Describe the characteristics of products which would suggest it would be better to use ABC as an indirect cost allocation method over a traditional method such as direct labor hours.
Describe the characteristics of products which would suggest it would be better to use ABC as an indirect cost allocation method over a traditional method such as direct labor hours.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Question
Describe the characteristics of products which would suggest it would be better to use ABC as an indirect cost allocation method over a traditional method such as direct labor hours.
![10:48 PM Fri Jan 20
=
ANALYZE, THINK, COMMUNICATE
ATC 5-1 Business Applications Case Using ABC to improve product costing
Drilling Innovations Inc. produces specialized cutting heads used by companies that drill for oil and natural gas. The
company recently implemented an ABC system for three of its products and is interested in evaluating its effectiveness
before converting to an ABC system for all of its products. To perform this evaluation the company has compiled data for
the three products using both the traditional system and the new ABC system. The traditional system uses a single driver
(machine hours). The ABC system uses a variety of cost drivers related to the activities used to produce the
cutting heads. The three products involved in the trial run of the ABC system were GS-157, HS-241, and OS- Page 248
367. The following data relate to these products.
Product
GS-157
HS-241
OS-367
Totals
Selling
Price per
Unit
$19.30
17.50
15.10
Units
Produced
A
120,000
90,000
40,000
Total Costs
Allocated:
Traditional
Costing
$1,600,000
1,100,000
400,000
$3,100,000
Cost per Unit:
Traditional
Costing
$13.3333
12.2222
10.0000
Total Cost
Allocated:
ABC
QAA
1,050,000
550,000
$3,100,000
Cost per
Unit
ABC
$1,500,000 $12.5000
11.6667
13.7500
a. Determine the gross profit margin for each product produced based on the ABC data [(Selling price - ABC cost per
unit) x Units produced].
b. Determine the gross profit margin for each product produced based on the traditional costing data [(Selling price -
Traditional cost per unit) × Units produced].
c. Provide a possible explanation as to why the cost of OS-367 increased under the ABC system while the cost GS-157
decreased.
d. Suggest what action management might take with respect to the discoveries resulting from the ABC versus traditional
costing analysis. Assume that Drilling Innovations expects to produce a gross profit margin on each product of at least
30 percent of the selling price.
ATC 5-2 Group Assignment Using ABC in a service business
A dialysis clinic provides two types of treatment for its patients. Hemodialysis (HD), an in-house treatment, requires that
patients visit the clinic three times each week for dialysis treatments. Peritoneal dialysis (PD) permits patients to self-
administer their treatments at home on a daily basis. On average, the clinic serves 102 HD patients and 62 PD patients. A
recent development caused clinic administrators to develop a keen interest in cost measurement for the two separate
services. Managed care plans such as HMOs began to pay treatment providers a fixed payment per insured participant
regardless of the level of services provided by the clinic. With fixed fee revenues, the clinic was forced to control costs to
ensure profitability. As a result, knowing the cost to provide HD versus PD services was critically important for the clinic. It
needed accurate cost measurements to answer the following questions. Were both services profitable, or was one service
carrying the burden of the other service? Should advertising be directed toward acquiring HD or PD patients? Should the
clinic eliminate HMO service?
Management suspected the existing cost allocation system was inaccurate in measuring the true cost of providing the
respective services; it had been developed in response to Medicare reporting requirements. It allocated costs between HD
and PD based on the ratio of cost to charges (RCC). In other words, RCC allocates indirect costs in proportion to revenues.
To illustrate, consider the allocation of $883,280 of indirect nursing services costs, which are allocated to the two treatment
groups in relation to the revenue generated by each group. Given that the clinic generated total revenue of $3,006,775, an
Q
Page_247
L](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fc0c69442-5408-4687-8b1d-fa9b633ef545%2Fb5ca2f3f-08dc-4275-9789-29036e1b3aa9%2F6a34h3j_processed.jpeg&w=3840&q=75)
Transcribed Image Text:10:48 PM Fri Jan 20
=
ANALYZE, THINK, COMMUNICATE
ATC 5-1 Business Applications Case Using ABC to improve product costing
Drilling Innovations Inc. produces specialized cutting heads used by companies that drill for oil and natural gas. The
company recently implemented an ABC system for three of its products and is interested in evaluating its effectiveness
before converting to an ABC system for all of its products. To perform this evaluation the company has compiled data for
the three products using both the traditional system and the new ABC system. The traditional system uses a single driver
(machine hours). The ABC system uses a variety of cost drivers related to the activities used to produce the
cutting heads. The three products involved in the trial run of the ABC system were GS-157, HS-241, and OS- Page 248
367. The following data relate to these products.
Product
GS-157
HS-241
OS-367
Totals
Selling
Price per
Unit
$19.30
17.50
15.10
Units
Produced
A
120,000
90,000
40,000
Total Costs
Allocated:
Traditional
Costing
$1,600,000
1,100,000
400,000
$3,100,000
Cost per Unit:
Traditional
Costing
$13.3333
12.2222
10.0000
Total Cost
Allocated:
ABC
QAA
1,050,000
550,000
$3,100,000
Cost per
Unit
ABC
$1,500,000 $12.5000
11.6667
13.7500
a. Determine the gross profit margin for each product produced based on the ABC data [(Selling price - ABC cost per
unit) x Units produced].
b. Determine the gross profit margin for each product produced based on the traditional costing data [(Selling price -
Traditional cost per unit) × Units produced].
c. Provide a possible explanation as to why the cost of OS-367 increased under the ABC system while the cost GS-157
decreased.
d. Suggest what action management might take with respect to the discoveries resulting from the ABC versus traditional
costing analysis. Assume that Drilling Innovations expects to produce a gross profit margin on each product of at least
30 percent of the selling price.
ATC 5-2 Group Assignment Using ABC in a service business
A dialysis clinic provides two types of treatment for its patients. Hemodialysis (HD), an in-house treatment, requires that
patients visit the clinic three times each week for dialysis treatments. Peritoneal dialysis (PD) permits patients to self-
administer their treatments at home on a daily basis. On average, the clinic serves 102 HD patients and 62 PD patients. A
recent development caused clinic administrators to develop a keen interest in cost measurement for the two separate
services. Managed care plans such as HMOs began to pay treatment providers a fixed payment per insured participant
regardless of the level of services provided by the clinic. With fixed fee revenues, the clinic was forced to control costs to
ensure profitability. As a result, knowing the cost to provide HD versus PD services was critically important for the clinic. It
needed accurate cost measurements to answer the following questions. Were both services profitable, or was one service
carrying the burden of the other service? Should advertising be directed toward acquiring HD or PD patients? Should the
clinic eliminate HMO service?
Management suspected the existing cost allocation system was inaccurate in measuring the true cost of providing the
respective services; it had been developed in response to Medicare reporting requirements. It allocated costs between HD
and PD based on the ratio of cost to charges (RCC). In other words, RCC allocates indirect costs in proportion to revenues.
To illustrate, consider the allocation of $883,280 of indirect nursing services costs, which are allocated to the two treatment
groups in relation to the revenue generated by each group. Given that the clinic generated total revenue of $3,006,775, an
Q
Page_247
L
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