDA, DAN O'BRIEN, AND RAO J. TATIKONDA.
After two years of study and $200,000 the committee found that low-volume products
caused more overhead than high-volume products. Just as the preliminary stages of
the ABC project were completed, the company was acquired by ITW. The management
of ITW implemented the 80/20 rule, which states that 80 percent of the profit is derived
from 20 percent of the products sold. ITW reduced the complexity of processes and
systems and modified the layout of its plant to accommodate just-in-time production.
Equipment was arranged in empowered decision-making production cells according to
product lines, which flattened the organizational structure and saved millions of dollars.
The stockroom, purchase orders, receiving reports, pick orders, and material handling
were eliminated. Costs related to purchasing, inspection, setup, overtime, idle time,
inventory control, engineering change notices, and the mainframe computer were
reduced.
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 5/e