CASE 7-26 Comprehensive Activity-Based Costing 102, 103, Cros Kolbec Community College (KCC) has 4,000 full-time students and offers a variety of neademic programs in three areas: professional studies, arts, and technology. The professional studies programs prepare students for administrative and clerical jobs in a variety of professional settings, including accounting, medicine, and law. The arts program's offerings are wide ranging and include graphic design, digital animation, culinary arts, cosmetology, and music arts. The technology programs are also varied, including information technology, medical laboratory technology, electrical engineering technology, pharmacy technology, and natural resources technology The chief financial officer of KCC. Lynn Jones, has consistently emphasized to other members of the senior management team the importance of understanding the costs of delivering the various academic programs. To that end, the costing system used at KCC tracks the direct costs of each program, which are shown below on an annual basis, along with the number of full-time students: Arts Total Fulltime students Professors' salaries Administrative salaries Supplies Teaching support Facilities Total direct cost Professional Studies 2,000 $1.260,000 105.000 40.000 160,000 275,000 $1,840,000 1.000 $ 650,000 70,000 150.000 100,000 150.000 S1.120,000 Technology 1,000 $ 780,000 70.000 50,000 80,000 175.000 SL.155.000 4,000 $ 2.690,000 245.000 240.000 340,000 600,000 4.115.000 It is very important to understand the overhead costs consumed by each academic program at KCC in determining the full cost of operating the programs. Central administration at KCC allocates financial resources to academic programs based on the estimated full cost per student of delivering the program. The overhead costs at KCC are significant, totalling over 60% of direct costs. Total annual overticad costs at KCC are as follows: Administrative salaries Facility costs Office expenses Total overhead costs Cost $ 900,000 1,300,000 300,000 $2,500,000 Traditionally, KCC has allocated overhead costs to academic programs on the basis of the number of full-time students in each program. This approach was deemed appropriate since Jones reasoned that increasing the number of students at KCC would result in higher overhead costs (e.... more facilities would be needed, more indirect support costs would be incurred, etc.). However, Jones is beginning to question the accuracy of the traditional approach since it results in a similar full cost per student for the arts and technology programs, which she feels doesn't make sense. Based on her knowledge of the programs, Jones feels that the technology program is probably more expensive to deliver than the arts program, but this does not come through in the traditional costing approach Jones recently attended a seminar on management techniques being used by leading educational institutions that, among other topics. covered the basics of the ABC approach. She likes the idea of being able to assign indirect costs to academic programs on the basis of how much of the support activity resources are consumed by each program. If Jones's instincts are correct in that some programs consume more resources of certain activities than others, this could have a significant impact on the overhead costs assigned to each under the ABC approach. Upon returning to KCC, Jones decides to implement ABC. She along with Assistant CFO James West, begins by identifying Page 285 the key activities used to support the teaching programs. Rather than getting too detailed with respect to identifying activities in the initial implementation. Jones decides to keep the process manageable and comes up with six key activities. Next, based on a series of interviews with various KCC employees who work in the departments covered by the identified activities. Jones and West estimate the percentage of the total administrative, facility, and office expense resources consumed by each activity. Again, to keep the process efficient. Jones rounds all percentages to the nearest 5%, figuring that a "close enough" approach will suffice for this initial implementation and recognizing that the estimates are subjective to begin with. The results are shown below: Activity Central administration Information systems technology Student counselling services Human resources Library operations Registrar's office Total Resource Distribution across Activities Administrative Facilities 20% 5% 20% 15% 5% 10% 20% 60% 25% 10% 100% Office 15% 15% 10% 10% 30% 20% 100% 100% Working with key personnel from each of the six activities shown above. Jones and West then identify the activity measure and the quantity of that measure used for each teaching program. Fortunately, KCC implemented an enterprise resource planning system a few years ago, which is already tracking much of the information needed regarding the activity measures and the specific quantities for each academic program: Arts Activity Central administration Information systems technology Student counselling services Human resources Measure Hours spent on program Processing hours Number of students counselled Number of admin. staff and faculty members Professional 6,000 6.000 180 7.000 3.000 115 Technology 7.000 12,000 205 Library operations Registrar's office Number of library circulations Full-time students 21 0.000 2.000 15 3,000 1.000 14 3,000 1.000 b. Using Exhibit 7-8 as a guide, calculate the activity rates for each of the activity cost pools. c Using the activity rates calculated in (b), complete the second-stage allocation of overhead to academic programs. 3. Based on the results of (2), calculate the total cost per student direct costs plus overhead) of operating each academic program. 4. Draft a memo to Jones explaining the key reasons for differences in the total cost per student of operating each academic program that arise between the traditional costing approach and ABC. EXHIBIT 7-7 First-Stage Allocations to Activity Cost Pools Activity Cost Pools Totals Taken from Customer Product Order Customer General Orders Design Size Relations Other Ledger Production Department Indirect factory wages $ 125.000 S230,000 $100,000 $50,000 $25,000 $500,000 Factory equipment depreciation.... 60,000 0 180.000 0 60,000 ,300,000 Factory utilities 10.000 60,000 0 48,000 120,000 Factory building lease 0 0 80,000 80,000 General Administrative Department: Administrative wages and salaries.... 60,000 40,000 120,000 160.000 400,000 Office equipment depreciation...... 15.000 12.500 22.500 50.000 Administrative building lease 0 0 60.000 60,000 Marketing Department: Marketing wages and salarios 55,000 20,000 150.000 25,000 250,000 Selling expenses. 5,000 35.000 10,000 50,000 Total... $320,000 $ 252.000 $380,200 $367.500 $490.00 $1,810,000 0 0 0 Exhibit 7-6 shows that Customch Orders consume 25% of the resources represented by the S500.000 or indirect factory wages: 254 x 5500.000 = $125.000 Other entries in the spreadsheet are computed in a similar fashion, Total Activity 1,000 orders EXHIBIT 7-8 Computation of Activity Rates (a) Activity Cost Pools Total Cost Customer orders $320,000 Product design $252.000 Order size $380.000 Customer relations $367.500 Other $490,500 *From Exhibit 7-7 400 designs 20,000 MHS 250 customers Not applicable (a) = (b) Activity Rate $320 per order $630 per design $19 per MH $1,470 per customer Not applicable