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JEA Laboratory.


The primary subject matter of this case concerns cost/managerial accounting--more specifically, activity-based costing. Secondary issues examined include analyses of marketing and operations. The case has a difficulty level appropriate for junior level courses. The case is designed to be taught in one class hour and is expected to require three hours of outside preparation by students.


This case involves designing an activity-based costing system for a service-oriented organization--a testing laboratory. Because of this service setting, the case complements activity-based costing material in cost/managerial accounting textbooks, virtually all of which focus heavily on manufacturing settings. The objective of the case is to enable students to understand the issues and procedures for designing a two-stage activity-based costing system as well as how to use the resulting cost information. The case also entails an analysis of marketing and operations based on this costing system.


Recommendations for Teaching Approaches

This case involves designing and analyzing an activity-based costing system for a laboratory. The objective of the case is to enable students to understand the issues and procedures for designing a two-stage activity-based costing system. Students are also asked to analyze marketing and operations issues based on this costing system.

Students should have an elementary knowledge of activity-based costing as a background for this case. The case is a blend of computations and analysis. Question 2 requires some analysis, but is largely computational. Students should be encouraged (or required) to use spreadsheet software for this question. Instructors should make sure to allow sufficient time (15 minutes) for discussion of questions 3 and 4, which deal with analyses based on the activity-based costing system implemented.

The case begins by describing the formation of the company called JEA Laboratory, as well as its management and strategy. Next, the case discusses the implementation of a new service (i.e., test) and then the duties performed by various personnel. The case concludes with a questioning tone about the profitability of the new service and suggests that the costing method used may not be proper.

Students are provided with costs in a typical account format (e.g., salaries, utilities, etc.) and with cost driver information. They need to select the appropriate cost drivers and use them to first assign costs to three different activities. Also, they will need to figure out that some costs are directly assigned to the activities. Then, the students will assign one of the activity's costs to two testing activities. Finally, the costs of the activities, as well as materials costs, are assigned to the two types of tests performed by the company. Based on this cost-assignment exercise, students should be able to offer suggestions on how the costing can be improved. Furthermore, based on the results of their cost assignments, students should be able to offer suggestions relating to marketing and operations issues.


1. Discuss the validity of the $2.13 labor and overhead cost assignment shown in Table 5.

This cost assignment, which is based on the total number of items tested, presumes that each of the two types of items require the same time, effort, and resources. This is clearly not true, as evidenced by large differences in activities such as setup and marketing.

2. Determine the total cost for each test using the activity-based costing approach suggested by the consultant. What modifications might you recommend to this approach?

Before assigning costs to the two types of tests, we use two preliminary stages to assign costs to activities.

 Operations &
Resources Driver Used Total Cost Maintenance

Salaries-Operations direct $696,500 $696,500
Salaries-Maintenance direct $59,600 $59,600
Salaries-Acctg. & Fin. direct $141,000
Salaries-Marketing direct $115,000
Depreciation-Building square feet $66,000 $63,682
Depreciation-Operations direct $31,000 $31,000
Utilities usage $19,900 $16,318
Travel direct $18,700
TOTAL assignment $1,147,700 $867,100

Resources & Finance Marketing

Salaries-Acctg. & Fin. $141,000
Salaries-Marketing $115,000
Depreciation-Building $00,795 $1,522
Utilities $01,393 $2,189
Travel $18,700
TOTAL $143,188 $137,411

Before assigning the Operations and Maintenance costs to the two activities within this cost pool, we need to compute the hours related to these activities, as follows:
Total available hours 8,000
Testing-Setup hrs. 579 (15/60 x 2,315)
Testing-Processing hrs. 7,421 (8,000 - 579)

Now, these hours are used as the cost driver to assign costs to the two activities, as follows:

 Driver Used Total Cost
Operations & testing & setup hrs. $867,100

Operations & Testing--Processing Testing--Setup
 Maintenance $804,371 $62,729

Next, we assign all costs, including materials, to the two tests:

Activity Driver Used Total Cost

Accounting & Finance no. of jobs $143,188
Marketing percent of effort $137,411
Testing-Processing no. of items tested $804,371
Testing-Setup no. of setups $62,729
Materials-Integ. Circuits direct assignment $83,750
Materials-Transformers direct assignment $92,250
Activity Circuits Transformers

Accounting & Finance $26,358 116,830
Marketing $34,353 103,059
Testing-Processing $499,008 305,363
Testing-Setup $11,516 51,213
Materials-Integ. Circuits $83,750
Materials-Transformers $92,250
TOTAL $654,985 668,715

Possible modifications of the ABC analysis:

* Attempt to directly trace the salaries in Operations to the two types of tests. Some of the testers may do testing for integrated circuits only or transformers only; for those that perform both types of tests, time sheets can be kept.

* Track the hours consumed by each type of test so that for Testing-Processing we could replace the cost driver "no. of items tested" with "number of processing hours".

Alternatively, we can weight the number of items by prices, presuming that prices are correlated with processing times.

* Perhaps, also, setup hours can be tracked for each type of test so that it could be used to assign Testing-Setup costs instead of "number of setups", since the setup times may differ between the two types of tests.

3. Should JEA Laboratory revise its marketing approach, as suggested by Amy Devorak? Why or why not?

With the ABC analysis, the profit margins are now:
 Integrated Circuits Transformers

Revenue per Test $2.90 $3.70
Total Cost per Test $1.96 $3.26
Profit per Test $0.94 $0.44

The complexity and the effort associated with testing transformers is reflected in the ABC costing approach, yielding a much higher cost for transformers than for integrated circuits. The resulting profit margins are the reverse of those obtained from the simplistic analysis done by Amy Devorak (see Table 5). Hence, instead of devoting more resources to transformers, they should consider shifting resources from transformers to integrated circuits.

One implication is that more marketing should be done for integrated circuits than for transformers. This will necessitate a switch of current emphasis, which devotes only 25 percent of total marketing to integrated circuits, while 75 percent is devoted to transformers. JEA Laboratory should also analyze the costs associated with each of its two main transformer customer groups--component manufacturers and research institutions (e.g., universities). If the costs relating to these two groups differ markedly, then JEA Laboratory should consider concentrating its transformer marketing efforts with the lower cost group. Another consideration should be the customers' job sizes. Marketing efforts should focus on those customers with larger numbers of items to test. Additionally, it may be prudent to undertake some marketing research to determine whether JEA Laboratory can raise the price of transformer testing without losing much volume.

4. How should JEA Laboratory revise its operations?

A benefit of activity-based costing is that it can be used to highlight areas for potential cost reduction. From Table 3, we see that although the lab tests far fewer transformers than integrated circuits, the number of jobs and setups are far greater for transformer testing. Setup costs, as well as costs of Accounting and Finance, which are driven by number of jobs, can be reduced by obtaining jobs having larger lot sizes and conducting tests in larger batch sizes. The lab might want to consider charging different prices for different lot sizes.

Arnold Schneider, Georgia Institute of Technology
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Article Details
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Title Annotation:a testing laboratory
Author:Schneider, Arnold
Publication:Journal of the International Academy for Case Studies
Article Type:Case study
Geographic Code:1USA
Date:Mar 1, 2006
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