Which of the following is one of the three guidelines for refining costing systems?

CHAPTER 5

ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT

5-1 What is broad averaging, and what consequences can it have on costs?

Broad averaging (or “peanut-butter costing”) describes a costing approach that uses broad averages for assigning (or spreading, as in spreading peanut butter) the cost of resources uniformly to cost objects when the individual products or services, in fact, use those resources in non-uniform ways. Broad averaging, by ignoring the variation in the consumption of resources by different cost objects, can lead to inaccurate and misleading cost data, which in turn can negatively impact the marketing and operating decisions made based on that information.

5-2 Inaccurate costing can result in two deviations. Name the two deviations and explain how they can impact a business.

These two deviations are overcosting and undercosting. Undercosting will cause underpricing and this can lead to sales that actually result in losses, because the sales may bring in less revenue than the cost of resources, though the company is under the assumption that it is making a profit and overcosting will lead to overpricing, causing a loss in market share to competitors producing similar products.

5-3 What is costing system refinement? Describe three guidelines for refinement.

Costing system refinement means making changes to a simple costing system that reduces the use of broad averages for assigning the cost of resources to cost objects and provides better measurement of the costs of overhead resources used by different cost objects. Three guidelines for refinement are 1. Classify as many of the total costs as direct costs as is economically feasible. 2. Expand the number of indirect cost pools until each of these pools is more homogenous. 3. Use the cause-and-effect criterion, when possible, to identify the cost-allocation base for each indirect-cost pool.

5-4 What are the fundamental cost objects in activity-based costing? How does activity-based costing work?

Individual activities are the fundamental cost objects in activity-based costing. Activity-based costing first uses resource drivers to assign the costs of resources to individual activities and then it uses activity drivers to assign the cost of these activities to products or services (as final cost objects).

5-5 How can a cost hierarchy lead to a more accurate costing system?

A cost hierarchy can lead to a more accurate costing system by focusing on the levels of cause- and-effect relationships between various activity cost pools on the one hand and final cost objects on the other hand. It categorizes various activity cost pools into four individual levels on the basis of the different types of cost drivers, cost-allocation bases, or the different degrees of difficulty in determining cause-and-effect relationships. These four levels of a cost hierarchy

(from the highest to the lowest cause-and-effect relationship to cost objects) are: output unit- level costs, batch-level costs, product-sustaining costs or service-sustaining costs, and facility- sustaining costs.

5-6 Which levels of cost hierarchy (under activity-based costing) are not used in simple costing systems and why they are important?

Out of four levels of hierarchy costs in activity-based costing, only ‘output unit-level costs’ is used in simple costing systems. In other words, there are three additional levels of hierarchy costs in activity-based-costing systems which are not used in simple costing systems as follows: batch-level costs, product-sustaining costs or service-sustaining costs, and facility-sustaining costs. These three additional levels of hierarchy costs are important because not all cost- allocation bases are unit level. Some are batch-level costs, some are product-sustaining costs and some are facility-sustaining costs which have no direct link with the cost objects.

5-7 Differentiate between simple costing systems and ABC systems.

The main difference between simple costing systems and ABC systems is due to having different focuses. Activities are the fundamental cost objects in ABC systems, while departments, centers or cost pools are the main fundamental cost objects in simple costing systems. Simple costing systems have one or a few indirect cost pools, irrespective of the heterogeneity in the facility while ABC systems have multiple indirect cost pools. Under ABS systems, the costs of activities are assigned to cost objects to compute their costs. Under simple costing systems, the costs of departments, centers or cost pools are assigned to cost objects to compute their costs.

5-8 How can ABC help with cost reduction and process improvement decisions?

ABC can help with cost reduction and process improvement decisions by identifying individual activities and their relevant costs. This can help managers to eliminate non-added value activities, reduce costs and improve the overall process.

5-9 “The cost of cost objects under simple costing systems and under activity-based-costing are never the same.” Do you agree? Explain.

No. It depends on a number of factors such as the variety and number of activities, cost allocation bases, and cost objects/products. For example: if a company produces one single product then the product cost under both simple costing systems and activity-based-costing can be the same. Or, when different products use resources from different activities in the same proportions as with simple costing systems.

5-10 Describe the main barriers for adopting an ABC system.

The main restrictions towards adopting an ABC system include the need to use more resources (e., experts and software packages) as well as the requirement for gathering additional data/information and performing more measurements to implement it. One of the main complications of ABC is that it requires managers to estimate costs of activity pools in order to identify and measure cost drivers for specified cost pools to be used as cost-allocation bases. It needs many calculations to determine costs of cost objects and these measurements are

eliminating non-added value activities can reduce the production costs. It can also be argued that by adopting the ABC system, the manager will be in a better position to make improved decisions in terms of pricing and product-mixed decisions. ABC could help to identify products that may be currently under-costed, and are being actually sold for losses, where the losses are masked by sales of very profitable product lines

5-16 Conroe Company is reviewing the data provided by its management accounting system. Which of the following statements is/are correct?

I. A cost driver is a causal factor that increases the total cost of a cost object. II. Cost drivers may be volume based or activity based. III drivers are normally the largest cost in the manufacturing process.

1. I, II, and III are correct.
2. I and II only are correct.
3. I only is correct.
4. II and III only are correct.

SOLUTION

Explanation Choice "2" is correct. The question asks which of a series of statements is/are correct. "None of the above" is not available, so one of the statements at least is correct. Statement I says that a cost driver is a causal factor that increases the total cost of a cost object. Statement I is correct. Statement II says that cost drivers may be volume based or activity based. Cost drivers may be volume‐based, activity‐based, or based on any number of other operational characteristics. So, that is two out of three. Statement II is correct. Statement III says that cost drivers are normally the largest cost in the manufacturing process. Cost drivers are what cause the costs, not the costs themselves. Statement III is incorrect

5-17 Nobis Company uses an ABC system. Which of the following statements is/are correct with respect to ABC?

I. Departmental costing systems are a refinement of ABC systems. II. ABC systems are useful in manufacturing, but not in merchandising or service industries. III systems can eliminate cost distortions because ABC develops cost drivers that have a cause-and-effect relationship with the activities performed.

1. I, II, and III are correct.
2. II and III only are correct.
3. III only is correct.
4. None of the listed choices is correct.

SOLUTION

Explanation Choice "3" is correct. The question asks which of a series of statements is/are correct with respect to ABC. Statement I says that departmental costing systems are a refinement of ABC systems. Actually, ABC systems are a refinement of departmental costing systems. Statement I is incorrect. Statement II says that ABC systems are useful in manufacturing, but not in merchandising or service industries. ABC systems are useful in all three of these business sectors. Statement II is incorrect. Statement III says that ABC systems can eliminate cost distortions because ABC develops cost drivers that have a cause‐and‐effect relationship with the activities performed. Statement III is correct.

5-18 Cost hierarchy. SharpPitch, Inc., manufactures karaoke machines for several well- known companies. The machines differ significantly in their complexity and their manufacturing batch sizes. The following costs were incurred in 2014: a. Indirect manufacturing labor costs such as supervision that supports direct manufacturing labor, $950, b. Procurement costs of placing purchase orders, receiving materials, and paying suppliers related to the number of purchase orders placed, $675, c. Cost of indirect materials, $180, d. Costs incurred to set up machines each time a different product needs to be manufactured, $450, e. Designing processes, drawing process charts, and making engineering process changes for products, $315, f. Machine-related overhead costs such as depreciation, maintenance, and production engineering, $975,500 (These resources relate to the activity of running the machines.) g. Plant management, plant rent, and plant insurance, $578,

Required:

1. Classify each of the preceding costs as output unit-level, batch-level, product-sustaining, or facility-sustaining. Explain each answer.
2. Consider two types of karaoke machines made by SharpPitch, Inc. One machine, designed for professional use, is complex to make and is produced in many batches. The other machine, designed for home use, is simple to make and is produced in few batches. Suppose that SharpPitch needs the same number of machine-hours to make each type of karaoke machine and that Forrester allocates all overhead costs using machine-hours as the only allocation base. How, if at all, would the machines be miscosted? Briefly explain why.
3. How is the cost hierarchy helpful to SharpPitch in managing its business?

SOLUTION

(20 min.) Cost hierarchy.

1. a. Indirect manufacturing labor costs of $$950,000 support direct manufacturing labor and are output unit-level costs. Direct manufacturing labor generally increases with output units and so will the indirect costs to support it. b. Batch-level costs are costs of activities that are related to a group of units of a product

(HT) and stress testing (ST) on materials and operates at capacity. Under its current simple costing system, CoreTech aggregates all operating costs of $1,800,000 into a single overhead cost pool. CoreTech calculates a rate per test-hour of $20 ($1,800,000 , 90,000 total test@hours). HT uses 50,000 test-hours, and ST uses 40,000 testhours. Gary Celeste, CoreTech’s controller, believes that there is enough variation in test procedures and cost structures to establish separate costing and billing rates for HT and ST. The market for test services is becoming competitive. Without this information, any miscosting and mispricing of its services could cause CoreTech to lose business. Celeste divides CoreTech’s costs into four activity-cost categories. a. Direct-labor costs, $276,000. These costs can be directly traced to HT, $204,000, and ST, $72,000. b. Equipment-related costs (rent, maintenance, energy, and so on), $495,000. These costs are allocated to HT and ST on the basis of test-hours. c. Setup costs, $630,000. These costs are allocated to HT and ST on the basis of the number of setuphours required. HT requires 15,000 setup-hours, and ST requires 6,000 setup-hours. d. Costs of designing tests, $399,000. These costs are allocated to HT and ST on the basis of the time required for designing the tests. HT requires 4,000 hours, and ST requires 2,000 hours.

Required:

1. Classify each activity cost as output unit-level, batch-level, product- or service-sustaining, or facility sustaining. Explain each answer.
2. Calculate the cost per test-hour for HT and ST. Explain briefly the reasons why these numbers differ from the $20 per test-hour that CoreTech calculated using its simple costing system.
3. Explain the accuracy of the product costs calculated using the simple costing system and the ABC system. How might CoreTech’s management use the cost hierarchy and ABC information to better manage its business?

SOLUTION

(25 min.) ABC, cost hierarchy, service.

1. Output unit-level costs a. Direct-labor costs, $276, b. Equipment-related costs (rent, maintenance, energy, and so on), $495, These costs are output unit-level costs because they are incurred on each unit of materials tested, that is, for every hour of testing.

Batch-level costs c. Setup costs, $630, These costs are batch-level costs because they are incurred each time a batch of materials is set up for either HT or ST, regardless of the number of hours for which the tests are subsequently run.

Service-sustaining costs d. Costs of designing tests, $399, These costs are service-sustaining costs because they are incurred to design the HT and ST tests, regardless of the number of batches tested or the number of hours of test time.

1. Heat Testing (HT) Stress Testing (ST) Total Per Hour Total Per Hour (1) (2) = (1) ÷ 50,

(3) (4) = (3) ÷

40,

Direct labor costs (given) $204,000 $4 $72,000 $1.

Equipment-related costs

$5 per hour* × 50,000 hours

275,000 5.

$5 per hour* × 40,000 hours

220,000 5.

Setup costs $30 per setup-hour† × 15,000 setup-hours

450,000 9.

$30 per setup-hour† × 6,000 setup-hours

180,000 4.

Costs of designing tests

$66 per hour** × 4,000 hours

266,000 5.

$66 per hour** × 2,000 hours

133,

0

3.

Total costs $1,195,000 $23 $605,000 $15.

*$495,000  (50,000 + 40,000) hours = $5 per test-hour †$630,000  (15,000 + 6,000) setup hours = $30 per setup-hour **$399,000  (4,000 + 2,000) hours = $66 per hour At a cost per test-hour of $20, the simple costing system undercosts heat testing ($23) and overcosts stress testing ($15). The reason is that heat testing uses direct labor, setup, and design resources per hour more intensively than stress testing. Heat tests are more complex, take longer to set up, and are more difficult to design. The simple costing system assumes that testing costs per hour are the same for heat testing and stress testing. 3. The ABC system better captures the resources needed for heat testing and stress testing because it identifies all the various activities undertaken when performing the tests and recognizes the levels of the cost hierarchy at which costs vary. Hence, the ABC system generates more accurate product costs. CoreTech’s management can use the information from the ABC system to make better pricing and product mix decisions. For example, it might decide to increase the prices charged for the more costly heat testing and consider reducing prices on the less costly stress testing. CoreTech should watch if competitors are underbidding CoreTech in stress testing and causing it to lose business. CoreTech can also use ABC information to reduce costs by eliminating processes and activities that do not add value, identifying and evaluating new methods to do testing that reduce the activities needed to do the tests, reducing the costs of doing various activities, and planning and managing activities.

AMSTERDAM

ENTERPRISES

Walliston Boutin Abbington

$

220

100

4

14

52

$2,

3,

5,

30%

30

30

$ 768

924

1,

$ 3,

4,

6,

$14,

1. Direct Professional Time Support Services

Client

Rate per Hour

Number of Hours Total

Rate per Hour Total

Amount Billed to Client (1) (2) (3) (4) = (2)  (3)

(5) (6) = (3)  (5) (7) = (4) + (6)

SAN ANTONIO

DOMINION

Walliston Boutin Abbington

$

220

100

26

5

39

$16,

1,

3,

$

75

75

$1,

375

2,

$18,

1,

6,

$26,

AMSTERDAM

ENTERPRISES

Walliston Boutin Abbington

$

220

100

4

14

52

$2,

3,

5,

$

75

75

$ 300

1,

3,

$ 2,

4,

9,

$16,

Requirement 1 Requirement 2 San Antonio Dominion $28,132 $26, Amsterdam Enterprises 14,092 16, $42,224 $42,

Both clients use 70 hours of professional labor time. However, San Antonio Dominion uses a higher proportion of Walliston’s time (26 hours), which is more costly. This attracts the highest support-services charge when allocated on the basis of direct professional labor costs.

1. Assume that the Walliston Group uses a cause-and-effect criterion when choosing the allocation base for support services. You could use several pieces of evidence to determine whether professional labor costs or hours is the driver of support-service costs:

a. Interviews with personnel. For example, staff in the major cost categories in support services could be interviewed to determine whether Walliston requires more support per hour than, say, Abbington. The professional labor costs allocation base implies that an hour of Walliston’s time requires 6 ($640 ÷ $100) times more support- service dollars than does an hour of Abbington’s time. b. Analysis of tasks undertaken for selected clients. For example, if computer-related costs are a sizable part of support costs, you could determine if there was a systematic

relationship between the percentage involvement of professionals with high billing rates on cases and the computer resources consumed for those cases.

5-21 Plant-wide, department, and ABC indirect cost rates. Automotive Products (AP) designs and produces automotive parts. In 2017, actual variable manufacturing overhead is $308,600. AP’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 AP’s controller Devon Smith 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 2014 using the simple costing system that uses machine-hours as the allocation base.
2. Compute the manufacturing overhead allocated to each customer in 2014 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 AP use the information available from its department-by-department analysis of manufacturing overhead costs?
5. AP’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

(20 min.) Plantwide, department, and ABC indirect cost rates. 1.

Design Engineering Production

CAD-design hours Engineering hours Machine hours

28%

19

3

51%

16

70

21%

65

27

The United Motors contract uses only 3% of total machines hours in 2011, yet uses 28% of CAD design-hours and 19% of engineering hours. The result is that the plantwide rate, based on machine hours, will greatly underestimate the cost of resources used on the United Motors contract. This explains the 157% increase in indirect costs assigned to the United Motors contract when department rates are used. The Leland Auto contract also uses far fewer machine- hours than engineering-hours and is also undercosted. In contrast, the Holden Motors contract uses less of design (51%) and engineering (16%) than of machine-hours (70%). Hence, the use of department rates will report lower indirect costs for Holden Motors than does a plantwide rate. Holden Motors was probably complaining under the use of the simple system because its contract was being overcosted relative to its consumption of MOH resources. United and Leland, on the other hand, were having their contracts undercosted and underpriced by the simple system. Assuming that AP is an efficient and competitive supplier, if the new department-based rates are used to price contracts, United and Leland will be unhappy. AP should explain to United and Leland how the calculation was done, and point out United’s high use of design and engineering resources and Leland’s high use of engineering resources relative to production machine hours. 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, AP 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 AP more opportunities for targeted cost management.

1. 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 78% ($240,000 ÷ $308,600) of the manufacturing overhead.

5-22 Plant-wide, department, and activity-cost rates. Triumph Trophies makes trophies and plaques and operates at capacity. Triumph does large custom orders, such as the participant trophies for the Minnetonka Little League. The controller has asked you to compare plant-wide, department, and activity-based cost allocation. Triumph Trophies Budgeted Information for the Year Ended November 30, 2014 Forming Department Trophies Plaques Total Direct materials $26,000 $22,500 $48, Direct manufacturing labor 31,200 18,000 49,

Overhead costs Set up 24, Supervision 20,

Assembly Department Trophies Plaques Total Direct materials $5,200 $18,750 $23, Direct manufacturing labor 15,600 21,000 36, Overhead costs Set up 46, Supervision 21,

Other information follows: Setup costs in each department vary with the number of batches processed in each department. The budgeted number of batches for each product line in each department is as follows: Trophies Plaques Forming department 40 116 Assembly department 43 103

Supervision costs in each department vary with direct manufacturing labor costs in each department. Required: 1. Calculate the budgeted cost of trophies and plaques based on a single plant-wide overhead rate, if total overhead is allocated based on total direct costs. 2. Calculate the budgeted cost of trophies and plaques based on departmental overhead rates, where forming department overhead costs are allocated based on direct manufacturing labor costs of the forming department and assembly department overhead costs are allocated based on total direct costs of the assembly department. 3. Calculate the budgeted cost of trophies and plaques if Triumph allocates overhead costs in each department using activity-based costing. 4. Explain how the disaggregation of information could improve or reduce decision quality.

SOLUTION

(50 min.) Plantwide, department, and activity-cost rates.

1. Trophies Plaques Total

Direct materials

Forming $26,000 $22,

Assembly 5,200 18, Total 31,200 41,

Direct manufacturing labor

Forming 31,200 18,

Assembly 15,600 21,

Total 46,800 39,

Trophies Plaques Total a Forming Dept.

Direct manufacturing labor costs $31,200 $18,000 $49,

Allocated overhead (0 × $31,200; $18,000) $28,392 $16,380 $44, b Assembly Dept.

Total direct costs ($5,200 + $15,600; $18,750 + $21,000) $20,800 $39,750 $60,

Allocated overhead (1  $20,800; $39,750) $11,666 $22,294 $33,

3.

Forming Department

Budgeted setup rate =

$24,

156 batches = $153 per batch

Budgeted supervision rate =

$20, $49,200 = $0 per direct-labor dollar

Assembly Department

Budgeted set up rate =

$46,

146 batches = $315 per batch

Budgeted supervision rate =

$21, $36,600 = $0 per direct manuf.-labor dollar

Trophies Plaques Total

Direct material costs $ 31,200 $ 41,250 $ 72, Direct labor costs 46,800 39,000 85, Total direct costs 78,000 80,250 158,

Forming Dept. overhead Set up $153  40; 116 6,154 17,846 24, Supervision 0 × $31,200; $18,000 13,172 7,600 20,

Assembly Department overhead Set up $315 × 43; 103 13,548 32,452 46, Supervision 0 × $15,600; $21,000 9,343 12,577 21,

Total costs $120,217 $150,725 $270,

1. As Triumph uses more refined cost pools, the costs of trophies decreases, and costs of plaques increases. This is because plaques use a higher proportion of cost drivers (batches of set ups and direct manufacturing labor costs) than trophies, whereas the direct costs (the allocation base used in the simple costing system) are slightly smaller for plaques compared to trophies. This results in plaques being undercosted and trophies overcosted in the simple costing system. Department costing systems increase the costs of plaques relative to trophies because the forming department costs are allocated based on direct manufacturing labor costs in the forming department and plaques use more direct manufacturing labor in this department compared to trophies. 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.

5-23 ABC, process costing. Parker Company produces mathematical and financial calculators and operates at capacity. Data related to the two products are presented here: Mathem atical

Fina ncial Annual production in units 60,000 120, Direct material costs $240,000 $480, Direct manufacturing labor costs $75,000 $150,

Direct manufacturing labor-hours 5,000 10, Machine-hours 40,000 80, Number of production runs 60 60 Inspection hours 1,500 750

Total manufacturing overhead costs are as follows: Total Machining costs $720, Setup costs 150, Inspection costs 135,

Required:

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.

5-24 Department costing, service company. CKM is an architectural firm that designs and builds buildings. It prices each job on a cost plus 20% basis. Overhead costs in 2014 are $4,011,780. CKM’s simple costing system allocates overhead costs to its jobs based on number of jobs. There were three jobs in 2014. One customer, Sanders, has complained that the cost of its building in Chicago was not competitive. As a result, the controller has initiated a detailed review of the overhead allocation to determine if overhead costs are charged to jobs in proportion to consumption of overhead resources by jobs. She gathers the following information. Quantity of Cost Drivers Used by Each Project Department Cost Driver Overhead Costs in 2017

Sanders Hanley Stanley

Design Design department hours $1,500,000 1,000 5,000 4, Engineering Number of engineers $500,030 2,000 2,000 2, Construction Labor-hours $2,011,750 20,800 21,500 19, $4011,

Required: 1. Compute the overhead allocated to each project in 2014 using the simple costing system. 2. Compute the overhead allocated to each project in 2014 using department overhead cost rates. 3. Do you think Sanders had a valid reason for dissatisfaction with the cost? How does the allocation, based on department rates, change costs for each project? 4. What value, if any, would CKM get by allocating costs of each department based on the activities done in that department?

SOLUTION

(20 mins.) Department costing, service company

Note: The cost driver for engineering is number of engineering-hours, not number of engineers. This change does not, however, affect the solution itself.

1. Using the simple costing system, total overhead costs are equally allocated to projects. There were 3 projects in 2014, so the overhead cost per project is

Overhead cost per project in 2014=

$4,011,

3



= $1,337,260 per project

1. Rates per unit cost driver.

Activity Cost Driver Rate Design Design department hours $1,500,000 ÷ (1,000 + 5,

• 4,000) = $150 per design- hour Engineering Engineering department hours

$500,030 ÷ (2,000 + 2,000 +

2,200) = $80 per engineering-hour Construction Labor-hours $2,011,750 ÷ (20,800 + 21,500 + 19,600) = $32. per labor-hour

Overhead cost allocated to each project using department overhead cost rates: Sanders Hanley Stanley Design: $150 × 1,000; 5,000; 4,000 $150,000 $ 750,000 $ 600, Engineering: $80 × 2,000; 2,000; 2,

161,300 161,300 177,

Construction: $32 × 20,800; 21,500; 19,

676,000 698,750 637,

Total overhead costs $987,300 $1,610,050 $1,414,

1. Sanders Hanley Stanley

a. Department rates (Requirement 2) b. Plantwide rate (Requirement 1)

$ 987,

$1,337,

$1,610,

$1,337,

$1,414,

$1,337,

Ratio of (a) ÷ (b) 0 1 1.

The overhead allocated to Sanders decreases by 26% under the department rates, the overhead allocated to Hanley increases by about 20%, and the overhead allocated to Stanley increases by about 6%. The three projects 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:

Department

Cost Driver Sanders Hanley Stanley Design Engineering Construction

Design-hours Engineering-hours Labor-hours

10%

32

33

50%

32

35

40%

36

32

The Sanders project uses only 10% of design-hours in 2014 and uses 32% of engineering-hours and 33% of construction hours. The result is that the overhead rate, based on allocating costs equally to all projects (33%), will greatly overestimate the cost of resources used on the Sanders project, which uses very few design-hours. This explains the 26% decrease in indirect costs assigned to the Sanders project when department rates are used. In contrast, the Hanley and Stanley projects use more of design (50% and 40%, respectively). Hence, the use of department rates will report higher indirect costs for Hanley and Stanley than does a single overhead rate.

What are the three guidelines for refinement?

What is costing system refinement describe three guidelines for refinement?

What are the three criteria for the design of cost management systems?

What is a reason for the company to refine the costing system?