Question

Problem 7-18 Activity-Based Costing and Bidding on Jobs [LO7-2, LO7-3, LO7-4]

Mercer Asbestos Removal Company removes potentially toxic asbestos insulation and related products from buildings. There has been a long-simmering dispute between the company’s estimator and the work supervisors. The on-site supervisors claim that the estimators do 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 $3.20 to determine the bid price. Since our average cost is only $2.81 per square foot, 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 not routine 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	850	thousand square feet
Estimating and job setup	Number of jobs	400	jobs
Working on nonroutine jobs	Number of nonroutine jobs	100	nonroutine jobs
Other (organization-sustaining costs and idle capacity costs)	None
Note: The 100 nonroutine jobs are included in the total of 400 jobs. Both nonroutine jobs and routine jobs require estimating and setup.

Costs for the Year
Wages and salaries	$	440,000
Disposal fees		824,000
Equipment depreciation		108,000
On-site supplies		64,000
Office expenses		340,000
Licensing and insurance		540,000
Total cost	$	2,316,000

Distribution of Resource Consumption Across Activities
	Removing Asbestos			Estimating and Job Setup			Working on Nonroutine Jobs			Other		Total
Wages and salaries	50	%		10	%		30	%		10	%	100	%
Disposal fees	70	%		0	%		30	%		0	%	100	%
Equipment depreciation	40	%		5	%		20	%		35	%	100	%
On-site supplies	60	%		30	%		10	%		0	%	100	%
Office expenses	15	%		35	%		20	%		30	%	100	%
Licensing and insurance	30	%		0	%		60	%		10	%	100	%

Required:

1. Perform the first-stage allocation of costs to the activity cost pools.

2. Compute the activity rates for the activity cost pools.

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.

a. A routine 1,000-square-foot asbestos removal job.

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

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

Answer 1

Answer 1
The first-stage allocation of costs to the activity cost pools.
	Removing Asbestos	Estimating and Job Setup	Working on Nonroutine Jobs	Other	Total
Wages and salaries	$220,000	$44,000	$132,000	$44,000	$440,000
Disposal fees	$576,800	$0	$247,200	$0	$824,000
Equipment depreciation	$43,200	$5,400	$21,600	$37,800	$108,000
On-site supplies	$38,400	$19,200	$6,400	$0	$64,000
Office expenses	$51,000	$119,000	$68,000	$102,000	$340,000
Licensing and insurance	$162,000	$0	$324,000	$54,000	$540,000
Total Cost	$1,091,400	$187,600	$799,200	$237,800	$2,316,000
Answer 2
Activity rate for Removing Asbestos = Total allocated cost / Total Square feets = $10,91,400 / 850000 = $1.284 per square feet
Activity rate for Estimating and Job setup = Total allocated cost / Total no.of jobs = $187600 / 400 jobs = $469 per job
Activity rate for working on non routine jobs = Total allocated cost / total nn routine jobs = $799200 / 100 jobs = $7992 per non routine job
Answer 3-a
Determination of total cost and average cost per thousand square feet
	Routine 1000 Sq.feet	Routine 2000 Sq.Feet	Non routine 2000 sq.feet
Removing Asbestos	$1,284.00	$2,568.00	$2,568.00
Estimating and Job Setup	$469.00	$469.00	$469.00
Working on Nonroutine Jobs	$0.00	$0.00	$7,992.00
Total Cost	$1,753.00	$3,037.00	$11,029.00
Average cost per 1000 Sq.feet	$1,753.00	$1,518.50	$5,514.50