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:

1. Using the plantwide approach:

a. Calculate the plantwide overhead rate.

b. Calculate the amount of overhead that would be assigned to each product.

2. Using a departmental approach:

a. Calculate the departmental overhead rates.

b. Calculate the total amount of overhead that would be assigned to each product.

c. Using your departmental overhead cost allocations, redo the controller’s segmented income statement (continue to allocate selling and administrative expenses based on sales dollars).

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

1.

Using the plantwide approach:

a.

Plantwide overhead rate = Total overhead   Total direct labor

= $1,350,000 45,000

= $30

b.

Assignment of overhead to each product:

	Basic	Advanced	Total
Total Labor hours consumed by each product	30,000	15,000	45,000
×
Plant wide overhead rate	$30	$30
Total overhead assighned	$900,000	$450,000	$1,350,000

________________________________________________________________________

2.a

Compute Departmental overhead rate as follows:

	Molding Department	Assembly and Pack Department
Manufacturing overhead costs	$787,500	$562,500
Machine hours	22,000
Direct Labor hours		30,000
Manufacturing overhead rate	[$787,500/22,000 = $35.50 per MH	[$562,500/30,000 = $18.75 per DLH

__________________________________________________________________

2.b

Compute the total amount of overhead cost assigned to each product:

	Basic	Advanced
Molding Department	[12,000 MH × $35.80 = $429,600]	[10,000 MH × $35.80 = $358,000]
Assembly and pack Department	[20,000 DLH × $18.75 = $375,000]	[10,000 DLH × $18.75 = $187,500]
Total Manufacturing overhead costs Assigned	$804,600	$545,500

_________________________________________________________________

2.c

Using your departmental overhead cost allocations, redo the controller’s segmented income statement:

	Basic	Advanced
Direct Materials cost	[20,000 units × $40 = $800,000]	[10,000 units × $60 = $600,000]
Direct Labor cost	[30,000 DLH × $20 = $600,000]	[15,000 DLH × $20 = $300,000]
Manufacturing overhead cost	$804,600	$545,500
Cost of goods produced and sold	$2,204,600	$1,445,500

__________________________________________________________________

	Basic	Advanced
Sales	$3,000,000	$2,000,000
Less: COGS	($2,204,600)	($1,445,500)
Gross Margin	$795,400	$554,500
Less: Selling and administrative expenses	($720,000)	($480,000)
Net Operating Income	$75,400	$74,500

__________________________________________________________________

3.a

Compute an activity rate for each activity cost pool:

______________________________________________________

3.b

Overhead Assigned	Basic	Advanced
Machining	[12,000 machine hours × $18.98 = $227,760]	[10,000 machine hours × $18.98 = $189,800]
Assembling and pack	[20,000 direct labor × $9.42 = $188,400]	[10,000 direct labor × $9.42 = $94,200]
Order processing	50 orders × $920 = $46,000]	200 orders × $920 = $184,000]
Setups	50 setups hours × $523.08 = $26,154]	600 setups hours × $523.08 = $313,848]
Total manufacturing overhead costs assigned	$488,314	$781,848

________________________________________________________

3.c

Overhead Assigned	Basic	Advanced
Sales Commission	[$3,000,000 × 5% = $150,000]	[$2,000,000 × 10% = $200,000]
Traceable fixed advertising	$150,000	$200,000
Total Traceable selling and administrative cost	$300,000	$400,000

Answer 2