Question

Spirits were high at the monthly meeting of the top management of Waterways. Installation was proceeding nicely on the 10 jobs for the city, and the company had just received confirmation that the local school board had accepted its bid to install irrigation systems in 25 school playgrounds. Unfortunately, not everyone was celebrating. Lee Williams, the vice-president of the installation and training division, was troubled. He has been supervising the city jobs and he believes the current system of assigning overhead costs to the jobs does not accurately reflect the actual cost of overhead.

“Several major things have changed since we set our overhead rate at 120% of direct labour cost,” Lee explained. “I’ve noticed that the new systems are requiring a lot of the more expensive glue and they were designed to accommodate only titanium fasteners. We are using special packaging to transport the systems to the sites, not to mention the new heavy equipment we had to purchase to prepare the ground for the install.”

Madison Tremblay, vice-president of sales and marketing, was quick to respond. “I can’t believe that you’re suggesting there’s something wrong with our bids,” he retorted. He was visibly annoyed. “This is the first time in several years that our sales group has been successful in increasing our market share,” he continued, “and now you want to mess with the pricing! I want you to explain that to the salespeople who have just received their first bonus commission cheques in a very long time.”

Ben Clark, who designed the new system, agreed with Madison, suggesting that maybe the problem was not with the cost, but was more likely cost control.

Their accountant, Jordan Leigh, did not like conflict. “I have an idea,” he said. “We have been investigating using a new costing system in our manufacturing plant called activity-based costing, or ABC. ABC is supposed to lead to more accurate overhead costing and it provides a better way to control overhead costs. With a little work, I think we could adapt it to our installation services.” When he off ered to do an analysis and bring his recommendations back to the next management meeting, the rest of the group agreed to wait for the results before making any changes.

Jordan’s first action was to identify and classify all the activities that consume resources during this specific type of installation into a number of cost pools, and then determine the overhead costs that should be assigned to each cost pool. At the same time, he determined a cost driver for each pool. The following table shows these cost pools along with the estimated overhead allocation to each one.

Activity Cost Pools		Cost Drivers		Estimated Overhead		Estimated Use per Activity
Supervision, security, maintenance		Number of workdays		$503,200		1,700
Liability insurance		Number of employees		94,400		800
Equipment costs		Hours of operation		78,660		11,400
Indirect supplies and delivery		Length in metres		234,000		234,000
Employee benefits		Direct labour cost		136,000		$544,000
				$1,046,260

Then, based on the information used to prepare the bids, Jordan determined that each of the 25 projects for the school board would require the following overhead activities.

Activity Cost Pools		Cost Drivers		Estimated Use per Job
Supervision, security, maintenance		Number of workdays		28
Liability insurance		Number of employees		4
Equipment costs		Hours of operation		260
Indirect supplies and delivery		Length in metres		3,100
Employee benefits		Direct labour cost		$12,000

The material costs for each project were expected to be $14,100.

(a) Calculate the estimated cost of this type of installation using both the traditional method and activity-based costing. (Round overhead rate per hour to 2 decimal places, e.g. 52.75. Round overhead rate for employee benefits to 0 decimal places, e.g. 15%. Round final answers to 0 decimal places, e.g. 52.)

Traditional Method		$
Activity-based Costing		$

Answer 1

Spirits
Answer a
Traditional costing	Amount $	Note
Direct Materials	14,100.00
Direct Labor	12,000.00	A
Overhead cost	14,400.00	B=A*120%
Cost of installation	40,500.00
Calculation of ABC rates		C	D	E=C/D
Activity cost pool	Cost Driver	Cost	Estimated Use	ABC rates
Supervision, security, maintenance	Number of workdays	503,200.00	1,700.00	296.00
Liability insurance	Number of employees	94,400.00	800.00	118.00
Equipment costs	Hours of operation	78,660.00	11,400.00	6.90
Indirect supplies and delivery	Length in meters	234,000.00	234,000.00	1.00
Employee benefits	Direct labor cost	136,000.00	544,000.00	25.00%
Total Costs		1,046,260.00
Overhead allocation		See E	F	G=E*F
Activity cost pool	Cost Driver	ABC Rates	Activity used	Cost assigned
Supervision, security, maintenance	Number of workdays	296.00	28.00	8,288.00
Liability insurance	Number of employees	118.00	4.00	472.00
Equipment costs	Hours of operation	6.90	260.00	1,794.00
Indirect supplies and delivery	Length in meters	1.00	3,100.00	3,100.00
Employee benefits	Direct labor cost	25.00%	12,000.00	3,000.00
Total Cost assigned				16,654.00
ABC costing	Amount $
Direct Materials	14,100.00
Direct Labor	12,000.00
Overhead cost	16,654.00
Cost of installation	42,754.00