TRADITIONAL

DRAPER COMPANY
Product Costs from Existing Costing System
Overhead rate:
$4,500,000 of overhead divided by $3,000,000 of direct labor cost =150% of direct labor cost
Standard Custom Total
Direct material.......................................$882,000$ 1 2,500$ 894,500
Direct labor.............................................2,910,000 90,000 3,000,000
Overhead
150% x$2,910,000................................. 4,365,000
150%x $90,000.................................... 135,000 4,500,000
Total cost.............................................. $8,157,000 $237,500 $8,394,500
Units produced....................................... 73,500 125
Cost per unit.......................................... $ 110.98 $1,900

ABC METHOD

DRAPER COMPANY
Product Costs from Activity Based Costing System
Overhead rates:
$300,000 setup-related costs divided by 60 setups = $5,000 per setup
$900,000 design-related costs divided by 15,000 design hours = $60 per design hour
$3,300,000 other overhead divided by $3,000,000 DL cost = 110% of direct labor cost

Standard Custom Total

Direct material.......................................$882,000 $12,500 $ 894,500
Direct labor..............................................2,910,000 90,000 3,000,000
Overhead:
$5,000 × 30 setups..................................150,000
$5,000 × 30 setups.................................. 50,000 300,000
$60 × 12,000 design hrs..........................720,000
$60 × 3,000 design hrs........................ 180,000 900,000
110% × $2,910,000................................3,201,000
110% × $90,000.................................... . 99,000 3,300,000
Total cost.................................................7,863,000 531,500 $8,394,500
Units produced.........................................÷ 73,500 ÷125
Cost per unit.............................................$106.98 $4,252

3)Because the existing system used direct labor cost as the only allocation baseand Custom consumed $90,000/$3,000,000 = 3% of
direct labor cost,the exist-ing system allocated 3% of all overhead to Custom.The activity information indicates Custom consumed
30/60 = 50% of setup-related activity and3,000/15,000 = 20% of design-related activity,so the reconciliation is as follows:
Total Per Unit
Cost of Custom from traditional system,as calculated in requirement (1)..............$237,500 $1,900
Adjustments for:
Understatement of setup-related
costs,$300,000 × (50% – 3%)..................$141,000
Understatement of design-related
costs,$900,000 × (20% – 3%)..................153,000
Total adjustments.................................. 294,000 2,352
Cost of Custom from ABC system,as
Calculated in requirement(2) $531,500 $4,252P14

( 4 ) T h e o n l y c o s t s h a n d l e d d i f f e r e n t l y b y t h e t w o c o s t i n g s y s t e m s w e r e t h e $ 3 0 0 , 0 0 0 of setup-
related costs and $900,000 of design-related costs,for a total of $1,200,000;this represents only 27% of the total
overhead of $4,500,000.The change in the costing system caused the reported cost of Custom to change from $237,500 to
$531,500,which is an increase of 124%.

SHAUTON COMPANY
Product Costs from Existing Costing System

Overhead rate:
$1,200,000 of overhead divided by 30,000 direct labor hours = $40 per direct labor hour

Fancy Plain Total

Direct material...............................................$ 60,000 $160,000 $220,000
Direct Labor....................................................28,000 272,000 300,000
Overhead:
$40x2,800 DLH.............................................112,000
$40x27,200 DLH........................................... 1,088,000 1,200,000
Total cost.......................................................$200,000 $1,520,000 $1,720,000
Units produced................................................ 200 16,000
Cost per unit.....................................................$ 1,000 $95
SHAUTON COMPANY
Product Costs from Activity Based Costing System

Overhead rates:
$135,000 setup-related costs divided by 90 setups = $1,500 per setup
$240,000 design-related costs divided by 8,000 design hours = $30 per design hour
$825,000 other overhead divided by 30,000 direct labor hours = $27.50 per direct labor hour

Fancy Plain Total

Direct material...............................$60,000 $160,000 $220,000
Direct labor....................................28,000 272,000 300,000
Overhead:
$1,500 × 45 setups........................67,500
$1,500 × 45 setups....................... 67,500 135,000
$30 × 3,000 design hrs..................90,000
$30 × 5,000 design hrs................. 150,000 240,000
$27.50 × 2,800 DLH......................77,000
$27.50 × 27,200 DLH................... 748,000 825,000
Total cost....................................$322,500$ 1,397,500 $1,720,000
Units produced................................÷200 ÷16,000
Cost per unit.................................$1,612.50 $87.34

(3)Because the existing system used direct labor hours as the only allocation base and Fancy consumed 2,800/30,000 = 9 1/3% of
direct labor hours,the existing system allocated 9 1/3% of all overhead to Fancy.The activity information indicates Fancy consumed
45/90 = 50% of setup-related activity and 3,000/8,000 =37.5% of design-related activity,so the reconciliation is as follows:

Total Per Unit

Cost of Fancy from traditional system,calculated in requirement (1)........ $200,000 $1,000.00
Adjustments for:
Understatement of setup costs,
$135,000 × (50% – 9 1/3%)...........................$54,900
Understatement of design costs,
$240,000 × (37.5% – 9 1/3%)........................67,600T
Total adjustments.........................................1 22,500 612.50
Cost of Fancy from ABC system,as calculated in requirement (2)........ $322,500 $1,612.50

4)The only costs handled differently by the two costing systems were the $135,000of setup-related costs and $240,000 of design-
related costs,for a total of$375,000;this represents only 31.25% of the total overhead of $1,200,000.

The change in the costing system caused the reported cost of Fancy to changefrom $200,000 to $322,500,which is an increase of
61.25%.

TUNNEY COMPANY
Product Costs from Existing Costing System

Overhead rate:
$1,000,000 of overhead divided by 50,000 direct labor hours = $20 per direct labor hour

Normal Enhanced Super Total

Direct material.......... $60,000 $20,000 $ 5,000 $85,000
Direct labor............... 300,000 35,000 5,000 340,000
Overhead:
$20x45,000 DLH.. 900,000
$20x4,500 DLH.... 90,000
$20x500 DLH....... 10,000 1,000,000
Total cost................... 1,260,000 $145,000 $20,000 $1,425,000
Units produced......... 30,000 1,000 50
Cost per unit............. $ 42 $ 145 $400

TUNNEY COMPANY
Product Costs from Activity Based Costing System
Overhead rates:
$400,000 batch-level overhead divided by 500 requisitions = $800 per requisition
$600,000 other overhead divided by 50,000 direct labor hours = $12 per direct labor hour

Normal Enhanced Super Total

Direct material.......... $60,000 $20,000 $5,000 $85,000
Direct labor............... 300,000 35,000 5,000 340,000
Overhead:
$800 × 150 req...... 120,000
$800 × 200 req...... 160,000
$800 × 150 req...... 120,000 400,000
$12 × 45,000 DLH.. 540,000
$12 × 4,500 DLH.... 54,000
$12 × 500 DLH....... 6,000 600,000
Total cost................... $1,020,000 $269,000 $136,000 $1,425,000
Units produced......... ÷30,000 ÷1,000 ÷50
Cost per unit............. $34 $269 $2,720
(2)Because the existing system used direct labor hours as the only allocationbase and Super consumed 500/50,000 = 1% of direct
labor hours,the existingsystem allocated 1% of all overhead to Super.The activity information indi-cates Super consumed 150/500 =
30% of batch-level activity,so the reconcilia-tion is as follows:

Total Per Unit

Cost of Super from traditional system,as calculated in requirement (1)............... $20,000 $ 400
Adjustment for understatement of batch-
level costs,$400,000 × (30% – 1%)......................... 116,000 2,320
Cost of Super from ABC system,ascalculated in requirement (2).................... $136,000 $2,720

(3) The only costs handled differently by the two costing systems were the $400,000of batch-level costs,which represents only 40% of
the total overhead of$1,000,000.
The change in the costing system caused the reported cost of Super to change from $20,000 to $136,000,which is an increase of
580%.

TEKSIZE COMPANY
Product Costs from Existing Costing System
Overhead rate:
$1,500,000 of overhead divided by 50,000 direct labor hours = $30 per direct labor hour

Regular Large Total

Direct material....................................... $10,000 $40,000 $50,000
Direct labor............................................ 120,000 480,000 600,000
Overhead:
$30 x10,000 DLH.............................. 300,000
$30 x40,000 DLH.............................. 1,200,000 1,500,000
Total cost............................................... $430,000 $1,720,000 $2,150,000
Units produced...................................... 10,000 10,000
Cost per unit.......................................... $43 $172

TEKSIZE COMPANY
Product Costs from Activity Based Costing System

Overhead rates:
$515,000 setup-related costs divided by 103 setups= $5,000 per setup
$985,000 other overhead divided by 50,000 direct labor hours = $19.70 per DLH

Regular Large Total

Direct material....................................... $10,000 $40,000 $50,000
Direct labor............................................ 120,000 480,000 600,000
Overhead:
$5,000x51 setups........................... .255,000
$5,000x52 setups............................ 260,000 515,000
$19.70x10,000 DLH......................... 197,000
$19.70x40,000 DLH......................... 788,000 985,000
Total cost.............................................. .$582,000 $1,568,000 $2,150,000
Units produced...................................... 10,000 10,000
Cost per unit.......................................... $58.20 $156.80

(3)Because the existing system used direct labor hours as the only allocation baseand Regular consumed 10,000/50,000 = 20% of
direct labor hours,the existingsystem allocated 20% of all overhead to Regular.The activity information indi-cates Regular consumed
51/103 = 49.51456% of setup-related activity,so the rec-onciliation is as follows:

Total Per Unit

Cost of Regular from traditionalsystem,as calculated in requirement (1)............... $430,000 $43.00
Adjustment for understatement of setup-
related costs,$515,000 × (49.51456% – 20%)......... 152,000 15.20
Cost of Regular from ABC
system,ascalculated in requirement (2)................................... $582,000 $58.20

(4)Yes,Teksize Company does have a diverse product line in the sense in which theterm is used in ABC.The fact that the two products
have the same annual unitvolumes does not matter,because the existing cost system does not use unitsas the allocation base.Regular
represents only 20% of direct labor hours butnearly 50% of setup-related costs,while Large has a very different mix,so adiverse
product line is present in Teksize Company.
DALLAS DIVISION
Product Costs from Existing Costing System

Overhead rate:
$800,000 of overhead divided by 20,000 directlabor hours = $40 per direct labor hour

#321 #333
Direct material............................................................... $6,000 $150
Direct labor.................................................................... 30,000 600
Overhead:
$40x7,200 DLH........................................................ 288,000
$40x120 DLH........................................................... 4,800
Total cost...................................................................... $324,000 $5,550
Units produced............................................................. 2,400 6
Cost per unit................................................................. $135 $925

DALLAS DIVISION
Product Costs from Activity Based Costing System

Overhead rates:
$240,000 batch-level costs divided by 1,600 setups = $150 per setup
$200,000 product-level costs divided by 2,000 design hours = $100 per design hour
$360,000 other overhead divided by 20,000 direct labor hours = $18 per DLH

#321 #333
Direct material............................................................... $6,000 $150
Direct labor.................................................................... 30,000 600
Overhead:
$150x40 setups....................................................... 6,000
$150x4 setups......................................................... 600
$100x20 design hrs.............................................. 32,000
$100x200 design hrs.............................................. 20,000
$18x7,200 DLH........................................................ 129,600
$18x120 DLH........................................................... 2,160
Total cost...................................................................... $203,600 $23,510
Units produced............................................................. 2,400 6
Cost per unit................................................................. $84.83 $3,918.33

(Continued)

3.
#321 #333
Usual selling price............................................... $150 $1,500
Product cost......................................................... 135 925
Gross margin....................................................... $15 $575
Percent of sales................................................... 10% 38%

4.
#321 #333
Usual selling price............................................... $150.00 $1,500.00
Product cost......................................................... 84.83 3,918.33
Gross margin (loss)............................................. $65.17 $(2,418.33)
Percent of sales................................................... 43% (161%)

(5)The ABC system shows that the relative profitabilities of the two products arethe reverse of what is shown by the existing
system:the existing system showsa very modest gross margin of 10% on #321,which is probably not enough tocover its marketing and
administrative costs,while showing a respectable 38%gross margin on #333.In contrast,the ABC system shows a 43% gross marginon
#321 and a substantial loss on #333.The low-volume product appears to bethe more profitable of the two under the existing
system,but appears to be amoney loser under ABC;the high-volume product appears weak under the exist-ing system,but highly
profitable under ABC.

(6)Based on the results of the ABC study,Dallas division management should con-sider meeting the competitor’s prices on #321;this
pricing strategy can be prof-itable in the long run and should avoid loss of market share.The strategy for#333 is not as clear.Customers
are not likely to accept the 200% price increaseneeded to make #333 reasonably profitable,and Dallas could lose some cus-tomers
who also buy large amounts of #321,if management discontinues #333or increases its price too much.Management should consider
several possibili-ties for low-volume products such as #333:

(a)Reduce batch- and product-level costs enough to become an efficient pro-ducer of low-volume products.This may require
creation of a small job-shop environment in a portion of the plant (or in another facility) wherelow-volume products could be made
more efficiently.The case indicatesthe existing plant was designed to produce long runs efficiently,whichmay explain the high batch-
and product-level costs.
(b)Reduce the number of products by designing a new one that can be substi-tuted for several low-volume,unprofitable products
that can then be discon-tinued;this essentially exchanges several low-volume products for one ofmuch higher volume,with substantial
batch- and product-level savings.
(c)Convince one of the current buyers of the low-volume products to becomea distributor of several such products;buying them
from Dallas in largerquantities,maintaining small inventories,and selling them to other cus-tomers.This can reduce Dallas’batch-level
costs and marketing costs,butit risks the loss of customers who like to buy the full line from one supplier.

(d)Raise prices gradually until all products are reasonably priced.This doesnot mean all products must show profits.(It is
acceptable for a good cus-tomer to occasionally buy a money-losing product.) Rather,it means thatthe company should not continue
making a money-losing product withouta good reason.It is not acceptable to have a customer who buys only themoney-losing
products,nor for the company to continue making a money-losing product that no “good customers”are buying.
(e)In addition to the usual per-unit prices,charge a lump-sum amount perorder for any small order of a low-volume product.This
charge could beset at a level to cover estimated batch- and product-level costs

WARRENTON DIVISION
Product Costs from OPICS

Overhead rate:
$1,930,000 of overhead divided by 25,000 direct labor hours = $77.20 per DLH

#33 #44
Direct material............................................................... $15,000 $120,000
Direct labor.................................................................... 6,000 60,000
Overhead:
$77.20x450 DLH...................................................... 34,740
$77.20x6,000 DLH................................................... 463,200
Total cost...................................................................... $55,740 $643,200
Units produced............................................................. 100 2,000
Cost per unit................................................................. $557.40 $321.60

WARRENTON DIVISION
Product Costs from TPICS

Overhead rates:
$340,000 machine-related costs divided by 20,000 machine hours = $17 per MH
$330,000 materials-related costs divided by $1,320,000 direct material cost = 25% of direct material cos
t$360,000 + $900,000 of remaining costs divided by 25,000 direct labor hours = $50.40per direct labor hour

#33 #44
Direct material...............................................................$15,000 $120,000
Direct labor....................................................................6,000 60,000
Overhead:
$17 × 300 MH............................................................. 5,100
$17 × 3,000 MH.......................................................... 51,000
25% × $15,000........................................................... 3,750
25% × $120,000......................................................... 30,000
$50.40 × 450 DLH...................................................... 22,680
$50.40 × 6,000 DLH................................................... 302,400
Total cost................................................................... $52,530 $563,400
Units produced.......................................................... .÷100 ÷2,000
Cost per unit ..............................................................$525.30 $281.70

(3)TPICS is not an ABC system because all the allocation bases are at the unit level.The changes management made do show many of
the attributes typically associ-ated with a change to ABC:the increase in the number of overhead cost pools,theattempt to create
homogeneous cost pools,and the use of three distinct allocationbases.These changes show an attempt was made to capture
differences amongthe demands placed on resources by the different products.But because there areno batch- or product-level drivers
used,the system cannot capture the demandsplaced on batch- and product-level activities,i.e.,it is not an ABC system.

WARRENTON DIVISION
Product Costs from Proposed New Costing System

Overhead rates:
$100,000 troubleshooting costs + $140,000 machine setup costs divided by 3,000setup hours = $80 per setup hour
$135,000 material handling costs divided by 15,000 loads = $9 per load
$195,000 materials administration costs divided by 10,000 vendor orders = $19.50 pervendor order
$260,000 engineering design costs divided by 4,000 design hours = $65 per designhour
$200,000 machine operation costs + $900,000 other overhead divided by 20,000machine hours = $55 per machine hour
#33 #44
Direct material............................................................... $15,000 $120,000
Direct labor.................................................................... 6,000 60,000
Overhead:
$80 × 300 setup hrs.................................................. 24,000
$80 × 400 setup hrs.................................................. 32,000
$9 × 20 loads............................................................. 180
$9 × 60 loads............................................................. 540
$19.50 × 90 orders.................................................... 1,755
$19.50 × 150 orders.................................................. 2,925
$65 × 280 design hrs................................................ 18,200
$65 × 300 design hrs................................................ 19,500
$55 × 300 MH............................................................. 16,500
$55 × 3,000 MH.......................................................... 165,000
Total cost...................................................................... $81,635 $399,965
Units produced............................................................. ÷100 ÷2,000
Cost per unit................................................................. $816.35 $199.98