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 Capacity (a)	units of Purchase(b)
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	$50	$49	-	-
Direct labor cost per case	$11	$8	-	-
Advertising costs	$200,000	$70,000	-	-
(a)Practical capacity less expected usage (all unused capacity is permanent).
(b)In 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	Fixed(a)	Variable(b)
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

(a) Costs associated with practical activity capacity. The machine fixed costs are all depreciation with direct labor hours as the driver.

(b) These 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
Revenues	$	$	$
Less variable expenses:
Direct materials
Direct labor
Variable overhead
Contribution margin	$	$	$
Less direct fixed expenses
Product margin	$	$	$
Less common fixed expenses
Operating income			$

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

Answer 1

SOLUTION

	Peanut Butter ($)	Cashew Butter ($)	Total ($)
Revenues (50,000*$100),(10,000*$80)	5,000,000	800,000	5,800,000
Less: variable expenses
Direct materials (50,000*$50),(10,000*$49)	(2,500,000)	(490,000)	(2,990,000)
Direct Labor (50,000*$11),(10,000*$8)	(550,000)	(80,000)	(630,000)
Variable overhead (Note 1)	(360,000)	(90,000)	(450,000)
Contribution margin	1,590,000	140,000	1,730,000
Less: Direct fixed expenses	200,000	70,000	(270,000)
Product Margin			1,460,000
Less: Common fixed expenses			(567,500)
Operating Income			892,500

Note 1 - Variable overhead-

Variable overhead rate = (Direct labor benefits + Variable machine overhead) / Direct labor hours

= ($200,000 + $250,000) / (40,000 + 10,000)

= $9 per direct labor hour

Peanut Butter overhead = $9 * 40,000 = $360,000

Cashew Butter overhead = $9 * 10,000 = $90,000

- Because the cashew butter segment margin is positive, it should not be dropped