Question

Question 1: Cost allocation

	Product A	Product B	Total
sales volume (units)	180	100	280
Revenue	$3,000	$18,000	$21,000
Variable costs:
direct materials	$600	$1,200	$1,800
direct labor	$1,200	$3,000	$4,200
Contribution margin	$1,200	$13,800	$15,000
Fixed costs			$12,600
Profit			$2,400

a) Allocate the fixed costs between products A and B. Use direct labor dollars as the cost driver.
allocation rate=$  per DL$
allocated costs for A=$
allocated costs for B=$

b) Compute the profit margins for products A and B:
profit margin for A=$
profit margin for B=$
Enter negative numbers with a minus sign, i.e., a loss of $1,000 should be entered as -1000, not as (1000) or ($1000).

c) Should you drop product A or product B in the short term? Why?

Keep both products -- both have positive contribution margin

Drop product A -- it has negative profit margin     

Drop product A -- it has negative contribution margin

Drop product A -- it has smaller contribution margin than product B

Should you drop product A or product B in the long term? Why?

Keep both products -- both have positive contribution margin

Drop product A -- it has negative profit margin    

Drop product A -- it has negative contribution margin

Drop product A -- it has smaller contribution margin than product B

d) If you drop product A in the short term,
    fixed costs will: remain the same decrease by $3,600

    profit will: decrease by $1,200 increase by $2,400


If you drop product A in the long term,
    fixed costs will: remain the same decrease by $3,600

    profit will: decrease by $1,200 increase by $2,400


e) Allocate the fixed costs between products A and B, using the number of units as the cost driver.
allocation rate=$  per unit
allocated costs for A=$
allocated costs for B=$
These allocated amounts are very different from what you got in part (a). In general, should we use the allocated costs from part (a) or from part (e)? Why?

use the allocated costs from (a) -- direct labor is always a better cost driver than the number of unitsuse the allocated costs from (e) -- the number of units is always a better cost driver than direct labor    it depends -- direct labor can be a better cost driver in some situations, and the number of units (or some other activity measure) can be a better cost driver in other situations

f) Suppose that a firm uses a labor-intensive production process. The most reasonable cost driver for manufacturing overhead costs is:

number of units

machine hours    

direct labor (measured in hours or dollars)

Suppose that a firm uses a machine-intensive production process. The most reasonable cost driver for manufacturing overhead costs is:

number of units

machine hours    

direct labor (measured in hours or dollars)

g) Suppose that a firm uses a machine-intensive process to make the components for the finished product and then uses a labor-intensive process to assemble the finished product. The firm wants to implement a refined cost allocation with two cost pools:
Pool 1: overhead costs related to the production of components (e.g., machine depreciation, rent for the factory building used to make the components, salaries of machine maintenance staff)
Pool 2: overhead costs related to the assembly of the finished product (e.g., depreciation on tools used by assembly workers, rent for the factory building used for assembly, salaries of labor supervisors)
The most reasonable cost drivers for the two pools are:

machine hours for both poolsmachine-hours for pool 1 and direct labor hours or dollars for pool 2    number of units for pool 1 and number of workers for pool 2direct labor hours or dollars for both pools

Answer 1

a	Allocation Rate =$12,600 / $4,200 =$3.00 per direct labor $
	Allocated Cost for A =$1,200*$3 =$3,600
	Allocated Cost for B =$3,000*$3 =$9,000
b	Computation of Profit Margin	Product A	Product B
	Revenue	$                       3,000	$                      18,000
	Less:Direct materials	$                          600	$                        1,200
	Less:Direct labor	$                       1,200	$                        3,000
	Contribution Margin	$                       1,200	$                      13,800
	Less:Allocated Fixed Costs	$                       3,600	$                        9,000
	Profit Margin	$                     -2,400	$                        4,800
c	In Short term the company should drop Product A as it has smaller contribution Margin than Product B
	In Long term the company should drop Product A as it has smaller Profit Margin than Product B
d	In short term Fixed cost will remain the same and Profit margin will decrease by $1,200
	In long term the Fixed cost will decrease by $3,600 and Profit will increase by $2,400
e	Allocation Rate =$12,600 / 280 units =$45.00 per unit
	Allocated Cost for A =180*$45 =$8,100
	Allocated Cost for B =100*$45 =$4,500
f	In a labor intensive unit Direct labor(in HOURS) is the most appropiate cost driver
	In a machine intensive unit Machine Hours is the most appropiate cost driver
g	Machine hours for Pool 1 and direct labor hours or dollars for pool 2