ABC SOLUTIONS
5-21 Plant-wide, department, and ABC indirect cost rates. Roadster Company (RC)
designs and produces automotive parts. In 2017, actual variable manufacturing overhead is
$280,000. RC’s simple costing system allocates variable manufacturing overhead to its three
customers based on machine-hours and prices its contracts based on full costs. One of its
customers has regularly complained of being charged noncompetitive prices, so RC’s
controller Matthew Draper realizes that it is time to examine the consumption of overhead
resources more closely. He knows that there are three main departments that consume
overhead resources: design, production, and engineering. Interviews with the department
personnel and examination of time records yield the following detailed information:
Required
1 Compute the manufacturing overhead allocated to each customer in 2017 using the simple
costing system that uses machine-hours as the allocation base.
2 Compute the manufacturing overhead allocated to each customer in 2017 using department-
based manufacturing overhead rates.
3. Comment on your answers in requirements 1 and 2. Which customer do you think was
complaining about being overcharged in the simple system? If the new department-based
rates are used to price contracts, which customer(s) will be unhappy? How would you
respond to these concerns?
4. How else might RC use the information available from its department-by-department
analysis of manufacturing overhead costs?
5. RC’s managers are wondering if they should further refine the department-by-department
costing system into an ABC system by identifying different activities within each
department. Under what conditions would it not be worthwhile to further refine the
department costing system into an ABC system?
SOLUTION
Plantwide, department, and ABC indirect cost rates.
1.
Actual plantwide variable MOH rate
based on machine hours, $280,000 5,000 $56 per machine hour
Southern Caesar Jupiter
Motors Motors Auto Total
Variable manufacturing overhead, allocated based on machine hours
($56 300; $56 3,700; $56 1,000)
$16,800 $207,200 $56,000 $280,000
2.
Departme MOH in Total
nt 2017 Driver Units Rate
Design $ 35,000 500 $70 per CAD-design hour
Production 25,000 500 $50 per engineering hour
Engineerin 220,000 5,000 $44
g per machine hour
Souther
n Caesar Jupite
Motors Motors r Auto Total
Design-related overhead, allocated on CAD-
design hours $ $ $
(150 $70; 250 $70; 100 $70) $10,500 17,500 7,000 35,000
Production-related overhead, allocated on
engineering hours
(130 $50; 100 $50; 270 $50) 6,500 5,000 13,500 25,000
Engineering-related overhead, allocated on
machine hours
(300 $44; 3,700 $44; 1,000 $44) 13,200 162,800 44,000 220,000
Total $185,30 $64,50 $280,00
$30,200
0 0 0
3.
Southern Caesar Jupiter
Motors Motors Auto
a. Department rates
(Requirement 2) $30,200 $185,300 $64,500
b. Plantwide rate
(Requirement 1) $16,800 $207,200 $56,000
Ratio of (a) ÷ (b) 1.80 0.89 1.15
The manufacturing overhead allocated to Southern Motors increases by 80% under the
department rates, the overhead allocated to Caesar decreases by about 11%, and the overhead
allocated to Jupiter increases by about 15%.
The three contracts differ sizably in the way they use the resources of the three
departments.
The percentage of total driver units in each department used by the companies is:
Cost Southern Caesar Jupiter
Department Driver Motors Motors Auto
Design CAD-design hours 30% 50% 20%
Engineering Engineering hours 26 20 54
Production Machine hours 6 74 20
The Southern Motors contract uses only 6% of total machines hours in 2017, yet uses
30% of CAD design-hours and 26% of engineering hours. The result is that the plantwide rate,
based on machine hours, will greatly underestimate the cost of resources used on the Southern
Motors contract. This explains the 80% increase in indirect costs assigned to the Southern
Motors contract when department rates are used. The Jupiter Auto contract also uses far fewer
machine-hours than engineering-hours and is also undercosted.
In contrast, the Caesar Motors contract uses less of design (50%) and engineering (20%)
than of machine-hours (74%). Hence, the use of department rates will report lower indirect
costs for Caesar Motors than does a plantwide rate.
Caesar Motors was probably complaining under the use of the simple system because
its contract was being overcosted relative to its consumption of MOH resources. Southern and
Jupiter, on the other hand, were having their contracts undercosted and underpriced by the
simple system. Assuming that Roadster Company (RC) is an efficient and competitive supplier,
if the new department-based rates are used to price contracts, Southern and Jupiter will be
unhappy. RC should explain to Southern and Jupiter how the calculation was done, and point
out Southern’s high use of design and engineering resources and Jupiter’s high use of
engineering resources relative to production machine hours. RC’s management should discuss
ways of reducing the consumption of those resources, if possible, and show willingness to
partner with them to do so. If the price rise is going to be steep, perhaps offer to phase in the
new prices.
4. Other than for pricing, RC can also use the information from the department-based
system to examine and streamline its own operations so that there is maximum value-added
from all indirect resources. It might set targets over time to reduce both the consumption of
each indirect resource and the unit costs of the resources. The department-based system gives
RC more opportunities for targeted cost management.
5. It would not be worthwhile to further refine the cost system into an ABC system if (1)
a single activity accounts for a sizable proportion of the department’s costs or (2) significant
costs are incurred on different activities within a department, but each activity has the same
cost driver or (3) there wasn’t much variation among contracts in the consumption of activities
within a department. If, for example, most activities within the design department were, in fact,
driven by CAD-design hours, then the more refined system would be more costly and no more
accurate than the department-based cost system. Even if there was sufficient variation,
considering the relative sizes of the three department cost pools, it may only be cost-effective
to further analyze the engineering cost pool, which consumes 79% ($220,000 $280,000) of
the manufacturing overhead.
5-23 ABC, process costing. Sander Company produces mathematical and financial
calculators and operates at capacity. Data related to the two products are presented here:
Total manufacturing overhead costs are as follows:
Required
1. Choose a cost driver for each overhead cost pool and calculate the manufacturing overhead
cost per unit for each product.
2. Compute the manufacturing cost per unit for each product.
3. How might Sander’s managers use the new cost information from its activity-based costing
system to better manage its business?
SOLUTION
ABC, process costing.
1. Rates per unit cost driver.
Activity Cost Driver Rate
Machining Machine-hours $360,000 ÷ (30,000 + 60,000)
= $4 per machine hour
Set up Production runs $108,000 ÷ (45 + 45)
= $1,200 per production run
Inspection Inspection-hours $117,000 ÷ (1,200 + 600)
= $65 per inspection hour
Manufacturing overhead cost per unit:
Mathematical
Financial
Machining: $4 × 30,000; 60,000 $120,000 $240,000
Set up: $1,200 × 45; $1,200 × 45 54,000 54,000
Inspection: $65 × 1,200; $65 × 600 78,000 39,000
Total manufacturing overhead costs $252,000 $333,000
Divide by number of units ÷ 45,000 ÷90,000
Manufacturing overhead cost per unit $ 5.60 $ 3.70
2.
Mathematical Financial
Manufacturing cost per unit:
Direct materials
$180,000 ÷ 45,000 $ 4.00
$360,000 ÷ 90,000 $4.00
Direct manufacturing labor
$90,000 ÷ 45,000 2.00
$180,000 ÷ 90,000 2.00
Manufacturing overhead (from requirement 1) 5.60 3.70
Manufacturing cost per unit $11.60 $9.70
3. Disaggregated information can improve decisions by allowing managers to see the
details that help them understand how different aspects of cost influence total cost per unit.
Managers can also understand the drivers of different cost categories and use this information
for pricing and product-mix decisions, cost reduction and process-improvement decisions,
design decisions, and to plan and manage activities. However, too much detail can overload
managers who don’t understand the data or what it means. Also, managers looking at per-
unit data may be misled when considering costs that aren’t unit-level costs.
