Question

Hopkinton Test Laboratories does heat testing (HT) and stress testing (ST) on materials and operates at capacity. Under its current simple costing system, Hopkinton aggregates all operating costs of $1,200,000 into a single overhead cost pool. Hopkinton calculates a rate per test-hour of $16 ($1,200,000 / 75,000 total test-hours). HT uses 50,000 test-hours, and ST uses 25,000 test-hours. Gary Mahoney, 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 this information, any miscosting and mispricing of its services could cause Hopkinton to lose business. Mahoney divides Hopkinton's costs into four activity-cost categories. (Click the icon to view the activity-cost categories.) Read the requirements. Requirement 1. Classify each activity cost as output unit-level, batch-level, product- or service-sustaining, or facility-sustaining. Explain each answer. Cost Item Cost-type Output unit-level Output unit-level a. Direct labor b. Equipment-related costs (rent, maintenance, energy, etc.) c. Setup costs d. Costs of designing tests Batch-level Service-sustaining Output unit-level costs are related to the number of units tested; required for each unit tested. Batch-level costs are related to a group of units of the service. They are not related to the number of units tested. Service-sustaining costs are costs used to support individual services regardless of the number of units or batches tested. Facility-sustaining costs are costs that can not be traced to individual services but support the company as a whole. Requirement 2. Calculate the cost per test-hour for HT and ST. Explain briefly the reasons why these numbers differ from the $16 per test-hour that Hopkinton olnulated reina ito cimnla nnetina cvetom

Answer 1

1. Classify each activity cost as output unit–level, batch-level, product- or service-sustaining, or facility sustaining. Explain each answer.

Answer:

Cost Item	Cost-Type
a. Direct Labor	Output unit-level
b. Equipment-related costs (rent, maintenance, energy, etc)	Output unit-level
c. Setup costs	Batch-level
d. Costs of designing tests	Service-sustaining

Explanation

Output unit-level costs:

a. Direct-labor costs, $225,000. These costs can be directly traced to HT, $175,000, and ST, $50,000.

b. Equipment-related costs (rent, maintenance, energy, and so on), $375,000. These costs are allocated to HT and ST on the basis of test-hours.

These are classified as output unit-level costs because they are incurred on each unit of materials tested, that is, specifically for every hour of testing.

Batch-level costs:

c. Setup costs, $360,000. These costs are allocated to HT and ST on the basis of the number of setup-hours required. HT requires 10,000 setup-hours, and ST requires 5,000 setup-hours.

These are classified as batch-level costs as they are incurred each time a batch of materials is set up for HT or ST, irrespective of the number of hours for which tests are subsequently run.

Service-sustaining costs:

d. Costs of designing tests, $240,000. These costs are allocated to HT and ST on the basis of the time required for designing the tests. HT requires 2,500 hours, and ST requires 1,500 hours.

These are classified as service-sustaining costs, as they are incurred to design the HT and ST tests, irrespecive of number of batches tested or number of hours of test time.

2. Calculate the cost per test-hour for HT and ST. Explain briefly the reasons why these numbers differ from the $16 per test-hour that Hopkinton calculated using its simple costing system.

	Heat Testing		Stress Testing
	Total (1)	Per Hour (2) = (1)/50000	Total (3)	Per Hour (4) = (3)/25000)
Direct labor costs (given)	175,000	3.5	50,000	2
Equipment-related costs
$5 per hour * 50000 hours	250,000	5
$5 per hour * 25000 hours			125,000	5
Setup Costs
$24 per setup-hour * 10000 setup hours	240,000	4.8
$24 per setup-hour * 5000 setup hours			120,000	4.8
Costs of designing tests
$60 per hour * 2500 Hours	150,000	3
$60 per hour * 1500 Hours			90,000	3.6
Total Costs	815,000	16.3	385,000	15.4

Equipment-related costs	375,000
Test Hours	75,000
Per hour cost	5
Setup costs	360,000
setup-hours	15,000
Per hour setup cost	24
Costs of designing tests	240,000
designing tests hours	4,000
Per hour designing cost	60

At a cost per test-hour of $16, the simple costing system under costs heat testing ($16.30) and over costs stress testing ($15.40). The reason is that HT uses direct labor, setup, and design resources per hour more intensively than ST. Heat tests are more complex, takes long time to set up, and more tough to design. The simple costing system assumes that testing costs per hour are the same for HT and ST.

3. Explain the accuracy of the product costs calculated using the simple costing system and the ABC system. How might Hopkinton's management use the cost hierarchy and ABC information to better manage its business.

The ABC system captures the resources needed for HT and ST in the best way as it identifies all the activities undertaken, when performing the test and recognize the levels of cost hierarchy at which costs differ. So, the ABC system produce more correct product costs. Hopinkton's management can use the information from the ABC system to make better pricing and product mix decisions. Like, it might decide to increase the prices charged for the more costly HT and plan to reduce prices on the less costly ST.

Hopinkton can also use ABC information to deduct the costs by cancelling processes and activities that do not add any value, identifying and evaluating new methods to do the testing that will reduce the activities needed to do the tests, reducing the costs of performing various activities, planning and managing activities