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:

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

a.

Activity Cost Pool	Manufacturing Overhead	Activity Measure	Volume of Activity Measure	Activity Rate
Machining	$ 417,500	Machine hours in Molding	22,000	$ 18.98 per MH
Assembly and Pack	282,500	Direct labor hours and Assemble and Pack	30,000	$ 9.42 per DLH
Order Processing	230,000	Number of Customer Orders	250	$ 920 per order
Setups	340,000	Setup Hours	650	$ 523.08 per setup hour.
Others	80,000
	$ 1,350,000

b.

Activity Cost Pool	Activity Measure	Volume of Activity Measure		Manufacturing Overhead
		Basic	Advanced	Basic	Advanced
Machining	Machine Hours in Molding	12,000	10,000	227,727	189,773
Assemble and Pack	Direct Labor Hours in Assemble and Pack	20,000	10,000	188,333	94,167
Order Processing	Number of Customer Orders	50	200	46,000	184,000
Setups	Setup Hours	50	600	26,154	313,846
Others				0	0
Totals				$ 488,214	$ 781,786

c.

	Basic	Advanced
Sales Commission	$ 150,000	$ 200,000
Traceable Advertising Costs	150,000	200,000
Total Traceable Selling and Advertising Costs	$ 300,000	$ 400,000

4.

Koontz Company
Income Statement
For the period ended....
	Basic	Advanced	Total
Sales Revenue	$ 3,000,000	$ 2,000,000	$ 5,000,000
Less: Variable Expenses
Direct Material Cost	800,000	600,000	1,400,000
Direct Labor	600,000	300,000	900,000
Variable Selling and Administrative Expenses	150,000	200,000	350,000
Total Variable Expenses	1,550,000	1,100,000	2,650,000
Contribution Margin	1,450,000	900,000	2,350,000
Traceable Fixed Costs
Manufacturing	488,214	781,786	1,270,000
Selling and Administrative	150,000	200,000	350,000
Total Traceable Fixed Costs	638,214	981,786	1,620,000
Segment Contribution Margin	811,786	(81,786)	730,000
Other Fixed Costs			580,000
Net Operating Income			150,000

5. Break-even point in dollar sales = Traceable Fixed Costs / Contribution Margin Ratio = ($ 981,786 / $ 900,000) x $ 2,000,000 = $ 2,181,747.