Question

Ayer Test Laboratories does heat testing (HT) and stress testing (ST) on materials and operates at capacity. Under its current simple costing system, Ayer aggregates all operating costs of $1,360,000 i 55,000 test-hours, and ST uses 30,000 test-hours. Gary Celeste, Ayer's controller, believes that there is enough variation in test procedures and cost structures to establish separate costing and billing mispricing of its services could cause Ayer to lose business. Celeste divides Ayer's costs into four activity-cost categories. (Click the icon to view the activity-cost categories.) Dead the c onta

Answer 1

Ayer Test Laboratories Requirement 1 A cost hierarchy categorizes various activity cost pools on the basis of the different types of cost drivers, or cost-allocation bases, or different degrees of difficulty in determining cause-and-effect (or benefits- received) relationships. Activity-based costing (ABC) systems commonly use a cost hierarchy having four levels. Output unit-level costs are related to the number of units. The cost is required for each unit produced. Batch-level costs are related to a group of units of the product. For example, setup costs are done for a group of units. Product-sustaining costs (service-sustaining costs) are costs used to support individual products regardless of the number of units or batches produced. Facility-sustaining costs are costs that can not be traced to individual products but support the company as a whole. ABC refines a costing system by identifying individual activities as the fundamental cost objects. An activity is an event, task, or unit of work with a specified purposeminus-for example, designing products, setting up machines, operating machines, and distributing products. In this example we have identified four activities: direct labor, equipment related costs, setup, and design. Each activity has been assigned a cost and a cost-allocation base. There is a seven-step approach to refining a cost system. 1. Identify the products that are chosen cost objects (HT and ST) 2.Identify the direct costs of the product.(Direct Labor) 3.Select the activities and cost allocations bases to use for allocating indirect costs to products. 4.Identify the indirect costs associated with each cost-allocation base. Requirement 2 Total Activity Cost/Total Allocation Base = Activity rate per allocation base Equipment 340000 / 85000 = per test hour Setup Costs 357000 / 17000 = per setup hour Design costs 283500 / 4500 = per design hour 63 Heat Test Hours allocated to the activity Total Cost Activity Rate X Direct Labor Equipment Setup Design Total 55000 13000 3000 220000 273000 189000 682000 Heat Test Hours allocated to the activity Total Cost Activity Rate X Direct Labor Equipment Setup Design Total 30000 4000 1500 120000 84000 94500 298500 Rate per Test hour (Heat Test) = 682000 / 55000 = 12.4 Rate per Test hour (Stess Test) = 298500 / 30000 = 9.95 per test hour per test hour The simple costing system uses one cost pool and only one allocation base for the overhead costs. The difference between the simple costing system and ABC is: (1) ABC systems trace more costs as direct costs; (2) ABC systems create homogeneous cost pools linked to different activities; and(3) for each activity-cost pool, ABC systems seek a cost-allocation base that has a cause-and-effect relationship with costs in the cost pool. Requirement 3 The above workings give a clear picture which costing system will result in more accurate product costs. More accurate product costs lead to better pricing, product-mix decisions, cost reduction, process improvement, product redesign, planning and managing. By categorizing costs into a cost hierarchy, management is able to more accurately determine the cost drivers of indirect costs.