Managerial Accounting: Chapter 4 Case 2

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  • Topic: Costs, Cost, Allocation
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Chapter 4

Case 2: Greetings Inc.: Activity-Based Costing

Solution:

1. An activity-based costing system may be appropriate for Wall Décor, when overhead allocation based job-order costing provides product cost distortion. As seen on previous case, this distortion happens when one product is manufacturing in high volume and the others are manufacturing in complexity as well as in low volume. In this situation Wall Décor should change its costing system for selling its high volume produced products whereas low-volume produced products have good profit.

2. The activity-based overhead rates for each of the four activities:

Activity Estimated Overhead Expected use of Cost Drivers Activity-Based Overhead Rates

Picking prints$36,000102,000 prints$0.30 per print

Inventory selection and management$91,700131,000 components$0.70 per component

Web-site optimization:
Unframed $25,800100,000 prints at capacity$0.258 per print at capacity Framed$103,20025,000 prints at capacity$4.128 per print at capacity

Framing and matting$123,90059,000 components at capacity$2.10 per component at capacity

3. The product costs for the following items using ABC:

Cost ElementsLance Armstrong unframed printJohn Elway print in steel frame, no matLambeau Field print in wood frame with mat
Direct Material
Print121620
Frame and glass46
Matting4

Direct Labor
(10/60×12)2
(10/60×12)+(20/60×21)9
(10/60×12)+(30/60×21)12.50

Manufacturing Overhead
Picking prints
(1 print × 0.30)0.30
(1 print × 0.30)0.30
(1 print × 0.30)0.30
Inventory selection and management
(1 component × 0.70)0.70
(2 components × 0.70)1.40
(3 components × 0.70)2.10
Web-site optimization:
Unframed
(1 print × 0.258)0.258
Framed
(1 print × 4.128)4.128
(1 print × 4.128)4.128

Framing and matting
(2 components × 2.10)4.20
(3 components × 2.10)6.30

Total cost$15.258$39.028$55.328

4. Overhead allocation based job-order costing had been resulted the price distortion for specially unframed prints due to the equal approach to all three categories, not considering their job capacities. But in reality, when ABC system applied on overhead allocation for unframed prints, apparently it is seen that the price decreased. This happens, because unframed prints in working process consume less resource from identified activity pools of ABC system compared to framed prints. Among the activity pools, the first is inventory selection and management activity that unframed prints get less share of overhead cost for this activity due to the counts of their components per print items. The second is web-site optimization activity that unframed prints again get less share of overhead cost for this activity due to less requirement of IT professional labor. The last is the framing and matting activity that only apples to framed prints, not unframed. Because production of unframed prints does not require frame and matting equipment, space and other overhead costs related to framing and matting. The potential implication of applying ABC system in the company is that there will not be product cost distortion and will provide the more exact cost, and it will help company to better evaluate its products as well as to better price its products.

5. In the case, IT professionals of Wall Décor have spent the majority of their time and resources to framed prints. In order to show the difference of amount of time spent on web optimization by IT professionals between on unframed and framed prints, total cost of web optimization activity had been split between unframed and framed categories. Time of IT professionals was used to subdivide the cost by resource consumption between unframed prints and framed prints. After this allocation identified, it is easy to see that how much of IT resources are being consumed by framed and...
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