Question

10.36 Volume and ABC allocations A world-famous photographer of wild animals and nature, Sonja Rego sells framed prints of select photographs over the Internet. Regardless of the picture bought, she offers buyers a choice in framing: a plain black frame or a fancy frame with a certificate of authenticity. Based on initial cost estimates, Sonja believes the Deluxe frames to be more profitable than the Standard frames. However, her profits have slipped every quarter even as the proportion of Deluxe frames sold has increased. She has asked for your help in figuring out what she might be doing wrong. She provides the following data: Deluxe Standard Units/year 1,000 5,000 Price per unit $350 $210 Materials ($/unit) 100 Labor ($/unit) She further informs us that her total overhead is $390,000 per year. 65 50

Answer 1

Solution:

Solution a) Calculation of Profit per unit for Deluxe and Standard prints, if Sonja allocates overheads using labour dollars as allocation base:

Total Overheads = $390,000 per year

Allocation of overheads using labour dollars as allocation base

Total Labour Cost = Labour Cost of Deluxe + Labour Cost of Standard

$75,000 + $2,50,000 = $325,000

Allocation to Deluxe = ($75,000 / $325,000) x $390,000 = $90,000

Allocation to Standard = ($250,000 / $325,000) x $390,000 = $300,000

Calculation of Profit per unit for Deluxe and Standard

	Deluxe		Standard
	Total $ (1000 Units)	Per Unit $	Total $ (5000 Units)	Per Unit $
Sales	3,50,000.00	350.00	10,50,000.00	210.00
Less: Variable Cost
Material	1,00,000.00	100.00	3,25,000.00	65.00
Labour	75,000.00	75.00	2,50,000.00	50.00
Total Variable Cost	1,75,000.00	175.00	5,75,000.00	115.00
Contribution = Sales - Total Variable Cost	1,75,000.00	175.00	4,75,000.00	95.00
Less: Fixed Cost (Overheads)	90,000.00	90.00	3,00,000.00	60.00
Profit	85,000.00	85.00	1,75,000.00	35.00

Therefore, Deluxe frames Profit per unit is $85 and Standard frames Profit per unit is $35.

Solution b) Division of Overheads

	$
Labour Related Overheads	1,56,000.00
Batch Related Overheads	1,36,500.00
Product Level Overheads	58,500.00
Facility Level Costs	39,000.00
Total Overheads	3,90,000.00

Allocation of Labour related overheads on the basis of labour cost:

Allocation to Deluxe = ($75,000 / $325,000) x $156,000 = $36,000

Allocation to Standard = ($250,000 / $325,000) x $156,000 = $120,000

Allocation of Batch related overheads on the basis of Number of Batches:

	Deluxe	Standard
Batch Size (prints)	50	250
Number of Frames	1000	5000
Number of Batches = Number of Frames / Batch Size (prints)	20	20

Total Number of Batches = Batches run for Deluxe + Batches run for Standard

= 20 + 20 = 40 Batches

   Allocation to Deluxe = (20 / 40) x $136,500 = $68,250

Allocation to Standard = (20 / 40) x $136,500 = $68,250

Product level Overheads will be divided equally for Deluxe and Standard

Income Statement for Deluxe and Standard

	Deluxe	Standard	Total
Number of Units	1000	5000
Revenue $	3,50,000.00	10,50,000.00	14,00,000.00
Materials $	1,00,000.00	3,25,000.00	4,25,000.00
Labour $	75,000.00	2,50,000.00	3,25,000.00
Labour related overhead $	36,000.00	1,20,000.00	1,56,000.00
Batch related overhead $	68,250.00	68,250.00	1,36,500.00
Product related overhead $	29,250.00	29,250.00	58,500.00
Product profit $	41,500.00	2,57,500.00	2,99,000.00
Facility Costs $			39,000.00
Profit $			2,60,000.00
Profit per unit $	41.50	51.50