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

	Requirement 1		Plantwide Approach
	a	Plantwide overhead rate			=	Total overhead/Total direct labor hours
					=	1350000/45000
					=	30
	b	Assignment of overhead to each product
						Basic	Advanced	Total
		Total Labor hours consumed by each product				30000	15000	45000
		Multiply by Plantwide overhead rate				30	30
			Total overhead assigned			900000	450000	1350000
	Requirment 2		Departmental approach
	a	Moulding department overhead rate			=	Total overhead in Moulding department/Total Machine hours in moulding department
					=	787500/22000
					=	35.79545
		Assembly department overhead rate			=	Total overhead in Assembly department/Total labor hour in assembly department
					=	562500/30000
					=	18.75
	b	Assignment of overhead to each product
						Basic	Advanced	Total
		Total Machine hours in Moulding department consumed by each product				12000	10000	22000
		Multiply by overhead rate as calculated above				35.79545	35.79545
		Total overhead of moulding department				429545.5	357954.5	787500
		Total Direct labor in assembly department consumed by each product				20000	10000	30000
		Multiply by overhead rate as calculated above				18.75	18.75
		Total overhead of Assembly department				375000	187500	562500
		Total Overhead allocated to products				804545.5	545454.5	1350000
	c	Controller's segmented Income Statement using departmental overhead cost allocation
						Basic	Advanced	Total
		Number of units produced & sold				20000	10000	30000
		Sales				3000000	2000000	5000000
		Cost of goods sold
		Direct Material				800000	600000	1400000
		Direct labor				600000	300000	900000
		Manufacturing overhead				804545.5	545454.5	1350000
		Total cost of goods sold				2204545	1445455	3650000
		Gross margin				795454.5	554545.5	1350000
		Selling & adminstrative expenses				720000	480000	1200000
		Net operating Income				75454.55	74545.45	150000
	Requirement 3
	Requirement a
		Activity cost pool	Activity measure	Total cost driver quantity	Total overhead amount	Basic	Advanced
		Machining	Machine hours in moulding	22000		12000	10000
		Amount allocated			417500	227727.3	189772.7
		Assemble and pack	Direct labor hours in assembly and packing	30000		20000	10000
		Amount allocated			282500	188333.3	94166.67
		Order processing	Number of customer orders		250	50	200
		Amount allocated			230000	46000	184000
		Setups	Setup hours		650	50	600
		Amount allocated			340000	26153.85	313846.2
	Requirment b	Total manufacturing overhead cost allocated to			1270000	488214.5	781785.5
	Requirement c
		Total selling & administrative cost traced to
		Sales commissions				150000	200000
		Fixed advertising costs				150000	200000
		Total				300000	400000
	Requirement 4
		Contribution format Income statement using activity based costing
						Basic	Advanced	Total
		Number of units produced & sold				20000	10000	30000
		Sales				3000000	2000000	5000000
		Variable costs
		Direct Material				800000	600000	1400000
		Direct labor				600000	300000	900000
		Selling commission				150000	200000	350000
		Total variable costs				1550000	1100000	2650000
		Contribution margin				1450000	900000	2350000
		Contribution ratio				48.33333	45
		Traceble fixed cost
		Manufacturing overhead				488214.5	781785.5	1270000
		Advertising cost				150000	200000	350000
		Total traceble fixed cost				638214.5	981785.5	1620000
		Common fixed costs
		Manufacturing overhead-other for unused capacity						80000
		Selling & adminstrative expenses						500000
		Net operating Income				811785.5	-81785.5	150000
	Requirement 5
		Breakeven point in dollars for advanced model
		=total fixed cost / Contribution ratio
		=981785.5/45%
		2181745.556
		OR
		=(total fixed cost / Contribution per unit)*Sales price
		=(981785.5/90)*200
		2181745.556