SHORT CASE STUDY

Green Test Laboratory (GTL) performs heat testing and stress testing on materials and operates at full capacity. Under its current simple costing system, GTL aggregates all operating costs of $2,404,000 into a single cost pool. GTL calculates a rate per test-hour of $18.78, ($2,404,000/128,000 total tests-hours). Heat testing uses 80,000 test-hours and stress testing uses 48,000 test-hours. Lee Chang, GTLs management accountant, believes that there is enough variation in test procedures and cost structures to establish separate costing and billing rates for heat testing and stress testing. The market for test services is becoming increasingly competitive. Without this information, any incorrect costing and pricing of its services could cause GTL to lose business. Lee divides GTLs costs into four activity cost categories as follows:

1) Direct labour costs, $450,000. These costs can be directly traced to heat testing, $350,000, and to stress testing, $100,000.

2) Equipment related costs (e.g. rent, maintenance, energy), $750,000. These costs are allocated to heat and stress testing on the basis of test hours.

3) Set up costs, $700,000. These costs are allocated to heat and stress testing on the basis of the number of set up hours required. Heat testing requires 13,500 set up hours and stress testing requires 4,000 set up hours.

4) Costs of designing tests, $504,000. These costs are allocated to heat and stress testing on the basis of the time required to design the tests. Heat testing requires 4,200 design hours, and stress testing requires 2,100 design hours.

REQUIRED:

a) Classify each activity cost as either: output unit level cost, batch level cost, product or service sustaining cost, or organisation sustaining cost. Justify the classification of each activity cost.

b) Calculate the cost per test hour for heat testing and for stress testing.

c) Explain how GTLs management could use the cost hierarchy and Activity Based Costing (ABC) information to manage its business better.

dIf you increase the number of indirect-cost pools in the companys costing system, you will definitely increase the accuracy of the costs of outputs. Do you agree or disagree? Explain your answer in two points.