ACTIVITY-BASED COSTING – CASE STUDY

Baxter Battery Company produces two automobile battery lines — a standard battery called the
SureStart and a deluxe, higher quality battery called the LongLife. Both batteries are sold
through automobile parts retail stores. No design options are available for the SureStart, but
Baxter produces the LongLife with different battery casing designs and battery handle locations
to customize the appearance for the auto parts stores. For example, the battery casing can be
produced in different colors with different brand names to suit the customers. The company has
reported its first loss ever of $2,000,000 as shown on the income statement.

The company is considering to switch to ABC. The first step in implementing ABC is to define
activities, activity cost pools, and cost drivers.
At Baxter Battery, the definition for each of the activity cost pools is:
• Customer Orders - assigned all costs of resources that are consumed by taking and
processing customer orders.
• Design changes - assigned all costs of resources consumed by customer requested design
changes.
• Order Size - assigned all costs of resources consumed as a consequence of the number of
units produced.
• Customer Relations – assigned all costs associated with maintaining relations with
customers.
• Other – assigned all organization-sustaining costs and unused capacity costs
  Complete the table with cost drivers
Activity Cost Pool Cost driver
Customer orders
Design changes
Order size
Customer relations
Other

The second step in implementing ABC is to assign overhead costs to activity cost pools. This is
also called first-stage allocation. Baxter Battery’s annual overhead costs (both manufacturing and
nonmanufacturing) that it intends to assign to its activity cost pools are as shown. Notice that
total costs for the Production Department ($14,000,000) equal the total manufacturing overhead
costs shown in Baxter Battery’s income statement. In addition, the total costs for the General
Administrative and Marketing Departments ($6,000,000 and $2,000,000, respectively) equal the
general administrative and marketing expenses shown in Baxter Battery’s income statement.

 Which costs from the income statement are excluded in this table of total overhead
costs? Why?
Next, Baxter Battery’s cross-functional interviews resulted in resource allocations as shown.

Notice for example that the indirect factory workers allocated 30% of their time to the customer
orders activity, 30% of their time to the design changes activity, 20% of their time to the order
size activity, 10% of their time to customer relations, and 10% of their time to the “other”
activity. Also note that 100% of the factory building lease is allocated to the “other” activity.
Since Baxter Battery has a single production facility that it does not plan to contract or expand,
the lease cost is an unavoidable organization-sustaining cost.
Once the percentage allocations have been determined, it is a simple matter to assign costs to
activity cost pools. For example, the indirect factory wages assigned to the customer orders
activity ($1,800,000) was computed by multiplying the total amount of indirect factory wages
($6,000,000) by the percentage of time that indirect factory workers spent on this activity (30%).

 Complete the table for assigning overhead costs to activity cost pools
Step 3: calculate activity rates
The ABC team determines that Baxter Battery will have these total activities for each activity
cost pool . . .
 10,000 customer orders,
 4,000 design changes,
 800,000 machine-hours,
 2,000 customers served.
Activity Cost Pools Total cost Total activity Activity rate
Customer orders
Design changes
Order size
Customer relations
Other
Total 22,000,000

Step 4: assign overhead costs to cost objects

SureStart
1. Requires no new design resources.
2. 800,000 batteries ordered with 4,000 separate orders.
3. Each SureStart requires 36 minutes of machine time for a total of 480,000 machine-
hours.
LongLife
1. Requires new design resources.
2. 400,000 batteries ordered with 6,000 separate orders.
3. 4,000 custom designs prepared.
4. Each LongLife requires 48 minutes of machine time for a total of 320,000 machine-
hours.

Overhead costs for SureStart

Activity Cost Pools Activity rate Activity ABC cost
Customer orders
Design changes
Order size
Total
 Overhead costs for LongLife
Activity Cost Pools Activity rate Activity ABC cost
Customer orders
Design changes
Order size
Total

 Now, if a customer placed twelve orders. Eight orders were for 60 SureStarts each,
and four orders were for 50 LongLifes each. The 480 SureStarts required 288
machine-hours, and 200 LongLifes required 160 machine-hours.
How much overhead cost is assigned to this customer?