Cost Accounting

A Managerial Emphasis
thirteenth edition
Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

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This presentation includes:

Exercise 5-17
Problems 5-28, 33

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Exercise 5-17

ABC, cost hierarchy, service. Plymouth Test

Laboratories does heat testing (HT) and stress
testing (ST) on materials and operates at capacity.
Under its current simple costing system, Plymouth
aggregates all operating costs of $1,280,000 into a
single overhead cost pool.
Plymouth calculates a rate per test-hour of $16
($1,280,000 80,000 total test-hours). HT uses
50,000 test-hours, and ST uses 30,000 test-hours.

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Gary Celeste, Plymouth’s controller, believes
that there is enough variation in test procedures
and cost structures to establish separate costing
and billing rates for HT and ST.

The market for test services is becoming

competitive. Without this information, any
miscosting and mispricing of its services could
cause Plymouth to lose business. Celeste
divides Plymouth’s costs into four activity-cost
categories.

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a. Direct-labor costs, $243,000. These costs can be
directly traced to HT, $183,000, and ST, $60,000.
b. Equipment-related costs (rent, maintenance,
energy, and so on), $400,000. These costs are
allocated to HT and ST on the basis of test-hours.
c. Setup costs, $385,000. These costs are allocated
to HT and ST on the basis of the number of setup
hours required. HT requires 13,500 setup-hours,
and ST requires 4,000 setup-hours.
d. Costs of designing tests, $252,000. These costs
are allocated to HT and ST on the basis of the time
required to design the tests. HT requires 2,800
hours, and ST requires 1,400 hours.

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1. Classify each activity cost as output unit-level,
batch-level, product- or service-sustaining, or
facility sustaining.

Output unit-level costs

a. Direct-labor costs, $243,000
b. Equipment-related costs (rent, maintenance,
energy, and so on), $400,000

These costs are output unit-level costs because

they are incurred on each unit of materials
tested, that is, for every hour of testing.

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Batch-level costs
c. Setup costs, $385,000

These costs are batch-level costs because they are

incurred each time a batch of materials is set up for
either HT or ST, regardless of the number of hours for
which the tests are subsequently run.

Service-sustaining costs
d. Costs of designing tests, $252,000.

These costs are service-sustaining costs because they

are incurred to design the HT and ST tests, regardless of
the number of batches tested or the number of hours of
test time.

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 2.a cost
At Calculate theofcost
per test-hour per
$16, the test-hour
simple for HT
costing system and ST.
undercosts heat
testing ($17.96) and overcosts stress testing ($12.73). The reason is that
Explain
heat briefly
testing uses the
direct reasons
labor, setup, andwhy
designthese numbers
resources per hour more
differ from
intensively the $16
than stress per
testing. test-hour
Heat that
tests are more Plymouth
complex, take longer to
set up, and are more difficult to design. The simple costing system
calculated
assumes using
that testing costsitspersimple
hour are costing system.
the same for heat testing and
stress testing.

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3. Explain the accuracy of the product costs
calculated using the simple costing system and the
ABC system.

The ABC system better captures the resources needed for

heat testing and stress testing because it identifies all the
various activities undertaken when performing the tests
and recognizes the levels of the cost hierarchy at which
costs vary.

Hence, the ABC system generates more accurate

product costs.

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How might Plymouth’s management use the
cost hierarchy and ABC information to better
manage its business?

Plymouth’s management can use the information from the

ABC system to make better pricing and product mix
decisions. For example, it might decide to increase the
prices charged for the more costly heat testing and consider
reducing prices on the less costly stress testing.

Plymouth should watch if competitors are underbidding

Plymouth in stress testing, and causing it to lose business.
Plymouth can also use ABC information to reduce costs by
eliminating processes and activities that do not add value.
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Problem 5-28

Job costing with single direct-cost category, single indir

ect-cost pool, law firm. Wigan Associates is a recently fo
rmed law partnership. Ellery Hanley, the managing partn
er of Wigan Associates, has just finished a tense phone
call with Martin Offiah, president of Widnes Coal. Offiah
strongly complained about the price Wigan charged for
some legal work done for Widnes Coal.

Hanley also received a phone call from its only other clie
nt (St. Helen’s Glass), which was very pleased with both
the quality of the work and the price charged on its most
recent job. Wigan Associates operates at capacity and u
ses a cost-based approach to pricing (billing) each job.

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Currently it uses a simple costing system with a single
direct-cost category (professional labor-hours) and a si
ngle indirect-cost pool (general support). Indirect costs
are allocated to cases on the basis of professional labo
r-hours per case. The job files show the following:

Professional labor costs at Wigan Associates are $70 an

hour. Indirect costs are allocated to cases at $105 an
hour. Total indirect costs in the most recent period were
$21,000.

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1. Why is it important for Wigan Associates
to understand the costs associated with
individual jobs?

Pricing decisions at Wigan Associates are heavily

influenced by reported cost numbers.

Suppose Wigan is bidding against another firm for a

client with a job similar to that of Widnes Coal. If the
costing system overstates the costs of these jobs, Wigan
may bid too high and fail to land the client. If the costing
system understates the costs of these jobs, Wigan may
bid low, land the client, and then lose money in handling
the case.

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2. Compute the costs of the Widnes Coal
and St. Helen’s Glass jobs using Wigan’s
simple costing system.

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Problem 5-33
Choosing cost drivers, activity-based costing,
activity-based management. Annie Warbucks runs
a dance studio with childcare and adult fitness
classes. Annie’s budget for the upcoming year is as
follows:

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1. Determine which costs are direct costs and which costs
are indirect costs of different programs.
Direct Costs Indirect Costs
Dance teacher salaries, Supplies, rent, maintenance,
Child care teacher salaries, Administration salaries, utilities,
Fitness instructor salaries Marketing expenses
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2. Choose a cost driver for the indirect costs and
calculate the cost per unit of the cost driver. Explain
briefly your choice of cost driver.

Supplies – Larger programs with more participants will require more

supplies. For example, as the number of dance participants increases, so
will the cost of dance accessories.
Rent, maintenance and utilities are all building-related costs. Square-
footage is the only space-oriented cost driver available.
Administration salaries – Larger programs require more time to enroll
students and collect fees. Consequently, the number of participants
appears to be a reasonable cost driver.
Marketing expenses – Marketing expenses include the cost of advertising
the studio. As the number of ads increases so do total marketing costs.
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3. Calculate the budgeted costs of each program.

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4. How can Annie use this information for pricing?

By dividing the full cost of each service line

by the number of participants, Annie can
see that fitness classes should be charged
a higher price. Most of the higher unit
cost is attributable to the cost of Aerobic
instructors.

What other factors should she consider?

Besides cost data, Annie should also consider
a variety of other factors before setting the
price for each service. Examples of other
issues she should consider include the
actions of competitors in her market, and the
quality of her facilities and instructors.
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