Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 32

Activity-Based Costing for an Administrative Service

The personnel department at LastCall Enterprises handles many administrative tasks for the two divisions that make up LastCall: LaidBack and StressedOut. LaidBack division manages the company's traditional business line. This business, although lucrative, is currently not growing. StressedOut, on the other hand, is the company's new business, which has experienced double-digit growth for each of the last three years.

The cost allocation system at LastCall allocates all corporate costs to the divisions based on a variety of cost allocation bases. Personnel costs are allocated based on the average number of employees in the two divisions.

There are two basic activities in the personnel department. The first, which is called employee maintenance, manages employee records. Virtually all of this activity occurs when employees are hired or leave the company. The other activity is payroll, which is an ongoing activity and requires the same amount of work for each employee regardless of the employee's salary.

Assorted data for LastCall for the last year follow:

	LaidBack	StressedOut	Total
Number of employees (average)	100	25	125
Employees hired/leaving	5	15	20

The personnel department incurred the following costs during the year:

Employee maintenance	$ 120,000
Payroll	17,500
Total	$ 137,500

Required

a.Under the current allocation system, what are the costs that will be allocated from personnel to LaidBack? To StressedOut?

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b.Suppose the company implements an activity-based cost system for personnel with the two activities, employee maintenance and payroll. Use the number of employees hired/leaving as the cost driver for employee maintenance costs and the average number of employees for payroll costs. What are the costs that will be allocated from personnel to LaidBack? To StressedOut?

Step 1 of 5

Activity based costing:

A two stage product costing method that assigns costs first two activities and then to products based on each product’s use of activities is called Activity Based Costing (ABC). ABC concept determines product costs based on activities consumed by the products.

Establishing ABC on real time basis is little challenging on the ABC concept introduction stage. The reason is that for every cost pools cost driver should be identified. If there is any error in finding cost drivers product costs would be varied. Therefore, identifying cost drivers is very important to allocate overhead rate to products or services.