# Activity-based costing requires four steps.

1. Activity-based costing requires four steps.RequirementR1. Rank the following steps in the order in which they would be completed.Number the first step as “1” until you have ranked all four steps.a. Compute the cost allocation rate for each activity.b. Identify the cost driver for each activity and estimate the total quantity ofeach driver’s allocation base.c. Allocate indirect costs to the cost object.d. Identify each activity and estimate its total indirect cost.2. Harry, Inc. manufactures motor scooters. Consider each of the followingexamples of quality costs.RequirementIndicate which of the following quality cost categories each example represents.P: Prevention costsA: Appraisal costsIF: Internal failure costsEF: External failure costs3. Farragut, Inc., uses activity-based costing to account for its chrome bumpermanufacturing process. Company managers have identified four manufacturingactivities: materials handling, machine setup, insertion of parts, and finishing. Thebudgeted activity costs for 2010 and their allocation bases are as follows:Farragut expects to produce 1,000 chrome bumpers during the year. The bumpersare expected to use 3,000 parts, require 20 setups, and consume 2,000 hours offinishing time.RequirementsR1. Compute the cost allocation rate for each activity.R2. Compute the indirect manufacturing cost of each bumper.4. Erickson Company manufactures wheel rims. The controller budgeted thefollowing ABC allocation rates for 2010:The number of parts is now a feasible allocation base because Erickson recentlypurchased bar coding technology. Erickson produces two wheel rim models:standard and deluxe. Budgeted data for 2010 are as follows:The company expects to produce 1,000 units of each model during the year.RequirementsR1. Compute the total budgeted indirect manufacturing cost for 2010.R2. Compute the ABC indirect manufacturing cost per unit of each model. Carry eachcost to the nearest cent.R3. Prior to 2010, Erickson used a direct labor hour single-allocation-base system.Compute the (single) allocation rate based on direct labor hours for 2010. Use thisrate to determine the indirect manufacturing cost per wheel rim for each model, tothe nearest cent.5. Refer to exercise 4. For 2011, Erickson’s managers have decided to use the sameindirect manufacturing costs per wheel rim that they computed in 2010. In additionto the unit indirect manufacturing costs, the following data are budgeted for thecompany’s standard and deluxe models for 2011:Because of limited machine-hour capacity, Erickson can produce either 2,000standard rims or 2,000 deluxe rims.RequirementsR1. If Erickson’s managers rely on the ABC unit cost data computed in 17-16, whichmodel will they produce? Carry each cost to the nearest cent. (All nonmanufacturingcosts are the same for both models.)R2. If the managers rely on the single-allocation-base cost data, which model willthey produce?R3. Which course of action will yield more income for Erickson?6. Refer to exercises 4 and 5. Controller Michael Bender is surprised by the increasein cost of the deluxe model under ABC. Market research shows that for the deluxerim to provide a reasonable profit, Erickson will have to meet a targetmanufacturing cost of $454 per rim. A value engineering study by Erickson’semployees suggests that modifications to the finishing process could cut finishingcost from $30 to $20 per hour and reduce the finishing direct labor hours per deluxerim from 4.5 hours to 4 hours. Direct materials would remain unchanged at $51 perrim, as would direct labor at $54 per rim. The materials handling, machine setup,and insertion of parts activity costs also would remain the same.RequirementWould implementing the value engineering recommendation enable Erickson toachieve its target cost for the deluxe rim?7. Lally, Inc., produces universal remote controls. Lally uses a JIT costing system.One of the company’s products has a standard direct materials cost of $7 per unitand a standard conversion cost of $26 per unit. During January 2011, Lally produced575 units and sold 570. It purchased $6,800 of direct materials and incurred actualconversion costs totaling $14,000.RequirementsR1. Prepare summary journal entries for January.R2. The January 1, 2011, balance of the Raw and in-process inventory account was$40. Use a T-account to find the January 31 balance.R3. Use a T-account to determine whether Conversion costs are over- orunderallocated for the month. By how much? Give the journal entry to close theConversion costs account.8. Millan & Co. makes electronic components. Mike Millan, the president, recentlyinstructed vice president Steve Bensen to develop a total quality control program.“If we don’t at least match the quality improvements our competitors are making,”he told Bensen, “we’ll soon be out of business.” Bensen began by listing various“costs of quality” that Millan incurs. The first six items that came to mind were:RequirementClassify each item as a prevention cost, an appraisal cost, an internal failure cost, oran external failure cost.9. Allen, Inc. manufactures bookcases and uses an activity-based costing system.Allen’s activity areas and related data follow:Allen produced two styles of bookcases in April: the standard bookcase and anunfinished bookcase, which has fewer parts and requires no finishing. The totals forquantities, direct materials costs, and other data follow:RequirementsR1. Compute the manufacturing product cost per unit of each type of bookcase.R2. Suppose that premanufacturing activities, such as product design, wereassigned to the standard bookcases at $5 each, and to the unfinished bookcases at$4 each. Similar analyses were conducted of postmanufacturing activities such asdistribution, marketing, and customer service. The postmanufacturing costs were$21 per standard bookcase and $18 per unfinished bookcase. Compute the fullproduct costs per unit.R3. Which product costs are reported in the external financial statements? Whichcosts are used for management decision making? Explain the difference.R4. What price should Allen’s managers set for unfinished bookcases to earn a unitprofit of $19?10. Lori, Inc., is using a costs-of-quality approach to evaluate design engineeringefforts for a new skateboard. Lori’s senior managers expect the engineering work toreduce appraisal, internal failure, and external failure activities. The predictedreductions in activities over the 2-year life of the skateboards follow. Also shown arethe cost allocation rates for each activity.RequirementsR1. Calculate the predicted quality cost savings from the design engineering work.R2. Lori spent $102,000 on design engineering for the new skateboard. What is thenet benefit of this “preventive” quality activity?R3. What major difficulty would Lori’s managers have in implementing this costs-ofquality approach? What alternative approach could they use to measure qualityimprovement?11. Review the following activities of the capital budgeting process:RequirementPlace the activities in sequential order as they occur in the capital budgetingprocess.12. Consider how White Valley Snow Park Lodge could use capital budgeting todecide whether the $12,500,000 Brook Park Lodge expansion would be a goodinvestment. Assume White Valley’s managers developed the following estimatesconcerning the expansion:Assume that White Valley uses the straight-line depreciation method and expectsthe lodge expansion to have a residual value of $600,000 at the end of its 12-yearlife.RequirementsR1. Compute the average annual net cash inflow from the expansion.R2. Compute the average annual operating income from the expansion.13. Refer to the White Valley Snow Park Lodge expansion project in exercise 2.RequirementCompute the payback period for the expansion project.14. Refer to the White Valley Snow Park Lodge expansion project in exercise 2.RequirementCalculate the ARR.15. Refer to the White Valley Snow Park Lodge expansion project in exercise 2.Assume theexpansion has zero residual value.RequirementsR1. Will the payback period change? Explain your answer and rec

alculate ifnecessary.R2. Will the project’s ARR change? Explain your answer and recalculate ifnecessary.R3. Assume White Valley screens its potential capital investments using thefollowing decision criteria:Will White Valley consider this project further, or reject it?16. Suppose White Valley is deciding whether to purchase new accounting software.The payback period for the $27,375 software package is five years, and thesoftware’s expected life is three years. White Valley’s required rate of return is12.0%.RequirementAssuming equal yearly cash flows, what are the expected annual cash savings fromthe new software?17. Your grandfather would like to share some of his fortune with you. He offers togive you money under one of the following scenarios (you get to choose):RequirementCalculate the present value of each scenario using an 8% discount rate. Whichscenario yields the highest present value? Would your preference change if youused a 10% discount rate?18. Assume you make the following investments:RequirementCalculate the value of each investment at the end of three years.19. Use the Present Value of $1 table (Appendix B, Table A) to determine thepresent value of $1 received one year from now. Assume a 14% interest rate. Usethe same table to find the present value of $1 received two years from now.Continue this process for a total of five years.RequirementsR1. What is the total present value of the cash flows received over the five-yearperiod?R2. Could you characterize this stream of cash flows as an annuity? Why, or whynot?R3. Use the Present Value of Annuity of $1 table (Appendix B, Table B) to determinethe present value of the same stream of cash flows. Compare your results to youranswer to part 1.R4. Explain your findings.20. Refer to the White Valley Snow Park Lodge expansion project in exercise 2.RequirementWhat is the project’s NPV? Is the investment attractive? Why?21. Consider the following statements about capital budgeting.RequirementFill in each statement with the appropriate capital budgeting method: Paybackperiod, ARR, NPV, or IRR.Decision CaseDominic Hunter, a second-year business student at the University of Utah, willgraduate in two years with an accounting major and a Spanish minor. Hunter istrying to decide where to work this summer. He has two choices: work full-time for abottling plant or work part-time in the accounting department of a meat-packingplant. He probably will work at the same place next summer as well. He is able towork 12 weeks during the summer. The bottling plant will pay Hunter $380 perweek this year and 7% more next summer. At the meat-packing plant, he couldwork 20 hours per week at $8.75 per hour. By working only part-time, he could taketwo accounting courses this summer. Tuition is $225 per hour for each of the fourhour courses. Hunter believes that the experience he gains this summer will qualifyhim for a full-time accounting position with the meat-packing plant next summer.That position will pay $550 per week. Hunter sees two additional benefits of workingpart-time this summer. First, he could reduce his studying workload during the falland spring semesters by one course each term. Second, he would have the time towork as a grader in the university’s accounting department during the 15-week fallterm. Grading pays $50 per week.RequirementsR1. Suppose that Hunter ignores the time value of money in decisions that coverthis short time period. Suppose also that his sole goal is to make as much money aspossible between now and the end of next summer. What should he do? Whatnonquantitative factors might Dominic consider? What would you do if you werefaced with these alternatives?R2. Now suppose that Hunter considers the time value of money for all cash flowsthat he expects to receive one year or more in the future. Which alternative doesthis consideration favor? Why?