AB Costing

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@ PART TWO COSTS AND COSTING SYSTEMS activity 355 facility level (or facility-sustaining) activity centre 376 activities activity driver 354 non-volume-driven overheaq Costs 369 activity-based costing (ABC) 353 product diversity 343 batch level activities 360 product level (or product-sustaining) 349 bill of activities 358 activities committed resources 367 resource driver 360 cost driver 354 root cause cost drivers 354 cost per unit of activity driver 378 traditional product costing system 254 cost pool rate 358 unit level activities 48 Review Questions 8.1 8.2 8.3 8.4 8.5 8.8 8.9 8.10 8.11 8.12 8.13 8.14 How does a traditional, volume-based costing system operate? LO 8.1 What problems can arise with using a volume-based costing system in a modern manufacturing environment? LO 84 Why would line managers suggesting that an apparently profitable product be dropped be a potential indicatores an outdated product costing system? LO 8.2 Describe the two dimensions of the activity-based costing model shown in Exhibit 8.3. Using the terms resolifces activity and resource driver, explain how costs are assigned to activities. LO 8.3 Referring to Exhibit 8.3, explain the concept of two dimensional activity-based costing. Are the activities in a Sifipi activity-based product costing system likely to be useful for activity management? Explain your answer. LO 88 You and your boss have just attended a presentation by the consulting firm, Always Better Costing, which explailigs how every organisation can benefit from adopting activity-based costing. Your boss is very keen to proceedui® activity-based product costing. How would you advise her? LO 8.4, 8.7, 8.8 There is not just one approach to activity-based costing; there are many. Describe some of the major differeiees between various approaches to activity-based costing. LO 8.4 Should facility level costs be included when estimating product costs for: LO 8.5 (a) reporting inventory balances (b) evaluating product profitability? Explain your answer. f List three factors that are important in selecting activity drivers. Explain why they are important, using exampIESs activity drivers for a bank. LO 8.5 Why would a product costing system based on a single, volume-based cost driver tend to overcost high-VOlls products in comparison to an activity-based costing system? LO 8.6 3 o Describe the circumstances in which the benefits from ABC will be greatest. Using the ‘Real life’ titled ‘ActlvaY'?a.fieS costing in the NSW public sector’ in the section ‘Step two: assigning the costs of manufacturing overhead actiey to products’, provide some examples of the benefits of activity-based costing in the public sector. LO 8.7 REASSS What factors may impede the introduction of ABC? LO 8.7 Why might organisations choose to implement a one-off ABC project rather than an ongoing system? LO 8‘88 9 What factors should be considered when deciding how many cost pools to use in activity-based costing? Lo CHAPTER EIGHT ACTIVITY-BASED COSTING @ C g16 net;»: system’ Discuss. LO 8.10 - ife’ in ‘When should ABC be used?’ suggests that the adoption of activity-based costing in Australia i Llfj hlas not been as high as one might expect. What limitations and other challenges to implementing 87 Bnd New zeacliacnostmg may be impacting the adoption of activity-based costing? LO 8.7, 8.11 REALLIFE aCﬂVity—baée’ itled ‘Activity-based costing in the NSW public sector’ in the section ‘Step two: assigning the costs of The‘Real “f-e mleerhead activities to products’ explains how activities were identified in the NSW public sector. manUfaCturlngeZ\:‘ the difficulties that might arise in estimating the cost of these activities. LO 8.12 REALLIFE Describ? -Som ed costing systems be used in service organisations? If so, are there any particular issues that ’ aCtlvzfi-ngVide an example to illustrate your answer. LO 8.12 i .C mpare the simple activity-based product costing system described in the chapter with the (appendlx) sivoe ABC system at Mason & Cox described in the appendix. Which approach would you have :::;F,:iennded to Mason & Cox? Explain your answer. LO 8.13 fhe fir - e 8. might aris 8.20 Distortion of product costs: manufacturer . Spinning Wheels Pty Ltd (SW) manufactures car and truck wheels. The company produces four t?a5|c, hlgh- L08.1 volume wheels used by manufacturers of large cars and trucks. SW also has two speciality wheel lines, which 8.2 are designed for use on expensive sports cars. SW costs all its products using a conventional volume-based costing system. . : . : Lately, SW’s profits have been declining. Foreign competitors have been undercutting SW’s prices in thre’e of its four major product lines, and its sales and market share have fallen significantly. In contrast, SWs speciality wheels have been selling steadily, although in relatively small numbers, in spite of three recent price increases. . ' At a recent staff meeting, SW’s managing director spoke about the issues faced by the company: Our profits are going down the tube. It costs us $30 to manufacture our X25 wheel. Thqt’s our bes.t seller, with a volume last year of 20000 units. But our chief competitor, based overseas, is selling e§sentlally the same wheel for $28. They can’t be making a profit. This is just another example of a foreign company dumping product on our shores. It's outrageous! I'm going to write to my local MP. The government needs to do something about this! On a bright note, thank goodness for our speciality wheels. Our salespeople have to push these Wheel:s more and more. Take the Z50 model, for example. It's a complicated thing to make and we don’t sell many, but look at the profit margin. Those wheels cost us $50 to make, and we’re selling them for $110 each! Required: 1. Do you think the managing director’s remarks are valid? What do you think is contributing to the problems faced by sw? . : 2. Do you think the managing director’s suggestion to push the sale of speciality wheels is a good one? Justify your response. . 3. What would you recommend that SW do to help address its situation? Justify your recommendations.

@ PART TWO COSTS AND COSTING SYSTEMS E8.22 LO8.3 8.4 8.5 8.6 E8.23 LO8.5 8.6 E8.24 LO8.5 Key features of activity-based costing: manufacturer Refer to the Spinning Wheels case in Exercise E8.21. Suppose the firm’s managing director has implement an activity-based costing system. decideg to Required: 1. List and briefly describe the key features that SW’s new product costing system should include 2. What impact will the new system be likely to have on the company’s situation? ' 3. What strategic options are likely to be considered once the results of the new costin ) S examined? 9 System arg Activity-based costing: service firm Brian Jones, the manager of Walkabout Tours, uses activity-based costing to calculate the cq company’s adventure walking trips. The company offers two basic trips: a two-day walk along the E chl)lrge and a five-day trip to the Flinders Ranges. The activities and costs relevant to the walking tri ollows: St of the I QUES'(ro Ps arg as Activity Activity driver Cost per unit of activity driver Advertise trips No. of trips $75 per trip Obtain national park permit Destination $150 per group permit issued Use equipment No. of person-days $30 per person per day Insure participants No. of people $7.50 per person Cook meals No. of person-days $37.50 per person per day Guide walkers $10.50 per kilometre Distance walked The El Questro Gorge trip caters for 8 people, does not enter national parks and covers a walking distance of 50 kilometres. The Flinders Ranges trip caters for 15 people, is based in the Mt Remarkable National Park and covers 100 kilometres. Required: 1. Calculate the total cost of each trip, the cost per person for each trip, and the cost per day for each trip; using the activity-based costing system. Before introducing activity-based costing, Brian had estimated the average cost of all trips at $97.50 per person per day. (This was based on the previous year’s costs, adjusted for any expected changes.) Explaifi how the activity-based system results in more accurate service cost estimates. N Classification of activities: winery Wallaby Gully Wines is a small, family-run operation in the Yarra Valley. The winery produces two varieties of wine, riesling and chardonnay. Among the winery’s activities are the following: 1. Pruning: At the end of a growing season the vines are pruned, which helps prepare them for the next harvest. 2. Tying: The vines are tied onto wires to help protect them from the cold. (This also occurs at the end of te season.) 3. Hilling: Dirt is piled up around the roots to help protect them from frost. 4. Conditioning: In the spring, dirt is levelled back from the roots. 5. Untying: The vines are untied from the wires to allow them freedom to grow during the spring and summef months. 6. Spraying: The vines are sprayed in the spring to protect them from disease and insects. 7. Harvesting: All of the grapes of both varieties are picked by hand to minimise damage. 8. Stemming and crushing: Batches of grapes are hand-loaded into a machine that gently removes the stems and crushes the grapes. E8.25 L08.5 E8.2¢ Log.5 E8.27 Log 5 Sk 10. K17 CHAPTER EIGHT ACTIVITY-BASED COSTING @ Pressing: After removal from the stemmer/crusher, the juice runs freely from the grapes. Filtering: The grapes are crushed mechanically to obtain more juice from them. Fermentation: The riesling grape juice is placed in steel tanks for fermentation. The chardonnay grape juice undergoes a two-stage fermentation process in oak barrels. 12. Ageing: The riesling wines are aged in the steel tanks for about one year. The chardonnays are aged in the oak barrels for about two years. 13. Bottling: A machine bottles the wine and corks the bottles. 14. Labelling: Each bottle is manually labelled with the name of the vintner, vintage and variety. 15. Packing: The bottles are manually packed in 12-bottle cases. 16. Case labelling: The cases are hand-stamped with the same information given on the bottle labels. 17. Shipping: The wine is shipped to wine distributors and retailers, mainly in Sydney and Melbourne. Generally, about 100 cases are shipped at a time. 18. Maintenance on buildings: This is done during the slow winter months. 19. Maintenance on equipment: This is done when needed, and on a routine basis for preventative maintenance. Required: Classify each of the activities listed as a unit, batch, product-sustaining or facility leyel activity. Activity costs and activity drivers: manufacturer . Puresound Ltd manufactures MP3 players in its Brisbane plant. The following costs are budgeted for March. Raw materials and components $4 425000 Insurance, plant 900000 Electricity, machinery 180000 Electricity, light 90000 Engineering design 915000 Depreciation, plant 1050000 Depreciation, machinery 2100000 Security wages, plant 60000 Equipment maintenance, wages 225000 Equipment maintenance, parts 45000 Setup wages 60000 Inspection of finished goods 45000 Property taxes 180000 45000 Natural gas, heating Required: 1. Assign the costs to the materials-related, machinery-related, setup, inspection, engineering and facility- sustaining activities and calculate the total cost of each activity. 2. ldentify an activity driver suitable for assigning each activity’s costs to products. Activity costs and activity drivers: manufacturer Refer to the information provided in Exercise E8.25. For each of the activities identified, indicate whether it represents a unit level, batch level, product level, or facility level activity. Explain your choice. Assigning activity costs to products: manufacturer Blusteel Ltd manufactures Blu-ray players and uses an activity-based product costing syste assigns labour and overhead costs. Below is an incomplete bill of activities for the high-volume product BluStandard. m that

388 E8.29 LO8.1 8.5 8.6 8.7 PART TWO COSTS AND COSTING SYSTEMS Blusteel Ltd bill of activities: BluStandard Annual quantity of activity driy e Activity Cost per unit of activity driver used by the product Process payables $90 per purchase order 400 purchase orders Program production $337.50 per production schedule 100 schedules Process sales order $112.50 per sales order 300 sales orders Issue materials $180 per issue 100 issues Set up solder machine $237 per setup 100 setups Solder circuit boards $22.50 per solder joint 40000 solder joints Insert motor $45 per player 5000 players Assemble player $27 per player 5000 players Design player Directly assigned cost of $18 000 for model BluStandard Required: 1. Complete the bill of activities and estimate the total activity cost of the BluStandard player, calculateq on an annual and per unit basis, assuming the annual production is 5000 units. 2. If the direct material cost of a BluStandard player is $67.50 per unit, what is the total unit cost of tha product? 3. Explain the treatment of the costs of the activity ‘design player’. Activity-based costing; quality control costs: manufacturer Stylish Manchester Ltd has used a traditional cost accounting system to apply quality control costs uniformly to all products at a rate of 16 per cent of direct labour cost. Monthly direct labour cost for the satin sheet range is $147000. In an attempt to distribute quality control costs more equitably, Stylish Manchester is considering activity-based costing. The following data relates to monthly quality control costs for its satin sheet range: Activity Activity driver Cost per unit of activity driver Quantity of activity driver Incoming material inspection Type of material $34.50 per type 24 types In-process inspection Number of units $0.42 per unit 35000 units Product certification Number of orders $216 per order 50 orders Required: 1. Calculate the monthly quality control cost to be assigned to the satin sheet product line under each of the following approaches: (a) traditional system that assigns overhead on the basis of direct labour costs (b) activity-based costing. 2. Does the traditional product costing system overcost or undercost the satin sheet product line with respect to quality control costs? By what amount and why? Problems with traditional costing systems; activity-based costing principles: manufacturer Peninsula Manufacturing has just completed a major change in its quality control (QC) process. Previouslys products were reviewed by QC inspectors at the end of each major process, and the company’s 10 Qc inspectors were charged as direct labour to the operation or job. In an effort to improve efficiency and qualitys a computerised video QC system was purchased for $500000. The system consists of a computer, 15 video cameras, other peripheral hardware, and software. The new system uses cameras stationed by QC engineefs at key points in the production process. Each time an operation changes or there is a new operatiomn CHAPTER EIGHT ACTIVITY-BASED COSTING @ the cameras are moved, and a new master picture is loaded into the computer by a QC engineer. The camera takes pictures of the units in process, and the computer compares them with a picture of a good unit. Any differences are sent to a QC engineer who removes the bad units and discusses the flaws with the production supervisors. The new system has replaced the 10 QC inspectors with two QC engineers. The operating costs of the new QC system, including the salaries of the QC engineers, have been included as factory overhead in calculating the company’s plantwide manufacturing overhead rate, which is based on direct labour dollars. The company’s managing director is confused. His production manager has told him how efficient the new system is, yet there is a large increase in the overhead rate. The calculation of the overhead rate before and after automation is as follows: Before After Budgeted manufacturing overhead $3800000 $4200000 Budgeted direct labour cost $2000000 $1400000 Budgeted overhead rate (as % of direct labour cost) 190% 300% ‘Three hundred per cent’, lamented the managing director. ‘How can We‘_compete with such a high overhead rate?’ Z Required: 1. Define manufacturing overhead and cite three examples of typical costs that would be included in manufacturing overhead. e : 2. Explain why the increase in the overhead rate should not have a negative financial impact on Peninsula Manufacturing. 3. Discuss how an activity-based costing system might benefit Peninsula Manufacturing. Comparison of activity-based and traditional product costs: manufacturer . Paris Fashions Ltd has switched from a traditional product costing system to an activity-based product costing system to assign manufacturing overhead costs to products. The table below shows the cost per unit of two products from its winter range under the two costing systems: Costing system Sweater Overcoat Traditional $39 $28 ABC $33 $50 Required: - 1. Describe the most likely features of Paris Fashions’ sweater and overcoat products by replacing the question marks in the following table with “Yes’ or ‘No". Product feature Sweater Overcoat High-volume product line ? Low-volume product line ? Produced in small batches ? Produced in large batches ? Simple to produce Complex to produce 2. Explain your answers to requirement 1.

@ PART TWO COSTS AND COSTING SYSTEMS v CHAPTER EIGHT ACTIVITY-BASED COSTING @ ES.31 (appendix) Assigning activity centre costs to activities: manufacturer Required: Bottle Brush Paints Ltd manufactures paint and uses an activity-based product costing system. Thg folloun 1. Calculate the costs assigned to the assembly centre given its usage of resource drivers during the year, as LO8.13 table lists the labour and overhead costs of the mixing centre for the current year, and their resource 4 Wlng follows: ; lva ’ Bottle Brush Paints Ltd mixing centre costs and resource drivers Number of employees 20 Amount of resouree 3 Floor area 1000 square metres 1] Total cost Resource driver consumed by the cent‘r’er Power used 10000 kilowatt hours e Wages $220000 Headcount 5 people ; E 176000 Wicwarhome 10000 kil 2. The costs listed above are not individual costs but a series of costs grouped together into cost categories Ner; W T orgs & gy. | 0 .a 0\'>vatt hourg such as wages, building costs and so on. Explain why Top Tech combined the costs from its general ledger Depreciation 44000 Machine hours 5000 machine hoygg into cost categories. Under what conditions is it appropriate to combine costs into cost categories? Give Other 22000 Headcount 5 people three examples of the types of costs likely to be included in each category. Total labour and overhead costs $462 000 . What is meant by the term resource driver? Can you suggest a better basis for assigning ‘Wages’ to activity centres? Required: 1. Complete the following table to calculate the cost of the activity ‘load mixer’ for the current year. This activity is performed in the mixing centre. Bottle Brush Paints Ltd activity: load mixer Amount of resource driver used to Cost category Mixing centre cost load mixer Cost of activity ‘load mixer’ Wages $220000 5% of total labour time in mixing centre ? Traditional and activity-based product costing: manufacturer Energy 176000 500 kilowatt hours ? The accountant for Snappy Photographic Supply Ltd has estimated the following activity cost pools and Depreciation 44000 100 machine hours ? activity drivers for the coming year: Other 22000 5% of total labour time in mixing centre ? Total cost $462000 - Budgeted Budgeted level for Cost per unit of ———— Activity overhead cost Activity driver activity driver activity driver 2. Why would Bottle Brush Paints use an activity-based product costing system that assigns labour as well as Machine setups $300000 No. of setups 100 $3000 per setup overhead costs to activities? Material handling 150000 Weight of raw material 50000 kilograms $3 per kilogram 3. How would the management accountant obtain details of the activities performed and the quantities of Hazardous waste control 75000 Weight of hazardous 10000 kilograms $7.50 per kilogram resource drivers used by the activities in the mixing centre? chemicals used E8.32 (appendix) Assigning costs to activity centres: manufacturer ' Quality control 112500 No. of inspections 1000 $112.50 per inspection Top Tech Ltd manufactures sophisticated six-tuner personal video recorders and has decided to develop ai Other overhead costs 300000 Machine hours 20000 $15 per machine hour LO8.13 activity-based product costing system to assign labour and overhead costs to products. The table below lists Total $937500 Top Tech'’s costs during the current year and the resource drivers to be used to assign these costs to activity ——— centres. : . An order for 1000 boxes of film development chemicals has the following production requirements: Top Tech Ltd Machine setups 4 setups Labour and overhead costs : . Raw material 10000 kilograms Total cost Resource driver Total amount of resource driver Hazardous materials 2000 kilograms Wages $ 720000 Headcount 100 employees Inspections 10 inspections Building costs 240000 Floor area 10000 square metres Machine hours 500 machine hours Energy 360000 Kilowatt hours 250000 kilowatt hours Other 60000 Headcount 100 employees Required: Total labour and overhead costs $1380000 1. Calculate the total overhead that should be assigned to the order for development chemicals. 2. What is the overhead cost per box of chemicals?

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