Question

Problem 4: Explanation of ABC Costing The United Center is home to both the Chicago Blackhawks and the Chicago Bulls addition to hosting other special events (circus, Disney On Ice, etc). They are trying determine the profitability of each type of activity (Bulls, Blackhawks, and Special Events). They have identified the following costs and want to use ABC to allocate these costs: Interest on Mortgage / Real Estate Taxes Salaries of Maintenance Personnel Set-Up Costs for Events (games and special events) Ticket Reservations / Ticket Sales $15,000,000 750,000 400,000 1,200,000 Here is other data related to the allocation of the indirect costs. Bulls Total Dates 45 Total Tickets Sold 900,000 Total Set-Up Hours 3.000 Total Clean-Up 1,200 Hours Average Ticket $90 Price Blackhawks 45 800,000 6,000 1,800 Special Events 30 450,000 7,500 1,000 $110 $60 Write a memo to Mary Reinsdorf-Wirtz, CEO of the United Center. In the memo explain to her the concept of ABC and how the above costs should be allocated. Also, attach a partial income statement showing revenues, the indirect costs (all four) and net income for each type of event and the total. You will have to decide how to allocate the indirect costs however use ABC and show the allocation for all four indirect costs. The memo should be professionally typed and reviewed for errors.

Answer 1

ABC (Activity based costing) is method of costing in which the indirect costs are allocated to products or departments by objectifying the activities during the production process. In simple terms the production process is divided into several activities (e.g. set up hours) and the related cost (e.g setup costs) is allocated to products based on such activity (e.g. number of set up hours). This system is much used in profitability analysis and target costing.

Assignment of cost driver to each cost pool
Activity	Cost driver	Estimated cost	Exepected activity			Total activity
			Bulls	Blackhawks	Special Events
Interest on Mortgage/ Real estate taxes	Dates	$             15,000,000	45	45	30	120
Salaries of Maintenance personnel	Clean-Up hours	$                    750,000	1,200	1,800	1,000	4,000
Set-up costs for Events (games and special events)	Set-Up hours	$                    400,000	3,000	6,000	7,500	16,500
Ticket reservation/ Ticket sales	Tickets Sold	$                1,200,000	900,000	800,000	450,000	2,150,000
Total overhead cost		$          17,350,000

Calculation of cost per activity
Activity	Total cost	Total activity	Activity rate
Interest on Mortgage/ Real estate taxes	$             15,000,000	120	125,000
Salaries of Maintenance personnel	$                    750,000	4,000	188
Set-up costs for Events (games and special events)	$                    400,000	16,500	24
Ticket reservation/ Ticket sales	$                1,200,000	2,150,000	0.56
Total	$          17,350,000

Allocation of overheads as per activity based costing
Activity	Cost per activity	Bulls		Blackhawks		Special Events		Total cost
		Activity	Cost	Activity	Cost	Activity	Cost
Interest on Mortgage/ Real estate taxes	$             125,000.00	45	$                5,625,000	45	$         5,625,000	30	$ 3,750,000	$   15,000,000
Salaries of Maintenance personnel	$                      187.50	1,200	$                    225,000	1,800	$             337,500	1,000	$      187,500	$         750,000
Set-up costs for Events (games and special events)	$                         24.24	3,000	$                      72,727	6,000	$             145,455	7,500	$      181,818	$         400,000
Ticket reservation/ Ticket sales	$                            0.56	900,000	$                    502,326	800,000	$             446,512	450,000	$      251,163	$     1,200,000
Total overhead cost			$                6,425,053		$         6,554,466		$ 4,370,481	$   17,350,000

Net income	Bulls	Blackhawks	Special events	Total
No of tickets sold	900,000	800,000	450,000	2,150,000
Avg ticket price	$                         90.00	$                      110.00	$                         60.00
Total revenue	$       81,000,000.00	$       88,000,000.00	$       27,000,000.00	$       196,000,000.00
Indirect costs	$       (6,425,052.85)	$       (6,554,466.17)	$       (4,370,480.97)	$       (17,350,000.00)
Net income (Revenue - Indirect costs)	$   74,574,947.15	$   81,445,533.83	$   22,629,519.03	$   178,650,000.00