Question

Green Test Laboratory (GTL) performs heat testing and stress testing on materials and operates at full capacity. Under its current simple costing system, GTL aggregates all operating costs of $2,404,000 into a single cost pool. GTL calculates a rate per test-hour of $18.78, ($2,404,000/128,000 total tests-hours). Heat testing uses 80,000 test-hours and stress testing uses 48,000 test-hours. Lee Chang, GTL’s management accountant, believes that there is enough variation in test procedures and cost structures to establish separate costing and billing rates for heat testing and stress testing. The market for test services is becoming increasingly competitive. Without this information, any incorrect costing and pricing of its services could cause GTL to lose business. Lee divides GTL’s costs into four activity cost categories as follows:

1. Direct labour costs, $450,000. These costs can be directly traced to heat testing, $350,000, and to stress testing, $100,000.
2. Equipment related costs (e.g. rent, maintenance, energy), $750,000. These costs are allocated to heat and stress testing on the basis of test hours.
3. Set up costs, $700,000. These costs are allocated to heat and stress testing on the basis of the number of set up hours required. Heat testing requires 13,500 set up hours and stress testing requires 4,000 set up hours.
4. Costs of designing tests, $504,000. These costs are allocated to heat and stress testing on the basis of the time required to design the tests. Heat testing requires 4,200 design hours, and stress testing requires 2,100 design hours.

a) ’If you increase the number of indirect-cost pools in the company’s costing system, you will definitely increase the accuracy of the costs of outputs.’ Do you agree or disagree? Explain your answer in two points.

Answer 1

a) Agree with the statement

· The indirect cost pools should be increased based on value adding activities consumed by the product. The non-value adding activities adding costs to the product should be eliminated as part of cost control and cost reduction.

· The indirect cost pools should be increased based on cost benefit analysis. It should be done only if there benefit in implementation compared to the cost incurred in studying activities and converting them to cost pool for ABC method.