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

Exercise 33

Activity-Based Costing for an Administrative Service

John's Custom Computer Shop (JCCS) assembles computers for both individual and corporate customers. The company is organized into two divisions: Personal and Business. Once a computer is built, it is shipped to the customer. Billing for all customers is handled by the corporate Accounts Receivable department. Accounts Receivable performs two major activities: billing and dispute resolution. Billing refers to preparing and sending the bills as well as processing the payments. Dispute resolution occurs when a customer refuses to pay, usually due to an error in billing.

The costs of the Accounts Receivable department are allocated to the two divisions based on the number of bills prepared. Kyle, the manager of the business division, has complained that the allocated costs from Accounts Receivable are beginning to make the business division look unprofitable and has asked you to recommend some changes to the allocation system. If he agrees with your recommendation, he will pass them on to the Chief Financial Officer.

Data on costs and activities in the Accounts Receivable department follow:

	Personal	Business	Total
Number of bills prepared	600	400	1,000
Number of disputes	60	12	72

The Accounts Receivable department incurred the following costs during the year:

Billing	$ 48,000
Dispute resolution	36,000
Total	$ 84,000

Required

a.Under the current allocation system, what is the cost that will be allocated from Accounts Receivable to Personal? To Business?

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b.Suppose the company implements an activity-based cost system for Accounts Receivable with two activities, billing and dispute resolution. What is the cost that will be allocated from Accounts Receivable to Personal? To Business? Use the number of bills prepared as the cost driver for billing costs and the number of disputes for dispute resolution costs.

Step 1 of 4

a.

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.

Determine the costs that will be allocated from Accounts receivable to personal to business:

Allocation of accounts receivable department’s costs to two basic activities using the number of bills prepared and number of disputes as allocation base is depicted as follows.