# LO 6.3How are costs allocated in an ABC system?

Step 1: Identify the activities that generate costs

Step 2: Now we will find cost pools and their relevant cost drivers

Step 3: Assign the cost of each activity (cost pool) on a fair basis which is cost drivers

cost assigned to total products of A = (cost pool/total units of relevant cost driver consumed) *units of cost driver consumed by total # of Products A

Step 4:  Divide the Answer from the step 3 by total units of product A produced to calculate unit cost

Step 5: Add prime cost per unit to it to calculate total unit cost of the product A

Explanation:

The costs in the ABC system are allocated to unit product on more fair basis than the tradition absorption costing which only assume one fair basis for allocation of overhead costs. ABC critisises traditional costing technique for using only one basis for absortion of Overheads.

Suppose both Mr. A and Mr. B drank 5 glasses of juices. Each glass of juice costs \$4. According to the Traditional absorption costing technique each individual must pay:

(5 Juices/2)*\$4=\$10

But ABC says its unfair, use a more appropriate basis for cost allocation. So upon investigating we came to know that Mr. A drank 3 glasses of juice and Mr. B drank 2 glasses of juice. So Mr. A must pay \$12(3*\$4) and Mr. B must pay \$8(2*\$4). This is more appropriate or fair basis of absorbing the overhead cost to each individual and is Activity Based Costing.

## Related Questions

Suppose the price level reflects the number of dollars needed to buy a basket of goods containing one can of soda, one bag of chips, and one comic book. In year one, the basket costs \$9.00. In year two, the price of the same basket is \$8.00. From year one to year two, there is at an annual rate of . In year one, \$72.00 will buy baskets, and in year two, \$72.00 will buy baskets. This example illustrates that, as the price level falls, the value of money . rises,falls,remains the same

From Year 1 to Year 2 : There is annual deflation 11.11%

As price falls, value of money rises

Explanation:

Given : Commodity Basket Cost = \$9 in Year 1 ; Commodity Basket Cost = \$8 in Year 2

From Year 1 to Year 2 : There has been fall in price level. Proportionate (%) Fall in price level = Change in Price / Old Price x 100

So, Fall in price level = [ ( 9 - 8 ) / 9] x 100 = 1/9 x 100 = 11.11%

Hence, from year 1 to year 2 : there has been 11% fall in price i.e Deflation

Considering Income = \$72  :

• Year 1 : It can purchase 72 / 9 = 8 commodity baskets
• Year 2 : It can purchase 72 / 8 = 9 commodity baskets

So, it illustrates that : As price falls, the purchasing power of money (value of money) rises.

Parrish Plumbing provides plumbing services to residential customers from Monday through Friday. Ken Parrish, the owner, believes that it is important for his imployees to have Saturday and Sunday off to spend with their families. However, he also recognizes that this policy has implications for profitability, and he is considering staying open on Saturday. Ken estimates that if his company stays open on Saturday, it can generate \$2500 of daily revenue each day for 52 days per year. The incremental daily costs will be \$700 for labor, \$500 for parts, \$100 for transportation, and \$200 for office staff. These costs do not include a share of monthly rent or a share of depreciation related office equipment.

Ken is determined not to have employees work on Sunday, but he would like to know the opportunity cost of not working on Saturday. Provide Ken with an estimate of the opportunity cost, and explain why you do not have to consider rent or depreciation of office equipment in your estimate.

Parrish Plumbing

1. Opportunity cost of not working on Saturday:

= \$52,000 per year.

2. Parrish's monthly rent or depreciation related to office equipment are not considered because they are not incremental costs.  Non-incremental costs do not make any difference to the decision to work on Saturday or not.  Therefore, the costs are regarded as sunk, because they must be incurred no matter the decision.  They are therefore irrelevant and non-variable in nature.

Explanation:

Daily revenue =     \$2,500

less relevant or incremental expenses:

Labor        \$700

Parts           500

Transport    100

Office staff 200     (1,500)

Incremental profit \$1,000 per week

Annual incremental profit = \$52,000 (52 * \$1,000) or opportunity cost

The opportunity cost of not working on Saturday for Parrish Plumbing is \$52,000, which is the foregone profit. This is calculated by subtracting operation costs from potential revenue. Sunk costs like rent or depreciation are not considered as they don’t affect incremental costs.

### Explanation:

To calculate the opportunity cost of not working on Saturday for Parrish Plumbing, we need to subtract the total costs associated with working on Saturday from the total revenue that could be generated if work was done on that day. Ken is projecting a daily revenue of \$2500 for each Saturday they would be opened for 52 Saturdays in a year, giving a total annual revenue of \$130,000 (\$2500 * 52).

The costs for staying open on Saturday include \$700 for labor, \$500 for parts, \$100 for transportation, and \$200 for office staff which totals to \$1500. Therefore, the net profit for working on a Saturday would be the revenue (\$2500) subtracted by the costs (\$1500), which gives us \$1000. Over 52 Saturdays in a year, this amounts to \$52,000 (\$1000 * 52). The \$52,000 is the opportunity cost of not working on Saturday. This represents the amount of profit Ken is foregoing to give his employees the day off.

Regarding why we don’t need to consider rent or depreciation of office equipment, those are considered sunk costs. Sunk costs are expenses that have already been incurred and cannot be recovered. These costs do not change regardless of business operations, hence, they are not relevant when considering incremental costs for extra operation days.

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On January 1, Year 1, Chaco Company sold \$300,000 of 10% twenty-year bonds. Interest is payable semiannually on June 30 and December 31. The bonds were issued for \$359,378, priced to yield 8%. What is the amount of effective interest expense that Chaco will record for the six months ended June 30, Year 1

The amount of effective interest expense that chaco will record in the first six months is \$14,375

Explanation:

interest payment that will be first made is on June 30, Year 1. Therefore, the outstanding balance used in the calculation is the issue price.

The interest expense is calculated by these formula

Interest expense = Effective semiannual interest rate × Outstanding balance

Interest expense = (8% ÷ 2) × \$359,378 = \$14,375

So the interest expense is gotten as %14,375

The Chaco Company will record an effective interest expense of \$14,375.12 for the six months ended June 30, Year 1.

### Explanation:

The effective interest method is a technique used for discounting bonds. This method is used to calculate the amount of interest expense for a specific time period. In this case, we are finding the effective interest for the six months ended June 30, Year 1 on a bond issued by the Chaco Company.

The formula for the effective interest method is: Book value of the bond at the beginning of the period X Yield rate/Number of periods per year.

The book value of the bond at the beginning of the time period (January 1, Year 1) was \$359,378. The yield was 8% and there are two periods in the year because the interest is paid semiannually.

So, the effective interest for the six months ended June 30, Year 1 = \$359,378 * 8%/2 = \$14,375.12.

Therefore, the amount of effective interest expense that Chaco will record for the six months ended June 30, Year 1 is \$14,375.12.

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The owner of an Italian restaurant has just been notified by her landlord that the monthly lease on the building in which the restaurant operates will increase by 20% at the beginning of the year. Her current prices are competitive with nearby restaurants of similar quality. However, she is now considering raising her prices by 20 percent to offset the increase in her monthly rent. Would you recommend that she raise prices?

No

Explanation:

In a competitive market, price should be a function of variable/marginal costs not fixed costs.

Telfer, Inc. reported net income of \$2.3 million in 2020. Depreciation for the year was \$157,100, accounts receivable decreased \$329,900, and accounts payable decreased \$302,000. Compute net cash provided by operating activities using the indirect method.

\$2,479,600

Explanation:

The computation of the operating activities via indirect method is shown below:

Cash flow from operating activities

Net income = \$2,300,000

Add : Depreciation for the year \$157,100

Add: Decrease in account receivable \$329,900

Less: Decrease in account payable -\$302,000

Net cash flow provided by operating activities \$2,479,600

Megan and Susan are roommates. They spend most of their time studying (of course), but they leave some time for their favorite activities: making pizza and brewing root beer. Megan takes 3 hours to brew a gallon of root beer and 2 hours to make a pizza. Susan takes 7 hours to brew a gallon of root beer and 5 hours to make a pizza.Megan's opportunity cost of making a pizza is ?
a. 2/3 gallon
b. 5/7 gallon
c. 1 1/2 gallons
d. 1 2/5 gallons
of root beer, and Susan's opportunity cost of making a pizza is ?
a. 2/3 gallon
b. 5/7 gallon
c. 1 1/2 gallons
d. 1 2/5 gallons
of root beer.
Who has an absolute advantage in making pizza, and who has a comparative advantage in making pizza?

1. a. 2/3 gallon
2. b. 5/7 gallon

Explanation:

1. Megan takes 3 hours to brew a gallon of root beer and 2 hours to make a pizza.

If she makes a pizza therefore, that is 2 hours that could have been used to make a gallon of root beer. However, it takes 3 hours to make a complete gallon so in those 2 hours only;

= 2/3 gallons would have been made

2. Susan takes 7 hours to brew a gallon of root beer and 5 hours to make a pizza.

Like Megan above, the 5 hours that would be used for Pizza would have gone towards making a gallon of beer. If it takes 7 hours to make a gallon then those 5 hours would have made;

= 5/7 gallons of root beer.