Solution Manual of Chapter 7 -
Managerial Accounting 15th
Edition (Ray H. Garrison, Eric
W. Noreen and Peter C.)
,Chapter 7
Activity-Based Costing: A Tool to Aid
Decision Making
Solutions to Questions because they possess intimate knowledge of
operations that is needed to design an effective
ABC system. Tapping the knowledge of
7-1 Activity-based costing differs from crossfunctional employees also lessens their
traditional costing systems in a number of ways. resistance to ABC because they feel included in
In activity-based costing, nonmanufacturing as the implementation process.
well as manufacturing costs may be assigned to
products. And, some manufacturing costs— 7-4 Unit-level activities are performed for each
including the costs of idle capacity—may be unit that is produced. Batch-level activities are
excluded from product costs. An activity-based performed for each batch regardless of how many
costing system typically includes a number of units are in the batch. Product-level activities
activity cost pools, each of which has its unique must be carried out to support a product
measure of activity. These measures of activity regardless of how many batches are run or units
often differ from the allocation bases used in produced. Customer-level activities must be
traditional costing systems. carried out to support customers regardless of
what products or services they buy. Organization-
7-2 When direct labor is used as an allocation sustaining activities are carried out regardless of
base for overhead, it is implicitly assumed that the company’s precise product mix or mix of
overhead cost is directly proportional to direct customers.
labor. When cost systems were originally
developed in the 1800s, this assumption may 7-5 Organization-sustaining costs,
have been reasonably accurate. However, direct customerlevel costs, and the costs of idle capacity
labor has declined in importance over the years should not be assigned to products. These costs
while overhead has been increasing. This represent resources that are not consumed by the
suggests that there is no longer a direct link products.
between the level of direct labor and overhead.
Indeed, when a company automates, direct labor 7-6 In activity-based costing, costs must first
is replaced by machines; a decrease in direct be allocated to activity cost pools and then they
labor is accompanied by an increase in overhead. are allocated from the activity cost pools to
This violates the assumption that overhead cost is products, customers, and other cost objects.
directly proportional to direct labor. Overhead cost
appears to be driven by factors such as product 7-7 Because people are often involved in
diversity and complexity as well as by volume, for more than one activity, some way must be found
which direct labor has served as a convenient to estimate how much time they spend in each
measure. activity. The most practical approach is often to
ask employees how they spend their time. It is
7-3 Top managers provide leadership that is also possible to ask people to keep records of how
needed to properly motivate all employees to they spend their time or observe them as they
embrace the need to implement ABC. Top perform their tasks, but both of these alternatives
managers also have the authority to link ABC data are costly and it is not obvious that the data
to the employee evaluation and reward system. would be any better. People who know they are
1
Cross-functional employees are also important being observed may change how they behave.
, lOMoARcPSD|58847208
this chapter, exclude some manufacturing costs
and include some nonmanufacturing costs.
7-8 In traditional cost systems, product-level
Second, the first-stage allocations are based on
costs are indiscriminately spread across all
interviews rather than verifiable, objective data.
products using direct labor-hours or some other
allocation base related to volume. As a
consequence, high-volume products are assigned
the bulk of such costs. If a product is responsible
for 40% of the direct labor in a factory, it will be
assigned 40% of the manufacturing overhead cost
in the factory—including 40% of the productlevel
costs of low-volume products. In an activitybased
costing system, batch-level and productlevel costs
are assigned more appropriately. This results in
shifting product-level costs back to the products
that cause them and away from the high-volume
products. (A similar effect will be observed with
batch-level costs if high-volume products are
produced in larger batches than lowvolume
products.)
7-9 Activity rates tell managers the average
cost of resources consumed to carry out a
particular activity such as processing purchase
orders. An activity whose average cost is high
may be a good candidate for process
improvements. Benchmarking can be used to
identify which activities have unusually large
costs. If some other organization is able to carry
out the activity at a significantly lower cost, it is
reasonable to suppose that improvement may be
possible.
7-10 The activity-based costing approach
described in the chapter is probably unacceptable
for external financial reports for two reasons.
First, activity-based product costs, as described in
The Foundational 15
1. The plantwide overhead rate is computed as follows:
Total estimated overhead cost (a) ............ $684,000
Total expected direct labor-hours (b) ........ 12,000 DLHs
Predetermined overhead rate (a) ÷ (b) .... $57.00 per DLH
2. The overhead cost assignments to Products Y and Z are as follows:
, Product Y Product Z
Total direct labor hours (a) ...................... 8,000 4,000
Plantwide overhead rate per DLH (b) ........ $57.00 $57.00
Manufacturing overhead assigned (a) × (b) $456,000 $228,000
3-6.
The activity rates are computed as follows:
(a)
Estimated (b) (a) ÷ (b)
Overhead Expected Activity
Activity Cost Pool Cost Activity Rate
Machining ............... $200,000 10,000 MH $20 per MH
Machine setups ....... $100,000 200 setups $500 per setup
Product design ........ $84,000 2 products $42,000 per product
General factory ....... $300,000 12,000 DLHs $25 Per DLH
7. Machine setups is a batch-level activity. A setup is performed to run a
batch of units. The cost of the setup is determined by the resources
consumed performing the setup and it is not influenced by the number
of units processed once the setup is complete.
8. The product design activity is a product-level activity. The product
design cost is determined by the number of products supported and it is
not influenced by the number of batches or units processed.
3
Managerial Accounting 15th
Edition (Ray H. Garrison, Eric
W. Noreen and Peter C.)
,Chapter 7
Activity-Based Costing: A Tool to Aid
Decision Making
Solutions to Questions because they possess intimate knowledge of
operations that is needed to design an effective
ABC system. Tapping the knowledge of
7-1 Activity-based costing differs from crossfunctional employees also lessens their
traditional costing systems in a number of ways. resistance to ABC because they feel included in
In activity-based costing, nonmanufacturing as the implementation process.
well as manufacturing costs may be assigned to
products. And, some manufacturing costs— 7-4 Unit-level activities are performed for each
including the costs of idle capacity—may be unit that is produced. Batch-level activities are
excluded from product costs. An activity-based performed for each batch regardless of how many
costing system typically includes a number of units are in the batch. Product-level activities
activity cost pools, each of which has its unique must be carried out to support a product
measure of activity. These measures of activity regardless of how many batches are run or units
often differ from the allocation bases used in produced. Customer-level activities must be
traditional costing systems. carried out to support customers regardless of
what products or services they buy. Organization-
7-2 When direct labor is used as an allocation sustaining activities are carried out regardless of
base for overhead, it is implicitly assumed that the company’s precise product mix or mix of
overhead cost is directly proportional to direct customers.
labor. When cost systems were originally
developed in the 1800s, this assumption may 7-5 Organization-sustaining costs,
have been reasonably accurate. However, direct customerlevel costs, and the costs of idle capacity
labor has declined in importance over the years should not be assigned to products. These costs
while overhead has been increasing. This represent resources that are not consumed by the
suggests that there is no longer a direct link products.
between the level of direct labor and overhead.
Indeed, when a company automates, direct labor 7-6 In activity-based costing, costs must first
is replaced by machines; a decrease in direct be allocated to activity cost pools and then they
labor is accompanied by an increase in overhead. are allocated from the activity cost pools to
This violates the assumption that overhead cost is products, customers, and other cost objects.
directly proportional to direct labor. Overhead cost
appears to be driven by factors such as product 7-7 Because people are often involved in
diversity and complexity as well as by volume, for more than one activity, some way must be found
which direct labor has served as a convenient to estimate how much time they spend in each
measure. activity. The most practical approach is often to
ask employees how they spend their time. It is
7-3 Top managers provide leadership that is also possible to ask people to keep records of how
needed to properly motivate all employees to they spend their time or observe them as they
embrace the need to implement ABC. Top perform their tasks, but both of these alternatives
managers also have the authority to link ABC data are costly and it is not obvious that the data
to the employee evaluation and reward system. would be any better. People who know they are
1
Cross-functional employees are also important being observed may change how they behave.
, lOMoARcPSD|58847208
this chapter, exclude some manufacturing costs
and include some nonmanufacturing costs.
7-8 In traditional cost systems, product-level
Second, the first-stage allocations are based on
costs are indiscriminately spread across all
interviews rather than verifiable, objective data.
products using direct labor-hours or some other
allocation base related to volume. As a
consequence, high-volume products are assigned
the bulk of such costs. If a product is responsible
for 40% of the direct labor in a factory, it will be
assigned 40% of the manufacturing overhead cost
in the factory—including 40% of the productlevel
costs of low-volume products. In an activitybased
costing system, batch-level and productlevel costs
are assigned more appropriately. This results in
shifting product-level costs back to the products
that cause them and away from the high-volume
products. (A similar effect will be observed with
batch-level costs if high-volume products are
produced in larger batches than lowvolume
products.)
7-9 Activity rates tell managers the average
cost of resources consumed to carry out a
particular activity such as processing purchase
orders. An activity whose average cost is high
may be a good candidate for process
improvements. Benchmarking can be used to
identify which activities have unusually large
costs. If some other organization is able to carry
out the activity at a significantly lower cost, it is
reasonable to suppose that improvement may be
possible.
7-10 The activity-based costing approach
described in the chapter is probably unacceptable
for external financial reports for two reasons.
First, activity-based product costs, as described in
The Foundational 15
1. The plantwide overhead rate is computed as follows:
Total estimated overhead cost (a) ............ $684,000
Total expected direct labor-hours (b) ........ 12,000 DLHs
Predetermined overhead rate (a) ÷ (b) .... $57.00 per DLH
2. The overhead cost assignments to Products Y and Z are as follows:
, Product Y Product Z
Total direct labor hours (a) ...................... 8,000 4,000
Plantwide overhead rate per DLH (b) ........ $57.00 $57.00
Manufacturing overhead assigned (a) × (b) $456,000 $228,000
3-6.
The activity rates are computed as follows:
(a)
Estimated (b) (a) ÷ (b)
Overhead Expected Activity
Activity Cost Pool Cost Activity Rate
Machining ............... $200,000 10,000 MH $20 per MH
Machine setups ....... $100,000 200 setups $500 per setup
Product design ........ $84,000 2 products $42,000 per product
General factory ....... $300,000 12,000 DLHs $25 Per DLH
7. Machine setups is a batch-level activity. A setup is performed to run a
batch of units. The cost of the setup is determined by the resources
consumed performing the setup and it is not influenced by the number
of units processed once the setup is complete.
8. The product design activity is a product-level activity. The product
design cost is determined by the number of products supported and it is
not influenced by the number of batches or units processed.
3
