PPM 2-2

1. ROBERT CO

Robert Co manufactures three products, P, Q and R and uses cost-plus pricing. Each product uses the same materials and the same type of direct labour, but in different quantities. For many years, the company has been using full absorption costing and absorbing overheads on the basis of direct labour hours. Budgeted production and sales volumes for P, Q and R for the next year are 20,000 units, 16,000 units and 22,000 units respectively.

The budgeted direct costs of the three products are:

P                                 Q                                   R

$ per unit                   $ per unit                    $ per unit

Direct materials                                                            25                               22                                 28

Direct labour ($12 per hour)                                      30                               36                                 24

Batch size (units per set-up)                                     500                             800                               400

Number of purchase orders per batch                      4                                 5                                   4

Machine hours per unit                                              1.5                             1.25                              1.4

In the next year, Robert Co also expects to incur indirect production costs of $1,377,400, and the company has calculated the Overhead Absorption Rate (OAR) to be $9.70 per direct labour hour. The indirect production costs of $1,377,400 are analysed as follows:

Cost pools                                                $                                                      Cost drivers

Machine set up costs                       280,000                                         Number of batches

Material ordering costs                   316,000                                 Number of purchase orders

Machine running costs                    420,000                                  Number of machine hours

General facility costs                        361,400                                  Number of machine hours

I. What is the full production cost per unit of product R, using Robert Co’s current method of absorption costing?

II. What is the overhead cost per unit for product P, using activity-based costing?

III. Which of the following statements about activity-based costing (ABC) in Robert Co are correct?

(1) ABC can be applied to all overhead costs, not just production overheads.

(2) ABC provides a more accurate cost per unit of P, Q or R, and as a result pricing should be improved.

(3) ABC recognises that overhead costs are not all related to production and sales volume of P, Q and R.

(4) ABC will be of limited benefit if Robert Co’s overhead costs are primarily volume related, or if the overheads represent a small proportion of the overall cost.

IV. Using activity-based costing, total overheads allocated to Product R amount to $576, 583. What is the budgeted full cost production per unit using activity-based costing, for Product R?

V. Using activity-based costing (ABC), the production cost of product P is very similar to the cost calculated using traditional absorption costing, but the cost for product Q is almost $10 less.

Demand for products P and Q is relatively elastic.

Which statements regarding products P and Q are true?

(1) If the company decides to adopt ABC, the price of product P will change.

(2) If the company decides to adopt ABC, sales volumes of P are likely to remain unchanged.

(3) If the company decides to adopt ABC, the price of product Q will go down.

(4) A reduced selling price is unlikely to give rise to increased sales volumes.

2. JAMES CO

James Co manufactures two products, Hello and Mello. A few years ago, James Co changed from absorbing overheads on a unitary basis (total overheads/total units produced) which gave an overhead per unit of $106.21, to the current system of absorbing overheads on a labour hour basis. James Co is now considering changing to activity-based costing (ABC) as the method used to absorb overheads into production.

The following information is available:

The fixed overhead costs of $371,750 have been analysed:

$

Purchasing related                       142,500

Set up related                                 31,250

Other                                              198,000

I. Using ABC, what is the overhead cost per unit for each unit of Mello (to two decimal places)?

II. The following statements have been made about ABC and cost drivers.

(1) In addition to estimating more accurately the true cost of production, ABC will also give a better indication of where cost savings can be made.

(2) Traditional absorption costing tends to under-allocate overhead costs to low-volume products.

Which of the above statements is/are true?

III. If James changed to ABC, the overhead cost per unit of Hello would be $116.83. What is the purchase order cost per unit included in the $116.83 (to the nearest $)?

IV. Which TWO of the following statements about ABC are correct?

V. For Hello, if ABC is used, what is the decrease in overhead cost per unit compared to the current labour hour based absorption costing system?

3. BUILDING CO

Building Co is a building business that provides a range of building services to the public. Recently it has been asked to quote for garage conversions (GC) and extensions to properties (EX) and has found that it is winning fewer GC contracts than expected. In addition, Building Co also produces and sells different types of brick to the construction industry. The three types of brick produced are clay, concrete and reclaimed bricks.

Building Co has a policy to price all jobs at budgeted total cost plus 50%. Overheads are currently absorbed on a labour hour basis. Building Co thinks that a switch to activity based costing (ABC) to absorb overheads would reduce the costs associated with GC and hence make them more competitive.

You are provided with the following data:

Overhead category                 Annual overheads                Activity driver                Total number of

activities per year

$

Supervisors                                                    90,000                                 Site visits                               500

Planners                                                         70,000                        Planning documents                    250

Property related                                         240,000                             Labour hours                        40,000

Total                                                             400,000

A typical GC takes 300 labour hours to complete. A GC requires only one site visit by a supervisor and needs only one planning document to be raised. An EX requires six site visits and five planning documents.

I. What are the total overheads assigned to a GC using labour hours to absorb the overheads?

GC

II. What are the total overheads assigned to an EX using ABC principles in respect of planning costs?

EX

III. What are the total overheads assigned to a GC using ABC principles in respect of supervisor costs?

GC

IV. Which of the following statements about Building Co and the use of ABC is true?

V. The absorption cost and ABC cost per service have now been correctly calculated as follows:

GC                               EX

Absorption cost                        $11,000                     $20,500

ABC cost                                     $10,260                     $20,980

Are the following statements true or false?

A. Changing to a system of ABC costing should lead to a more competitive price being charged for the GC.

B. Using ABC would cause total overhead costs to increase.

4. CHARLES

Charles produces three products, J, K and L. The capacity of Charles’s plant is restricted by process alpha. Process alpha is expected to be operational for eight hours per day and can produce 1,200 units of J per hour, 1,500 units of K per hour and 600 units of L per hour.

Selling prices and material costs for each product are as follows.

Product                           Selling price                     Material cost                    Throughput contribution

$ per unit                          $ per unit                                   $ per unit

J                                               150                                      70                                                 80

K                                              120                                      40                                                 80

L                                              300                                     100                                               200

Conversion costs are $720,000 per day.

I. Which TWO of the following statements about using TA are true?

II. What is the profit per day if daily output achieved is 6,000 units of J, 4,500 units of K and 1,200 units of L?

III. What are the conversion costs per factory hour?

IV. What is the efficiency of the bottleneck process given the output achieved is 6,000 units of J, 4,500 units of K and 1,200 units of L?

V. A change in factory cost arose, giving a new figure for conversion costs per factory hour of $80,000. What is the revised throughput accounting (TPAR) ratio for each product?

i. J

ii. K

iii. L

5. RICHARD CO

Richard Co is a private hospital carrying out two types of procedures on patients. Each type of procedure incurs the following direct costs:

Procedure A                                Procedure B

Surgical time and materials                                    $1,200                                          $2,640

Anaesthesia time and materials                              $800                                            $1,620

Richard Co currently calculates the overhead cost per procedure by taking the total overhead cost and simply dividing it by the number of procedures, then rounding the cost to the nearest 2 decimal places. Using this method, the total cost is $2,475.85 for Procedure A and $4,735.85 for Procedure B.

Recently, another local hospital has implemented activity-based costing (ABC). This has led the finance director at Richard Co to consider whether this alternative costing technique would bring any benefits to Richard Co. He has obtained an analysis of Richard Co’s total overheads for the last year and some additional data, all of which is shown below:

Cost                                                                    Cost driver                                                Costs in $

Administrative costs                  Administrative time per procedure                          1,870,160

Nursing costs                                          Length of patient stay                                      6,215,616

Catering costs                                             Number of meals                                            966,976

General facility costs                             Length of patient stay                                     8,553,600

Total overhead costs                                                                                                        17,606,352

Procedure A                                  Procedure B

Number of procedures                                                        14,600                                            22,400

Administrative time per procedure (hours)                          1                                                   1.5

Length of patient stay per procedure (hours)                     24                                                   48

Average no. of meals required per patient                           1                                                     4

I. Using the traditional costing system, what is the overhead cost per procedure?

II. Under activity-based costing (ABC), what is the nursing cost per hour?

III. Under activity-based costing (ABC), what is the administration cost per hour?

IV. When using activity-based costing (ABC), the full cost for Procedure A is approximately $2,297 and $4,853 for Procedure B. Richard Co has decided that an activity-based costing (ABC) system is too time consuming and costly to implement.

Which of the following statements is/are true?

(1) Whilst the comparative costs of Procedures A and B are different under ABC, they are not different enough to justify the implementation of an ABC system.

(2) A similar allocation of overheads can be achieved simply by using ‘patient hours’ as a basis to absorb the costs.

V. When using activity-based costing (ABC), the full cost for Procedure A is approximately $2,297 and $4,853 for Procedure B.

Which of the following statements is/are true?

(1) Using ABC, the allocation of overhead costs would more fairly represent the use of resources driving the overheads.

(2) The cost of Procedure A goes up using ABC and the cost of Procedure B goes down because the largest proportion of the overhead costs is the nursing and general facility costs.

6. JOSEPH BOOKS

Joseph Books publishes two forms of book.

The company publishes a children’s book (CB), which is sold in large quantities to government-controlled schools. The book is produced in four large production runs. The second book is a comprehensive technical journal (TJ). It is produced in monthly production runs, 12 times a year.

The directors are concerned about the performance of the two books and are wondering what the impact would be of a switch to an activity based costing (ABC) approach to accounting for overheads. They currently use absorption costing, based on number of books produced for all overhead calculations. Overheads amount to $2,880,000.

The CB will be inspected on 180 occasions next year, whereas the TJ will be inspected just 20 times.

Machine time per unit is six minutes for the CB and ten minutes for the TJ.

Joseph Books will produce its annual output of 1,000,000 CBs in four production runs and approximately 10,000 TJs per month in each of 12 production runs.

I. Joseph Books has decided to adopt ABC. Management has put together a list of steps. Match each of the steps in ABC to the correct order in which they should be carried out.

A. Calculate the overhead cost per unit of CB and TJ.

B. Calculate the absorption rate for each ‘cost driver’.

C. Determine what causes the cost of each activity – the ‘cost driver’.

D. Identify major activities within each department which creates cost.

E. Create a cost centre/cost pool for each activity – ‘the activity cost pool’.

II. What is the overhead cost per unit of the CB using the current system of absorption costing?

III. What is the total activity based allocation of quality control overheads for production of the TJ?

IV. The overheads involved have been analysed as follows:

Overhead                                         $                                          Activity driver

Production costs                     2,160,000                                 Machine hours

Quality control                          668,000                           Number of inspections

Production set up costs            52,000                                Number of set ups

2,880,000

What is the total activity based allocation of production overheads for production of the CB?

V. If Joseph Books decides to introduce an ABC costing system, which of the following is an advantage of ABC that they can expect to benefit from?

7. WILLIAM CO

William Co (W Co) provides a range of environmentally friendly cleaning services to business customers, often providing a specific service to meet a client’s needs. Its customers range from large offices and factories to specialist care wards at hospitals, where specialist cleaning equipment must be used, and regulations adhered to.

W Co offers both regular cleaning contracts and contracts for one-off jobs. For example, its latest client was a chain of restaurants which employed them to provide an extensive clean of all their business premises after an outbreak of food poisoning.

The cleaning market is very competitive, although there are only a small number of companies providing a chemical free service. W Co has always used cost-plus pricing to determine the prices which it charges to its customers but recently, the cost of the cleaning products W Co uses has increased. This has meant that W Co had to increase its prices, resulting in the loss of several regular customers to competing service providers.

The finance director at W Co has heard about target costing and is considering whether it could be useful at W Co.

I. Which TWO of the following statements correctly explain the difficulties faced if target costing is used in a service industry?

II. What would be, in the right sequence, the main steps involved in deriving a target cost for W Co?

III. Which TWO of the following statements are true?

IV. Which of the following statement(s) is/are true?

(1) W Co may not be able to get hold of any comparative data available for the one-off jobs, and therefore setting the target cost will be difficult.

(2) Some of the work available is very specialist. It may be difficult to establish the market price for a service like this, thus making it difficult to derive a target cost.

V. Which of the following statement(s) is/are true?

(1) If after calculating a target cost W Co finds that a cost gap exists, it will then be forced to examine its internal processes and costs more closely.

(2) If W Co cannot achieve any reduction in the cost of the cleaning products it uses, it should consider whether it can source cheaper non-chemical products from alternative suppliers.

8. JOHN CO

John Co manufactures webcams, devices which can provide live video and audio streams via personal computers. It has recently been suffering from liquidity problems and hopes that these will be eased by the launch of its new webcam, which has revolutionary audio and video quality. The webcam is expected to have a product life cycle of two years. Market research has already been carried out to establish a target selling price and projected lifetime sales volumes for the product. Cost estimates have also been prepared, based on the current proposed product specification. John Co uses life cycle costing to work out the target costs for its products. You are provided with the following relevant information for the webcam:

Projected lifetime sales volume                             50,000 units

Target selling price per unit                                          $200

Target profit margin                                                        35%

Note. Estimated lifetime cost per unit:

$                              $

Manufacturing costs

Direct material (bought in parts)                             40

Direct labour                                                               26

Machine costs                                                             24

Quality control costs                                                  10

100

Non-manufacturing costs                                                                          60

Estimated lifetime cost per unit                                                             160

The following information has been identified as relevant:

(1) Direct material cost: all of the parts currently proposed for the webcam are bespoke parts. However, most of these can actually be replaced with standard parts costing 55% less. However, three of the bespoke parts, which currently account for 20% of the estimated direct material cost, cannot be replaced, although an alternative supplier charging 10% less has been sourced for these parts.

(2) Direct labour cost: the webcam uses 45 minutes of direct labour, which costs $34.67 per hour. The use of more standard parts, however, will mean that while the first unit would still be expected to take 45 minutes, there will now be an expected rate of learning of 90% (where ‘b’ = – 0.152). This will end after the first 100 units have been completed.

I. What is the direct material cost per unit in light of the new information in point (1)?

II. What is the average direct labour cost per unit in light of the new information in point (2)?

III. What is the target cost of the new webcam?

IV. Which of the following represents a possible method for closing the target cost gap for the webcam?

V. Are the following statements about John Co’s target costing system true or false?

A. A cost gap is the difference between the target price and the target cost of the webcam.

B. Target costing ensures that new product development costs are recovered in the target price for the webcam.

9. PAUL CO

Paul Co develops and sells computer games. It is well known for launching innovative and interactive role-playing games and its new releases are always eagerly anticipated by the gaming community. Customers value the technical excellence of the games and the durability of the product and packaging.

Paul Co has previously used a traditional absorption costing system and full cost plus pricing to cost and price its products. It has recently recruited a new finance director who believes the company would benefit from using target costing. He is keen to try this method on a new game concept called Spiral, which has been recently approved.

After discussion with the board, the finance director undertook some market research to find out customers’ opinions on the new game concept and to assess potential new games offered by competitors. The results were used to establish a target selling price of $45 for Spiral and an estimated total sales volume of 350,000 units. Paul Co wants to achieve a target profit margin of 35%.

The finance director has also begun collecting cost data for the new game and has projected the following:

Production costs per unit                                                    $

Direct material                                                                   3.00

Direct labour                                                                      2.50

Direct machining                                                               5.05

Set-up                                                                                  0.45

Inspection and testing                                                      4.30

Total non-production costs                                            $000

Design (salaries and technology)                                  2,500

Marketing consultants                                                   1,700

Distribution                                                                      1,400

I. What is the forecast cost gap for the new game?

II. Which of the following statements would the finance director have used to explain to Paul Co’s board what the benefits were of adopting a target costing approach so early in the game’s life cycle?

(1) Costs will be split into material, system, and delivery and disposal categories for improved cost reduction analysis.

(2) Customer requirements for quality, cost and timescales are more likely to be included in decisions on product development.

(3) Its key concept is based on how to turn material into sales as quickly as possible in order to maximise net cash.

(4) The company will focus on designing out costs prior to production, rather than cost control during live production.

III. The direct labour cost per unit has been based on an expected learning rate of 90% but now the finance director has realised that a 95% learning rate should be applied.

Which of the following statements is true?

IV. Paul Co is thinking about expanding its business and introducing a new computer repair service for customers. The board has asked if target costing could be applied to this service.

Which of the following statements regarding services and the use of target costing within the service sector is true?

V. The board of Paul Co has asked the finance director to explain what activities can be undertaken to close a cost gap on its computer games.

Which TWO of the following would be appropriate ways for Paul Co to close a cost gap?

10. ANTHONY CO

Anthony Co (A Co) makes two products, B1 and B2. Its machines can only work on one product at a time. The two products are worked on in two departments by differing grades of labour. The labour requirements for the two products are as follows:

B1                       B2

Minutes per unit of product

Department 1                                                                                 12                       16

Department 2                                                                                 20                       15

There is currently a shortage of labour and the maximum times available each day in Departments 1 and 2 are 480 minutes and 840 minutes, respectively. The bottleneck or limiting factor is labour in Department 1. The current selling prices and costs for the two products are shown below:

B1                      B2

$ per unit         $ per unit

Selling price                                                                                 50.00                 65.00

Direct materials                                                                          10.00                 15.00

Direct labour                                                                               10.40                  6.20

Variable overheads                                                                     6.40                   9.20

Fixed overheads                                                                         12.80                 18.40

Profit per unit                                                                             10.40                 16.20

As part of the budget-setting process, A Co needs to know the optimum output levels. All output is sold.

I. What is the maximum number of each product that could be produced each day?

A. B1 Department 1

B. B1 Department 2

C. B2 Department 1

D. B2 Department 2

II. What is the throughput per minute of bottleneck resource of B2 (to two decimal places)?

III. Using traditional contribution analysis, what is the contribution per unit of limiting factor of B1 (to two decimal places)?

IV. If A Co decides to apply the theory of constraints, match each of the steps to the correct order in which they should be carried out.

A. Subordinate everything else to the decisions made about exploiting the bottlenecks.

B. Elevate the system’s bottlenecks.

C. Identify A Co’s bottlenecks.

D. Decide how to exploit the system’s bottlenecks.

V. A Co needs to decide whether to base its decisions about optimum levels of production using a throughput accounting approach, or a limiting factor approach.

Which of the following is an example of an advantage of choosing a throughput accounting approach?

11. MARK CO

Mark Co, a shoe manufacturer, has developed a new product called the ‘Smart Shoe’ for children, which has a built-in tracking device. The shoes are expected to have a life cycle of two years, at which point Mark Co hopes to introduce a new type of Smart Shoe with even more advanced technology. Mark Co plans to use life cycle costing to work out the total production cost of the Smart Shoe and the total estimated profit for the two-year period. Mark Co has spent $5.6m developing the Smart Shoe.

The time spent on this development meant that the company missed out on the opportunity of earning an estimated $800,000 contribution from the sale of another product.

The company has applied for and been granted a ten-year patent for the technology, although it must be renewed each year at a cost of $200,000. The costs of the patent application were $500,000, which included $20,000 for the salary costs of Mark Co’s lawyer, who is a permanent employee of the company and was responsible for preparing the application.

The following information relating to the Smart Shoe is also available for the next two years: Total ‘Smart Shoe’ Revenue $34.3m

Mark Co is negotiating with marketing companies with regard to its advertising campaign on another product, ‘Smart Boots’. Mark Co is uncertain as to what the total marketing costs will be each year. However, the following information is available as regards the probabilities of the range of costs which are likely to be incurred:

I. What is the total expected profit for Mark Co on the ‘Smart Shoe’ for the two-year period?

II. What is the total expected value of the marketing cost for the two years on the ‘Smart Boots’ range?

III. Which TWO of the following statements about lifecycle costing are true?

IV. Which ONE of the following statements is true, if a decision is made using expected values?

V. Further research has shown that there will be environmental costs at the end of production of $250,000. Mark Co is considering how to account for these costs.

Which TWO of the following statements about Environmental Management Accounting are true?

12. THOMAS CO

Thomas Co is an electronics business operating within an advanced manufacturing technology environment, producing fitness watches, weighing scales and other electronic items. It uses life cycle costing (LCC).

Thomas Co is about to launch a new electronic gadget called the Diam, for measuring health statistics in patients who are unwell. It intends to sell the gadget to hospitals.

20X1                      20X2

Number of Diams                                                                   5,000                     7,500

Components cost per unit                                                   $12.00                  $10.00

Labour cost per unit                                                             $14.00                  $12.00

Total fixed production costs                                               $5,000                  $4,500

Total fixed selling and distribution costs                          $1,000                  $1,200

Thomas Co is also thinking of developing a ‘smart’ weighing scales that scans food labels and give nutrients based on the weight.

I. What is the life cycle cost per unit for the Diam (to two decimal places)?

II. Which TWO of the following statements about using LCC for the diam are true?

III. Which of the following costs would be included in the life cycle cost of the smart weighing scales?

IV. When would the bulk of Thomas Co’s products’ life cycle costs normally be determined?

V. Are the following statements true or false?

(1) Thomas Co uses an expensive costing system

(2) Thomas Co’s costing system is quicker to use than traditional absorption costing

13. TASTY TAKES BAKERY

Tasty Takes Bakery makes three types of cake: brownies, muffins and cupcakes. The costs, revenues and demand for each of the three cakes are as follows:

Brownies                      Muffins                     Cupcakes

Batch size (units)                                                          40                                 30                                20

Selling price ($ per unit)                                            1.50                             1.40                             2.00

Material cost ($ per unit)                                          0.25                             0.15                             0.25

Labour cost ($ per unit)                                             0.40                             0.45                             0.50

Overheads ($ per unit)                                              0.15                             0.20                             0.30

Minimum daily demand (units)                                30                                 20                                10

Maximum daily demand (units)                              140                                90                               100

The minimum daily demand is required for a long-term contract with a local café and must be met.

The cakes are made in batches using three sequential processes: weighing, mixing and baking. The products must be produced in their batch sizes but are sold as individual units. Each batch of cakes requires the following amount of time for each process:

Brownies                      Muffins                     Cupcakes

Weighing (minutes)                                                     15                                 15                                20

Mixing (minutes)                                                          20                                 16                                12

Baking (minutes)                                                         120                               110                             120

The baking stage of the process is done in three ovens which can each be used for eight hours a day, a total of 1,440 available minutes. Ovens have a capacity of one batch per bake, regardless of product type.

Tasty Takes Bakery uses throughput accounting and considers all costs, other than material, to be ‘factory costs’ which do not vary with production.

I. On Monday, in addition to the baking ovens, Tasty Takes Bakery has the following process resources available:

Process                  Minutes available

Weighing                          240

Mixing                               180

Which of the three processes, if any, is a bottleneck activity?

II. Tasty Takes Bakery has done a detailed review of its products, costs and processes and has identified potential actions to improve its throughput accounting ratio (TPAR). Which TWO of the following statements will improve the throughput accounting ratio (TPAR)?

III. On Wednesday, the mixing process is identified as the bottleneck process. On this day, only 120 minutes in the mixing process are available.

Assuming that Tasty Takes Bakery wants to maximise profit, what is the optimal production plan for Wednesday?

IV. In a previous week, the weighing process was the bottleneck and the resulting throughput accounting ratio (TPAR) for the bakery was 1.45.

Which of the following statements about the TPAR for the previous week is/are true?

(1) The bakery’s operating costs exceeded the total throughput contribution generated from its three products.

(2) Less idle time in the mixing department would have improved the TPAR.

(3) Improved efficiency during the weighing process would have improved the TPAR.

V. On Friday, due to a local food festival at the weekend, Tasty Takes Bakery is considering increasing its production of cupcakes. These cupcakes can be sold at the festival at the existing selling price.

The company has unlimited capacity for weighing and mixing on Friday, but its existing three ovens are already fully utilised. Therefore, in order to supply cupcakes to the festival, Tasty Takes Bakery will need to hire another identical oven at a cost of $45 for the day.

How much will profit increase by if the company hires the new oven and produces as many cupcakes as possible?

14. DAVID CO

David Co is involved in the processing of sheet metal into products R, U and V using three processes: pressing, stretching and rolling. The factory has many production lines, each of which contains the three processes. Raw material for the sheet metal is first pressed, then stretched and finally rolled. The processing capacity varies for each process and the factory manager has provided the following data:

Processing time per metre in hours

Product R                  Product U                   Product V

Pressing                                         0.50                            0.50                              0.40

The total annual processing hours for the factory is 225,000. On average, one hour of labour is needed for each of the 225,000 hours of factory time. Labour is paid $10 per hour.

The raw materials cost per metre is $2.50 for product U. Other factory costs (excluding labour and raw materials) are $18,000,000 per year. Selling prices per metre are $60 for product U. The return per factory hour of product R is $134.

David carries very little inventory. Pressing has been identified as the bottleneck.

I. What is the conversion cost per factory hour?