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

Solution
(a) Activity Rate for each cost poll is as follows-
Cost Pool	Activity Rate
Machining	$18.98	per m/c
Assemble & Pack	$9.42	per DLH
Order Processing	$920	per order
Setups	$523.08	per hour
(b) Total Mfring overhead cost
Cost Pool	Basic	Advanced
Machining	$227760	$189900
Assemble & Pack	$188400	$94200
Order Processing	$46000	$184000
Setups	$26154	$313848