Introduction to Management Accounting

AFM 102
March 11, 2011
Review Problem

1
Garber Company uses a traditional activity-based costing system to assign $600,000 of committed
resource costs for customer service on the basis of the following information gathered from interviews
with customer service personnel:

ACTIVITY TIME PERCENTAGE ESTIMATED COST DRIVER QUANTITY

Handle customer orders 75% 8,000 customer orders
Process customer complaints 10% 400 customer complaints
Perform customer credit checks 15% 450 credit checks
100%

a) Compute the activity cost driver rates using this system.

b) Suppose instead that Garber uses time-driven ABC to assign the $600,000 of committed
resource costs to the three activities. Compute the time-driven activity cost driver rates,
assuming 10,000 hours of useful work and the unit time estimates that follow:

ACTIVITY UNIT TIME (HOURS)

Handle customer orders 0.75
Process customer complaints 3.50
Perform customer credit checks 3.00

c) Suppose that the quantities of activities this period are 8,000 customer orders, 400 customer
complaints, and 450 credit checks. Using the information and activity cost driver rates
developed in part b), determine the cost assigned to each of the activities and the estimated
hours of unused capacity as well as the associated cost. What actions might managers take after
evaluating such information?

d) Suppose that in the next time period, the quantities of activities change to 8,500 customer
orders, 350 customer complaints, and 500 credit checks. Using the information and activity cost
driver rates developed in part b), determine the cost assigned to each of the activities and the
estimated hours of unused capacity as well as the associated cost.

e) Explain why the activity cost driver rates computed in part a are different from the rates
computed in part b).
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(a) Cost Activity
Assigned Driver Cost Driver
Activity Percent Cost* Quantity Rate**
Handle customer $56.25 per
orders 75% $450,000 8,000 customer order
Process customer $150.00 per
complaints 10% $60,000 400 customer complaint
Perform customer $200.00 per
credit checks 15% $90,000 450 credit check
100% $600,000
* $600,000 times the given percentage.
** Assigned Cost divided by Cost Driver Quantity.

(b) Capacity cost rate = $600,000/10,000 = $60 per hour.

Unit
Time
Activity (Hours) Activity Cost Driver Rate
Handle customer orders 0.75 $45 Per customer order
Process customer complaints 3.50 $210 Per customer complaint
Perform customer credit checks 3.00 $180 Per credit check

3
(a) Cost Activity
Assigned Driver Cost Driver
Activity Percent Cost* Quantity Rate**
Handle customer $56.25 per
orders 75% $450,000 8,000 customer order
Process customer $150.00 per
complaints 10% $60,000 400 customer complaint
Perform customer $200.00 per
credit checks 15% $90,000 450 credit check
100% $600,000
* $600,000 times the given percentage.
** Assigned Cost divided by Cost Driver Quantity.

(b) Capacity cost rate = $600,000/10,000 = $60 per hour.

Unit
Time
Activity (Hours) Activity Cost Driver Rate
Handle customer orders 0.75 $45 Per customer order
Process customer complaints 3.50 $210 Per customer complaint
Perform customer credit checks 3.00 $180 Per credit check

(c) Unit Quantity

Time of Total Cost
Activity (Hours) Activities Hours Assigned
Handle customer orders 0.75 8,000 6,000 $360,000
Process customer complaints 3.50 400 1,400 $84,000
Perform customer credit checks 3.00 450 1,350 $81,000
Total 8,750 $525,000

Practical capacity used = 8,750  10,000 = 87.5%

Unused capacity = 10,000 − 8,750 hours = 1,250 hours.
Unassigned cost = $600,000 − $525,000 = $75,000.

Managers can try to reduce the unused capacity and its associated
expense. Alternatively, managers can try to generate new uses for the 4
(d) Unit Quantity
Time of Total Cost
Activity (Hours) Activities Hours Assigned
Handle customer orders 0.75 8,500 6,375 $382,500
Process customer
complaints 3.50 350 1,225 $73,500
Perform customer credit
checks 3.00 500 1,500 $90,000
Total 9,100 $546,000

Practical capacity used = 9,100  10,000 = 91.0%

Unused capacity = 10,000 − 9,100 hours = 900 hours.
Unassigned cost = $600,000 − $546,000 = $54,000.

(e) The costs driver rates in (a) and (b) likely differ because not all the
practical capacity of the resources supplied during the period was used
for productive work, as illustrated in parts (c) and (d). The ABC
system in part (a) overestimated the costs of performing activities by
apportioning all customer service costs to the three activities and
therefore assigned not only the costs of resource capacity used, but
also the cost of unused resources. Determining the unit times to
complete each activity in conjunction with the time-driven ABC
system in part (b) provides clearer information about the resources
needed for each activity and about the unused capacity. 5