Question

shady lady sells window coverings to both commercial and residential customers. the following information relates to its budgeted operations for the current year:

                                                            Commercial                                  Residential

Revenues                                                 $300,000                                     $480,000

Direct materials cost           $30,000                                   $70,000

Direct labour cost               100,000                                    300,000

Overhead costs                   55,000                185,000          162,000                   532,000

Operating income (loss)                               115,000                                       $(52,000)

The controller, susan chan, is concerned about the residential product line. she cannot understand why this line is not more profitable given that window coverings are less complex to install for residential customers. in addition, the residential client base resides close to the company office, so travel costs are not as expensive on a per client visit for residential customers. as a result, she has decided to take a closer look at the overhead costs assigned to the two products lines to determine whether a more accurate product costing model can be developed. following are the three activity cost pools and related information she developed:

                  Activity cost pools                      Estimated overhead                         Cost drivers

                  Scheduling and travel                         $84,000                                   Hours of travel

                  Set-up time                                         77,000                                   Numbers of setup

                  Supervision                                         56,000                                   Direct labour cost

                                                      Expected use of cost drivers per product

                                                      Commercial                      Residential

             Scheduling and travel              1,000                               680

             Set-up time                            450                                 250

a. calculate the activity-based overhead rates for each of the three costs pools, and determine the overhead cost assigned to each product line.

b. calculate the operating income for each product line, using the activity-based overhead rates.

c. what do you believe Susan Chan should do?

Answer 1

a.				Overhead cost	Activity measure		Total activity	Activity rate
				a			b	(a/b)
	Scheduling and travel			84000	Hours of travel		1680	50
							(1000+680)
	Setup time			77000	Number of setups		700	110
							(450+250)
	Supervision			56000	Direct labor cost		400000	0.14
							(100000+300000)
	Overhead cost assigned to each product line:
				Commercial			Residential
				Activity measure	Activity rate	Overhead assigned	Activity measure	Activity rate	Overhead assigned
				1	2	(1*2)	3	4	(3*4)
	Scheduling and travel			1000	50	50000	680	50	34000
	Setup time			450	110	49500	250	110	27500
	Supervision			100000	0.14	14000	300000	0.14	42000
	Total cost assigned					113500			103500
b.	Operating income for each product line:
					Commercial		Residential
					$	$	$	$
	Revenues					300000		480000
	Direct materials cost				30000		70000
	Direct labor costs				100000		300000
	Overhead costs				113500	243500	103500	473500
	Operating income (loss)					56500		6500
c.	Susan should allocate the overhead based on activity-based overhead rates
	Since it provides correct operating income for Residential compared to the current method