Question

Problem 7-18 Activity-Based Costing and Bidding on Jobs [LO7-2, L07-3, L07-4] 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 $2.50 to determine the bid price. Since our average cost is only $2.01 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 Disposal fees Equipment depreciation On-site supplies Office expenses Licensing and insurance Total cost $ 308,000 706,000 90,000 50,000 210,000 410,000 $ 1,774,000 Distribution of Resource Consumption Across Activities Estimating Working on Removing and Job Nonroutine Asbestos Setup Jobs Wages and salaries 60% 10% 20% Disposal fees 70% 30% Equipment depreciation 40% 5% 25% On-site supplies 70% 20% 10% Office expenses 15% 35% 20% Licensing and insurance 25% 0% 50% 0% Other 10% 0% 30% 0% 30% 25% Total 100% 100% 100% 100% 100% 100%

Answer 1

Solution

Mercer Asbestos Removal Company

First-stage allocation of costs to the activity cost pools:

Mercer Asbestos Removal Company
First-stage allocation of costs to the activity cost pools:
	Removing Asbestos	Estimating and Job Setup	Working on non-routine jobs	Other	Total
Wages and Salaries	$184,800	$30,800	$61,600	$30,800	$308,000
Disposal Fees	$494,200	$0	$211,800	$0	$706,000
Equipment Depreciation	$36,000	$4,500	$22,500	$27,000	$90,000
On-site Supplies	$35,000	$10,000	$5,000	$0	$50,000
Office Expenses	$31,500	$73,500	$42,000	$63,000	$210,000
Licensing and Insurance	$102,500	$0	$205,000	$102,500	$410,000
Total Cost	$884,000	$118,800	$547,900	$223,300	$1,774,000

Note: the allocation of overhead costs is done based on percentage consumption across activities.

Computation of activity rates for the activity cost pool:

	Activity Cost	Activity Cost Pool	Activity rate
Removing Asbestos	$884,000	850,000 square feet	$1.04 per square feet
Estimating and job setup	$118,800	400 jobs	$297 per job
Working on non-routine jobs	$547,900	100 non-routine jobs	$5,479 non-routine jobs

	Routine 1,000 sq. ft. job	Routine 2,000 sq. ft. job	Nonroutine 2,000 sq. ft. job
Total cost of the job	$1,337	$2,377	$7,856
Average cost per thousand square feet	$1,337	$1,188.50	$3,928

Computations:

Total cost of routine 1,000 sq. ft. job = total cost/number thousand square feet

Total cost = cost of removing asbestos + cost of estimating and job setup

= ($1.04) x 1,000 + $297 = $1,337

Average cost = total cost/number of thousand square feet

= $1,337/1 = $1,337

Total cost of routine 2,000 square feet asbestos removal job:

(1.04 x 2,000) + 297 = $2,377

Average cost = $2,377/2 = $1,188.50

Total cost of non-routine 2,000 square feet asbestos removal job:

Total cost = cost of removing asbestos + cost of estimating and job setup + cost of working on non-routine jobs

= ($1.04 x 2,000) + 297 + 5,479 = $7,856

Average cost = 7,856/2 = $3,928