To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Activity-Based Costing and Management LEARNING OBJECTIVES Chapter addresses the following questions: Q1 How is activity-based costing (ABC) different from traditional costing? Q2 What are activities, and how are they identified? Q3 What process is used to assign costs in an ABC system? Q4 How are cost drivers selected for activities? Q5 What is activity-based management (ABM)? Q6 What are the benefits, costs, and limitations of ABC and ABM? These learning questions (Q1 through Q6) are cross-referenced in the textbook to individual exercises and problems COMPLEXITY SYMBOLS The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems Questions Having a Single Correct Answer: No Symbol This question requires students to recall or apply knowledge as shown in the textbook This question requires students to extend knowledge beyond the applications e shown in the textbook Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):  Step skills (Identifying)  Step skills (Exploring)  Step skills (Prioritizing)  Step skills (Envisioning) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-2 Cost Management QUESTIONS 7.1 If direct labor hours are used for tending machines and equipment, small batches take fewer direct labor hours and so are allocated less overhead However, if overhead costs increase more with setup time than with direct labor costs, the cost to set up for a large batch is likely similar to the cost of setting up a small batch The cost per unit is then probably much lower for the large batch than for the small batch 7.2 Organization-sustaining activities are activities related to the overall organization and unaffected by customers served or by quantities of products, batches, or units Facilitysustaining activities are activities related to the overall operations of a production facility and unaffected by customers served or by quantities of products, batches, or units Customer-sustaining activities are customer service activities that are independent of sales volumes and mix Product-sustaining activities occur to support a product line or a single product if it is not part of a product line Batch-level activities increase as the number of batches increase These activities include setup and monitoring batches of product Unit-level activities increase proportionately with production volumes or sales volumes 7.3 Because ABC uses more cost pools and more cost drivers to reflect cause and effect relationships, ABC costs usually map the relation between cost and use of resources more accurately Hence ABC costs reflect different proportions of the resource costs than traditional costs 7.4 No, increasing the number of cost pools and cost drivers can increase measurement error because small measurement errors for each pool and each driver can distort total cost once costs are allocated, simply from the increase in calculations that take place In addition, if the production process is very simple and products use the same amount of resources each, increasing the number of cost pools will not increase the accuracy of the allocations 7.5 No, because it is expensive to implement, the costs outweigh the benefits for some firms Firms that are already operating efficiently may not benefit from an ABC system, especially if they have available capacity Research has shown that ABC is more successful within organizations that use flexible systems, have integrated information systems, and produce a variety of products 7.6 Yes, ABC can be used in service industries In service organizations, ABC may be especially helpful if there are capacity limits Service industries often have a large proportion of fixed resources, and understanding the relationship between cost and the use of these resources can improve the efficiency of the organization 7.7 Measurement error could decrease because ABC can a better job of allocating costs to the use of resources Better allocation reduces problems such as product crosssubsidization, in which costs are overallocated to some products and underallocated to others However, measurement error could increase because increasing the number of cost pools and cost drivers results in small measurement errors for each pool and each To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-3 driver As the number of calculations increase, these small measurement errors interact as costs are allocated (rates are developed and used as multipliers), and so the size of measurement error is likely to increase 7.8 Several costs that are incurred when implementing an ABC system include the time it takes employees or consultants to determine appropriate cost pools and cost drivers, the cost to track and measure the number of activities because these may not be recorded in the accounting system, and the cost to set up an information system to develop ABC reports Several benefits include the ability to identify non-value added activities, and a better understanding of the use of overhead resources 7.9 First, meet with accounting employees to learn about all of the different activities they perform Identify activities that are homogeneous and can be pooled together For example, budget preparation for each department is probably similar, but it may take different amounts of time according to the complexity of the department Pool all of the various budgeting activities Once a list of activities has been identified, employees’ opinions about appropriate cost drivers can be solicited Activities that have the same cost drivers could probably be pooled 7.10 Yes, research has shown that ABC is more successful within organizations that use flexible systems, have integrated information systems, and produce a variety of products With ABC, a better mapping of the use of resources to each product line allows managers to choose the optimal product mix In addition, if the processes are complex, ABC allows analysis of the activities underlying complex processes so improvements are easier to identify, as are non-value added activities In these cases, the costs are likely less than the benefits achieved 7.11 Activity-based costing analyzes the activities performed in manufacturing and service production Once the activities are identified, costs for each activity are collected into separate cost pools Next a cost driver is chosen that reflects changes in the costs of activities The cost driver is used to allocate the costs of the activity to products, services, or some other cost object There are multiple cost pools and drivers Traditional costing uses only a few overhead cost pools and allocates the costs based on drivers such as direct labor hours, direct labor cost, or machine hours In a traditional cost system, the cost pools are very large and so it is impossible to find an allocation base that reflects resource use It is merely a logical system of assigning part of overhead costs to each product or service ABC, on the other hand, selects cost pools around activities so that a cost driver can be chosen to better reflect a product or service’s use of resources Therefore, ABC systems have more cost pools and drivers Because an ABC system is more complex, more time, effort, and money are required to implement ABC systems than traditional costing systems 7.12 Activity-based costing is a method of allocating costs to products or other cost objects Activity-based management is the process of using ABC information to improve operations and profitability by analyzing the actual activities and processes to reduce non-value added activities, and improve the efficiency of activities In addition, managers may be able to better understand different products’ uses of fixed resources, which could be important if there are capacity constraints To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-4 Cost Management 7.13 There are several reasons for using ABC and ABM to improve an organization’s environmental performance Environment-related activities, such as disposing of hazardous substances and cleaning up spills of these substances, are non-value added If those types of activities can be minimized, costs are also likely to be reduced In addition, most companies would prefer to avoid the negative reputation effects that are associated with pollution problems Once managers become aware of environmental costs, they may realize that investing in prevention activities will actually reduce costs in the long run 7.14 Prevention activities are activities performed to insure defect-free production These activities could include inspecting incoming direct materials designing and redesigning products and manufacturing processes to reduce defect rates identifying areas where defects arise and solving the underlying cause of the defects Appraisal activities are activities performed to identify defective units, and include the following activities: Inspection of products Inspection of manufacturing process Monitoring of service delivery process Testing Production activities are activities undertaken in the production or rework of failed units These include Labor tasks and materials to produce spoiled units Reworking spoiled units Post-Sales activities are activities undertaken after the product has been sold to remedy problems caused by defects and failed units These activities include Accepting returned products and exchanging them for good products or refunding their cost Repairing defective units Preparing for and participating in legal actions that result from defective units To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-5 EXERCISES 7.15 ABC Cost Hierarchy A Receptionist salary is an organization-level cost because the receptionist serves everyone who comes through the door and thus cannot be identified with one product or unit B Financial forecasting software is an organizational-level cost if it is used to forecast sales for the entire company However if it used only by one product line, it is a productsustaining cost C Photocopy machine rental is a facility-level cost when everyone uses the machine, but could be a product, batch or unit related cost if a password were used to keep track of copies made for each client or department D Janitorial service is a facility-level cost because the entire facility uses this evenly E Audit manager’s salary is a unit-level cost because the managers is in charge of a number of different audits and bills his or her time to each audit F Long distance telephone charges are unit-level if the bill includes details of to whom the calls were made, and could be product-sustaining if the calls are marketing a particular product It just depends upon the purpose of the calls Some companies have Watts lines and pay a flat fee for all long distance calls In this case the cost is an organization-level cost G Meal costs for entertaining clients could be a customer-sustaining cost if related only to that particular customer, or product related if the customer is associated with only one product H Costs of annual employee golf party is an organization-level because it benefits all departments I Office supplies such as paperclips and tablets of paper are organization-level costs unless they can be traced to a particular product or batch J Annual subscription for income tax regulations is a product-sustaining cost if it pertains to one department of the firm If it pertains to the entire firm, it is a facility-level cost 7.16 MicroBrew Northwest Following are the CMA answers to this question However, one could argue that some of the unit-level costs could instead be categorized as batch-level A Facility-level costs: Manufacturing facility $1,500,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-6 Cost Management B Product-sustaining costs: Product development $1,250,000 C Batch-level costs: Production setup D Unit-level costs: Materials handling Production line labor Power (assuming most power is to cool beer and run machines, not for overhead) Total unit-level costs $700,000 $ 850,000 2,500,000 500,000 $3,850,000 7.17 ABC Cost Hierarchy A Unit-level activities and costs relate to each unit produced, in this case, each car rented The cost of washing each car between rentals is an example of a unit level cost Costs for the activities of making the reservation, turning the vehicle over to the renter, and completing the paperwork at the end of the rental are also unit-level B Batch-level activities and costs relate to the number of batches produced For a car rental fleet, cars at a number of outlets are probably sent for oil changes or other routine maintenance in batches Car rental companies located off-site near an airport usually operate a shuttle service from the airport to the rental car location Multiple passengers are usually picked up and dropped off on each run of shuttle Batch-level costs for the shuttle would include vehicle depreciation, maintenance, and gasoline, plus the driver’s labor costs C Product-sustaining activities and costs relate to entire product lines For a car rental company, the different types of cars for rent could be considered product lines, for example economy cars, mid-sized cars, and so on Or the company might see its product lines more broadly, such as a product line of cars and a separate line for trucks Advertising and marketing costs are likely to be product-line related if the company advertises either trucks or cars, but not both D Customer-sustaining activities and costs relate to the different clients Sometimes businesses establish a relationship with car rental agencies if employees need to travel by car for business These customers may require special attention, such as car delivery, or last minute rentals The costs of these services are customer-sustaining Rental companies also have programs such as the Hertz #1 Club, where members receive preferential treatment Special costs for these programs include extra personnel to process the rental and park the vehicle in an easily accessible location E Facility-sustaining costs relate to the facility For a car rental agency, these could include depreciation and maintenance of the building and parking lots for each outlet Facilitysustaining costs would also include the facility manager’s salary, electricity and janitorial service, computer terminals, and property taxes To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-7 F Organization-sustaining costs relate to the entire organization The CEO’s salary, and building lease, rent or depreciation costs at the company’s headquarters are all organization-sustaining costs Companies such as Hertz also have large organizationwide costs for computerized reservation and vehicle inventory systems 7.18 Cost Pools and Cost Drivers F D G B A E C Machining (As machine hours increase, costs such as maintaining machines increase) Purchasing activities (As number of invoices increases, costs such as wages for employees filling out invoices and supplies used by these employees increase.) Inspection (As the number of units produced increases, the number of units inspected also increases.) Assembly (As the number of parts increases, it takes more overhead cost in material handling, etc to assemble the product.) Payroll (As number of employees increases, more employee time and supplies are needed to produce paychecks.) A special quick freezing process for food (Food is usually frozen in batches As the number of batches increases, costs such as electricity and quick-freezing supplies increases.) Laundry in a hospital (As the number of laundry pounds increases, more labor and supplies costs are incurred because more batches of clothes are washed 7.19 Kalder Products A Total engineering change cost (6*$300) Total allocated cost for AJ40 (1*1,000/(1*1,000 + 1.5*1,000)*(6*300) Remainder is allocated to AJ60 B Total engineering change cost (6*$300) Total allocated cost for AJ40 (4*$300) Remainder is allocated to AJ60 $1,800 720 $1,080 $1,800 1,200 $ 600 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-8 Cost Management C Comparison of costs allocated under the two systems: Traditional costing ABC costing Product Cross Subsidization Overcharge (Undercharge) Percent Overcharge (Undercharge) AJ40 $ 720 1,200 AJ60 $1,080 600 $ (480) $ 480 (40)% 80% Total $1,800 1,800 $ Cross subsidization means that one product is allocated more overhead cost relative to its use of overhead resources and, therefore, other products’ overhead cost is less than their use of resources 7.20 Applewood Electronics A Manufacturing cost per unit under traditional cost accounting In the traditional cost accounting system, overhead is allocated to products based on machine hours The rate per hour is calculated as follows: Total estimated overhead $4,800,000 Estimated machine hours: Monarch (8.0 hours x 22,000 units) Regal (4.0 hours x 4,000 units) Total estimated machine hours 176,000 16,000 192,000 Estimated allocation rate per machine hour ($4,800,000/192,000) $25.00 The total manufacturing cost per unit is the sum of per unit direct material, direct labor, machine usage, and allocated overhead, as follows: Direct material Direct labor Machine usage Overhead Total Monarch $208.00 1.5 DL hrs x $12 18.00 mach hrs x $18 144.00 mach hrs x $25 200.00 $570.00 Regal $584.00 3.5 DL hrs x $12 42.00 mach hrs x $18 72.00 mach hrs x $25 100.00 $798.00 Manufacturing cost per unit under ABC First, calculate the allocation rate for each of the ABC pools: Soldering Shipments Quality control ($942,000/1,570,000 solder joints) ($860,000/20,000 shipments) ($1,240,000/77,500 units inspected) $0.60 per solder joint $43.00 per shipment $16.00 per inspection To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management Purchase orders Machine power Machine setups ($950,400/190,080 purchase orders) ($57,600/192,000 machine hours) ($750,000/30,000 setups) 7-9 $5.00 per purchase order $0.30 per machine hour $25.00 per setup Next, calculate total manufacturing costs allocated to each product under the ABC system and then calculate the total manufacturing cost per unit: Monarch _ Soldering 1,185,000 solder jts x $0.60 $ 711,000 Shipments 16,200 shipments x $43 696,600 Quality control 56,200 inspections x $16 899,200 Purchase orders 80,100 POs x $5 400,500 Machine power 176,000 mach hrs x $0.30 52,800 Machine setups 16,000 x $25 400,000 Total Manufacturing Overhead $3,160,100 Total Manufacturing Overhead Per Unit $3,160,100/22,000 units Direct material Direct labor 1.5 DL hrs x $12 Machine usage mach hrs x $18 Total Manufacturing Cost Per Unit $143.64 208.00 18.00 144.00 Regal $1,639,900/4,000 3.5 DL hrs x $12 mach hrs x $18 $513.64 385,000 solder jts 3,800 shipment 21,300 inspectio 109,980 POs x $5 16,000 mach hrs 14,000 x $25 $1,639,900 $ 409.98 584.00 42.00 72.00 $1,107.98 B The traditional costing system allocates a lump sum of overhead based only on machine hours, while the ABC system uses six cost pools to allocate the overhead Allocations using these cost pools and cost drivers more accurately reflect the flow of resources C Operating profit per unit under traditional cost accounting: Monarch Selling Price $ 900.00 Manufacturing (570.00) Selling, General, and Administrative (265.00) Traditional costing operating profit $ 65.00 Regal $1,140.00 (798.00) (244.50) $ 97.50 Operating profit per unit under ABC: Selling Price Manufacturing Selling, General, and Administrative ABC costing operating profit Monarch $900.00 (513.64) (265.00) $121.36 Regal $1,140.00 (1,107.98) (244.50) $ (212.48) D Based on the profit information using ABC, Applewood should concentrate on the Monarch Under ABC, it appears that the organization incurs a loss for each unit sold of Regal Using this ABC information would definitely affect the recommendation because one product appears to have a negative profit margin To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-10 Cost Management Note: This problem is from an old CMA exam The calculations shown in this problem probably include fixed costs Remember from Chapter that organizations need to emphasize the product with the highest contribution margin to maximize profits; however, that product cannot be identified with the information given in this problem Applewood would need to separate costs into flexible (those that vary with activity) and committed (those that not vary with activity) to determine the ABC contribution margin for each product Once this is done, the product with highest contribution margin can be identified and emphasized 7.21 Palmer Company A Manufacturing cost per unit: Machine setup Material handling Machining Assembly Inspection Direct materials Total Costs setups x $50.00 19 parts x $0.50 x 100 units 1.25 machine hours x $26.00 x 100 units 1.5 direct labor hours x $22.00 x 100 units 100 units x $12.00 100 units x $100.00 Cost Per Unit $18,800/100 units $ 100 950 3,250 3,300 1,200 10,000 $18,800 $188 B Full cost per unit Total manufacturing cost per unit Research and marketing costs per unit Other non-manufacturing costs per unit Total full cost per unit $188 140 320 $648 C Cost savings required: First, calculate the maximum full cost that would allow the company to achieve a profit of 10% based on full cost: Selling price = Full Cost + 10% x Full Cost $650.00 = 100% x Full Cost + 10% x Full Cost $650.00 = 110% x Full Cost Full Cost = $650.00/110% Full Cost = $590.91 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-19 E An ABC system allocates costs using more cost pools and more appropriate cost drivers, so costs are likely to be less distorted For example, if direct labor hours were abnormally high for one job, under the traditional costing system the indirect costs assigned to that job would be higher even if more costs were not incurred Under ABC this possibility for error is minimized because there are more allocation bases than direct labor hours The ABC system is more costly to implement because it takes time to develop and many employees need to be involved ABC is more useful in analyzing operations to improve quality and reduce costs Non-value added activities can be identified and other activities can be simplified, once they have been identified This doesn’t tend to happen with traditional costing 7.30 Kim Mills A sample spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) A 1&2 Following are excerpts from a sample spreadsheet for this problem Input Area Denim Direct Costs: Direct materials Direct labor cost $8,000 $660 Light-Weight Cotton Heavy-Weight Cotton $24,000 $1,320 $20,000 $920 Overhead Costs: Machine Setup Inspection Total Overhead Volumes: Units Direct labor hours Machine hours Number of set-ups Inspection hours Total $52,000 $2,900 $40,000 $11,000 $6,996 $57,996 1,000 33 500 10 83.3 4,000 66 1,333 30 333.3 2,000 46 1,500 20 166.6 7,000 145 3,333 60 583.2 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-20 Cost Management TRADITIONAL PROCESS COSTING Note: Because there are no beginning or ending inventories, equivalent units are equal to physical units Also, there is no need to calculation conversion cost per unit separately for the two departments because conversion costs are allocated in both departments to the number of bolts produced With no beginning or ending inventories, the number of bolts produced is identical in the two departments Equivalent Conversion Cost Per Unit Total Conversion Costs to Account for: Direct labor Overhead Total Total $2,900 $57,996 $60,896 Total Units (Bolts) to Account for 7,000 Equivalent Conversion Cost Per Unit Process Cost Report Number of bolts Direct materials Conversion costs Total Costs Accounted for Summary of Cost Per Unit: Direct materials Conversion costs Total $8.69943 Denim 1,000 LW Cotton 4,000 HW Cotton 2,000 Total 7,000 $8,000 $8,699 $16,699 $24,000 $34,798 $58,798 $20,000 $17,399 $37,399 $52,000 $60,896 $112,896 $8.00 $8.70 $16.70 $6.00 $8.70 $14.70 $10.00 $8.70 $18.70 B Process Costing Activity-Based Costing Denim $16.70 17.49 Light-Weight Cotton $14.70 12.70 Heavy-Weight Cotton $18.70 22.29 Cost Per Bolt Overstated (Understated by Traditional Process Costing $ (0.79) $ 2.00 $ (3.59) Under process costing, the cost per bolt of light-weight cotton was overstated; it absorbed costs incurred by denim and heavy-weight cotton because costs under process costing are allocated to the department and then to the product The production volume of lightweight cotton (4,000 bolts) is much larger than either denim (1,000 bolts) or heavy weight cotton (2,000 bolts) When conversion costs are allocated based on number of units rather than based on the flow of resources used, the product with the most units is allocated relatively more cost The production of light-weight cotton requires proportionately fewer set-ups than the other two products, so it should be allocated less of the cost for set-up Light-weight cotton also uses proportionately fewer machine hours, and so it should also be allocated less of the machine activity costs In addition, lightweight cotton uses less direct labor per bolt than the other two products Under traditional process costing, direct labor is combined with other conversion costs and is allocated to units without regard to the actual labor used To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-21 C Managers may want to investigate machine set-up costs and reduce them, or reduce the number of set-ups required for all products In addition, perhaps inspection activities could be analyzed and costs reduced The managers might also investigate reasons why light-weight cotton uses significantly less direct labor than the other two products Perhaps direct labor could be used more efficiently, reducing the direct labor cost 7.31 The Pond Kit Company A Total Cost Per Batch: Material handling Forming Molding setup Packing and shipping Inspection Direct labor Direct materials Total costs 20 parts x $1 per part x 10 kits $ 200.00 molding hours x $40 per hour x 10 kits 800.00 batch x $50.00 50.00 30 pounds x $1.30 per pound x 10 kits 390.00 $10 per kit x 10 kits 100.00 $20 per kit x 10 kits 200.00 $100 per kit x 10 kits 1,000.00 $2,740.00 B Total budgeted cost per kit = Total budgeted cost per batch / Number of kits per batch = $2,740.00 / 10 kits = $274.00 per kit C Total Cost from Parts A and B Marketing ($15,000/1,000 batches) Customer Service ($25,000/1,000 batches) Total Cost per Kit Cost Per Batch (10 kits per batch) $2,740 $274.00 15 1.50 25 2.50 $2,780 $278.00 D There are other potential activities that could be chosen for this company Some activities could be separated further into more pools For example, packing and shipping could be separated into a packing activity and a shipping activity Molding may consist of several different tasks that could be considered separate activities Alternatively, some of these cost pools could possibly be combined, such as molding setup and forming There are many different choices that could be made for these activities E The new ABC system can lead to identification of non-value-added costs by focusing manager attention on the organization’s activities and cost drivers As activities are analyzed, some tasks or procedures in these activities might be identified as non-value added, and then eliminated For example, if the ponds could be redesigned to require fewer parts, material-handling costs would likely be reduced If specific types of defects cause inspection time to increase, redesigning parts or processes to eliminate the defects would decrease inspection time and also decrease customer service costs for product failures The packing and shipping activities could be analyzed to determine whether To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-22 Cost Management steps could be combined or some tasks eliminated or outsourced at lower cost There are many other non-value activities that students might have identified 7.32 Data Processors A These activities are not the only possible set Each of these activities could be separated into a number of other activities For example, the activity of issuing new credit cards could be further separated into the following cost pools: Verifying authorization of new credit cards to be issued Mailing new credit cards Validating new credit cards (before first use of the card) Each cost pool could be disaggregated into more cost pools Alternatively, some of these cost pools could be aggregated in some organizations B Activity Estimated Cost Estimated Activity Rate Transaction processing $2,000,000 5,000,000$ 0.40 Statements 1,000,000 250,000 4.00 New credit cards 500,000 100,000 5.00 Billing disputes 90,000 3,000 30.00 C The volume of activities cannot be predicted with certainty from one month to the next For example, although the number of credit cards issued last period is known, economic changes affect the number of people who will apply, as will advertising campaigns and competition among financial institutions Some activities, such as issuing monthly statements, are easier to estimate than other activities, such as resolving billing disputes The number of customers holding credit card accounts probably remains somewhat constant, although each month some credit card customers are gained and lost It is more difficult to predict the number of billing disputes, which fluctuate with the volume of transactions and also with the degree of problems such as fraudulent credit card use, retailer errors, and charges for unsatisfactory goods or services Costs will be different than expected because it is not possible to perfectly predict future costs There may be unanticipated changes in prices, such as electricity rates, telephone charges, or employee health care costs If activity volumes are higher than expected, then employee overtime pay may exceed expectations Information technology programming and operating costs may be higher or lower than expected For example, there could be fewer problems than expected when making improvements to the transaction processing system There are also likely to be random fluctuations in costs such as office supplies D Practical capacity is the maximum capacity under typical operating conditions, taking into account regularly scheduled holidays and other down time This company has several different types of capacity The discussions below address three types of capacity; students may think of others To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-23 One type of capacity for Data Processors is the capacity of the computerized technology to process transactions Because transactions occur at any time and anywhere in the world, this capacity must operate 24 hours per day, 365 days per year The capacity limit would be measured in terms of the maximum volume of transactions that could be processed The practical capacity of the computerized technology for transaction processing is almost certainly higher than the estimated activity level The company’s contracts with its customers probably include guarantees that the system is capable of processing a higher volume of transactions than expected In addition, the company probably has back-up ―hot‖ sites that are fully operational and can take over processing in the case of system failure due to technological problems, natural disasters, terrorist attacks, etc Capacity for Data Processors also includes the employee capacity to handle services such as billing disputes This type of practical capacity is likely to be higher than estimated activity levels during slow times, but it could be lower when activities are unexpectedly high However, the company probably has contractual commitments to resolve billing disputes within a maximum number of days Thus, the company must be capable of expanding its employee practical capacity, as needed, to meet actual activity levels The company may be able to expand this capacity quickly by using employee overtime or temporary labor Another type of capacity for Data Processors is the physical capacity for printing and mailing monthly statements Once again, the company is probably contractually committed to performance of this service in a timely manner, so the company must have sufficient capacity to handle higher than expected volume Because it may be difficult to quickly expand this type of physical capacity, the company’s practical capacity is probably higher than its expected activity level 7.33 Steps in ABC A Government agencies use cost information to evaluate and improve the efficiency of their services Most agencies rely on support through a budgeting process, and improving their efficiency helps them obtain operating funds In addition, managers may want to move up in the organization’s ranks, and information about their effectiveness is found through cost reports and budgets Governments are also interested in improving their cost systems because of their stewardship responsibility They are responsible for efficiently using public funds and maximizing constituent benefits B Following are the five steps listed in the handbook: Analyze Activities Gather Costs Trace Costs to Activities Establish Output Measures Analyze Costs To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-24 Cost Management Following are the six steps listed in the textbook: Identify the relevant cost object Identify activities Assign (trace and allocate) costs to activity-based cost pools For each ABC cost pool, choose a cost driver For each ABC cost pool, calculate an allocation rate * Allocation Rate = Activity Cost/Volume of Cost Driver For each ABC cost pool, allocate activity costs to the cost object * Allocation = Allocation Rate * Actual Volume of Activity The handbook does not have a step to identify the relevant cost object Therefore, step from the textbook is similar to step in the handbook The textbook has no step to gather costs; the textbook assumes that costs are gathered Step from the handbook is similar to step in the textbook (traces and allocate costs to cost pool) Step is similar in both methods, although the language used is different Step in the handbook is very general while, steps and in the textbook cover the same processes, but in more detail 7.34 Jefferson County Animal Shelter A The staff member identified the following three cost objects Each cost object represents one of organization’s three services Animal shelter Obedience training Veterinarian services One possibility for cost pools is to create one pool for each cost object This approach assumes that all costs can be directly assigned to one of these three services Based on the following summary, it appears that some of the costs can be directly traced to the cost objects However, some of the costs are indirect (Note: Judgment is involved in these classifications; students might have categorized costs differently For example, students might have classified veterinarians and technicians as indirect if they assumed that these employees provide services for the animal shelter in addition to the veterinarian clinic.) Director and staff salaries Animal shelter employees’ salaries Veterinarians and technicians Animal trainers* Food and supplies** Building-related costs Total Direct Costs _ Animal Obedience Veterinarian Shelter Training Services Indirect Total $ $ $ $ 60,000 $ 60,000 100,000 0 100,000 0 150,000 150,000 20,000 20,000 0 40,000 50,000 75,000 125,000 0 200,000 200,000 $170,000 $20,000 $225,000 $260,000 $675,000 * The problem indicates that animal trainers provide training classes and also train animals housed in the animal shelter 50% of the animal trainer time is devoted to obedience classes The remaining 50% is assumed to relate to training for animals housed in the animal shelter To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-25 ** The problem states that $75,000 of this cost is used by the veterinary clinic The remainder ($50,000) is assumed to be used in the animal shelter A decision must be made about whether to allocate the two indirect costs to the three services ―Director and staff salaries‖ is most likely a facility-level cost for general administration, which would NOT normally be allocated to individual product lines ―Building-related costs‖ is also a facility-level cost Sometimes this type of cost is allocated to individual products, and sometimes it is not The following solution assumes that the building-related costs are NOT allocated to the shelter’s individual services B There are three cost pools to consider—one for each of the organization’s services For the animal shelter, a cost driver could be the number of animal days On a daily basis, each animal would require similar time from employees to clean their cages, feed, and groom, and similar supplies such as food and bedding Another possible cost driver is the total number of animals housed However, this cost driver would not capture differences in cost caused by lengthy animal stays A cost driver for obedience training could be number of classes, number of families taking classes, or number of weeks in which classes are held Because each class would require about the same amount of time regardless of the number of families per class, number of classes is probably a better cost driver A cost driver for veterinary services could be the number of animal-visits Similar amounts of time and resources would be used per animal, although this assumes that the product mix of (e.g., neutering and vaccinations) remains relatively constant C Given the cost pools identified in part A and the cost drivers in part B, the allocation rates are as follows: Allocation Cost Pool Total Cost Cost Driver Volume Rate Animal shelter $170,000 Animal days 27,375 $ 6.21 Obedience training 20,000 # of classes 125 160.00 Veterinarian services 225,000 Animal visits 5,000 45.00 The allocation rate for the animal shelter indicates that the average cost of housing a pet for one day is $6.21 The allocation rate for obedience training indicates that it costs on average $160 to offer a training class The allocation rate for veterinarian services indicates that it costs on average $45 to provide veterinarian care per animal-visit D Quality activities include: * Prevention activities performed to insure defect-free production * Appraisal activities performed to identify defective units * Production activities undertaken in the production or rework of failed units * Post-sales activities undertaken after the product has been sold to remedy problems caused by defects and failed units To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-26 Cost Management The shelter is experiencing a post-sales activity when animals are returned because of behavior problems No, the current ABC system does not include cost pools related to any of the types of quality activities listed in Part E.1 above For example, the system does not track the cost of training dogs while they are housed in the animal shelter (prevention), the cost of evaluating dog readiness for adoption (appraisal), the cost of additional training for dogs with greater than normal behavioral problems (production), or the cost of dogs returned because of behavior problems (post-sales) There are many possible answers to this question; students may think of other cost pools or drivers A possible cost pool could be the cost per animal returned Costs in this pool could include costs for further training activities, for admitting the animal to the facility and working with families to find other animals, and the cost to house the animals while waiting for a new family The cost driver for this cost pool would be the number of animals returned There are some costs that cannot be measured, such as the cost of potential adopters who decide not to adopt another animal because of a bad experience 7.35 Usefulness of ABC A Accountants are likely to believe that ABC information would be useful because ABC separates overhead costs into more cost pools, and cost drivers are chosen to reflect the cause and effect relationship for costs, accountants might believe that this information would be useful for their organizations In addition, the process of implementing ABC encourages managers to identify and eliminate non-value-added activities B Managers cannot be certain that new ideas will be implemented correctly in their organization In addition, because the ideas are new, managers cannot know for certain that they work for every organization, or just for some types of organizations Therefore they cannot know for certain it will be effective for their organization Furthermore, managers cannot know for certain whether employees in their organization will support the new idea or resist, and additional uncertainty arises about the effectiveness of new ideas when employees are resistant to these changes Students may have thought of additional uncertainties C Managers may adopt a new method if they study the method and believe that the benefits will exceed the costs for their organization Managers are accustomed to making decisions under uncertainty; they not need absolute ―proof‖ before adopting a potentially beneficial method In addition, managers are more apt to adopt a new method if competitors are adopting it They may feel that competitors will have an edge because of this new method and worry that their organization will suffer if the method is not adopted Or managers may believe they can move ahead of competitors by employing the new method Consultants and others who sell the methods may convince managers that the method is appropriate for their organization, and so the managers adopt it To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-27 D Over time, many different types of organizations implement a new idea and for some organizations it works well and for others it does not work well Evidence accumulates that the new method is not a cure-all for organizational problems New methods are developed and are advertised widely that may overshadow the older methods In addition, over time some new method ideas become common practice For example, a focus on quality has become commonplace E In a recession, managers focus less attention on expanding operations and more attention on improving cost effectiveness, competitiveness, and profitability ABC information can help organizations identify non-value added activities, reduce costs, improve quality, and compete more effectively These results are more important when business conditions are less favorable 7.36 Colombo Frozen Yogurt A Sales Revenue Less: Price Promotions Net Sales Less: COGS – Ingredients, Packaging & Storage1 Less: COGS – Pick/Pack & Shipping2 Gross Margin Less: Merchandising Less: SG&A Income Impulse Segment Yogurt Shops Total $23,880,000 $5,970,000 $29,850,000 (3,600,000) (900,000) (4,500,000) 20,280,000 5,070,000 25,350,000 (11,400,000) (2,850,000) (14,250,000) (2,625,000) (375,000) (3,000,000) 6,255,000 1,845,000 8,100,000 (1,680,000) (45,000) (1,725,000) (3,861,000) (39,000) (3,900,000) $ 714,000 $1,761,000 $ 2,475,000 The case states that the portion of COGS related to ingredients, packaging, and storage are the same across segments Therefore, these costs are allocated equally to all cases: Impulse segment: $14,250,000 x (1,200,000 cases/1,500,000 cases) $11,400,000 Yogurt shops: $14,250,000 x (300,000 cases/1,500,000 cases) 2,850,000 Total $14,250,000 Pick/pack & shipping costs are allocated as follows: Full pallets @ $75 each: Cases in full pallets Divided by cases per pallet Number of full pallets Times cost per full pallet Total full pallet cost 60,000 ÷ 75 800 x $75 $60,000 240,000 ÷ 75 3,200 x $75 $240,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-28 Cost Management Individual orders @ $2.25 per case: Individual cases Times cost per case Total individual case cost Total pick/pack cost x $2.25 1,140,000 60,000 x $2.25 $2,565,000 $135,000 $2,625,000 $375,000 B No, these were not the only possible cost objects Alternatives included: geographic regions, individual manufacturing processes, size of customers (in terms of total annual sales), product flavors, and sales people C The set of ABC activities is different from traditional cost categories because traditional costing systems tend to aggregate costs that may be driven by different factors into single cost pools, but ABC activities and cost pools are associated with cost drivers This is more easily done when costs are separated into a larger number of cost pools There are many possible answers to this question; students may think of reasons not listed here Because past cost data were accumulated using these cost categories, maintaining the old categories would make it easier for the managers to analyze cost trends The managers might have believed that the old cost categories were sufficient—i.e., that they provided the most appropriate breakdowns of costs under ABC The managers might have believed that the cost to identify and gather data for new categories would exceed the benefit The use of old categories reduced implementation time and avoided the need for significant employee training D Pick/pack and shipping costs: Shipping costs are likely to vary with the number of units shipped, where a unit may be defined as a case or a pound of weight However, shipping costs might also vary according to the size of a shipment; it costs less to deliver a large quantity to one location than to deliver smaller quantities to many locations Thus, the shipping costs might be considered batch-level Picking and packing costs probably vary with the time needed to locate, obtain, and pack a single shipment This cost might be a unit-level cost that varies with number of cases However, it probably costs less per case to pick/pack a full pallet than a smaller order Therefore, the pick/pack costs are likely to be batch-level, where a batch is an individual shipment [Note: Students often focus on the unit-level aspect of the pick/pack and shipping costs and fail to recognize potential classification as batch-level Student difficulty with this question might be caused partly by a lack of understanding of operations in a warehouse setting.] Selling, general, and administrative costs: Selling, general and administrative costs probably include salaries and other costs for sales, general management, accounting, human resources, etc These costs are most likely to be considered facility-level costs Overall, they probably not vary with the individual numbers of units, To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-29 batches, products, or customers serviced Although selling costs might vary with some level of sales activity, these costs are not likely to be a major part of the overall selling, general and administrative costs Alternatively, these costs might be considered product-level from the perspective of General Mills Colombo Frozen Yogurt is one product line within a much larger company E Pick/pack and shipping costs: Colombo has chosen two cost drivers for the pick/pack and shipping costs One cost driver is the number of full pallets, and the other driver is the number of individual cases As discussed in Part D, some parts of the pick/pack and shipping costs are likely to vary with number of units such as weight, that could be represented either by number of cases or number of pallets Other parts of these costs are likely to vary with the number of batches The cost drivers chosen by Colombo allow for lower total cost per batch when a full pallet is shipped Therefore, the choice of cost drivers appears to be reasonable Selling, general, and administrative costs: As discussed in Part D, the selling, general, and administrative costs are most likely facility-level costs that are not usually allocated to individual product lines Thus, it can argued that the cost driver chosen—and any other cost driver—would not be appropriate However, under the assumption that most of the selling, general, and administrative costs consist of selling costs, then it would be appropriate to allocate these costs to product lines In that case, it would be reasonable to use sales representative time as a cost driver because greater time is likely to cause higher costs [Note: Students have a tendency to discuss whether they agree with Colombo’s method for estimating the volume of the cost driver rather than to discuss the reasonableness of the cost driver itself This misunderstanding can lead to a meaningful class discussion about the difference between cost measurement and cost behavior.] F There is no one answer to this part Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-30 Cost Management BUILD YOUR PROFESSIONAL COMPETENCIES 7.37 Focus on Professional Competency: Research A Learning objective Q6 (―What Are the Benefits, Costs, and Limitations of ABC and ABM?‖) specifically addressed the following uncertainties related to ABC calculations: Choice of activities Choice of cost drivers Inability to foresee all possible uses of information Choice of denominator in allocation rate Mismeasurement of costs assigned to cost pools These uncertainties lead to uncertainties about the interpretation of ABC information For example, uncertainties about selection of the best cost driver lead to uncertainties about whether costs are likely to vary with changes in the volume of the cost driver Similarly, if managers cannot be certain whether the costs assigned to cost pools are mismeasured, then they also cannot be certain that ABC costs represent the actual costs of each activity B Research is needed to identify activities and cost drivers and to establish a plan for implementation Research includes discussing operations and costs with individuals throughout the organization, meeting and holding discussions with members of an ABC team, investigating the ABC practices used by other companies, reading articles and cases about ABC, attending courses on ABC implementation, and other activities An ABC team should consist of individuals from different functional areas within the organization Because of their different backgrounds, team members bring different types of knowledge and perceptions about the company to the team meetings This diversity increases creativity and also increases the likelihood that appropriate issues will be considered as choices are made about activities and cost drivers Following ABC system implementation, managers and accountants should continue to evaluate the effectiveness of the system design and consider improvements as needed Even a system that is highly appropriate at one point in time can become less useful as operations evolve over time This requires research into the usefulness of the existing system and investigation of potential modifications C Available information about ABC and ABM practices include articles, books, lectures, courses, and the personal experiences of people Accountants should always strive to perform their work in a professional manner When there are no authoritative rules, accountants need to investigate alternative sources of information (see part C.1) and determine the best course of action To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-31 Articulating assumptions and reasoning provides two major benefits First, the process of articulation leads to discovery of flaws in the assumptions and reasoning Most people engage in more careful thinking when they articulate it Second, presenting assumptions and explaining reasoning to other people often leads to the discovery of new relevant information Other people may point out flaws in the assumptions or recommend better solutions Conflicting recommendations might exist because of differences in operations, accounting systems, implementation resources, and goals Accountants use professional judgment and elicit advice from experts, when appropriate, as they choose among conflicting recommendations Accountants are better able to apply judgment when they conduct sufficient research to fully understand the ABC methods and the reasons for conflicting recommendations 7.38 Integrating Across the Curriculum: Corporate Social Responsibility The answers in this problem depend on the definitions used for environmental accounting The U.S Environmental Protection Agency (EPA) defines three types of environmental accounting:1 National income accounting: National-level reporting of the consumption of renewable and nonrenewable natural resources Financial accounting: Company-level reporting that focuses primarily on the public disclosure of material environmental liabilities and costs according to GAAP Management accounting: Company-, segment-, product line-, facility-, or systemlevel reporting of environmental information to support management decision making The information could be used to plan and to direct management attention towards environmental issues; assist managers in making specific decisions such as purchasing, outsourcing, capital investments, product pricing, risk management, process/product design, or compliance strategies; or control and motivate behavior to improve business results Traditionally, companies have not publicly disclosed environmental management accounting information However, some governments have begun requiring companies to publicly disclose this type of information, and the awards described in the problem are designed to encourage greater voluntary disclosure The solutions provided below assume that ―environmental accounting‖ means public disclosure and/or internal use of environmental management accounting A Environmental accounting is an ethical problem because of potential conflicts among the interests of managers, companies, shareholders, vendors, customers, competitors, governments, society in general, and future generations Managers, companies, and shareholders are often interested in maximizing profits, which often conflicts with management emphasis on environmental considerations or public disclosure of Office of Pollution Prevention and Toxics, U.S Environmental Protection Agency, An Introduction to Environmental Accounting As A Business Management Tool: Key Concepts And Terms, EPA 742-R-95-001, June 1995, accessible at www.epa.gov/opptintr/acctg/resources.htm To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-32 Cost Management environmental information When companies report more environmental information, they are more likely to be forced by governmental regulation or by public opinion to reduce negative environmental effects Competitors and other companies in the supply chain (vendors and customers) are also affected by a company’s environmental reporting Information about environmental issues related to one company is likely to be informative about environmental issues for other companies in an industry Consumers and public interest groups generally prefer more information about environmental issues to improve their abilities to monitor companies and take actions against companies they see as degrading the environmental Governments are often caught in the middle While they want to protect public environmental interests, they also want to promote economic growth B The answer to this question depends on the companies that students investigate Students often have difficulty distinguishing between ―pleasing‖ presentations and informative presentations The answer to this question should include specific reasons about information on one site being more understandable or easy to find than on another site C Company responsibilities for reporting environmental information are partly a function of environmental regulation In countries where greater disclosure is required, companies have a clear legal responsibility to provide it Company responsibilities for voluntary disclosure are less clear Because of the conflicts of interest mentioned in Part A above, managers have no clear-cut responsibility If viewed from the perspective of shareholders, the company’s responsibility might be to minimize environmental disclosure Employees have a stake in the company’s financial well-being and might also prefer less disclosure; however, employees and their families might be affected by environmental problems such as air quality degradation or hazardous waste In this case, the company’s responsibility might be to provide greater disclosure Companies generally not assume responsibility for competitors However, greater disclosure by one company in an industry might stimulate similar disclosures by competitors The responsibility to suppliers and customers includes mixed incentives Less disclosure might help all related companies achieve higher profits, but greater disclosure could lead to improved environmental performance across the supply chain Company managers often view their responsibility toward government regulators and the general public as meeting minimum legal requirements However, this view of responsibility assumes that companies have no social responsibility for environmental matters An alternative view is that companies are responsible for the stewardship of resources they use today and for the resources available to future generations Many people would argue that company responsibilities lie somewhere in between these two extremes—that managers have responsibilities to generate profits and also to find ways to minimize adverse environmental effects From this viewpoint, managers have a responsibility to use environmental accounting to help them make better environmental decisions D The answer to this question depends on the interpretation of ―better reporting‖ for environmental behavior, policies, and procedures In Chapter (Exhibit 1.9, page 12), higher quality reports were defined as more relevant, understandable, and available Given this definition, a better environmental report would provide information that is more useful to constituents such as shareholders, regulators, customers, and the general public It would be easier to understand and would be readily available in a timely To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-33 manner Outsiders who read an environmental report can determine whether the report is easy to understand and available However, it is more difficult to determine whether a report provides the most useful information, particularly when disclosures are voluntary When information is provided voluntarily, it may be biased For example, an environmental report could provide considerable information about a single environmentally-friendly project, but be silent about environmental problems Therefore, it may not be possible to determine whether one company provides better environmental reporting than another However, suppose it CAN be determined that one company provides better environmental reporting than another In that case, better reporting might occur because the company has better environmental policies and procedures, which in turn could lead to better environmental behavior However, the other company could have better environmental behavior, policies, and procedures but simply fail to provide better reporting E Obviously, governmental regulation is a factor affecting the publication of environmental accounting reports In the absence of such regulation, companies are likely to be influenced by the actions of other companies—particularly competitors—and public opinion Managers also create and are influenced by the company’s mission and core competencies Companies that place high priority on environmental responsibility are more likely to present a public environmental accounting report F Many factors influence governmental emphasis on matters such as environmental accounting Governments in economically stable countries are likely to place a greater emphasis on the environment Countries in which citizens are more concerned about the environment will also place greater emphasis on the environment Governments are also influenced by the actions of other governments and by the requirements of international organizations such as the European Union G Methods similar to the ones described in the chapter for measuring quality costs could be used to measure environmental costs The first step would be to identify different types of environmental activities, costs, and drivers One example is the list of cost categories included in the problem, developed by Japan’s Ministry of the Environment H There are two ways that preparing and publishing environmental accounting reports help companies reduce its environmental costs First, the process of preparing these reports necessarily includes investigation of environmental accounting and reports released by other companies This investigation can lead to new ideas for reducing environmental costs Second, companies that public release environmental information might be encouraged to more actively engage in continuous environmental improvements I This question is open-ended, so answers will vary It is important to clarify the trade-offs made when arriving at conclusions for this type of problem Some people have a tendency to adopt a ―high road‖ and fail to recognize the practicalities of governmental regulation Other people tend to the opposite—they dismiss what they perceive as idealistic solutions and fail to seek creative or new solutions The best solutions are those which clarify trade-offs, recognize limitations, and yet still seek to achieve improvement ... of 10% based on full cost: Selling price = Full Cost + 10% x Full Cost $650.00 = 100% x Full Cost + 10% x Full Cost $650.00 = 110% x Full Cost Full Cost = $650.00/110% Full Cost = $590.91 To download... ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-16 Cost Management PROBLEMS 7.27 Steps in ABC A Identify and sum the costs into activity-based cost pools Choose a cost. .. http://downloadslide.blogspot.com Chapter 7: Activity-Based Costing and Management 7-19 E An ABC system allocates costs using more cost pools and more appropriate cost drivers, so costs are likely to be less distorted