Brief Exercise 6-1 (30 minutes) - UiO

Prelab Questions for Exercise 11: Sketch a growth curve for batch growth of E.coli with x-axis as growth time and y-axis as the log(# of cells). Label the phases of ...


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proach assumes that overhead costs are proportional to volume. However, overhead costs are often driven by other factors, including the number of batches run and product complexity, that are only loosely related, if at all, to volume. Activity-based costing attempts to more accurately assign overhead costs to products based on the activities that they cause rather than just on the number of units produced or direct labor-hours required.
3-4 The hierarchical levels are:
1. Unit-level activities, which are performed each time a unit is produced.
2. Batch-level activities, which are performed each time a batch of goods is handled or processed.
3. Product-level activities, which are performed as needed to support specific products.
4. Facility-level activities, which sustain an organization’s general capabilities.
3-5 Activity-based costing involves two stages of overhead cost assignments. In the first stage, costs are assigned to activity cost pools. In the second stage, costs are allocated from the activity cost pools to products.
3-6 In a conventional costing system, overhead costs are allocated to products using some measure of volume such as direct labor-hours or machine-hours. Consequently, the high-volume products, which have the largest amount of direct labor-hours or machine-hours, are allocated most of the overhead cost. In activity-based costing, some of the overhead costs are typically allocated using batch-level or product-level allocation bases. For example, if each product is allocated a total of $10,000 in product-level cost irrespective of its volume, then a high-volume product will be allocated exactly the same total overhead as a low-volume product. In contrast, if a measure of volume like direct labor-hours or machine-hours were used to allocate this cost, the high-volume product would be allocated a larger total sum than the low-volume product.
3-7 Activity-based costing improves the accuracy of product costs in three ways. First, activity-based costing increases the number of cost pools used to accumulate overhead costs. Rather than accumulating all overhead costs in a single, plantwide pool, or accumulating them in departmental pools, costs are accumulated for each major activity. Second, the activity cost pools are more homogeneous than departmental cost pools. In principle, all of the costs in an activity cost pool pertain to a single activity. In contrast, departmental cost pools contain the costs of many different activities carried out in the department. Third, activity-based costing changes the bases used to assign overhead costs to products. Rather than assigning costs on the basis of direct labor or some other measure of volume, costs are assigned on the basis of activity measures that gauge how much of the overhead resource has been consumed by a particular activity.
3-8 While the product costs computed using activity-based costing are almost certainly more accurate than those computed using more conventional costing methods, activity-based costing nevertheless rests on some questionable assumptions about cost behavior. In particular, activity-based costing assumes that costs are proportional to activity. In reality, costs appear to increase less than in proportion to increases in activity. This implies that activity-based product costs will be overstated for purposes of making decisions. (The same criticism can be leveled at conventional product costs.) Second, the costs of implementing and maintaining an activity-based costing system can be high and the benefits may not justify this cost.
Brief Exercise 3-1 (10 minutes)
a.Various individuals manage the parts inventories.Product-levelb.A clerk in the factory issues purchase orders for a job.Batch-levelc.The personnel department trains new production workers.Facility-leveld.The factory’s general manager uses her office in the factory building.Facility-levele.Direct labor workers assemble products.Unit-levelf.Engineers design new products.Product-levelg.The materials storekeeper issues raw materials to be used in jobs.Batch-levelh.The maintenance department performs periodic preventative maintenance on general-use equipment.Facility-level
Some of these classifications are debatable and depend on the specific circumstances found in particular companies.
Brief Exercise 3-2 (15 minutes)
1. The activity rates are computed as follows:

Activity Cost Pool(a)
Estimated
Overhead
Cost(b)
Expected
Activity(a) ÷ (b)
Activity
RateLabor related $ 52,0008,000DLHs$ 6.50per DLHMachine related 15,00020,000MHs0.75per MHMachine setups 42,0001,000setups42.00per setupProduction orders 18,000500orders36.00per orderProduct testing 48,0002,000tests24.00per testPackaging 75,0005,000packages15.00per packageGeneral factory  108,8008,000DLHs13.60per DLHTotal $358,800
2. The predetermined overhead rate based entirely on direct labor-hours would be computed as follows:

Total estimated overhead cost (a) $358,800Total expected direct labor-hours (b)      8,000DLHsPredetermined overhead rate (a) ÷ (b) $   44.85per DLH Brief Exercise 3-3 (30 minutes)
The unit product costs for the products are a combination of direct materials, direct labor, and overhead costs. The overhead costs assigned to each product would be computed as follows:

J78B52 Expected
Activity AmountExpectedActivityAmountLabor related, at $7.00 per direct labor-hour  1,000 $ 7,000  40 $ 280 Machine related, at $3.00 per machine-hour  3,200  9,600  30  90 Machine setups, at $40.00 per setup  5  200  1  40 Production orders, at $160.00 per order  5  800  1  160 Shipments, at $120.00 per shipment  10  1,200  1  120 General factory, at $4.00 per direct labor-hour  1,000    4,000  40   160 Total overhead cost assigned (a)  $22,800 $ 850 Number of units produced (b)    4,000   100 Overhead cost per unit (a) ÷ (b) $   5.70 $8.50 
The unit product costs combine direct materials, direct labor, and overhead costs as follows:

J78B52Direct materials $ 6.50$31.00Direct labor 3.756.00Manufacturing overhead (see above)    5.70   8.50Unit product cost $15.95$45.50 Brief Exercise 3-4 (30 minutes)
1. Using the company's conventional costing system, the overhead costs applied to the products would be computed as follows:

 Product H  Product L TotalNumber of units produced (a) 40,0008,000Direct labor-hours per unit (b)    0.40 0.40Total direct labor-hours (a) × (b) 16,0003,20019,200
Total manufacturing overhead (a) $1,632,000Total direct labor-hours (b)       19,200DLHsPredetermined overhead rate (a) ÷ (b) $      85.00per DLH
 Product H  Product L TotalManufacturing overhead applied per unit 0.40 DLH per unit × $85.00 per DLH $      34.00$   34.00Number of units produced       40,000     8,000Total manufacturing overhead applied $1,360,000$272,000$1,632,000
2. Using the proposed ABC system, overhead costs would be applied as follows:

Product HProduct LTotalTotal manufacturing overhead applied (a) $816,000$816,000$1,632,000Number of units produced (b)    40,000     8,000Manufacturing overhead per unit (a) ÷ (b) $   20.40$ 102.00 Brief Exercise 3-4 (continued)
3. Under the company’s old method of allocating overhead costs, the high-volume product, Product H, was allocated most of the overhead cost. This occurred simply because the high-volume product is responsible for most of the direct labor-hours. When the overhead is split evenly between the two products, $544,000 of overhead cost is shifted from the high-volume product, Product H, to the low-volume product, Product L. Consequently, the shift from direct labor-hours as an allocation base to an even split of the overhead costs between the two products favors the high-volume product, Product H, and penalizes the low-volume product, Product L. Note that on a per unit basis, the impact is much greater for the low-volume product, Product L, than for the high-volume product, Product H. This is because the impact per unit of shifting the $544,000 in overhead costs is much greater for the low-volume product than for the high-volume product.
Brief Exercise 3-5 (45 minutes)
1. The journal entries are:

a.Raw Materials 928,000Accounts Payable 928,000b.Work in Process 822,000Manufacturing Overhead 109,000Raw Materials 931,000c.Work in Process 396,000Manufacturing Overhead 72,000Wages Payable 468,000d.Manufacturing Overhead 284,000Accumulated Depreciation 284,000e.Manufacturing Overhead 175,000Accounts Payable 175,000
f. Compute the amount of overhead applied.

Activity ActualOverhead Activity Cost PoolRateActivityAppliedMachine related $1815,000$270,000Purchase orders 7890070,200Machine setups 631,30081,900General factory 1412,000 168,000Total $590,100
Work in Process 590,100Manufacturing Overhead 590,100g.Finished Goods 1,830,000Work in Process 1,830,000 Brief Exercise 3-5 (continued)
2.
Raw MaterialsWork in ProcessBal.25,000931,000(b)Bal.44,0001,830,000(g)(a)928,000(b)822,000(c)396,000(f)590,100
Finished GoodsAccumulated DepreciationBal.86,000284,000(d)(g)1,830,000
Accounts PayableWages Payable928,000(a)468,000(c)175,000(e)
Manufacturing Overhead(b)109,000590,100(f)(c)72,000(d)284,000(e)175,000640,000590,100Bal.49,900
3. The overhead over- or underapplied can be computed as follows:

Actual overhead incurred $640,000Overhead applied  590,100Overhead underapplied $ 49,900 Exercise 3-6 (15 minutes)
1. & 2.
ActivityActivity ClassificationExamples of Activity Measuresa.Preventive maintenance is performed on general-purpose production equipment.Organization-sustainingNot applicable; these costs probably should not be assigned to products or customers.b.Products are assembled by hand.Unit-levelTime spent assembling products.c.Reminder notices are sent to customers who are late in making payments.Customer-levelNumber of reminders; time spent preparing reminders.d.Purchase orders are issued for materials to be used in production.Batch-levelNumber of purchase orders; time spent preparing purchase orderse.Modifications are made to product designs.Product-levelNumber of modifications made; time spent making modificationsf.New employees are hired by the personnel office.Organization-sustainingNot applicable; these costs probably should not be assigned to products or customers.g.Machine settings are changed between batches of different products.Batch-levelNumber of batch setups; time spent making setupsh.Parts inventories are maintained in the storeroom. (Each product requires its own unique parts.)Product-levelNumber of products; number of parts; time spent maintaining inventories of partsi.Insurance costs are incurred on the company’s facilities.Organization-sustainingNot applicable; these costs probably should not be assigned to products or customers. Exercise 3-7 (45 minutes)
1. The unit product costs under the company's conventional costing system would be computed as follows:

MerconWurconTotalNumber of units produced (a) 10,00040,000Direct labor-hours per unit (b)    0.20   0.25Total direct labor-hours (a) × (b)  2,00010,00012,000
Total manufacturing overhead (a) $336,000 Total direct labor-hours (b)    12,000DLHsPredetermined overhead rate (a) ÷ (b) $   28.00per DLH
MerconWurcon Direct materials $10.00$ 8.00Direct labor 3.003.75Manufacturing overhead applied:0.20 DLH per unit × $28.00 per DLH 5.600.25 DLH per unit × $28.00 per DLH      7.00Unit product cost $18.60$18.75 Exercise 3-7 (continued)
2. The unit product costs with the proposed ABC system can be computed as follows:

Activity Cost PoolEstimated
Overhead
Cost*(b)
Expected
Activity(a) ÷ (b)
Activity
RateLabor related $168,00012,000direct labor-hours$14.00per direct labor-hourEngineering design  168,0008,000engineering-hours$21.00per engineering-hour$336,000
*The total overhead cost is split evenly between the two activity cost pools.

 MerconWurcon ExpectedExpectedActivity AmountActivityAmountLabor related, at $14.00 per direct labor-hour 2,000$  28,00010,000$140,000Engineering design, at $21.00 per engineering-hour 4,000    84,0004,000   84,000Total overhead cost assigned (a) $112,000$224,000Number of units produced (b) 10,00040,000Overhead cost per unit (a) ÷ (b) $11.20$5.60 Exercise 3-7 (continued)
The unit product costs combine direct materials, direct labor, and overhead costs:

MerconWurconDirect materials $10.00$ 8.00Direct labor 3.003.75Manufacturing overhead (see above)  11.20   5.60Unit product cost $24.20$17.35
3. The unit product cost of the high-volume product, Wurcon, declines under the activity-based costing system, whereas the unit product cost of the low-volume product, Mercon, increases. This occurs because half of the overhead is applied on the basis of engineering design hours instead of direct labor-hours. When the overhead was applied on the basis of direct labor-hours, most of the overhead was applied to the high-volume product. However, when the overhead is applied on the basis of engineering-hours, more of the overhead cost is shifted over to the low-volume product. Engineering-hours is a product-level activity, so the higher the volume, the lower the unit cost and the lower the volume, the higher the unit cost.
Exercise 3-8 (30 minutes)
1. Entry (a) is the amount of actual manufacturing overhead cost incurred during the year. Debits to Manufacturing Overhead represent actual overhead costs incurred and credits represent overhead applied to products.

2. The activity rates would be computed as follows:

Activity Cost Pool(a)
Estimated
Overhead
Cost(b)
Expected
Activity(a) ÷ (b)
Activity
RateLabor related $156,00026,000DLHs$6per DLHPurchase orders $11,000220orders$50per orderParts management $80,000100part types$800per part typeBoard etching $90,0002,000boards$45per boardGeneral factory $180,00020,000MHs$9per MH
3. Computation of the manufacturing overhead cost applied to production:

Activity Cost Pool(a)
Activity Rate(b)
Actual Activity(a) × (b)
Applied
OverheadLabor related $6per DLH25,000DLHs$150,000Purchase orders $50per order200orders10,000Parts management $800per part type110part types88,000Board etching $45per board1,800boards81,000General factory $9per MH22,000MHs 198,000Total $527,000
4. The overhead over- or underapplied can be computed as follows:

Actual overhead incurred $530,000Overhead applied  527,000Overhead underapplied $  3,000 Exercise 3-9 (30 minutes)
The overhead applied to each product can be computed as follows:

Product A
Activity Cost Pool(a)
Activity Rate(b)
Actual Activity(a) × (b)
Applied
OverheadLabor related $6per DLH6,000DLHs$ 36,000Purchase orders $50per order60orders3,000Parts management $800per part type30part types24,000Board etching $45per board500boards22,500General factory $9per MH3,000MHs   27,000Total $112,500
Product B
Activity Cost Pool(a)
Activity Rate(b)
Actual Activity(a) × (b)
Applied
OverheadLabor related $6per DLH10,000DLHs$ 60,000Purchase orders $50per order30orders1,500Parts management $800per part type25part types20,000Board etching $45per board900boards40,500General factory $9per MH8,000MHs   72,000Total $194,000
Product C
Activity Cost Pool(a)
Activity Rate(b)
Actual Activity(a) × (b)
Applied
OverheadLabor related $6per DLH4,000DLHs$ 24,000Purchase orders $50per order20orders1,000Parts management $800per part type40part types32,000Board etching $45per board400boards18,000General factory $9per MH5,000MHs   45,000Total $120,000 Exercise 3-9 (continued)
Product D
Activity Cost Pool(a)
Activity Rate(b)
Actual Activity(a) × (b)
Applied
OverheadLabor related $6per DLH5,000DLHs$ 30,000Purchase orders $50per order90orders4,500Parts management $800per part type15part types12,000Board etching $45per board0boards0General factory $9per MH6,000MHs   54,000Total $100,500
Note that the sum of the overhead costs applied to the individual products ($112,500 + $194,000 + $120,000 + $100,500) equals the total amount of overhead applied ($527,000).
Exercise 3-10 (30 minutes)
1. Activity rates can be computed as follows:

Activity Cost Pool(a)
Estimated
Overhead
Cost(b)
Expected
Activity(a) ÷ (b)
Activity
RateMachine setups $21,600180setups$120per setupSpecial processing $180,0004,000MHs$45per MHGeneral factory $288,00024,000DLHs$12per DLH
2. The unit product costs would be computed as follows, starting with the computation of the manufacturing overhead:

RimsPostsMachine setups:$120 per setup × 100 setups $ 12,000$120 per setup × 80 setups $   9,600Special processing:$45 per MH × 4,000 MHs 180,000$45 per MH × 0 MHs 0General factory:$12 per DLH × 8,000 DLHs 96,000$12 per DLH × 16,000 DLHs              192,000Total overhead cost (a) $288,000$201,600Number of units produced (b) 20,00080,000Overhead cost per unit (a) ÷ (b) $14.40$2.52RimsPostsDirect materials $17.00$10.00Direct labor:$16 per DLH × 0.40 DLHs 6.40$16 per DLH × 0.20 DLHs 3.20Manufacturing overhead (see above)  14.40   2.52Unit product cost $37.80$15.72 Problem 3-11 (15 minutes)
ActivityLevelPossible Activity Measures a.Milling machines are used to make components for products.UnitNumber of units processed; Machine-hours b.A percentage of all completed goods are inspected on a random basis.UnitNumber of units inspected; Inspection time c.Production orders are issued for jobs.BatchNumber of production orders d.The company’s grounds crew maintains planted areas surrounding the factory.FactoryArbitrary* e.Employees are trained in general procedures.Factory or ProductArbitrary if factory-level* f.The human resources department screens and hires new employees.FactoryArbitrary* g.Purchase orders are issued for materials required in production.BatchNumber of purchase orders h.Material is received on the receiving dock and moved to the production area.Batch or UnitNumber of material moves i.The plant controller prepares periodic accounting reports.FactoryArbitrary* j.The engineering department makes modifications in the designs of products.ProductEngineering time k.Machines are set up between batches of different products.BatchNumber of setups; Setup time l.The maintenance crew does routine periodic maintenance on general-purpose equipment.FactoryArbitrary*
*Factory-level costs are commonly allocated using an arbitrary allocation base such as direct labor-hours.
Problem 3-12 (75 minutes)
1. The company’s estimated total direct labor-hours for the year can be computed as follows:

Flexible model: 1,000 units × 2.0 DLH per unit 2,000Rigid model: 10,000 units × 1.0 DLH per unit 10,000Total direct labor-hours 12,000
Using direct labor-hours as the allocation base, the predetermined overhead rate would be:
 EMBED Equation.DSMT4 
The unit product costs are computed as follows:

FlexibleRigidDirect materials $110.00$ 80.00Direct labor 30.0015.00Manufacturing overhead:$50.00 per DLH × 2.0 DLHs 100.00$50.00 per DLH × 1.0 DLHs           50.00Unit product cost $240.00$145.00
2. Activity rates can be computed as follows:

(a)Estimated (b)
Expected
Activity(a) ÷ (b)
Activity
RateOverhead Activity Cost PoolCostPurchase orders $20,000400orders$50.00per orderRework requests $10,000200requests$50.00per requestProduct testing $210,0002,100tests$100.00per testMachine related $360,0004,000MHs$90.00per MH Problem 3-12 (continued)
3. a.FlexibleRigidExpectedExpectedActivityAmountActivityAmountPurchase orders, at $50.00 per order 100$   5,000300$ 15,000Rework requests, at $50.00 per request 603,0001407,000Product testing, at $100.00 per test 90090,0001,200120,000Machine related, at $90.00 per MH 1,500 135,0002,500 225,000Total overhead cost assigned (a) $233,000$367,000Number of units produced (b) 1,00010,000Overhead cost per unit (a) ÷ (b) $233.00$36.70
b. Using activity-based costing, the unit product costs would be:

FlexibleRigidDirect materials $110.00$ 80.00Direct labor 30.0015.00Manufacturing overhead  233.00   36.70Unit product cost $373.00$131.70 Problem 3-12 (continued)
4. Unit product costs are distorted as a result of using direct labor-hours as the base for applying overhead costs to products. Although the flexible model requires twice as much labor as the rigid model, it still is not being assigned enough overhead cost according to the activity-based costing system.

According to the activity-based costing system, the flexible model is more expensive to manufacture than the company thought. Note that the flexible model accounts for 37.5% of the machine-hours worked, although it represents a small part of the company’s total output. Also, it consumes a disproportionately large amount of the other activities.

When activity-based costing is used in place of direct labor-hours as the basis for assigning overhead cost to products, the unit product cost of the flexible model jumps up from $240.00 to $373.00. If the $240.00 figure is being used as the basis for pricing, then the selling price may be too low for the flexible model. This may be the reason why profits have been declining for the last several years. It may also be the reason why sales of the flexible model have been increasing rapidly.

Problem 3-13 (75 minutes)
1. The activity rates are computed as follows:

Activity Cost Pool(a)
Estimated
Overhead
Cost(b)
Expected
Activity(a) ÷ (b)
Activity
RateLabor related $35,0007,000DLHs$5per DLHProduction orders $4,0002,000orders$2per orderMaterial receipts $10,450950receipts$11per receiptRelay assembly $7,0001,000relays$7per relayGeneral factory $240,00040,000MHs$6per MH
2. a. The journal entry to record actual manufacturing overhead costs is:

Manufacturing Overhead 296,690Accounts Payable 296,690
 Manufacturing Overhead (2a)296,690 
b. The manufacturing overhead applied is computed as follows:

(a)
Activity
Rate(b)
Actual
Activity(a) × (b)
Applied
OverheadActivity Cost PoolLabor related $5per DLH6,700DLHs$ 33,500Production orders $2per order1,900orders3,800Material receipts $11per receipt700receipts7,700Relay assembly $7per relay930relays6,510General factory $6per MH42,000MHs 252,000Total $303,510 Problem 3-13 (continued)
c. The journal entry to record applied manufacturing overhead is:

Work in Process 303,510Manufacturing Overhead 303,510
 Manufacturing Overhead (2a)296,690303,510(2c) 
d. The overhead is overapplied by $6,820. This can be determined from the T-account or directly:

 Manufacturing Overhead (2a)296,690303,510(2c)6,820
Actual overhead incurred $296,690Overhead applied  303,510Overhead overapplied $  (6,820)
3. a. Overhead cost is applied to the products as follows:

Product AActivity Cost Pool(a)
Activity
Rate(b)
Actual
Activity(a) × (b)
Applied
OverheadLabor related $5per DLH2,400DLHs$12,000Production orders $2per order100orders200Material receipts $11per receipt400receipts4,400Relay assembly $7per relay170relays1,190General factory $6per MH12,000MHs 72,000Total $89,790 Problem 3-13 (continued)
Product BActivity Cost Pool(a)
Activity
Rate(b)
Actual
Activity(a) × (b)
Applied
OverheadLabor related $5per DLH500DLHs$ 2,500Production orders $2per order350orders700Material receipts $11per receipt200receipts2,200Relay assembly $7per relay400relays2,800General factory $6per MH7,000MHs 42,000Total $50,200
Product CActivity Cost Pool(a)
Activity
Rate(b)
Actual
Activity(a) × (b)
Applied
OverheadLabor related $5per DLH3,000DLHs$15,000Production orders $2per order500orders1,000Material receipts $11per receipt100receipts1,100Relay assembly $7per relay0relays0General factory $6per MH8,000MHs 48,000Total $65,100
Product DActivity Cost Pool(a)
Activity
Rate(b)
Actual
Activity(a) × (b)
Applied
OverheadLabor related $5per DLH800DLHs$ 4,000Production orders $2per order950orders1,900Material receipts $11per receipt0receipts0Relay assembly $7per relay360relays2,520General factory $6per MH15,000MHs 90,000Total $98,420
b. The total amount applied to the products ($89,790 + $50,200 + $65,100 + $98,420 = $303,510) is the same as the total manufacturing overhead applied that appears as the credit entry in the manufacturing overhead T-account.
Problem 3-14 (75 minutes)
1. a. When direct labor-hours are used to apply overhead costs to products, other factors affecting the incurrence of overhead costs are ignored. The company’s predetermined overhead rate would be:
 EMBED Equation.DSMT4 

b. The unit product costs are computed as follows:

Model N 800 XLModel N 500Direct materials $ 75.00$ 25.00Direct labor:$18.00 per DLH × 3.0 DLHs 54.00$18.00 per DLH × 1.0 DLHs 18.00Manufacturing overhead:$85.00 per DLH × 3.0 DLHs 255.00$85.00 per DLH × 1.0 DLHs               85.00Unit product cost $384.00$128.00
2. a. Activity rates can be computed as follows:

Activity Cost Pool(a) Estimated Overhead Cost(b) Expected Activity(a) ÷ (b) Activity RateMachine setups $360,000300setups$1,200.00per setupSpecial processing $165,00016,500MHs$10.00per MHGeneral factory $1,260,00021,000DLHs$60.00per DLH Problem 3-14 (continued)
b. The unit product costs would now be computed as follows, starting with the computation of the manufacturing overhead:

Model N 800 XLModel N 500Machine setups:$1,200.00 per setup × 100 setups $120,000$1,200.00 per setup × 200 setups $240,000Special processing:$10.00 per MH × 16,500 MHs 165,000$10.00 per MH × 0 MHs 0General factory:$60.00 per DLH × 9,000 DLHs 540,000$60.00 per DLH × 12,000 DLHs               720,000Total overhead cost (a) $825,000$960,000Number of units produced (b) 3,00012,000Overhead cost per unit (a) ÷ (b) $275.00$80.00
Model N 800 XLModel N 500Direct materials $ 75.00$25.00Direct labor:$18.00 per DLH × 3.0 DLHs 54.00$18.00 per DLH × 1.0 DLHs 18.00Manufacturing overhead (see above)  275.00   80.00Unit product cost $404.00$123.00
3. It is important to note that, even under activity-based costing, 71% of the company’s overhead costs continue to be applied to products on the basis of direct labor-hours:

Machine setups (number of setups) $  360,00020%Special processing (machine-hours) 165,0009General factory (direct labor-hours)  1,260,000 71Total $1,785,000100% Problem 3-14 (continued)
Thus, the shift in overhead cost from the high-volume product Model N 500 to the low-volume product Model N 800 XL occurred as a result of reassigning only 29% of the company’s overhead costs.

The increase in unit cost of Model N 800 XL can be explained as follows: First, where possible, overhead costs have been traced to the products rather than being lumped together and spread uniformly over all units. Therefore, special processing costs, which are all due to processing Model N 800 XL, have been assigned to Model N 800 XL and none to Model N 500 under the activity-based costing approach.

Second, the costs associated with the batch-level activity (machine setups) have been assigned on the basis of setups rather than direct labor-hours. Each setup, regardless of the batch size, is assigned the same amount of machine setup cost. Some products are produced in large batches and some are produced in small batches. The smaller the batch, the higher the per unit cost of the batch activity. In this example, the data can be analyzed as follows:

Model N 800 XL:Machine setup cost from ABC system (a) $1,200per setupAverage number of units per setup 3,000 units ÷ 100 setups (b) 30units per setupAverage setup cost per unit (a) ÷ (b) $40.00per unitModel N 500:Machine setup cost from ABC system (a) $1,200per setupAverage number of units per setup 12,000 units ÷ 200 setups (b) 60units per setupAverage setup cost per unit (a) ÷ (b) $20.00per unit
Thus, the average setup cost per unit is 2.0 times as great for Model N 800 XL as for Model N 500. Such differences in cost are obscured when direct labor-hours (or any similar measure of volume) is used as the basis for applying overhead costs to products.

Problem 3-15 (75 minutes)
1. The activity rates are computed as follows:

Activity Cost Pool(a) Estimated Overhead Cost(b) Expected Activity(a) ÷ (b) Activity RateLabor related $18,0002,000DLHs$9.00per DLHPurchase orders $1,050525orders$2.00per orderProduct testing $3,500350tests$10.00per testTemplate etching $70028templates$25.00per templateGeneral factory $50,00010,000MHs$5.00per MH
2. a. The journal entry to record actual manufacturing overhead costs is:

Manufacturing Overhead 83,700Accounts Payable 83,700
 Manufacturing Overhead (2a)83,700 
b. The manufacturing overhead applied is computed as follows:

Activity Cost Pool(a) Activity Rate(b) Actual Activity(a) × (b) Applied OverheadLabor related $9.00per DLH2,200DLHs$19,800Purchase orders $2.00per order1,000orders2,000Product testing $10.00per test360tests3,600Template etching $25.00per template30templates750General factory $5.00per MH12,000MHs  60,000Total $86,150 Problem 3-15 (continued)
c. The journal entry to record applied manufacturing overhead is:

Work in Process 86,150Manufacturing Overhead 86,150
 Manufacturing Overhead (2a)83,70086,150(2c)
d. The overhead is overapplied by $2,450. This can be determined from the T-account or directly:

 Manufacturing Overhead (2a)83,70086,150(2c)2,450
Actual overhead incurred $83,700Overhead applied  86,150Overhead overapplied $(2,450)
3. a. Overhead cost is applied to the products as follows:

Product AActivity Cost Pool(a) Activity Rate(b) Actual Activity(a) × (b) Applied OverheadLabor related $9.00per DLH500DLHs$ 4,500Purchase orders $2.00per order320orders640Product testing $10.00per test200tests2,000Template etching $25.00per template0 templates0General factory $5.00per MH3,400MHs 17,000Total $24,140 Problem 3-15 (continued)
Product BActivity Cost Pool(a) Activity Rate(b) Actual Activity(a) × (b) Applied OverheadLabor related $9.00per DLH300DLHs$ 2,700Purchase orders $2.00per order120orders240Product testing $10.00per test60tests600Template etching $25.00per template14templates350General factory $5.00per MH2,200MHs 11,000Total $14,890
Product CActivity Cost Pool(a) Activity Rate(b) Actual Activity(a) × (b) Applied OverheadLabor related $9.00per DLH700DLHs$ 6,300Purchase orders $2.00per order500orders1,000Product testing $10.00per test0tests0Template etching $25.00per template10templates250General factory $5.00per MH1,800MHs   9,000Total $16,550
Product DActivity Cost Pool(a) Activity Rate(b) Actual Activity(a) × (b) Applied OverheadLabor related $9.00per DLH700DLHs$ 6,300Purchase orders $2.00per order60orders120Product testing $10.00per test100tests1,000Template etching $25.00per template6templates150General factory $5.00per MH4,600MHs 23,000Total $30,570 Problem 3-15 (continued)
b. The total amount applied to the products ($24,140 + $14,890 + $16,550 + $30,570 = $86,150) is the same as the total manufacturing overhead applied that appears as the credit entry in the manufacturing overhead T-account.

Problem 3-16 (120 minutes)
1. Activity rates for the activity centers are computed below:

Activity Cost Pool(a) Estimated Overhead Cost(b) Expected Activity(a) ÷ (b) Activity RateMachining $52,00013,000MHs$4.00per MHPurchase orders $24,0003,000orders$8.00per orderParts management $36,00060part types$600.00per part typeTesting $63,000700tests$90.00per testGeneral factory $414,00046,000DLHs$9.00per DLH
2. The journal entries follow below:

a. Raw Materials 415,000Accounts Payable 415,000 b. Work in Process 220,000Manufacturing Overhead 180,000Raw Materials 400,000 c. Work in Process 190,000Manufacturing Overhead 140,000Sales Commission Expense 36,000Administrative Salaries Expense 80,000Salaries and Wages Payable 446,000 d. Sales Travel Expense 12,000Accounts Payable 12,000 e. Manufacturing Overhead 158,000Accounts Payable 158,000 f. Advertising Expense 50,000Accounts Payable 50,000 Problem 3-16 (continued)
g. Manufacturing Overhead 143,000Depreciation Expense 57,000Accumulated Depreciation 200,000
h. Compute the amount of overhead applied.

Activity Cost Pool(a) Activity Rate(b) Actual Activity(a) × (b) Applied OverheadMachining $4.00per MH13,200MHs$ 52,800Purchase orders $8.00per order2,950orders23,600Parts management $600.00per part type100part types60,000Testing $90.00per test760tests68,400General factory $9.00per DLH47,000DLHs 423,000Total $627,800
Work in Process 627,800Manufacturing Overhead 627,800 i. Finished Goods 1,007,800Work in Process 1,007,800 j. Accounts Receivable 1,480,000Sales 1,480,000Cost of Goods Sold 1,000,000Finished Goods 1,000,000 Problem 3-16 (continued)
3. Accounts ReceivableRaw Materials(j)1,480,000 Bal.5,000400,000(b) (a)415,000  Bal.20,000 Work in ProcessFinished GoodsBal.10,0001,007,800 (i) Bal.8,0001,000,000 (j) (b)220,000 (i)1,007,800  (c)190,000 Bal.15,800 (h)627,800  Bal.40,000 Accumulated DepreciationManufacturing Overhead200,000 (g) (b)180,000627,800 (h)  (c)140,000 (e)158,000 (g)143,000  6,800Bal. Accounts PayableSalaries and Wages Payable415,000 (a) 446,000(c)12,000 (d) 158,000 (e) 50,000 (f) Commissions ExpenseAdministrative Salaries Expense(c)36,000 (c)80,000 Sales Travel ExpenseAdvertising Expense(d)12,000 (f)50,000 Depreciation ExpenseCost of Goods Sold(g)57,000 (j)1,000,000 Sales1,480,000 (j)  Problem 3-16 (continued)
4. Overhead was overapplied by $6,800 for the year. The actual manufacturing overhead incurred was $621,000 ($180,000 + $140,000 + $158,000 + $143,000 = $621,000) and the overhead applied was $627,800.

Actual overhead incurred $621,000Overhead applied  627,800Overhead overapplied $ (6,800)
The journal entry to close the overapplied overhead to Cost of Goods Sold would be as follows:

Manufacturing Overhead 6,800Cost of Goods Sold 6,800
This journal entry would be posted to the T-accounts as follows:

Manufacturing OverheadCost of Goods Sold(b)180,000627,800(h) (j)1,000,0006,800(4)(c)140,000(e)158,000 993,200(g)143,000 (4)6,800   0Bal.
5.Flint Corporation Income StatementSales $1,480,000Less cost of goods sold     993,200Gross margin 486,800Less selling and administrative expenses:Commission expense $36,000Administrative salaries expense 80,000Sales travel expense 12,000Advertising expense 50,000Depreciation expense  57,000   235,000Net operating income $  251,800
Problem 3-17 (75 minutes)
1. The company expects to work 40,000 direct labor-hours, computed as follows:

LEC 40: 60,000 units × 0.40 DLH per unit 24,000DLHsLEC 90: 20,000 units × 0.80 DLH per unit 16,000DLHsTotal direct labor-hours 40,000DLHs
Using direct labor-hours as the base, the predetermined manufacturing overhead rate would be:
 EMBED Equation.DSMT4 
The unit product cost of each product would be:

LEC 40LEC 90Direct materials $30.00$50.00Direct labor 6.0012.00Manufacturing overhead: $22.80 per DLH × 0.40 DLHs 9.12$22.80 per DLH × 0.80 DLHs           18.24Unit product cost $45.12$80.24 Problem 3-17 (continued)
2. Activity rates can be computed as follows:

Activity Cost Pool(a) Estimated Overhead Cost(b) Expected Activity(a) ÷ (b) Activity RateMaintaining inventory $225,0001,500part types$150.00per part typeProcessing purchase orders $182,0002,800orders$65.00per orderQuality control $45,0002,250tests$20.00per testMachine-related $460,00010,000MHs$46.00per MH
3 a.
LEC 40 LEC 90 Expected Activity AmountExpected ActivityAmountMaintaining parts inventory, at $150.00 per part type 600$  90,000900$135,000Processing purchase orders, at $65.00 per order t2,000130,00080052,000Quality control, at $20.00 per test 50010,0001,75035,000Machine-related, at $46.00 per MH 1,600   73,6008,400 386,400Total manufacturing overhead cost $303,600$608,400Units produced 60,00020,000Manufacturing overhead per unit $5.06$30.42 Problem 3-17 (continued)
b. Using activity-based costing, the unit product costs would be:

LEC 40LEC 90Direct materials $30.00$50.00Direct labor 6.0012.00Manufacturing overhead (see above)    5.06 30.42Unit product cost $41.06$92.42
4. Although the LEC 90 accounts for only 25% of the company’s total production, it is responsible for 60% of the part types carried in inventory and 84% of the machine-hours worked. It is also responsible for 78% of the tests needed for quality control. These factors have been concealed as a result of using direct labor-hours as the base for assigning overhead cost to products. Since the LEC 90 is responsible for a majority of the activity, under activity-based costing it is assigned a larger amount of overhead cost.

The LEC 90 may not be as profitable as management believes, and this may be the reason for the company’s declining profits. Note that from part (1), the unit product cost of the LEC 90 is $80.24. In part (3), however, the activity-based costing system sets the unit product cost of the LEC 90 at $92.42. This is a difference of $12.18 per unit. If management bases the LEC 90’s selling price on the lower figure of $80.24, it is possible that the company may actually be losing money on this product. This could explain declining profits and the apparent popularity of the LEC 90.

Problem 3-18 (60 minutes)
1. The first step is to determine the activity rates:

Serving a Party Serving a Diner Serving Drinks Total cost (a) $32,800$211,200$69,600Total activity (b) 8,000parties32,000diners58,000drinksCost per unit of activity (a)÷(b) $4.10per party$6.60per diner$1.20per drink
2. According to the ABC system, the cost of serving each of the parties can be computed as follows:

Serving a Party Serving a Diner Serving Drinks Cost per unit of activity $4.10per party$6.60per diner$1.20per drink
a. A party of four diners who order three drinks:

143partydinersdrinksCost $4.10$26.40$3.60$34.10
b. A party of two diners who order no drinks:

120partydinersdrinksCost $4.10$13.20$0.00$17.30
c. A lone diner who orders two drinks:

112partydinerdrinksCost $4.10$6.60$2.40$13.10 Problem 3-18 (continued)
3. The average cost per diner for each party can be computed by dividing the total cost of the party by the number of diners in the party as follows:

a. $34.10 ÷ 4 diners = $8.53 per diner
b. $17.30 ÷ 2 diners = $8.65 per diner
c. $13.10 ÷ 1 diner = $13.10 per diner

4. The average cost per diner differs from party to party under the activity-based costing system for two reasons. First, the cost of serving a party ($4.10) does not depend on the number of diners in the party. Therefore, the average cost per diner of this activity decreases as the number of diners in the party increases. With only one diner, the cost is $4.10. With two diners, the average cost per diner is cut in half to $2.05. With five diners, the average cost per diner would be only $0.82. And so on. Second, the average cost per diner differs also because of the differences in the number of drinks ordered by the diners. If a party does not order any drinks, as was the case with the party of two, no costs of serving drinks are assigned to the party.

The average cost per diner differs from the overall average cost of $9.80 per diner because the $9.80 per diner figure does not recognize differences in the diners’ demands on resources. It does not recognize that some diners order more drinks than others nor does it recognize that there are some economies of scale in serving larger parties. (The batch-level costs of serving a party can be spread over more diners if the party is larger.)

We should note that the activity-based costing system itself does not recognize all of the differences in diners’ demands on resources. For example, there are undoubtedly differences in the costs of preparing the various meals on the menu. It may or may not be worth the effort to build a more detailed activity-based costing system that would take such nuances into account.
Analytical Thinking (150 minutes)
1.(a) Estimated Overhead Costs(b) Expected Activity(a) ÷ (b) Predetermined Overhead RatePurchasing $15,000300 orders1$50 per orderMaterial handling 16,000400 receipts2$40 per receiptProduction orders and equipment setup 6,00060 setup-hours3$100 per setup-hourInspection 18,000600 inspection-hours$30 per inspection-hourFrame assembly 12,0001,500 assembly-hours$8 per assembly-hourMachine related 32,0008,000 machine-hours4$4 per machine-hour
60 + 90 + 150 = 300280 + 105 + 215 = 4003Standard: 10 setups × 1 hour per setup 10 hours Specialty: 25 setups × 2 hours per setup 50 hours Total setup hours 60 hours4Standard: 10,000 units × 0.5 hours per unit 5,000 hours Specialty: 2,500 units × 1.2 hours unit 3,000 hours Total machine-hours 8,000 hours Analytical Thinking (continued)
Overhead cost charged to each product:

StandardSpecialtyActivityAmountActivityAmountPurchasing, at $50 per order:Leather 50$ 2,50010$   500Fabric 703,500201,000Synthetic 001507,500Material handling, at $40 per receipt:Leather 702,80010400Fabric 853,40020800Synthetic 002158,600Production orders and equipment setup, at $100 per hour 101,000505,000Inspection, at $30 per hour 2006,00040012,000Frame assembly, at $8 per hour 7005,6008006,400Machine related, at $4 per hour 5,000 20,0003,000 12,000Total manufacturing overhead cost $44,800$54,200
Manufacturing overhead cost per unit of product:
Standard: $44,800 ÷ 10,000 units = $4.48 per unit
Specialty: $54,200 ÷ 2,500 units = $21.68 per unit
Analytical Thinking (continued)
2. The unit product cost of each product under activity-based costing is given below. For comparison, the costs computed by the company’s accounting department using conventional costing are also provided.

Activity-Based CostingDirect Labor-Hour BaseStandardSpecialtyStandardSpecialtyDirect materials $10.00$20.00$10.00$20.00Direct labor 6.004.806.004.80Manufacturing overhead    4.48 21.68   8.25   6.60Total unit product cost $20.48$46.48$24.25$31.40
3. The president was probably correct in being concerned about the profitability of the products, but the problem is apparently with the specialty product rather than the standard. Traditional overhead cost assignment using a volume-based measure has resulted in the high-volume product subsidizing the low-volume product. Thus, unit costs for both products are badly distorted. These distorted costs have had a major impact on management’s pricing policies and on management’s perception of the margin being realized on each product. The specialty briefcases are apparently being sold at a loss even without considering nonmanufacturing costs:

Standard BriefcasesSpecialty BriefcasesSelling price per unit $26.25$42.50 Unit product cost  20.48 46.48 Gross margin (loss) per unit $ 5.77$(3.98)
Based on these data, the company should not shift its resources entirely to the production of specialty briefcases. Whether or not the specialty briefcases can be made profitable depends on a number of factors including the sensitivity of the market to an increase in the selling price of the specialty briefcase.
Analytical Thinking (continued)
Note to the Instructor: You may wish to mention to your class that before any decision can be made regarding dropping a product line, a careful analysis will have to be made of the potential avoidable costs. The unit product costs probably include some idle capacity costs and organization-sustaining costs that are not relevant in such a decision.

4. Perhaps the competition hasn’t been able to touch FirstLine Case’s price because the company has been selling its specialty briefcases at a price that is below its cost. Thus, rather than “gouging” its customers, FirstLine Case’s competitor is probably just pricing its specialty items at a normal markup over their cost. Indeed, according to the activity-based costing system, if FirstLine Case is to realize a profit on its specialty items it may need to charge a price more in line with its competitor’s price (over $50 per unit).

When a company sells a product at a price substantially below that of its competitors, the company’s management should take a careful look at the costing system to be sure that the product is being assigned all the costs that it causes.
Case (150 minutes)
1. a. The predetermined overhead rate would be computed as follows:
 EMBED Equation.DSMT4 
b. The unit product cost per pound, using the company’s present costing system, would be:

Mona LoaMalaysianDirect materials (given) $4.20$3.20Direct labor (given) 0.300.30Manufacturing overhead: 0.025 DLH × $60 per DLH  1.50 1.50Total unit product cost $6.00$5.00
c. The selling price per pound of each coffee would be:

Mona LoaMalaysianManufacturing cost per pound $6.00$5.00Add markup at 30%  1.80 1.50Selling price per pound $7.80$6.50
2. a. Overhead rates by activity center:

Activity Center(a) Estimated Overhead Costs(b) Expected Activity(a) ÷ (b) Predetermined Overhead RatePurchasing $513,0001,710 orders$300 per orderMaterial handling $720,0001,800 setups$400 per setupQuality control $144,000600 batches$240 per batchRoasting $961,00096,100 hours$10 per hour Blending $402,00033,500 hours$12 per hour Packaging $260,00026,000 hours$10 per hour 
Case (continued)
Before we can determine the amount of overhead cost to assign to the products we must first determine the activity for each of the products in the six activity centers. The necessary computations follow:

Number of purchase orders:Mona Loa: 100,000 pounds ÷ 20,000 pounds per order = 5 ordersMalaysian: 2,000 pounds ÷ 500 pounds per order = 4 ordersNumber of batches:Mona Loa: 100,000 pounds ÷ 10,000 pounds per batch = 10 batchesMalaysian: 2,000 pounds ÷ 500 pounds per batch = 4 batchesNumber of setups:Mona Loa: 10 batches × 3 setups per batch = 30 setupsMalaysian: 4 batches × 3 setups per batch = 12 setupsRoasting hours:Mona Loa: 1 hour × (100,000 pounds ÷ 100 pounds) = 1,000 hoursMalaysian: 1 hour × (2,000 pounds ÷ 100 pounds) = 20 hoursBlending hours:Mona Loa: 0.5 hour × (100,000 pounds ÷ 100 pounds) = 500 hoursMalaysian: 0.5 hour × (2,000 pounds ÷ 100 pounds) = 10 hoursPackaging hours:Mona Loa: 0.1 hour × (100,000 pounds ÷ 100 pounds) = 100 hoursMalaysian: 0.1 hour × (2,000 pounds ÷ 100 pounds) = 2 hours Case (continued)
Using the activity figures, manufacturing overhead costs can be assigned to the two products as follows:

Mona LoaMalaysianExpected ActivityAmountExpected ActivityAmountPurchasing, at $300 per order 5 orders$ 1,5004 orders$1,200Material handling, at $400 per setup 30 setups12,00012 setups4,800Quality control, at $240 per batch 10 batches2,4004 batches960Roasting, at $10 per roasting hour 1,000 hours10,00020 hours200Blending, at $12 per blending hour 500 hours6,00010 hours120Packaging, at $10 per packaging hour 100 hours   1,0002 hours      20Total overhead cost $32,900$7,300
b. According to the activity-based costing system, the manufacturing overhead cost per pound is:

Mona LoaMalaysianTotal overhead cost assigned (above) (a) $32,900$7,300Number of pounds manufactured (b) 100,0002,000Cost per pound (a) ÷ (b) $0.33$3.65
c. The unit product costs according to the activity-based costing system are:
Mona LoaMalaysianDirect materials (given) $4.20$3.20Direct labor (given) 0.300.30Manufacturing overhead  0.33 3.65Total unit product cost $4.83$7.15 Case (continued)
3. MEMO TO THE PRESIDENT: Analysis of CBI’s data shows that several activities other than direct labor drive the company’s manufacturing overhead costs. These activities include purchase orders issued, number of setups for material processing, and number of batches processed. The company’s present costing system, which relies on direct labor time as the sole basis for assigning overhead cost to products, significantly undercosts low-volume products, such as the Malaysian coffee, and significantly overcosts high-volume products, such as our Mona Loa coffee.

An implication of the activity-based costing analysis is that our low-volume products may not be covering the costs of the manufacturing resources they use. For example, Malaysian coffee is currently priced at $6.50 per pound, but this price is significantly below its activity-based cost of $7.15 per pound. Under our present costing and pricing system, our high-volume products, such as our Mona Loa coffee, may be subsidizing our low-volume products. Some adjustments in prices may be required.
Case (continued)
ALTERNATIVE SOLUTION:

Most students will compute the manufacturing overhead cost per pound of the two coffees as shown above. However, the per pound cost can also be computed as shown below. This alternative approach provides additional insight into the data and facilitates emphasis of some points made in the chapter.

Mona LoaMalaysianTotalPer Pound (÷ 100,000)TotalPer Pound (÷ 2,000)Purchasing $ 1,500$0.015$1,200$0.600Material handling 12,0000.1204,8002.400Quality control 2,4000.0249600.480Roasting 10,0000.1002000.100Blending 6,0000.0601200.060Packaging    1,000 0.010      20 0.010Total $32,900$0.329$7,300$3.650
Note particularly how batch size impacts unit cost data. For example, the cost to the company to process a purchase order is $300, regardless of how many pounds of coffee are contained in the order. Twenty thousand pounds of the Mona Loa coffee are purchased per order (with five orders per year), and just 500 pounds of the Malaysian coffee are purchased per order (with four orders per year). Thus, the purchase order cost per pound for the Mona Loa coffee is just 1.5 cents, whereas the purchase order cost per pound for the Malaysian coffee is 40 times as much, or 60 cents. As stated in the text, this is one reason why unit costs of low-volume products, such as the Malaysian coffee, increase so dramatically when activity-based costing is used.
Teamwork In Action
Student answers will vary depending on the operations they observe at the restaurant they visit and on how they define a unit and products. The following are only suggestive of the answers that might be offered for a fast food restaurant that sells hamburgers and beverages:

a.Unit-level activities and costsGrilling a burger, assembling a hamburger, making a milkshake, costs of ingredients, costs of containers, etc.b.Customer-level activities and costsTaking an order, assembling ordered items, bagging order, taking payment, etc.c.Product-level activities and costsCost of soft ice cream maker, cost of deep fat fryer, cost of soda dispenser, etc.d.Facility-level activities and costsCost of building rent, cost of manager’s salary, heating and lighting the building, etc.
Ethics Challenge (15 minutes)
Most people would probably feel that the most equitable way to divide the dinner bill among a group of friends is for each person to pay for the cost of what he or she individually consumed. However, it would be easier to split the bill equally among the individuals.

This relates to material in the chapter because the method of dividing up the bill according to what each individual orders is similar to ABC and the method of simply dividing the bill by the number of individuals is similar to traditional costing methods. Figuring out the cost of what each individual consumes properly allocates costs to the individuals who incurred them. However, it sometimes is difficult to trace some costs to individuals. For example, some dishes may be shared. This is also similar to ABC in that some costs are easier to trace than others.
Communicating in Practice (30 minutes)
Date: Current Date
To: Maria Graham
From: Student’s Name
Subject: Overhead Allocation

I understand that you are thinking about purchasing a small manufacturing company that assembles and packages its many products by hand. The company currently uses direct labor hours to allocate overhead to its products, but you plan to introduce automation. You have asked me to comment on whether this technique should be continued.

Direct labor is an appropriate allocation base for overhead when overhead is highly correlated with direct labor and direct labor “drives” overhead costs. This may have been true when the assembly process was largely manual, but after automation you may find that the relation between direct labor and overhead is far weaker. When a factory is automated, direct labor tends to decrease while overhead costs increase. Direct labor costs decrease because machines replace direct laborers. Overhead costs increase as a result of additional depreciation, power costs, insurance and other related costs. This suggests that there will no longer be a direct relationship between overhead and direct labor (that is, when direct labor costs increase there is not a related increase in overhead costs). Hence, direct labor will no longer be an appropriate way to allocate overhead costs to products.

Activity-based costing may be the best alternative. In activity-based costing, overhead costs are allocated based on the activities required to make the products and the resources that are consumed by these activities. This technique is more complex than the approach the company is currently using. Activity-based costing is costly to implement and to maintain, but you may find that the benefits of having more accurate product costs will outweigh these costs—particularly if you intend to rely on product costs for pricing and other decisions.






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