5-23 (30 min.) Activity-based costing, service company.

Speediprint Corporation owns a small printing press that prints leaflets, brochures, and advertising
materials. Speediprint classifies its various printing jobs as standard jobs or special jobs.
Speediprint’s simple job-costing system has two direct-cost categories (direct materials and direct
labor) and a single indirect-cost pool. Speediprint operates at capacity and allocates all indirect
costs using printing machine-hours as the allocation base.
Speediprint is concerned about the accuracy of the costs assigned to standard and special jobs
and therefore is planning to implement an activity-based costing system. Speediprint’s ABC
system would have the same direct-cost categories as its simple costing system. However, instead
of a single indirect-cost pool there would now be six categories for assigning indirect costs: design,
purchasing, setup, printing machine opera- tions, marketing, and administration. To see how
activity-based costing would affect the costs of standard and special jobs, Speediprint collects the
following information for the fiscal year 2014 that just ended.

Required:
1. Calculate the cost of a standard job and a special job under the simple costing system.
2. Calculate the cost of a standard job and a special job under the activity-based costing system.
3. Compare the costs of a standard job and a special job in requirements 1 and 2. Why do the
simple and activity-based costing systems differ in the cost of a standard job and a special job?
4. How might Speediprint use the new cost information from its activity-based costing system to
better manage its business?
 SOLUTION

1. Total indirect costs = $75,000 + $45,000 + $18,000 + $20,000 + $19,500 + $24,000

= $201,500
Total machine-hours = (400 × 10) + (200 × 10) = 6,000
Indirect cost rate per machine-hour = $201,500 ÷ 6,000
= $33.583 per machine-hour

Standard Special
Simple Costing System Job Job
Cost of supplies per job $100.00 $125.00
Direct labor cost per job 90.00 100.00
Indirect cost allocated to each job
(10 machine hours × $33.583 per machine hour) 335.83 335.83
Total costs $525.83 $560.83

2. Activity-based costing system

Quantity of Cost
Driver Consumed
during 2014
(see column (1))
Total Cost of
Standard Special Activity Allocation
Activity Cost Driver Job Job (given) Rate
(1) (2) (3) (4) (5) (6) = (5) ÷ ((3) + (4)), or given
Machine operations machine hours 4,000 2,000 $75,000 $ 12.50 per machine hour
(400 jobs × 10 mach. hrs.
per job; 200 jobs × 10
mach. hrs. per job)
Setups (4 × 400; 7 × 200) setup hours 1,600 1,400 $45,000 $ 15.00 per setup hour
Purchase orders (given) no. of purchase orders 400 500 $18,000 $ 20.00 per purchase order
Design $20,000
Marketing Percentage of revenue $19,500 $ 0.05 per dollar of sales
Administration dir. labor costs $36,000 $20,000 $24,000 $0.42857 per dollar of direct
($90 × 400; $100 × 200) manuf. labor cost
 Total Costs
Standard Special
Job Job
Cost of supplies ($100 × 400; $125 × 200) $ 40,000 $ 25,000
Direct labor costs ($90 × 400; $100 × 200) 36,000 20,000
Indirect costs allocated:
Machine operations ($12.50 per mach. hr. × 4,000; 2,000) 50,000 25,000
Setups ($15 per setup hr. × 1,600; 1,400) 24,000 21,000
Purchase orders ($20 per order × 400; 500) 8,000 10,000
Design 4,000 16,000
Marketing (0.05 × $600 × 400; 0.05 × $750 × 200) 12,000 7,500
Administration (0.42857 × $36,000; $20,000) 15,429 8,571
Total costs $189,429 $133,071
Cost of each job ($189,429 ÷ 400; $133,071 ÷ 200) $ 473.57 $ 665.36

3.
Standard Special
Cost per job Job Job
Simple Costing System $525.83 $560.83
Activity-based Costing System $473.57 $665.36
Difference (Simple – ABC) $ 52.26 $ (104.53)

Relative to the ABC system, the simple costing system overcosts standard jobs and undercosts
special jobs. Both types of jobs need 10 machine hours per job, so in the simple system, they are
each allocated $335.83 in indirect costs. But, the ABC study reveals that each standard job
consumes less of the indirect resources such as setups, purchase orders, and design costs than a
special job, and this is reflected in the lower indirect costs allocated to the standard jobs and higher
indirect costs allocated to special jobs in the ABC system.

4. Speediprint can use the information revealed by the ABC system to change its pricing
based on the ABC costs. Under the simple system, Speediprint was making a gross margin of 12%
on each standard job ([$600 – $525.83] ÷ $600) and 25% on each special job ([$750 – $560.83]
÷ $750). But, the ABC system reveals that it is actually making a gross margin of 21% ([$600 –
$473.57] ÷ $600) on each standard job and about 11% ([$750 – $665.36] ÷ $750) on each special
job. Depending on the market competitiveness, Speediprint may either want to reprice the different
types of jobs, or it may choose to market standard jobs more aggressively than before.
Speediprint can also use the ABC information to improve its own operations. It could
examine each of the indirect cost categories and analyze whether it would be possible to deliver
the same level of service, but consume fewer indirect resources, or find a way to reduce the per-
unit-cost-driver cost of some of those indirect resources.
5-24 (30 min.) Activity-based costing, manufacturing.

Fancy Doors, Inc., produces two types of doors, interior and exterior. The company’s simple
costing system has two direct cost categories (materials and labor) and one indirect cost pool. The
simple costing system allocates indirect costs on the basis of machine-hours. Recently, the owners
of Fancy Doors have been concerned about a decline in the market share for their interior doors,
usually their biggest seller. Information related to Fancy Doors production for the most recent year
follows:

The owners have heard of other companies in the industry that are now using an activity-based
costing system and are curious how an ABC system would affect their product costing decisions.
After analyzing the indirect cost pool for Fancy Doors, the owners identify six activities as
generating indirect costs: production scheduling, material handling, machine setup, assembly,
inspection, and marketing. Fancy Doors collected the following data related to the indirect cost
activities:

Marketing costs were determined to be 3% of the sales revenue for each type of door.

Required:
1. Calculate the cost of an interior door and an exterior door under the existing simple costing
system.
2. Calculate the cost of an interior door and an exterior door under an activity-based costing
system.
3. Compare the costs of the doors in requirements 1 and 2. Why do the simple and activity-based
costing systems differ in the cost of an interior and exterior door?
4. How might Fancy Door, Inc., use the new cost information from its activity-based costing
system to address the declining market share for interior doors?

SOLUTION

1. Simple costing system:

Total indirect costs = $190,000 + $90,000 + $50,000 + $120,000 + $16,000 + 3%[($250 × 3,200)
+ ($400 × 1,800)]
= $511,600
Total machine-hours = 5,500 + 4,500 = 10,000
Indirect cost rate per machine-hour = $511,600 ÷ 10,000
= $51.16 per machine-hour

Simple Costing System Interior Exterior

Direct materialsa $192,000 $162,000
Direct manufacturing laborb 153,600 129,600
Indirect cost allocated to each job
($51.16 × 5,500; 4,500 machine hours) 281,380 230,220

Total costs $626,980 $521,820

Total cost per unit

($626,980 ÷ 3,200; $521,820 ÷ 1,800) $ 195.93 $ 289.90
a
$60 × 3,200 units; $90 × 1,800 units
b
$32 × 1.5 × 3,200 units; $32 × 2.25 × 1,800 units
 2. Activity-based costing system

Total Cost of Cost Driver

Activity Activity Cost Driver Quantity Allocation Rate
(1) (2) (3) (4) (5) = (2) ÷ (4)

Product scheduling $190,000 production runs 125c $1,520.00 per production run
Material handling $ 90,000 material moves 240d $ 375.00 per material move
Machine setup $ 50,000 machine setups 200e $ 250.00 per setup
Assembly $120,000 machine hours 10,000 $ 12.00 per machine hour
Inspection $ 16,000 inspections 400f $ 40.00 per inspection
Marketing Percentage of $ 0.03 per dollar of sales
revenues
c
40 + 85 = 125; d 72 + 168 = 240; e 45 + 155 = 200; f 250 + 150 = 400

ABC System Interior Exterior

Direct materials $192,000 $162,000
Direct manufacturing labor 153,600 129,600
Indirect costs allocated:
Product scheduling ($1,520 per run × 40; 85) 60,800 129,200
Material handling ($375.00 per move × 72; 168) 27,000 63,000
Machine setup ($250 per setup × 45; 155) 11,250 38,750
Assembly ($12 per MH × 5,500; 4,500) 66,000 54,000
Inspection ($40 per inspection × 250; 150) 10,000 6,000
Marketing (0.03 × $250 × 3,200; 0.03 × $400 × 1,800) 24,000 21,600
Total costs $544,650 $604,150

Total cost per unit

($544,650 ÷ 3,200 units; $604,150 ÷ 1,800 units) $ 170.20 $ 335.64

3.
Cost per unit Interior Exterior
Simple Costing System $195.93 $289.90
Activity-based Costing System $170.20 $335.64
Difference (Simple – ABC) $ 25.73 $ (45.74)

Relative to the ABC system, the simple costing system overcosts interior doors and undercosts
exterior doors. Interior doors require 1.72 machine-hours per unit while exterior doors require 2.5
machine-hours per unit. In the simple-costing system, overhead costs are allocated to the interior
and exterior doors on the basis of the machine-hours used by each type of door. The ABC study
reveals that the ratio of the cost of production runs, material moves, and setups for each exterior
door versus each interior door is even higher than the ratio of 2.5 to 1.72 machine-hours for each
exterior relative to each interior door. This higher ratio results in higher indirect costs allocated to
exterior doors relative to interior doors in the ABC system.

4. Fancy Doors, Inc. can use the information revealed by the ABC system to change its pricing
based on the ABC costs. Under the simple system, Fancy Doors was making an operating margin
of 21.6% on each interior door ([$250 – $195.93] ÷ $250) and 27.5% on each exterior door ([$400
– $289.90] ÷ $400). But, the ABC system reveals that it is actually making an operating margin
of about 32% ([$250 – $170.20] ÷ $250) on each interior door and about 16% ([$400 – $335.64]
÷ $400) on each exterior door. Fancy Doors, Inc., should consider decreasing the price of its
interior doors to be more competitive. Fancy Doors should also consider increasing the price of
its exterior doors, depending on the competition it faces in this market.
Fancy Doors can also use the ABC information to improve its own operations. It could
examine each of the indirect cost categories and analyze whether it would be possible to deliver
the same level of service, but consume fewer indirect resources, or find a way to reduce the per-
unit-cost-driver cost of some of those indirect resources. Making these operational improvements
can help Fancy Doors to reduce costs, become more competitive, and reduce prices to gain further
market share while increasing its profits.
5-25 (30 min.) ABC, retail product-line profitability.

Henderson Supermarkets (HS) operates at capacity and decides to apply ABC analysis to three
product lines: baked goods, milk and fruit juice, and frozen foods. It identifies four activities and
their activity cost rates as follows:

The revenues, cost of goods sold, store support costs, activities that account for the store support
costs, and activity-area usage of the three product lines are as follows:

Under its simple costing system, HS allocated support costs to products at the rate of 30% of cost
of goods sold.

Required:
1. Use the simple costing system to prepare a product-line profitability report for HS.
2. Use the ABC system to prepare a product-line profitability report for HS.
3. What new insights does the ABC system in requirement 2 provide to HS managers?
SOLUTION

1. The simple costing system (Panel A of Solution Exhibit 5-25) reports the following:
Baked Milk & Frozen
Goods Fruit Juice Products Total
Revenues $59,500 $66,000 $51,000 $176,500
Costs
Cost of goods sold 36,000 48,000 34,000 118,000
Store support (30% of COGS) 10,800 14,400 10,200 35,400
Total costs 46,800 62,400 44,200 153,400
Operating income $12,700 $ 3,600 $ 6,800 $ 23,100

Operating income ÷ Revenues 21.34% 5.45% 13.33% 13.09%

2. The ABC system (Panel B of Solution Exhibit 5-25) reports the following:
Baked Milk & Frozen
Goods Fruit Juice Products Total
Revenues $59,500 $66,000 $51,000 $176,500
Costs
Cost of goods sold 36,000 48,000 34,000 118,000
Ordering ($102 × 25; 20; 15) 2,550 2,040 1,530 6,120
Delivery ($78 × 90; 35; 30) 7,020 2,730 2,340 12,090
Shelf-stocking ($21 × 190; 180; 40) 3,990 3,780 840 8,610
Customer support
($0.22 × 13,500; 17,500; 8,000) 2,970 3,850 1,760 8,580
Total costs 52,530 60,400 40,470 153,400
Operating income $ 6,970 $ 5,600 $10,530 $ 23,100

Operating income ÷ Revenues 11.71% 8.48% 20.65% 13.09%

These activity costs are based on the following:

Baked Milk & Frozen
Activity Cost Allocation Rate Goods Fruit Juice Products
Ordering $102 per purchase order 25 20 15
Delivery $78 per delivery 90 35 30
Shelf-stocking $21 per hour 190 180 40
Customer $0.22 per item sold 13,500 17,500 8,000
support

3. The rankings of products in terms of relative profitability are:

Simple Costing System ABC System
1. Baked goods 21.33% Frozen products 20.65%
2. Frozen products 13.33 Baked goods 11.71
3. Milk & fruit juice 5.45 Milk & fruit juice 8.48

The percentage revenue, COGS, and activity costs for each product line are:
 Baked Milk & Frozen
Goods Fruit Juice Products Total
Revenues 33.71 37.39 28.90 100.00
COGS 30.51 40.68 28.81 100.00
Activity areas:
Ordering 41.67 33.33 25.00 100.00
Delivery 58.06 22.58 19.36 100.00
Shelf-stocking 46.34 43.90 9.76 100.00
Customer support 34.62 44.87 20.51 100.00

The baked goods line drops sizably in profitability when ABC is used. Although it constitutes
30.71% of COGS, it uses a higher percentage of total resources in each activity area, especially
the high-cost delivery activity area. In contrast, frozen products draw a much lower percentage of
total resources used in each activity area than its percentage of total COGS. Hence, under ABC,
frozen products are much more profitable.
Henderson Supermarkets may want to explore ways to increase sales of frozen products.
It may also want to explore price increases on baked goods.
 SOLUTION EXHIBIT 5-25
Product-Costing Overviews of Henderson Supermarkets

PANEL A: SIMPLE COSTING SYSTEM

}
INDIRECT Store
COST Support
POOL

}
COST
ALLOCATION COGS
BASE

COST OBJECT:
PRODUCT LINE } Indirect Costs
Direct Costs

DIRECT
COST } COGS

PANEL B: ABC SYSTEM

INDIRECT
Shelf- Customer
COST Ordering Delivery
Stocking Support
POOL

COST Number of Number of Hours of Number of

Purchase Order Deliveries Shelf-Stocking Items Sold
ALLOCATION
BASE
Indirect Costs
COST OBJECT:
PRODUCT LINE Direct Costs

DIRECT
COST
COGS
14-18 (20−30 min.) Customer profitability, service company.

Instant Service (IS) repairs printers and photocopiers for five multisite companies in a tristate area.
IS’s costs consist of the cost of technicians and equipment that are directly traceable to the
customer site and a pool of office overhead. Until recently, IS estimated customer profitability by
allocating the office overhead to each customer based on share of revenues. For 2013, IS reported
the following results:

Tina Sherman, IS’s new controller, notes that office overhead is more than 10% of total costs, so
she spends a couple of weeks analyzing the consumption of office overhead resources by
customers. She collects the following information:

Required:
1. Compute customer-level operating income using the new information that Sherman has
gathered.
2. Prepare exhibits for IS similar to Exhibits 14-4 and 14-5. Comment on the results.
3. What options should IS consider, with regard to individual customers, in light of the new data
and analysis of office overhead?
 SOLUTION
1.
Avery Okie Wizard Grainger Duran
Revenues $260,000 $200,000 $322,000 $122,000 $212,000
Technician and equipment cost 182,000 175,000 225,000 107,000 178,000
Gross margin 78,000 25,000 97,000 15,000 34,000
Service call handling
($75 × 150; 240; 40; 120; 180) 11,250 18,000 3,000 9,000 13,500
Web-based parts ordering
($80 × 120; 210; 60; 150; 150) 9,600 16,800 4,800 12,000 12,000
Billing/Collection
($50 × 30; 90; 90; 60; 120) 1,500 4,500 4,500 3,000 6,000
Database maintenance
($10 × 150; 240; 40; 120; 180) 1,500 2,400 400 1,200 1,800
Customer-level operating income $ 54,150 $ (16,700) $ 84,300 $(10,200) $ 700

2. Customers Ranked on Customer-Level Operating Income

Cumulative
Customer-Level
Operating Income
Customer-Level Customer-Level Cumulative as a % of Total
Operating Customer Operating Income Customer-Level Customer-Level
Customer Income Revenue as a % of Revenue Operating Income Operating Income
Code (1) (2) (3) = (1) ÷ (2) (4) (5) = (4) ÷ $112,250
Wizard $ 84,300 $ 322,000 26.18% $ 84,300 75%
Avery 54,150 260,000 20.83% 138,450 123%
Duran 700 212,000 0.33% 139,150 124%
Grainger (10,200) 122,000 –8.36% 128,950 115%
Okie (16,700) 200,000 –8.35% 112,250 100%
$112,250 $1,116,000

Customer-Level Operating Income

$100,000

$84,300
$80,000
Customer-Level Operating Income

$60,000 $54,150

Wizard
$40,000
Avery

$20,000 Duran

Grainger Okie
$700
$0

$(10,200)
-$20,000 $(16,700)

-$40,000
Customers
The table and graph above present the summary results.
The following is the whale curve of cumulative profitability for Instant Service’s customers.

Whale Curve of Cumulative Profitability for Instant

Service's Customers
140%

120%
Percent of Total Income
Cumulative Income as a

100%

80%

60%

40%

20%

0%
Wizard Avery Duran Grainger Okie
Customers

Wizard, the most profitable customer, provides 75% of total operating income. The three best
customers provide 124% of IS’s operating income, and the other two, by incurring losses for IS,
erode the extra 24% of operating income down to IS’s operating income.

3. The options that IS should consider include:

a. Increase the attention paid to Wizard and Avery. These are “key customers,” and every
effort has to be made to ensure they retain IS. IS may well want to suggest a minor
price reduction to signal how important it is in their view to provide a cost-effective
service to these customers.
b. Seek ways of reducing the costs or increasing the revenues of the problem accounts—
Okie and Grainger. For example, are the copying machines at those customer locations
outdated and in need of repair? If yes, an increased charge may be appropriate. Can IS
provide better on-site guidelines to users about ways to reduce breakdowns?
c. As a last resort, IS may want to consider dropping particular accounts. For example, if
Grainger (or Okie) will not agree to a fee increase but has machines continually
breaking down, IS may well decide that it is time not to bid on any more work for that
customer. But care must then be taken to otherwise use or get rid of the excess fixed
capacity created by “firing” unprofitable customers.
Time-Driven ABC
Marketing Specialists Inc. (MSI) provides a range of services to its retail clients—customer
service for inquiries, ordering taking, credit checking for new customers, and a variety of related
services. Auto Supermarket (AS) is a large auto dealer that provides financing for the autos and
trucks that it sells. AS has approached MIS to manage the inquiries that come in regarding these
loans. AS is not satisfied with the performance of the call center it currently uses for handling
inquiries on these loans and is considering a change to MSI. MSI has been asked to estimate the
cost of providing the service for the coming year. There are two types of loans at AS, one for
autos and SUVs and another for light trucks. The loans for auto and truck buyers typically have
different types of customers and loan terms, so the nature and volume of the inquiries are
expected to differ. MSI would use its own call center to handle the AS engagement. The MSI
call center’s annual costs are as follows:

Call Center Costs

Salaries $4,223,555
Utilities 2,387,446
Leasing of facilities 1,983,063
Other expenses 801,036
$9,395,100

MSI’s call center is staffed 12 hours per day with 60 call staff always available. Each staff has a
paid 10-minute break for each hour worked, and an unpaid 1-hour break for a lunch/dinner
during their 12-hour shift. Thus, the call center has 12,045,000 minutes (11 hrs. ×50 min. × 60
staff × 365 days) available for calls during the year.

AS and MSI work together to estimate the number of calls and time required for each call, based
on AS’s prior experience with its current call center.

Inquiries Total Calls Average Number Total Time

Answered of Minutes/Call (minutes)
Inquire re: rates and terms
Autos 96,000 5 480,000
Trucks 32,000 7 224,000
Inquire re: loan application status
Autos 37,500 6 225,000
Trucks 6,750 11 74,250
Inquire re: payment status
Autos 39,000 3 117,000
Trucks 12,000 4 48,000
Inquire re: other matters
Autos 29,000 11 319,000
Trucks 8,500 15 127,500
1,614,750
Required
1. Determine the amount that MSI should propose to charge AS for the coming year using
TDABC, assuming MSI desired a profit of 25 percent of incurred cost.

Suppose that in addition to the call center engagement outlined above, AS also provides the
following annual service to 10 other clients:

Total Calls Average Number of Total Time

Answered Minutes/Call (minutes)
Platinum Regional Bank 234,000 6.0 1,404,000
Healthwise Software Inc 66,788 5.0 333,940
Johnson Manufacturing 122,665 4.0 490,660
Lesco Online Shopping 233,756 6.0 1,402,536
Babcock Insurance Service 55,455 5.5 305,003
Garcia Electric Supply and Service 38,956 3.4 132,450
Gilbert’s Online Garden Supplies 145,902 4.0 583,608
Financial Planning Services Inc 68,993 11.0 758,923
Porter’s Camera and Optical 198,440 6.0 1,190,640
Jordan Auto 965,887 3.0 2,897,661
Total 9,499,421

Required
2. What is the unused capacity at MSI, not assuming that AS becomes a customer? What
are the implications for the operating and marketing strategies at AS?

3. Assume that AS comes back to MSI with a revised proposal. The revised proposal
includes call center activity as described in problem 5-64, but in addition, AS wants MSI
to provide error-checking services for those who apply for loans at AS. MSI would use
some of the call center staff, after appropriate training, to complete the processing of the
credit checks. AS expects the following service to be needed:

Processing Credit Checks Requests Min./request

Auto 45,600 10
Truck 12,500 18

What would be the unused capacity with the revised proposal? What would be the cost of
the unused capacity?
Solution
1. Determine the amount that MSI should propose to charge AS for the coming year using
TDABC, assuming MSI desired a profit of 25 percent of incurred cost.

The TDABC rate per minute for MSI is determined as follows:

Practical Capacity = 11 hrs. x 50 mins x 60 staff x 365 days = 12,045,000 mins

Total Projected Costs ÷ Practical Capacity = €9,395,100 ÷ 12,045,000 = €0.78 per minute
The charge to AS should be estimated as follows:
First, the cost of the engagement: total time in minutes 1,614,750 × €0.78 = €1,259,505
Second, the markup on the cost: €1,259,505 × 1.25 = €1,574,381

2. What is the unused capacity at MSI, not assuming that AS becomes a customer? What
are the implications for the operating and marketing strategies at AS?

Practical capacity 12,045,000

Capacity used without AS customer 9,499,421
Unused capacity 2,545,579

Thee 2,545,579 minutes of unused capacity is relatively large (21.1% of total capacity)
and has important implications for MSI’s operating and marketing strategy. First, it
indicates the importance of getting the AS engagement, which would reduce unused
capacity to 7.7%, a substantial improvement. Also, it points to the need to examine
staffing levels to bring down the cost of unused capacity. Alternatively, MSI can use the
unused time to provide staff training in order to improve their performance and to make
MSI’s services more attractive to other potential clients.

3. What would be the unused capacity with the revised proposal? What would be the cost of
the unused capacity?

Total minutes used AS

From part 1 1,614,750
Processing Credit Checks:
Auto 45,600×10 = 456,000 456,000
Truck 12,500×18 = 225,000 225,000
2,295,750

Minutes other clients: 9,499,421

Total 11,795,171

Practical capacity 12,045,000

Capacity used 11,795,171
Unused capacity 249,829

Cost of unused capacity = 249,829 × €0.78 = €194,867