Revising a time-driven activity-based cost system, adding products Refer to the Madison Dairy ice cream plant example described in this chapter. Required (a) Suppose that production-related computer resource expenses of $1 8,000 per month have been inadvertently overlooked for inclusion in the cost system. Explain how the time-driven BBC model should be updated to reflect this cost. Answer: Time-driven activity-based costing systems (T DAB or Time-Driven BBC) estimate two parameters and then assign indirect costs similar to the way direct costs are assigned.
Cost rate for each type of indirect resource Identify all costs incurred to supply the resource Identify the practical capacity supplied by the resource Determine the capacity cost rate of the resource by dividing its cost by the practical capacity The time-driven BBC model will now include a capacity cost rate for computer resources = $18,000 divided by the practical capacity computer hours per month. The computer resources Usage can measure in computer time per product or production run. (b) Suppose that energy costs of $4,000 per month to run the machinery have also been inadvertently overlooked for inclusion in the cost system.
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How should the activity-based cost model be updated to include this cost, and what will be the effect on the machine hour rate? Answer: Before the machinery energy costs were calculated It was: The machinery rate was computed as $15,400 divided by 308 practical capacity hours, which equals $50 per hour. The energy costs of $4,000 per month will be added to the $15,400 monthly machinery costs, The Correct machinery resource cost of $19,400 per month, leading to a higher rate per hour. The new rate is $19,400/308 = $62. 99, which can be rounded to $63 per hour for convenience. ) If the company wishes to introduce a new flavor, what information is needed in order to determine the cost of producing this new flavor? Answer: If the company introduces a new flavor, the new flavors consumption of direct and indirect resources will need to be estimated and then multiplied by the appropriate cost or cost rate. For example, start with the quantity of direct materials and labor hours per gallon produced, and multiply these amounts by the related cost per unit of direct materials and wage rate, respectively.
Next, estimate the quantity of indirect labor (for changeovers, scheduling and product maintenance) and machine time (for production runs and setups). These will then be multiplied by the associated capacity cost rates of each indirect resource and added to the direct materials and direct labor costs in order to compute the total cost of producing the new flavor. 5_16 (a) Suppose indirect labor costs have increased by from the original setting but all other information remains the same.
Determine the total time- driven activity-based costs assigned to each of the four products (flavors) after incorporating the 10% increase in indirect labor costs and prepare an income statement similar to that shown in Exhibit 5-5 A 10% increase in indirect labor costs will increase the indirect labor capacity cost rate by (from $35 to $38. 50) and therefore will increase the indirect labor costs assigned to products by 10%. The revised income statement that is similar to Exhibit 5-5 will show indirect labor costs that are 10% higher than in Exhibit 5-5, with correspondingly lower product gross profits, as shown below. Small differences may result if the calculations are performed in a spreadsheet package. ) (b) Suppose that in addition to the change in part a, the unit time for scheduling a production run decreased from four hours per run to three hours per run. Determine the new total time-driven activity-based costs assigned to each of the four products (flavors) and prepare an income statement similar to that shown in Exhibit 5-5 but also showing the total cost of unused capacity.
With the reduction in unit time for scheduling a production from four hours per run to three hours per run, we first compute the revised indirect labor hours per month and then multiply by the new indirect labor capacity cost rate of $38. 50 per hour. The revised indirect labor hours per month are calculated as follows: Vanilla Chocolate Strawberry Mocha-Almond Schedule production runs, purchasing, etc. Hours per run) 3 Changeovers (hours per batch) 2. 0 1. 0 2. 5 4. 0 Number of employees per changeover Indirect labor hours per changeover 6 7. 12 Indirect labor time per run (batch) 9 10. 5 15 Number of production runs x 12 X 12 Indirect labor per run 108 72 84 90 Product-sustaining (hrs per month) Indirect labor hours per month 117 81 93 99 Indirect rate per hour x $38. 50 Indirect labor cost $4,504. 50 $3,118. 50 $3,580. 50 $3,811. 50 The new income statement shows lower indirect labor costs than in part (a) because of the reduced scheduling time per run. (Small differences may result if he calculations are performed in a spreadsheet package. Total Sales $30,000 $ 24,000 $3, 960 $2,800 $60,760 Direct materials $6,000 $4,800 $720 $520 $12,040 Direct labor (including fringes) $8,750 $7,000 $1,050 $700 $17,500 Indirect labor usage $4,505 $3,119 $3,581 $3,812 $15,017 Machine usage $6, 700 $5,000 $1,660 $1,640 $15,000 Gross profit (loss) $4,045 $4,081 $1,203 Gross profit (loss) as percent of sales 13. 48% 17. 00% -77. 05% -138. 29% 1. 98% Combining direct labor and indirect labor costs, the summary income statement showing unused capacity costs is as follows: Totals with Assigned Costs Unused Capacity Costs
Totals with Capacity Costs Direct labor and indirect labor $32,517 $68 $32,585 400 $15,400 $(468) $735 1. 21% a Labor capacity cost = $4,655 x 7 employees = $32,585. Employees perform direct labor and indirect labor tasks. 5-32 Part proliferation: role for activity-based costing An article in the Wall Street Journal by Neal Tempting and Joseph B. White (June 23, 1993) reported on the major changes occurring at General Motors. Its new chief executive officer, John Smith, had been installed after the board of directors requested the resignation of Robert Steppes, the previous chief.
John Smith’s North American Strategy Board identified 30 components that could be simplified for 1994 models. GM had 64 different versions of the cruise control/turn signal mechanism. It planned to reduce that to 24 versions the next year and the following year to just 8. The tooling for each one cost Gem’s A. C. Rochester division about $250,000. Smith said, ‘We’ve been talking about too many parts doing the same job for 25 years, but we weren’t focused on it. ” (Note that the tooling cost is only one component of the cost of proliferating components.
Other costs include the design and engineering costs for each different component, purchasing costs, setup and scheduling costs, plus the stocking and service costs for every individual component in each GM dealership around the United States. Gem’s proliferation of parts was mind-boggling. GM made or bought 139 different hood hinges, compared with one for Ford. Saginaw Plant Six juggled parts for 167 different steering columns?down from 250 the previous year but still far from the goal of fewer than 40 by decade’s end. This approach increased Gem’s costs exponentially.
Not only did the company pay far more engineers than competitors did to design steering columns, but it also needed extra tools and extra people to move parts around, and it suffered from quality glitches when workers confused one steering column with another. Required: (a) How could an inaccurate and distorted product costing system have contributed to the over proliferation of parts and components at General Motors? A traditional cost system, which assigns direct materials and direct labor to products, and allocates factory support based on direct labor, cannot signal the cost of component and product variety.
Marketing research may identify that consumers like to choose from a variety of options (especially when the alternatives are available without any cost associated with choosing; e. G. , you can have any color of this or any variety of that). In this situation, product engineers can design lots of varieties and options. The cost system assigns cost only on the direct labor and materials content of these options. Thus making one million units of one steering column appears to cost the same as making 100,000 of 4 different steering columns, 10,000 each of 30 other steering columns, and 1 ,OOH each of 300 other columns.
But making 334 steering columns in batch sizes ranging from, for example, 100 to 10,000, and designing and supporting 34 different steering columns is much more expensive than just producing 5 or at most 40 different columns. A traditional cost system would report that production costs of labor and materials for the 1,000,000 steering columns is the same whether they are produced in 5 varieties, 40 varieties, or 334 varieties. Thus model and component proliferation is virtually impossible to stop when companies cost products using traditional cost systems. B) What characteristics should a new cost system have that would enable it to signal accurately to product designers and market researchers about the cost of customization and variety? In order to understand the cost of variety, the new cost system should identify the cost of introducing new varieties, colors, and options. The cost system will show the cost of setting up or changing over to make the new variety, color and option, a cost that will be independent of the number of units produced after the setup.
Also the new cost system will show the cost of designing and supporting each new variety, color, and option (technically, in BBC terms, called the “product-sustaining’ costs) that will be independent of the number of units produced. With the more accurate understanding of the costs of resources that perform batch and product-sustaining activities, the product engineers and marketing managers can jointly make better decisions on whether the higher cost of introducing another customized option will be compensated with higher sales volumes and/or higher margins.
As a specific example, one of General Motors’ competitors examined the cost of how many wire harnesses it used in a given car model. Currently it was producing 12 different wire harnesses, a number that seemed optimal using its traditional cost system. The BBC system?which incorporated the economics of attach production and product-sustaining expenses?revealed that the optimal number of harnesses was 5 or 6. And when the cost of stocking and servicing all the dealerships was incorporated into the analysis, the optimal number dropped to 2.
In effect, the apparent savings in direct materials and labor from having customized wire harnesses for individual combinations of car options was far lower than the much higher support costs triggered by high engineering, production support, and service resources associated with having to produce, stock, and service 12 different wire harnesses for a single car model. 5-36 a) Calculate the practical capacity and the capacity cost rates for each of Treason’s personnel resources: brokers, account managers, financial planners, principals, and customer service representatives.
Answer: (b) Calculate the practical capacity and the capacity cost rates for each of Spinach’s resources: production and setup employees, machines, receiving and production control employees, shipping and packaging employees, and engineers. Answer: (c) Using these capacity cost rates and the production data in Exhibits 5-10 and 5-11, calculate revised costs and profits for Spinach’s three product lines. What preference does your cost assignment have on reported product costs and profitability? What causes any shifts in cost and profitability?