Concept explainers
Activity-based costing for a service company
Wells Fargo insurance Services (WFIS) is an insurance brokerage company that classified insurance products as either “easy” or “difficult.” Easy and difficult products were defined as follows:
Easy: Electronic claims, few inquiries, mature product
Difficult: Paper claims, complex claims to process, many inquiries, a new product with complex options
The company originally allocated processing and service expenses on the basis of revenue. Under this traditional allocation approach, the product profitability report revealed the following:
Easy Product | Difficult Product | Total | |
Revenue | $600 | $400 | $1,000 |
Processing and service expenses | 420 | 280 | 700 |
Income from operations | $180 | $120 | $ 300 |
Operating income margin | 30% | 30% | 30% |
WFIS decided to use activity-based costing to allocate the processing and service expenses. The following activity-based costing analysis of the same data illustrates a much different profit picture for the two types of products:
Easy Product | Difficult Product | Total | |
Revenue | $600 | $400 | $1,000 |
Processing and service expenses | 183 | 517 | 700 |
Income from operations | $417 | $(117) | $ 300 |
Operating income margin | 70% | (29%) | 30% |
Explain why the activity-based profitability report reveals different information from the traditional sales allocation report.
Source: Dan Patras and Kevin Clancy, “ABC in the Service Industry: Product Line Profitability at Acordia, Inc.” As Easy as ABC Newsletter, issue 12. Spring 1993
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Chapter 26 Solutions
EBK FINANCIAL & MANAGERIAL ACCOUNTING
- Activity Based Costing Give your answers to the following questions; Why do product costing systems based on a single, volume based cost driver tend to overcost high volume products? What undesirable strategic effects can such distortion of product costs have? What is meant by activity analysis? Give 3 criteria for determining whether an activity adds value. What is meant by customer profitability analysis as it relates to activity based costing? Give an example of an activity that might be performed more commonly for one customer than another.arrow_forwardEmployee training is an example of discretionary fixed costs. Select one: True False Below are the measures of cost functions except: a. Regression analysis b. Engineering analysis c. Visual fit analysis d. Maintenance analysis Cost behavior is linear in nature on cost driver levels. Select one: True False Discretionary cost are the fixed cost that are able to achieve at desired level of service or production. Select one: True False Period costs are the cost identified with goods produced. Select one: True False Lease payment is the example of discretionary fixed cost. Select one: True False Below are the examples of committed costs, except: a. Mortgage payment b. Depreciation c. Tax payment d. Management salary Direct labor cost includes wages of all the labors that can be traced specifically. Select one: True False Cost are assumed to be fixed or changes within the relevant range of activity. Select one: True Falsearrow_forwardYou have been asked by management to classify the costs associated with the start-up of this new product line. Using the cost information provided below, classify each cost under the appropriate heading according to the chart provided below. Note that some costs may be classified under more than one heading. For example, a cost may be a fixed cost and a period cost. Name of cost Variable Cost Fixed Cost Direct Materials Direct Labor Factory Overhead Period Cost Prime Cost Conversion Cost Carlson “New Product” Cost Information Cost Amount Cost Type Depreciation on Building (annual) $ 10,000 Direct Labor Cost (per unit) $ 75 Direct Materials Cost (per unit) $ 60 Factory Utilities (per unit) $ 8 Indirect Materials (per unit) $ 4 Interest on Investments (annual) $3,000 Machinery Rental (monthly) $ 6,000 Marketing (annual) $ 35,000 Rent from Tenant (annual) $40,000…arrow_forward
- Which of the following statements is not a characteristic of a target costing system? It is a good system to compare the cost of your products with that of your competitors Assists with ensuring that a business can achieve its desired profit levels Focuses on cost reductions after the product has been designed Focuses on the manufacturing processes to see if improvements can be made from a cost perspective.arrow_forward1. Customer profitability analysis allows managers to do which of the following:a. Identify the closest competitor.b. Focus solely on service calls.c. Sell to higher end customers.d. Manage each customers costs-to-serve. 2. Transferred-in units and cost flows are similar to:a. Materials added at the end of the process.b. Materials added at the beginning of the process.c. Conversion costs added at the end of the process.d. Conversion costs added at the beginning of the process.3. In making decisions about whether to sell at split-off or process joint products further, the allocation of joint manufacturing costs is treated as a(n):a. Essential costb. Weighted average costc. Sunk costd. Period cost 4. Cost allocation provides a service firm a basis for evaluating the:a. Cost and profitability of its services.b. Value of its services.c. Manufacturing costs for the company.d. The exact cost of each department 5. Customer lifetime value is concerned with which of the following:a.…arrow_forwardRequired information Skip to question [The following information applies to the questions displayed below.] Zenon Computer competes at the retail level on the basis of customer service. It has invested significant resources in its customer service department. Recently, the company has installed a traditional activity-based costing (ABC) system to provide better cost information for pricing, decision making, and customer profitability analysis. Most of the costs of running the customer service department are considered committed (i.e., short-term fixed) costs (principally, personnel and equipment costs). The budgeted cost for the upcoming period is $832,000. Activity analysis, recently conducted when the ABC system was implemented, revealed the following information: Activities Percentage of Employee Time Estimated (Budgeted) Cost Driver Quantity Handling customer orders 75% 8,320 customer orders Processing customer complaints 10 416 customer complaints Conducting customer credit checks…arrow_forward
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- Accounting ABC manufactures wreaths according to customer specifications and ships them to customers using a logistics organization such as FedEx. Which two terms below describe the cost of shipping these wreaths? a. Variable cost and Period cost b. Fixed cost and Period cost c. Variable cost and Product cost d. Fixed cost and Product costarrow_forwardWhich of the following statements about activity-based costing (ABC) is false? Group of answer choices Activity-based costing differs from traditional costing systems in that products are not cross-subsidized. Activity-based costing is more likely to result in major differences from traditional costing systems if the firm manufactures only one product rather than multiple products. Activity-based costing is useful for allocating marketing and distribution costs. In activity-based costing, cost drivers are what cause costs to be incurred.arrow_forwardThe following statements refer to organisations that use service costing:(i) The service provided will be a homogenous product.(ii) The cost of materials is relatively small compared to labour, expenses and overheads.(iii) A problem with service costing is the difficulty in defining a realistic cost unit.(iv) Inventory levels are generally high in-service costing industries.Which of the above statements are correct?a) (i) and (ii)b) (ii) and (iii)c) (ii) and (iv)d) (i) and (iv)arrow_forward
- Managerial AccountingAccountingISBN:9781337912020Author:Carl Warren, Ph.d. Cma William B. TaylerPublisher:South-Western College PubFinancial And Managerial AccountingAccountingISBN:9781337902663Author:WARREN, Carl S.Publisher:Cengage Learning,
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