CH APTE R 6

Cost Allocation and Activity-Based Costing

TRUE-FALSE

1. Indirect costs occur because resources are shared by more than cost object.

2. Cost allocation is the process of assigning direct costs to products.

3. Cost allocation methods that provide the most accurate full cost for financial reporting
also provide the most accurate information for making decisions within the company.

4. One of the reasons that companies allocate costs is to reduce the frivolous use of common
resources.

5. One of the reasons that companies allocate costs is to discourage managers from
exploring the use of externally provided services.

6. From a decision-making standpoint, the allocated cost should measure the sunk cost of
using a company resource.

7. Once the opportunity cost associated with a shared resource is determined, it is unlikely
to change.

8. In order to provide full cost information for external reporting purposes, indirect
production costs must be allocated to goods produced.

9. Cost-plus contracts guarantee that the supplier will be paid for production costs plus
some fixed amount or percentage of the cost.

10. The more costs that are allocated to a cost plus contract, the more the supplier will be
paid under the contract.

11. A cost objective is the product, service or department that will receive the allocated cost.

12. Large cost pools that contain many different kinds of costs are the most useful to
managers making decisions.

13. The allocation base selected should have a cause-and-effect relationship with the costs to
be allocated.

14. In the direct method of allocating costs, service department costs are allocated only to
other service departments, not to the production departments.

15. When service departments costs are allocated using actual costs and actual usage, the
charge one operating manager receives will depend on the usage of other managers.
6-2 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

16. Allocating actual service department costs allows the service departments to pass on the
costs of inefficiencies to the production departments.
 Chapter 6 Cost Allocation and Activity-Based Costing 6-3

17. Managers should not be held responsible for controllable costs.

18. Allocating fixed costs on a per unit basis leads to better decision making.

19. Allocating fixed costs on a per unit basis will make the managers receiving the
allocations perceive the costs as variable.

20. ABC is less likely than traditional costing systems to undercost complex, low-volume
products.

21. ABC is always cost effective.

22. Under the ABC approach costs are assigned to products using a cost driver.

23. Activity-based costing and activity-based management are synonymous.

24. Activity-based management aims at improving the efficiency and effectiveness of

business processes.

25. Activity-based management uses benchmarking to compare the cost of an activity in one
organization to the cost for a similar activity in another organization

Answers
1 T 6 F 11 T 16 T 21 F
2 F 7 F 12 T 17 F 22 F
3 F 8 T 13 T 18 F 23 F
4 T 9 T 14 F 19 T 24 T
5 F 10 T 15 T 20 T 25 T
6-4 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

MULTIPLE CHOICE

29. Indirect costs occur when

A. resources are shared by more than one product or service.
B. costs cannot be directly traced to products or services.
C. multiple departments share a piece of equipment.
D. All of the above are correct.

30. The process of assigning indirect costs is called

A. directional association.
B. variable costing.
C. cost allocation.
D. joint costing.

31. Which of the following is not a reason that companies allocate costs?
A. to calculate the full cost of products for financial reporting purposes
B. to discourage managers from using external suppliers
C. to reduce the frivolous use of company resources
D. to provide information needed by managers to make appropriate decisions

32. Costs may be allocated to

A. products.
B. services.
C. departments.
D. any of the above.

33. From a decision-making standpoint, the allocated cost should measure the
A. sunk cost of the equipment involved.
B. variable costs of the goods purchased.
C. opportunity cost of using a company resource.
D. product cost of the goods produced.

34. If managers are not charged for centrally administered services, they are likely to
A. seek outside suppliers.
B. limit their frivolous use of these services.
C. consider the services as free.
D. evaluate and consider lower-cost alternatives for the services.

35. Full cost information

A. is required by GAAP for external reporting purposes.
B. does not require allocation of indirect costs.
C. provides managers with the most accurate information for making decisions.
D. treats all costs as fixed costs.
 Chapter 6 Cost Allocation and Activity-Based Costing 6-5

36. A contract which specifies that the suppler will be paid for the cost of production as well
as some fixed amount or percentage of cost is called a(n)
A. approved overrun.
B. cost-plus contract.
C. allocation plan.
D. indirect cost budget.

37. Cost-plus contracts are common in which of the following industries?

A. manufactured home builders
B. soft drink bottlers
C. defense contractors
D. newspaper publishers

38. A major problem with cost-plus contracts is that they

A. are not acceptable under GAAP.
B. cause the supplier to take significant financial risks.
C. require the supplier to use variable costing.
D. create an incentive to allocate as much cost as possible to the goods produced
under the cost-plus contract.

39. Which of the following is not a step in the cost allocation process?
A. List the steps in the production process.
B. Select an allocation base to relate the cost pools to the cost objectives.
C. Form cost pools.
D. Identify the cost objectives.

40. The cost objective is the

A. reason for allocating the cost.
B. calculation based on budgeted amounts.
C. product, service, or department that is to receive the allocation.
D. maximum amount to be allocated to any single department.

41. The product, service, or department that is to receive the cost allocation is called the
A. cost-plus recipient.
B. cost object.
C. terminal.
D. pool for manufacturing overhead.

42. Which of the following is least likely to be a cost objective?

A. salaries such as those in the accounting and personnel departments
B. individual products such as spades and mowers
C. product lines such as loans and estate plans
D. departments such as assembly and finishing
6-6 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

43. A grouping of individual costs whose total is allocated using one allocation base is called
a
A. cost objective.
B. cost pool.
C. direct cost.
D. sunk cost.

44. A cost pool is

A. not necessary in cost-plus contracts.
B. useful when separating mixed costs into their fixed and variable components.
C. allocated using a single allocation base.
D. a method of allocating costs among service departments.

45. The thing for which a cost is being calculated is a(n)

A. cost object
B. cost pool
C. cost driver
D. sunk cost

46. The overriding concern in forming a cost pool is to ensure that

A. there are no variable costs in the cost pool.
B. the total amount in the cost pool is less than the direct costs for the product.
C. only costs which have been budgeted are included in the cost pool.
D. the costs in the pool are homogeneous or similar.

47. Which of the following statements about cost pools is not true?
A. The costs in each of the cost pools should be homogeneous or similar.
B. Managers must make a cost-benefit decision when determining how many cost
pools are appropriate.
C. Only four different kinds of costs may be included in a single cost pool.
D. More cost pools usually provide more accurate information, but are more
expensive.

48. An allocation base

A. is the minimum amount to be allocated to a cost object.
B. coordinates the manufacturing overhead costs as they are incurred.
C. will always be less than the variable costs for a product.
D. relates the cost pool to the cost objectives.

49. An allocation base

A. relates the cost pool to the cost objectives.
B. is a characteristic that is common to all of the cost objectives.
C. ideally uses a cause-and-effect relationship.
D. All of the above are true.
 Chapter 6 Cost Allocation and Activity-Based Costing 6-7

50. Which of the following is not a criterion used to allocate fixed costs?
A. ability to bear costs
B. equity
C. feasible outcomes
D. relative benefits

51. Which of the following is not a service department in a typical manufacturing firm?
A. security
B. fabrication
C. maintenance
D. personnel

52. The method of allocation which allocates service department costs to production
departments but not to other service departments is called the
A. equity method.
B. direct method.
C. reciprocal method.
D. sequential or step method.

53. Service department costs are allocated to producing departments

A. so that the costs can be allocated to the products in the producing departments.
B. because the costs of the service is not material.
C. so the service will not be purchased externally.
D. All of the above.

54. Which of the following allocations would not occur when the direct method is used in a
manufacturing company?
A. personnel department costs allocated to the maintenance department.
B. maintenance department costs allocated to the finishing department.
C. assembly department costs allocated to Product C.
D. All of the above allocations could occur when the direct method is used.

55. The advantage of allocating budgeted rather than actual service department costs is that
A. managers are not motivated to evaluate the charges.
B. only one cost pool is necessary.
C. service departments cannot pass on the costs of inefficiencies and waste.
D. this practice is acceptable under GAAP.

56. The type of costs which are affected by the manager’s decisions and for which the
manager should be held accountable are
A. indirect costs.
B. controllable costs.
C. basis costs.
D. pooled costs.
6-8 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

57. Managers are correct when they perceive that almost all cost allocations are
A. insignificant.
B. arbitrary.
C. designed to make them look bad.
D. unnecessary.

58. When fixed costs are unitized, they

A. are stated on a per unit basis.
B. may appear to be variable costs.
C. may cause managers to make decisions that are not in the best interest of the
company as a whole.
D. All of the above are true.

59. An allocation of a predetermined amount that is not affected by changes in the activity
level of the organizational unit receiving the allocation is called a(n)
A. allocation base.
B. unitized cost.
C. lump-sum allocation.
D. cost driver.

60. Lump-sum allocations

A. allocate fixed costs so that they appear fixed to the manager.
B. are not affected by the activity level in the department receiving the allocation.
C. Both A and B are true.
D. Neither A nor B is true.

61. Lump sum allocations

A. should generally be adjusted each month.
B. will change when the activity levels of any of the user departments change.
C. are not impacted by the usage of the allocated resource by other departments.
D. make fixed costs appear variable.

62. Which of the following is not a problem caused by assigning actual service department
costs to operating departments based on actual usage of service department activities by
the operating departments?
A. The cost assigned to one manager will be affected by the service usage of another
manager.
B. Inefficiencies in the service department will be passed along to the operating
departments.
C. Operating managers having high peak capacity requirements will not have to bear
the full cost of meeting this peak capacity.
D. All of the above are problems caused by actual allocation.
 Chapter 6 Cost Allocation and Activity-Based Costing 6-9

63. The Copy Department of the Carnival Company is budgeted to incur $40,000 per month
in fixed costs and $0.02 per copy in variable costs. It allocates copy costs to user
departments as follows: Fixed costs are allocated (as a lump sum) based on budgeted
fixed costs and estimated peak demand for each department. Variable costs are allocated
based on the budgeted rate per copy times the department's actual usage. Which of the
following is not an advantage of this allocation scheme over allocating actual costs based
on actual usage?
A. Using departments are not charged for cost overruns in the copy department.
B. The amount charged to one using department is not affected by the number of
copies used by another department.
C. Managers in the using departments pay for the fixed costs that are created by their
demands for capacity.
D. All of the above are advantages of this allocation system.

64. Which of the following are desirable characteristics of an allocation received by a

manager of a producing department from a service department for using the resources of
the service department?
A. The amount of the allocation should be based solely on the usage of the service by
the producing department and not a function of the use of the service by other
departments.
B. The manager should be able to budget for the cost.
C. The allocation should force the production manager to pay for the capacity
demands the production manager is creating.
D. All of the above are desirable characteristics of an allocation received by a
manger of a producing department from a service department.

65. Companies which use only one or two cost pools rather than several cost pools
A. may have seriously distorted product costs.
B. will have higher record-keeping costs.
C. will be able to more accurately price products to cover the cost and generate a
profit.
D. are likely to be using ABC.

66. When activity based costing is implemented, the initial outcome is normally that:
A. the cost of all products will be higher.
B. The cost of all products will be lower
C. The cost of low volume products will be higher and the cost of high volume
products will be lower
D. The cost of low volume products will be lower and the cost of high volume
products will be higher.
6-10 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

Answers
29 D 51 B
30 C 52 B
31 B 53 A
32 D 54 A
33 C 55 C
34 C 56 B
35 A 57 B
36 B 58 D
37 C 59 C
38 D 60 C
39 A 61 C
40 C 62 D
41 B 63 D
42 A 64 D
43 B 65 A
44 C 66 C
45 A
46 D
47 C
48 D
49 D
50 C
 Chapter 6 Cost Allocation and Activity-Based Costing 6-11

MATCHING

152. Match each of the following terms with the phrase that most closely describes it. Each
answer may be used only once.

_____ 1. ability to bear costs

_____ 2. activity-based costing

_____ 3. activity-based management

_____ 4. cost allocation

_____ 5. cost driver

_____ 6. cost objective

_____ 7. cost pool

_____ 8. cost-plus contract

_____ 9. lump-sum allocation

_____ 10. unitized costs

A. Assigning indirect costs to cost objectives

B. A method of allocation that assigns more costs to more profitable cost objects
C. A measure of the activity that is used to allocate costs
D. Fixed costs stated on a per unit basis
E. Price for this includes actual costs plus a fixed amount or percentage
F. A recently developed method of cost allocation that uses cost drivers to allocate costs to
products
G. The object or recipient of the cost allocation
H. Has the goal of improving efficiency and effectiveness by analyzing and costing activities
I. A grouping of individual costs whose total is allocated using one allocation base
J. Allocations of fixed costs in which predetermined amounts are allocated regardless of
changes in the level of activity

Answers
1. B 6. G
2. F 7. I
3. H 8. E
4. A 9. J
5. C 10. D
6-12 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

EXERCISES

153. Keystone Company’s copy department, which does almost all of the photocopying for the
sales department and the administrative department, budgets the following costs for the
year, based on the expected activity of 4,000,000 copies:

Salaries (fixed) $90,000

Employee benefits (fixed) 10,000
Depreciation of copy machines (fixed) 10,000
Utilities (fixed) 5,000
Paper (variable, 1 cent per copy) 40,000
Toner (variable, 1 cent per copy) 40,000

The costs are assigned to two cost pools, one for fixed and one for variable costs. The
costs are then assigned to the sales department and the administrative department. Fixed
costs are assigned on a lump-sum basis, 30 percent to sales and 70 percent to
administration. The variable costs are assigned at a rate of 3 cents per copy. Assuming
4,800,000 copies were made during the year, 2,500,000 for Sales and 2,300,000 for
Administration, calculate the copy department costs allocated to sales and separately to
Administration.

Answer
Total fixed costs to be allocated = $90,000 + 10,000 + 10,000 + 5,000 = $115,000.

Fixed costs allocated to Sales ($115,000  .3) $ 34,500

Variable costs allocated to Sales (2,500,000 copies  $.02) 50,000
Total costs allocated to Sales $ 84,500

Fixed costs allocated to Admin. ($115,000  .7) $ 80,500

Variable costs allocated to Admin (2,300,000 copies  $.02) 46,000
Total costs allocated to Sales $126,500
 Chapter 6 Cost Allocation and Activity-Based Costing 6-13

154. Flowers Banking and Loan Company has a graphic design department that designs loan
forms and other documents used by the company’s two subsidiaries (Flowers Personal
Banking and Auburn Business Banking). For practical purposes, the costs of the graphic
design department are primarily fixed and relate to the salaries of the department’s two
employees.
Each subsidiary receives a cost allocation of $50 per design hour. Jobs requested by the
subsidiaries generally take weeks to complete often causing the subsidiaries to go outside
the company for design services rather than wait for jobs to be completed. Outside design
services cost $70 per hour. How does the allocation ($50 per design hour) compare to the
opportunity cost of using design services?

Answer
The allocation of $50 per hour must be less than the opportunity cost (subsidiaries are
willing to pay $70 per hour to avoid delays). Thus, they must have a benefit that exceeds
$70.
155. Tasco Manufacturing produces small electric motors used by appliance manufacturers. In
the past year, the company has experienced severe excess capacity due to competition
from a foreign company that has entered Tasco’s market. The company is currently
bidding on a potential order from Corinth Appliances for 6,000 Model 209 motors. The
estimated cost of each motor as follows:

Direct material $ 30
Direct labor 20
Overhead 80
Total $130

The predetermined overhead rate is $4 per direct labor dollar based on estimated annual
overhead of $12,000,000 and estimated annual direct labor of $3,000,000. The
$12,000,000 of overhead is composed of $6,000,000 of variable costs and $6,000,000 of
fixed costs. The largest fixed cost relates to depreciation of plant and equipment.

a. With respect to overhead, what is the opportunity cost of producing a Model 209
motor?
b. Suppose Tasco can win the Corinth business by bidding a price of $92 per motor
(but no higher price will result in a winning bid). Should Tasco bid $92?
c. Discuss how an allocation of overhead based on opportunity cost would facilitate
an appropriate bidding decision.

Answer
a. Direct material $30
Direct labor 20
Variable overhead ($2.00 per direct labor $)* 40
Total $90
* Variable overhead rate = $6,000,000 ÷ $3,000,000
6-14 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

b. Any bid greater than $90 (that’s accepted) will generate incremental profit. If
Tasco can get the order with a bid of $92, the company should bid this amount.

c. The opportunity cost related to overhead, in this case, is the variable overhead
amount. An allocation based on the opportunity cost idea, helps managers focus
on incremental costs—the information needed for decision making.

156. Precise Instrumentation manufactures a variety of electronic instruments that are used in
military and civilian applications. Sales to the military are generally on a cost-plus profit
basis with profit equal to 10 percent of cost. Instruments used in military applications
require more direct labor time because “fail-safe” devices must be installed.
At the start of the year, Precise estimates that the company will incur $50,000,000 of
overhead, $8,000,000 of direct labor, and 250,000 machine hours. Consider the Model
VR12 gauge that is produced for both civilian and military uses:

Civilian Military
Direct material $3,000 $3,500
Direct labor $ 900 $1,200
Machine hours 42 45

a. Calculate the cost of civilian and military versions of Model VR12 using both
direct labor dollars and machine hours as alternative allocation bases.
b. Explain why Precise Instruments may decide to use machine hours as an overhead
allocation base.

Answer
a. Overhead rate based on direct-labor dollars
($50,000,000 ÷ $8,000,000 labor) = $6.25 per dollar of labor

Overhead rate based on machine hours

($50,000,000 ÷ 250,000 machine hours) = $200 per machine hour

Civilian Military
Labor $ Mach.Hrs. Labor $ Mach.Hrs.
Direct material $3,000 $ 3,000 $ 3,500 $ 3,500
Direct labor 900 900 1,200 1,200
Overhead 5,625 8,400 7,500 9,000
Cost $9,525 $12,300 $12,200 $13,700

b. The price charged for the civilian version of the Model VR12 does not depend on
allocated costs. However, the military version is sold for “cost” plus 10 percent of
cost. Therefore, the company has an incentive to make cost appear higher rather
than lower. This can be accomplished by allocating overhead cost using machine
hours as the allocation base. This base results in a higher cost ($13,700) compared
to an allocation based on direct labor dollars which results in a cost of only
$12,200.
 Chapter 6 Cost Allocation and Activity-Based Costing 6-15

157. Mooring Company allocates manufacturing overhead costs to products based on the
machine hours used. Manufacturing overhead costs are expected to total $166,950 in the
coming period and the company plans to use 47,700 machine hours in the same period.
Product X requires three machine hours per unit and Product Y requires four machine
hours per unit. The current production schedule calls for 7,500 units of Product X and
6,300 units of Product Y.

A. What is the overhead application rate per machine hour?

B. If production and overhead cost occur as scheduled, how much manufacturing
overhead will be allocated to Product X and how much will be allocated to
Product Y?

Answer
A. $166,950 / 47,700 = $3.50 per machine hour

B. Product X = 7,500 units × 3 machine hours/unit × $3.50 per machine hour =

$78,750

Product Y = 6,300 units × 4 machine hours/unit × $3.50 per machine hour = $88,200

158. Kendrick Apparel is the designer and maker of elaborate prom dresses. The president of
Kendrick wants to switch to an activity-based approach in the upcoming year to assign
prices to the gowns. Production line setups are a major activity at Kendrick. Next year
Kendrick expects to perform 1,500 setups at a total cost of $102,000. Kendrick plans to
produce 170 dresses of the debonair design, which will require three setups. How much
setup cost will be allocated to each dress of the debonair design that is produced?

Answer
Cost per setup = $102,000 ÷ 1,500 = $68

Cost of setups related to the A128 design = 3  $68 = $204

Setup cost per debonair dress = $204 ÷ 170 = $1.20

159. Cortez Company has three service departments (A1, A2, A3) and two production
departments (B1, B2). The following data relate to Cortez’s allocation of service
department costs:
Budgeted Costs Number of Employees
A1 $3,000,000 80
A2 2,000,000 60
A3 1,000,000 30
B1 300
B2 500
6-16 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

Service department costs are allocated by the direct method. The number of employees is
used as the allocation base for all service department costs.
a. Allocate service department costs to production departments.
b. Calculate the total service department cost allocated to each production
department.

Answer
B1 has 300 ÷ 800 = 37.5% of production department employees.

B2 has 500 ÷ 800 = 62.5% of production department employees.

Cost Allocated to
Department Costs B1 B2
A1 $3,000,000 $1,125,000 $1,875,000
S2 2,000,000 750,000 1,250,000
A3 1,000,000 375,000 625,000
Total cost $6,000,000 $2,250,000 $3,750,000

160. Dillard Industries produces electronic equipment for the marine industry. Maintenance
costs are allocated to assembly and testing on the basis of square footage occupied, and
computing costs are allocated on the basis of the number of computer terminals. The
following data relate to allocations of service department costs:
Maintenance Computing Assembly Testing
Service department costs $400,000 $800,000
Square footage 77,000 33,000
Terminals 6 10

Allocate the service department costs to production departments using the direct method.

Answer
Assembly Testing
Maintenance ($400,000) 70% 30%
Computing ($800,000) 37.5% 62.5%

Service dept. costs allocated to Assembly:

(.70  $400,000) + (.375  $800,000) = $280,000 + $300,000 = $580,000
Service dept. costs allocated to Testing:
(.30  $400,000) + (.625  $800,000) = $120,000 + $500,000 = $620,000
 Chapter 6 Cost Allocation and Activity-Based Costing 6-17

161. Farm Land Financial Services has two divisions: Financial Planning and Business
Consulting. The firm’s accountants are in the process of selecting an allocation base to
allocate centrally provided personnel costs to the divisions. Two allocation bases have
been proposed—salary and headcount (number of employees). Personnel costs are
expected to be $2,500,000. The following data relate to the allocation:

Financial Planning Business Consulting

Salaries $14,000,000 $18,000,000
Headcount 150 50

a. Prepare a schedule showing the allocations to the two divisions using each
allocation base.
b. Referring to your answer to part a, explain why allocations are sometimes
considered arbitrary.

Answer
a. Allocation Base
Financial Planning Business Consulting
Proportion Amount Proportion Amount
Salaries .4375 $1,093,750 .5625 $1,406,250
Headcount .75 $1,875,000 .25 $625,000

b. Both headcount and salary appear to be plausible allocation bases, but they result
in very different allocations. This suggests that in many cases allocations are
somewhat arbitrary.

162. The costs of the personnel department at Wanson Company total $180,000. These costs
are allocated based on the number of employees in the production departments. If 66 of
Celtic’s 165 production employees work in the sanding department, what amount of the
personnel department costs should be allocated to the sanding department?

Answer
($180,000 / 165) × 66 = $72,000

163. The personnel department at Harton Company has $45,000 in budgeted costs for the
coming period. Harton is trying to determine whether to allocate these costs to the two
production departments based on the number of employees or on machine hours used in
the department. Information about the production departments is given below:

Department C Department D
Number of employees 15 35
Anticipated machine hours 600 400

Calculate the costs allocated to each of the production departments using each allocation
base. Comment on which allocation base is preferable.
6-18 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

Answer
When number of employees as the allocation base:
Department C = $45,000 × (15/50) = $13,500
Department D = $45,000 × (35/50) = $31,500

When number of machine hours as the allocation base:

Department C = $45,000 × (600/1,000) = $27,000
Department D = $45,000 × (400/1,000) = $18,000

The number of employees is a better allocation base because it is more closely related to
personnel department costs.

164. King Company has a regional division and a national division and a travel department
which supports the employees in both divisions. The fixed costs of the travel department
($30,000 per month) are allocated based on the peak usage of reservation services. The
national division has a peak monthly usage of 300 reservations and the regional has a
peak usage of 200 reservations. The variable costs of the travel department are allocated
to the divisions based on the number of reservations made, at a rate of $20 per
reservation.

A. If the regional division requires 180 reservations and the national division
requires 170 reservations, calculate the amount of travel department costs that will
be allocated to each of the divisions.
B. Explain why the allocation is higher to national when it uses fewer reservations.

Answer
A. Regional division = [$30,000 × (200/500)] + ($20 × 180) = $15,600

National division = [$30,000 × (300/500)] + ($20 × 170) = $21,400

B. National has higher peak needs and so is being charged a higher amount for
capacity.

165. Corporation has three departments, Civil, Criminal, Auditing and Probate. Each
department uses the services of the photocopying department. The photocopying
department has 10 copiers, and each copier can produce 100,000 copies per month and
has a fixed cost of $1,000 per month. The variable cost to produce a copy is $0.03 per
copy.

The three production departments have monthly consumption information as follows:

Peak Demand Average Demand March Usage

Civil 600,000 copies 300,000 410,000
Criminal 200,000 copies 180,000 190,000
Probate 200,000 copies 180,000 170,000
 Chapter 6 Cost Allocation and Activity-Based Costing 6-19

During March, the actual costs incurred in the Copying Department were:
$10,300 fixed and $23,870 in variable costs.

A. Describe three alternative ways that the production departments could be charged
for services.
B. Assign the actual cost of March copying to the production departments based on
the actual copies used by each department. What is the cost per copy? (Round to
two decimal places for cost per copy and whole dollars for charges to
departments.)
C. Assign the cost of March copying to the production departments using a dual rate.
Assign the budgeted fixed cost based on peak usage requirements. Assign the
budgeted variable cost based on actual usage. What is the total cost per copy
assigned to each department?
D. Which way do you believe is more equitable? Why?

Answer
A. Actual cost per copy on actual copies used
Budgeted total cost per copy based on average usage times actual copies used.
Dual allocation as in c below

B. 4.44 cents per copy

Civil - $18,204
Criminal - $8,436
Probate $7,548

C. Civil: 4.46 cents per copy

(600,000/1,000,000 × 10,000) + (410,000 × .03) =$18,300

Criminal: 4.05 cents per copy

(200,000/1,000,000 × 10,000) + (190,000 × .03) = $7,700

Probate: 4.18 cents per copy

(200,000/1,000,000 × 10,000) + (170,000 × .03) = $7,100

D. Dual rate (c) will encourage the departments demanding the capacity to pay
capacity costs.

166. Metal Inc. received an offer from a retail company to purchase 2,000 metal outdoor tables
for $155 each. Metal Inc.’s accountants determine that the following costs apply to the
tables:

Direct material $ 90
Direct labor 45
Manufacturing overhead 70
Total $205
6-20 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

Of the $70 of overhead, $14 is variable and $56 relates to fixed costs. The $56 of fixed
overhead is allocated as $1.25 per direct labor dollar.
a. What will be the real effect on profit if the order is accepted?
b. Explain why managers who focus on reported cost per unit may be inclined to
turn down the order.

Answer
a. The manufacturing overhead allocation includes $56 of fixed cost which will not
increase if the special order is accepted (i.e., it is not an incremental cost). The
incremental revenue and incremental costs associated with the order suggests that
the company will be better off by $12,000 if the order is accepted.

Incremental revenue (2,000  $155) $310,000

Incremental costs
Material (2,000  $90) $180,000
Labor (2,000  $45) 90,000
Variable overhead (2,000  $14) 28,000 298,000
Incremental profit $ 12,000

b. Managers who focus on reported cost may (incorrectly) treat the $56 of fixed cost
as an incremental cost. In this case they will (incorrectly) conclude that the order
should not be accepted because the total cost of $205 is more than the offer price
of $155.

167. Clark Manufacturing allocates factory overhead using one cost pool with direct labor
hours as the allocation base. Clark has two production departments (A1 and A2). The
new accountant at Clark estimates that next year the total factory overhead costs will be
$4,000,000 and approximately 500,000 direct labor hours will be worked. The accountant
also estimates that A1 will use 150,000 direct labor hours and there will be about
$2,000,000 in overhead costs in A1. A2 will use 350,000 direct labor hours and there will
be $2,000,000 in overhead costs in A2. Clark has two products: R4 and R5. It takes two
direct labor hours in A1 and three direct labor hours in A2 to complete one unit of R4. It
takes one direct labor hour in A1 and four direct labor hours in A2 to complete one unit
of R5.

Which product will be undercosted and which will be overcosted using a single cost pool
system? Support your answer with appropriate calculations.
 Chapter 6 Cost Allocation and Activity-Based Costing 6-21

Answer
The use of a single cost pool causes R4 to be undercosted and R5 to be overcosted. With
a single cost pool, both products receive the same allocation of cost per labor hour.
However, R4 uses relatively more time in A1 where overhead costs are high while R5
uses relatively more time in A2 where overhead costs are low.

The one-cost pool overhead rate is:

$4,000,000 ÷ 500,000 DLH = $8 /DLH

Each product requires 5 direct labor hours in total. Therefore, each will be allocated $40
in overhead costs ($8  5)

When separate cost pools are used, the amount of overhead allocated to each product if
Clark used a separate overhead cost pool for each production department is:

A1’s overhead rate will be $2,000,000 ÷ 150,000 DLH = $13.33 per direct labor hour
A2’s overhead rate will be $2,000,000 ÷ 350,000 DLH = $5.71 per direct labor hour

Overhead allocated to each unit of R4 will be:

(2 labor hours  $13.33) + (3 labor hours  $5.71) $43.79

Overhead allocated to each unit of R5 will be:

(1 labor hour  $13.33) + (4 labor hours  $5.71) $36.17

168. The following are six cost pools established for a company using activity-based costing.
The pools are related to the company’s products using cost drivers. For each of the
preceding cost pools, identify a possible cost driver.

COST POOL COST DRIVER

(1) Inspection of raw materials ______________
(2) Production equipment repairs and maintenance ______________
(3) Raw materials storage ______________
(4) Plant heat, light, water, and power ______________
(5) Finished product quality control ______________
(6) Production line setups ______________

Answer
COST POOL COST DRIVER
(1) Inspection of raw materials Number of receipts, pounds
(2) Production equipment repairs and maintenance Machine hours, square feet
(3) Raw materials storage Dollar value of raw materials
(4) Plant heat, light, water, and power Square footage
(5) Finished product quality control Number of inspections
(6) Production line setups Number of setups
6-22 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

169. Ralston’s Machining produces specialized equipment. Currently, overhead costs are
allocated at a rate of $5 per machine hour produced and the company used 20,000
machine hours last year. Ralston’s CEO has heard about ABC, and would like to see if it
makes any difference in the costs allocated to jobs at the company.

The accounting staff has provided the following information about manufacturing
overhead:
Amount Cost Driver
Setups $30,000 Number of setups
Equipment 20,000 Number of machine hours
Inspection 50,000 Number of inspections

The company estimates that it will perform 150 setups and 1,000 inspections each year
and will use 2,000 machine hours. Job CRT will require 18 setups, 85 machine hours, and
60 inspections.

A. Using ABC, what amount of manufacturing overhead will be allocated to Job

CRT?
B. What amount would Ralston allocate to job CRT using their current, traditional
system?
C. Why do the two methods yield such different answers?

Answer
A. Using ABC costing,
[18 × ($30,000/150)] + [85 × ($20,000/2,000)] + [60 × ($50,000/1,000)] = $7,450

B. Using the current system, 85 × ($100,000/2,000) = $4,250

C. The order uses the 4% of annual machine hours, but 12% of annual setup and 6%
of annual inspections. It is a heavy user of non-unit based drivers, and is costed
much higher when this is recognized.

170. Williams Appliances supplies parts for laundry and kitchen appliances. Customer orders
are placed over the Internet and are generally filled in one or two days using express mail
services.
Frank Farnsworth, a consultant with Consultancy Services, has been asked to conduct an
ABM study of inventory management at Williams Appliances. In this regard he has
determined that the cost of filling customer orders in the past year consisted primarily of
$250,000 of salary expense related to five workers who “pick” parts from the warehouse
and $550,000 of salary expense related to six workers who pack the orders for shipment.
In the past year, the company filled 100,000 orders. Based on work performed for a chain
of auto supply stores, Frank has determined a benchmark cost of $4 per order.

a. Comment on the advisability of comparing the costs at Williams Appliances to

those at an auto supply chain store.
 Chapter 6 Cost Allocation and Activity-Based Costing 6-23

b. Frank has observed the following: Workers go to a box that contains individual
customer order sheets. They take the bottom order (the “oldest”) and go into the
warehouse with a handcart and a box. They then fill the order and carry the parts
to a packing station. Can you suggest ways of improving this process?

Answer
a. The cost of filling orders at Williams Appliances is:
($250,000 + $550,000) ÷ 100,000 = $8 per order
The cost of filling orders at the auto supply chain is only $4 per order. While this
is lower, it may be that, due to its size, the appliance auto chain has a “state of the
art” warehouse. It may be unrealistic for Williams Appliances, which is relatively
small, to compare itself to such a large company.

b. Possibly, order “pickers” can take multiple order sheets out to the warehouse
when individual orders are small. This will save considerable time going back and
forth to the warehouse and may lead to lower costs if the company is willing to
fire or reassign one or more of the five workers who pick parts.

SHORT-ANSWER ESSAYS

171. List the four major reasons that companies allocate costs.

Answer
Companies allocate costs (1) to provide information needed to make appropriate
decisions, (2) to reduce the frivolous use of common resources, (3) to encourage
managers to evaluate the efficiency of internally provided services, and (4) to calculate
the “full cost” of products for financial reporting purposes and for determining cost-based
prices.

172. What is a cost-plus contract? Why are cost-plus contracts used?

Answer
The supplier is paid for all costs of production as well as some fixed amount or
percentage of cost in a cost-plus contract. Cost-plus contracts are used when suppliers
need to be assured that they will be reimbursed for their costs and will not bear any of the
financial risk associated with the project.

173. What is the difference between a cost pool and a cost objective?

Answer
A cost pool is a grouping of individual costs whose total is allocated using one allocation
base. A cost objective is the product, service, or department that will receive the cost
allocation.
6-24 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

174. Why is it better to allocate budgeted rather than actual service department costs?

Answer
If budgeted costs are allocated, service departments cannot pass on the costs of
inefficiencies and waste to the user departments. If actual service department costs are
allocated, the service departments have no incentive to control their costs. Budgeted
allocations can also be more timely.

175. Why are lump-sum allocations used to allocate fixed costs?

Answer
When lump-sum allocations are used to allocate fixed costs, the costs will appear fixed to
the managers whose departments receive the allocations. If lump-sum allocations are not
used, an increase in volume will lead to an increased allocation of fixed costs and may
cause incorrect decisions.

176. If a manager is allocated the costs of service departments based on actual costs and actual
activity usage levels, what frustrations might the manager feel?

Answer
The manager will not be able to plan or control costs since the charge the manager
receives will be a function of the manager’s usage and the usage of the other managers as
well as cost control in the service department.

177. Describe the difference between the traditional approach to allocating costs and activity-
based costing.

Answer
The traditional approach to allocating costs assumes that all overhead costs are
proportional to production volume. In activity-based costing, the company identifies the
activities that cause costs and allocates costs based on the volume of the activities that
caused the costs. These activities may or may not be related to production volume.

178. What is the difference between ABC and ABM?

Answer
While ABC focuses on activities with the goal of measuring the costs of products and
services produced by them, ABM focuses on activities with the goal of managing the
activities themselves.

*179. What are the four steps in ABM?

Answer
Determine major activities, identify resource used by each activity; evaluate the
performance of the activities; and identify ways to improve the efficiency and
effectiveness of the activities