Chapter 5 Activity-Based Costing and Management 203

Required:
1. Activity-based costing (ABC) is said to result in improved costing accuracy when compared with
traditional costing procedures. Briefly explain how this improved accuracy is attained.
2. Assume that the firm uses traditional costing procedures, allocating total costs on the basis of bill-
able hours. Determine the profitability of the firm’s e-commerce and information systems activi-
ties, expressing your answer both in dollars and as a percentage of activity revenue.
3. Repeat requirement (2), using activity-based costing.
4. Stephen Shiffer, one of the firm’s partners, doesn’t care where his professionals spend their time
because, as he notes, “many clients have come to expect both services and we need both to stay in
business. Also, information systems and e-commerce professionals are paid the same hourly rate.”
Should Shiffer’s attitude change? Explain.
5. Is an aggressive expansion of either service currently desirable? Briefly discuss.

■ Problem 5–46
Kitchen King’s Toledo plant manufactures three product lines, all multi-burner, ceramic cook tops. The Straightforward ABC
plant’s three product models are the Regular (REG), the Advanced (ADV), and the Gourmet (GMT). calculations
Until recently, the plant used a job-order product-costing system, with manufacturing overhead applied (LO 5-1, 5-2, 5-3, 5-4,
on the basis of direct-labor hours. The following table displays the basic data upon which the traditional 5-5)
costing system was based.
2. Machine-related costs for
REG ADV GMT REG line: $135,000
Planned annual production: 3. Total cost per unit, under
Volume in units ...................... 5,000 4,000 1,000 ABC, for GMT line: $663.90
Production runs ..................... 40 runs of 125 units 40 runs of 100 units 20 runs of 50 units 5. Cost distortion per unit
Direct material $129 $151 $203 for ADV line: overcosted by
Direct labor: $8.85
(not including setup) .............. $171 (9 hrs. @ $19 per hr.) $209 (11 hrs. @ $19 per hr.) $247 (13 hrs. @ $19 per hr.)
Machine hours (MH)
per product unit ..................... 10 MH 12 MH 17 MH
Total machine hours consumed
by product line in a year ......... 50,000 (10 MH 3 5,000) 48,000 (12 MH 3 4,000) 17,000 (17 MH 3 1,000)

The annual budgeted overhead is $1,224,000, and the company’s predetermined overhead rate is
$12 per direct-labor hour. The product costs for the three product models, as reported under the plant’s
traditional costing system, are shown in the following table.

REG ADV GMT

Direct material ............................................ $129.00 $151.00 $203.00
Direct labor
(not including set-up time) ....................... 171.00 (9 hr. @ $19) 209.00 (11 hr. @ $19) 247.00 (13 hr. @ $19)
Manufacturing overhead............................... 108.00 (9 hr. @ $12) 132.00 (11 hr. @ $12) 156.00 (13 hr. @ $12)
Total cost per unit ........................................ $408.00 $492.00 $606.00

Kitchen King’s pricing policy is to set a target price for each product equal to 130 percent of the full
product cost. Due to price competition from other appliance manufacturers, REG units were selling at
$525, and ADV units were selling for $628. These prices were somewhat below the firm’s target prices.
However, these results were partially offset by greater-than-expected profits on the GMT product line.
Management had raised the price on the GMT model to $800, which was higher than the original target
price. Even at this price, Kitchen King’s customers did not seem to hesitate to place orders, Moreover,
the company’s competitors did not mount a challenge in the market for the GMT product line. Neverthe-
less, concern continued to mount in Toledo about the difficulty in the REG and ADV markets. After all,
these were the plant’s bread-and-butter products, with projected annual sales of 5,000 REG units and
4,000 ADV units.
Kitchen King’s director of cost management, Angela Ramirez, had been thinking for some time
about a refinement in the Toledo plant’s product-costing system. Ramirez wondered if the traditional,
volume-based system was providing management with accurate data about product costs. She had read
about activity-based costing, and wondered if ABC would be an improvement to the plant’s
204 Chapter 5 Activity-Based Costing and Management

product-costing system. After some discussion, an ABC proposal was made to the company’s top man-
agement, and approval was obtained. The data collected for the new ABC system is displayed in the
following table.
Cost
Activity Driver
Cost Cost Product Quantity for
Activity Pool Driver Line Product Line
Machine related ............................................ $310,500 Machine REG 50,000
Hours ADV 48,000
GMT 17,000
Total 115,000

Material handling .......................................... 52,500 Production REG 40

Runs ADV 40
GMT 20
Total 100
Purchasing ................................................... $ 75,000 Purchase REG 100
Orders ADV 96
GMT 104
Total 300
Setup ............................................................ 85,000 Production REG 40
Runs ADV 40
GMT 20

Total 100

Inspection .................................................... 27,500 Inspection REG 400

Hours ADV 400
GMT 300
Total 1,100

Shipping ....................................................... 66,000 Shipments REG 500

ADV 400
GMT 200
Total 1,100

Engineering .................................................. 32,500 Engineering REG 250

Hours ADV 200
GMT 200
Total 650

Facility ......................................................... 575,000 Machine REG 50,000

Hours ADV 48,000
GMT 17,000
Total 115,000

Required:
1. Show how the company’s overhead rate of $12 per direct-labor hour was calculated.
2. Complete an activity-based costing analysis for Kitchen King’s three product lines. Display the
results of your ABC analysis in a table similar to Exhibit 5–7 in the text.
3. Prepare a table similar to Exhibit 5–8, which computes the new product cost for each product line
under ABC.
4. Prepare a table similar to Exhibit 5–9, which compares the overhead cost, total product cost, and
target price for each product line under the two alternative costing systems.
5. Was each of Kitchen King’s three product lines overcosted or undercosted? By how much per
unit?
6. Build a spreadsheet: Construct an Excel spreadsheet to solve requirement (2). Show how the solu-
tion would change if the machine-related cost pool was $621,000, and the facility cost pool was
$1,150,000.
 Chapter 5 Activity-Based Costing and Management 205

■ Problem 5–47
Refer to your solution to requirement (2) of the preceding problem. Continuation of Preceding
Required: Prepare an exhibit similar to Exhibit 5–6 in the text to explain the ABC calculations for Problem; Explaining ABC
the material-handling activity. Use your exhibit to explain ABC to a friend who is not a business major. (LO 5-2, 5-3, 5-4)
Pool rate for material-
handling activity: $525 per
production run

■ Problem 5–48
Wilmington Office Equipment Corporation manufactures two types of filing cabinets—Deluxe and Activity-Based Costing; Cost
Executive—and applies manufacturing overhead to all units at the rate of $80 per machine hour. Produc- Distortion; Product Promotion
tion information follows. (LO 5-1, 5-2, 5-3, 5-4,
Deluxe Executive 5-5)
Direct-material cost ................................................................................................ $40 $65 2. Application rate, product
Direct-labor cost ..................................................................................................... 25 25 shipping: $3,200 per OS
Budgeted volume (units) .......................................................................................... 16,000 30,000 2. Deluxe, total cost per unit:
$253.50
The controller, who is studying the use of activity-based costing, has determined that the firm’s over-
head can be identified with three activities: manufacturing setups, machine processing, and product
shipping. Data on the number of setups, machine hours, and outgoing shipments, which are the activi-
ties’ three respective cost drivers, follow.
Deluxe Executive Total
Setups ............................................................................................ 100 60 160
Machine hours ................................................................................. 32,000 45,000 77,000
Outgoing shipments ......................................................................... 200 150 350

The firm’s total overhead of $6,160,000 is subdivided as follows: manufacturing setups, $1,344,000;
machine processing, $3,696,000; and product shipping, $1,120,000.

Required:
1. Compute the unit manufacturing cost of Deluxe and Executive filing cabinets by using the com-
pany’s current overhead costing procedures.
2. Compute the unit manufacturing cost of Deluxe and Executive filing cabinets by using activity-
based costing.
3. Is the cost of the Deluxe filing cabinet overstated or understated (i.e., distorted) by the use of
machine hours to allocate total manufacturing overhead to production? By how much?
4. Calculate the aggregate amount by which the Deluxe cabinet line is undercosted by the company’s
current traditional overhead costing procedures. Then calculate the aggregate amount by which the
traditional system overcosts the Executive cabinet line.
5. Assume that the current selling price of a Deluxe filing cabinet is $270 and the marketing manager
is contemplating a $30 discount to stimulate volume. Is this discount advisable? Briefly discuss.

■ Problem 5–49
Digital Light Corporation has just completed a major change in its quality control (QC) process. Previ- Overhead Application;
ously, products had been reviewed by QC inspectors at the end of each major process, and the com- Activity-Based Costing
pany’s 10 QC inspectors were charged as direct labor to the operation or job. In an effort to improve (LO 5-1, 5-2, 5-3, 5-4,
efficiency and quality, a computerized video QC system was purchased for $500,000. The system con- 5-5)
sists of a minicomputer, 15 video cameras, other peripheral hardware, and software. The new system
uses cameras stationed by QC engineers at key points in the production process. Each time an operation
changes or there is a new operation, the cameras are moved, and a new master picture is loaded into the
computer by a QC engineer. The camera takes pictures of the units in process, and the computer com-
pares them to the picture of a “good” unit. Any differences are sent to a QC engineer who removes the
bad units and discusses the flaws with the production supervisors. The new system has replaced the 10
QC inspectors with two QC engineers.
The operating costs of the new QC system, including the salaries of the QC engineers, have been
included as factory overhead in calculating the company’s plantwide manufacturing-overhead rate,
which is based on direct-labor dollars. The company’s president is confused. His vice president of