To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Systems Design: Activity-Based Costing Solutions to Questions 3-1 The most common methods of assigning overhead costs to products are plantwide overhead rates, departmental overhead rates, and activity-based costing 3-2 The assumption, implicit in conventional costing systems, that overhead cost is proportional to direct labor, is being increasingly questioned Automation has decreased the amount of direct labor, overhead costs have increased, and companies now handle many more products that differ substantially in volume, batch size, and complexity Activity-based costing attempts to more accurately assign overhead costs to products based on the activities required to make products and the resources consumed by those activities 3-3 The departmental approach to assigning overhead cost to products usually assumes that overhead costs are proportional to direct laborhours or machine-hours However, overhead costs are often driven by other factors, including the number of batches run and product complexity, that are only loosely related, if at all, to volume Activity-based costing attempts to more accurately assign overhead costs to products based on the activities that they cause rather than just on the direct labor-hours required to make a unit 3-4 The hierarchical levels are: Unit-level activities, which are performed each time a unit is produced Batch-level activities, which are performed each time a batch is handled or processed Product-level activities, which are performed to support specific products Facility-level activities, which sustain an organization’s general capabilities 3-5 Activity-based costing involves two stages of overhead cost assignments In the first stage, costs are assigned to activity cost pools In the second stage, costs are allocated from the activity cost pools to products 3-6 In a conventional costing system, overhead costs are allocated to products using some measure of volume such as direct labor-hours or machine-hours Consequently, the high-volume products, which have the largest amount of direct labor-hours or machine-hours, are allocated most of the overhead cost In activity-based costing, some of the overhead costs are typically allocated using batch-level or product-level allocation bases For example, if each product is allocated a total of $10,000 in product-level cost irrespective of its volume, then a high-volume product will be allocated exactly the same total overhead as a low-volume product In contrast, if a measure of volume like direct labor-hours or machine-hours were used to allocate this cost, the high-volume product would be allocated more in total than the low-volume product 3-7 Activity-based costing improves the accuracy of product costs in three ways First, activity-based costing increases the number of cost pools used to accumulate overhead costs Rather than accumulating all overhead costs in a single, plantwide pool, or accumulating them in departmental pools, costs are accumulated for each major activity Second, the activity cost pools are more homogeneous than departmental cost pools In principle, all of the costs in an activity cost pool pertain to a single activity In contrast, departmental cost pools contain the costs of many different activities carried out in the department Third, activity-based costing changes the bases used to assign overhead costs to products Rather than assigning costs © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 95 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com on the basis of direct labor or some other measure of volume, costs are assigned on the basis of the activities that presumably cause overhead costs 3-8 While the product costs computed using activity-based costing are almost certainly more accurate than those computed using more conventional costing methods, activity-based costing nevertheless rests on some questionable assumptions about cost behavior In particular, activity-based costing assumes that costs are proportional to activity In reality, costs appear to increase less than in proportion to increases in activity This implies that activity-based product costs will be overstated for purposes of making decisions (The same criticism can be leveled at conventional product costs.) Second, the costs of implementing and maintaining an activity-based costing system can be high and its benefits may not justify this cost © The McGraw-Hill Companies, Inc., 2010 All rights reserved 96 Introduction to Managerial Accounting, 5th edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Brief Exercise 3-1 (10 minutes) a Receive raw materials from suppliers: Batch-level b Manage parts inventories: Product-level c Do rough milling work on products: Unit-level d Interview and process new employees in the personnel department: Facility-level e Design new products: Product-level f Perform periodic preventive maintenance on general-use equipment: Facility-level g Use the general factory building: Facility-level h Issue purchase orders for a job: Batch-level Some of these classifications are debatable and depend on the specific circumstances found in particular companies © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 97 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Brief Exercise 3-2 (15 minutes) The activity rates are computed as follows: Activity Cost Pool Labor related Machine related Machine setups Production orders Product testing Packaging General factory Total (a) Estimated Overhead Cost $ 48,000 67,500 84,000 112,000 58,500 90,000 672,000 $1,132,000 (b) Expected Activity 20,000 DLHs 45,000 MHs 600 setups 400 orders 900 tests 6,000 packages 20,000 DLHs (a) ÷ (b) Activity Rate $2.40 $1.50 $140.00 $280.00 $65.00 $15.00 $33.60 per per per per per per per DLH MH setup order test package DLH The predetermined overhead rate based entirely on direct labor-hours would be computed as follows: Total estimated overhead cost (a) Total expected direct labor-hours (b) Predetermined overhead rate (a) ÷ (b) $1,132,000 20,000 DLHs $56.60 per DLH © The McGraw-Hill Companies, Inc., 2010 All rights reserved 98 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Brief Exercise 3-3 (30 minutes) The overhead costs assigned to each product would be computed as follows: Labor related, at $6.00 per direct labor-hour Machine related, at $4.00 per machine-hour Machine setups, at $50.00 per setup Production orders, at $90.00 per order Shipments, at $14.00 per shipment General factory, at $9.00 per direct labor hour Total overhead cost assigned (a) # of units produced Overhead cost per unit K425 Expected Activity Amount 80 100 1 80 $ 480 400 50 90 14 720 $1,754 200 $8.77 M67 Expected Activity Amount 500 1,500 4 10 500 $ 3,000 6,000 200 360 140 4,500 $14,200 2,000 $7.10 The product costs combine direct materials, direct labor, and overhead costs as follows: Direct materials Direct labor Manufacturing overhead (see above) Unit product cost K425 $13.00 5.60 8.77 $27.37 M67 $56.00 3.50 7.10 $66.60 © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 99 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Brief Exercise 3-4 (30 minutes) Using the company's conventional costing system, the overhead costs applied to the products would be computed as follows: Number of units produced (a) Direct labor-hours per unit (b) Total direct labor-hours (a) × (b) Product H 50,000 0.20 10,000 Total manufacturing overhead (a) Total direct labor-hours (b) Predetermined overhead rate (a) ÷ (b) Manufacturing overhead applied per unit 0.20 DLH per unit × $160.00 per DLH Number of units produced Total manufacturing overhead applied Product L 10,000 0.20 2,000 Total 12,000 $1,920,000 12,000 DLHs $160.00 per DLH Product H Product L $ 32.00 50,000 $1,600,000 Total $ 32.00 10,000 $320,000 $1,920,000 Using the proposed ABC system, overhead costs would be applied as follows: Product H Product L Total manufacturing overhead applied (a) $960,000 Number of units produced (b) 50,000 Manufacturing overhead per unit (a) ÷ (b) $19.20 Total $960,000 $1,920,000 10,000 $96.00 © The McGraw-Hill Companies, Inc., 2010 All rights reserved 100 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Brief Exercise 3-4 (continued) Under the company’s old method of allocating overhead costs, the highvolume product, Product H, was allocated most of the overhead cost This occurred simply because the high-volume product is responsible for most of the direct labor-hours When the overhead is split evenly between the two products, $640,000 of overhead cost is shifted from the high-volume product, Product H, to the low-volume product, Product L Consequently, the shift from direct labor-hours as an allocation base to an even split of the overhead costs between the two products favors the high-volume product, Product H, and penalizes the low-volume product, Product L Note that on a per unit basis, the impact is much greater for the low-volume product, Product L, than for the high-volume product, Product H This is because the impact per unit of shifting the $640,000 in overhead costs is much greater for the low-volume product than for the high-volume product © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 101 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Brief Exercise 3-5 (45 minutes) The journal entries are: a Raw Materials Accounts Payable 854,000 b Work in Process Manufacturing Overhead Raw Materials 780,000 68,000 c Work in Process Manufacturing Overhead Wages Payable 330,000 55,000 d Manufacturing Overhead Accumulated Depreciation 225,000 e Manufacturing Overhead Accounts Payable 194,000 854,000 848,000 385,000 225,000 194,000 f Compute the amount of overhead applied Activity Cost Pool Machine related Purchase orders Machine setups General factory Total Activity Rate $24 $85 $175 $16 Actual Activity 3,800 700 400 22,000 Work in Process Manufacturing Overhead 572,700 g Finished Goods Work in Process 1,690,000 Overhead Applied $ 91,200 59,500 70,000 352,000 $572,700 572,700 1,690,000 © The McGraw-Hill Companies, Inc., 2010 All rights reserved 102 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Brief Exercise 3-5 (continued) Bal (a) Bal Raw Materials 18,000 (b) 854,000 24,000 Bal (g) Finished Goods 46,000 1,690,000 848,000 Bal (b) (c) (f) Bal Work in Process 24,000 (g) 1,690,000 780,000 330,000 572,700 16,700 Accumulated Depreciation (d) 225,000 Accounts Payable (a) 854,000 (e) 194,000 Wages Payable (c) 385,000 Manufacturing Overhead (b) 68,000 (f) 572,700 (c) 55,000 (d) 225,000 (e) 194,000 Bal 30,700 The overhead overapplied or underapplied can be computed as follows: Actual overhead incurred $542,000 Overhead applied 572,700 Overhead overapplied $(30,700) © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 103 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Exercise 3-6 (30 minutes) Entry (a) is the amount of actual manufacturing overhead cost incurred during the year Debits to Manufacturing Overhead represent actual overhead costs incurred and credits represent overhead applied to products The activity rates would be computed as follows: Activity Cost Pool Labor related Purchase orders Parts management Board etching General factory (a) Estimated Overhead Cost (b) Expected Activity $280,000 $90,000 $120,000 $360,000 $400,000 40,000 1,500 400 2,000 80,000 (a) ÷ (b) Activity Rate DLHs $7 per DLH orders $60 per order part types $300 per part type boards $180 per board MHs $5 per MH Computation of the manufacturing overhead cost applied to production: Activity Cost Pool (a) Activity Rate (b) Actual Activity Labor related $7 per DLH 41,000 DLHs Purchase orders $60 per order 1,300 orders Parts management $300 per part type 420 part types Board etching $180 per board 2,150 boards General factory $5 per MH 82,000 MHs Total (a) × (b) Applied Overhead $ 287,000 78,000 126,000 387,000 410,000 $1,288,000 The overhead overapplied or underapplied can be computed as follows: Actual overhead incurred Overhead applied Overhead underapplied $1,302,000 1,288,000 $ 14,000 © The McGraw-Hill Companies, Inc., 2010 All rights reserved 104 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Problem 3-18A (continued) Thus, the shift in overhead cost from the high-volume product X99 to the low-volume product X200 occurred as a result of reassigning only 30% of the company’s overhead costs The increase in unit cost of X200 can be explained as follows: First, where possible, overhead costs have been traced to the products rather than being lumped together and spread uniformly over all units Therefore, special processing costs, which are all due to processing X200, have been assigned to the X200 and none to X99 under the activity-based costing approach Second, the costs associated with the batch-level activity (machine setups) have been assigned on the basis of setups rather than direct labor-hours Each setup, regardless of the batch size, is assigned the same amount of machine setup cost Some products are produced in large batches and some are produced in small batches The smaller the batch, the higher the per unit cost of the batch activity In this example, the data can be analyzed as follows: X200: Machine setup cost from ABC system (a) $2,400 per setup Average number of units per setup 5,000 units ÷ 50 setups (b) 100 units per setup Average setup cost per unit (a) ÷ (b) $24 per unit X99: Machine setup cost from ABC system (a) $2,400 per setup Average number of units per setup 30,000 units ÷ 100 setups (b) 300 units per setup Average setup cost per unit (a) ÷ (b) $8 per unit Thus, the average setup cost per unit is three times as great for X200 as for X99 Such differences in cost are obscured when direct labor-hours (or any similar measure of volume) is used as the basis for applying overhead costs to products © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 135 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ethics Challenge (15 minutes) Most people would probably feel that the most equitable way to divide the dinner bill among a group of friends is for each person to pay for the cost of what he or she individually consumed However, it would be easier to split the bill equally among the individuals This relates to material in the chapter because the method of dividing up the bill according to what each individual orders is similar to ABC and the method of simply dividing the bill by the number of individuals is similar to traditional costing methods Figuring out the cost of what each individual consumes properly allocates costs to the individuals who incurred them However, it sometimes is difficult to trace some costs to individuals For example, some dishes may be shared This is also similar to ABC in that some costs are easier to trace than others © The McGraw-Hill Companies, Inc., 2010 All rights reserved 136 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Communicating in Practice (30 minutes) Date: To: From: Subject: Current Date Maria Graham Student’s Name Overhead Allocation I understand that you are thinking about purchasing a small manufacturing company that assembles and packages its many products by hand The company currently uses direct labor hours to allocate overhead to its products, but you plan to introduce automation You have asked me to comment on whether this technique should be continued Direct labor is an appropriate allocation base for overhead when overhead is highly correlated with direct labor and direct labor “drives” overhead costs This may have been true when the assembly process was largely manual, but after automation you may find that the relation between direct labor and overhead is far weaker When a factory is automated, direct labor tends to decrease while overhead costs increase Direct labor costs decrease because machines replace direct laborers Overhead costs increase as a result of additional depreciation, power costs, insurance and other related costs This suggests that there will no longer be a direct relationship between overhead and direct labor (that is, when direct labor costs increase there is not a related increase in overhead costs) Hence, direct labor will no longer be an appropriate way to allocate overhead costs to products Activity-based costing may be the best alternative In activity-based costing, overhead costs are allocated based on the activities required to make the products and the resources that are consumed by these activities This technique is more complex than the approach the company is currently using Activity-based costing is costly to implement and to maintain, but you may find that the benefits of having more accurate product costs will outweigh these costs—particularly if you intend to rely on product costs for pricing and other decisions © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 137 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Teamwork In Action Student answers will vary depending on the operations they observe at the restaurant they visit and on how they define a unit and products The following are only suggestive of the answers that might be offered for a fast food restaurant that sells hamburgers and beverages: a Unit-level activities and costs b Customer-level activities and costs c Product-level activities and costs d Facility-level activities and costs Grilling a burger, assembling a hamburger, making a milkshake, costs of ingredients, costs of containers, etc Taking an order, assembling ordered items, bagging order, taking payment, etc Cost of soft ice cream maker, cost of deep fat fryer, cost of soda dispenser, etc Cost of building rent, cost of manager’s salary, heating and lighting the building, etc © The McGraw-Hill Companies, Inc., 2010 All rights reserved 138 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANALYTICAL THINKING (150 minutes) Overhead rates: Purchasing Material handling Production orders and equipment setup Inspection Frame assembly Machine related (a) Estimated Overhead Costs $12,000 $15,000 (b) Expected Activity 200 orders1 300 receipts2 (a)  (b) Predetermined Overhead Rate $60 per order $50 per receipt $20,250 250 setup hours3 $81 per setup hour $16,000 800 inspection hours $20 per inspection hour $8,000 1,600 assembly hours $5 per assembly hour $30,000 10,000 machine-hours $3 per machine-hour 40 + 60 + 100 = 200 orders 60 + 80 + 160 = 300 receipts Standard: 50 setups × hour per setup Specialty: 100 setups × hours per setup Total setup hours 300 + 500 = 800 hours Standard: 10,000 units × 0.5 hours per unit Specialty: 2,500 units × hours per unit Total machine-hours 50 hours 200 hours 250 hours 5,000 hours 5,000 hours 10,000 hours © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 139 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANALYTICAL THINKING (continued) Overhead cost charged to each product: Purchasing @ $60 per order: Leather Fabric Synthetic Material handling @ $50 per receipt: Leather Fabric Synthetic Production orders and equipment setup @ $81 per hour Inspection @ $20 per hour Frame assembly @ $5 per hour Machine related @ $3 per hour Total overhead cost Standard Activity Amount Specialty Activity Amount 34 48 $ 2,040 2,880 12 100 $ 360 720 6,000 52 64 2,600 3,200 16 160 400 800 8,000 50 300 800 5,000 4,050 6,000 4,000 15,000 $39,770 200 500 800 5,000 16,200 10,000 4,000 15,000 $61,480 Manufacturing overhead cost per unit of product: Standard: $39,770 ÷ 10,000 units = $3.98 per unit (rounded) Specialty: $61,480 ÷ 2,500 units = $24.59 per unit (rounded) © The McGraw-Hill Companies, Inc., 2010 All rights reserved 140 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANALYTICAL THINKING (continued) The unit product cost of each product line under activity-based costing is given below For comparison, the costs computed by the company’s accounting department using conventional costing are also provided Direct materials Direct labor Manufacturing overhead Total unit product cost Activity-Based Costing Standard Specialty $20.00 6.00 3.98 $29.98 $17.50 3.00 24.59 $45.09 Direct LaborHour Base Standard Specialty $20.00 6.00 9.00 $35.00 $17.50 3.00 4.50 $25.00 The president was probably correct in being concerned about the profitability of the products, but the problem is apparently with the specialty product line rather than the standard product line Traditional overhead cost assignment using a volume-based measure has resulted in the high-volume product subsidizing the low-volume product Thus, unit costs for both products are badly distorted These distorted costs have had a major impact on management’s pricing policies and on management’s perception of the margin being realized on each product The specialty briefcases are apparently being sold at a loss even without considering nonmanufacturing costs: Selling price per unit Unit product cost Gross margin (loss) per unit Standard Briefcases $36.00 29.98 $ 6.02 Specialty Briefcases $40.00 45.09 ($ 5.09) Based on these data, the company should not shift its resources entirely to the production of specialty briefcases Whether or not the specialty briefcases can be made profitable depends on a number of factors including the sensitivity of the market to an increase in the selling price of the specialty line © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 141 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANALYTICAL THINKING (continued) Note to the Instructor: You may want to mention to your class that before any decision can be made regarding dropping a product, a careful analysis will have to be made of the potential avoidable costs Some of the costs included in the unit product costs are probably costs of idle capacity and organization-sustaining costs that are not relevant Perhaps the competition hasn’t been able to touch CarryAll’s price because CarryAll has been selling its specialty briefcases at a price that may be below its cost Thus, rather than “gouging” its customers, CarryAll’s competitor is probably just pricing its specialty items at a normal markup over their cost Indeed, according to the activity-based costing system, if CarryAll is to realize a profit on its specialty items it may need to charge a price more in line with its competitor’s price When a company sells a product at a price substantially below that of its competitors, the company’s management should take a careful look at the costing system to be sure that the product is being assigned all the costs for which it is responsible © The McGraw-Hill Companies, Inc., 2010 All rights reserved 142 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CASE (150 minutes) a The predetermined overhead rate would be computed as follows: Expected manufacturing overhead cost $2,200,000 = Estimated direct labor-hours 50,000 DLHs =$44 per DLH b The unit product cost per pound, using the company’s present costing system, would be: Direct materials (given) Direct labor (given) Manufacturing overhead: 0.02 DLH × $44 per DLH Total unit product cost Kenya Dark $4.50 0.24 Viet Select 0.88 $5.62 $2.90 0.24 0.88 $4.02 a Overhead rates by activity center: Activity Center (a) Estimated Overhead Costs (b) Expected Activity Purchasing $560,000 2,000 orders Material handling $193,000 1,000 setups Quality control $90,000 500 batches Roasting $1,045,000 95,000 roasting hours Blending $192,000 32,000 blending hours Packaging $120,000 24,000 packaging hours (a) ÷ (b) Predetermined Overhead Rate $280 $193 $180 $11 per order per setup per batch per roasting hour $6 per blending hour $5 per packaging hour © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 143 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CASE (continued) Before we can determine the amount of overhead cost to assign to the products we must first determine the activity for each of the products in the six activity centers The necessary computations follow: Number of purchase orders: Kenya Dark: 80,000 pounds ÷ 20,000 pounds per order = orders Viet Select: 4,000 pounds ÷ 500 pounds per order = orders Number of batches: Kenya Dark: 80,000 pounds ÷ 5,000 pounds per batch = 16 batches Viet Select: 4,000 pounds ÷ 500 pounds per batch = batches Number of setups: Kenya Dark: 16 batches × setups per batch = 32 setups Viet Select: batches × setups per batch = 16 setups Roasting hours: Kenya Dark: 80,000 pounds × 1.5 roasting hours per 100 pounds = 1,200 roasting hours Viet Select: 4,000 pounds × 1.5 roasting hours per 100 pounds = 60 roasting hours Blending hours: Kenya Dark: 80,000 pounds × 0.5 blending hours per 100 pounds = 400 blending hours Viet Select: 4,000 pounds × 0.5 blending hours per 100 pounds = 20 blending hours Packaging hours: Kenya Dark: 80,000 pounds × 0.3 packaging hours per 100 pounds = 240 packaging hours Viet Select: 4,000 pounds × 0.3 packaging hours per 100 pounds = 12 packaging hours © The McGraw-Hill Companies, Inc., 2010 All rights reserved 144 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CASE (continued) Using the activity figures, manufacturing overhead costs can be assigned to the two products as follows: Kenya Dark Activity Rate Expected Activity Amount Activity Rate Expected Activity Amount Purchasing $280 per order orders $ 1,120 Material handling $193 per setup 32 setups 6,176 Quality control $180 per batch 16 batches 2,880 Roasting $11 per roasting hour 1,200 roasting hours 13,200 Blending $6 per blending hour 400 blending hours 2,400 Packaging $5 per packaging hour 240 packaging hours 1,200 Total overhead cost $26,976 Viet Select Purchasing $280 per order Material handling $193 per setup Quality control $180 per batch Roasting $11 per roasting hour Blending $6 per blending hour Packaging $5 per packaging hour Total overhead cost 16 60 20 12 orders setups batches roasting hours blending hours packaging hours $2,240 3,088 1,440 660 120 60 $7,608 © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 145 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CASE (continued) b According to the activity-based costing system, the manufacturing overhead cost per pound is: Total overhead cost assigned (above) (a) Number of pounds manufactured (b) Cost per pound (a) ÷ (b) Kenya Dark $26,976 80,000 $0.34 Viet Select $7,608 4,000 $1.90 c The unit product costs according to the activity-based costing system are: Direct materials (given) Direct labor (given) Manufacturing overhead Total unit product cost Kenya Dark $4.50 0.24 0.34 $5.08 Viet Select $2.90 0.24 1.90 $5.04 MEMO TO THE PRESIDENT: Analysis of JSI’s data shows that several activities other than direct labor drive the company’s manufacturing overhead costs These activities include purchase orders issued, number of setups for material processing, and number of batches processed The company’s present costing system, which relies on direct labor time as the sole basis for assigning overhead cost to products, significantly undercosts low-volume products, such as the Viet Select coffee, and significantly overcosts high-volume products, such as our Kenya Dark coffee An implication of the activity-based costing analysis is that our lowvolume products may not be covering the costs of the manufacturing resources they use For example, Viet Select coffee is currently priced at $5.03 per pound ($4.02 plus 25% markup), but this price is below its activity-based cost of $5.04 per pound Under our present costing and pricing system, our high-volume products, such as our Kenya Dark coffee, may be subsidizing our low-volume products Some adjustments in prices may be required © The McGraw-Hill Companies, Inc., 2010 All rights reserved 146 Introduction to Managerial Accounting, 5th edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CASE (continued) ALTERNATIVE SOLUTION: Most students will compute the manufacturing overhead cost per pound of the two coffees as shown above However, the per pound cost can also be computed as shown below This alternative approach provides additional insight into the data and facilitates emphasis of some points made in the chapter Purchasing Material handling Quality control Roasting Blending Packaging Total Kenya Dark Per Pound Total (÷ 80,000) $ 1,120 6,176 2,880 13,200 2,400 1,200 $26,976 $0.014 0.077 0.036 0.165 0.030 0.015 $0.337 Viet Select Per Pound Total (÷ 4,000) $2,240 3,088 1,440 660 120 60 $7,608 $0.560 0.772 0.360 0.165 0.030 0.015 $1.902 Note particularly how batch size impacts unit cost data For example, the cost to the company to process a purchase order is $280, regardless of how many pounds of coffee are contained in the order Twenty thousand pounds of the Kenya Dark coffee are purchased per order (with four orders per year), and just 500 pounds of the Viet Select coffee are purchased per order (with eight orders per year) Thus, the purchase order cost per pound for the Kenya Dark coffee is just 1.4 cents, whereas the purchase order cost per pound for the Viet Select coffee is 40 times as much, or 56 cents As stated in the text, this is one reason why unit costs of low-volume products, such as the Viet Select coffee, increase so dramatically when activity-based costing is used © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 147 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Research and Application Jet Blue succeeds first and foremost because of its operational excellence customer value proposition Pages 1-3 of the 10-K/A make numerous references to Jet Blue’s goal of being a “leading low-fare, low-cost passenger airline.” For example, page discusses three major aspects of the company’s strategy—to stimulate demand with low fares, to continuously decrease operating costs, and to offer point-to-point flights to underserved and/or overpriced markets Page describes how the company lowers its operating costs by efficiently utilizing its aircraft, maintaining a productive workforce, operating only one type of aircraft, and streamlining the reservation booking process Jet Blue faces numerous business risks as described in pages 17-23 of the 10-K/A Students may mention other risks beyond those specifically mentioned in the 10-K/A Here are four risks faced by Jet Blue with suggested control activities:  Risk: Rising fuel prices may lower profits Control activities: Page 23 of the 10-K/A mentions that Jet Blue uses a fuel hedging program to help control this risk  Risk: Jet Blue’s reputation could be severely harmed by a major airplane crash Control activities: Implement a rigorously monitored preventive maintenance program Provide pilots with state-of-the-art flight training  Risk: Page 20 of the 10-K/A mentions that approximately 75% of Jet Blue’s daily flights have JFK or LaGuardia airport as their destination or point of origin This exposes Jet Blue to the risk of a downturn in the local New York City economy or to a downturn in local tourism due to a terrorist act or some other factor Control activities: Increase the number of cities served so that a smaller portion of total revenues is tied to New York City  Risk: Jet Blue’s workforce could seek to unionize This process could result in work slowdowns or stoppages and it could increase operating expenses Control activities: Establish a Human Resource Management Department that proactively works with employees to ensure that their morale remains high and that they feel fairly treated © The McGraw-Hill Companies, Inc., 2010 All rights reserved 148 Introduction to Managerial Accounting, 5th edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Research and Application (continued) In a manufacturing context, a unit refers to an individual unit of product In an airline context, a “unit” refers to a passenger on a particular flight Two examples of unit-level activities include baggage handling and ticket processing Both activities are directly influenced by the number of passengers served JetBlue’s point-to-point flights simplify the baggage handling process because there is no need to transfer luggage from one flight to numerous other connecting flights Point-to-point flights also lower the incidence of mishandled bags JetBlue reports that it mishandled only 2.99 bags per 1,000 customers (see page 10 of the 10-K/A) JetBlue uses technology to streamline ticket processing Page of the 10-K/A mentions that 75.4% of the company’s sales were booked at www.jetblue.com This is the company’s least expensive form of ticket processing It also mentions that JetBlue further simplified ticket processing by enabling on-line check-ins, allowing customers to change reservations through the website, and installing 76 kiosks in 19 cities In a manufacturing context, a batch refers to a number of units of product that are processed together A batch-level cost is the same regardless of how many units of the product are included in the batch In an airline context, a “batch” refers to a flight departure Examples of batch-level activities include refueling the airplane, performing pre-flight maintenance, and cleaning the interior of the cabin The costs to refuel an airplane, maintain it, and clean it are essentially the same regardless of how many passengers are on board Through 2004, JetBlue operated 70 Airbus A320 airplanes (see page of the 10-K/A) Using only one type of aircraft simplifies the gate turnaround process, which includes all of the batch-level activities mentioned in the prior paragraph Page of the 10-K/A says that JetBlue operated each airplane an average of 13.4 hours per day, which the company believes was higher than any other major U S airline Efficient gate turnarounds are one of the keys to JetBlue’s high rate of aircraft utilization © The McGraw-Hill Companies, Inc., 2010 All rights reserved Solutions Manual, Chapter 149 ... McGraw-Hill Companies, Inc., 2010 All rights reserved 96 Introduction to Managerial Accounting, 5th edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com... McGraw-Hill Companies, Inc., 2010 All rights reserved 98 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com... McGraw-Hill Companies, Inc., 2010 All rights reserved 100 Introduction to Managerial Accounting, 5th Edition To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com