Chapter 22 – Exercises & Cases

Multiple Choice Questions

1. Activity-based costing allocates overhead based on:
   a) Direct labor hours only
   b) Machine hours only
   c) Activities that drive costs
   d) Volume of production
   Answer: c) ABC allocates based on activities that drive costs.

2. A cost driver is:
   a) The cost of an activity
   b) A factor that causes activity cost
   c) The total overhead
   d) Direct materials cost
   Answer: b) Cost driver is a factor that causes activity cost.

3. Traditional costing may:
   a) Always be accurate
   b) Overcost high-volume products
   c) Never distort costs
   d) Always use ABC
   Answer: b) Traditional costing may overcost high-volume products.

4. Activity-based costing is most beneficial when:
   a) Overhead is small
   b) Products are identical
   c) Overhead is significant and products are diverse
   d) Simple operations
   Answer: c) ABC is most beneficial when overhead is significant and products are diverse.

5. A cost pool is:
   a) A single cost
   b) A grouping of costs by activity
   c) Only direct costs
   d) Only overhead
   Answer: b) Cost pool is a grouping of costs by activity.

6. Activity rate is calculated as:
   a) Total costs ÷ Total units
   b) Activity cost ÷ Cost driver volume
   c) Cost driver volume ÷ Activity cost
   d) Units ÷ Costs
   Answer: b) Activity rate = Activity cost ÷ Cost driver volume.

7. ABC provides:
   a) Less accurate costs
   b) More accurate costs
   c) Same accuracy as traditional
   d) No cost information
   Answer: b) ABC provides more accurate costs.

8. Traditional costing uses:
   a) Multiple overhead rates
   b) Single overhead rate
   c) No overhead allocation
   d) Only direct costs
   Answer: b) Traditional costing uses a single overhead rate.

9. Cost drivers should be:
   a) Difficult to measure
   b) Causal, measurable, cost-effective
   c) Unrelated to activities
   d) Only volume-based
   Answer: b) Cost drivers should be causal, measurable, and cost-effective.

10. ABC is most appropriate when:
    a) Products are very similar
    b) Overhead is small
    c) Products consume resources differently
    d) Simple cost structure
    Answer: c) ABC is most appropriate when products consume resources differently.

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Questions

1. What is activity-based costing? How does it differ from traditional costing?

2. Why might traditional costing provide inaccurate product costs?

3. What are the steps in implementing activity-based costing?

4. What is a cost driver? How do you identify appropriate cost drivers?

5. What is a cost pool? How are cost pools created?

6. How do you calculate activity-based product costs?

7. What are the advantages and disadvantages of ABC compared to traditional costing?

8. When should a business use ABC? When might traditional costing be sufficient?

9. How can ABC help with decision-making?

10. How can Luxembourg SMEs implement ABC effectively?

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Problems Set A

Problem A-1: Identify Activities

List five activities for a manufacturing business and suggest cost drivers for each.

Problem A-2: Calculate Activity Rate

Activity cost: €8,000 Cost driver volume: 400 units

Calculate activity rate.

Problem A-3: Allocate Activity Costs

Activity rate: €20 per setup Product requires: 3 setups

Calculate activity cost allocated to product.

Problem A-4: ABC Product Cost

Product has:

• Direct materials: €50
• Direct labor: €30
• Activity costs: Setup €60, Processing €40, Inspection €20

Calculate total product cost.

Problem A-5: Compare Traditional vs. ABC

Traditional overhead: €30,000 ÷ 2,000 hours = €15/hour Product uses 2 hours: Traditional overhead = €30

ABC: Setup €50 (1 setup), Processing €20 (2 hours × €10), Inspection €15 (1 inspection) ABC overhead = €85

Explain the difference.

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Problems Set B

Problem B-1: Complete ABC Implementation

A business has overhead of €40,000:

• Setup: €10,000 (200 setups)
• Processing: €20,000 (4,000 machine hours)
• Inspection: €6,000 (300 inspections)
• Ordering: €4,000 (100 orders)

Product X uses: 2 setups, 10 machine hours, 1 inspection, 1 order

Calculate: a) Activity rates
b) Activity costs for Product X
c) Total overhead for Product X

Problem B-2: Traditional vs. ABC Comparison

Traditional:

• Total overhead: €50,000
• Total direct labor hours: 5,000
• Overhead rate: €10 per hour
• Product A: 2 hours = €20 overhead
• Product B: 3 hours = €30 overhead

ABC:

• Setup: €15,000 (300 setups) = €50 per setup
• Processing: €25,000 (5,000 hours) = €5 per hour
• Inspection: €10,000 (500 inspections) = €20 per inspection

Product A: 1 setup, 2 hours, 1 inspection Product B: 3 setups, 3 hours, 2 inspections

Calculate overhead for each product under both methods and compare.

Problem B-3: Multi-Activity ABC

A service company has:

• Client acquisition: €12,000 (30 clients)
• Project setup: €8,000 (40 projects)
• Service delivery: €20,000 (1,000 service hours)
• Administration: €5,000 (500 transactions)

Service A: New client, 1 project, 20 hours, 10 transactions Service B: Existing client, 1 project, 15 hours, 8 transactions

Calculate total cost for each service (assume direct costs: Service A €500, Service B €400).

Problem B-4: ABC Profitability Analysis

Using ABC, a business finds:

• Product A: Cost €100, Price €120, Profit €20 (16.7%)
• Product B: Cost €80, Price €100, Profit €20 (20%)

Using traditional costing:

• Product A: Cost €90, Price €120, Profit €30 (25%)
• Product B: Cost €110, Price €100, Loss €10 (-10%)

Analyze the difference and implications for decision-making.

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Comprehensive Problem

Comprehensive Problem 22: Complete Activity-Based Costing Implementation

Luxembourg Manufacturing SME wants to implement ABC to get more accurate product costs.

Company Information:

• Produces three products: X, Y, Z
• Currently uses traditional costing (single overhead rate)
• Wants to implement ABC

Overhead Activities and Costs:

1. Material Handling: €8,000

   • Cost driver: Number of material moves
   • Total moves: 400

2. Machine Setup: €12,000

   • Cost driver: Number of setups
   • Total setups: 300

3. Quality Inspection: €6,000

   • Cost driver: Number of inspections
   • Total inspections: 600

4. Production Processing: €14,000

   • Cost driver: Machine hours
   • Total machine hours: 3,500

5. Packaging: €4,000

   • Cost driver: Number of packages
   • Total packages: 2,000

6. Engineering/Design: €6,000

   • Cost driver: Engineering hours
   • Total hours: 200

• Total Overhead: €50,000

Product Information:

Product X (High Volume, Simple):

• Units produced: 1,000
• Direct materials: €50 per unit
• Direct labor: €30 per unit
• Material moves: 50
• Setups: 20
• Inspections: 100
• Machine hours: 1,000
• Packages: 1,000
• Engineering hours: 10

Product Y (Medium Volume, Moderate):

• Units produced: 500
• Direct materials: €80 per unit
• Direct labor: €50 per unit
• Material moves: 150
• Setups: 100
• Inspections: 200
• Machine hours: 1,500
• Packages: 500
• Engineering hours: 80

Product Z (Low Volume, Complex):

• Units produced: 200
• Direct materials: €120 per unit
• Direct labor: €80 per unit
• Material moves: 200
• Setups: 180
• Inspections: 300
• Machine hours: 1,000
• Packages: 500
• Engineering hours: 110

Current Traditional Costing:

• Total overhead: €50,000
• Total direct labor cost: €64,000
• Overhead rate: 78.125% of direct labor cost

Required:

1. Calculate Activity Rates:
   a) Material handling rate
   b) Machine setup rate
   c) Quality inspection rate
   d) Production processing rate
   e) Packaging rate f) Engineering/design rate

2. Calculate Product Costs Using ABC:
   a) Product X (all activities)
   b) Product Y (all activities)
   c) Product Z (all activities)
   d) Show cost per unit for each product

3. Compare to Traditional Costing:
   a) Calculate product costs using traditional method
   b) Compare ABC vs. traditional for each product
   c) Identify which products are overcosted/undercosted
   d) Calculate profit margins under both methods

4. Profitability Analysis:

   • Product X: Selling price €150
   • Product Y: Selling price €200
   • Product Z: Selling price €350 a) Calculate profit per unit under ABC
     b) Calculate profit per unit under traditional
     c) Analyze differences
     d) Which products are most/least profitable?

5. Decision-Making:
   a) Based on ABC, which product should the company focus on?
   b) What pricing adjustments might be needed?
   c) What cost management actions are suggested?
   d) Should any products be discontinued?

6. Implementation Considerations:
   a) What are the benefits of ABC for this company?
   b) What are the challenges?
   c) What steps are needed to implement?
   d) Is ABC worth the cost?

7. Luxembourg Considerations:
   a) How does ABC help with Luxembourg compliance?
   b) What PCN accounts are involved?
   c) How does VAT affect the analysis?
   d) What are the Luxembourg-specific benefits?

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Cases

Case 22-1: Implementing ABC

A Luxembourg SME is considering implementing ABC. Management is concerned about the complexity and cost but recognizes that current costing may not be accurate.

Questions for Analysis:

1. Should this company implement ABC? Why or why not?

2. What are the key activities for this type of business?

3. What cost drivers would be appropriate?

4. How can they implement ABC without it being too complex?

5. What are the expected benefits?

6. How can they justify the cost?

Case 22-2: Cost Distortion Problem

A company discovers that traditional costing shows Product A as very profitable, but ABC shows it's actually unprofitable. Management is confused and needs to understand what happened.

Questions for Analysis:

1. Why did traditional costing show Product A as profitable?

2. Why does ABC show it as unprofitable?

3. What activities is Product A consuming?

4. Should Product A be discontinued or repriced?

5. What other products might have similar issues?

6. How should the company respond?

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Solutions are published in supplementary/instructor/solutions/chapter_22_solutions.md.