Question

Hopkinton Test Laboratories does heat testing (HT) and stress testing (ST) on materials and operates at capacity. Under its current simple frosting system. Hopkinton aggregates all operating costs of $1,300,000 into a single overhead cost pool. Hopkinton calculates a rate per two-hour of $13 (1,300,000/100,000 total test hours). HT uses 60,000 test hours, and ST uses 40,000 test hours. Gary O'Laughlin, Hopkinton's controller, believes that there is enough variation in test procedures and cost structures to establish separate costing and billing rates for HT and ST. The market for test services is becoming competitive. Without the information, any mispricing of its services could cause Hopkinton to pose business. O'Laughlin divides Hopkinton into four activity cost categories.

1. Classify each activity cost as output multi-level, batch level, product or service sustaining, or facility sustaining. Explain each answer.
2. Calculate the cost per test hour for HT and ST. Explain briefly the reasons why these numbers differ from the $13 per test hour that Hopkinton calculated using it's simple costing system.
3. Explain the accuracy of the product costs calculated using the simple costing system and the ABC system. How might Hopkinton management use the cost hierarchy and ABC information to better manage its business?

Data Table a. Direct-labor costs, $243,000. These costs can be directly traced to HT, $183,000, and! ST, $60.000 b. Equipment-related costs (rent, maintenance, energy, and so on), $400,000. These costs are allocated to HT and ST on the basis of test-hours. c. Setup costs, $385,000. These costs are allocated to HT and ST on the basis of the number of setup-hours required. HT requires 13,500 setup-hours, and ST requires 4,000 setup-hours. d. Costs of designing tests, $252,000. These costs are allocated to HT and ST on the basis of the time required to design the tests. HT requires 2,800 hours, and ST requires 1,400 hours. Print Done

Answer 1

1.	Output unit-level costs: Direct labor costs: $ 243,000 Equipment related costs: $ 400,000 These costs are incurred for each individual unit tested. Hence, they are output level costs. Batch level costs: Setup costs: $ 385,000 These costs are incurred each time a batch of materials is setup. The number of hours of each test does not affect these costs, only the batches produced do. Hence, they are called batch level costs. Product or service sustaining: Costs of designing tests: $ 252,000 These costs are incurred for designing the two tests. They are independent of the number of units or the batches tested. Hence, they are product or service sustaining costs.
2.	Cost Heating Tests Stress Testing ($) Total cost Per hour Total cost Per hour Direct labor costs 243,000 183,000 3.05 60,000 1.5 Equipment related costs 400,000 240,000 4 160,000 4 Setup costs 385,000 297,000 4.95 88,000 2.2 Cost of designing 252,000 168,000 2.8 84,000 2.1 Total costs 888,000 14.8 392,000 9.8 Note on how the above total costs are calculated: Direct costs are directly traced and given in the question. Equipment related costs are allocated on the basis of number of test hours. The total cost of $400,000 is divided by the total number of test hours (60,000 + 40,000 = 100,000) to get the per hour rate. = 400,000 / 100,000 = $4/hour. The per hour rate is multiplied with the number of hours for each test to get the total cost incurred for each test. HT = 4 x 60,000 = $240,000 ST = 4 x 40,000 = $160,000 Setup costs are allocated on the basis of setup hours. The total cost of $385,000 is divided by the total number of setup hours required (13,500 + 4,000 = 17,500) to arrive at the rate per setup hour. = 385,000 / 17,500 = $22/ setup hour The per hour rate is multiplied with the number of set up hours required for each test to arrive at the total cost incurred for each test. HT = 22 x 13,500 = $297,000 ST = 22 x 4,000 = $88,000 Cost of designing is allocated on the basis of hours required to design. The total cost of $252,000 is divided by the total design hours required (2,800 + 1,400 = 4,200) to get the rate per designing hour. = 252,000 / 4,200 = $60 / design hour The per hour rate is multiplied with the number of design hours required for each test to arrive at the total cost incurred for each test. HT = 60 x 2,800 = $168,000 ST = 60 x 1,400 = $84,000 Note on how the per hour rate for each test (HT and ST) is calculated: Take the amount obtained under total cost (which is calculated above) and divide it with number of test-hours, which is 60,000 for HT and 40,000 for ST. This gives the per test-hour rate for each of cost incurred. For eg: HT incurs a set up cost of $297,000 and it has 60,000 test hours. Hence, the per hour rate has been obtained 297,000 / 60,000 = $4.95 / setup hour. To check the accuracy of per hour calculations, ensure that the total under the column of per hour rate and the total cost for each test divided by the total test hours for the test is the same. for eg: the total per hour cost for HT as per calculations in the table above is 14.8 which is 3.05 + 4 + 4.95 + 2.8. The total cost incurred by HT is $888,000 and the total test hours is 60,000, which gives a per hour rate of 888,000 / 60,000 = 14.8/ hour. Both the per rate calculations tally. The accuracy of per hour rate for ST can be checked similiarily Hopkinton calculated $13 as the test hour rate using simple-costing method. This method overcharges ST by $3.2 (13 - 9.8) and undercharges HT by $1.8 (14.8 - 13). HT uses more design hours and setup hours than ST does, it is more labor intensive and incurs more equipment related costs. HT incurs all costs more intensively ST. Thus, charging costs under simple costing charges more to ST than the actual charge it incurs, and leads to overcharging.
3.	As seen above, HT incurs more costs than ST does. Charging costs under simple costing pushes up the cost of ST and leads to overcharging when it doesn’t actually incur as much. ABC costing on the other hand charges amounts based on the actual usage. It gives a fairer allocation of costs. It is more complex than traditional method of simple costing, but more accurate. It considers the actual hours used by the test for setup, design, labor and equipment related activities and allocates costs based on these cost drivers which are a more accurate basis for allocation than total test hours of each test. Hopkinton can make use of this information to make better pricing decisions. Since Hopkinton works in a competitive market, the pricing decision has a very strong influence on the demand for its products. It can raise the price for HT since it incurs more costs while reducing costs for ST which incurs lower costs. Competitors who use ABC costing will adopt a similar strategy for pricing their products. Thus, if Hopkinton does not adopt an appropriate strategy, it will lose business to competition. ABC information can also help Hopkinton eliminate any activity that does not add value to the product, which helps reduce cost. The system provide more reliable data for management decision making compared to traditional methods.