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 $2.70 to determine the bid price. Since our average cost is only $2.40 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	800	thousand square feet
Estimating and job setup	Number of jobs	500	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 500 jobs. Both nonroutine jobs and routine jobs require estimating and setup.

Costs for the Year
Wages and salaries	$	323,000
Disposal fees		759,000
Equipment depreciation		90,000
On-site supplies		56,000
Office expenses		250,000
Licensing and insurance		450,000
Total cost	$	1,928,000

Distribution of Resource Consumption Across Activities
	Removing Asbestos			Estimating and Job Setup			Working on Nonroutine Jobs			Other		Total
Wages and salaries	60	%		10	%		20	%		10	%	100	%
Disposal fees	60	%		0	%		40	%		0	%	100	%
Equipment depreciation	40	%		5	%		20	%		35	%	100	%
On-site supplies	70	%		20	%		10	%		0	%	100	%
Office expenses	15	%		35	%		20	%		30	%	100	%
Licensing and insurance	25	%		0	%		60	%		15	%	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

Solution 1:

First stage allocation of cost to activity cost pools
Particulars	Total Cost	Removing Asbestos		Estimating and Job Setup		Working on non routine job		Others
		%	Amount	%	Amount	%	Amount	%	Amount
Wages & Salaries	$323,000.00	60%	$193,800.00	10%	$32,300.00	20%	$64,600.00	10%	$32,300.00
Disposal Fees	$759,000.00	60%	$455,400.00	0%	$0.00	40%	$303,600.00	0%	$0.00
Equipment depreciation	$90,000.00	40%	$36,000.00	5%	$4,500.00	20%	$18,000.00	35%	$31,500.00
On Site Supplies	$56,000.00	70%	$39,200.00	20%	$11,200.00	10%	$5,600.00	0%	$0.00
Office Expenses	$250,000.00	15%	$37,500.00	35%	$87,500.00	20%	$50,000.00	30%	$75,000.00
Licensing and Insurance	$450,000.00	25%	$112,500.00	0%	$0.00	60%	$270,000.00	15%	$67,500.00
Total	$1,928,000.00		$874,400.00		$135,500.00		$711,800.00		$206,300.00

Solution 2:

Determination of activity rate for each activity
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate
					Removing Asbestos	$874,400.00	Thousand of Square Feet	800	$1,093.00
Estimating and Job Setup	$135,500.00	Number of Jobs	500	$271.00
Working on non routine job	$711,800.00	Number of non routine jobs	100	$7,118.00
Other	$206,300.00	No allocation
Total	$1,928,000.00

Solution 3a:

Total cost of routine 1000 square foot asbestos removal job = Cost of routine removal job + Estimating and job setup

= $1,093*1 + $271*1 = $1,364

Average cost per thousand square feet = $1,364 / 1 = $1,364 per thousand square feet.

Solution 3b:

Total cost of routine 2000 square foot asbestos removal job = Cost of routine removal job + Estimating and job setup

= $1,093*2 + $271*1 = $2,457

Average cost per thousand square feet = $2,457 / 2 = $1,228.50 per thousand square feet.

Solution 3c:

Total cost of non routine 2000 square foot asbestos removal job = Cost of removal job + Estimating and job setup + cost of working on non routine job

= $1,093*2 + $271*1 + $7,118 = $9,575

Average cost per thousand square feet = $9,575 / 2 = $4,787.50 per thousand square feet.