Cost Accounting (14th Edition)

170 CHAPTER 5 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT
Required
Under its simple costing system, FS allocated support costs to products at the rate of 30% of cost of
goods sold.
1. Use the simple costing system to prepare a product-line profitability report for FS.
2. Use the ABC system to prepare a product-line profitability report for FS.
3. What new insights does the ABC system in requirement 2 provide to FS managers?
5-25 ABC, wholesale, customer profitability. Ramirez Wholesalers operates at capacity and sells furniture
items to four department-store chains (customers). Mr. Ramirez commented, “We apply ABC to determine
product-line profitability. The same ideas apply to customer profitability, and we should find out our
customer profitability as well.” Ramirez Wholesalers sends catalogs to corporate purchasing departments
on a monthly basis. The customers are entitled to return unsold merchandise within a six-month period from
the purchase date and receive a full purchase price refund. The following data were collected from last
year’s operations:
Chain
1 2 3 4
Gross sales $55,000 $25,000 $100,000 $75,000
Sales returns:
Number of items 101 25 65 35
Amount $11,000 $ 3,500 $ 7,000 $ 6,500
Number of orders:
Regular 45 175 52 75
Rush 11 48 11 32
Ramirez has calculated the following activity rates:
Activity
Regular order processing
Rush order processing
Returned items processing
Catalogs and customer support
Cost-Driver Rate
$25 per regular order
$125 per rush order
$15 per item
$1,100 per customer
Required
Customers pay the transportation costs. The cost of goods sold averages 70% of sales.
Determine the contribution to profit from each chain last year. Comment on your solution.
5-26 ABC, activity area cost-driver rates, product cross-subsidization. Idaho Potatoes (IP) operates at
capacity and processes potatoes into potato cuts at its highly automated Pocatello plant. It sells potatoes to
the retail consumer market and to the institutional market, which includes hospitals, cafeterias, and university
dormitories.
IP’s simple costing system, which does not distinguish between potato cuts processed for retail and
institutional markets, has a single direct-cost category (direct materials, i.e. raw potatoes) and a single
indirect-cost pool (production support). Support costs, which include packaging materials, are allocated
on the basis of pounds of potato cuts processed. The company uses 1,200,000 pounds of raw potatoes to
process 1,000,000 pounds of potato cuts. At the end of 2011, IP unsuccessfully bid for a large institutional
contract. Its bid was reported to be 30% above the winning bid. This feedback came as a shock because IP
included only a minimum profit margin on its bid and the Pocatello plant was acknowledged as the most
efficient in the industry.
As a result of its review process of the lost contract bid, IP decided to explore ways to refine its costing
system. The company determined that 90% of the direct materials (raw potatoes) related to the retail market
and 10% to the institutional market. In addition, the company identified that packaging materials could be
directly traced to individual jobs ($180,000 for retail and $8,000 for institutional). Also, the company used ABC
to identify three main activity areas that generated support costs: cleaning, cutting, and packaging.
Cleaning Activity Area—The cost-allocation base is pounds of raw potatoes cleaned.
Cutting Activity Area—The production line produces (a) 250 pounds of retail potato cuts per cuttinghour
and (b) 400 pounds of institutional potato cuts per cutting-hour. The cost-allocation base is cuttinghours
on the production line.
Packaging Activity Area—The packaging line packages (a) 25 pounds of retail potato cuts per packaginghour
and (b) 100 pounds of institutional potato cuts per packaging-hour. The cost-allocation base is
packaging-hours on the production line.