Question

Activity-Based Life-Cycle Costing

Kagle design engineers are in the process of developing a new “green” product, one that will significantly reduce impact on the environment and yet still provide the desired customer functionality. Currently, two designs are being considered. The manager of Kagle has told the engineers that the cost for the new product cannot exceed $500 per unit (target cost). In the past, the Cost Accounting Department has given estimated costs using a unit-based system. At the request of the Engineering Department, Cost Accounting is providing both unit- and activity-based accounting information (made possible by a recent pilot study producing the activity-based data).

Unit-based system:
Variable conversion activity rate: $100 per direct labor hour
Material usage rate: $10 per part

ABC system:
Labor usage: $20 per direct labor hour
Material usage (direct materials): $25 per part
Machining: $80 per machine hour
Purchasing activity: $170 per purchase order
Setup activity: $3,700 per setup hour
Warranty activity: $600 per returned unit (usually requires extensive rework)
Customer repair cost: $30 per repair hour (average)

Activity and Resource Information (annual estimates)
	Design A		Design B
Units produced	20,000		20,000
Direct material usage	340,000	parts	315,000	parts
Labor usage	50,000	hours	120,000	hours
Machine hours	50,000		60,000
Purchase orders	2,500		2,000
Setup hours	700		350
Returned units	1,300		250
Repair time (customer)	2,100		600

Required:

1. Select the lower-cost design using unit-based costing.
Design A

Are logistical and post-purchase activities considered in this analysis?
No

2. Select the lower-cost design using ABC analysis.
Design B

3. What if the post-purchase cost was an environmental contaminant and amounted to $10 per unit for Design A and $40 per unit for Design B? Compute the Post-purchase cost for each design.

	Post-Purchase Cost
Design A	$
Design B	$

Assume that the environmental cost is borne by society. Now which is the better design?
Design A

Activity-Based Supplier Costing

Ventana Company is a car window repair and replacement company operating in the after-sales market. Ventana’s purchasing manager uses two suppliers (Jones Glass and Claro Glass) for the source of its passenger car windows. Data relating to side windows (Side) and windshields (WS) are given below.

I. Activity costs

Activity
Adverse buying*	720,000
Supplier returns**	82,500

* Extra cost of purchasing from local car dealer because of insufficient delivery of supplier.
** Windows returned because they were not ordered or because they were defective.

II. Supplier Data

	Jones Glass							Claro Glass
	Side			WS				Side			WS
Unit purchase price		$60			$135				$57			$132
Units purchased		15,000			15,000				30,000			30,000
Insufficient units		900			900				3,900			3,900
Returned units		375			375				1,500			1,500

Required:

1. Calculate the activity rates for assigning costs to suppliers.

Adverse buying rate	$	per adverse purchase
Supplier return rate	$	per return

2. Calculate the total unit purchasing cost for each component for each supplier. If required, round your answers to the nearest cent.

	Total unit cost
	Jones Glass	Claro Glass
Side	$	$
WS	$	$

Answer 1

ANSWER:

Activity-Based Life-Cycle Costing:

Requirement 1:

Particulars	Design A	Design B
Material ($10 per part)	340,000 * 10 = $3,400,000	315,000 * 10 = $3,150,000
Variable conversion activity $100 per direct	50,000 * 100 = $5,000,000	120,000 *100 = $12,000,000
Total cost (A)	$8,400,000	$15,150,000
Units produced (B)	20,000	20,000
Cost per unit (A / B)	$420	$757.5

Therfore, the lower cost design using unit based costing is Design A.

Logistical and post purchase activities are are not considered in this analysis.

Requirement 2:

ABC Analysis

Particulars	Design A	Design B
Material ($25 per part)	340,000 * 25 = $8,500,000	315,000 * 25 = $7,875,000
Labour ($20 per hour)	50,000 * 20 = $1,000,000	120,000 * 20 = $2,400,000
Machining ($80 per hour)	50,000 * 80 = $4,000,000	60,000 * 80 = $4,800,000
Purchasing ($170 per purchase)	2,500 * 170 = $425,000	2,000 * 170 = 340,000
Setup ($3,700 per setup hour)	3,700 * 700 = $42,590,000	3,700 * 350 = $1,295,000
Warranty Activity ($600 per returned unit)	1,300 * 600 = $780,000	250 * 600 = 150,000
Customer repair cost ($30 per repair hour)	2,100 * 30 = $63,000	600 * 30 = $18,000
Total cost	$57,358,000	$16,878,000

The lower cost design is Design B.

Requirement 3:

Post purchase cost:

After taking into consideration the Post purchase cost the revised cost is as follows:

Design A =  $10 * 20,000 = $200,000

Design B = $40 * 20,000 = $800,000

Also, there will be no impact on the cost if, the environmental cost is borne by the society.

Thus, Design B is better.

Activity-Based Supplier Costing

Requirement 1:

Total insufficient units = 900 + 900 + 3,900 + 3,900 = 9,600

Total returned units = 375 + 375 + 1,500 + 1,500 = 3,750

Adverse buying rate = Adverse buying cost / Total insufficient units = 720,000 / 9,600 = $75 per adverse purchase

Supplier return rate = Supplier return cost / Total returned units = 82,500 / 3,750 = $22 per return

Requirement 2:

Allocation of activity cost:

Particulars	Jones glass	Claro glass
	Side	WS	Side	WS
Adverse buying cost	(900 * 75) = $67,500	(900 * 75) = $67,500	(3,900 * 75) = $292,500	(3,900 * 75) = $292,500
Supplier returns cost	(375 * 22) = $8,250	(375 * 22) = $8,250	(1,500 * 22) = $33,000	(1,500 * 22) = $33,000
Total activity cost	$75,750	$75,750	$325,500	$325,500
(/) units purchased	15,000	15,000	30,000	30,000
Activity cost per unit	$5.05	$5.05	$10.85	$10.85

Total unit cost: [Unit purchase price + Activity cost per unit]

	Jones Glass	Claro glass
Side	60 + 5.05 = $65.05	57 + 10.85 = $67.85
WS	135 + 5.05 = $140.05	132 + 10.85 = $142.85

Total unit cost