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Product Profitability and Activity-Based Costing Methodologies

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Problem: 4.49 (Product Profitability)

Complete problem 4.49 in Hilton. As you complete the problem, refer to the following suggestions:
You will be calculating unit costs for products A and B using both traditional and activity-based costing methodologies.
a. When developing your activity-based costing rates, be sure to show the activity/resource, cost, volume, and rate per unit of measure.
b. Using your activity based rates, apply actual activities of products A and B to determine total cost by product and unit costs. Separate the activity/resources by unit, batch, product, customer, and facility levels.
c. Determine unit costs by using traditional costing.
d. Compare the unit costs using activity-based costing and traditional costing approaches and analyze the reason for the differences.

An ABC team at Drugs 'R Us, a pharmaceutical company, identified these data for a typical month:

Activity Activity
Cost in a Volume in a
Activity/Resource Cost-Driver Base Typical Month Typical Month
1. Unit Level
1.1 Acquire and use material Number of units \$ 60,000 1,000,000 units
for Product A produced
1.2 Acquire and use direct labor Number of direct-labor 20,000 2,000 direct
For Product A hours worked labor hours
1.3 Acquire and use material Number of units 80,000 800,000 units
for Product B produced
1.4 Acquire and use direct labor Number of direct-labor 30,000 2,000 direct
For Product B hours worked labor hours
2. Batch Level
2.1 Quality control Number of batches 30,000 100 batches
3. Product Level
3.1 Provide product-level advertising Number of promotions 100,000 100 promotions
3.2 Provide product-level records Number of products 20,000 2 products
4. Customer Level
4.1 Take customer product orders Number of customer 40,000 2,000 customer
orders orders
4.2 Deal with customer complaints Number of complaints 20,000 1,000 complaints
5. Facility Level
5.1 Supervise direct labor Amount of direct-labor 10,000 \$50,000
Costs activities 1.2 and
1.4 (supervision
costs _ 20% of
direct labor costs.)
5.2 Use main building Number of square feet 40,000 10,000 square
feet
The company's management wants you to compute the total cost and unit cost of each product for the
month of July, which had the following level of activities:
Product A Product B
1.1 and 1.3 Material 800,000 units 900,000 units
1.2 and 1.4 Direct labor 1,600 hours 2,100 hours
2.1 Quality control—batches 50 batches 40 batches
3.1 Advertising projects—promotions 50 promotions 40 promotions
3.2 Products recorded 1 product 1 product
4.1 Customer orders 800 customer orders 900 customer orders
4.2 Customer complaints 600 complaints 300 complaints
5.1 Direct-labor supervision \$16,000 \$31,500
5.2 Main building use 6,000 sq. ft. 3,000 sq. ft.

Required
a. Compute the cost-driver rate for each cost-driver base.

b. Use ABC to compute the cost of each of the two products given the activity level for the month of
July. Compute both the total cost and unit cost for each product for the month of July.

c. Assume that the company's traditional costing system had assigned overhead costs at a rate of \$.10
per unit of output plus \$20.00 per direct-labor hour. Overhead costs are the sum of the batch-level,
product-level, customer-level, and facility-level costs. Using this traditional costing approach, compute
the cost of each product (including material and direct-labor costs) given the activity level for
the month of July. Compute both the total cost and unit cost for each product for the month of July.

d. Do the unit costs of the two products computed under ABC and traditional costing systems differ
significantly? If so, what causes the differences?

Problem 6.34 (Customer Profitability)

Analyze the profitability of the Premium and Standard products in light of the promotion costs being incurred for each product. Determine the margins associated with each product and the related return on net sales for each.

Determine the advisability of continuing the promotional spending related to each product in light of your findings. What would you recommend?

Beaujolais Financial Group (BFG) segments its customers into premium members, who purchase extensive services, and standard members, who purchase minimal services. It offers premium members a 10 percent discount on the total package of services purchased but requires standard members to pay full price. BFG devotes one full-time customer representative per 100 premium members and one per 1,000 standard members. Customer representatives receive salaries and a bonus of 1 percent of customer revenue (after 10 percent discount, if applicable). BFG estimates that it spends twice as much on total promotions for premium members to encourage their loyalty. General and administrative cost, which is not traced to customers, is \$2,400,000 per year.

Required
a. Estimate BFG's customer and overall profitability.
b. Write a short memo that critiques BFG's customer service policies and measurements.
c. Build a spreadsheet. Develop a spreadsheet to answer requirement (a).

Exercise 11.44 (Interpretation of Regression Data)

Unsafe Insurance Company needs to forecast its personnel department costs. The following output was obtained from a regression program used to estimate the department's costs as a function of the number of employees:
SUMMARY OUTPUT
Dependent variable = Personnel costs
Regression Statistics
R-square 0.7255
Standard error 612.0926
Observations 24

Independent Variable Coefficients Standard Error T -Statistic
Intercept 8,421.441 2,687.979 3.133
Employees 492.703 164.949 2.987

Monthly data for the past two years were used to construct these estimates. Cost relationships are expected to be the same for the coming period.
Required
1. What are the estimated personnel costs for 4,200 employees?
2. How confident are you that a significant cost-driver relation exists?

Problem 17.65 ( Use of a flexible Budget: Review of Chapter 16 and 17)

This problem requires the completion of a detailed variance analysis. In performing your calculations, it will be necessary to use the high-low method of cost estimation. In addition, the text gives several hints to make the solution easier.

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Solution Preview

Problem: 4.49 (Product Profitability)

Complete problem 4.49 in Hilton. As you complete the problem, refer to the following suggestions:
You will be calculating unit costs for products A and B using both traditional and activity-based costing methodologies.
a. When developing your activity-based costing rates, be sure to show the activity/resource, cost, volume, and rate per unit of measure.
b. Using your activity based rates, apply actual activities of products A and B to determine total cost by product and unit costs. Separate the activity/resources by unit, batch, product, customer, and facility levels.
c. Determine unit costs by using traditional costing.
d. Compare the unit costs using activity-based costing and traditional costing approaches and analyze the reason for the differences.

An ABC team at Drugs 'R Us, a pharmaceutical company, identified these data for a typical month:

Activity Activity
Cost in a Volume in a
Activity/Resource Cost-Driver Base Typical Month Typical Month
1. Unit Level
1.1 Acquire and use material Number of units \$ 60,000 1,000,000 units
for Product A produced
1.2 Acquire and use direct labor Number of direct-labor 20,000 2,000 direct
For Product A hours worked labor hours
1.3 Acquire and use material Number of units 80,000 800,000 units
for Product B produced
1.4 Acquire and use direct labor Number of direct-labor 30,000 2,000 direct
For Product B hours worked labor hours
2. Batch Level
2.1 Quality control Number of batches 30,000 100 batches
3. Product Level
3.1 Provide product-level advertising Number of promotions 100,000 100 promotions
3.2 Provide product-level records Number of products 20,000 2 products
4. Customer Level
4.1 Take customer product orders Number of customer 40,000 2,000 customer
orders orders
4.2 Deal with customer complaints Number of complaints 20,000 1,000 complaints
5. Facility Level
5.1 Supervise direct labor Amount of direct-labor 10,000 \$50,000
Costs activities 1.2 and
1.4 (supervision
costs _ 20% of
direct labor costs.)
5.2 Use main building Number of square feet 40,000 10,000 square
feet
The company's management wants you to compute the total cost and unit cost of each product for the
month of July, which had the following level of activities:
Product A Product B
1.1 and 1.3 Material 800,000 units 900,000 units
1.2 and 1.4 Direct labor 1,600 hours 2,100 hours
2.1 Quality control—batches 50 batches 40 batches
3.1 Advertising projects—promotions 50 promotions 40 promotions
3.2 Products recorded 1 product 1 product
4.1 Customer orders 800 customer orders 900 customer orders
4.2 Customer complaints 600 complaints 300 complaints
5.1 Direct-labor supervision \$16,000 \$31,500
5.2 Main building use 6,000 sq. ft. 3,000 sq. ft.

Required
a. Compute the cost-driver rate for each cost-driver base.
(A) (B) (=A/B)
Rate per
Activity Activity Unit of
Activity/Resource Cost Volume Unit of Measure Measure
1. Unit Level
1.1 Materials for Product A \$60,000 1,000,000 units \$0.06
1.2 Direct labor for Product A \$20,000 2,000 direct labor hrs \$10.00
1.3 Materials for Product ...

Solution Summary

Product profitability and activity-based costing methodologies are examined.

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