Question

Problem 7-19 Second Stage Allocations and Product Margins [LO7-4, LO7-5]

Pixel Studio, Inc., is a small company that creates computer-generated animations for films and television. Much of the company’s work consists of short commercials for television, but the company also does realistic computer animations for special effects in movies.

The young founders of the company have become increasingly concerned with the economics of the business—particularly since many competitors have sprung up recently in the local area. To help understand the company’s cost structure, an activity-based costing system has been designed. Three major activities are carried out in the company: animation concept, animation production, and contract administration. The animation concept activity is carried out at the contract proposal stage when the company bids on projects. This is an intensive activity that involves individuals from all parts of the company in creating story boards and prototype stills to be shown to the prospective client. Once a project is accepted by the client, the animation goes into production and contract administration begins. Almost all of the work involved in animation production is done by the technical staff, whereas the administrative staff is largely responsible for contract administration. The activity cost pools and their activity measures are listed below:

Activity Cost Pool	Activity Measure	Activity Rate
Animation concept	Number of proposals	$	6,300	per proposal
Animation production	Minutes of completed animation	$	8,600	per minute
Contract administration	Number of contracts	$	6,200	per contract

These activity rates include all of the company’s costs, except for its organization-sustaining costs and idle capacity costs. There are no direct labor or direct materials costs.

Preliminary analysis using these activity rates has indicated that the local commercial segment of the market may be unprofitable. This segment is highly competitive. Producers of local commercials may ask three or four companies like Pixel Studio to bid, which results in an unusually low ratio of accepted contracts to bids. Furthermore, the animation sequences tend to be much shorter for local commercials than for other work. Since animation work is billed at fairly standard rates according to the running time of the completed animation, this means that the revenues from these short projects tend to be below average. Data concerning activity in the local commercial market appear below:

Activity Measure	Local Commercials
Number of proposals	17
Minutes of completed animation	11
Number of contracts	6

The total sales from the 6 contracts for local commercials was $280,000.

Required:

1. Calculate the cost of serving the local commercial market.

2. Calculate the margin earned serving the local commercial market. (Remember, this company has no direct materials or direct labor costs.)

Answer 1

Solution 1:

Computation of cost of serving Local commercial market
Particulars	Amount
Animation concept (17*$6,300)	$107,100.00
Animation Production (11*$8,600)	$94,600.00
Contract administration (6*$6,200)	$37,200.00
Cost of serving local commercial market	$238,900.00

Solution 2:

Profitability Analysis - Local Commercial Market
Particulars		Amount
Revenue		$280,000.00
Costs:
Animation Concept	$107,100.00
Animation Production	$94,600.00
Contract Administration	$37,200.00
Total Cost		$238,900.00
Customer Margin		$41,100.00