By Dennis Caplan, University at Albany (State University of New York)



CHAPTER 11:  Activity-Based Costing


Exercises and Problems


Discussion Question 11-1: Colorado Airlines is operating at capacity on its Denver to New York route, offering three flights each day on this route, using Boeing 737’s, each with a capacity of 120 passengers. Airline management wants to determine the least expensive way to increase daily capacity from 360 passengers to 480 passengers. One possibility is to add one more Boeing 737 per day. The other possibility is to replace the current equipment with Boeing 727’s, which hold 160 passengers each. In either case, management believes the planes will continue to operate at capacity. 


To ascertain the least expensive way to increase passenger capacity on the Denver-to-New York route, management has asked you to determine what “drives” the airline’s operating costs.



Consider the following cost drivers:


a)                  Number of flights per day

b)                  Number of miles flown per day

c)                  Number of passengers served per day

d)                 Number of passenger miles (miles flown per day multiplied by number of passengers)


For each of the following costs, identify the most appropriate cost driver from the above list.


1.                  Passenger meals

2.                  Airplane fuel

3.                  Ground personnel who refuel the plane, and mechanics on the ground

4.                  Ground personnel who serve passengers at the ticket counter and at the gate.

5.                  Cockpit crew salaries (Federal Aviation Administration regulations limit pilots to fly no more than a certain number of hours per month).

6.                  Flight attendant salaries (assume that Federal Aviation Administration regulations limit flight attendants to fly no more than a certain number of hours per month, and require one flight attendant for every 40 passengers).

7.                  Economic depreciation of the airplane (i.e., without regard to the depreciation method chosen for accounting purposes, choose the cost driver that best captures the wear and tear on the equipment, and determines the economic life of the plane).

8.                  Personnel who handle baggage



11-2: You are the Chief Financial Officer of a large New York hospital that has decided to implement activity-based costing. Which of the following would you choose as the allocation base for allocating the costs of the Linen and Laundry Department to the four patient wards that utilize linen and laundry services, if your objective is to generate the most accurate cost information possible? The four wards are: (1) surgery, (2) adolescent care, (3) maternity and nursery, and (4) pediatric care.


(A)       Patient occupancy rates (i.e., patient days) in each ward.


(B)       The number of washing machines in the Laundry and Linen Department


(C)       The number of Medicare patients in each ward.


(D)       The number of patient admissions to each ward.



11-3: In which of the following situations are the techniques of activity-based costing most likely to lead to improved production or marketing decisions.


(I)        The All-Direct Company, which incurs significant direct costs, but no overhead costs, to manufacture its extensive and ever-changing product line.


(II)       The One-Size-Fits-All Hat Company, which makes a single product that is sold to many different kinds of retailers, in varying volumes, through various marketing channels, in many different geographic regions.


(III)     The Iowa Wind Turbine Electric Cooperative, which has direct costs and fixed overhead, but no variable overhead.


(A)       (I) and (II), but not (III)        


(B)       (I) and (III), but not (II)


(C)       (I) only


(D)       (II) only



11-4: For a generic manufacturing facility (i.e., without being told what the factory makes):


A)        Give two examples of overhead expenses for which direct labor hours is a more appropriate allocation base than machine time.


B)        Give two examples of overhead expenses for which machine time is a more appropriate allocation base than direct labor hours.



11-5: The Silver City Mining Company mines copper and aluminum in Southwestern New Mexico. Traditionally, overhead costs were allocated to the two metals based on direct labor hours. Using this method in 2005, overhead costs per ton are $50 for aluminum and $60 for copper.


The company switched to activity-based costing, using multiple cost pools, and allocating each cost pool using an allocation base that more accurately captures the cause and effect relationship between the mining operations and overhead costs. Also, several overhead cost categories were reclassified as direct costs. The company had used an Actual Costing system prior to implementing ABC (i.e., overhead rates were calculated at the end of the year, when actual amounts were known), and continued to use Actual Costing after implementation of ABC. To study the effect of the new ABC system, it was retroactively applied to 2005, in order to compare the results to the old method. Which of the following outcomes under the new system suggests that an error was made in the calculation of overhead rates?


(A)       The new overhead rates were $45 per ton of aluminum and $62 per ton of copper.


(B)       The new overhead rates were $45 per ton of aluminum and $58 per ton of copper.


(C)       The new overhead rates were $55 per ton of aluminum and $58 per ton of copper.


(D)       The new overhead rates were $55 per ton of aluminum and $62 per ton of copper.



11-6: The Santa Cruz Candy Company makes five types of candies in its sole factory, including chocolate truffles and chocolate mints. Truffles are hand-dipped, so making truffles is labor-intensive, and furthermore, only the most experienced (and highest paid) employees can make truffles. Production of mints is highly automated: they don’t require much labor, but the machine operators are also highly-skilled and highly-paid. The manager of truffles production (Candy Lowenski) and the manager of mints production (Coco Hernandez) are discussing their preferences for how factory overhead should be allocated to their products. The three choices are direct labor dollars, direct labor hours, and machine hours. Of course, each manager would like to report the highest profits possible from her product line.


Required: In one, two or three (no more than three) complete sentences (each sentence must have a verb and a period, among other grammatical components), predict what position each manager will take with respect to her preferred allocation base, and explain your reasoning. 



11-7: The Braintree Furniture Company manufactures two lines of furniture: an upscale, handcrafted line called Richleau, which is produced in small quantities; and a mass-produced, inexpensive line called Particleboard. Both lines are made in the same factory. Richleau is very labor intensive relative to Particleboard. Braintree just switched from a traditional costing method that allocated overhead based on direct labor hours to an activity-based costing system. Under activity-based costing, the amount of overhead allocated to Richleau will be


(A)       higher than under the traditional costing method.


(B)       lower than under the traditional costing method.


(C)       either higher or lower than under the traditional costing method, depending on the underlying economics of the business.


(D)       lower than under traditional costing, as long as activity-based costing is implemented in a way that provides more accurate cost information.



11-8: The not-for-profit health clinic Shots-Я-Us provides various types of vaccinations and other shots, especially flu shots, to the public for free or for a nominal fee. The clinic is funded by several local governmental agencies as well as by a number of charitable organizations. Since different donors wish to fund different types of shots, the clinic determines the full cost of each type of shot, by adding overhead to the direct costs, and then provides this information to current and prospective donors.


Following are actual and budgeted costs for Shots-Я-Us for 2003:





Number of patient visits

Number of shots administered


Fixed overhead: salaries, rent for the facility, insurance, depreciation.


Variable overhead: nursing staff hoursly wages, utilities, disposable supplies.


Cost of hypodermics (a direct cost)


Cost of medications (a direct cost)


























Which of the following is probably not a significant cost driver for variable overhead, and hence, would probably be a poor choice as the cost allocation base for allocating variable overhead?


(A)       The number of shots administered


(B)       The dollar value of the medication administered


(C)       The number of patient visits


(D)       The amount of nursing staff time spent administering each type of shot



11-9: Pink Ink, Inc. has two products and two overhead cost pools:



Product A

Product B

In Total

Units produced

Direct Costs (per unit):


    Labor (paid $20 per hour)

Materials Handling cost pool

Everything Else cost pool

















A)        Using direct labor hours as the allocation base, what is the overhead rate for Materials Handling overhead?


B)        What is the total cost to make each unit of Product B, if all overhead is allocated based on units produced?


C)        How much Everything Else overhead would be applied to each unit of product A, if this cost pool is allocated to product using direct materials dollars as the allocation base?



11-10: Following is information about Aztech Industries:



Model A

Model B

Model C


Units produced

Direct materials (per unit)

Direct labor (per unit)


Cost driver information:

  number of parts (per unit)

  direct labor hours (per unit)

  square feet (in total for all units)


Overhead costs:

  Labor Support

  Materials Support

  Facility Cost

    Total overhead














































Use activity-based costing to calculate the total cost for each Model C heater. Allocate Labor Support using direct labor hours, Materials Support using number of parts, and Facility Cost using square feet.



11-11: The Crouse Travel Company applies overhead to its international camping tours using activity-based costing. Following is information about the three overhead cost pools:




Total Costs


Allocation Base

Total Quantity of the Allocation Base Incurred







Number of tours

Tourist travel days*

Number of tourists





* For any given tour, the number of tourist travel days is the number of tourists multiplied by the number of days in the tour. For example, 10 tourists on a seven-day tour would constitute 70 tourist travel days.



A)        Calculate the overhead rates.


B)        Five of the 40 tours were 10-day trips to Patagonia. These tours averaged 12 tourists per trip. How much overhead would be applied to these five Patagonia tours?



11-12 (A continuation of 6-15): Sister Rachel recently attended a seminar on activity-based costing held in Las Vegas. The other sisters were somewhat skeptical about Sister Rachel’s attendance at this particular seminar, and she is eager to put to use what she learned there. She suggests that the orphanage implement a refined costing system, and she develops the following information.


Costs vary with the age of the children. The number and ages of children were as follows:









(ages 0 - 5)







(ages 6 – 12)







(ages 13 - 18)














Everyone agrees that 2000 was a very successful year for the Orphanage, so the 2001 budget was based on 2000 actual costs. The following information pertains to 2000:


  -         Food costs per meal were $4 for pre-schoolers, $5 for pre-teens, and $6.50 for teenagers.  3 meals are served per day, 365 days per year.

  -         The cost of clothing is twice as much (per child) for teenagers as for the other two age groups.

  -         Laundry and linen costs per child do not vary with the age of the child.  However, this category also includes the cost of a diaper service.  1/3 of pre-school children are in diapers, and the cost is $15 per week, 52 weeks per year.

  -         Educational costs do not apply to pre-school children.

  -         Only teenagers receive an allowance.  The allowance is $20 per week, 50 weeks per year.


A)        Identify the cost drivers for the following expenses:

            (A)       Diaper service

            (B)       Educational costs

            (C)       Allowances    


B)        Prepare a flexible budget for 2001, making use of the information compiled by Sister Rachel, as well as information about fixed costs from the original 2001 budget.


C)        Should Sister Sarah be satisfied with the orphanage’s financial results and efforts to control costs in 2001?  Briefly explain.



11-13: The 601 Blue Jean Company has decided to allocate the cost of its Warehouse and Distribution Center to its customers using activity-based costing, in order to better assess profitability by customer. The warehouse manager determines that the only costs that are economically feasible to trace directly to the customer are outbound freight costs. The manager then decides that the following overhead cost pools should be allocated to customers using the following cost drivers:


Overhead Cost Pool

Cost Driver (Allocation Base)

Order Processing Department

Order Filling Department

Quality Control Department

Shipping Department

Number of individual orders processed for that customer

Number of line items on all pull-tickets for that customer

Number of cartons shipped to that customer

Number of cartons shipped to that customer


Following are relevant data for each overhead cost pool:


Order Processing Department

Total costs for this department

Total number of orders processed


Order Filling Department

Total costs for this department

Total number of line-items on all pull tickets

Quality Control Department

Total costs for this department

Total number of cartons shipped


Shipping Department

Total costs for this department

Total number of cartons shipped

















Following is information pertaining to two customers:


7-9-11 Stores:

Sales revenue for the year

Number of orders

Number of pull ticket line-items

Number of cartons

Outbound freight costs


Men’s Large and Big Stores:

Sales revenue for the year

Number of orders

Number of pull ticket line-items

Number of cartons

Outbound freight costs
















A)        Compute the overhead rates for each of the four overhead cost pools.


B)        Calculate the amount of overhead that would be applied to 7-9-11 Stores


C)        Calculate the amount of overhead that would be applied to Men’s Large & Big Stores


D)        Explain (in one or two sentences) or show (by calculation) how your answers to Parts (B) and (C) would change if the company combined Quality Control and Shipping into one overhead cost pool, and allocated overhead for this cost pool to customers based on the number of cartons shipped to that customer.




Return to Chapter 11


Go to the Next Chapter


Return to the Table of Contents



Management Accounting Concepts and Techniques; copyright 2006; most recent update: November 2010


For a printer-friendly version, contact Dennis Caplan at