ACTIVITY-BASED COSTING & MANAGEMENT
->a method of assigning indirect costs to products and services which involves finding cost of each activity involved in the
production process and assigning costs to each product based on its consumption of each activity.
Use the following information for questions 8 to 16:
Big 4 Inc. specializes in the distribution of pharmaceutical products. Big 4 buys from pharmaceutical companies and resells to
each of three different markets:
a. MC supermarket chains
b. Drugstore chains
c. K and G single-store pharmacies
Laura Rodriquez, the new controller of Big 4 reported the following data for August 2006:
MC Supermarket Drugstore K and G
Average revenue per delivery 30,900 10,500 1,980
Average cost of goods sold per delivery 30,000 10,000 1,800
Number of deliveries 120 300 1,000
For many years, Big 4has used gross margin percentage to evaluate the relative profitability of its customer groups
(distribution outlets). Ms. Rodriguez recently attended a seminar on activity-based costing and decides to consider using it at
Big 4. Ms. Rodriquez meets with all the key managers and many staff members. Generally, these individuals agree that there
are five key activity areas at Big 4:
Activity Area Cost Driver
1. Customer purchase order processing Purchase orders by customers
2. Line-item ordering Line items per purchase order
3. Store delivery Store deliveries
4. Cartons shipped to stores Cartons shipped
5. Shelf-stocking at customer store Hours of shelf-stocking
Each customer purchase order consists of one or more line items. A line item represents a single product (such as Extra-
Strength Ponstan capsules). Each store delivery entails the delivery of one or more cartons of products to a customer. Each
product is delivered in one or more separate cartons. Big 4 staff stack cartons directly onto display shelves in a store.
Currently, there is no charge for this service, and not all customers use Big 4 for this activity.
The August 2006 operating costs (other than cost of goods sold) of Big 4 are P 301,080. These operating costs are assigned
to the five activity areas. The costs in each area and the quantity of the cost allocation base used in that area for August 2006
are as follows:
Activity Area Total costs in Aug 2006 Total units of cost-allocation
base used in Aug 2006
1. Customer purchase order processing 80,000 2,000 orders
2. Line-item ordering 63,840 21,280 line items
3. Store delivery 71,000 1,420 store deliveries
4. Cartons shipped to stores 76,000 76,000 cartons
5. Shelf-stocking at customer store 10,240 640 hours
301,080
=========
Other data for August 2006 include the following:
MC Supermarket Drugstore K&K
Total number of orders 140 360 1,500
Average number of line items per order 14 12 10
Total number of store deliveries 120 300 1,000
Average number of cartons shipped per store delivery 300 80 16
Average number of hours of shelf stocking per store delivery 3.0 0.6 0.1
1. What is the 2006 gross margin for MC Supermarket Chains? 30,900 - 30,000 = 900 × 120
a. 112,000 c. 122,000
b. 150,000 d. 108,000
2. What is the 2006 gross margin for Drugstore Chains?
a. 100,000 c. 120,000
b. 150,000 d. 250,000
3. What is the 2006 gross margin for K and G Single Stores?
a. 180,000 c. 200,000
b. 120,000 d. 320,000
4. What is the operating income of Big 4?
a. 132,080 c. 136,920
b. 123,980 d. 163,290
5. The operating income margin of MC Supermarket Chains in August 2006 using the activity-based information is:
a. 1.31% c. 2.00%
b. 1.25% d. 1.51%
6. The operating income margin of Drugstore Chains in August 2006 using the activity-based information is:
a. 3.43% c. 1.75%
b. 2.56% d. 2.18%
7. The operating income margin of K and G Single Stores in August 2006 using the activity-based information is:
a. 0.37% c. 0.43%
b. 0.75% d. 0.27%
8. The total operating income under activity-based costing for August 2006 is:
a. 136,920 c. 106,220
b. 119,080 d. 123,000
9. The ratio of operating costs to revenues for MC Supermarkets Chains is:
a. 1.60% c. 1.75%
b. 1.50% d. 2.00%
ACTIVITY-BASED COSTING & MANAGEMENT page 03
PROBLEMS
1. Classification of Activities
Lubin Electronics Inc. makes avionics equipment for private aircraft manufacturers. The production process takes place in
three departments. The following costs were budgeted for February:
Computer programming production 27,000
Custodial wages plant 4,500
Depreciation machinery 95,000
Depreciation plant 60,000
Electricity machinery 11,600
Eectricity plant 7,400
Engineering design 36,000
Equipment maintenance wages 14,100
Equipment maintenance parts and supplies 2,900
Heating plant 3,200
Inspection production 3,800
Insurance plant 10,000
Property taxe4s 9,300
Raw materials, components, subassemblies 280,000
Setup wages 19,000
Required:
(1) Identify each of the costs as one of the following:
(a) A unit-level activity ->is an activity performed on each individual product or service. At this level, the cost drivers will be
volume-based since the amount of activity will proportionally depend on the number of units produced.
(b) A batch-level activity ->are performed each time a batch of goods is produced. The number of times batch-level activities (such
as setting up a machine) are performed varies according to the number of batches made.
(c) A product-level activity ->are performed as needed to support the production of each different type of product. Examples of
product-sustaining activities are maintaining product specifications, performing engineering change notices and developing
special testing routines.
(d) A facility-level activity ->support a facility's general manufacturing process. Examples of facility-sustaining
activities are lighting and cleaning the facility, facility security and managing the facility.
(2) Specify an appropriate cost driver for tracing to the products the costs that are associated with the various activity levels
previously identified.
2. Customer Cost with ABC
The following cost data have been accumulated for Ker Tuxedo Rentals:
Activity Center Cost Driver Amount of Activity Center Costs
Selling Labor hours 900 hours 38,000
Alterations Number altered 200 units 6,500
Cleaning & Preparation Number rented 750 units 16,800
General Overhead Labor hours 900 hours 52,000
Mitch Davis, a customer, necessitated two hours of selling time. He rented seven tuxedos and three of them required
alterations.
Required: Compute the total cost that should be assigned to Mitch Davis.
3. Account Balances Under JIT Costing.
Ian Koh, general manager of Toba Corporations Midwest Division, has provided the following information for transactions
that occurred during March. This division uses a JIT cost system.
(a) Raw materials were purchased at the cost of P 104,000.
(b) All materials purchased were requisitioned for production.
(c) Direct labor costs of P 77,000 were incurred.
(d) Actual factory overhead costs amounted to P 225,000.
(e) Applied conversion costs totaled P 290,000. This included P 77,000 of direct labor.
(f) All units were completed.
Required:
(1) Determine the March 31 balance in the Conversion Cost account.
(2) Determine the March 31 balance in the Finished Goods account.
4. Cost Estimation with Volume-Based Costing and ABC.
Neils Customized Gift Service (NCGS) contracts with corporate clients to print their logos and emblems on small giftware
items such as pens, cups, calculators, coasters, etc. Cat Nitz, the controller of NCGS, has provided the following information
on overhead cost estimates for 2005:
Activity Estimated Cost Cost Driver
Supervision 855,000 Direct labor hours
Power 450,000 Kilowatt hours
Maintenance 720,000 Machine hours
Setups 225,000 Setup hours
The following are estimated 2005 and planned January activity levels of the cost drivers:
Cost Driver Estimated Activity for 2005 Planned Level in Jan. 2005
Direct labor hours 300,000 35,000
Kilowatt hours 150,000 12,000
Machine hours 120,000 10,000
Setup hours 100,000 8,000
Required:
(1) Estimate overhead costs for January 2005 using direct labor hours as the allocation base.
(2) Estimate overhead costs for January 2005 using activity-base costing.
ACTIVITY-BASED COSTING & MANAGEMENT page 04
TRUE/FALSE. Correct statements are highlighted/in bold font.
1. Unit-level activities are performed each time a unit is produced. true
2. Factors that measure the consumption of activities by products and other cost objects are value-added costs. f - activity driver
3. Activity drivers should be classified as either unit-level or non-unit-level.
4. Product diversity means that products consume overhead activities in systematically different proportions. true
5. The consumption ratio is the amount of each activity consumed by a product.
6. An activity-based costing system first assigns costs to activities and then to cost objects.
7. A volume-based costing system emphasizes direct tracing and driver tracing. F - Activity-based costing
8. An activity dictionary lists the activities in an organization along with some critical activity attributes.
9. Activity attributes are financial and nonfinancial information items that describe individual activities.
10. A work distribution matrix is derived from an interview or a written survey.
11. Resource drivers are factors that measure the consumption of resources by product. False - activities
12. To calculate an activity rate, the practical capacity of each activity must be determined.
13. Activity inputs are the resources consumed by the activity in producing its output.
14. Activity analysis is the effort expended to identify those factors that are the root causes of activity costs. F - driver analysis
15. One of the questions answered by activity analysis should be "What activities are done?"
16. Activities necessary to remain in business are called valuable activities. F - value-added activities
17. Discretionary activities are necessary to comply with legal mandates. Required
18. Costs that are caused by the inefficient performance of value-added activities are value added costs F - non value added
cost
19. The value-added standard is the waste-free component of the value-added activity.
20. One of the three major dimensions of measuring activity performance is quality.
21. One way to improve efficiency is to produce higher activity output with higher cost. F - lower
22. Velocity is the length of time that it takes to produce a unit o output from the time raw materials are received until the good is
delivered. F - Cycle Time, Velocity - number of units produced in a given time.
23. Appraisal costs are incurred to determine whether products and services are conforming to their requirements or customer
needs.
24. A defective product is one that does conform to specifications. F - does not comform
25. Environmental costs are costs that are incurred because poor environmental quality may or does exists.
26. Quality improvement can increase profitability by decreasing costs.
27. Zero defects means that most products conform to specifications. F - all
28. Activity elimination focuses on nonvalue-added activities.
29. Environmental internal failure costs are the costs of activities performed after discharging contaminants and waste into the
environment. F - but not discharged into the environment
30. Control activities are performed by an organization or its customers in response to poor quality. F - Failure Activities
31. Control activities are performed by an organization to prevent or detect poor quality.
32. Environmental costs are associated with the creation, detection, remediation, and prevention of environmental degradation.
33. Sustainable development is development that meets the needs of the present without compromising the ability of future
generations to meet their own needs.
MATCHING
Match each item with the correct statement below.
a. activity drivers
b. activity-based costing system
c. consumption ratio
d. unit-level activities
e. activity attributes
f. resource drivers
1. Activities that are performed each time a unit is produced. D
2. Factors that measure the consumption of activities by products and other cost objects. A
3. Financial and nonfinancial information items that describe individual activities. E
4. System that emphasizes direct tracing and driver tracing. B
5. Factors that measure the consumption of resources by activities. F
Match each item with the correct statement below.
a. activity analysis
b. value-added costs
c. velocity
d. activity inputs
e. activity output measure
f. activity output
6. Resources consumed by the activity in producing its output. D
7. Result or product of an activity. F
8. The number of times an activity is performed. E
9. Process that answers the question "How many people perform the activities?" A
10. Costs necessary to perform value-added activities with perfect efficiency. B
ACTIVITY-BASED COSTING & MANAGEMENT page 05
Match each item with the correct statement below.
a. cycle time
b. direct tracing
c. activity sharing
d. driver tracing -> when resources are shared by several activities.
e. value-added activities
f. activity selection
11. Involves choosing among different sets of activities that are caused by competing strategies. F
12. Increases the efficiency of necessary activities by using economies of scale. C
13. The length of time it takes to produce a unit of output from the time raw materials are received until the good is delivered to
finished goods inventory. A
14. Activities necessary to remain in business E
15. Cost assignment method used for a cost of a resource that is exclusively used by an activity. B
COMPLETION
1. _______________ are performed each time a unit is produced. Unit level Activity
2. _______________ are factors that measure the consumption of activities by products and other cost objects and can be
classified as either unit-level or nonunit-level. Activity Drivers
3. When products consume overhead activities in systematically different proportion due to such things as product size, product
complexity, setup time and size of batches this is known as ______________. Product diversity
4. The _______________ is calculated by taking the amount of the activity driver per product and dividing it by total driver
quantity. Consumption ratio
5. ____________ assigns costs to activities and then costs to cost objects.
6. ____________ are financial and nonfinancial information items that describe individual activities. Activity attributes
7. A company will sometimes use a ____________ which identifies the amount of labor consumed by each activity. Work
distribution matrix
8. Accurate ____________ allow managers to make better pricing decisions, customer-mix decisions, and other customer-
related decisions that improve profitability. Customer cost
9. Tracing ______________ costs to suppliers can enable managers to choose the true low-cost supplier. ->receiving,
purchasing. Supplier -driven
10. _____________ is a system-wide, integrated approach that focuses managements attention on activities with the objective
of improving customer value and profit achieved by providing this value. Activity-based Management (abc part ng abm)
11. A focus on cost reduction instead of cost assignment and emphasizing the maximization of systemwide performance is known
as _______________. process-value analysis
12. A _______________ is classified as value-added provided it simultaneously meets three conditions. discretionary activity - 3
conditions are activity produces a change of state, the chage of state was not achievable by preceding activities, and the
activity enables other to be performed. those activities that are only allowed by the management
13. When a new product can be designed to use components already being used by other products this is known as __________.
activity sharing
14. _________ are incurred to prevent poor quality in the products and services being produced. quality cost
15. The cost of recalls would be an example of a(n) __________. quality cost
16. Reinspection and design changes are examples of ____________ costs. quality cost
17. Cleaning up a polluted lake or an oil spill are examples of __________ costs. realized external failure
18. Companies will incur costs to perform such tasks as recycling products, controlling pollution, reducing contaminates. All of
these tasks are examples of ___________ costs. environmental prevention
19. ___________ is concerned with doing the activity right the first time it is performed. quality
20. Activities necessary to remain in business are known as __________. value-added activities
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