How can ABM be used by service companies?
Service companies perform different activities to deliver services. The cost determination based on those activities and making decisions on that basis is the application of ABM by service companies.
Activity-based management is a management system that uses activity-based costing to make decisions for making profits and satisfying customers. An activity can be any task, operation, or procedure.
Activity-based costing uses activities as a base to determine the cost of the product.
The activity-based management keeps the records of the primary activities of the business, determines the cost of those activities, and then uses that information to make decisions.
A service company conducts various activities to deliver services to the customers. Each service provided may be a group of activities by service companies. Services companies allocate the indirect cost in the same manner as the manufacturing company. In order to determine the cost using activity following four steps are followed –
1) To identify activities and estimate their total cost
2) Identifying the allocation base for each activity
3) To compute the predetermined overhead allocation rate for each activity
4) Allocate the indirect costs
Based on the cost allocation, decisions are made to charge per customer, and cost-cutting ways are looked for.
The activities used by service companies may be different based on the nature of the business.
Koehler makes handheld calculators in two models: basic and professional. Koehler estimated $721,000 of manufacturing overhead and 515,000 machine hours for the year. The basic model actually consumed 230,000 machine hours, and the professional model consumed 285,000 machine hours.
Compute the predetermined overhead allocation rate using machine hours (MHr) as the allocation base. How much overhead is allocated to the basic model? To the professional model?
Stegall, Inc. manufactures motor scooters. For each of the following examples of quality costs, indicate which of the following quality cost categories each example represents: prevention costs, appraisal costs, internal failure costs, or external failure costs.
1. Preventive maintenance on machinery
2. Direct materials, direct labor, and manufacturing overhead incurred to rework a defective scooter that is detected in-house through inspection
3. Lost profits from lost sales if the company’s reputation is hurt because customers previously purchased a poor-quality scooter
4. Cost of inspecting raw materials, such as chassis and wheels
5. Working with suppliers to achieve on-time delivery of defect-free raw materials
6. Cost of warranty repairs on a scooter that malfunctions at a customer’s location
7. Costs of testing durability of vinyl
8. Cost to reinspect reworked scooters
The Alexander Manufacturing Company in Rochester, Minnesota, assembles and tests electronic components used in smartphones. Consider the following data regarding component T24 (amounts are per unit):
Direct materials cost $ 81.00
Direct labor cost 21.00
Activity-based costs allocated ?
Total manufacturing product cost ?
The activities required to build the component follow:
Cost Allocated to Each Unit
Number of raw component chassis
3 X $1.50 = $4.50
Number of dip insertions
? X 0.50 = 14.50
Number of manual insertions
13 X 0.40 = ?
Number of components solders
3 X 1.50 = 4.50
Number of backload insertions
7 X ? = 2.80
Number of testing hours
0.39 60.0 = ?
Number of defect analysis hours
0.10 X ? = 4.00
Total activity-based costs
2. Why might managers favor this ABC system instead of Alexander’s older system, which allocated all manufacturing overhead costs on the basis of direct labor hours?
Question: Oscar, Inc. manufactures bookcases and uses an activity-based costing system. Oscar’s activity areas and related data follow:
Budgeted Cost of Activity
Predetermined Overhead Allocation Rate
Number of parts
Number of assembling direct labor hours
Number of finished units*
*Refers to number of units receiving the finishing activity, not the number of units transferred to Finished Goods Inventory
Oscar produced two styles of bookcases in October: the standard bookcase and an unfinished bookcase, which has fewer parts and requires no finishing. The totals for quantities, direct materials costs, and other data follow:
Total Units Produced
Total Direct materials Costs
Total Direct Labor Costs
Total Number of Parts
Total Assembling Direct Labor Hours
2. Suppose that pre-manufacturing activities, such as product design, were assigned to the standard bookcases at $5 each and to the unfinished bookcases at $3 each. Similar analyses were conducted of post-manufacturing activities such as distribution, marketing, and customer service. The post-manufacturing costs were $20 per standard bookcase and $18 per unfinished bookcase. Compute the full product costs per unit.
Harris Systems specializes in servers for workgroup, e-commerce, and ERP applications. The company’s original job costing system has two direct cost categories: direct materials and direct labor. Overhead is allocated to jobs at the single rate of $22 per direct labor hour.
A task force headed by Harris’s CFO recently designed an ABC system with four activities. The ABC system retains the current system’s two direct cost categories. Overhead costs are reflected in the four activities. Pertinent data follow:
Activity Allocation Base Predetermined Overhead
Materials handling Number of parts $ 0.85
Machine setup Number of setups 500.00
Assembling Number of assembling hours 80.00
Shipping Number of shipments 1,500.00_______
Harris Systems has been awarded two new contracts, which will be produced as Job A and Job B. Budget data relating to the contracts follow:
Job A Job B__
Number of parts 15,000 2,000
Number of setups 6 4
Number of assembling hours 1,500 200
Number of shipments 1 1
Total direct labor hours 8,000 600
Number of units produced 100 10
Direct materials cost $ 220,000 $ 30,000
Direct labor cost $ 160,000 $ 12,000__
1. Compute the budgeted product cost per unit for each job, using the original costing system (with two direct cost categories and a single overhead allocation rate).
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