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ACC560 Chapter 4 E4-2 E4-3 E4-9 E4-12 P4-2A P4-4A

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E4-2 Ayala Inc. has conducted the following analysis related to its product lines, using a
traditional costing system (volume-based) and an activity-based costing system. Both the
traditional and the activity-based costing systems include direct materials and direct labor

(a) For each product line, compute operating income using the traditional costing system.
(b) For each product line, compute operating income using the activity-based costing system.
(c) Using the following formula, compute the percentage difference in operating income
for each of the product lines of Ayala: [Operating Income (ABC) 2 Operating Income
(traditional cost)] 4 Operating Income (traditional cost). (Round the percentage to
two decimals.)
(d) Provide a rationale as to why the costs for Product 540X are approximately the same
using either the traditional or activity-based costing system.

E4-3 American Fabrics has budgeted overhead costs of $990,000. It has allocated overhead
on a plantwide basis to its two products (wool and cotton) using direct labor hours
which are estimated to be 450,000 for the current year. The company has decided to experiment
with activity-based costing and has created two activity cost pools and related
activity cost drivers. These two cost pools are: cutting (cost driver is machine hours) and
design (cost driver is number of setups). Overhead allocated to the cutting cost pool is
$360,000 and $630,000 is allocated to the design cost pool. Additional information related
to these pools is as follows.

Wool  Cotton  Total
Machine hours  100,000  100,000  200,000
Number of setups  1,000  500  1,500

(a) Determine the amount of overhead allocated to the wool product line and the cotton
product line using activity-based costing.
(b) What amount of overhead would be allocated to the wool and cotton product lines
using the traditional approach, assuming direct labor hours were incurred evenly
between the wool and cotton? How does this compare with the amount allocated
using ABC in part (a)?

E4-9 Danny Baden’s Verde Vineyards in Oakville, California, produces three varieties of
wine: Merlot, Viognier, and Pinot Noir. His winemaster, Russel Hansen, has identified the
following activities as cost pools for accumulating overhead and assigning it to products.
1. Culling and replanting. Dead or overcrowded vines are culled, and new vines are planted
or relocated. (Separate vineyards by variety.)
2. Tying. The posts and wires are reset, and vines are tied to the wires for the dormant
3. Trimming. At the end of the harvest, the vines are cut and trimmed back in preparation
for the next season.
4. Spraying. The vines are sprayed with chemicals for protection against insects and fungi.
5. Harvesting. The grapes are hand-picked, placed in carts, and transported to the crushers.
6. Stemming and crushing. Cartfuls of bunches of grapes of each variety are separately
loaded into machines which remove stems and gently crush the grapes.
7. Pressing and filtering. The crushed grapes are transferred to presses which mechanically
remove the juices and filter out bulk and impurities.
8. Fermentation. The grape juice, by variety, is fermented in either stainless-steel tanks
or oak barrels.
9. Aging. The wines are aged in either stainless-steel tanks or oak barrels for one to three
years depending on variety.
10. Bottling and corking. Bottles are machine-filled and corked.
11. Labeling and boxing. Each bottle is labeled, as is each nine-bottle case, with the name
of the vintner, vintage, and variety.
12. Storing. Packaged and boxed bottles are stored awaiting shipment.
13. Shipping. The wine is shipped to distributors and private retailers.
14. Heating and air-conditioning of plant and offices.
15. Maintenance of buildings and equipment. Printing, repairs, replacements, and general
maintenance are performed in the off-season.
For each of Verde’s 15 activity cost pools, identify a probable cost driver that might be used
to assign overhead costs to its three wine varieties.

E4-12 Kragan Clothing Company manufactures its own designed and labeled sports attire
and sells its products through catalog sales and retail outlets. While Kragan has for years
used activity-based costing in its manufacturing activities, it has always used traditional
costing in assigning its selling costs to its product lines. Selling costs have traditionally
been assigned to Kragan’s product lines at a rate of 70% of direct material costs. Its direct
material costs for the month of March for Kragan’s “high-intensity” line of attire are
$400,000. The company has decided to extend activity-based costing to its selling costs.
Data relating to the “high-intensity” line of products for the month of March are as follows.

(a) Compute the selling costs to be assigned to the “high-intensity” line of attire for the
month of March (1) using the traditional product costing system (direct material cost
is the cost driver), and (2) using activity-based costing.
(b) By what amount does the traditional product costing system undercost or overcost the
“high-intensity” product line?

P4-2A Schultz Electronics manufactures two large-screen television models: the Royale
which sells for $1,600, and a new model, the Majestic, which sells for $1,300. The production
cost computed per unit under traditional costing for each model in 2014 was as

In 2014, Schultz manufactured 25,000 units of the Royale and 10,000 units of the
Majestic. The overhead rate of $38 per direct labor hour was determined by dividing total
expected manufacturing overhead of $7,600,000 by the total direct labor hours (200,000)
for the two models.

Under traditional costing, the gross profit on the models was Royale $552 or
($1,600 - $1,048), and Majestic $590 or ($1,300 - $710). Because of this difference,
management is considering phasing out the Royale model and increasing the production
of the Majestic model.

Before finalizing its decision, management asks Schultz’s controller to prepare an
analysis using activity-based costing (ABC). The controller accumulates the following
information about overhead for the year ended December 31, 2014.
The cost drivers used for each product were:

Cost Driver Royale Majestic Total
Purchase orders  17,000 23,000 40,000
Machine setups  5,000 13,000 18,000
Machine hours  75,000 45,000 120,000
Inspections  11,000 17,000 28,000
(a) Assign the total 2014 manufacturing overhead costs to the two products using activity based
costing (ABC) and determine the overhead cost per unit.
(b) What was the cost per unit and gross profit of each model using ABC costing?
(c) Are management’s future plans for the two models sound? Explain

P4-4A Benton Corporation produces two grades of wine from grapes that it buys from
California growers. It produces and sells roughly 3,000,000 liters per year of a low-cost,
high-volume product called CoolDay. It sells this in 600,000 5-liter jugs. Benton also produces
and sells roughly 300,000 liters per year of a low-volume, high-cost product called
LiteMist. LiteMist is sold in 1-liter bottles. Based on recent data, the CoolDay product has
not been as profi table as LiteMist. Management is considering dropping the inexpensive
CoolDay line so it can focus more attention on the LiteMist product. The LiteMist product
already demands considerably more attention than the CoolDay line.
Jack Eller, president and founder of Benton, is skeptical about this idea. He points out
that for many decades the company produced only the CoolDay line and that it was
always quite profitable. It wasn’t until the company started producing the more complicated
LiteMist wine that the profi tability of CoolDay declined. Prior to the introduction of
LiteMist, the company had simple equipment, simple growing and production procedures,
and virtually no need for quality control. Because LiteMist is bottled in 1-liter bottles, it
requires considerably more time and effort, both to bottle and to label and box than does
CoolDay. The company must bottle and handle 5 times as many bottles of LiteMist to sell
the same quantity as CoolDay. CoolDay requires 1 month of aging; LiteMist requires
1 year. CoolDay requires cleaning and inspection of equipment every 10,000 liters; LiteMist
requires such maintenance every 600 liters.

Jack has asked the accounting department to prepare an analysis of the cost per liter
using the traditional costing approach and using activity-based costing. The following
information was collected.
Answer each of the following questions. (Round all calculations to three decimal places.)
(a) Under traditional product costing using direct labor hours, compute the total manufacturing
cost per liter of both products.

(b) Under ABC, prepare a schedule showing the computation of the activity-based overhead
rates (per cost driver).
(c) Prepare a schedule assigning each activity’s overhead cost pool to each product, based
on the use of cost drivers. Include a computation of overhead cost per liter.
(d) Compute the total manufacturing cost per liter for both products under ABC.

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