Activity Based Costing & Traditional Costing System

Exercise 4-11 (Algorithmic)
ABC Overhead Calculation

Alaine Productions is a progressive company that is considering the implementation of activity-based costing techniques to better understand and control costs associated with its human resources (HR) department. Currently, the department incurs annual costs of $748,000. Velma Alaine, the company’s president, believes that there are four primary activities within the department: recruiting new employees, responding to employee questions about benefits, general employee administration, and employee termination/separation. She asked the HR manager to identify possible drivers and costs associated with each of these activities. The manager provided the following data:

Activity Allocation Base Overhead Cost
Recruitment Number of applicants $245,000
Query response Number of questions 145,000
Administration Number of employees 300,000
Separation Number of terminations/separations 58,000

The HR manager determined that in the most recent year there were 2,000 applications received; 2,300 benefits-related questions from employees; an average monthly employment of 400 individuals; and 100 employees who either were terminated or otherwise left the company.


A.  Estimate the overhead cost for each activity. Round your answers to the nearest dollar, if required.

Recruitment $  per applicant
Query response $  per question
Administration $  per employee
Separation $  per termination/separation

B.  Which activity is the most expensive and which is the least expensive?

Most expensive
Least expensive


Problem 4-18
The Impact of ABC and JIT

Pritchett Enterprises manufactures hiking and outdoor equipment. The company’s plant in western Colorado has recently seen dramatic changes in manufacturing processes. Management is concerned that the current cost system no longer captures the impact of the diversity of activities involved in its production processes. As a result, management is evaluating whether activity-based costing may provide more accurate and meaningful cost data. The production environment includes the following primary activities and cost drivers:

The company has decided to implement just-in-time inventory management techniques. Using JIT will reduce the amount of inventory on hand at any point in time and save approximately $50,000 annually on inventory carrying costs. In addition, there will be 70 percent fewer purchase orders for inventory issued, but twice as many setups for production runs. The company will also be able to receive a 2 percent discount on raw materials purchases because of the long-term nature of the orders.


A.  If raw materials purchases are $1,000,000 per year (that is, the cost before the above mentioned changes are implemented), what quantitative impact will the change to JIT have on the overall costs for the company?
The impact would be total  of $.

B.  Switching to a  system often improves the quality of products and the timeliness of their delivery.

C.  Does it appear that the move to JIT will be positive or negative for the company?
The move will ……… since the JIT system will ……………….the company’s ability to respond more quickly to customers’ needs and reduce the company’s investment in inventories.


Brief Exercise 4-2
ABC Activities and Cost Drivers

Jakubielski and Martin, CPAs, is a full-service CPA firm that provides accounting, tax, and consulting services to its clients. The firm is considering changing to an activity-based costing system and has asked for your input regarding the design of the system. The firm has identified certain activities that are integral to the practice, and it would like your suggestions regarding potential cost drivers.


For each of the following activities, identify a potential cost driver. Please note that you may not use all drivers and some may be used more than once.

Activity Cost Driver
a.  Client interview
b.  Tax return preparation
c.  Tax return review
d.  Data input
e.  Report assembly
f.  Research
g.  Report writing
h.  Site visits


Brief Exercise 4-3
ABC Overhead Calculation

Timeless Timepieces produces and sells watches. The following data are available for various activities within the company:


Calculate the overhead rates for each of the three activities. Round your answer to the nearest cent, if needed.

Unpacking $per unpacked box
Inspecting $  per inspected batch
Packing $  per packed watch


Problem 4-15 (Algorithmic)
Traditional vs. ABC: Advantages of ABC

David Mayes, Inc., manufactures plastic and ceramic outdoor dinnerware. The company’s western plant has changed from a manual-labor operation to a robotics-intensive environment. As a result, management is considering moving from a direct-labor-based overhead rate to an activity-based costingsystem. The controller has chosen the following activity cost pools and cost drivers for factory overhead:

Overhead Cost Information Cost Driver Driver Activity
Purchase orders $190,000 Number of orders 24,000
Setup costs 191,000 Number of setups 12,000
Testing costs 405,000 Number of tests 15,000
Machine maintenance 820,000 Machine hours 51,000


When required, round interim calculations and final answers to the nearest cent.

A.  Calculate the overhead rate for each cost driver.

Purchase orders $  per order
Setup costs $ per setup
Testing costs $ per test
Machine maintenan $ per machine hour

B.  An order for 50 ceramic dish sets had the following requirements:

Number of purchase orders 3
Number of setups 24
Number of product tests 7
Machine hours 120

How much overhead should be assigned to this order?

Purchase orders $
Setup costs $
Testing costs $
Machine maintenance $
Total $

C.  Would you expect the new activity-based system to allocate a different amount of overhead?


Exercise 4-8 (Algorithmic)
ABC Overhead Calculation: Traditional vs. ABC

The following overhead cost information is available for the Anakin, Inc., for the previous year:

Activity Allocation Base Overhead Cost
Purchasing Number of purchase orders $480,000
Receiving Number of shipments received 100,000
Machine setups Number of setups 480,000
Quality control Number of inspections 180,000

During the year, 8,000 purchase orders were issued; 25,000 shipments were received; 2,000 machine setups occurred; and 15,000 inspections were conducted. Employees worked a total of 25,000 hours on production. The division managers are trying to decide whether they should use a traditional overhead allocation method based on direct labor hours or switch to an activity-based costing system.


A.  Determine the overhead rate, using the traditional overhead allocation method based on direct labor hours. Round your answer to one decimal place, if required.
$ per direct labor hour

B.  Determine the overhead rate for each of the activities, assuming that activity-based costing is used. Round your answer to one decimal place, if required.

Overhead Rate
Purchasing $ per purchase order
Receiving $ per shipment received
Machine setups $ per setup
Quality control $ per inspection


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