Cost Accounting (Raiborn and Kinney) SOLMAN Chapter 04 PDF

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CHAPTER 4Activity-Based Management and Activity-Based CostingQuestions Activity-based management is a management approach that associates the activities executed by an organization with the value customers derive from products. Efficiency and effectiveness are achieved by reducing the level of activ...

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CHAPTER 4 Activity-Based Management and Activity-Based Costing Questions 1.

Activity-based management is a management approach that associates the activities executed by an organization with the value customers derive from products. Efficiency and effectiveness are achieved by reducing the level of activities that do not create value for the customer and by improving execution of activities that do create customer value. Specific tools used in ABM include activity analysis, cost driver analysis, activity-based costing, continuous improvement, operational control, performance evaluation, and business process reengineering.

2.

Activity analysis is used to separate activities into two groups: those that add value to the product or service and those that do not add value. Once the non-value-added activities are identified, managers seek to reduce or eliminate the level of the drivers of those activities. If such efforts are successful, NVA costs will be reduced without impairing the value of products or services to the consumer. The result should be an increase in profits.

3.

Value-added activities are viewed from the customer's perspective because it is the customer who is the final evaluator of the “worth” of a product or service and, therefore, the activities involved in creating that product or service. The customer is also the person who should, in the final analysis, be the one who determines whether he or she actually wants to pay the price for engaging in NVA activities.

4.

In a televised football game, the value-added activities are the actual game plays. Non-value-added activities consist of commercials and the time between plays. Activities such as “moving the chains,” measuring to determine if a first down was made, moving the ball from the end of one play to the point where it will be put in play next are all non-value-added activities. People who believe that the commercials are informative and interesting and that the time between plays allows them an opportunity to examine the strategies of the teams and project what each team is likely to do may disagree with this assessment.

5.

The five people would probably not calculate the same MCE. First, times of processes will differ and a value chart will typically contain both minimum and maximum times for an activity; thus, the individuals may choose different times within the range to determine total cycle time. Additionally, some people may believe that certain activities (such as packaging and inspection) are value-added, while others may believe the same activities to be non-value-added. However, all five would probably

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agree that a significant portion of “total” cycle time is unnecessary time from a customer’s perspective. 6.

Yes, cost drivers exist in traditional accounting systems although they are generally called "overhead allocation bases." In traditional systems, a single cost driver such as direct labor hours or machine hours is commonly used rather than multiple cost drivers. Also in traditional systems, volume-based cost drivers are more the norm than non-volume-based (e.g., square footage) cost drivers. Finally, traditional accounting stresses finding an allocation base that demonstrates strong statistical correlation to the cost, but ABC emphasizes searching for multiple cost drivers that bear cause-and-effect relationships to the cost.

7.

By using a single cost pool and a single cost driver to allocate overhead, the more traditional methods of overhead assignment ignore the influence on cost of the different activities that occur to make a product. In this manner, low-volume specialty products, which cause a disproportionate amount of overhead costs, are only assigned an average charge for overhead, thereby shifting costs to the standard product lines. ABC does a better job of tracing costs to the products that caused the various costs by using multiple cost pools and multiple cost drivers. Additionally, most costs in a traditional costing system are viewed as being either variable on a per-unit-of-activity basis or fixed. Activity-based costing recognizes that the “unit” causing a change in variable costs may also be a batch-level or a process-level “unit.” Thus, rather than spreading costs over all units produced, ABC spreads costs over all units produced within the appropriate level of activity.

8.

All companies are not likely to benefit equally from adopting ABC. The greatest benefits are likely to be gained by firms with complex production processes; firms that produce products that vary relative to cost, complexity, and volume; and firms that have a high level of overhead costs that are fixed relative to production volume.

9.

Implementation of ABC requires a significant commitment of time and resources. Significant time is consumed by preparing process and value charts, identifying cost drivers, and determining how to split production costs into pools that are relatively homogeneous relative to a particular cost driver. Identifying cost drivers typically requires internal surveys and interviews with company personnel. Additional time is consumed evaluating, selecting, and implementing any software that is used to manage the ABC data collection and cost assignments. Exercises

12.

Each student will have a different answer. No solution provided.

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10.

Each student will have a different answer. No solution provided. However, it is likely that students will determine that quality inspection is non-value-added for the clothing manufacturer and value-added for the pharmaceutical company.

13.

Each student will have a different answer. No solution provided.

11.

a. None of the items are value-added activities; products should be designed so that schedule changes should not be needed. b. Number of factory schedule changes is the driver. c. Eliminate factory schedule changes except for those asked for by a customer (in which case the customer should be charged for the cost of the change) or for critical changes necessary to realize significant quality improvements and cost reductions.

16.

a. Cycle time = 6 + 180 + 3 + 3 + 2 + 6 = 200 hours b. Value-added processing time = 3 hours of mixing and cooking + 2 hours of bottling MCE = (3 + 2) ÷ 200 = 5 ÷ 200 = 2.5%

17.

a. Value-added activities: Remove sod and level site Build forms Mix and pour concrete Level concrete and smooth Remove forms Total

Time 10 12 5 2 1 30 hours

b. Non-value-added activities: Purchase materials Obtain rental equipment Drying time Return rental tools Clean up Total

Time 5 3 22 1 2 33 hours

c. Total cycle time = 30 + 33 = 63 hours MCE = 30 ÷ 63 = 47.6%

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14.

a. Value-added activities: Measuring and cutting Assembling Building fireplace Pegging logs Cutting & framing Sealing joints Total value-added time

Time 3 7 9 4 2 4 29 days

b. Non-value-added activities Time Receiving 1 Storing 5 Handling 7 Setting up & moving scaffolding 6 County inspections 3 Total non-value-added time 22 days c. Total cycle time = 29 + 22 = 51 days MCE = 29 ÷ 51 = 56.9% d. VA activities are those that increase the worth of the product or service in the eyes of the customer and for which the customer is willing to pay. NVA activities are those that do not increase a product’s value in the customer’s perspective. 15.

a. Receiving ingredients Moving ingredients to stockroom Storing ingredients in stockroom Moving ingredients from stockroom Mixing ingredients Packaging ingredients Moving packaged seasoning to warehouse Storing packaged seasoning in warehouse Moving packaged seasoning from warehouse to trucks Total minutes of cycle time

120 80 7,160 80 360 150 100 20,000 120 28,170

b. The value added functions are (1) mixing ingredients and (2) packaging ingredients. (360 min + 150 min = 510 min) c. MCE = (360 + 150)  28,170 = 510 ÷ 28,170 = 1.8%

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d. The company could do many things to improve its MCE. The primary areas on which to concentrate are the times spent storing ingredients in the stockroom and storing packaged seasoning in the warehouse. Probably the most significant improvement in MCE would come from adopting JIT (just-in-time) management of all inventories, which would allow the firm to concentrate on reducing total cycle time by not purchasing materials until they are needed and not producing finished goods until they are demanded by customers. 19.

a. The production process in Malvaney Corp. must have a significant amount of non-value-added time built into the cycle time. The most likely cause of this NVA time is one or more bottleneck processes that create long wait periods when no production is occurring and goods are simply stored or stacked until they can pass through the process. A fairly simple way to determine where the bottlenecks are is to walk through the plant and see where materials or partially completed units are being stacked in sight or being brought back into the production area from a storage location. Another indicator of a bottleneck is where labor is waiting for a machine to complete a process so that additional materials can be input. In addition to bottlenecks, the company could be engaging in rush orders that remove regularly scheduled production from processing. Always trying to catch up on backorders will create delays in processing current orders. It is possible that if all backorders were filled, the current orders could be processed at a much more rapid pace. Finally, defective units caused by rushing to complete orders will have to be reworked, thereby causing an even longer delay in processing time. b. A value chart allows a company to analyze all activities that comprise total cycle time. The role of the value chart is to identify those activities that do not add value in the eyes of the consumer. By focusing managerial attention on reducing or eliminating such activities, total cycle time is reduced and total costs are reduced.

18.

Each student will have a different answer; the following are illustrative examples. a. machine hours (for maintenance related to the volume of usage of machinery), average age of equipment (for obsolescence and agerelated maintenance) b. number of setups (volume driver), total time of setups (alternative volume measure)

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c. number of engineering changes (volume of engineering changes), number of process changes (volume of changes to the manufacturing processes), number of engineering change orders (number of requests for changes to products and processes) d. number of transactions processed (volume measure), number of service calls (for usage), number of installations (for usage), number of viruses/worms (for usage), pages of documents printed (volume) e. pounds of material processed (volume of work processed), number of different types of material handled (complexity of material handling), number of purchase orders (volume of work processed by staff and number of suppliers used) f. pounds of materials received (volume measure), distance of average shipment received (cost driver for commercial freight carriers) g. number of product defects (volume of quality defects), pounds of scrap and waste (volume of quality defects), number of quality inspections (number of batches) h. number of print ads (volume measure), seconds of air time (cost measure), number of new ads developed (measure of professional time) i. average amount of material inventory (volume of material stored), square footage of storage area (storage capacity) j. machine hours (for machine-driven usage), outside air temperature (for weather-related usage) k. amount of investment in factory machinery and buildings (total cost basis for depreciation) 21.

Each student will have a different answer; the following are illustrative examples. a. number of print ads (volume measure), seconds of air time (cost measure) b. hours of operation (time measure) c. number of transactions processed (volume measure), number of calls (for usage), number of installations (for usage), number of documents processed (for usage) d. number of clients (volume measure), number of invoices sent (for usage) e. assessed value of factory building (cost measure) f. number of employees (volume measure), number of payroll checks processed (volume measure)

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20.

a. b. c. d. e. f. g. h. i. j.

O U B O P P O U (could be product/process if left on all the time) U (per order) O

23.

a. Allocation rate = Cost ÷ Allocation base Contracts rate = $180,000 ÷ 300,000 = $0.60 per contract page Regulation rate = $250,000 ÷ 500 = $500 per review request Court rate = $575,000 ÷ 2,500 = $230 per professional hour b. Contracts: 14,000 × $0.60 Regulation: 18 × $500 Court: 210 × $230 Total

$ 8,400 9,000 48,300 $65,700

c. The rates will be used to bill other departments for the costs incurred in the legal department. If the legal department operates efficiently, its billings should equal or exceed the costs it incurs. The firm can hire an outside law firm to perform the legal work rather than do the work internally. It is difficult to determine, without more information, how this action would affect total costs. However, it would tend to make the legal costs much more variable and less fixed. 22.

a. Total support cost = $250,000 + $80,000 = $330,000 Partner hours = 4 x 2,000 = 8,000 Staff hours = 10 x 2,500 = 25,000 Total hours = 8,000 + 25,000 = 33,000 hours Support rate per hour = $330,000 ÷ 33,000 = $10 b. Total hours = 50 + 200 = 250 Total support cost = 250 x $10 = $2,500 c. Professional support rate per hour = $250,000 ÷ 33,000 = $7.58 (rounded) Administrative support rate per hour = $80,000 ÷ 8,000 = $10 d. Professional support (250 total hours x $7.58) $1,895 Administrative support (50 x $10) 500 Total support cost $2,395

25.

a. Total setup cost = $4,500 x 6 = $27,000 Total setup cost per unit = $27,000 ÷ (450 + 33,750 + 6,000)

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= $27,000 ÷ 40,200 = $0.67 (rounded) Product #453 ($0.67 x 450) $ 301.50 Product #529 ($0.67 x 33,750) 22,612.50 Product #663 ($0.67 x 6,000) 4,020.00 Total setup cost assigned (off due to rounding) $26,934.00 b. Product #453 ($4,500 x 2) Product #529 ($4,500 x 3) Product #663 ($4,500 x 1)

Total Cost ÷ # of Units = Cost per Unit $ 9,000 450 $20.00 $13,500 33,750 $0.40 $ 4,500 6,000 $0.75

c. Total number of setups would have been 3; total setup cost = $13,500 Product #453 = $4,500 ÷ 450 = $10 Product #529 = $4,500 ÷ 33,750 = $0.13 (rounded) Product #663 = $4,500 ÷ 6,000 = $0.75 24.

a. $300,000 ÷ 300,000 calls = $1 per call $150,000 ÷ 37,500 purchase orders = $4 per purchase order $135,000 ÷ 22,500 receiving reports = $6 per receiving report Cost assignment: 150 calls × $1 40 purchase orders × $4 20 receiving reports × $6 Total cost assigned

$150 160 120 $430

b. $430 ÷ 80 units = $5.38 (rounded) per unit c. $585,000 ÷ 300,000 = $1.95 per call $1.95 x 150 calls = $292.50 27.

a. $1,000,000 ÷ (85,000 + 15,000) = $1,000,000 ÷ 100,000 = $10 per machine hour Total OH assigned to regular dictionaries = $10 x 85,000 = $850,000 Total OH assigned to hand-sewn dictionaries = $10 x 15,000 = $150,000 b. Utilities-related: $400,000 ÷ 100,000 = $4 per machine hour Inspection-related: $600,000 ÷ 30,000 = $20 per inspection hour Total OH to regular dictionaries = ($4 x 85,000) + ($20 x 5,000)

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= $340,000 + $100,000 = $440,000 Total OH to hand-sew dictionaries = ($4 x 15,000) + ($20 x 25,000) = $60,000 + $500,000 = $560,000 c.

Regular Revenues $3,200,000 Direct costs (2,500,000) Overhead assigned (440,000) Profit before tax $ 260,000

Hand-Sewn $2,800,000 (2,200,000) (560,000) $ 40,000

Management should not stop producing the regular dictionaries as these are generating a rate of return on revenues of 8%, while the hand-sewn dictionaries are only generating 1.4%. 26.

a. Overhead rate = $2,640,000 ÷ 220,000 units = $12 per unit Mowers Revenue $13,000,000 Less: Direct material (2,000,000) Direct labor (1,200,000) Overhead* (2,400,000) Profit (loss) $ 7,400,000 Less: Admin. expense Income before tax Number of units ÷ 200,000 Profit per unit $37.00

Tractors $11,900,000

Total $24,900,000

(1,800,000) (4,000,000) (240,000) $ 5,860,000

(3,800,000) (5,200,000) (2,640,000) $13,260,000 (3,600,000) $ 9,660,000

÷ 20,000 $293.00

*Mowers: $12 × 200,000 = $2,400,000; Tractors: $12 x 20,000 = $240,000 b. Mowers: $1,200,000 ÷ $20 per hour = 60,000 direct labor hours Tractors: $4,000,000 ÷ $20 per hour = 200,000 direct labor hours Overhead rate = $2,640,000 ÷ 260,000 = $10.15 per DLH (rounded) Mowers Revenue $13,000,000 Less: Direct material (2,000,000) Direct labor (1,200,000) Overhead* (609,000) Profit (loss) $ 9,191,000 Less: Admin. expense Income before tax Number of units ÷ 200,000 Profit per unit (rounded) $45.96

Tractors $11,900,000

Total $24,900,000

(1,800,000) (3,800,000) (4,000,000) (5,200,000) (2,030,000) (2,640,000)** $ 4,070,000 $13,260,000 (3,600,000) $ 9,660,000 ÷ 20,000 $203.50

*Mowers: $10.15 × 60,000 = $609,000; Tractors: $10.15 x 200,000 =

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$2,030,000 **Off due to rounding of rate per DLH

c. Rate per DLH: $1,490,000 ÷ 260,000 = $5.73 (rounded) Rate per MH: $1,150,000 ÷ 100,000 = $11.50 Mowers $13,000,000

Revenue Less: Direct material (2,000,000) Direct labor (1,200,000) Overhead* (688,800) Profit (loss) $ 9,111,200 Less: Admin. expense Income before tax Number of units ÷ 200,000 Profit per unit (rounded) $45.56

Tractors $11,900,000

Total $24,900,000

(1,800,000) (3,800,000) (4,000,000) (5,200,000) (1,951,000) (2,640,000)** $ 4,149,000 $13,260,000 (3,600,000) $ 9,660,000 ÷ 20,000 $207.45

*Mowers: ($5.73 x 60,000) + ($11.50 x 30,000) = $343,800 + $345,000 = $688,800 Tractors: ($5.73 x 200,000) + ($11.50 x 70,000) = $1,146,000 + $805,000 = $1,951,000 **Off due to rounding of rate per DLH

d. The profit per unit in part (c) provides the best picture. The solution to part (a) does not recognize the difference in direct labor time and the solution to part (b) does not recognize the difference in machine time. Costs should be attached to products using the most rationale and measurable bases of activity. However, given that the profits per unit are not significantly different, the allocation base in part (b) would be acceptable if the additional tracking of machine hours is not easily nor inexpensively handled.

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a. As variety in products increases, costs will also increase. Thus, the shift to small special orders will increase costs in purchasing (more orders, more calls to get prices, more space required for catalogs, etc.), receiving (more orders and receipts to handle and account for), storage (different products must be grouped together and differentiated from other products for easy accessibility), accounting (more inventory to account for, potentially more suppliers to pay), customer service (new larger catalogs, possible complaints from customers receiving wrong or slightly wrong orders, more time for sales calls), production scheduling (variety in setups, increase in movement of materials depending on production run), and laboratory work (research and d...