Tax BChap010

Chapter 10
Fundamentals of Cost Management

True / False Questions

1. Activity-based cost management (ABM) uses the information provided by activity-based costing (ABC) to
identify ways to improve operations.

True False

2. Activity-based costing (ABC) can be used to provide information for managerial decision-making in
service, merchandising, and manufacturing companies.

True False

3. Storing materials, work-in-process items, and finished goods in inventory are essential, value-added
activities in most companies.

True False

4. In general, decreasing (or eliminating) the resources committed to nonvalue-added activities will decrease
customer response time.

True False

5. In general, the unit-level costs in an activity-based costing (ABC) system are variable costs.

True False

6. In general, the capacity-level costs in an activity-based costing (ABC) system are variable costs.

True False

7. Managerial decisions based on activity-based costing (ABC) information affect only volume-level, batch-
level, and product-level costs.

True False

8. The basic concepts involved in activity-based costing (ABC) can be used to determine customer
profitability as well as product costs.

True False

10-1
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McGraw-Hill Education.
9. The cost driver rate is computed by dividing the total cost per activity by the estimated number of units
produced.

True False

10. Activity-based costing (ABC) techniques used to evaluate customer profitability can also be applied to
evaluating suppliers.

True False

11. The difference between the resources used and the resources supplied is called unused resource capacity in
a typical activity-based cost management (ABM) system.

True False

12. Unused resource capacity plus the amount of the resources used is equal to the amount of resources
supplied.

True False

13. Theoretical capacity is the amount of production possible assuming expected downtime for scheduled
maintenance and normal breaks and vacations.

True False

14. Theoretical capacity is the long-run expected volume based on reasonably attainable working conditions.

True False

15. Unused capacity costs incurred for the benefit of a company's customers (e.g., meet seasonal demands)
should be assigned to the customers that require (use) the excess capacity.

True False

16. In general, managerial decisions affecting capacity-level costs and activities also affect volume-level,
batch-level, and product-level cost and activities.

True False

17. Tangible customer expectations include how the product's salespeople treat customers and the time required
to deliver the product to the customer.

True False

18. Quality can be defined as the degree to which a product or service performs as it was designed to do.

True False

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19. A cost of quality system is based on the trade-off between incurring costs to meet product (or service)
specifications and the costs of failing to meet those specifications.

True False

20. Internal failure costs include materials wasted in the production process and correcting products before they
are sold.

True False

Multiple Choice Questions

21. Which of the following statements about activity-based costing (ABC) is not true? (CIA adapted)

A. In ABC, cost drivers cause costs to be linked to products.

B. ABC is useful for assigning marketing and distribution costs.
C. ABC differs from traditional costing systems in that products are not cross-subsidized.
D. ABC is more likely to result in major differences from traditional costing systems if the firm
manufactures only one product rather than multiple products.

22. In an activity-based costing (ABC) system, cost reduction is accomplished by identifying and eliminating:
(CPA adapted)
All Cost Drivers Non value-added Activities

A. No No
B. Yes Yes
C. No Yes
D. Yes No

A. Option A
B. Option B
C. Option C
D. Option D

10-3
23. Barter Company's cost management and product costing procedures follow activity-based costing (ABC)
principles. Activities have been identified and classified as being either value-added or nonvalue-added for
each product. Which of the following activities, used in Barter's production process, is nonvalue-added?
(CPA adapted)

A. Drill press activity.

B. Heat treatment activity.
C. Design engineering activity.
D. Raw materials storage activity.

24. Activity analysis is one of the first stages in implementing an activity-based costing system. Which of the
following steps in "activity analysis" is usually performed first?

A. Classify all activities as value-added or nonvalue-added.

B. Chart, from start to finish, the activities used to complete the product or service.
C. Identify the process objectives that are defined by what the customer wants or expects from the process.
D. Continuously improve the efficiency of all value-added activities and develop plans to eliminate or
reduce nonvalue-added ones.

25. Activity analysis is an important approach to operations control and the successful implementation of an
activity-based costing (ABC) system. Which of the following procedures is not part of activity analysis?

A. Chart, from start to finish, the activities used to complete the product or service.
B. Classify all activities as either value-added or nonvalue-added activities.
C. Identify the process objectives as defined by what the customer desires from the process.
D. Compute the predetermined rate per activity by dividing the total cost pool by the total cost drivers.

10-4
26. Finesse is a specialty molder of plastic jar covers for the cosmetics industry. Because the products sold are
expensive cosmetics, the large cosmetic companies who purchase the jar covers are highly sensitive to the
appearance of the product. Any cuts, nicks, abrasions, or pieces of dirt embedded will result in rejection of
the units. The company spends a significant amount of time in the quality control area. The following list of
sub-activities has been developed for quality control:
Number Activity Description

Move units from production area to inspection
3.1
area
3.2 Quality Control inspector reviews lots
Quality Control inspector determines lots to be
3.3
inspected
3.4 Each unit is physically inspected
Defective units are returned to production area
3.5
for rework
Good units are sent to shipping for packaging
3.6
and shipment to final customer
Record of units inspected is recorded in
3.7
production office
In an activity listing with value-added scores:

A. Activity 3.4 would be assigned a high value-added ranking.

B. Activity 3.5 would be assigned a high value-added ranking.
C. Activity 3.6 would receive the highest ranking.
D. Activity 3.4 would receive a higher ranking than activity 3.1.

10-5
27. Finesse is a specialty molder of plastic jar covers for the cosmetics industry. Because the products sold are
expensive cosmetics, the large cosmetic companies who purchase the jar covers are highly sensitive to the
appearance of the product. Any cuts, nicks, abrasions, or pieces of dirt embedded will result in rejection of
the units. The company spends a significant amount of time in the quality control area. The following list of
sub-activities has been developed for quality control:

3.1
area
3.3
inspected
3.5
for rework
3.6
3.7
production office
The sub-activities of this company indicate that:

A. The company has many value added activities because customers do not want to be shipped defective
units.
B. The company has many non-value added activities.
C. The company should concentrate on eliminating defects during the production process.
D. Both B and C.

28. Which of the following activities is most likely to be classified as value-added for a manufacturing
company?

A. Storing.
B. Ordering.
C. Inspecting.
D. Assembling.

29. Which of the following activities is most likely to be classified as value-added for a merchandise
company?

A. Purchasing.
B. Waiting.
C. Receiving.
D. Setting up.

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30. Activity-based cost management (ABM) can best be defined as:

A. a cost system using multiple departmental overhead rates.

B. the use of cost information gathered using activity-based costing (ABC).
C. a quality-control system focusing on eliminating errors and mistakes.
D. an incentive system for a company's key decision-makers.

31. Which of the following items would be classified as a volume-level cost in an activity-based cost
management (ABM) system?

A. Indirect materials.
B. Production supervisor's salary.
C. Depreciation on factory building.
D. Research and development.

32. Which of the following items would be classified as a batch-level cost in an activity-based cost

A. Indirect labor.
D. Machinery set-up costs.

33. Which of the following items would be classified as a product-level cost in an activity-based cost

A. Change order to meet a new customer's specification.

B. Movement of materials for products in production.
C. Long-term lease payments for factory equipment.
D. Insurance and property taxes on faculty building.

34. Which of the following items would not be used as the cost driver for a volume-level cost in an activity-
based cost management (ABM) system?

A. Direct labor hours.

B. Machine hours.
C. Units produced.
D. Square footage.

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35. In an activity-based cost management (ABM) system, facility-level costs are those that are incurred to:

A. sustain the company's marketing program.

B. maintain the plant's production capacity.
C. support the research and development process.
D. cause a change in the engineering plans for a product.

36. McArthur Company has gathered the following data related to its production process of two of its products
for the week ended April 30:
Model Item #B-200 Item #C440

Quantity produced 60 100
Unit-level material cost $42,000 $100,000
Variable conversion cost 72,000 300,000
Total direct costs $114,000 $400,000
Indirect costs:
Indirect manufacturing cost 163,200 272,000
Indirect operating cost 255,000 425,000
Total indirect costs 418,200 697,000
Total costs $532,200 $1,097,000
The costs above that appear to be allocated rather than traced are:

A. Unit level material costs.

B. Variable conversion costs.
C. Indirect production costs only.
D. All indirect costs.

37. Fence Industries is preparing its annual profit plan. As part of its analysis of the profitability of its
customers, management estimates that the $12,000 for sales support should be assigned to the individual
customers from the information given as follows:
Customer A Customer B
Units purchased 100,000 200,000
Purchase orders (annual) 5 20
What is the amount of the sales support costs that should be allocated to Customer A assuming Fence uses
units purchased to compute activity-based costs?

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.

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What is the amount of the sales support costs that should be allocated to Customer B, assuming Fence uses

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.

What is the amount of the sales support costs that should be allocated to Customer A, assuming Fence uses
purchases orders to compute activity-based costs?

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.

10-9
What is the amount of the sales support costs that should be allocated to Customer B, assuming Fence uses

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.

41. Republic Industries decides to price delivery service according to the results of a recent activity-based
costing (ABC) study. The study indicates Republic should charge $8 per order, 2% of the order's value for
general delivery costs, $1.25 per item, and $30 for delivery.
A year later, Republic collected the following information for two of its best customers:
Cost driver Customer C Customer D

Number of orders 18 8
Number of deliveries 10 10
Number of items 2,000 4,000
Order value $120,000 $80,000
What are the total delivery costs charged to Customer D during the year?

A. $5,344.
B. $5,364.
C. $6,900.
D. $6,964.

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costing (ABC) study. The study indicates Republic should charge $8 per order, 2% of the order's value for

Order value $120,000 $80,000
What are the total delivery costs charged to Customer C during the year?

A. $5,344.
B. $5,364.
C. $6,900.
D. $6,964.

43. Benton Company is preparing its annual profit plan. As part of its analysis of the cost of its purchasing
activity, management estimates that the $48,000 for purchasing support should be assigned to the
individual vendors from the information given as follows:
Vendor A Vendor B
Number of shipments received 12 52
What is the amount of the purchasing costs that should be allocated to Vendor A, assuming Benton uses

A. $9,600.
B. $16,000.
C. $32,000.
D. $38,400.

10-11
Vendor A Vendor B
What is the amount of the purchasing costs that should be allocated to Vendor B, assuming Benton uses

A. $9,600.
B. $16,000.
C. $32,000.
D. $38,400.

Vendor A Vendor B

A. $9,600.
B. $16,000.
C. $32,000.
D. $38,400.

10-12
Vendor A Vendor B

A. $9,600
B. $16,000
C. $32,000
D. $38,400

Vendor A Vendor B
number of shipments received to compute activity-based costs?

A. $9,000.
B. $16,000.
C. $32,000.
D. $39,000.

10-13
Vendor A Vendor B

A. $9,000
B. $16,000
C. $32,000
D. $39,000

49. Express Travel decides to price delivery service according to the results of a recent activity-based costing
(ABC) study. The study indicates Express Travel should charge $16 per order, 1% of the order's value for
A year later, Express Travel collected the following information for three of its customers:
Customer Customer Customer

Cost driver
A B C
Number of orders 18 8 12
Number of
10 10 24
deliveries
Number of items 2,000 4,000 12,000
Order value $120,000 $80,000 $100,000
What are the total delivery costs charged to Customer A during the year?

A. $5,738.
B. $6,650.
C. $6,938.
D. $20,235.

10-14

Cost driver
A B C
Number of
10 10 24
deliveries
Number of items 2,000 4,000 12,000
Order value $120,000 $80,000 $100,000
What are the total delivery costs charged to Customer B during the year?

A. $13,490.
B. $11,378.
C. $10,800.
D. $10,578.


Cost driver
A B C
Number of
10 10 24
deliveries
Number of items 2,000 4,000 12,000
Order value $120,000 $80,000 $100,000

A. $16,863.
B. $20,000.
C. $31,272.
D. $32,272.

10-15
52. Activity-based costing (ABC) information cannot be used by managerial decision-makers to evaluate the:

A. profitability of a customer.
B. market potential of a product.
C. cost of using a particular supplier.
D. whether to continue providing a service.

53. Crafter Lumber Supply noticed a recent decline in the amount of purchases from a key customer. Worried
that other customers might also reduce their purchases, Crafter's management decided to evaluate the cost
of its delivery service. Which of the following cost drivers is more appropriate for general administrative
costs of the Delivery Department?

A. Number of different items ordered.

B. Value of each order.
C. Total number of items in each order.
D. Number of deliveries made.

54. The unused resource capacity is the difference between the resources supplied and the resources:

A. purchased.
B. wasted.
C. used.
D. on hand.

55. The amount of resources used in an activity-based costing (ABC) system for a specific activity is computed
by multiplying the:

A. cost driver rate and the actual cost driver volume.

B. cost driver rate and the planned cost driver volume.
C. overhead rate and the actual cost driver volume.
D. overhead rate and the planned cost driver volume.

10-16
56. South Beach Industries reports the following information about resources. At the beginning of the year,
South Beach estimated it would spend $180,000 for materials, $42,000 for purchasing, $35,000 for setups,
and $36,000 for repairs.
Cost Driver
Rate Volume
Resources used
Materials $10/lb 18,350 lbs
$250/purchase 160 purchase
Purchasing
order orders
Setups $450/setup 80 setups
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for materials for South Beach.

A. $12,700.
B. $3,500.
C. $19,270.
D. $9,200.

10-17
Cost Driver
Rate Volume
Resources used
Purchasing
order orders
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for purchasing for South Beach.

A. $5,538.
B. $2,000.
C. $4,300.
D. $2,300.

10-18
Cost Driver
Rate Volume
Resources used
Purchasing
order orders
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for setups for South Beach.

A. $2,500.
B. $1,080.
C. $1,500.
D. $1,000.

10-19
Cost Driver
Rate Volume
Resources used
Purchasing
order orders
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for repairs for South Beach.

A. $4,800.
B. $10,800.
C. $6,000.
D. $3,600.

60. Macon Publishing reports the following information about resources. At the beginning of the year, Macon
estimated it would spend $42,000 for setups and $21,000 for clerical.
Cost Driver
Rate Volume
Resources used
Setups $250 175 runs
Clerical 30 500 pages typed
Resources supplied
Setups $45,000
Clerical 20,000
Compute unused resource capacity for setups for Macon Publishing.

A. $1,250.
B. $3,000.
C. $1,750.
D. $5,000.

10-20
61. Macon Publishing reports the following information about resources. At the beginning of the year, Macon
estimated it would spend $42,000 for setups and $21,000 for clerical.
Cost Driver
Rate Volume
Resources used
Resources supplied
Setups $45,000
Clerical 20,000
Compute unused resource capacity for clerical for Macon Publishing.

A. $5,000.
B. $1,000.
C. $6,000.
D. $1,260.

62. Denim Products reports the following information about resources. At the beginning of the year, Denim
estimated it would spend $84,000 for setups and $41,000 for quality testing.
Cost Driver
Rate Volume
Resources used
Setups $250/run 350 runs
Quality testing $40/test 900 tests
Resources supplied
Setups $90,000
Quality testing 40,000
Compute unused resource capacity for setups for Denim Products.

A. $6,000.
B. $2,500.
C. $1,000.
D. $3,500.

10-21
Cost Driver
Rate Volume
Resources used
Resources supplied
Setups $90,000
Compute unused resource capacity for quality testing for Denim Products.

A. $4,000.
B. $2,000.
C. $1,000.
D. $5,000.

64. Scallon Products reports the following information about resources. At the beginning of the year, Scallon
estimated it would spend $8,000 for energy and $12,000 for repairs.
Cost Driver
Rate Volume
Resources used
Energy $0.80/MH 11,350 MH
Repairs $24/job 600 jobs
Resources supplied
Energy $10,500
Repairs 18,000
Compute unused resource capacity for energy for Scallon Products.

A. $8,000.
B. $1,080.
C. $1,420.
D. $2,500.

10-22
65. Scallon Products reports the following information about resources. At the beginning of the year, Scallon
estimated it would spend $8,000 for energy and $12,000 for repairs.
Cost Driver
Rate Volume
Resources used
Resources supplied
Energy $10,500
Repairs 18,000
Compute unused resource capacity for repairs for Scallon Products.

A. $2,400.
B. $12,000.
C. $6,000.
D. $3,600.

66. The amount of production possible under normal working conditions, including planned downtime and
scheduled vacations, is called:

A. actual capacity.
B. normal capacity.
C. practical capacity.
D. theoretical capacity.

67. Which of the following statements is(are) true?
(A) Theoretical capacity is the long-run expected volume based on reasonably attainable working
conditions.
(B) The cost of excess capacity is allocated to individual cost objects using the cost driver rate.

A. Only A is true.
B. Only B is true.
C. Both A and B are true.
D. Neither A nor B is true.

10-23
68. Which of the following statement is(are) true?
(A) Unused capacity costs incurred for the benefit of a company's customers (e.g., meet seasonal demands)
(B) In general, managerial decisions affecting capacity-level costs and activities also affect volume-level,

A. Only A is true.
B. Only B is true.

69. A company has high winter demand and low summer demand for its services. The cost of the unused
summer capacity should be allocated:

A. to an account called Idle Capacity.

B. evenly to all customers.
C. only to the winter customers.
D. only to the summer customers.

70. Which of the following is not an explanation of why a company would operate at less than theoretical
capacity?

A. Scheduled maintenance of equipment.

B. Breakdowns in equipment.
C. Customer demand is less than anticipated.
D. Customer demand is more than anticipated.

71. Marine Enterprises has developed the following unit costs for the production of one of its products, based
on a normal activity of 10,000 units per month:
Direct materials 2.0 pounds @ $12 = $24.00

Direct labor 1.5 hours @ $15 = $22.50
Variable overhead 120% of direct labor cost
Fixed overhead 140% of direct labor cost
What is the total amount of direct labor budgeted for a month in which production is expected to be 11,000
units?

A. $165,000.
B. $225,000.
C. $247,500.
D. $297,000.

10-24
72. Marine Enterprises has developed the following unit costs for the production of one of its products, based
on a normal activity of 10,000 units per month:

What is the total amount of overhead included in the overhead budget for a month in which production is
expected to be 11,000 units?

A. $612,000.
B. $643,500.
C. $600,000.
D. $594,000.

73. The degree to which a good or service meets specifications is called:

A. conformance to specifications.
B. customer quality demands.
C. a conformance cost.
D. a compliance cost.

74. Which of the following statements regarding quality costs is(are) false?
(A) In a cost of quality system, internal and external failure costs are called conformance costs.
(B) Prevention costs are costs incurred to detect individual units of product that do not conform to its
specifications.

A. Only A is false.
B. Only B is false.
C. Both A and B are false.
D. Neither A nor B is false.

75. Which of the following is not an example of a prevention cost?

A. Training employees to improve quality.

B. Designing products to reduce production problems.
C. Correcting product defects before they are sold.
D. Inspecting the production process as it occurs.

10-25
76. Which of the following is an example of a prevention cost?

A. Machine inspection.
B. Warranty repairs.
C. Field testing.
D. Marketing costs.

77. Which of the following is an example of an internal failure cost?



78. Which of the following is not an example of an external failure cost?

A. Accepting company liability resulting from product failure.

B. Experiencing decreasing sales as a result of poor-quality products.
C. Repairing or replacing defective products after they've been sold.
D. Testing products in use at the customer's site.

79. Which of the following statements regarding the trade-off between conformance and nonconformance costs
is(are) false?
(A) The optimal level for a company's quality control program occurs when its conformance costs equal its
nonconformance costs.
(B) There is an inverse relationship between the costs spent on nonconformance costs and the level of
quality achieved.

A. Only A is false.
B. Only B is false.

80. Which of the following items is included in almost all quality control systems?

A. Quality-related waiting time.

B. Quality planning and analysis.
C. Excess or obsolete inventory.
D. Quality-related overtime.

10-26
81. Water Industries' quality control report for August contains the following items.
Gathering, analysis, and reporting quality data $1,000

Inspecting raw materials received from vendors 2,000
Testing and inspecting finished products 3,000
Visiting customer sites to test product 4,000
Designing product to reduce production problems 5,000
Repairing and/or replacing products under
6,000
warranty
Maintaining the equipment used to gather quality
7,000
data
Cost (net) of materials wasted during production 8,000
What would be the total of the prevention costs on the August quality control report for Water Industries?

A. $5,000.
B. $7,000.
C. $11,000.
D. $15,000.


6,000
warranty
7,000
data
What would be the total of the appraisal costs on the August quality control report for Water Industries?

A. $7,000.
B. $11,000.
C. $12,000.
D. $15,000.

10-27

6,000
warranty
7,000
data
What would be the total of the internal failure costs on the August quality control report for Water
Industries?

A. $8,000.
B. $13,000.
C. $14,000.
D. $16,000.


6,000
warranty
7,000
data
What would be the total of the external failure costs on the August quality control report for Water
Industries?

A. $4,000.
B. $6,000.
C. $7,000.
D. $14,000.

10-28

6,000
warranty
7,000
data
What would be the total of the conformance costs on the August quality control report for Water
Industries?

A. $22,000.
B. $20,000.
C. $15,000.
D. $13,000.


6,000
warranty
7,000
data
What would be the total of the nonconformance costs on the August quality control report for Water
Industries?

A. $22,000.
B. $21,000.
C. $14,000.
D. $13,000.

10-29
87. Glory Enterprises quality control report for August contains the following items.
Liability costs associated with defective

$10,000
products
Disposal costs of defective products failing
20,000
inspection
Disposal costs of raw materials failing
30,000
inspection
Quality training provided to workers 40,000
Lost sales due to poor quality and defective
50,000
products
Advertising costs to offset perception of poor
60,000
product quality
Raw materials used to correct defects before
70,000
product was sold
Testing and inspecting a sample of finished
80,000
goods
What would be the total of the conformance costs on the August quality control report for Glory
Enterprises?

A. $200,000.
B. $170,000.
C. $150,000.
D. $90,000.

10-30

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the nonconformance costs on the August quality control report for Glory
Enterprises?

A. $120,000.
B. $150,000.
C. $180,000.
D. $210,000.

10-31

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the prevention costs on the August quality control report for Glory Enterprises?
A. $180,000.
B. $120,000.
C. $90,000.
D. $70,000.

10-32

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the appraisal costs on the August quality control report for Glory Enterprises?

A. $30,000.
B. $70,000.
C. $80,000.
D. $90,000.

10-33

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the internal failure costs on the August quality control report for Glory
Enterprises?

A. $60,000.
B. $90,000.
C. $100,000.
D. $120,000.

10-34

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the external failure costs on the August quality control report for Glory
Enterprises?

A. $70,000.
B. $110,000.
C. $120,000.
D. $140,000.

93. Which of the following is not a prevention activity in controlling quality?

A. Certifying suppliers.
B. Field testing.
C. Quality training.
D. Process improvement.

94. Which of the following is a prevention activity in controlling quality?

A. Designing products for manufacturability.

B. Inspecting machines.
C. Statistical process control.
D. Field testing.

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95. Which of the following is an appraisal activity?

A. Quality evaluations.
B. Statistical process control.
C. Warranty repairs.
D. Field replacements.

96. Which of the following is a prevention activity?

A. Field replacements.
C. Supplier certification.
D. Statistical process control.

97. Which of the following is an internal failure activity?

B. Inspecting materials.
C. Inspecting machines.
D. Delaying processes.

98. Internal failure activities:

A. seek to prevent defects in the products or services being produced.

B. inspect inputs and attributes of individual units of products or services to detect whether they conform to
specifications or customer expectations.
C. correct defective processes or products and services before they are delivered to customers.
D. are activities required after defective products or services are delivered to customers.

99. External failure activities:


B. inspect inputs and attributes of individual units of products or services to detect whether they conform to
specifications or customer expectations.

10-36
100. Prevention activities:


B. inspect inputs and attributes of individual units of products or services to detect whether they conform
to specifications or customer expectations.

101. Appraisal activities:


B. inspect inputs and attributes of individual units of products or services to detect whether they conform
to specifications or customer expectations.

102. Forensic Specialists developed the following information for its first quarter cost of quality report:
Sales $5,600,000
Cost of goods sold $3,360,000
Disposing of scrap $235,200
Quality training $84,000
Inspecting materials on delivery $280,000
Performance reviews $70,000
Resolving customer complaints $31,920
Certifying suppliers $140,000
The total cost of prevention activities for Forensic Specialists is:

A. $294,000.
B. $224,000.
C. $459,200.
D. $504,000.

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Sales $5,600,000
The relevant percentage to be used to express internal failure activities at Forensic Specialists is:

A. 27.9%.
B. 4.77%.
C. 4.2%.
D. 15.02%.

Sales $5,600,000
The total cost of external failure activities at Forensic Specialists is:

A. $420,560.
B. $31,920.
C. $117,600.
D. $175,000.

10-38
Sales $5,600,000
The relevant percentage to be used to express appraisal activities at Forensic Specialists is:

A. 5.7%.
B. 33.2%.
C. 2.75%.
D. 8.3%.

106. Tabor Detective Services is evaluating its system. The company gathered the information below:
Available Value-Adding
Hours per Time (hours Average
Process Week per client) Demand
Interviews 70 2 20
Research 130 3 30
Pursuit 75 0.5 120
Travel 200 4 45
Practical capacity is 75% for each process.

Which process is most likely to be a current bottleneck?

A. Interviews.
B. Research.
C. Pursuit.
D. Travel.

Essay Questions

10-39
107. Windom Corporation manufactures small airplane propellers. Sales for April totaled $850,000. Information
regardin
g resources for the month follows:
Resources Resources

Used Supplied
Parts management $30,000 $35,000
Energy 50,000 50,000
Quality inspections 45,000 50,000
Long-term labor 25,000 35,000
Temporary labor 20,000 24,000
Setups 70,000 100,000
Materials 150,000 150,000
Depreciation 60,000 100,000
Marketing 70,000 75,000
Customer service 10,000 20,000
Administrative 50,000 70,000
In addition, Windom spent $25,000 on 50 engineering changes with a cost driver rate of $500 and $30,000
on eight outside contracts with a cost driver rate of $3,750.
Required:
a. Prepare a traditional income statement.

b. Prepare an activity-based income statement.

10-40

108. Rock Island Manufacturing makes motor brackets. Information regarding resources for the month follows:
Resources Resources

Used Supplied
Energy 100,000 100,000
Setups 140,000 200,000
Materials 300,000 300,000
Marketing 140,000 150,000
In addition, Rock Island spent $25,000 on 40 engineering changes with a cost driver rate of $600.
Required:
a. Prepare an analysis of the unused resource capacity for the month.

10-41
109. Mirror Industries manufactures electric trolling motors. Sales for the month totaled $1,700,000.
Information regarding resources for the month follows:
Resources Resources

Used Supplied
Administrative $100,000 $140,000
Energy 100,000 100,000
Engineering 50,000 52,000
Marketing 140,000 150,000
Materials 300,000 300,000
Parts management 60,000 70,000
Setups 140,000 200,000
Required:

10-42
110. Miracle Mile Corporation manufactures electric scooters. Information regarding resources for the month
follows:
Resources Resources

Used Supplied
Energy 100,000 100,000
Marketing 140,000 150,000
Materials 300,000 300,000
Setups 140,000 200,000
Required:

10-43
111. Taylor's Cafe Supply Company delivers restaurant supplies throughout the city. Taylor's adds 4% to the
order cost to cover the delivery cost. The delivery fee is meant to just cover the cost of delivery. A
consultant has analyzed the delivery service using activity-based costing methods and identified four
activities. Data on these activities are:
Driver
Activity Cost Driver Cost
Volume
number of 4,000
Process order $25,000
orders orders
number of 80,000
Load truck 50,000
items items
Deliver number of 4,000
30,000
merchandise orders orders
number of 6,000
Process invoice 24,000
invoices invoices
Total overhead $129,000
Two of Taylor’s customers are City Diner and Le Chien Chaud. Below are data on orders and deliveries to
these two customers:
City Diner Le Chien Chaud

Order value $24,000 $32,000
Number of items 550 1,600
Number of
12 120
invoices
Required:
(a) What would be the delivery charge for each customer under the current policy of 4% of order value?
(b) What would the activity-based costing system estimate as the cost of delivering to each customer?

10-44
112. Vargas Financial (VF) only offers checking accounts. Customers can write checks and use a network of
automated teller machines. VF earns revenue by investing the money deposited (subject to reserve
requirements). Currently VF averages 6% return annually on its investments. In order to compete with
larger banks, VF pays depositors 1% on all deposits. A recent study classified the operating costs of the
bank into four activities. Data on these activities are:
Driver
Volume
number of 10,000,000
Use ATM $2,00,000
uses uses
number of
Visit branch 6,000,000 750,000 visits
visits
Process number of
4,000,000 40,000,000
transaction transactions
transactions
General bank
total deposits 8,000,000 $450,000,000
overhead
Total
$20,000,000
overhead
Data on two representative customers are shown below:
ATM uses 300 50
Branch visits 5 20
Number of transactions 60 1,200
Average deposit $450 $10,000
Required:
(a) Compute the operating profits of the Vargas Financial.

(b) Compute the profit of Customer A and Customer B, assuming that customer costs are based only on
deposits.
(c) Compute the profit of Customer A and Customer B, assuming that customer costs are computed using
the information in the activity-based costing analysis.

10-45
113. Mobile Repair Company is preparing its annual profit plan. As part of its analysis of the cost of its
purchasing activity, management estimates that the $125,000 for purchasing support should be assigned to
the individual vendors from the information given as follows:
Vendor Vendor Vendor

A B C
Units purchased 100,000 200,000 200,000
Purchase orders (annual) 6 24 100
Number of shipments
12 52 25
received
Required:
a. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Mobile Repair uses
units purchased to compute activity-based costs.
b. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Mobile Repair uses
purchases orders to compute activity-based costs.
c. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Mobile Repair uses
number of shipments to compute activity-based costs.

10-46
114. Bison Creek Company is preparing its annual profit plan. As part of its analysis of the cost of its
purchasing activity, management estimates that the $250,000 for purchasing support should be assigned to
the individual vendors from the information given as follows:

A B C
Units purchased 100,000 100,000 500,000
Purchase orders (annual) 12 24 50
Number of shipments
12 52 100
received
Required:
a. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Bison Creek uses
b. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Bison Creek uses
c. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Bison Creek uses

10-47
115. Hidden Valley Company produces precision components. Hidden Valley has six customers, one accounts
for 40 percent of the sales, with the remaining five accounting for the rest of the sales. The five smaller
customers purchase components in roughly equal quantities. Orders placed by the smaller customers are
about the same size. Data concerning Hidden Valley 's customer activity follow:
Large Five Small

Customer Customers
Orders placed 10 350
Number of sales calls 20 230
Manufacturing cost $600,000 $900,000
Order-filling costs for Hidden Valley Company total $180,000, and sales-force costs are $275,000.
Required:
a. Allocate the order-filling and sales force costs to the customers based on sales volume.
b. Allocate the order-filling and sales force costs to the customers using an activity-based costing
approach.

10-48
116. Kingston Company produces precision components. Kingston has 11 customers, one accounts for 60
percent of the sales, with the remaining ten accounting for the rest of the sales. The ten smaller customers
purchase components in roughly equal quantities. Orders placed by the smaller customers are about the
same size. Data concerning Kingston's customer activity follow:
Large Ten Small

Customer Customers
Order-filling costs for Kingston Company total $360,000, and sales-force costs are $300,000.
Required:
approach.

10-49
percent of the sales, with the remaining ten accounting for the rest of the sales. The ten smaller customers
purchase components in roughly equal quantities. Orders placed by the smaller customers are about the
same size. Data concerning Kingston's customer activity follow:
Large Ten Small

Customer Customers
Sales $1,800,000 $1,200,000
Required:
a. Determine the profitability of each of the two classes of customers (large and small). Allocate the order-
filling and sales force costs to the customers based on sales volume.
b. Determine the profitability of each of the two classes of customers (large and small). Allocate the order-
filling and sales force costs to the customers using an activity-based costing approach.

10-50
118. Bountiful Harvest Distribution delivers supplies to small grocers throughout the region. Bountiful currently
adds 5% to the order cost to cover the delivery cost. The delivery fee is meant to just cover the cost of
delivery. A consultant has analyzed the delivery service using activity-based costing methods and
identified four activities. Data on these activities are:
Driver
Volume
number of
Process order $50,000 4,000 orders
orders
Load truck number of items 100,000 80,000 items
number of
Deliver goods 60,000 4,000 orders
orders
Process number of 6,000
48,000
invoice invoices invoices
Three of Bountiful's customers are Rosy's Corner Market, Katy's Fine Foods, and Amy's City Market.
Below are data on orders and deliveries to these three customers:
Rosy’s Katy’s Amy’s

Order value $48,000 $64,000 $120,000
Number of items 550 1,600 1,750
Number of invoices 12 120 18
Required:

10-51
119. Gruber Industries provides the following information about resources:
Cost Driver
Cost Driver Volume
Rate
Resources used
Materials $12 15,000 pounds
Energy 48 675 machine hours
Setups 300 150 setups
Purchasing 240 160 purchase orders
Customer service 160 175 returns
Long-term labor 80 640 labor hours
840 administrative
Administrative 60
hours
Resources supplied
Materials $192,000
Energy 36,480
Setups 50,400
Purchasing 44,000
Customer service 35,200
Long-term labor 53,000
Administrative 54,000
In addition, sales for the period totaled $600,000.
Required:
Compute the unused resource capacity for each preceding item.

10-52
120. Jones Industries provides the following information about resources:
Cost Driver
Cost Driver Volume
Rate
Resources used
Materials $24 25,000 gallons
Long-term labor 80 1,600 labor hours
2,200 administrative
Administrative 75
hours
Resources supplied
Materials $625,000
Energy 86,480
Setups 60,400
Purchasing 74,000
Required:

10-53
121. Morrison Supply provides the following information about resources:
Cost Driver
Cost Driver Volume
Rate
Resources used
Administrative $50
hours
Materials 12 50,000 units
Resources used
Administrative $68,000
Energy 66,480
Materials 625,000
Purchasing 34,000
Setups 60,400
Required:

10-54
122. The following represents the financial information of Fabriz Corporation, a manufacturer of electronic
components, for two months:
March April
Sales $539,000 $495,000
Costs:
Process inspection 3,300 3,760
Scrap 3,700 3,860
Quality training 37,600 26,000
Warranty repairs 8,600 9,600
Testing equipment 14,000 14,000
Customer complaints 5,600 6,800
Rework 34,000 37,000
Preventive maintenance 27,000 19,000
Materials inspection 13,000 9,600
Field testing 18,800 24,800
Required:
a. Classify these items into prevention, appraisal, internal failure, or external failure costs.
b. Calculate the ratio of the prevention, appraisal, internal failure, and external failure costs to sales for
March and April.

10-55
123. Categorize each of the following quality activities by placing an X in the appropriate column.
Required:
Interna Externa
Preventio Apprais l l
n al Failure Failure
Inspecting
raw
materials
1.
received
from
vendors
Cost (net)
of materials
2. wasted
during
production
Gathering,
analysis,
3. and
reporting
quality data
Repairing
and/or
replacing
4.
products
under
warranty
Testing
product in
5. use at
customer
sites
Maintaining
the
equipment
6.
used to
gather
quality data
Testing and
inspecting
7.
finished
products
Designing
product to
8. reduce
production
problems

10-56

Required:
Inter Exter
Preventi Apprai nal nal

on sal Failu Failur
re e
1. Lost sales
Materials
2.
inspection
End-of-process
3.
sampling
4. Process inspection
5. Warranty repairs
6. Product design
7. Rework
8. Field testing
9. Scrap
10
Product liability
.
11 Reinspection/retest

. ing
12
Quality training
.

10-57
125. The following represents the financial information of Madison Tool Corporation, a manufacturer of testing
equipment:
May
Customer complaints $11,200
Field testing 37,600
Materials inspection 26,000
Preventive maintenance 54,000
Process inspection 6,600
Quality training 75,200
Rework 68,000
Scrap 7,400
Testing equipment 28,000
Warranty repairs 17,200
Required:
a. Classify these items into prevention, appraisal, internal failure, or external failure costs. Determine the
total cost of each category.

10-58
126. The following represents quality cost data for Monnett Corporation:
Field testing $67,100

Finished goods inspection 48,700
Product design 96,700
Product liability insurance 48,000
Rework 68,000
Scrap 17,400
Required:
a. Classify these items into prevention, appraisal, internal failure, or external failure costs. Determine the
total cost of each category.

10-59
127. Fine Grape produces premium wine. Its success in the industry is due to its quality, although all of its
customers, wine shops and specialty grocery stores, are very cost conscious and negotiate for price cuts on
all large orders. Noting that the wine industry is becoming increasingly competitive, Fine Grape is looking
for a way to meet the challenge. It is negotiating with Culinary Delights, a regional specialty grocery store,
to purchase a large order of wine. Fine Grape is currently producing at under-capacity and would like to
keep its production facilities, gaining better economies of scale by increasing production. Culinary
Delights has agreed to a large order but only at a price of $39 per bottle. The special order can be
purchased in one batch with available capacity. Fine Grape prepared these data: Next month's operating
information (per unit, for 10,000 bottles, made in 10 batches of 1,000 each)
Sales price $55

Per unit costs
Variable manufacturing costs 22
Batch-level costs 5
Variable marketing costs 10
Fixed manufacturing costs 6
Fixed marketing costs 2
Special order information (order is produced in one

batch)
Sales units 2,000
Sales price per bottle $39
No variable marketing costs are associated with this order, but Fine Grape has spent $2,500 during the past
two months trying to get Culinary Delights to purchase the special order.
Required:
(1) How much will the special order change Fine Grape’s total operating income?
(2) How much would the special order change Fine Grape’s total operating income if fine Grape is
operating at full capacity and would lose the sale of the 2,000 bottles to regular customers?
(3) How might the special order fit into Fine Grape’s competitive strategy?

10-60
128. Joseph Hutton Enterprises has met all production requirements for the current month and has an
opportunity to produce additional units of product with its excess capacity. Unit selling prices and costs for
three models of one of its product lines are as follows:
No Standard

Frills Options Super
Selling price $35.00 $45.00 $65.00
Direct materials 10.00 12.00 14.00
Direct labor ($15/hr.) 7.50 12.00 21.00
Variable Overhead 4.00 6.40 11.20
Fixed Overhead 3.00 5.00 5.00
Variable overhead is charged to products on the basis of direct labor dollars, and fixed overhead is charged
to products on the basis of machine hours.
Required:
(1) If Joseph Hutton Enterprises has excess machine capacity and can add more labor as needed (neither
machine capacity nor labor is a constraint), the excess production capacity should be devoted to producing
which product or products?
(2) If Joseph Hutton Enterprises has excess machine capacity but a limited amount of labor time, the
production capacity should be devoted to producing which product or products?

10-61
129. Smooth, Inc. manufactures bath and beauty products such as soaps, skin creams, lotions, and other
products primarily for people with dry and sensitive skin. It has just introduced a new line of product that
removes the spotting and wrinkling in skin associated with aging. It sells these products in pharmacies and
department stores at prices slightly higher than those of other brands because of Smooth's excellent
reputation for quality and effectiveness.
Smooth currently has very low utilization of plant capacity. Two years ago, in anticipation of rapid
growth, the company opened a new large manufacturing plant, which has yet to be utilized more than 50
percent. Partly for this reason, Smooth has sought new partners and was able, with the help of financial
analysts, to locate suitable business partners. The first potential partner identified in this search was a large
supermarket chain, Price-Mart, which is interested in the partnership because it wants Smooth to
manufacture an age cream to sell in its stores. The product would be essentially the same as the Smooth
product but would be packaged in the Price-Mart brand name. The agreement would pay Smooth $2.00 per
unit and would allow Price-Mart a limited right to advertise the product as manufactured for Price-Mart by
Smooth. Smooth's CFO has made some calculations and has determined that the direct materials, direct
labor, and other variable costs needed for the Price-Mart order would be about $1.00 per unit as compared
to the full cost of $2.50 (materials, labor, and overhead) for the equivalent Smooth product.
Required:
Should Smooth Inc. accept the proposal from Price-Mart? Why or why not? (Include strategic
considerations)

10-62
130. Stonehouse Corporation developed the following information regarding quality for the first quarter of the
year 2016:
Sales $6,800,000
Wasted time $285,600
Training $102,000
Inspecting materials $340,000
Total $1,021,360
Required:
Prepare a cost of quality report sorting costs by quality activity and expressing in relevant percentage
terms.

10-63
131. Identify each of the following as Prevention Activities (P), Appraisal Activities (A), Internal Failure
Activities (I) or External Failure Activities (E):
(1) Field Testing

(2) Statistical process control
(3) Sampling at the end of process
(4) Disposing of scrap
(5) Quality evaluations
(6) Retesting
(7) Settling product liability
(8) Resolving customer complaints
(9) Lost sales
(10) Restoring reputation

132. For each of the following products or services, indicate the most important customer quality attributes and
the most important customer quality tradeoffs.
(a) Personal computer

(b) Legal representation in divorce court
(c) New home purchase
(d) Meals in a fast food restaurant
(e) Airline travel
(f) Prom dress
(g) Cruise ship vacation
(h) Auto repair

10-64
133. Describe the four steps that are taken in an activity analysis.

134. Companies are continuously seeking ways to improve the quality of production and reduce costs. One of
the areas is to work with suppliers to improve the quality and reliability of parts and products shipped. In
an article entitled "In Defense of Activity-Based Cost Management," Robert S. Kaplan says:
An ABC model can play a major role in improving supplier relationships as well. These relationships must
be a vital part of any quality and cycle-time improvement program. A key insight is to use ABC to
distinguish between low-price and low-cost suppliers. Traditional cost accounting, with its emphasis on
purchase price variances, encourages purchasing people to continually scan the population of potential
suppliers to obtain low price quotations. Most companies have learned, the hard way, that many of their
low-price suppliers are actually extremely high-cost suppliers. (Source: Management Accounting:
November, 1992)
Required:
(a) Explain what Kaplan means by "many of their low-price suppliers are actually extremely high-cost
suppliers."
(b) What general prevention and appraisal activities can be used to improve the quality and reliability of
parts and products shipped from suppliers?

10-65
135. Traditionally, companies in the United States have employed a "push" manufacturing style. Studies in
Activity Based Management and Quality Control have indicated that this approach is filled with many non-
value-added activities, which increase overall costs and reduce profits. The "push" style is being replaced
with a "pull" approach.
Required:
Briefly describe the major differences between the push and pull approaches. What non-value added
activities are eliminated in a pull manufacturing system?

10-66
136. Lyon Toys, Inc. (LTI) manufactures a variety of electronic toys for children aged 3 to 14 years. The
company started as a Ma & Pa basement operation, and grew steadily over the last nine years. It now
employs over 100 people and has sales revenue of over $250 million. Katie Burger, the CEO of LTI also
recognizes that competition has increased during this period; therefore, future growth will not be easy.
Burger recognizes that one of the areas of weakness is the accounting and costing system. Burger's
maternal uncle, Martin, had maintained the accounts for the company. He meticulously kept track of all the
invoices that were received, payments made, and painstakingly prepared crude annual reports. With Martin
passing away at the age of 85, Burger decided to hire a professional cost management expert to keep track
of the company's costs. She hired Molly Wright, who had just completed her CMA.
After acquainting Wright with the company and its people, Burger decided to get down to business. She
called Wright to her office to have a serious conversation about accounting and costing, in particular.
Burger: Molly, I would like you to pay particular attention to developing an official costing system.
Currently, we don't have one. I believe this should be your first priority because competition is rising and if
we do not understand our costs, we might start losing business to our rivals.
Wright: I understand your point very well, Ms. Burger.
Burger: Call me Katie.
Wright: Very well, Katie. I have a few ideas that I picked up from my CMA courses that I think are worth
implementing. However, it looks like we need to start with the basics.
Required:
Assume the role of Molly Wright. Write a brief report outlining the basics of a cost management
information system. Include in your report the following:
• Resources and costs

• Supply of resources vs. the use of resources
• Classification of costs (three dimensions of resources)
• Alternative costing systems

10-67
137. What is the relationship between customer profitability analysis and ABC?

138. Cost allocation bases are factors that cost management analysts use to assign indirect costs to cost objects.
Ideally, cost-allocation bases should reflect a cause-and-effect relationship between resource spending and
use. Ideally, an Activity-Based-Costing (ABC) approach will provide a more accurate and useful
accounting for an organization's resources. Recent studies have found that, in spite of increasing costs and
diminishing resources, very few Higher Education Institutions use the tools and techniques of an ABC cost
allocation system to assign costs to academic departments. While direct costs, such as faculty salaries, are
traceable to individual academic departments or courses, many indirect costs, such as facility use,
computer use, and student support services, are more difficult to assign. In a traditional approach, many
higher education institutions assign such costs based on a single factor, such as the number of courses
taught in the university. (Source: Activity-Based Costing for Higher Education Institutions, Management
Accounting Quarterly, Winter, 2001)
Required:
(a) Explain why the use of a single-cost driver such as the number of courses may result in inaccurate
management information as to the cost of running courses in individual academic departments.
(b) For each of the indirect costs listed below, identify an appropriate cost-driver that might be used to
allocate costs to determine the cost of offering a single course in an academic department if an Activity-
Based-Costing model were used.
• Computer use
• Facility use
• Student services
• Course design
• Lecturing/class meeting time
• Assignment grading

10-68
139. Explain the differences between resources used, resources supplied, and unused resource capacity.

10-69
140. Franklin Industrial Equipment Corporation manufactures lawn mowers and snow blowers. It also
manufactures engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine Division
(ED) also sells about 40% of its output to the outside market (these are multipurpose engines). Its annual
capacity is 150,000 units and annual output is 135,000 units. All engines sold internally to the LMAD are
priced at cost plus 20% markup.
In January 2016, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy' 20,000
engines. Jean Wyse, the controller of ED, computed the costs of manufacturing these engines as follows:
Total Per unit

Materials $300,000 $15.00
Labor 400,000 20.00
Special equipment 36,000 1.80
Quality inspection 24,000 1.20
Other manufacturing costs 350,000 17.50
Total costs $1,110,000 $55.50
Wyse quoted a price of $66.60 for each engine transferred to the SBAD. Jeb Hart, the manager of SBAD,
was furious to note that the ED was "trying to make money off a sister division." He argued that the price
must include only the cost of materials, as all other costs will be incurred irrespective of whether or not
SBAD places the order for 20,000 engines. Mark Matley, the production manager of ED, pointed out that
the special equipment will be purchased only for fulfilling this internal order. Moreover, he argued that
inspection must also be done just like on all other engines; therefore, the inspection costs must also be
included. Labor is paid a flat monthly salary. Other manufacturing costs include both variable and fixed
components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED must charge to the SBAD?
(b) What are the pros and cons of internal sourcing?

10-70
141. Quality costs can be divided into two categories: conformance and nonconformance. Explain the difference
between the two and give two examples of each.

142. Describe the four types of quality costs and give an example of each.

143. Explain the difference between actual activity, theoretical capacity, practical capacity, and normal
activity.

10-71
144. Jessica Long, the production manager of Maxim Corporation is frustrated by the company's policy of not
scrapping defective units but reworking them. She has pointed out several times to senior management that
some units are beyond rework and should be scrapped. According to her, in most cases, it would be
cheaper to scrap and build a new unit from scratch rather than trying to rework a defective unit. However,
Peter Crouch, the CEO, is not convinced. He wants his controller, Melinda Gates, to gather some
information.
After researching the problem, Gates provides the following information:
Selling price: $132 per unit

Manufacturing costs:
Direct materials 27
Direct labor 32
Variable overhead 24
Fixed overhead 32
Reworking costs:
Materials: $25
Labor: 48
Direct machining costs: 35
Gates also observes that reworking a defective product consumes more labor time than making a unit from
scratch. As a result, for every three units reworked, Maxim forgoes the production and sale of two units.
Required:
(a) Do you agree with Jessica Long that it is cheaper to scrap than rework a defective unit? Show your
computations.
(b) How can the cost information generated by Gates be useful in reducing the number of defectives?

10-72
145. Stella McDonald is a purchasing agent for a motorcycle manufacturer. Stella is evaluating two potential
suppliers of seats for the company's motorcycles. One supplier (A) quotes a price of $165 per seat and
assures 100% quality and delivery standards. The second supplier (B) quotes a price of $135 per seat but
does not give any written assurances on quality or delivery. McDonald is not sure which supplier should
be awarded the contract.
Assume you are the management accountant for the motorcycle manufacturer. McDonald asks you to
prepare an estimate of the related costs of buying the seats from supplier B. She tells you that the estimate
is needed because unless dollar estimates are attached to nonfinancial factors, such as lost production costs,
her supervisor will not give it full attention. McDonald provides you with the following information:
• Production output is 2,000 motorcycles per year based on 250 production days a year.
• Production time per day is 8 hours at a cost of $4,000 per hour to run the production line.
• Lost production time due to poor quality is 1%.
• Satisfied customers purchase, on average, three motorcycles during a lifetime.
• Satisfied customers recommend the product, on average, to 5 other people.
• Marketing estimates that using the seat from supplier B will result in 5 lost customers per year from
repeat business and referrals.
• Average contribution margin per motorcycle is $5,000.
Required:
Estimate the costs of buying motorcycle seats from supplier B. (Note: This problem requires you to think
creatively and make reasonable estimates; therefore, there is more than one correct answer.)

10-73
146. Thompson Metal Corporation (TMC) supplies various types of machine tools to manufacturing companies.
TMC has always paid a lot of attention to the quality of its products. Recently, an outside supplier has
approached TMC to supply an important and intricate component of one of its more advanced tools that
TMC has been manufacturing in-house. Sam Weiss, a junior accountant at TMC, has collected the
following information regarding this proposal.
The cost of manufacturing one unit of this component internally are as follows:
Direct materials: $29.60

Direct labor: 13.00
Variable overhead: 19.50 (@150% of direct labor cost)
Fixed overhead: 26.00 (@200% of direct labor cost)
Total cost: $88.10
The outside supplier has quoted a price of $90 per unit for supplying this component. The following is a
conversation that took place among the manufacturing manager (Dana Rice), buyer (Emily Scanlon), and
Sam Weiss.
Weiss: I think that we should continue to manufacture internally because we can save $1.90 per unit on
this component.
Rice: According to your report, we would save $1.90 per unit, but I do not agree with those numbers.
Weiss: What do you mean? I have followed the same costing guidelines this company has used for years. I
have even cross-checked my numbers with historical data and know for sure that the overhead rates which
I have used are correct.
Rice: I am sure you have done your job thoroughly, but I think that our costing system is archaic. This
component is complex and difficult to manufacture. I believe that our overhead allocation method does not
accurately capture the production difficulties and the additional resources that are devoted to the
manufacture of this component. For example, a significant portion of our quality problems are due to this
component. We spend close to a third of our quality inspection time on just this component alone, but that
is not reflected. These quality problems cause delays in getting this component to the assembly
department, and that causes a delay in getting the final product to the customers. Many of our customers
are expecting just-in-time deliveries, and they get upset when we're late.
Scanlon: I know that the supplier that has approached us has a strong reputation for quality. Therefore, we
can rest assured that we will have negligible quality problems.
Rice: Sam, your report does not consider this additional benefit from buying outside. I would appreciate if
you can rework your numbers to better reflect the true costs associated with manufacturing this component
internally.
Required:
(a) Assume the role of Sam Weiss. What are the different elements of costs that are likely to be associated
with the manufacture of the component? Does the current costing system capture these costs?
(b) Recommend improvements in the costing system.
(c) How can Weiss quantify "qualitative" benefits such as quality and on-time delivery?

10-74

147. Mulvey Corporation manufactures large kitchen appliances. The following represents financial information
for two years:
2016 2017
Sales $7,840,000 $7,040,000
Costs:
Process Inspection 52,800 60,000
Scrap 57,600 60,200
Quality Training 610,000 440,000
Warranty Repairs 140,000 150,000
Testing Equipment 230,000 230,000
Resolving Customer
89,000 108,400
Complaints
Rework 544,000 390,000
Preventative Maintenance 440,000 304,000
Material Inspection 210,000 150,000
Field Testing 300,000 400,000
Total costs $2,673,400 $2,292,600
Required:
(a) Classify these items into costs of prevention (P), appraisal (A), internal failure (I) or external failure
(E) activities.
(b) Calculate the ratio of prevention, appraisal, internal failure, and external failure costs to sales for 2016
and 2017.
(c) Prepare a cost of quality report for 2016.

10-75
148. Scranton Extruded Plastics is a company involved in the injection molding process of plastic extruders.
The company had a process of inspection, checking line work, and handling returns from customers to
identify and correct quality problems. Scrapped extruders were ground into powder and fed back to the
extruders as raw material; thus, all scrapped extruders were reused at some point. The company's cost
accounting system indicated that the cost of scrap was "zero," a view also held by Scranton's management.
(Source: "Activity Based management" by Peter B. B. Turney published in Management Accounting)
Required:
a) Comment on the view that scrap costs were zero at Scranton Extruded Plastics.
b) Identify internal and external failure activities that were required by Scranton.
c) Identify prevention and appraisal activities that could have been employed.

10-76
Chapter 10 Fundamentals of Cost Management Answer Key
True / False Questions

1. Activity-based cost management (ABM) uses the information provided by activity-based costing (ABC)
to identify ways to improve operations.

TRUE
ABM is the managerial use of ABC information.

AACSB: Analytical Thinking
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 10-01 Describe how activity-based cost management can be used to improve operations.
Topic: Using Activity-Based Cost Management to Add Value

2. Activity-based costing (ABC) can be used to provide information for managerial decision-making in
service, merchandising, and manufacturing companies.

TRUE
ABC is not limited to just manufacturing companies.

Blooms: Apply
Difficulty: 2 Medium
Gradable: automatic

3. Storing materials, work-in-process items, and finished goods in inventory are essential, value-added
activities in most companies.

FALSE
These are all nonvalue-added activities.

10-77
Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

4. In general, decreasing (or eliminating) the resources committed to nonvalue-added activities will
decrease customer response time.

TRUE
The "extra" work is being removed, so the time to complete is shorter.

Blooms: Remember
Gradable: automatic

5. In general, the unit-level costs in an activity-based costing (ABC) system are variable costs.

TRUE
Unit-level (or volume-related) increase as volume increases—this is the definition of variable cost.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 10-02 Use the hierarchy of costs to manage costs.

6. In general, the capacity-level costs in an activity-based costing (ABC) system are variable costs.

FALSE
Capacity-level costs are normally fixed costs.

Blooms: Remember
Gradable: automatic

10-78
7. Managerial decisions based on activity-based costing (ABC) information affect only volume-level,
batch-level, and product-level costs.

FALSE
Capacity-level costs are also affected.

Blooms: Remember
Gradable: automatic

8. The basic concepts involved in activity-based costing (ABC) can be used to determine customer
profitability as well as product costs.

TRUE
The definition of the cost object is the only thing that is different.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 10-03 Describe how the actions of customers and suppliers affect a firm’s costs.
Topic: Managing the Cost of Customers and Suppliers

9. The cost driver rate is computed by dividing the total cost per activity by the estimated number of units
produced.

FALSE
Divided by the estimated cost driver level.

Blooms: Remember
Gradable: automatic
Learning Objective: 10-04 Use activity-based costing methods to assess customer and supplier costs.

10-79
10. Activity-based costing (ABC) techniques used to evaluate customer profitability can also be applied to
evaluating suppliers.

TRUE
ABC can be used for both suppliers and customers.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

11. The difference between the resources used and the resources supplied is called unused resource
capacity in a typical activity-based cost management (ABM) system.

TRUE
This is the definition of unused resource capacity.

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 10-05 Distinguish between resources used and resources supplied.
Topic: Managing the Cost of Capacity

12. Unused resource capacity plus the amount of the resources used is equal to the amount of resources
supplied.

TRUE
Unused + Used = total available

Blooms: Remember
Gradable: automatic

10-80
13. Theoretical capacity is the amount of production possible assuming expected downtime for scheduled
maintenance and normal breaks and vacations.

FALSE
Theoretical capacity does not allow for any downtime, whether planned or unplanned.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 10-06 Design cost management systems to assign capacity costs.

14. Theoretical capacity is the long-run expected volume based on reasonably attainable working
conditions.

FALSE
Theoretical is based on ideal or perfect conditions.

Blooms: Remember
Gradable: automatic

15. Unused capacity costs incurred for the benefit of a company's customers (e.g., meet seasonal demands)

TRUE
This is the concept of matching costs with the object that benefits from it.

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-81
16. In general, managerial decisions affecting capacity-level costs and activities also affect volume-level,

TRUE
All levels may be affected by managerial decisions.

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

17. Tangible customer expectations include how the product's salespeople treat customers and the time
required to deliver the product to the customer.

FALSE
These are intangible expectations.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 10-07 Describe how activities that influence quality affect costs and profitability.
Topic: Managing the Cost of Quality

18. Quality can be defined as the degree to which a product or service performs as it was designed to do.

TRUE
This is the most general definition of quality.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-82
19. A cost of quality system is based on the trade-off between incurring costs to meet product (or service)
specifications and the costs of failing to meet those specifications.

TRUE
There is a tension between the two that must be considered.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
Learning Objective: 10-08 Compare the costs of quality control to the costs of failing to control quality.

20. Internal failure costs include materials wasted in the production process and correcting products before
they are sold.

TRUE
Internal failures occur before the products leave the firm; external failures occur after the product
leaves.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

Multiple Choice Questions

10-83
21. Which of the following statements about activity-based costing (ABC) is not true? (CIA adapted)

A. In ABC, cost drivers cause costs to be linked to products.

B. ABC is useful for assigning marketing and distribution costs.
C. ABC differs from traditional costing systems in that products are not cross-subsidized.
D. ABC is more likely to result in major differences from traditional costing systems if the firm
manufactures only one product rather than multiple products.
In order for ABC to reflect a maximum benefit, there must be more than one product.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

22. In an activity-based costing (ABC) system, cost reduction is accomplished by identifying and
eliminating: (CPA adapted)
All Cost Drivers Non value-added Activities

A. No No
B. Yes Yes
C. No Yes
D. Yes No

A. Option A
B. Option B
C. Option C
D. Option D
A full range of cost drivers is necessary, coupled with the elimination of nonvalue-added activities.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-84
23. Barter Company's cost management and product costing procedures follow activity-based costing
(ABC) principles. Activities have been identified and classified as being either value-added or
nonvalue-added for each product. Which of the following activities, used in Barter's production process,
is nonvalue-added? (CPA adapted)

A. Drill press activity.

B. Heat treatment activity.
C. Design engineering activity.
D. Raw materials storage activity.
Raw materials storage is nonvalue-added as it creates nothing compared to the other three alternatives
which create value.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

24. Activity analysis is one of the first stages in implementing an activity-based costing system. Which of
the following steps in "activity analysis" is usually performed first?

A. Classify all activities as value-added or nonvalue-added.

B. Chart, from start to finish, the activities used to complete the product or service.
C. Identify the process objectives that are defined by what the customer wants or expects from the
process.
D. Continuously improve the efficiency of all value-added activities and develop plans to eliminate or
(a), (b), and (d) are later steps in the process of activity analysis.

AICPA: FN Measurement
Blooms: Remember
Gradable: automatic

10-85
25. Activity analysis is an important approach to operations control and the successful implementation of an
activity-based costing (ABC) system. Which of the following procedures is not part of activity
analysis?

A. Chart, from start to finish, the activities used to complete the product or service.
B. Classify all activities as either value-added or nonvalue-added activities.
C. Identify the process objectives as defined by what the customer desires from the process.
D. Compute the predetermined rate per activity by dividing the total cost pool by the total cost drivers.
Activity analysis has four steps—computing the activity rates is not one of them.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-86
26. Finesse is a specialty molder of plastic jar covers for the cosmetics industry. Because the products sold
are expensive cosmetics, the large cosmetic companies who purchase the jar covers are highly sensitive
to the appearance of the product. Any cuts, nicks, abrasions, or pieces of dirt embedded will result in
rejection of the units. The company spends a significant amount of time in the quality control area. The
following list of sub-activities has been developed for quality control:

3.1
area
3.3
inspected
3.5
for rework
3.6
3.7
production office
In an activity listing with value-added scores:

A. Activity 3.4 would be assigned a high value-added ranking.

B. Activity 3.5 would be assigned a high value-added ranking.
C. Activity 3.6 would receive the highest ranking.
D. Activity 3.4 would receive a higher ranking than activity 3.1.
The shipping of good units to final customers is the highest value-added activity.

Gradable: automatic

10-87
27. Finesse is a specialty molder of plastic jar covers for the cosmetics industry. Because the products sold
are expensive cosmetics, the large cosmetic companies who purchase the jar covers are highly sensitive
to the appearance of the product. Any cuts, nicks, abrasions, or pieces of dirt embedded will result in
rejection of the units. The company spends a significant amount of time in the quality control area. The
following list of sub-activities has been developed for quality control:

3.1
area
3.3
inspected
3.5
for rework
3.6
3.7
production office
The sub-activities of this company indicate that:

A. The company has many value added activities because customers do not want to be shipped
defective units.
B. The company has many non-value added activities.
C. The company should concentrate on eliminating defects during the production process.
D. Both B and C.
The company has both many nonvalue-added activities and should concentrate on eliminating
production defects.

AACSB: Reflective Thinking
Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-88
28. Which of the following activities is most likely to be classified as value-added for a manufacturing
company?

A. Storing.
B. Ordering.
C. Inspecting.
D. Assembling.
Storing, ordering, and inspecting are all nonvalue-added.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

29. Which of the following activities is most likely to be classified as value-added for a merchandise
company?

A. Purchasing.
B. Waiting.
C. Receiving.
D. Setting up.
Waiting, receiving, and setting up are all nonvalue-added.

Blooms: Remember
Gradable: automatic

10-89
30. Activity-based cost management (ABM) can best be defined as:

A. a cost system using multiple departmental overhead rates.

B. the use of cost information gathered using activity-based costing (ABC).
C. a quality-control system focusing on eliminating errors and mistakes.
D. an incentive system for a company's key decision-makers.
ABM is the use of activity analysis to make decisions and manage costs.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

31. Which of the following items would be classified as a volume-level cost in an activity-based cost

A. Indirect materials.

D. Research and development.
The production supervisor's salary and depreciation on the building are facilities-level, research &
development is product-level.

Blooms: Remember
Gradable: automatic

10-90
32. Which of the following items would be classified as a batch-level cost in an activity-based cost

A. Indirect labor.

D. Machinery set-up costs.
Indirect labor is a volume-level, the production supervisor's salary and depreciation on the building are
facilities-level.

Blooms: Remember
Gradable: automatic

33. Which of the following items would be classified as a product-level cost in an activity-based cost

A. Change order to meet a new customer's specification.

B. Movement of materials for products in production.
C. Long-term lease payments for factory equipment.
D. Insurance and property taxes on faculty building.
Material moves would be a batch-level, lease payments and insurance/taxes on the building are
facilities-level.

Blooms: Remember
Gradable: automatic

10-91
34. Which of the following items would not be used as the cost driver for a volume-level cost in an activity-
based cost management (ABM) system?

A. Direct labor hours.

B. Machine hours.
C. Units produced.
D. Square footage.
Square footage is not related to the volume of production—it is related to the size of the building.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

35. In an activity-based cost management (ABM) system, facility-level costs are those that are incurred to:

A. sustain the company's marketing program.

B. maintain the plant's production capacity.
C. support the research and development process.
D. cause a change in the engineering plans for a product.
Facility-level are related to the overall facility.

Blooms: Remember
Gradable: automatic

10-92
36. McArthur Company has gathered the following data related to its production process of two of its
products for the week ended April 30:
Model Item #B-200 Item #C440

Quantity produced 60 100
Unit-level material cost $42,000 $100,000
Variable conversion cost 72,000 300,000
Total direct costs $114,000 $400,000
Indirect costs:
Indirect manufacturing cost 163,200 272,000
Indirect operating cost 255,000 425,000
Total indirect costs 418,200 697,000
Total costs $532,200 $1,097,000
The costs above that appear to be allocated rather than traced are:

A. Unit level material costs.

B. Variable conversion costs.
C. Indirect production costs only.
D. All indirect costs.
Indirect costs are always allocated as part of overhead.

AICPA: BB Critical Thinking
Blooms: Apply
Difficulty: 3 Hard
Gradable: automatic

10-93
What is the amount of the sales support costs that should be allocated to Customer A assuming Fence
uses units purchased to compute activity-based costs?

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.
100,000/(100,000 + 200,000) × $12,000 = $4,000

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

What is the amount of the sales support costs that should be allocated to Customer B, assuming Fence
uses units purchased to compute activity-based costs?

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.
200,000/(100,000 + 200,000) × $12,000 = $8,000

10-94
Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

What is the amount of the sales support costs that should be allocated to Customer A, assuming Fence
uses purchases orders to compute activity-based costs?

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.
5/(5 + 20) × $12,000 = $2,400

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-95
What is the amount of the sales support costs that should be allocated to Customer B, assuming Fence
uses purchases orders to compute activity-based costs?

A. $2,400.
B. $4,000.
C. $8,000.
D. $9,600.
20/(5 + 20) × $12,000 = $9,600

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-96
costing (ABC) study. The study indicates Republic should charge $8 per order, 2% of the order's value
for general delivery costs, $1.25 per item, and $30 for delivery.

Order value $120,000 $80,000
What are the total delivery costs charged to Customer D during the year?

A. $5,344.
B. $5,364.
C. $6,900.
D. $6,964.
$8(8) + .02($80,000) + $1.25(4,000) + $30(10) = $6,964

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-97
costing (ABC) study. The study indicates Republic should charge $8 per order, 2% of the order's value
for general delivery costs, $1.25 per item, and $30 for delivery.

Order value $120,000 $80,000

A. $5,344.
B. $5,364.
C. $6,900.
D. $6,964.
$8(18) + .02($120,000) + $1.25(2,000) + $30(10) = $5,344

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-98
Vendor A Vendor B

A. $9,600.
B. $16,000.
C. $32,000.
D. $38,400.
$100,000/($100,000 + 200,000) × $48,000 = $16,000

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-99
Vendor A Vendor B

A. $9,600.
B. $16,000.
C. $32,000.
D. $38,400.
$200,000/($100,000 + 200,000) × $48,000 = $32,000

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-100
Vendor A Vendor B

A. $9,600.
B. $16,000.
C. $32,000.
D. $38,400.
6/(6 + 24) × $48,000 = $9,600

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-101
Vendor A Vendor B

A. $9,600
B. $16,000
C. $32,000
D. $38,400
24/(6 + 24) × $48,000 = $38,400

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-102
Vendor A Vendor B

A. $9,000.
B. $16,000.
C. $32,000.
D. $39,000.
12/(12 + 52) × $48,000 = $9,000

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-103
Vendor A Vendor B

A. $9,000
B. $16,000
C. $32,000
D. $39,000
52/(12 + 52) × $48,000 = $39,000

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-104
49. Express Travel decides to price delivery service according to the results of a recent activity-based
costing (ABC) study. The study indicates Express Travel should charge $16 per order, 1% of the order's
value for general delivery costs, $2.50 per item, and $45 for delivery.

Cost driver
A B C
Number of
18 8 12
orders
Number of
10 10 24
deliveries
Number of items 2,000 4,000 12,000
Order value $120,000 $80,000 $100,000
What are the total delivery costs charged to Customer A during the year?

A. $5,738.
B. $6,650.
C. $6,938.
D. $20,235.
$16(18) + .01($120,000) + $2.50(2,000) + $45(10) = $6,938

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-105

Cost driver
A B C
Number of
18 8 12
orders
Number of
10 10 24
deliveries
Number of items 2,000 4,000 12,000
Order value $120,000 $80,000 $100,000
What are the total delivery costs charged to Customer B during the year?

A. $13,490.
B. $11,378.
C. $10,800.
D. $10,578.
$16(8) + .01($80,000) + $2.50(4,000) + $45(10) = $11,378

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-106

Cost driver
A B C
Number of
18 8 12
orders
Number of
10 10 24
deliveries
Number of items 2,000 4,000 12,000
Order value $120,000 $80,000 $100,000

A. $16,863.
B. $20,000.
C. $31,272.
D. $32,272.
$16(12) + .01($100,000) + $2.50(12,000) + $45(24) = $32,272

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

52. Activity-based costing (ABC) information cannot be used by managerial decision-makers to evaluate
the:

A. profitability of a customer.

B. market potential of a product.
C. cost of using a particular supplier.
D. whether to continue providing a service.
Market potential is not based on cost information—it is based on external marketing data.

Blooms: Remember
Gradable: automatic
10-107

53. Crafter Lumber Supply noticed a recent decline in the amount of purchases from a key customer.
Worried that other customers might also reduce their purchases, Crafter's management decided to
evaluate the cost of its delivery service. Which of the following cost drivers is more appropriate for
general administrative costs of the Delivery Department?

A. Number of different items ordered.

B. Value of each order.
C. Total number of items in each order.
D. Number of deliveries made.
The size of the administration of the delivery department would be related to the number of deliveries.

Blooms: Remember
Difficulty: 3 Hard
Gradable: automatic

54. The unused resource capacity is the difference between the resources supplied and the resources:

A. purchased.
B. wasted.
C. used.
D. on hand.
This is the definition of unused resource capacity.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-108
55. The amount of resources used in an activity-based costing (ABC) system for a specific activity is
computed by multiplying the:

A. cost driver rate and the actual cost driver volume.
B. cost driver rate and the planned cost driver volume.
C. overhead rate and the actual cost driver volume.
D. overhead rate and the planned cost driver volume.
Resources used would be related to actual level of activity, so the actual cost driver volume should be
used. Cost driver rate should be used since this is a measure of the resources being supplied.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-109
South Beach estimated it would spend $180,000 for materials, $42,000 for purchasing, $35,000 for
setups, and $36,000 for repairs.
Cost Driver
Rate Volume
Resources used
Purchasing
order orders
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for materials for South Beach.

A. $12,700.
B. $3,500.
C. $19,270.
D. $9,200.
$192,700 - [$10(18,350)] = $9,200

Blooms: Apply
Gradable: automatic

10-110
Cost Driver
Rate Volume
Resources used
Purchasing
order orders
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for purchasing for South Beach.

A. $5,538.
B. $2,000.
C. $4,300.
D. $2,300.
$44,300 - [$250(160)] = $4,300

Blooms: Apply
Gradable: automatic

10-111
Cost Driver
Rate Volume
Resources used
Purchasing
order orders
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for setups for South Beach.

A. $2,500.
B. $1,080.
C. $1,500.
D. $1,000.
$37,500 - [$450(80)] = $1,500

Blooms: Apply
Gradable: automatic

10-112
Cost Driver
Rate Volume
Resources used
Purchasing
order orders
Repairs 36 700 jobs
Resources

supplied
Materials $192,700
Purchasing 44,300
Setups $37,500
Repairs 30,000
Compute unused resource capacity for repairs for South Beach.

A. $4,800.
B. $10,800.
C. $6,000.
D. $3,600.
$30,000 - [$36(700)] = $4,800

Blooms: Apply
Gradable: automatic

10-113
60. Macon Publishing reports the following information about resources. At the beginning of the year,
Macon estimated it would spend $42,000 for setups and $21,000 for clerical.
Cost Driver
Rate Volume
Resources used
Resources supplied
Setups $45,000
Clerical 20,000
Compute unused resource capacity for setups for Macon Publishing.

A. $1,250.
B. $3,000.
C. $1,750.
D. $5,000.
$45,000 - [$250(175)] = $1,250

Blooms: Apply
Gradable: automatic

10-114
61. Macon Publishing reports the following information about resources. At the beginning of the year,
Macon estimated it would spend $42,000 for setups and $21,000 for clerical.
Cost Driver
Rate Volume
Resources used
Resources supplied
Setups $45,000
Clerical 20,000
Compute unused resource capacity for clerical for Macon Publishing.

A. $5,000.
B. $1,000.
C. $6,000.
D. $1,260.
$20,000 - [$30(500)] = $5,000

Blooms: Apply
Gradable: automatic

10-115
Cost Driver
Rate Volume
Resources used
Resources supplied
Setups $90,000
Compute unused resource capacity for setups for Denim Products.

A. $6,000.
B. $2,500.
C. $1,000.
D. $3,500.
$90,000 - [$250(350)] = $2,500

Blooms: Apply
Gradable: automatic

10-116
Cost Driver
Rate Volume
Resources used
Resources supplied
Setups $90,000
Compute unused resource capacity for quality testing for Denim Products.

A. $4,000.
B. $2,000.
C. $1,000.
D. $5,000.
$40,000 - [$40(900)] = $4,000

Blooms: Apply
Gradable: automatic

10-117
64. Scallon Products reports the following information about resources. At the beginning of the year,
Scallon estimated it would spend $8,000 for energy and $12,000 for repairs.
Cost Driver
Rate Volume
Resources used
Resources supplied
Energy $10,500
Repairs 18,000
Compute unused resource capacity for energy for Scallon Products.

A. $8,000.
B. $1,080.
C. $1,420.
D. $2,500.
$10,500 - [$0.80(11,350)] = $1,420

Blooms: Apply
Gradable: automatic

10-118
65. Scallon Products reports the following information about resources. At the beginning of the year,
Scallon estimated it would spend $8,000 for energy and $12,000 for repairs.
Cost Driver
Rate Volume
Resources used
Resources supplied
Energy $10,500
Repairs 18,000
Compute unused resource capacity for repairs for Scallon Products.

A. $2,400.
B. $12,000.
C. $6,000.
D. $3,600.
$18,000 - [$24(600)] = $3,600

Blooms: Apply
Gradable: automatic

66. The amount of production possible under normal working conditions, including planned downtime and
scheduled vacations, is called:

A. actual capacity.

B. normal capacity.
C. practical capacity.
D. theoretical capacity.
This is the definition of practical capacity.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic
10-119

67. Which of the following statements is(are) true?
(A) Theoretical capacity is the long-run expected volume based on reasonably attainable working
conditions.
(B) The cost of excess capacity is allocated to individual cost objects using the cost driver rate.

A. Only A is true.

B. Only B is true.
Theoretical capacity is based on perfect conditions.

Blooms: Remember
Difficulty: 3 Hard
Gradable: automatic

68. Which of the following statement is(are) true?
(A) Unused capacity costs incurred for the benefit of a company's customers (e.g., meet seasonal
demands) should be assigned to the customers that require (use) the excess capacity.
(B) In general, managerial decisions affecting capacity-level costs and activities also affect volume-
level, batch-level, and product-level cost and activities.

A. Only A is true.

B. Only B is true.
Both A and B are true.

Blooms: Remember
Difficulty: 3 Hard
Gradable: automatic

10-120
69. A company has high winter demand and low summer demand for its services. The cost of the unused
summer capacity should be allocated:

A. to an account called Idle Capacity.

B. evenly to all customers.
C. only to the winter customers.
D. only to the summer customers.
The excess capacity exists so the winter customers' demand can be satisfied. Since it is purchased to
ensure supply for the winter customers, they should be charged.

Blooms: Remember
Gradable: automatic

70. Which of the following is not an explanation of why a company would operate at less than theoretical
capacity?

A. Scheduled maintenance of equipment.

B. Breakdowns in equipment.
C. Customer demand is less than anticipated.
D. Customer demand is more than anticipated.
More than anticipated customer demand would cause the company to operate at theoretical capacity.

Blooms: Apply
Gradable: automatic

10-121
71. Marine Enterprises has developed the following unit costs for the production of one of its products,
based on a normal activity of 10,000 units per month:

What is the total amount of direct labor budgeted for a month in which production is expected to be
11,000 units?

A. $165,000.
B. $225,000.
C. $247,500.
D. $297,000.
11,000 × $22.50 = $247,500

Blooms: Apply
Gradable: automatic

10-122
72. Marine Enterprises has developed the following unit costs for the production of one of its products,
based on a normal activity of 10,000 units per month:

What is the total amount of overhead included in the overhead budget for a month in which production
is expected to be 11,000 units?

A. $612,000.
B. $643,500.
C. $600,000.
D. $594,000.
($22.50 × 11,000 × 120% = $297,000) + ($22.50 × 10,000 × 140% = 315,000) = $612,000

Difficulty: 3 Hard
Gradable: automatic

73. The degree to which a good or service meets specifications is called:

A. conformance to specifications.

B. customer quality demands.
C. a conformance cost.
D. a compliance cost.
This is the definition of conformance to specifications.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-123
74. Which of the following statements regarding quality costs is(are) false?
(A) In a cost of quality system, internal and external failure costs are called conformance costs.
(B) Prevention costs are costs incurred to detect individual units of product that do not conform to its
specifications.

A. Only A is false.

B. Only B is false.
Failure costs are nonconformance costs.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

75. Which of the following is not an example of a prevention cost?


Correcting defects is an internal failure cost. The problems were not prevented.

Blooms: Remember
Gradable: automatic

10-124
76. Which of the following is an example of a prevention cost?

A. Machine inspection.

C. Field testing.
D. Marketing costs.
Field testing is an appraisal cost; warranty repairs and marketing costs are external failure costs.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

77. Which of the following is an example of an internal failure cost?


Training and design are prevention costs; inspection is an appraisal cost.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

78. Which of the following is not an example of an external failure cost?

A. Accepting company liability resulting from product failure.

B. Experiencing decreasing sales as a result of poor-quality products.
C. Repairing or replacing defective products after they've been sold.
D. Testing products in use at the customer's site.
Testing products at a customer's site is an appraisal cost.

10-125
Blooms: Remember
Gradable: automatic

79. Which of the following statements regarding the trade-off between conformance and nonconformance
costs is(are) false?
(A) The optimal level for a company's quality control program occurs when its conformance costs
equal its nonconformance costs.
(B) There is an inverse relationship between the costs spent on nonconformance costs and the level of
quality achieved.

A. Only A is false.

B. Only B is false.
Both A and B are true statements.

Blooms: Remember
Difficulty: 3 Hard
Gradable: automatic

80. Which of the following items is included in almost all quality control systems?

A. Quality-related waiting time.

B. Quality planning and analysis.
C. Excess or obsolete inventory.
D. Quality-related overtime.
Almost every system includes planning, not all include waiting time, inventory problems, or overtime.

Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-126

Designing product to reduce production
5,000
problems
6,000
warranty
Maintaining the equipment used to gather
7,000
quality data
Cost (net) of materials wasted during
8,000
production
What would be the total of the prevention costs on the August quality control report for Water
Industries?

A. $5,000.
B. $7,000.
C. $11,000.
D. $15,000.
$1,000 + 2,000 + $5,000 + 7,000 = $15,000

Blooms: Apply
Gradable: automatic

10-127

5,000
problems
6,000
warranty
7,000
quality data
8,000
production
What would be the total of the appraisal costs on the August quality control report for Water Industries?
A. $7,000.
B. $11,000.
C. $12,000.
D. $15,000.
$3,000 + $4,000 = $7,000

Blooms: Apply
Gradable: automatic

10-128

5,000
problems
6,000
warranty
7,000
quality data
8,000
production
What would be the total of the internal failure costs on the August quality control report for Water
Industries?

A. $8,000.
B. $13,000.
C. $14,000.
D. $16,000.
$8,000

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-129

5,000
problems
6,000
warranty
7,000
quality data
8,000
production
What would be the total of the external failure costs on the August quality control report for Water
Industries?

A. $4,000.
B. $6,000.
C. $7,000.
D. $14,000.
$6,000

Blooms: Apply
Difficulty: 1 Easy
Gradable: automatic

10-130

5,000
problems
6,000
warranty
7,000
quality data
8,000
production
What would be the total of the conformance costs on the August quality control report for Water
Industries?

A. $22,000.
B. $20,000.
C. $15,000.
D. $13,000.
$7,000 + $15,000 = $22,000

Blooms: Apply
Gradable: automatic

10-131

5,000
problems
6,000
warranty
7,000
quality data
8,000
production
What would be the total of the nonconformance costs on the August quality control report for Water
Industries?

A. $22,000.
B. $21,000.
C. $14,000.
D. $13,000.
$8,000 + $6,000 = $14,000

Blooms: Apply
Gradable: automatic

10-132

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the conformance costs on the August quality control report for Glory
Enterprises?

A. $200,000.
B. $170,000.
C. $150,000.
D. $90,000.
$30,000 + 40,000 + 80,000 = $150,000

Blooms: Apply
Gradable: automatic

10-133

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the nonconformance costs on the August quality control report for Glory
Enterprises?

A. $120,000.
B. $150,000.
C. $180,000.
D. $210,000.
$10,000 + 20,000 + 50,000 + 60,000 + 70,000 = $210,000

Blooms: Apply
Gradable: automatic

10-134

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the prevention costs on the August quality control report for Glory
Enterprises?

A. $180,000.
B. $120,000.
C. $90,000.
D. $70,000.
$30,000 + $40,000 = $70,000

Blooms: Apply
Gradable: automatic

10-135

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the appraisal costs on the August quality control report for Glory
Enterprises?

A. $30,000.
B. $70,000.
C. $80,000.
D. $90,000.
$80,000

Blooms: Apply
Gradable: automatic

10-136

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the internal failure costs on the August quality control report for Glory
Enterprises?

A. $60,000.
B. $90,000.
C. $100,000.
D. $120,000.
$20,000 + 70,000 = $90,000

Blooms: Apply
Gradable: automatic

10-137

$10,000
products
20,000
inspection
30,000
inspection
50,000
products
60,000
product quality
70,000
product was sold
80,000
goods
What would be the total of the external failure costs on the August quality control report for Glory
Enterprises?

A. $70,000.
B. $110,000.
C. $120,000.
D. $140,000.
$10,000 + 50,000 + 60,000 = $120,000

Blooms: Apply
Gradable: automatic

93. Which of the following is not a prevention activity in controlling quality?

A. Certifying suppliers.

B. Field testing.
C. Quality training.
D. Process improvement.
Field testing is an appraisal activity.

10-138
Blooms: Remember
Gradable: automatic

94. Which of the following is a prevention activity in controlling quality?

A. Designing products for manufacturability.

B. Inspecting machines.
C. Statistical process control.
D. Field testing.
Designing products for manufacturability is prevention, while the other choices are appraisal.

Blooms: Remember
Gradable: automatic

95. Which of the following is an appraisal activity?


B. Statistical process control.
C. Warranty repairs.
D. Field replacements.
The use of statistical process control is appraisal, while the other activities are in different quality areas.

Blooms: Remember
Gradable: automatic

10-139
96. Which of the following is a prevention activity?

A. Field replacements.

C. Supplier certification.
D. Statistical process control.
Supplier certification is clearly prevention, while the other choices are further down the quality line.

Blooms: Remember
Gradable: automatic

97. Which of the following is an internal failure activity?


B. Inspecting materials.
C. Inspecting machines.
D. Delaying processes.
Delaying processes is an internal failure activity, while the other choices are prevention activities.

Blooms: Remember
Gradable: automatic

98. Internal failure activities:


B. inspect inputs and attributes of individual units of products or services to detect whether they
conform to specifications or customer expectations.
Choice A is prevention and B is appraisal, while D is external failure, and C is internal failure.

10-140
Blooms: Remember
Gradable: automatic

99. External failure activities:


Choice A is prevention and B is appraisal, while C is internal failure, and D is external failure.

Blooms: Remember
Gradable: automatic

100. Prevention activities:



Blooms: Remember
Difficulty: 1 Easy
Gradable: automatic

10-141
101. Appraisal activities:



Blooms: Remember
Gradable: automatic

Sales $5,600,000
The total cost of prevention activities for Forensic Specialists is:

A. $294,000.
B. $224,000.
C. $459,200.
D. $504,000.
$84,000 + $140,000 + $280,000 = $504,000.

Blooms: Apply
Gradable: automatic

10-142
Sales $5,600,000
The relevant percentage to be used to express internal failure activities at Forensic Specialists is:

A. 27.9%.
B. 4.77%.
C. 4.2%.
D. 15.02%.
Quality total is $841,120; internal failure is $235,200, which is 27.9% of the total.

Blooms: Apply
Gradable: automatic

10-143
Sales $5,600,000
The total cost of external failure activities at Forensic Specialists is:

A. $420,560.
B. $31,920.
C. $117,600.
D. $175,000.
Resolving customer complaints is an external failure ($31,920).

Blooms: Apply
Gradable: automatic

10-144
Sales $5,600,000
The relevant percentage to be used to express appraisal activities at Forensic Specialists is:

A. 5.7%.
B. 33.2%.
C. 2.75%.
D. 8.3%.
$70,000 ÷ 841,120 = 8.32%

Blooms: Apply
Gradable: automatic

10-145
106. Tabor Detective Services is evaluating its system. The company gathered the information below:
Available Value-Adding
Hours per Time (hours Average
Process Week per client) Demand
Interviews 70 2 20
Research 130 3 30
Pursuit 75 0.5 120
Travel 200 4 45
Practical capacity is 75% for each process.

Which process is most likely to be a current bottleneck?

A. Interviews.
B. Research.
C. Pursuit.
D. Travel.
Average demand of 120 × 75% = 90 exceeds hours per week of 75

Blooms: Apply
Difficulty: 3 Hard
Gradable: automatic

Essay Questions

10-146
107. Windom Corporation manufactures small airplane propellers. Sales for April totaled $850,000.
Resources Resources

Used Supplied
Energy 50,000 50,000
Setups 70,000 100,000
Materials 150,000 150,000
Marketing 70,000 75,000
In addition, Windom spent $25,000 on 50 engineering changes with a cost driver rate of $500 and
$30,000 on eight outside contracts with a cost driver rate of $3,750.
Required:


a.
Sales $850,000
Parts management $35,000
Energy 50,000
Quality inspections 50,000
Temporary labor 24,000
Setups 100,000
Materials 150,000
Depreciation 100,000
Marketing 75,000
Engineering changes 25,000
Outside contracts 30,000
Total costs 764,000
10-147
Operating profits $86,000
b.
Sales $850,000
Unused
Resources Resource Resource
Used Capacity Supplied
Costs:
Unit:
Parts management $30,000 $5,000 $35,000
Energy 50,000 0 50,000
Materials 150,000 0 150,000
Temporary labor 20,000 4,000 24,000
Outside contracts 30,000 0 30,000
Total unit 280,000 9,000 289,000
Batch:
Quality inspections 45,000 5,000 50,000
Setups 70,000 30,000 100,000
Total batch 115,000 35,000 150,000
Product:
Marketing 70,000 5,000 75,000
Customer service 10,000 10,000 20,000
Engineering change 25,000 0 25,000
Total product 105,000 15,000 120,000
Facility:
Long-term labor 25,000 10,000 35,000
Depreciation 60,000 40,000 100,000
Administrative 50,000 20,000 70,000
Total facility 135,000 70,000 205,000
Total costs 635,000 129,000 764,000 764,000
Operating profit $86,000
Feedback: a. engineering changes: $25,000 = 50 × $500; outside contracts $30,000 = 8 × $3,750

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual

10-148
10-149
108. Rock Island Manufacturing makes motor brackets. Information regarding resources for the month
follows:
Resources Resources

Used Supplied
Energy 100,000 100,000
Setups 140,000 200,000
Materials 300,000 300,000
Marketing 140,000 150,000
In addition, Rock Island spent $25,000 on 40 engineering changes with a cost driver rate of $600.
Required:

a.
Unused
Costs:
Unit:
Parts
$60,000 $10,000 $70,000
management
Energy 100,000 0 100,000
Materials 300,000 0 300,000
Temporary
40,000 8,000 48,000
labor
Total unit 500,000 18,000 518,000
Batch:
Quality
90,000 10,000 100,000
inspections
Setups 140,000 60,000 200,000
Total batch 230,000 70,000 300,000
Product:
10-150
Marketing 140,000 10,000 150,000
Customer
20,000 20,000 40,000
service
Engineering
24,000 1,000 25,000
change
Total
184,000 31,000 215,000
product
Facility:
Long-term
50,000 20,000 70,000
labor
Depreciation 120,000 80,000 200,000
Administrative 100,000 40,000 140,000
Total facility 270,000 140,000 410,000
Total costs $1,184,000 $259,000 $1,443,000
Feedback: a. engineering changes: $24,000 = 40 × $600

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual

10-151
10-152
109. Mirror Industries manufactures electric trolling motors. Sales for the month totaled $1,700,000.
Resources Resources

Used Supplied
Energy 100,000 100,000
Marketing 140,000 150,000
Materials 300,000 300,000
Setups 140,000 200,000
Required:

a.
Sales $1,700,000
Depreciation 200,000
Energy 100,000
Engineering 52,000
Marketing 150,000
Materials 300,000
Parts management 70,000
Quality inspections 100,000
Setups 200,000
Temporary labor 48,000
Total costs 1,470,000
Operating profits $230,000
b

.
10-153
$1,700,00
Sales
0
Unused
Resourc Resourc
Resourc
e e
es
Capacit Supplie
Used
y d
Costs:
Unit:
$100,00
Energy $100,000 $0
0
Materials 300,000 0 300,000
Parts
60,000 10,000 70,000
management
Temporary
40,000 8,000 48,000
labor
Total unit 500,000 18,000 518,000
Batch:
Quality
90,000 10,000 100,000
inspections
Setups 140,000 60,000 200,000
Total
230,000 70,000 300,000
batch
Product:
Customer
20,000 20,000 40,000
service
Engineering 50,000 2,000 52,000
Marketing 140,000 10,000 150,000
Total
210,000 32,000 242,000
product
Facility:
Administrati
100,000 40,000 140,000
ve
Depreciation 120,000 80,000 200,000
Long-term
50,000 20,000 70,000
labor
Total
270,000 140,000 410,000
facility
1,210,00 1,470,00
Total costs 260,000 1,470,000
0 0
Operating
$230,000
profit

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual
10-154

10-155
10-156
110. Miracle Mile Corporation manufactures electric scooters. Information regarding resources for the month
follows:
Resources Resources

Used Supplied
Energy 100,000 100,000
Marketing 140,000 150,000
Materials 300,000 300,000
Setups 140,000 200,000
Required:

Unused
Costs:
Unit:
Energy $100,000 $0 $100,000
Materials 300,000 0 300,000
Parts
60,000 10,000 70,000
management
Temporary labor 40,000 8,000 48,000
Total unit 500,000 18,000 518,000
Batch:
Quality
90,000 10,000 100,000
inspections
Setups 140,000 60,000 200,000
Total batch 230,000 70,000 300,000
Product:
Customer
20,000 20,000 40,000
service
Engineering 50,000 2,000 52,000
10-157
Marketing 140,000 10,000 150,000
Total product 210,000 32,000 242,000
Facility:
Administrative 100,000 40,000 140,000
Depreciation 120,000 80,000 200,000
Long-term labor 50,000 20,000 70,000
Total facility 270,000 140,000 410,000
Total costs 1,210,000 260,000 1,470,000

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual

10-158
10-159
111. Taylor's Cafe Supply Company delivers restaurant supplies throughout the city. Taylor's adds 4% to the
order cost to cover the delivery cost. The delivery fee is meant to just cover the cost of delivery. A
consultant has analyzed the delivery service using activity-based costing methods and identified four
activities. Data on these activities are:
Driver
Volume
number of 4,000
Process order $25,000
orders orders
number of 80,000
Load truck 50,000
items items
Deliver number of 4,000
30,000
number of 6,000
Process invoice 24,000
invoices invoices
Two of Taylor’s customers are City Diner and Le Chien Chaud. Below are data on orders and
deliveries to these two customers:
City Diner Le Chien Chaud

Order value $24,000 $32,000
Number of items 550 1,600
Number of
12 120
invoices
Required:

a. City Diner: $960; Le Chien Chaud: $1,280

b. City Diner: $1,079.25; Le Chien Chaud: $2,855.00
Feedback: a. City Diner: $24,000 × .04 = $960; Le Chien Chaud: $32,000 × .04 = $1,280
b. cost driver rates:
Driver
Cost
Activity Cost Volume Rate
Driver
=
Process order number $25,000 /4,000 $6.25/order
of orders =
10-160
orders
number /80,000
Load truck 50,000 $0.625/item
of items items =
number
Deliver /4,000
of 30,000 $7.50/order
merchandise orders =
orders
number /6,000
Process
of 24,000 invoices $4.00/invoice
invoice
invoices =
Cost of

delivery:
Le
City
Chien
Diner
Activity Cost Chaud Cost
Volume
Volume
50 100
Process order $312.50 $625.00
orders orders
550 1,600
Load truck 343.75 1,000.00
items items
Deliver 50 100
375.00 750.00
Process 12 120
48.00 480.00
Total cost $1,079.25 $2,855.00
$312.50 = 50 orders × $6.25 per order; $625 = 100 orders × $6.25

$343.75 = 550 items × $0.625 per item; $1,000 = 1,600 items × $0.625
$375.00 = 50 orders × $7.50 per order; $750 = 100 orders × $7.50
$48.00 = 12 invoices × $4.00 per invoice; $480 = 120 invoices × $4.00

Blooms: Analyze
Gradable: manual

10-161
10-162
112. Vargas Financial (VF) only offers checking accounts. Customers can write checks and use a network of
automated teller machines. VF earns revenue by investing the money deposited (subject to reserve
requirements). Currently VF averages 6% return annually on its investments. In order to compete with
larger banks, VF pays depositors 1% on all deposits. A recent study classified the operating costs of the
bank into four activities. Data on these activities are:
Driver
Volume
number of 10,000,000
Use ATM $2,00,000
uses uses
number of
Visit branch 6,000,000 750,000 visits
visits
Process number of
4,000,000 40,000,000
transactions
General
total
bank 8,000,000 $450,000,000
deposits
overhead
Total
$20,000,000
overhead
Data on two representative customers are shown below:
ATM uses 300 50
Branch visits 5 20
Number of transactions 60 1,200
Average deposit $450 $10,000
Required:
(a) Compute the operating profits of the Vargas Financial.

(b) Compute the profit of Customer A and Customer B, assuming that customer costs are based only on
deposits.
(c) Compute the profit of Customer A and Customer B, assuming that customer costs are computed
using the information in the activity-based costing analysis.

a. $2,500,000
b. A: $2.50; B: $55.56
c. A: - $91.50; B: $32.22
Feedback:
10-163
Revenues: $450,000,000
a. $27,000,000
× 6%
interest on deposits:
4,500,000
$45,000,000 × 1%
costs as given 20,000,000
total costs 24,500,000
operating profits $2,500,000
b. operating costs $20,000,000/deposits $450,000,000 =

4.4444%
Revenue
A: $450 × 6% $27.00
B: $10,000 × 6% $600.00
Costs:
Interest on deposits
A: $450 × 1% 4.50
B: $10,000 × 1% 100.00
Operating costs
A: $450 × 4.4444% 20.00
B: $10,000 × 4.4444% 444.44
Profit $2.50 $55.56
c.
Driver
Activity Cost Rate
Volume
10,000,000
Use ATM $2,000,000 $0.20/use
uses
Visit
6,000,000 750,000 visits $8/visit
branch
Process 40,000,000
4,000,000 $0.10/transaction
General
bank 8,000,000 $450,000,000 1.7778%
overhead
Revenue
A: $450 × 6% $27.00
B: $10,000 × 6% $600.00
Costs:
Interest on deposits
A: $450 × 1% 4.50
B: $10,000 × 1% 100.00
Operating costs
10-164
Use ATM
A: 300 × $0.20 60.00
B. 50 × $0.20 10.00
Visit branch
A: 5 × $8 40.00
B: 20 × $8 160.00
Process transactions
A: 60 × $0.10 6.00
B: 1,200 × $0.10 120.00
General overhead
A: $450 × 1.778% 8.00
B: $10,000 × 1.7778% 177.78
Profit $-91.50 $32.22

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual

10-165
113. Mobile Repair Company is preparing its annual profit plan. As part of its analysis of the cost of its
purchasing activity, management estimates that the $125,000 for purchasing support should be assigned
to the individual vendors from the information given as follows:

A B C
Units purchased 100,000 200,000 200,000
Purchase orders
6 24 100
(annual)
Number of shipments
12 52 25
received
Required:
a. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Mobile Repair
uses units purchased to compute activity-based costs.
b. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Mobile Repair
uses purchases orders to compute activity-based costs.
c. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Mobile Repair
uses number of shipments to compute activity-based costs.

a. A: $25,000; B: $50,000; C: $50,000

b. A: $5,769; B: $23,077; C: $96,154
c. A: $16,854; B: $73,034; C: $35,112
Feedback: a. A: [100,000/(100,000 + 200,000 + 200,000)] × $125,000 = $25,000

B: [200,000/(100,000 + 200,000 + 200,000)] × $125,000 = $50,000
C: [200,000/(100,000 + 200,000 + 200,000)] × $125,000 = $50,000
b. A: [6/(6 + 24 + 100)] × $125,000 = $5,769
B: [24/(6 + 24 + 100)] × $125,000 = $23,077
C: [100/(6 + 24 + 100)] × $125,000 = $96,154
c. A: [12/(12 + 52 + 25)] × $125,000 = $16,854
B: [52/(12 + 52 + 25)] × $125,000 = $73,034
C: [25/(12 + 52 + 25)] × $125,000 = $35,112

Blooms: Analyze
Gradable: manual

10-166
114. Bison Creek Company is preparing its annual profit plan. As part of its analysis of the cost of its
purchasing activity, management estimates that the $250,000 for purchasing support should be assigned
to the individual vendors from the information given as follows:

A B C
Units purchased 100,000 100,000 500,000
Purchase orders
12 24 50
(annual)
Number of shipments
12 52 100
received
Required:
a. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Bison Creek uses
b. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Bison Creek uses
c. Prepare a schedule to allocate the purchasing costs to the three vendors, assuming Bison Creek uses

a. A: $100,000; B: $100,000; C: $50,000

b. A: $34,884; B: $69,767; C: $145,349
c. A: $18,293; B: $79,268; C: $152,439
Feedback: a. A: [100,000/(100,000 + 100,000 + 50,000)] × $250,000 = $100,000

B: [100,000/(100,000 + 100,000 + 50,000)] × $250,000 = $100,000
C: [50,000/(100,000 + 100,000 + 50,000)] × $250,000 = $50,000
b. A: [12/(12 + 24 + 50)] × $250,000 = $34,884
B: [24/(12 + 24 + 50)] × $250,000 = $69,767
C: [50/(12 + 24 + 50)] × $250,000 = $145,349
c. A: [12/(12 + 52 + 100)] × $250,000 = $18,293
B: [52/(12 + 52 + 100)] × $250,000 = $79,268
C: [100/(12 + 52 + 100)] × $250,000 = $152,439

Blooms: Analyze
Gradable: manual

10-167
115. Hidden Valley Company produces precision components. Hidden Valley has six customers, one
accounts for 40 percent of the sales, with the remaining five accounting for the rest of the sales. The five
smaller customers purchase components in roughly equal quantities. Orders placed by the smaller
customers are about the same size. Data concerning Hidden Valley 's customer activity follow:
Large Five Small

Customer Customers
Order-filling costs for Hidden Valley Company total $180,000, and sales-force costs are $275,000.
Required:
approach.

a. Large: $182,000; Small: $273,000

b. Large: $27,000; Small: $428,000
Feedback: a. Large: 200,000/(200,000 + 300,000) × ($180,000 + 275,000) = $182,000; Small:

300,000/(200,000 + 300,000) × ($180,000 + 275,000) = $273,000
b. Order-filling: Large: 10/(10 + 350) × $180,000 = $5,000; Small: 350/(10 + 350) × $180,000 =
$175,000
Sales-force: Large: 20/(20 + 230) × $275,000 = $22,000; Small: 230/(20 + 230) × $275,000 = $253,000
Large: $5,000 + $22,000 = $27,000; Small: $175,000 + $253,000 = $428,000

Blooms: Analyze
Gradable: manual

10-168
percent of the sales, with the remaining ten accounting for the rest of the sales. The ten smaller
about the same size. Data concerning Kingston's customer activity follow:
Large Ten Small

Customer Customers
Required:
approach.

a. Large: $396,000; Small: $264,000

b. Large: $34,000; Small: $626,000
Feedback: a. Large: 300,000/(300,000 + 200,000) × ($360,000 + 300,000) = $396,000; Small:

200,000/(300,000 + 200,000) × ($180,000 + 275,000) = $264,000
$350,000
Large: $10,000 + $24,000 = $34,000; Small: $350,000 + $276,000 = $626,000

Blooms: Analyze
Gradable: manual

10-169
10-170
percent of the sales, with the remaining ten accounting for the rest of the sales. The ten smaller
about the same size. Data concerning Kingston's customer activity follow:
Large Ten Small

Customer Customers
Sales $1,800,000 $1,200,000
Required:
a. Determine the profitability of each of the two classes of customers (large and small). Allocate the
order-filling and sales force costs to the customers based on sales volume.
b. Determine the profitability of each of the two classes of customers (large and small). Allocate the
order-filling and sales force costs to the customers using an activity-based costing approach.

a. Large: $504,000; Small: $336,000

b. Large: $866,000; Small: -$26,000
Feedback: a. Large: 300,000/(300,000 + 200,000) × ($360,000 + 300,000) = $396,000; Small: 200,000/

(300,000 + 200,000) × ($360,000 + 300,000) = $264,000
Large Ten Small

Customer Customers
Revenues $1,800,000 $1,200,000
Order-filing & sales-force
396,000 264,000
costs
Operating profit $504,000 $336,000
$350,000
Large Ten Small

Customer Customers
Revenues $1,800,000 $1,200,000
10-171
Order-filing costs 10,000 350,000
Sales-force costs 24,000 276,000
Operating profit $866,000 $-26,000

Blooms: Analyze
Gradable: manual

10-172
10-173
118. Bountiful Harvest Distribution delivers supplies to small grocers throughout the region. Bountiful
currently adds 5% to the order cost to cover the delivery cost. The delivery fee is meant to just cover the
cost of delivery. A consultant has analyzed the delivery service using activity-based costing methods
and identified four activities. Data on these activities are:
Driver
Volume
number of
Process order $50,000 4,000 orders
orders
number of
Load truck 100,000 80,000 items
items
number of
Deliver goods 60,000 4,000 orders
orders
Process number of 6,000
48,000
Total
$258,000
overhead
Three of Bountiful's customers are Rosy's Corner Market, Katy's Fine Foods, and Amy's City Market.
Below are data on orders and deliveries to these three customers:
Rosy’s Katy’s Amy’s

Order value $48,000 $64,000 $120,000
Number of items 550 1,600 1,750
Number of invoices 12 120 18
Required:

a. Rosy's: $2,400; Katy's: $3,200; Amy's: $6,000

b. Rosy's: $2,158.50; Katy's: $5,710.00; Amy's: $3,019.00
Feedback: a. Rosy's: $48,000 × .05 = $2,400; Katy's: $64,000 × .05 = $3,200; Amy's: $120,000 × .05 =
$6,000
(b) Delivery cost based on activity-based costing:
Cost driver rates:
Driver
Cost
Activity Cost Volume Rate
Driver
=
10-174
number
/4,000
Process order of $50,000 $12.50/order
orders =
orders
number /80,000
Load truck 100,000 $1.25/item
of items items =
number
Deliver /4,000
of 60,000 $15.00/order
merchandise orders =
orders
number /6,000
Process
of 48,000 invoices $8.00/invoice
invoice
invoices =
Cost of delivery:
Activity Rosy’s Katy’s Amy’s
Process order:
R: $12.50 × 50 $625.00
K: $12.50 × 100 $1,250.00
A: $12.50 × 25 $312.50
Load truck
R: $1.25 × 550 687.50
K: $1.25 × 1,600 2,000.00
A: $1.25 × 1,750 2,187.50
Deliver merchandise
R: $15 × 50 750.00
K: $15 × 100 1,500.00
A: $15 × 25 375.00
Process invoice
R: $8 × 12 96.00
K: $8 × 120 960.00
A: $8 × 18 144.00
$2,158.50 $5,710 $3,019.00

Blooms: Analyze
Gradable: manual

10-175
10-176
119. Gruber Industries provides the following information about resources:
Cost
Driver Cost Driver Volume
Rate
Resources used
Materials $12 15,000 pounds
160 purchase
Purchasing 240
orders
Long-term labor 80 640 labor hours
840 administrative
Administrative 60
hours
Resources supplied
Materials $192,000
Energy 36,480
Setups 50,400
Purchasing 44,000
In addition, sales for the period totaled $600,000.
Required:

Unused
Resources Resources
Capacit
Used Supplied
y
$12 ×
Materials $180,000 $192,000 $12,000
15,000
48 ×
Energy 32,400 36,480 4,080
675
300 ×
Setups 45,000 50,400 5,400
150
240 ×
Purchasing 38,400 44,000 5,600
160
10-177
Customer 160 ×
28,000 35,200 7,200
service 175
Long-term 80 ×
51,200 53,000 1,800
labor 640
Administrativ 60 ×
50,400 54,000 3,600
e 840

Blooms: Analyze
Gradable: manual

10-178
10-179
120. Jones Industries provides the following information about resources:
Cost
Rate
Resources used
Materials $24 25,000 gallons
170 purchase
Purchasing 350
orders
Administrative 75
hours
Resources supplied
Materials $625,000
Energy 86,480
Setups 60,400
Purchasing 74,000
Required:

Unused
Resources Resources
Capacit
Used Supplied
y
$24 ×
Materials $600,000 $625,000 $25,000
25,000
90 ×
Energy 78,300 86,480 8,180
870
450 ×
Setups 58,500 60,400 1,900
130
350 ×
Purchasing 59,500 74,000 14,500
170
Customer 210 ×
17,850 35,200 17,350
service 85
10-180
Long-term 80 ×
128,000 153,000 25,000
labor 1,600
Administrativ 75 ×
165,000 188,000 23,000
e 2,200

Blooms: Analyze
Gradable: manual

10-181
10-182
121. Morrison Supply provides the following information about resources:
Cost
Rate
Resources used
Administrative $50
hours
Materials 12 50,000 units
120 purchase
Purchasing 145
orders
Resources used
Energy 66,480
Materials 625,000
Purchasing 34,000
Setups 60,400
Required:

Unused
Resources Resources
Capacit
Used Supplied
y
Administrativ $50 ×
60,000 68,000 $8,000
e 1,200
Customer 310 ×
20,150 31,200 11,050
service 65
80 ×
Energy 61,600 66,480 4,880
770
Long-term 90 ×
144,000 163,000 19,000
labor 1,600
12 ×
Materials 600,000 625,000 25,000
50,000
10-183
145 ×
Purchasing 17,400 34,000 16,600
120
450 ×
Setups 51,750 60,400 8,650
115

Blooms: Analyze
Gradable: manual

10-184
10-185
122. The following represents the financial information of Fabriz Corporation, a manufacturer of electronic
components, for two months:
March April
Sales $539,000 $495,000
Costs:
Process inspection 3,300 3,760
Scrap 3,700 3,860
Quality training 37,600 26,000
Warranty repairs 8,600 9,600
Testing equipment 14,000 14,000
Customer complaints 5,600 6,800
Rework 34,000 37,000
Preventive maintenance 27,000 19,000
Materials inspection 13,000 9,600
Required:
a. Classify these items into prevention, appraisal, internal failure, or external failure costs.
b. Calculate the ratio of the prevention, appraisal, internal failure, and external failure costs to sales for
March and April.

a. Prevention: Process inspection, quality training, testing equipment, preventive maintenance, materials
inspection.
Appraisal: Field testing.
Internal failure: Scrap, rework.
External failure: Customer complaints, warranty repairs.
b. March April
Prevention: 17.6% 14.6%
Appraisal: 3.5% 5.0%
Internal failure 7.0% 8.3%
External failure 2.6% 3.3%
Feedback: b. Prevention:
March: $3,300 + 37,600 + 14,000 + 27,000 + 13,000 = $94,900/539,000 = 17.6%
April: $3,760 + 26,000 + 14,000 + 19,000 + 9,600 = $72,360/495,000 = 14.6%
Appraisal:
March: $18,800/539,000 = 3.5%
April: $24,800/495,000 = 5.0%
Internal failure:
10-186
March: $3,700 + 34,000 = $37,700/539,000 = 7.0%
April: $3,860 + 37,000 = $40,860/495,000 = 8.3%
External failure:
March: $5,600 + 8,600 = $14,200/539,000 = 2.6%
April: $6,800 + 9,600 = $16,400/495,000 = 3.3%

Blooms: Analyze
Gradable: manual

10-187
10-188
Required:
Intern Externa
Preventio Apprais al l
Inspecting
raw
materials
1.
received
from
vendors
Cost (net)
of materials
2. wasted
during
production
Gathering,
analysis,
3. and
reporting
quality data
Repairing
and/or
replacing
4.
products
under
warranty
Testing
product in
5. use at
customer
sites
Maintaining
the
equipment
6.
used to
gather
quality data
Testing and
inspecting
7.
finished
products
Designing
product to
8. reduce
production
problems

10-189
Intern Externa
Preventio Apprais al l
Inspecting
raw
materials
1. X
received
from
vendors
Cost (net)
of materials
2. wasted X
during
production
Gathering,
analysis,
3. and X
reporting
quality data
Repairing
and/or
replacing
4. X
products
under
warranty
Testing
product in
5. use at X
customer
sites
Maintaining
the
equipment
6. X
used to
gather
quality data
Testing and
inspecting
7. X
finished
products
Designing
product to
8. reduce X
production
problems

10-190
Blooms: Apply
Gradable: manual

10-191
10-192
Required:
Inter Exter

on sal Failu Failur
re e
1. Lost sales
Materials
2.
inspection
End-of-process
3.
sampling
4. Process inspection
5. Warranty repairs
6. Product design
7. Rework
8. Field testing
9. Scrap
10
Product liability
.

. ing
12
Quality training
.

Inter Exter

on sal Failu Failur
re e
1. Lost sales X
Materials
2. X
inspection
End-of-process
3. X
sampling
4. Process inspection X
5. Warranty repairs X
6. Product design X
7. Rework X
8. Field testing X
9. Scrap X
10 Product liability X
10-193
.
X
. ing
12
Quality training X
.

Blooms: Apply
Gradable: manual

10-194
10-195
125. The following represents the financial information of Madison Tool Corporation, a manufacturer of
testing equipment:
May
Customer complaints $11,200
Field testing 37,600
Rework 68,000
Scrap 7,400
Required:
a. Classify these items into prevention, appraisal, internal failure, or external failure costs. Determine
the total cost of each category.

a. Prevention: Process inspection, quality training, testing equipment, preventive maintenance, and
materials inspection: $189,800
Appraisal: Field testing: $37,600
Internal failure: Scrap, rework: $75,400
External failure: Customer complaints, warranty repairs: $28,400
Feedback:
Int Ext
May Prev Appr
Fail Fail
Customer
11,200 11,200
complaints
Materials
26,000 26,000
inspection
Preventive
54,000 54,000
maintenance
Process
6,600 6,600
inspection
Quality
75,200 75,200
training
Rework 68,000 68,000
10-196
Scrap 7,400 7,400
Testing
28,000 28,000
equipment
Warranty
17,200 17,200
repairs
331,200 189,800 37,600 75,400 28,400

Blooms: Analyze
Gradable: manual

10-197
10-198
126. The following represents quality cost data for Monnett Corporation:
Field testing $67,100

Finished goods inspection 48,700
Product design 96,700
Product liability insurance 48,000
Rework 68,000
Scrap 17,400
Required:
a. Classify these items into prevention, appraisal, internal failure, or external failure costs. Determine
the total cost of each category.

a. Prevention: Materials inspection, preventive maintenance, process inspection, product design, quality
training, and testing equipment: $345,800
Appraisal: Field testing, Finished goods inspection: $115,800
Internal failure: Scrap, rework: $85,400
External failure: Product liability insurance, warranty repairs: $125,200
Feedback:
Int Ext
May Prev Appr
Fail Fail
Field testing 67,100 $67,100
Finished
goods 48,700 48,700
inspection
Materials
37,000 37,000
inspection
Preventive
54,000 54,000
maintenance
Process
46,900 46,900
inspection
Product
96,700 96,700
design
Product 48,000 48,000
10-199
liability
insurance
Quality
75,200 75,200
training
Rework 68,000 68,000
Scrap 17,400 17,400
Testing
36,000 36,000
equipment
Warranty
77,200 77,200
repairs
672,200 345,800 115,800 85,400 125,200

Blooms: Analyze
Gradable: manual

10-200
10-201
127. Fine Grape produces premium wine. Its success in the industry is due to its quality, although all of its
customers, wine shops and specialty grocery stores, are very cost conscious and negotiate for price cuts
on all large orders. Noting that the wine industry is becoming increasingly competitive, Fine Grape is
looking for a way to meet the challenge. It is negotiating with Culinary Delights, a regional specialty
grocery store, to purchase a large order of wine. Fine Grape is currently producing at under-capacity and
would like to keep its production facilities, gaining better economies of scale by increasing production.
Culinary Delights has agreed to a large order but only at a price of $39 per bottle. The special order can
be purchased in one batch with available capacity. Fine Grape prepared these data: Next month's
operating information (per unit, for 10,000 bottles, made in 10 batches of 1,000 each)
Sales price $55

Per unit costs
Variable manufacturing costs 22
Batch-level costs 5
Fixed manufacturing costs 6
Fixed marketing costs 2
Special order information (order is produced in

one batch)
Sales units 2,000
Sales price per bottle $39
No variable marketing costs are associated with this order, but Fine Grape has spent $2,500 during the
past two months trying to get Culinary Delights to purchase the special order.
Required:
(1) How much will the special order change Fine Grape’s total operating income?
(2) How much would the special order change Fine Grape’s total operating income if fine Grape is
operating at full capacity and would lose the sale of the 2,000 bottles to regular customers?
(3) How might the special order fit into Fine Grape’s competitive strategy?

Feedback: (1)
Price per bottle $55,00

Current production &
10,000
sales (in units)
Variable costs per unit
Variable
$22.000
manufacturing
= $5 per bottle × 1,000
Costs per batch 5,000
bottles per batch
Number of batches for 1
10-202
special order
Batch level costs/unit $2.50 = $5,000/2,000
Special order
Price $39
Bottles 2,000
Plant Capacity: capacity is available and no other uses for the plant capacity are expected. Total
relevant manufacturing costs (variable costs per unit plus batch costs per unit)
$22 + $2.50 = $24.50. Accept the offer. The price for the special order is greater than the cost to
manufacture.
The $39 price is greater than $24.50, so the special order will increase operating income by $29,000 =
2,000 × ($39 - $24.50) or 2,000 × ($39 - $22) - $5,000 = $29,000.
(2) Fine Grape is at full capacity, so the sale of the special order would require Fine Grape to lose some
amount of current sales. We now assume that a total of 10,000 bottles will be produced (full capacity)
and that 10 batches will be used, as before; thus, batch-level costs will be the same, with or without the
special order, so batch level costs are now irrelevant and can be ignored
Contribution of special order

$34,000
2,000 × ($39 - $22)
Less: Lost contribution on loss of regular
sales: 46,000
2,000 × ($55 - $22 - $10)
Net loss of the special order under full
($12,000)
capacity
Note that the cost of trying to get the expected order ($2,500) is sunk and irrelevant in this decision.
(3) If special orders such as this can be planned and scheduled carefully, the production rate at Fine
Grape can be increased to lower overall costs per unit. Lower overall costs can help Fine Grape to
become more cost competitive. Also, increased production levels will help to most efficiently utilize the
plant and thus minimize fixed plant costs. Moreover, special orders can help Fine Grape grow the
business by developing new customers. Special orders such as the one to Culinary Delights can lead to
additional orders for existing and new products.

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual

10-203
10-204
128. Joseph Hutton Enterprises has met all production requirements for the current month and has an
opportunity to produce additional units of product with its excess capacity. Unit selling prices and costs
for three models of one of its product lines are as follows:
No Standard

Selling price $35.00 $45.00 $65.00
Direct labor ($15/hr.) 7.50 12.00 21.00
Fixed Overhead 3.00 5.00 5.00
Variable overhead is charged to products on the basis of direct labor dollars, and fixed overhead is
charged to products on the basis of machine hours.
Required:
(1) If Joseph Hutton Enterprises has excess machine capacity and can add more labor as needed
(neither machine capacity nor labor is a constraint), the excess production capacity should be devoted to
producing which product or products?
(2) If Joseph Hutton Enterprises has excess machine capacity but a limited amount of labor time, the
production capacity should be devoted to producing which product or products?

Feedback: (1) When there is no limit on production capacity, the super model should be manufactured
since it has the highest contribution margin per unit.
No Standard

Selling price $35.00 $45.00 $65.00
Direct labor ($15/hr.) 7.50 12.00 21.00
Total Variable Cost $21.50 $30.40 $46.20
Contribution Margin $13.50 $14.60 $18.80
(2) When labor is in short supply, the No Frills Model should be manufactured since it has the highest
contribution margin per direct labor hour. See below.
No Standard

Contribution Margin $13.00 $14.60 $18.80
Labor Hours Required 0.5 0.80 1.4
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Contribution Margin/hr. $26.00 $18.25 $13.43

Blooms: Analyze
Gradable: manual

10-206
129. Smooth, Inc. manufactures bath and beauty products such as soaps, skin creams, lotions, and other
products primarily for people with dry and sensitive skin. It has just introduced a new line of product
that removes the spotting and wrinkling in skin associated with aging. It sells these products in
pharmacies and department stores at prices slightly higher than those of other brands because of
Smooth's excellent reputation for quality and effectiveness.
Smooth currently has very low utilization of plant capacity. Two years ago, in anticipation of rapid
growth, the company opened a new large manufacturing plant, which has yet to be utilized more than 50
percent. Partly for this reason, Smooth has sought new partners and was able, with the help of financial
analysts, to locate suitable business partners. The first potential partner identified in this search was a
large supermarket chain, Price-Mart, which is interested in the partnership because it wants Smooth to
manufacture an age cream to sell in its stores. The product would be essentially the same as the Smooth
product but would be packaged in the Price-Mart brand name. The agreement would pay Smooth $2.00
per unit and would allow Price-Mart a limited right to advertise the product as manufactured for Price-
Mart by Smooth. Smooth's CFO has made some calculations and has determined that the direct
materials, direct labor, and other variable costs needed for the Price-Mart order would be about $1.00
per unit as compared to the full cost of $2.50 (materials, labor, and overhead) for the equivalent Smooth
product.
Required:
Should Smooth Inc. accept the proposal from Price-Mart? Why or why not? (Include strategic
considerations)

Feedback: To begin the analysis, the Smooth CFO should recognize that the $2.50 full cost for its
product includes $1.50 of irrelevant fixed overhead. Only the variable costs of $1.00 per unit are
relevant. From this standpoint, the sales to Price-Mart makes good sense, since there would be a
contribution of $1.00 ($2.00 price less $1.00 relevant cost) per unit sold. Moreover, sales to Price-Mart
would utilize Smooth's available capacity. If these sales were to continue for the long term, then average
fixed costs would be reduced and Smooth's profitability would be improved in the long term as well.
However, the sales to Price-Mart could be a potentially serious strategic mistake for Smooth. Smooth's
reputation is built upon quality and product excellence, features which give it a clear differentiation in
the market. To sell its products in a supermarket, even under another brand name, would cheapen the
image of all Smooth products, and cause it to lose market share in its usual distribution channels, the
pharmacies and department stores. This is especially true given that Price-Mart has the limited right to
market the product as manufactured by Smooth. How limited is that right? Smooth could be trading a
short-term gain for a potential long-term disaster in the deal with Price-Mart. It should look for business
partners that are more in line with its strategy.

Blooms: Analyze
Difficulty: 1 Easy
Gradable: manual

10-207
130. Stonehouse Corporation developed the following information regarding quality for the first quarter of
the year 2016:
Sales $6,800,000
Wasted time $285,600
Training $102,000
Inspecting materials $340,000
Total $1,021,360
Required:
Prepare a cost of quality report sorting costs by quality activity and expressing in relevant percentage
terms.

Stonehouse Corporation
Cost of Quality Report
First Quarter, 2016
Percent
Amounts
of Sales
Sales $6,800,000 100%
Prevention

Activities
Certifying Suppliers $170,000
Training 102,000 $272,000 4.00%
Appraisal Activities
Inspecting Materials $340,000
Performance
85,000 425,000 6.25%
Reviews
Internal Failure

Activities
Wasted Time $285,600 285,600 4.20%
External Failure

Activities
Resolving Customer
$38,760 38,760 0.57%
Complaints
Total $1,021,360 15.02%

Blooms: Analyze
10-208
Gradable: manual

131. Identify each of the following as Prevention Activities (P), Appraisal Activities (A), Internal Failure
Activities (I) or External Failure Activities (E):
(1) Field Testing

(2) Statistical process control
(3) Sampling at the end of process
(4) Disposing of scrap
(5) Quality evaluations
(6) Retesting
(7) Settling product liability
(8) Resolving customer complaints
(9) Lost sales
(10) Restoring reputation

(1) A, (2) A, (3) A, (4) I, (5) P, (6) I, (7) E, (8) E, (9) E, (10) E

Blooms: Analyze
Gradable: manual

10-209
132. For each of the following products or services, indicate the most important customer quality attributes
and the most important customer quality tradeoffs.
(a) Personal computer

(b) Legal representation in divorce court
(c) New home purchase
(d) Meals in a fast food restaurant
(e) Airline travel
(f) Prom dress
(g) Cruise ship vacation
(h) Auto repair

Attributes
(a) Speed, memory, storage, reliability, customer service

(b) Effectiveness, timeliness, understanding of emotional issues
(c) Location, location, location
(d) Speed, flavor of food, location, existence of drive through windows
(e) Comfort, services, in-flight entertainment, reliability
(f) Style, cost, accessibility, material
(g) Food, entertainment, destination
(h) Knowledge, cost, speed, accessibility of garage
Quality tradeoffs
(a) Speed, memory, storage, performance, reliability, customer service, cost

(b) Cost, knowledge of specialty, accessibility
(c) Appearance, cost, distance to job, repairs needed
(d) Flavor of food, comfort, and nutritional value of food
(e) Convenience of flight, time required to get to destination, comfort
(f) Style, functionality, cost
(g) Time of year traveled (on versus off season), location of cabin, types of services and food
(h) Time, cost, convenience

Blooms: Analyze
Gradable: manual

10-210
133. Describe the four steps that are taken in an activity analysis.

1. Identify the process objectives defined by what the customer wants or expects from the process.
2. Chart, from start to finish, the activities used to complete the product or service.
3. Classify all activities as value-added or nonvalue-added.
4. Continuously improve the efficiency of all value-added activities and develop plans to eliminate or

Blooms: Remember
Gradable: manual

10-211
134. Companies are continuously seeking ways to improve the quality of production and reduce costs. One
of the areas is to work with suppliers to improve the quality and reliability of parts and products
shipped. In an article entitled "In Defense of Activity-Based Cost Management," Robert S. Kaplan says:
An ABC model can play a major role in improving supplier relationships as well. These relationships
must be a vital part of any quality and cycle-time improvement program. A key insight is to use ABC to
distinguish between low-price and low-cost suppliers. Traditional cost accounting, with its emphasis on
purchase price variances, encourages purchasing people to continually scan the population of potential
suppliers to obtain low price quotations. Most companies have learned, the hard way, that many of their
low-price suppliers are actually extremely high-cost suppliers. (Source: Management Accounting:
November, 1992)
Required:
(a) Explain what Kaplan means by "many of their low-price suppliers are actually extremely high-cost
suppliers."
(b) What general prevention and appraisal activities can be used to improve the quality and reliability of
parts and products shipped from suppliers?

(a) A low price supplier can be a high cost supplier if:
• They offer low prices only when they can deliver large volumes of materials. This requires the
purchasing company to incur costs of storage for materials.
• The company must check items in through a receiving dock and incur excessive paperwork costs.
• The quality of the product shipped is poor, resulting in production defects and excessive quality
control activities related to materials.
• Costs of inspection increase as defective items shipped must be inspected.
• Poor quality materials lead to product breakdowns, leading to external failure costs such as warranty
replacements and product repairs.
• Delivery time may be unpredictable, leading to costs of expediting, rescheduling, unexpected plant
downtime, and great increases in confusion.
• Costs of scrap, rework, and obsolescence increase due to defective items.
• Downtime increases due to poor quality materials.
(b) Prevention activities can include certifying suppliers or by using only suppliers of materials that can
guarantee high quality. Appraisal activities can include inspecting materials upon delivery and
providing regular evaluation of suppliers so that they will know how well they are meeting a company's
quality needs.

Blooms: Understand
Gradable: manual

10-212
135. Traditionally, companies in the United States have employed a "push" manufacturing style. Studies in
Activity Based Management and Quality Control have indicated that this approach is filled with many
non-value-added activities, which increase overall costs and reduce profits. The "push" style is being
replaced with a "pull" approach.
Required:
Briefly describe the major differences between the push and pull approaches. What non-value added
activities are eliminated in a pull manufacturing system?

A push manufacturer begins by forecasting total orders for a time period. The manufacturer orders
materials based on the forecast. Production schedules are produced based on the forecast. Production is
then "pushed" through. Because production is based on sales, the company may end up producing units
for which there is not as much demand as forecast, or have too few units available of a product for
which there is heavy demand. This creates costs of storing excess inventory and opportunity cost of lost
sales. In addition, because units are pushed through the system, the timing of receiving materials is not
balanced to the production of activities, particularly at production bottlenecks, which results in a
wasteful buildup of inventories, either temporary or permanent. Push production can reduce motivation
to improve quality and can reinforce motivation to overuse non-bottleneck activities.
A pull manufacturer "pulls" production through the process by customer orders, rather than "pushes"
them through with master production schedules. A sales order triggers a production order. The
production order triggers orders to suppliers, who ship parts immediately. The Just-in-Time approach is
flexible to customer needs and requires lower inventory costs than traditional methods. Because
suppliers tend to be preapproved and more reliable, costs of quality are reduced. Non-value added
activities such as storage, quality control, downtime, waiting time are avoided in a pull manufacturing
system.

Blooms: Understand
Gradable: manual

10-213
10-214
136. Lyon Toys, Inc. (LTI) manufactures a variety of electronic toys for children aged 3 to 14 years. The
company started as a Ma & Pa basement operation, and grew steadily over the last nine years. It now
employs over 100 people and has sales revenue of over $250 million. Katie Burger, the CEO of LTI
also recognizes that competition has increased during this period; therefore, future growth will not be
easy.
Burger recognizes that one of the areas of weakness is the accounting and costing system. Burger's
maternal uncle, Martin, had maintained the accounts for the company. He meticulously kept track of all
the invoices that were received, payments made, and painstakingly prepared crude annual reports. With
Martin passing away at the age of 85, Burger decided to hire a professional cost management expert to
keep track of the company's costs. She hired Molly Wright, who had just completed her CMA.
After acquainting Wright with the company and its people, Burger decided to get down to business. She
called Wright to her office to have a serious conversation about accounting and costing, in particular.
Burger: Molly, I would like you to pay particular attention to developing an official costing system.
Currently, we don't have one. I believe this should be your first priority because competition is rising
and if we do not understand our costs, we might start losing business to our rivals.
Wright: I understand your point very well, Ms. Burger.
Burger: Call me Katie.
Wright: Very well, Katie. I have a few ideas that I picked up from my CMA courses that I think are
worth implementing. However, it looks like we need to start with the basics.
Required:
Assume the role of Molly Wright. Write a brief report outlining the basics of a cost management
information system. Include in your report the following:
• Resources and costs

• Supply of resources vs. the use of resources
• Classification of costs (three dimensions of resources)
• Alternative costing systems

A cost manager implementing a costing system must make other individuals aware of the following
basics of cost management systems.
Resources and costs
• Resources are consumed by organizations to transform inputs into outputs

• Resources are not free
Supply versus use of resources
• A distinction must be made between resources acquired and resources used

• Some resources are acquired in advance, whereas others are acquired as needed
• The resources acquired may not all be used, thereby creating excess capacity
• Additional demand may require acquiring additional resources.
The dimensions of resources
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• Resources are identified by three dimensions:
• Type of resource acquired (material, conversion, operating)
• How the resource is used (production, non-production)
• How traceable a resource is to a particular decision (direct, indirect)
Alternative costing systems
• The nature of supply and use of resources gives rise to different costing systems
• Three alternative costing systems exist:
• Throughput costing
• Variable costing
• Absorption costing

AACSB: Communication
Blooms: Understand
Gradable: manual

137. What is the relationship between customer profitability analysis and ABC?

ABC relies on a cost hierarchy of unit-, batch-, product-line-, customer-, and facility-level costs. In
customer profitability analysis (CPA) the focus is on the customer-level costs.
To use ABC, the traditional steps of determining the customer-related activities, the appropriate cost
drivers, and then the costs per unit of activity still exist. Once the costs are developed for the activities,
key customers can be analyzed. The first step in such an analysis is developing an income statement for
each customer that shows not only the revenue from the customer and the cost of the products sold but
also the costs related to each customer-related activity used. Those with losses are problems.
A second analysis showing each of the key customer-related costs as a percent of gross margin for each
customer being analyzed and comparing these percentages against a company norm for each customer-
related cost can be prepared. These relative measures are more effective than the dollar figures since
significant deviations from the norm are more obvious, e.g., the norm for one item is 2 percent and a
customer's percentage is 10 percent.
This analysis can be expanded to look for trends in usage—was this a one-time aberration or has the
problem continued for a while and it is growing.

Blooms: Remember
Gradable: manual

10-216
138. Cost allocation bases are factors that cost management analysts use to assign indirect costs to cost
objects. Ideally, cost-allocation bases should reflect a cause-and-effect relationship between resource
spending and use. Ideally, an Activity-Based-Costing (ABC) approach will provide a more accurate and
useful accounting for an organization's resources. Recent studies have found that, in spite of increasing
costs and diminishing resources, very few Higher Education Institutions use the tools and techniques of
an ABC cost allocation system to assign costs to academic departments. While direct costs, such as
faculty salaries, are traceable to individual academic departments or courses, many indirect costs, such
as facility use, computer use, and student support services, are more difficult to assign. In a traditional
approach, many higher education institutions assign such costs based on a single factor, such as the
number of courses taught in the university. (Source: Activity-Based Costing for Higher Education
Institutions, Management Accounting Quarterly, Winter, 2001)
Required:
(a) Explain why the use of a single-cost driver such as the number of courses may result in inaccurate
management information as to the cost of running courses in individual academic departments.
(b) For each of the indirect costs listed below, identify an appropriate cost-driver that might be used to
allocate costs to determine the cost of offering a single course in an academic department if an Activity-
Based-Costing model were used.
• Computer use
• Facility use
• Student services
• Course design
• Lecturing/class meeting time
• Assignment grading

(a) Using a single cost allocation base to assign costs does not take into account the level of resources
consumed by the cost objects. Some courses may require the use of more resources, such as computer
and lab time. No distinction is made between fixed costs and variable costs. This method assumes that
all courses consume the same activities in the same proportions; in reality, some programs may be
subsidizing others.
(b) Computer use - number of computer hours
Facility use - square footage
Student services - number of students
Course design - number of courses
Class meeting time - number of classroom hours
Grading assignments - number of assignments

Blooms: Remember
Gradable: manual

10-217
139. Explain the differences between resources used, resources supplied, and unused resource capacity.

Resources used is a calculated amount, computed by taking the cost driver rate multiplied by the cost
driver volume. Resources supplied are the expenditures or the amounts spent on an activity. Unused
resource capacity is the difference between resources used and resources supplied.

Blooms: Analyze
Gradable: manual

10-218
10-219
140. Franklin Industrial Equipment Corporation manufactures lawn mowers and snow blowers. It also
manufactures engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine
Division (ED) also sells about 40% of its output to the outside market (these are multipurpose engines).
Its annual capacity is 150,000 units and annual output is 135,000 units. All engines sold internally to the
LMAD are priced at cost plus 20% markup.
In January 2016, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy' 20,000
engines. Jean Wyse, the controller of ED, computed the costs of manufacturing these engines as
follows:
Total Per unit

Materials $300,000 $15.00
Labor 400,000 20.00
Special equipment 36,000 1.80
Quality inspection 24,000 1.20
Other manufacturing costs 350,000 17.50
Total costs $1,110,000 $55.50
Wyse quoted a price of $66.60 for each engine transferred to the SBAD. Jeb Hart, the manager of
SBAD, was furious to note that the ED was "trying to make money off a sister division." He argued that
the price must include only the cost of materials, as all other costs will be incurred irrespective of
whether or not SBAD places the order for 20,000 engines. Mark Matley, the production manager of ED,
pointed out that the special equipment will be purchased only for fulfilling this internal order. Moreover,
he argued that inspection must also be done just like on all other engines; therefore, the inspection costs
must also be included. Labor is paid a flat monthly salary. Other manufacturing costs include both
variable and fixed components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED must charge to the SBAD?
(b) What are the pros and cons of internal sourcing?

(a) The costs that are explicitly associated with the manufacture of engines required by the SBAD are as
follows:
Materials: $300,000
Special equipment: 36,000
Inspection: 24,000
Other manufacturing costs: 175,000
Total $535,000 $26.75 per unit
Therefore, the minimum price at which the ED can 'sell' to the SBAD would be $32.10 ($26.75 × 1.20).
It is important to note that excess capacity exists; therefore, the ED does not have any opportunity costs
associated with the SBAD's order.
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(b) The pros of internal sourcing are as follows:
• Productive use of excess capacity.

• Potential cost savings.
• Protection of proprietary knowledge.
The cons of internal sourcing are as follows:
• Setting internal pricing policies and refereeing disputes.

• Supporting inefficient operations with artificially high internal prices.
It is important to note that any policy stated as "cost plus 20 percent" is asking for trouble, because
"cost" is undefined. If market prices are available, the company probably should use these for internal
sales, with a policy of sourcing internally at the market price. Using cost-based internal prices may be
necessary, but creates the complications of creating the price that motivates managers to benefit
themselves and the company as a whole.

Blooms: Remember
Gradable: manual

141. Quality costs can be divided into two categories: conformance and nonconformance. Explain the
difference between the two and give two examples of each.

Conformance costs ensure that quality conforms to the firms requirements. Conformance costs are made
up of prevention costs and appraisal costs. Nonconformance costs are the cost of failing to control
quality. These include internal failure costs and external failure costs.
Feedback: Many different examples are possible here.

Blooms: Remember
Gradable: manual

10-221
142. Describe the four types of quality costs and give an example of each.

The four types of quality costs are prevention, appraisal, internal failure, and external failure. Prevention
costs are incurred to prevent defects in the products or services being produced. Examples include
materials inspection, process inspection, equipment inspection, quality training, machine inspection, and
product design. Appraisal costs are incurred to detect individual units of product that do not conform to
specifications. Examples include end-of-process sampling and field testing. Internal failure costs are
incurred when nonconforming products are detected before delivery to the customer. Examples include
scrap, rework, and reinspection/retesting. External failure costs are incurred when nonconforming
products are detected after delivery to the customer. Examples include warranty repairs, product
liability, marketing costs, and lost sales.
Feedback: Many different examples are possible here.

Blooms: Remember
Gradable: manual

143. Explain the difference between actual activity, theoretical capacity, practical capacity, and normal
activity.

Actual activity is the volume actually produced during a period. Theoretical capacity is the amount that
could be produced under ideal or perfect conditions. Theoretical capacity does not make allowances for
normal maintenance and downtime. Practical capacity is the volume that could be produced allowing for
expected breaks, normal maintenance, and downtime. Normal activity is the long-run expected volume
produced.

Blooms: Analyze
Gradable: manual

10-222
10-223
144. Jessica Long, the production manager of Maxim Corporation is frustrated by the company's policy of
not scrapping defective units but reworking them. She has pointed out several times to senior
management that some units are beyond rework and should be scrapped. According to her, in most
cases, it would be cheaper to scrap and build a new unit from scratch rather than trying to rework a
defective unit. However, Peter Crouch, the CEO, is not convinced. He wants his controller, Melinda
Gates, to gather some information.
After researching the problem, Gates provides the following information:
Selling price: $132 per unit

Manufacturing costs:
Direct materials 27
Direct labor 32
Variable overhead 24
Fixed overhead 32
Reworking costs:
Materials: $25
Labor: 48
Direct machining costs: 35
Gates also observes that reworking a defective product consumes more labor time than making a unit
from scratch. As a result, for every three units reworked, Maxim forgoes the production and sale of two
units.
Required:
(a) Do you agree with Jessica Long that it is cheaper to scrap than rework a defective unit? Show your
computations.
(b) How can the cost information generated by Gates be useful in reducing the number of defectives?

(a) The costs of scrapping versus reworking can be determined as follows:
Scrap Rework
Sales revenue $0 $132
Relevant costs 0 (108)1
Contribution margin lost 0 (26)2
Net benefit (loss) $0 ($2)
1. Given in the problem ($25 + $48 + $35)

2. Contribution margin per unit is $39 ($132 - $27 - $32 - $24 - $10). Opportunity cost is $26 as
follows: $39 x 2 = $78 ç 3 = $26
From the computations, it is clear that scrapping is cheaper. Jessica Long is therefore correct.
10-224
(b) The cost information generated by Gates can be useful in reducing the number of defectives in
several ways. First, it gets the attention of management by quantifying the impact of poor quality on
profits (senior managers like to see the financial implications of nonfinancial indicators). Next, it
focuses the attention of managers, engineers, and even operators to the sources of these costs. Once the
magnitude of the problem is understood and the sources of costs identified, the next step is to find ways
to identify the sources of the quality problem (i.e., why are these defectives being produced). Then the
company can use total quality management principles to improve processes that cause defective
products.

Blooms: Apply
Gradable: manual

10-225
10-226
145. Stella McDonald is a purchasing agent for a motorcycle manufacturer. Stella is evaluating two potential
suppliers of seats for the company's motorcycles. One supplier (A) quotes a price of $165 per seat and
assures 100% quality and delivery standards. The second supplier (B) quotes a price of $135 per seat
but does not give any written assurances on quality or delivery. McDonald is not sure which supplier
should be awarded the contract.
Assume you are the management accountant for the motorcycle manufacturer. McDonald asks you to
prepare an estimate of the related costs of buying the seats from supplier B. She tells you that the
estimate is needed because unless dollar estimates are attached to nonfinancial factors, such as lost
production costs, her supervisor will not give it full attention. McDonald provides you with the
following information:
• Production output is 2,000 motorcycles per year based on 250 production days a year.
• Production time per day is 8 hours at a cost of $4,000 per hour to run the production line.
• Lost production time due to poor quality is 1%.
• Satisfied customers purchase, on average, three motorcycles during a lifetime.
• Satisfied customers recommend the product, on average, to 5 other people.
• Marketing estimates that using the seat from supplier B will result in 5 lost customers per year from
repeat business and referrals.
• Average contribution margin per motorcycle is $5,000.
Required:
Estimate the costs of buying motorcycle seats from supplier B. (Note: This problem requires you to
think creatively and make reasonable estimates; therefore, there is more than one correct answer.)

There is more than one right answer to this problem. The response to this problem should show
estimates for: 1) lost revenue from repeat business and referrals from satisfied customers and 2) cost
associated with re-work and lost production. Students may experience a level of frustration in
completing this problem. However, this is part of the process in learning how difficult it may be to make
financial estimates regarding opportunity costs. Also, it should show that purchasing a higher quality
product at a greater cost saves money in the long run.
Annual costs of the seat are as follows:
If purchased from supplier A, $165 × 2,000 seats = $330,000.

If purchased from supplier B, $135 × 2,000 seats = $270,000.
The difference in purchase costs is $60,000 in favor of supplier B.

However, this analysis does not include opportunity costs of purchasing from supplier B. These costs
are as follows:
Lost customers from repeat business and referrals (5 customers × $5,000 contribution margin) =
$25,000.
Lost production time (1% × 250 days × 8 hours × $4,000 per hour) = $80,000.
The above analysis shows that the company could experience an increase in costs (due to lost
opportunities) of $45,000 ($25,000 + $80,000 - $60,000).
Note: Some students may analyze the costs associated with lost production time as the contribution
10-227
margin lost because of not producing motorcycles.
Lost time = 1% × 250 days × 8 hours = 20 hours.
Assuming that it takes one hour to assemble a motorcycle, the company loses contribution margin of
$100,000 from the possible sale of 20 additional motorcycles ($5,000 × 20 motorcycles). In this
situation, the total cost associated with purchasing from supplier B increases to $65,000 ($25,000 +
$100,000 - $60,000).

Blooms: Analyze
Difficulty: 3 Hard
Gradable: manual

10-228
10-229
146. Thompson Metal Corporation (TMC) supplies various types of machine tools to manufacturing
companies. TMC has always paid a lot of attention to the quality of its products. Recently, an outside
supplier has approached TMC to supply an important and intricate component of one of its more
advanced tools that TMC has been manufacturing in-house. Sam Weiss, a junior accountant at TMC,
has collected the following information regarding this proposal.
The cost of manufacturing one unit of this component internally are as follows:
Direct materials: $29.60

Direct labor: 13.00
(@150% of direct labor
Variable overhead: 19.50
cost)
(@200% of direct labor
Fixed overhead: 26.00
cost)
Total cost: $88.10
The outside supplier has quoted a price of $90 per unit for supplying this component. The following is
a conversation that took place among the manufacturing manager (Dana Rice), buyer (Emily Scanlon),
and Sam Weiss.
Weiss: I think that we should continue to manufacture internally because we can save $1.90 per unit on
this component.
Rice: According to your report, we would save $1.90 per unit, but I do not agree with those numbers.
Weiss: What do you mean? I have followed the same costing guidelines this company has used for
years. I have even cross-checked my numbers with historical data and know for sure that the overhead
rates which I have used are correct.
Rice: I am sure you have done your job thoroughly, but I think that our costing system is archaic. This
component is complex and difficult to manufacture. I believe that our overhead allocation method does
not accurately capture the production difficulties and the additional resources that are devoted to the
manufacture of this component. For example, a significant portion of our quality problems are due to
this component. We spend close to a third of our quality inspection time on just this component alone,
but that is not reflected. These quality problems cause delays in getting this component to the assembly
department, and that causes a delay in getting the final product to the customers. Many of our customers
are expecting just-in-time deliveries, and they get upset when we're late.
Scanlon: I know that the supplier that has approached us has a strong reputation for quality. Therefore,
we can rest assured that we will have negligible quality problems.
Rice: Sam, your report does not consider this additional benefit from buying outside. I would
appreciate if you can rework your numbers to better reflect the true costs associated with manufacturing
this component internally.
Required:
(a) Assume the role of Sam Weiss. What are the different elements of costs that are likely to be
associated with the manufacture of the component? Does the current costing system capture these costs?
(b) Recommend improvements in the costing system.
(c) How can Weiss quantify "qualitative" benefits such as quality and on-time delivery?

10-230
(a) Several costs are likely to be incurred to manufacture the component. Examples include:
• direct and indirect materials

• direct and indirect labor
• machining
• inspecting
• reworking
• packaging
• procurement of materials
• design and engineering
The current costing system appears to capture direct materials and direct labor costs separately, and
lump all other costs into overhead. It is also not clear as to what items are included as part of overhead.
Moreover, the current costing system seems to assume that all products consume overhead resources in
a fixed ratio, thereby ignoring that the manufacture of complex components would likely consume more
resources than the level of resources consumed by simple components. Moreover, the current costing
system fails to identify the additional costs due to the quality problems associated with this component.
(b) The most important change to the costing system is better tracing of costs and identification of cost
drivers. By separating the costs of machining, inspection, reworking, packaging, procurement, design
and engineering costs, TMC will be able to attach costs to products (or components) based on their
consumption of the different resources. Such a system will allow managers to more clearly identify all
costs and benefits associated with buying the component from an outside supplier versus continuing to
manufacture it internally.
(c) Factors such as quality and on-time delivery are becoming important sources of competitive
advantage. Unfortunately, very few organizations are attempting to "quantify" these benefits. The costs
associated with poor quality can be tracked by recording the costs of additional inspection, reworking,
scrap, and warranty. The notion of Cost of Quality (COQ) has been adopted by several companies and is
providing valuable information for managers to make process improvements. Similarly, costs associated
with late delivery because of poor processes can be tracked. These would include expediting costs in
order to meet delivery schedules and potential lost sales due to poor on-time delivery performance.

Blooms: Remember
Gradable: manual

10-231
10-232
147. Mulvey Corporation manufactures large kitchen appliances. The following represents financial
information for two years:
2016 2017
Sales $7,840,000 $7,040,000
Costs:
Process Inspection 52,800 60,000
Scrap 57,600 60,200
Quality Training 610,000 440,000
Warranty Repairs 140,000 150,000
Testing Equipment 230,000 230,000
Resolving Customer
89,000 108,400
Complaints
Rework 544,000 390,000
Preventative Maintenance 440,000 304,000
Material Inspection 210,000 150,000
Field Testing 300,000 400,000
Total costs $2,673,400 $2,292,600
Required:
(a) Classify these items into costs of prevention (P), appraisal (A), internal failure (I) or external failure
(E) activities.
(b) Calculate the ratio of prevention, appraisal, internal failure, and external failure costs to sales for
2016 and 2017.
(c) Prepare a cost of quality report for 2016.

(a)
Costs:
Process Inspection A
Scrap I
Quality Training P
Warranty Repairs E
Testing Equipment A
Resolving Customer Complaints E
Rework I
Preventative Maintenance P
Material Inspection A
Field Testing A
(b)
10-233
Mulvey Corporation
Percen Percen
Year 2016 t of Year 2017 t of
Sales Sales
Sales $7,840,000 100% $7,040,000 100%
Prevention

Activities
Preventative
$440,000 5.61% $304,000 4.32%
Maintenance
Quality
610,000 7.78% 440,000 6.25%
Training
Appraisal

Activities
Process
$52,800 0.67% 60,000 0.85%
Inspection
Testing
230,000 2.93% 230,000 3.27%
Equipment
Material
210,000 2.68% 150,000 2.13%
Inspection
Field Testing 300,000 3.83% 400,000 5.68%
Internal
Failure
Activities
Scrap $57,600 0.73% 60,200 0.86%
Rework 544,000 6.94% 390,000 5.54%
External
Failure
Activities
Resolving
Customer $89,000 1.14% 108,400 1.54%
Complaints
Warranty
140,000 1.79% 150,000 2.13%
Repairs
Total $2,673,400 34.09% $2,292,000 32.57%
(c)
Mulvey Corporation
Year, 2016
Percent of
Amounts
Sales
Sales $7,840,000 100%
Prevention

Activities
Preventative $440,000
10-234
Maintenance
Quality
610,000 $1,050,000 13.39%
Training
Appraisal

Activities
Process
$52,800
Inspection
Testing
230,000
Equipment
Material
210,000
Inspection
Field Testing 300,000 792,800 10.11%
Internal
Failure
Activities
Scrap $57,600
Rework 544,000 601,600 7.67%
External
Failure
Activities
Resolving
Customer $89,000
Complaints
Warranty
140,000 229,000 2.92%
Repairs
Total $2,673,400 34.09%

Blooms: Apply
Gradable: manual

10-235
10-236
148. Scranton Extruded Plastics is a company involved in the injection molding process of plastic extruders.
The company had a process of inspection, checking line work, and handling returns from customers to
identify and correct quality problems. Scrapped extruders were ground into powder and fed back to the
extruders as raw material; thus, all scrapped extruders were reused at some point. The company's cost
accounting system indicated that the cost of scrap was "zero," a view also held by Scranton's
management. (Source: "Activity Based management" by Peter B. B. Turney published in Management
Accounting)
Required:
a) Comment on the view that scrap costs were zero at Scranton Extruded Plastics.
b) Identify internal and external failure activities that were required by Scranton.
c) Identify prevention and appraisal activities that could have been employed.

(a) Cost of scrap, if properly measured, was certainly not free. It is obvious that many non-value added
activities were using resources at Scranton Extruded Plastics, including inspection, checking line work,
handling returns from customers, and grinding and reprocessing scrapped extruders.
(b) Internal failure activities:
Rework of scrapped units

Grinding of scrapped units
Delay in process due to handling returns
External failure activities:
Replacing defective products

Resolving customer complaints
Opportunity cost of lost production on machines used for rework
Restoring reputation when customers are unhappy with product
Possible lost sales due to poor quality products received by customers
(c) Prevention activities:
The company could design products to be made without defects.

Evaluate the machines that are producing defective extruders for possible redesign.
Evaluate processes to remove causes of defects.
Quality control training so that machine operators can spot defective units and stop machines before
excessive defective units are produced.
Appraisal activities:
The company should make sure that materials used conform to specifications and examine materials
upon delivery.
The company should ensure that machines are operating properly within specifications.
The company could employ manual inspection of the production process and give QC inspectors the
10-237
authority to shut down any machine that is malfunctioning.
The company could use equipment to monitor the production process.
Sampling at the end of the production process could be employed to ensure quality before defective
units are shipped to customers.

Blooms: Apply
Gradable: manual

10-238

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Chapter 10

Fundamentals of Cost Management

True / False Questions

Multiple Choice Questions

A. In ABC, cost drivers cause costs to be linked to products.

All Cost Drivers Non value-added Activities

A. Drill press activity.

A. Classify all activities as value-added or nonvalue-added.

Number Activity Description

In an activity listing with value-added scores:

A. Activity 3.4 would be assigned a high value-added ranking.

Number Activity Description

The sub-activities of this company indicate that:

A. a cost system using multiple departmental overhead rates.

A. Change order to meet a new customer's specification.

A. Direct labor hours.

A. sustain the company's marketing program.

Model Item #B-200 Item #C440

A. Unit level material costs.

Cost driver Customer C Customer D

Cost driver Customer C Customer D

Customer Customer Customer

Customer Customer Customer

Customer Customer Customer

A. Number of different items ordered.

A. cost driver rate and the actual cost driver volume.

Compute unused resource capacity for materials for South Beach.

Compute unused resource capacity for purchasing for South Beach.

Compute unused resource capacity for setups for South Beach.

Compute unused resource capacity for repairs for South Beach.

Compute unused resource capacity for setups for Macon Publishing.

Compute unused resource capacity for clerical for Macon Publishing.

Compute unused resource capacity for setups for Denim Products.

Compute unused resource capacity for energy for Scallon Products.

Compute unused resource capacity for repairs for Scallon Products.

A. to an account called Idle Capacity.

A. Scheduled maintenance of equipment.

Direct materials 2.0 pounds @ $12 = $24.00

Direct materials 2.0 pounds @ $12 = $24.00

A. Training employees to improve quality.

A. Training employees to improve quality.

A. Accepting company liability resulting from product failure.

A. Quality-related waiting time.

Gathering, analysis, and reporting quality data $1,000

Gathering, analysis, and reporting quality data $1,000

Gathering, analysis, and reporting quality data $1,000

Gathering, analysis, and reporting quality data $1,000

Gathering, analysis, and reporting quality data $1,000

Gathering, analysis, and reporting quality data $1,000

Liability costs associated with defective

Liability costs associated with defective

Liability costs associated with defective

Liability costs associated with defective

Liability costs associated with defective

Liability costs associated with defective

A. Designing products for manufacturability.

A. seek to prevent defects in the products or services being produced.

A. seek to prevent defects in the products or services being produced.

A. seek to prevent defects in the products or services being produced.