Question

Koontz Company manufactures two models of industrial components—a Basic model and an Advanced Model. The company considers all of its manufacturing overhead costs to be fixed and it uses plantwide manufacturing overhead cost allocation based on direct labor-hours. Koontz’s controller prepared the segmented income statement that is shown below for the most recent year (he allocated selling and administrative expenses to products based on sales dollars):

	Basic			Advanced			Total
Number of units produced and sold		20,000			10,000		30,000
Sales	$	3,000,000		$	2,000,000	$	5,000,000
Cost of goods sold		2,300,000			1,350,000		3,650,000
Gross margin		700,000			650,000		1,350,000
Selling and administrative expenses		720,000			480,000		1,200,000
Net operating income (loss)	$	(20,000	)	$	170,000	$	150,000

Direct laborers are paid $20 per hour. Direct materials cost $40 per unit for the Basic model and $60 per unit for the Advanced model. Koontz is considering a change from plantwide overhead allocation to a departmental approach. The overhead costs in the company’s Molding Department would be allocated based on machine-hours and the overhead costs in its Assembly and Pack Department would be allocated based on direct labor-hours. To enable further analysis, the controller gathered the following information:

	Molding			Assemble and Pack			Total
Manufacturing overhead costs	$	787,500		$	562,500	$	1,350,000
Direct labor hours:
Basic		10,000			20,000		30,000
Advanced		5,000			10,000		15,000
Machine hours:
Basic		12,000			-		12,000
Advanced		10,000			-		10,000

Required:

3. Koontz’s production manager has suggested using activity-based costing instead of either the plantwide or departmental approaches. To facilitate the necessary calculations, she assigned the company’s total manufacturing overhead cost to five activity cost pools as follows:

Activity Cost Pool	Activity Measure	Manufacturing Overhead
Machining	Machine-hours in Molding	$	417,500
Assemble and pack	Direct labor hours in Assemble and Pack		282,500
Order processing	Number of customer orders		230,000
Setups	Setup hours		340,000
Other (unused capacity)			80,000
		$	1,350,000

She also determined that the average order size for the Basic and Advanced models is 400 units and 50 units, respectively. The molding machines require a setup for each order. One setup hour is required for each customer order of the Basic model and three hours are required to setup for an order of the Advanced model.

The company pays a sales commissions of 5% for the Basic model and 10% for the Advanced model. Its traceable fixed advertising costs include $150,000 for the Basic model and $200,000 for the Advanced model. The remainder of the company’s selling and administrative costs are organization-sustaining in nature.

Using the additional information provided by the production manager, calculate:

a. An activity rate for each activity cost pool.

b. The total manufacturing overhead cost allocated to the Basic model and the Advanced model using the activity-based approach.

c. The total selling and administrative cost traced to the Basic model and the Advanced model using the activity-based approach.

4. Using your activity-based cost assignments from requirement 3, prepare a contribution format segmented income statement that is adapted from Exhibit 7-8. (Hint: Organize all of the company’s costs into three categories: variable expenses, traceable fixed expenses, and common fixed expenses.)

5. Using your contribution format segmented income statement from requirement 4, calculate the break-even point in dollar sales for the Advanced model.

Answer 1

3
a.	Activity rate:
	Activity cost pool		Manufacturing overhead	Activity measure				Activity measure in $	Activity rate
			a					b	a/b
	Machining		417500	Machine hours in molding				22000	18.98	Per machine hour
								(12000+10000)
	Assemble and pack		282500	Direct labor hours in assemble and pack				30000	9.42	Per direct labor hour
								(20000+10000)
	Order processing		230000	Number of customer orders			(Note:1)	250	920.00	Per order
	Setups		340000	Setup hours			(Note:2)	650	523.08	Per setup hours
	Note:1
	Number of customer orders=Units sold/Average order size
						Basic	Advanced	Total
	Units sold				a	20000	10000
	Average order size				b	400	50
	Number of customer orders				a/b	50	200	250
	Note:2
	Setup hours=Number of customer orders*Setup hours per order
						Basic	Advanced	Total
	Number of customer orders				a	50	200
	Setup hours per order				b	1	3
	Setup hours				a*b	50	600	650
b.	Total manufacturing overhead cost allocated:
			Basic					Advanced
	Activity		Activity rate			Activity Measure cost	Overhead cost	Activity rate			Activity driver cost	Overhead cost
			a			b	a*b	c			d	a*b
	Machining		18.98	Per machine hour		12000	227727.273	18.98	Per machine hour		10000	189772.7
	Assemble and pack		9.42	Per direct labor hour		20000	188333.333	9.42	Per direct labor hour		10000	94166.67
	Order processing		920.00	Per order		50	46000	920.00	Per order		200	184000
	Setups		523.08	Per setup hours		50	26153.8462	523.08	Per setup hours		600	313846.2
	Total overhead assigned						488214					781786
c.	Traceable selling and administrative cost:
					Basic	Advanced	Total
	Sales commission				150000	200000
					(3000000*5%)	(2000000*10%)
	Fixed advertising cost				150000	200000
	Total				300000	400000	700000