Question

Holliston Test Laboratories does heat testing (HT) and stress testing (ST) on materials and operates at capacity. Under its current simple costing system, Holliston aggregates all operating costs of $1,275,000 into a single overhead cost pool. Holliston calculates a rate per test-hour of $15 ($1,275,000 / 85,000 total test-hours). HT uses 60,000 test-hours, and ST uses 25,000 test-hours. Gary Sarsfield, Holliston'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 Holliston to lose business. Sarsfield divides Holliston'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 a. Direct labor Output unit-level b. Equipment-related costs (rent, maintenance, energy, etc.) C. Setup costs Batch-level Service-sustaining d. Costs of designing tests 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 $15 per test-hour that Holliston calculated using its simple costing system. First, determine the formula used to calculate the cost for each activity in each test type. (1) X (2) Cost per activity Calculate the cost of each activity and the total cost of the heat testing and stress testing. Heat Test (HT) Stress Test (ST) Total Total Cost Cost Direct labor Equipment Setup Design Total Determine the formula to calculate the HT cost per test-hour and enter the amounts to calculate the rate. (Round the rate to the nearest cent.) (3) (4) HT Cost per test-hour + per test-hour

Answer 1

1.

	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, $418,000. These costs can be directly traced to HT, $360,000 and ST, $58,000.

b. Equipment related costs (rent, maintenance, energy and so on), $340,000. These costs are allocated to HT and ST on the basis of test-hours.

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

Batch-level costs:

c. Setup costs, $396,00. These costs are allocated to HT and ST on the basis of the number of setup-hours required. HT requires 11,500 setup-hours and ST requirs 5,000 setups-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, $270,000. 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 2,500 hours.

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

2.

	Heat Testing	Stress Testing
	Total (1)	Per hour (2) = (1)/ 60,000	Total (3)	Per hour (4) = (3)/ 25,000
Direct labor costs (given)	360000	6	58000	2.32
Equipment-related costs
$4 per hour * 60,000	240000	4
$4 per hour * 25,000			100000	4
Setup costs
$24 per setup-hour * 11,500 setup hours	276000	4.6
$24 per setup-hour * 5000 setup hours			120000	4.8
Cost of designing tests
$54 per hour * 2500 hours	135000	2.25
$54 per hour * 2500 hours			135000	5.4
Total Costs	1011000	16.85	413000	16.52

Equipment-related costs	340000
Test hours	85000
per hour cost	4

setup cost	396000
setup -hours	16500
Per hour setup cost	24

Cost of designing tests	270000
designing tests hours	5000
per hour designing cost	54

At a cost per test-hour of $15, the simple costing system under costs heat testing ($16.85) and over costs stress testing ($11.12). The reason is that HT uses direct labor, setup and design resources per hour more intensively than ST. Heat tests are complex, tasks long time to setup and more tough to design. The simple costing system assumes that testing costs per hour are the same for HT and ST.

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 tests.

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.