Question

Keep-or-Drop: Traditional Versus Activity-Based Analysis

Nutterco, Inc., produces two types of nut butter: peanut butter and cashew butter. Of the two, peanut butter is the more popular. Cashew butter is a specialty line using smaller jars and fewer jars per case. Data concerning the two products follow:

	Peanut Butter	Cashew Butter	Unused Capacitya	units of Purchaseb
Expected sales (in cases)	50,000	10,000	-	-
Selling price per case	$100	$80	-	-
Direct labor hours	40,000	10,000	-	As needed
Receiving orders	500	250	250	500
Packing orders	1,000	500	500	250
Material cost per case	$55	$48	-	-
Direct labor cost per case	$11	$9	-	-
Advertising costs	$300,000	$60,000	-	-
aPractical capacity less expected usage (all unused capacity is permanent).
bIn some cases, activity capacity must be purchased in steps (whole units). These steps are provided as necessary. The cost per step is the fixed activity rate multiplied by the step units. The fixed activity rate is the expected fixed activity costs divided by practical activity capacity.

Annual overhead costs are listed below. These costs are classified as fixed or variable with respect to the appropriate activity driver.

Activity	Fixeda	Variableb
Direct labor benefits	$0	$200,000
Machine	200,000	250,000
Receiving	200,000	22,500
Packing	100,000	45,000
Total costs	$500,000	$517,500

aCosts associated with practical activity capacity. The machine fixed costs are all depreciation with direct labor hours as the driver.

bThese costs are for the actual levels of the cost driver.

Required:

1. Prepare a traditional segmented income statement, using a unit-level overhead rate based on direct labor hours.

Nutterco, Inc.
Traditional Income Statement
	Peanut Butter	Cashew Butter	Total
	$	$	$
Less variable expenses:
Contribution margin	$	$	$
Product margin	$	$	$
Operating income			$

Using this approach, determine whether the cashew butter product line should be kept or dropped.

2. Prepare an activity-based segmented income statement. Use a minus sign to indicate a negative product margin.

Nutterco, Inc.
Activity-Based Income Statement
	Peanut Butter	Cashew Butter	Total
	$	$	$
Contribution margin	$	$	$
Less traceable expenses:
Product margin	$	$	$
Less unused activity expenses:
Operating income			$

Using ABC approach, determine whether the cashew butter product line should be kept or dropped.

Answer 1

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Part 1	Traditional income statement:
		Peanut	Cashew	Total
		Butter	Butter
Revenues		$     5,000,000	$       800,000	$     5,800,000
Less variable expenses:
Direct materials	50,000*$55 and 10,000*$48	$   (2,750,000)	$     (480,000)	$   (3,230,000)
Direct labor	50,000*$11 and 10,000*$9	$      (550,000)	$       (90,000)	$      (640,000)
Variable overheads	Working-1	$      (360,000)	$       (90,000)	$      (450,000)
Contribution margin		$     1,340,000	$       140,000	$     1,480,000
Less direct fixed expenses		$      (300,000)	$       (60,000)	$      (360,000)
Product margin		$     1,040,000	$         80,000	$     1,120,000
Less common fixed expenses	$500,000+$22,500+$45,000			$      (567,500)
Operating income				$         552,500
Because the cashew butter segment margin is positive, it should not be dropped.
Working-1
Direct Labor Benefits	$                                                        200,000
Variable Machine overheads	$                                                        250,000
	$                                                        450,000	a
Total Labor Hours	50,000	b
Variable OH rate	$                                                                     9	a/b
Peanut Butter overhead = $9 × 40,000	$                                                        360,000
Cashew Butter overhead = $9 × 10,000	$                                                          90,000
Part 1	Activity-based statement:
		Peanut	Cashew	Total
		Butter	Butter
Revenues		$     5,000,000	$       800,000	$     5,800,000
Less variable costs	DM+DL+Variable Overheads	$   (3,660,000)	$     (660,000)	$   (4,320,000)
Contribution margin		$     1,340,000	$       140,000	$     1,480,000
Less traceable expenses:
Advertising		$      (300,000)	$       (60,000)	$      (360,000)
Receiving	Working-b	$      (115,000)	$       (57,500)	$      (172,500)
Packing	Working-c	$         (80,000)	$       (40,000)	$      (120,000)
Product margin		$         845,000	$       (17,500)	$         827,500
Less unused activity expenses:
Receiving	$200*250			$         (50,000)
Packing	$50*500			$         (25,000)
Less common fixed expenses
(machine depreciation)				$      (200,000)
Operating income				$         552,500
Now, the analysis favors dropping the cashew butter line because the product margin is a negative.
Working-b
Fixed receiving rate = $200,000/(500 + 250 + 250) = $200/receiving order
Variable receiving rate = $22,500/750 = $30/receiving order
Receiving for Peanut line = ($200 × 500) + ($30 × 500) = $115,000
Receiving for Cashew line = ($200 × 250) + ($30 × 250) = $57,500
Working-c
Fixed packing rate = $100,000/(1,000 + 500 + 500) = $50/packing order
Variable packing rate = $45,000/(1,000 + 500) = $30/packing order
Packing for Peanut line = ($50 × 1,000) + ($30 × 1,000) = $80,000
Packing for Cashew line = ($50 × 500) + ($30 × 500) = $40,000
Working-d
$200 × 250; $50 × 500