Question

equired information [The following information applies to the questions displayed below.] Miami Valley Architects Inc. provides a wide range of engineering and architectural consulting services through its three branch offices in Columbus, Cincinnati, and Dayton, Ohio. The company allocates resources and bonuses to the three branches based on the net income of the period. The results of the firm’s performance for the most recent year follows ($ in thousands): Columbus Cincinnati Dayton Total Sales $ 1,500 $ 1,419 $ 1,067 $ 3,986 Less: Direct labor 382 317 317 1,016 Direct materials 281 421 185 887 Overhead 710 589 589 1,888 Net income $ 127 $ 92 $ (24 ) $ 195 Miami Valley accumulates overhead items in one overhead pool and allocates it to the branches based on direct labor dollars. For this year, the predetermined overhead rate was $1.859 for every direct labor dollar incurred by an office. The overhead pool includes rent, depreciation, and taxes, regardless of which office incurred the expense. Some branch managers complain that the overhead allocation method forces them to absorb a portion of the overhead incurred by the other offices. Management is concerned with the recent operating results. During a review of overhead expenses, management noticed that many overhead items were clearly not correlated to the movement in direct labor dollars as previously assumed. Management decided that applying overhead based on activity-based costing and direct tracing wherever possible should provide a more accurate picture of the profitability of each branch. An analysis of the overhead revealed that the following dollars for rent, utilities, depreciation, and taxes could be traced directly to the office that incurred the overhead ($ in thousands): Columbus Cincinnati Dayton Total Direct overhead $ 180 $ 270 $ 177 $ 627 Activity pools and their corresponding cost drivers were determined from the accounting records and staff surveys as follows: General administration $ 409,000 Project costing 48,000 Accounts payable/receiving 139,000 Accounts receivable 47,000 Payroll/Mail sort and delivery 30,000 Personnel recruiting 38,000 Employee insurance processing 14,000 Proposals 139,000 Sales meetings/Sales aids 202,000 Shipping 24,000 Ordering 48,000 Duplicating costs 46,000 Blueprinting 77,000 $ 1,261,000 Amount of Cost Driver Use by Location Cost Driver Columbus Cincinnati Dayton Direct labor cost $ 382,413 $ 317,086 $ 317,188 Timesheet entries 6,000 3,800 3,500 Vendor invoices 1,020 850 400 Client invoices 588 444 96 Employees 23 26 18 New hires 8 4 7 Insurance claims filed 230 260 180 Proposals 200 250 60 Contracted sales 1,824,439 1,399,617 571,208 Projects shipped 99 124 30 Purchase orders 135 110 80 Copies duplicated 162,500 146,250 65,000 Blueprints 39,000 31,200 16,000 4. Evaluate the concerns of management regarding the volume-based cost technique currently used

Answer 1

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Solution : o overhead cost Assigned to each branch under ABC: Chincinnati Columbus Total Dayton 1ool- tool. 91494 26 $71. 37.44t. 39-364- tool. 100+ 39.6H 46-10- 4493-1- 52-137. 34-3370 42-11- 34 334 31201 26.124. 1962- 4. r). 26-871- 36-847- 26-877 1001 cost driver Direct labor cost Timesheet Entries Vendor anvoices client invoices Emmployees New hires Insurance claims filed Proposals contracted sale progacted shipped porchase orders copies duplicated Blueprints 38814. 10o tool. 1004. 1004 21-05+ 38-84- 49-02-14 36884. 49-01 37-81-1- 39.134 36-19-1- 39-221- 48.071. 39-134. 4 1 4+ 47.48-1- 45.244 10. 15005 t- 1186-12 24-62-1 17.394 18-56-1 10ot. root. Toot Activity - based overhead Allocation: (in thousands): $ 409 $48 particulars cost driver columbus chintinnat Dayton General Admin Direct labor $153-84 $127.56 $127.60 COM project costing Timestect $21.65 & 1371 $12.63 entries Accounts payable / receivy vendor $62-46 & 50.05 $24.49 Allants recerlle client invoices $2450 $ 12.50 sy parroll froil Employees $10.30 & 1-64 for Sorry detery personnel New hires $16.00 $8.00 14.00 saroiting Employee intrance Insurance + 481 h 18.47 $ 3.76 Processing claims filed proposals 354.51 $ 68.14 & 16-35 $139 $47 $30. $38. $14 $ 139. propalats

particulars Sales meetings I sales and Shipping ordering Doplicating costs Blueprinting Total cost driver Columbus Cincinnati Dayton Total contracted 197010 & 74049 & 30-40 Sales 9202 projected Shipped $9.394 11.769 2-85 124 porthose orders $1994 & 16-25 & 1482 48 Copics duptcoted $ 20.00 $ 18000 98.00 $ 46 Blueprints $34084 $27087 9 14-29 & 77 $529.34 1453041 8278.26 $1261 administration expenses allocated to branches: calculation for general Toral direct labor 317188 dollors = $382413 + 1317086 + 11016687 Allocation direct of laboy general costs. admin For expenses example is based on relative OL t for crom = 1382413 - 37.61-% x f 409 $ 1016687 - 1 153.84 ②. contribution of each branch: (in thousands) Sales particulars Columbus $ Joo less Direct labor $382 Derect Materials $281 Direct overhead $ 180 cancinnati $ 1419 S 315 1420 $ 270 Dayton $ 1067 319- $ 185 Total $3986 I to16 $ 887 S 627 $ 197 a $657 $ yu $ 387 $ 1456. contribution Margin

3 Profitability of each branch. under ABC: (in thoosands) particulars Cincinnobo $ 1419 $ 317 Sales Less: Direa Labor Direct Materials Diret overhead Contribution margin Activity based overhead Columbus & 1.500 382 1241 $ 180 $657 $(529) $128 $ 128 Dayton $t067 317 9185 1 177 § 421 $290 Total $7986 $ to 6 1887 $ 627 $ 1456 S (1961) $195 $49 4388 9 (453) $(42) 9 (298) $ 110 operating income 4 Evaluating Management concerns: Overhead Costs are usually aggregated in pools and allocated to products and other cost objects based on volome measures such as direct labor dollars cors machine hours. The lost object, therefore, supposely Shares proportionally in for its production cor) existence. If however, overhead varies in accordance with variables other than volume, then product costs and othe cost objects will be exroneously determined. As the solution indicates the profitability of the cinennato and Dayton offices is vastly different employing direct tracing as ABC than under the corrent approach. The obvious benefit to the Company is more more easuitable ealor distribution of bonuses and resources to these locations. In addition, existing marketing Strategy may be promoting the wrong location and Strategic planning may be based on Sporious assumptions concerning relative profitability.

service This case also illustrates that ABC is appecable to organisations as well as to manufacturing and that cost objects can consist of projects, locations, costumers etc., as well as products. In essence, the better information we have about the profitability of any cost object, the better chance of sleeping organizations profitable. However, the process of identifying activities and allocating costs from the general ledger to the activities is a difficult time consurning process Extensive interviews with fonctional managers and workers are normally rejoined. This process is time consoming and often costly.