Solutions Guide: Please do not present as your own



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LO 6

7-45 Activity-based costing for environmental costs How can a firm use activity-based costing to help control and reduce environmental costs?

Environmental costs include explicit costs, such as the direct costs of modifying technology and processes, costs of cleanup and disposal, costs for permits to operate a facility, fines levied by government agencies and litigation fees. Implicit environmental costs are often more closely tied to the infrastructure required to monitor environmental issues. These costs include administration and legal counsel, employee education and awareness, and the loss of goodwill if environmental disasters occur. Using traditional cost systems, environmental-related costs are often hard to pinpoint because they are usually hidden in support cost pools

To use activity-based costing to help control and reduce environmental costs, the

activities that cause environmental costs must be identified. Next, the costs

associated with the activities must be determined. These costs must then be

assigned to the most appropriate products, distribution channels and customers.

As in all types of management accounting and control systems, it is only when

managers and employees become aware of how the activities in which they

engage generate environmental costs that they can control and reduce them.

LO4 7-50 Target'costing: unit cost Calcutron Company is contemplating introducing a new type of calculator to complement its existing line of scientific calculators. The target price of the calculator is $75; annual sales volume of the new calculator is expected to be 500,000 unlteTCalcutron has a 15% return-on-sales target.

Required

Compute the unit target cost per calculator.

The target cost for a Calcutron calculator is computed as follows:

| |Target sales (500,000 calculators ( $75) |$37,500,000 |

| | | |

| |Less: Target profit (15% ( $75/calculator ( 500,000 | |

| |calculators) |5,625,000 |

| | | |

| |Target cost for 500,000 calculators |$31,875,000 |

| | | |

| |Unit target cost ($31,875,000/500,000 calculators) |$ 63.75 |

LO 4 7-51 Target costing: return on sales Stacy Yoo, president of Caremore, Inc., an appliance manufacturer in Seattle, Washington, has been trying to decide whether one of her product-line managers, Bill Mann, has been achieving the companywide return-on-sales target of 45%. Stacy has just received data from the new target costing system regarding Bill's operation. Bill's sales volume was 300,000 appliances with an average selling price of $500 and expenses totaling $90 million.

Required

Determine whether Bill's return-on-sales ratio has met the companywide target. Has Bill done a good or a poor job? Explain.

To compute the return on sales (ROS) for Bill Mann, it is necessary to determine Bill’s profit margin:

Sales (300,000 units ( $500) $150,000,000

Less: Expenses 90,000,000

= Profit Margin (ROS ( Sales) $60,000,000

ROS ( $150,000,000 = $60,000,000, so ROS = 40%.

Thus, Bill Mann has not met the company-wide return-on-sales target of 45%. Assuming Bill’s initial target costs and target sales prices were consistent with the company-wide return-on-sales target, Bill should explain the causes for below-target performance. Potential problem areas include manufacturing costs and misestimation of customer demand for the products’ functionality at the target prices. Evaluating whether Bill has done a good or poor job will involve determining the extent to which Bill could control cost, and evaluating Bill’s judgment in setting prices.

LO 5,6 7-62 Environmental costs, activity-based costing, Kaizen costing Bevans Co. makes two products, product X and product Y. Bevans has produced product X for many years without generating any hazardous wastes. Recently, Bevans developed product Y, which is superior to product X in many respects. However, production of product Y generates hazardous wastes. Because of the hazardous wastes, Bevans now must deal with hazardous waste disposal, govern¬mental environmental reports and inspections, and safe handling procedures.

Bevans Co. uses a cost driver rate based on machine hours to assign manufacturing support costs to its two products. Because of concerns about the accuracy of the product costing system, Joel Dempsey, the controller, undertook an activity-based costing analysis of the manufacturing support costs. The resulting cost information is summarized in the following table:

Product X Product Y

Direct costs (material plus labor) $9,000,000 $4,000,000

Unit-level support $2,000,000 $1,000,000

Batch-level support $15,000,000 $20,000,000

Product-level support $5,000,000 $8,000,000

Environmental support — $14,000,000

Total machine hours 10,000,000 6,000,000

Number of units 100,000,000 40,000,000

a. Compute product costs per unit for products X and Y using the current cost driver rate base onmachine hours for manufacturing support costs.

b. Compute product costs per unit for products X and Y using the activity-based costing figure provided in the table.

c. Explain the reasons for the differences in cost for each product using the two cost systems

(You may wish to compute unit-level support, batch-level support, product-level support and environmental support costs per unit.)

d. Bevans has been selling products X and Y at a price equal to 1.5 times the product cost

computed using the machine-hour-based cost driver rate for manufacturing support costs

Compute these prices and provide recommendations to Bevans' management concerning

profit improvement through pricing changes and cost reduction through manufacturing

improvements.

|(a) | |Product X |Product Y | |

| |Direct costs | | | |

| |(material plus labor) |$9,000,000 |$4,000,000 | |

| |Unit-level support |2,000,000 |1,000,000 | |

| |Batch-level support |15,000,000 |20,000,000 | |

| |Product-level support |5,000,000 |8,000,000 | |

| |Environmental support |      —        |14,000,000 | |

| | Total support |$22,000,000 |$43,000,000 |$65,000,000 |

| | | | | |

| |Total machine hours |10,000,000 |6,000,000 |16,000,000 |

| |Number of units |100,000,000 |40,000,000 | |

| | | | | |

| |Current cost driver rate: | | | |

| | | | | |

| | Total support ( machine | | | |

| |hours | | |$4.0625 |

| | | | | |

| |Costs using current cost | | | |

| |driver rate | | | |

| | | | | |

| |Direct costs | | | |

| |(material plus labor) |$ 9,000,000 |$ 4,000,000 | |

| | | | | |

| |Applied support: | | | |

| |$4.0625 per machine hour |40,625,000 |24,375,000 | |

| | | | | |

| |Total costs |$49,625,000 |$28,375,000 | |

| | | | | |

| |Number of units |100,000,000 |40,000,000 | |

| |Cost per unit |$0.50 |$0.71 | |

| |(b) | | | |Per unit |

| | | |Product X |Product Y |X |Y |

| | |Direct costs |$ 9,000,000 |$ 4,000,000 |$0.09 |$0.10 |

| | |(material plus labor) | | | | |

| | | | | | | |

| | |Unit-level support |$ 2,000,000 |$ 1,000,000 |0.02 |0.03 |

| | |Batch-level support |15,000,000 |20,000,000 |0.15 |0.50 |

| | |Product-level support |5,000,000 |8,000,000 |0.05 |0.20 |

| | |Environmental support |       —       |14,000,000 | — |0.35 |

| | | Total support |$22,000,000 |$43,000,000 |$0.22 |$1.08 |

| | | | | | | |

| | |Total costs |$31,000,000 |$47,000,000 | | |

| | |Number of units |100,000,000 |40,000,000 | | |

| | |Cost per unit using ABC |$0.31 |$1.18 | | |

| | | | | | | |

(c) As shown in part (b), product Y’s support costs per unit are higher in each support category than product X’s. Although some of the cost differences per unit may result from special features that contribute to product Y’s superiority, some of product Y’s higher costs clearly result from generation of hazardous wastes that product X does not generate. There is also the possibility that some costs related to dealing with environmental issues are included in product-level support costs. Product Y’s costs can be disaggregated further to highlight the costs associated with hazardous wastes as input to the decision on whether to seek a process that reduces or eliminates hazardous wastes.

| |(d) | |Product X |Product Y |

| | |Cost per unit using current cost driver rate |$0.50 |$0.71 |

| | |Price, 1.5 ( cost |$0.75 |$1.07 |

| | | | | |

| | |Cost per unit using ABC |$0.31 |$1.18 |

| | |Price, 1.5 ( cost |$0.47 |$1.77 |

| | | | | |

Of the two costing systems here, the activity-based costing system more accurately assigns costs of resource usage to the two products. The cost system based on a plant-wide rate results in product X essentially subsidizing product Y. Product Y’s price under this system does not even cover the product’s reported activity-based costs. Consequently, the company should evaluate a price increase for product Y or ways to decrease product-related costs for product Y. The company can use the activity-based costing driver rates as a starting point for potential manufacturing cost reductions. Also, as stated in part (c), the company may be able to reduce product Y’s costs by using a process that reduces or eliminates hazardous wastes.

Product X’s price could be reduced and still generate a profit. In making such a decision, the company would evaluate expected changes in demand (if any) if product X’s price were reduced.

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