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

Exercise 35

Comparative Income Statements and Management Analysis

Bob's Baskets, Inc., manufactures and sells two types of baskets, deluxe and standard. Last year,

Bob's Baskets had the following costs and revenues:

BOB'S BASKETS, INC. Income Statement
	Deluxe	Standard	Total
Revenue	$216,000	$240,000	$ 456,000
Direct materials	20,000	20,000	40,000
Direct labor	48,000	72,000	120,000
Overhead costs
Administration			30,000
Production setup			60,000
Quality control			30,000
Distribution			24,000
Operating profit			$ 152,000

Bob's Baskets currently uses labor costs to allocate all overhead but is considering implementing an activity-based costing system. After interviewing the sales and production staff, management decides to allocate administrative costs on the basis of direct labor costs but to use the following bases to allocate the remaining overhead:

		Activity Level
Activity	Cost Driver	Deluxe	Standard
Setting up	Number of production runs	20	10
Performing quality control	Number of inspections	60	20
Distribution	Number of units shipped	80,000	120,000

Required

a.Complete the income statement using the preceding activity bases.

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b.Write a report indicating how management might use activity-based costing to reduce costs.

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c.Restate the income statement for Bob's Baskets using direct labor costs as the only overhead allocation base.

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d.Write a report to management stating why product line profits differ using activity-based costing compared to the traditional approach. Indicate whether activity-based costing provides more accurate information and why (if you believe it does provide more accurate information). Indicate in your report how the use of labor-based overhead allocation could cause management at Bob's Baskets to make suboptimal decisions.

Step 1 of 24

Activity-based Costing:

Activity-based Costing which is more popularly known as ABC method is an accounting method in which the firms identify the various activities and then assigns indirect costs incurred to carry out those activities.