Marvel Bank & Trust operates in a very competitive marketplace, using a traditional labor-hour-based system to determine the cost of processing its mortgage loans. Recently, the firm explored a switch to activity-based costing to determine the wisdom of its previous ways. The following information is available:ActivityCostDriveDriver UnitsApplication processing $900,000 Applications4,000Loan underwriting 800,000 Underwriting hours16,000Loan closure 880,000 Legal hours8,000Total$2,580,000??Two loan applications, among many others, were originated and closed during the year. No. 7439 consumed 3.5 hours in loan underwriting and 1.5 hours in loan closure, for a total of 5.0 hours. No. 7809 also required 5.0 hours of time, subdivided as follows: 2.0 hours in loan

Question

underwriting and 3.0 hours in loan closure.Required: A. Use an activity-based-costing system and determine the cost of processing, underwriting, and closing the two loan applications.B. Determine the cost of processing the two loans if Marvel uses the traditional labor-hour-based system. Conversations with management found that, on average, each application took nine labor hours of processing time, excluding underwriting and closure.C. Is Marvel making a mistake by continuing to use a traditional system that is based on an average labor cost per hour? Why?

What will be an ideal response?

Answer 1

A. Pool rates:
Application processing: $900,000 ÷ 4,000 = $225 per application
Loan underwriting: $800,000 ÷ 16,000 = $50 per underwriting hour
Loan closure: $880,000 ÷ 8,000 = $110 per legal hour
Application no. 7439: Application ($225) + underwriting (3.5 × $50 = $175) + closure (1.5 × $110 = $165) = $565
Application no. 7809: Application ($225) + underwriting (2.0 × $50 = $100) + closure (3.0 × $110 = $330) = $655

B. Total labor hours: Application processing (4,000 × 9 = 36,000) + underwriting (16,000) + closure (8,000) = 60,000
Average rate per hour: $2,580,000 ÷ 60,000 = $43 per hour
Application no. 7439: (9 + 5) × $43 = $602
Application no. 7809: (9 + 5) × $43 = $602

C. Yes. The traditional system results in an average cost per hour of $43; yet, Marvel's hourly charges vary greatly based on the function being performed. Rates range from $25 per hour ($225 ÷ 9) for application processing, to $50 per hour for underwriting, to $110 for legal services. ABC produces an improved determination of cost because three separate drivers are used rather than just one.