1.

Med Max buys surgical supplies from a variety of manufacturers and then resells and delivers these
supplies to hundreds of hospitals. Med Max sets its prices for all hospitals by marking up its cost of
goods sold to those hospitals by 6%. For example, if a hospital buys supplies from Med Max that had
cost Med Max $100 to buy from manufacturers, Med Max would charge the hospital $106 to purchase
these supplies.

For years, Med Max believed that the 6% markup covered its selling and administrative expenses and
provided a reasonable profit. However, in the face of declining profits Med Max decided to implement an
activity-based costing system to help improve its understanding of customer profitability. The company
broke its selling and administrative expenses into five activities as shown below:

Activity Cost Pool Activity Measure Total Cost Total Activity

Customer deliveries Number of deliveries $ 595,000 7,000 deliveries
Manual order processing Number of manual orders 292,000 4,000 orders
Electronic order processing Number of electronic orders 299,000 13,000 orders
Line item picking Number of line items picked 760,000 400,000 line items
Other organization-sustaining costs NA 630,000

Total selling and administrative expenses $ 2,576,000

Med Max gathered the data below for two of the many hospitals that it serves—City General and County
General (each hospital purchased medical supplies that had cost Med Max $37,000 to buy from its
manufacturers):

Activity
Activity Measure City General County General
Number of deliveries 14 20
Number of manual orders 0 48
Number of electronic orders 17 0
Number of line items picked 110 270

Required:
1. Compute the total revenue that Med Max would receive from City General and County General. (Omit
the "$" sign in your response.)

Total Revenue
City General $
County General $
2. Compute the activity rate for each activity cost pool. (Round the "Line item picking" to 2 decimal
places. Omit the "$" sign in your response.)

Activity Cost Pool Activity Rate

Customer deliveries $ per delivery
Manual order processing $ per manual order
Electronic order processing $ per electronic order
Line item picking $ per line item picked

3. Compute the total activity costs that would be assigned to City General and County General. (Round
your intermediate calculations and final answers to 2 decimal places. Omit the "$" sign in your
response.)

Total Activity Costs

City General $
County General $

4. Compute Med Max’s customer margin for City General and County General. (Hint: Do not overlook
the $37,000 cost of goods sold that Med Max incurred serving each hospital.) (Loss amount should
be indicated with a minus sign. Round your intermediate calculations and final answers to 2
decimal places. Omit the "$" sign in your response.)

Customer Margin
City General $
County General $

Explanation:
1.
Total revenue received:

City
County General
General
Cost of goods sold to the hospital (a) $ 37,000 $ 37,000
Markup percentage 6% 6%
 Markup in dollars (b) $ 2,220 $ 2,220
Revenue received from hospitals (a) + (b) $ 39,220 $ 39,220

2.
Activity Rates:

(a)
Estimated
Overhead (b) (c)
Activity Cost Pool cost Expected Activity Activity Rate
per
deli
deliverie ver
Customer deliveries $ 595,000 7,000s $85.00y
per
ma
nua
l
ord
Manual order processing $ 292,000 4,000 orders $73.00er
per
ele
ctro
nic
ord
Electronic order processing $ 299,000 13,000 orders $23.00er
760,000 400,000 1.90 per
line
line ite
Line item picking $ $
items m
pick
ed

3.
Activity costs are assigned to the two hospitals as follows:

City General:

(a) (b) (a) × (b)

Activity Cost Pool Activity Rate Activity ABC Cost
Customer deliveries $ 85.00 per delivery 14 deliveries $
 Manual order processing $ 73.00 per order 0 orders

Electronic order processing $ 23.00 per order 17 orders

Line item picking $ 1.90 per line item 110 line items

Total activity costs $

County General:

(a) (b) (a) × (b)

Activity Cost Pool Activity Rate Activity ABC Cost
Customer
$ 85.00 per delivery 20 deliveries $ 1,700.00
deliveries
Manual $ 73.00 per order 48 orders 3,504.00
order
processing
Electronic
order $ 23.00 per order 0 orders 0
processing
Line item per line
$ 1.90 270 line items 513.00
picking item

Total
activity $ 5,717.00
costs

4.
Customer margins for the two hospitals:

City County
General General
Sales $ 39,220.00 $ 39,220.00
Cost of goods sold 37,000.00 37,000.00

Gross margin 2,220.00 2,220.00

Customer deliveries 1,190.00 1,700.00

Manual order processing 0 3,504.00
Electronic order processing 391.00 0
Line item picking 209.00 513.00

Total activity costs 1,790.00 5,717.00

Customer margin $ 430.00 $ (3,497.00)

2.
Rocky Mountain Corporation makes two types of hiking boots—Xactive and the Pathbreaker. Data
concerning these two product lines appear below:

Xactive Pathbreaker
Selling price per unit $121.00 $ 85.00
Direct materials per unit $ 64.90 $ 51.00
Direct labor per unit $ 11.20 $ 8.00
Direct labor-hours per unit 1.4 DLHs 1.0 DLHs
27,00 70,00
Estimated annual production and sales
0 units 0 units

The company has a traditional costing system in which manufacturing overhead is applied to units
based on direct labor-hours. Data concerning manufacturing overhead and direct labor-hours for the
upcoming year appear below:

Estimated total manufacturing overhead $2,156,000

Estimated total direct labor-hours 107,800 DLHs

Required:
1. Compute the product margins for the Xactive and the Pathbreaker products under the company’s
traditional costing system. (Loss amounts should be indicated with a minus sign. Omit the "$"
sign in your response.)

Xactive Pathbreaker Total

Product margin $ $ $

2. The company is considering replacing its traditional costing system with an activity-based costing
system that would assign its manufacturing overhead to the following four activity cost pools (the
Other cost pool includes organization-sustaining costs and idle capacity costs):

Estimated Expected Activity

Pathbreake
Overhead Cost
Activities and Activity Measures Xactive r Total
37,800
Supporting direct labor (direct labor-hours)
$ 700,700 70,000 107,800
Batch setups (setups) 737,000 380 290 670
Product sustaining (number of products) 640,000 1 1 2
Other 78,300 NA NA NA
 Total manufacturing overhead cost $ 2,156,000

Compute the product margins for the Xactive and the Pathbreaker products under the activity-based
costing system. (Loss amounts should be indicated with a minus sign. Round your
intermediate calculations to 2 decimal places and final answers to the nearest dollar amount.
Omit the "$" sign in your response.)

Xactive Pathbreaker Total

Product margin $ $ $

3. Prepare a quantitative comparison of the traditional and activity-based cost assignments. (Do not
round intermediate calculations. Round your percentage answers to one decimal place and
other answers to the nearest dollar amount. Omit the "$" & "%" signs in your response.)

Xactive Pathbreaker Total

% of % of
Amount Total Amount Amount Total Amount Amount
Traditional Cost System
Direct materials $ % $ % $
Direct labor % %
Manufacturing
% %
overhead

Total cost assigned to

$ $ $
products
 Activity-Based Costing
System
Direct costs:
Direct materials $ % $ % $
Direct labor % %
Indirect costs:
Supporting direct labor % %
Batch setups % %
Product sustaining % %

Total cost assigned to

$ $ $
products

Costs not assigned to

products:
Other

Total cost $

Explanation:
1.
Under the traditional direct labor-hour based costing system, manufacturing overhead is applied to
products using the predetermined overhead rate computed as follows:

Predetermined Estimated total manufacturing overhead cost

=
overhead rate Estimated total direct labor-hours

$2,156,000
= = $20.00 per DLH
107,800 DLHs*

*27,000 units of Xactive @ 1.4 DLH per unit + 70,000 units of the Pathbreaker @ 1 DLH per unit =
37,800 DLHs + 70,000 DLHs = 107,800 DLHs

Consequently, the product margins using the traditional approach would be computed as follows:
 Xactive Pathbreaker Total
Sales $ 3,267,000 $ 5,950,000 $ 9,217,000

Direct materials 1,752,300 3,570,000 5,322,300

Direct labor 302,400 560,000 862,400
Manufacturing
overhead
applied @
$20.00 per direct
labor-hour 756,000 1,400,000 2,156,000

Total
2,810,700 5,530,000 8,340,700
manufacturing cost

Product margin $ 456,300 $ 420,000 $ 876,300

Note that all of the manufacturing overhead cost is applied to the products under the company's
traditional costing system.

2.
The first step is to determine the activity rates:

(a) (b) (a) ÷ (b)

Activity Cost Pool Total cost Total activity Activity Rate
Supporting direct labor $ 700,700 107,800 DLH $ 6.50 per DLH
Batch setups $ 737,000 670 setups $ 1,100 per setup
320,00 per
Product sustaining
$ 640,000 2 products $ 0product

*The Other activity cost pool is not shown above because it includes organization-sustaining and idle
capacity costs that should not be assigned to products.

Under the activity-based costing system, the product margins would be computed as follows:

Xactive Pathbreaker Total

Sales $ 3,267,000 $ 5,950,000 $ 9,217,000

Direct materials 1,752,300 3,570,000 5,322,300

Direct labor 302,400 560,000 862,400
 Supporting direct labor 245,700 455,000 700,700
Batch setups 418,000 319,000 737,000
Product sustaining 320,000 320,000 640,000

Total cost 3,038,400 5,224,000 8,262,400

Product margin $ 228,600 $ 726,000 $ 954,600

3.
Traditional Cost System Xactive Pathbreaker
Direct materials $1,752,300 / $5,322,300 = 32.9% $3,570,000 / $5,322,300 = 67.1%
Direct labor $302,400 / $862,400 = 35.1% $560,000 / $862,400 = 64.9%
Manufacturing overhead $756,000 / $2,156,000 = 35.1% $1,400,000 / $2,156,000 = 64.9%

Activity-Based Costing System

Direct costs:
Direct materials $1,752,300 / $5,322,300 = 32.9% $3,570,000 / $5,322,300 = 67.1%
Direct labor $302,400 / $862,400 = 35.1% $560,000 / $862,400 = 64.9%
Indirect costs:
Supporting direct labor $245,700 / $700,700 = 35.1% $455,000 / $700,700 = 64.9%
Batch setups $418,000 / $737,000 = 56.7% $319,000 / $737,000 = 43.3%
Product sustaining $320,000 / $640,000 = 50.0% $320,000 / $640,000 = 50.0%

3.
Denny Asbestos Removal Company removes potentially toxic asbestos insulation and related products
from buildings. The company’s estimator has been involved in a long-simmering dispute with the on-site
work supervisors. The on-site supervisors claim that the estimator does not adequately distinguish
between routine work such as removal of asbestos insulation around heating pipes in older homes and
nonroutine work such as removing asbestos-contaminated ceiling plaster in industrial buildings. The on-
site supervisors believe that nonroutine work is far more expensive than routine work and should bear
higher customer charges. The estimator sums up his position in this way: “My job is to measure the area
to be cleared of asbestos. As directed by top management, I simply multiply the square footage by
$4,000 per thousand square feet to determine the bid price. Since our average cost is only $3,000 per
thousand square feet, that leaves enough cushion to take care of the additional costs of nonroutine work
that shows up. Besides, it is difficult to know what is routine or nonroutine until you actually start tearing
things apart.”

To shed light on this controversy, the company initiated an activity-based costing study of all of its
costs. Data from the activity-based costing system follow:

Activity Cost Pool Activity Measure Total Activity

Removing asbestos Thousands of square feet 500 thousand square feet
Estimating and job setup Number of jobs 230 jobs*
Working on nonroutine jobs Number of nonroutine jobs 30 nonroutine jobs
Other (organization-sustaining
and idle capacity costs) None Not applicable

* The total number of jobs includes nonroutine jobs as well as routine jobs. Nonroutine jobs as well as
routine jobs require estimating and setup work.

Costs for the Year

Wages and salaries $ 200,000
Disposal fees 596,000
Equipment depreciation 21,000
On-site supplies 62,000
Office expenses 194,000
Licensing and insurance 376,000

Total cost $ 1,449,000

 Distribution of Resource Consumption Across Activities

Estimating Working on
Removing and Job Nonroutine
Asbestos Setup Jobs Other Total
Wages and salaries 32% 11% 33% 24% 100%
Disposal fees 73% 0% 27% 0% 100%
Equipment depreciation 40% 0% 39% 21% 100%
On-site supplies 46% 10% 23% 21% 100%
Office expenses 11% 32% 21% 36% 100%
Licensing and insurance 49% 0% 35% 16% 100%

Required:

1. Perform the first-stage allocation of costs to the activity cost pools. (Leave no cells blank - be
certain to enter "0" wherever required. Omit the "$" sign in your response.)

Removing Estimating and Working on

Asbestos Job Setup Nonroutine Jobs Other Total
Wages and salaries $ $ $ $ $
Disposal fees
Equipment depreciation
On-site supplies
Office expenses
Licensing and insurance

Total cost $ $ $ $ $

2. Compute the activity rates for the activity cost pools. (Round your answers to 2 decimal places.
Omit the "$" sign in your response.)

Activity Cost Pool Activity Rate

Removing asbestos $ per thousand square feet
Estimating and job setup $ per job
Working on nonroutine jobs $ per nonroutine job
3. Using the activity rates you have computed, determine the total cost and the average cost per
thousand square feet of each of the following jobs according to the activity-based costing
system. (Round your intermediate and final answers to 2 decimal places. Omit the "$" sign in
your response.)

a. A routine 2,000-square-foot asbestos removal job.

Total cost of the job $

Average cost per thousand square feet $

b. A routine 4,000-square-foot asbestos removal job.

Total cost of the job $

Average cost per thousand square feet $

c. A nonroutine 2,000-square-foot asbestos removal job.

Total cost of the job $

Average cost per thousand square feet $

Explanation:
1.
Wages and salaries:
Removing Asbestos = 32% × $200,000 = $64,000
Estimating and Job Setup = 11% × $200,000 = $22,000
Working on Nonroutine Jobs = 33% × $200,000 = $66,000
Other = 24% × $200,000 = $48,000

Disposal fees:
Removing Asbestos = 73% × $596,000 = $435,080
Estimating and Job Setup = 0% × $596,000 = $0
Working on Nonroutine Jobs = 27% × $596,000 = $160,920
Other = 0% × $596,000 = $0

Equipment depreciation:
Removing Asbestos = 40% × $21,000 = $8,400
Estimating and Job Setup = 0% × $21,000 = $0
Working on Nonroutine Jobs = 39% × $21,000 = $8,190
Other= 21% × $21,000 = $4,410

On-site supplies:
Removing Asbestos = 46% × $62,000 = $28,520
Estimating and Job Setup = 10% × $62,000 = $6,200
Working on Nonroutine Jobs = 23% × $62,000 = $14,260
Other = 21% × $62,000 = $13,020

Office expenses:
Removing Asbestos = 11% × $194,000 = $21,340
Estimating and Job Setup = 32% × $194,000 = $62,080
Working on Nonroutine Jobs = 21% × $194,000 = $40,740
Other = 36% × $194,000 = $69,840

Licensing and insurance:

Removing Asbestos = 49% × $376,000 = $184,240
Estimating and Job Setup = 0% × $376,000 = $0
Working on Nonroutine Jobs = 35% × $376,000 = $131,600
Other = 16% × $376,000 = $60,160

2.
(b)
(a) (a) ÷ (b)
Activity Total
Total Cost Activity Rate
Cost Pool Activity
Removing thousand per thousand square
asbestos $ 741,580 500square feet $ 1,483.16feet
Estimating and job setup $ 90,280 230 jobs $ 392.52 per job
14,057.0
Working on nonroutine jobs
$421,710 30 nonroutine jobs $ 0 per nonroutine job

3.
The costs of each of the jobs can be computed as follows using the activity rates computed above:

a.
Routine 2,000-square-foot job:

Removing asbestos ($1,483.16 per thousand square feet × 2 thousand

square feet) $ 2,966.32
Estimating and job setup ($392.52 per job × 1 job) 392.52
Nonroutine job (not applicable) 0

Total cost of the job $ 3,358.84

Average cost per thousand square feet ($3,358.84 ÷ 2 thousand

$1,679.42
square feet)

b.
Routine 4,000-square-foot job:
 Removing asbestos ($1,483.16 per thousand square feet × 4 thousand square feet) $ 5,932.64
Estimating and job setup ($392.52 per job × 1 job) 392.52
Nonroutine job (not applicable) 0

Total cost of the job $ 6,325.16

Average cost per thousand square feet ($6,325.16 ÷ 4 thousand square feet) $1,581.29

c.
Nonroutine 2,000-square-foot job:

Removing asbestos ($1,483.16 per thousand square feet × 2 thousand square feet) $ 2,966.32
Estimating and job setup ($392.52 per job × 1 job) 392.52
Nonroutine job ($14,057.00 per nonroutine job × 1 nonroutine job) 14,057.00

Total cost of the job $ 17,415.84

Average cost per thousand square feet ($17,415.84 ÷ 2 thousand square feet) $8,707.92

4.
Erte, Inc., manufactures two models of high-pressure steam valves, the XR7 model and the ZD5 model.
Data regarding the two products follow:

Annual Total Direct

Product Direct Labor-Hours Production Labor-Hours
XR7 0.3 DLHs per unit 20,000 Units 6,000 DLHs
ZD5 0.5 DLHs per unit 42,000 Units 21,000 DLHs

27,000 DLHs

Additional information about the company follows:

a.Product XR7 requires $37 in direct materials per unit, and product ZD5 requires $26.
b.The direct labor rate is $50 per hour.
c. The company has always used direct labor-hours as the base for applying manufacturing overhead
cost to products. Manufacturing overhead totals $1,799,300 per year.
d.Product XR7 is more complex to manufacture than product ZD5 and requires the use of a special
milling machine.
e.Because of the special work required in (d) above, the company is considering the use of activity-
based costing to apply overhead cost to products. Three activity cost pools have been identified and
the first-stage allocations have been completed. Data concerning these activity cost pools appear
below:

Estimated Total Activity

Estimated
Activity Cost Pool Activity Measure Total Cost XR7 ZD5 Total
Machine setups Number of setups $ 165,900 84 126 210
Special milling Machine-hours 283,400 1,090 0 1,090
General factory Direct labor-hours 1,350,000 6,000 21,000 27,000

$ 1,799,300

Required:
1. Assume that the company continues to use direct labor-hours as the base for applying overhead cost
to products.

a. Compute the predetermined overhead rate. (Round your answer to the nearest dollar amount.
Omit the "$" sign in your response.)

Predetermined overhead rate $ per DLH

b. Determine the unit product cost of each product. (Round pre-determined overhead rate to nearest
dollar amount. Round other intermediate answers and the final answer to two decimal places.
Omit the "$" sign in your response.)

Model
XR7 ZD5
Unit product cost $ $
2. Assume that the company decides to use activity-based costing to apply overhead cost to products.

a. Compute the activity rate for each activity cost pool. Also, compute the amount of overhead cost that
would be applied to each product. (Round your overhead cost per unit to 2 decimal places. Omit
the "$" sign in your response.)

Activity cost Pool Activity Rate

Machine setups $ Per setup
Special processing $ Per MH
General factory $ Per DLH

Activity Cost Pool Model XR7 Model ZD5

Total overhead cost $ $
Overhead cost per unit $ $

b. Determine the unit product cost of each product. (Round your intermediate and final answers to 2
decimal places. Omit the "$" sign in your response.)

Unit product cost of Model XR7 $

Unit product cost of Model ZD5 $

Explanation:
1.
a.
When direct labor-hours are used to apply overhead cost to products, the company’s predetermined
overhead rate would be:

Predetermined Manufacturing overhead cost

=
overhead rate Direct labor hours

$1,799,300
= = $67 per DLH
27,000 DLHs

1.
b.
Model
XR7 ZD5
Direct materials $ 37.00 $ 26.00
Direct labor: ($50 per DLH × .3 DLH; $50 per DLH × .5DLH) 15.00 25.00
Manufacturing overhead: ($67 per DLH × .3 DLH; 67 per DLH × .5 DLH) 20.10 33.50
 Total unit product cost $ 72.10 $ 84.50

2.
a.
Predetermined overhead rates for the activity cost pools:

(a) (b)
Estimated Estimated (a) ÷ (b)
Activity cost Pool Total cost Total Activity Activity Rate
Machine setups $ 165,900 210 setups $ 790 per setup
Special milling $ 283,400 1,090 MHs $ 260 per MH
General factory $ 1,350,000 27,000 DLHs $ 50 per DLH

The overhead applied to each product can be determined as follows:

Model XR7
(a) × (b)
(a) (b) Overhead
Activity Cost Pool Activity rate Activity Applied
79 setup
Machine setups $ per setup 84 $ 66,360
0 s
26
Special milling $ per MH 1,090 MHs 283,400
0
General factory $ 50 per DLH 6,000 DLHs 300,000

Total manufacturing overhead cost (a) $ 649,760

Number of units produced (b) 20,000

Overhead cost per unit (a) ÷ (b) $ 32.49

Model ZD5
(a) × (b)
(a) (b) Overhead
Activity Cost Pool Activity rate Activity Applied
 79 setup
Machine setups $ per setup 126 $ 99,540
0 s
26
Special milling $ per MH 0 MHs 0
0
General factory $ 50 per DLH 21,000 DLHs 1,050,000

Total manufacturing overhead cost (a) $ 1,149,540

Number of units produced (b) 42,000

Overhead cost per unit (a) ÷ (b) $ 27.37

2.
b.
The unit product cost of each model under activity-based costing would be computed as follows:

Model
XR7 ZD5
Direct materials $ 37.00 $ 26.00
Direct labor ($50per DLH × .3 DLH; $50 per DLH × .5DLH) 15.00 25.00
Manufacturing Overhead (above) 32.49 27.37

Total unit product cost $ 84.49 $ 78.37

Comparing these unit cost figures with the unit costs in Part 1(b), we find that the unit product cost for
Model XR7 has increased from $72.10 to $84.49, and the unit product cost for Model ZD5 has decreased
from $84.50 to $78.37.