Question

Question 1: Cost allocation

	Product A	Product B	Total
sales volume (units)	180	100	280
Revenue	$1,000	$6,000	$7,000
Variable costs:
direct materials	$200	$400	$600
direct labor	$400	$1,000	$1,400
Contribution margin	$400	$4,600	$5,000
Fixed costs			$4,200
Profit			$800

a) Allocate the fixed costs between products A and B. Use direct labor dollars as the cost driver.
allocation rate=$   per DL$
allocated costs for A=$   
allocated costs for B=$   

b) Compute the profit margins for products A and B:
profit margin for A=$   
profit margin for B=$   
Enter negative numbers with a minus sign, i.e., a loss of $1,000 should be entered as -1000, not as (1000) or ($1000).

c) Should you drop product A or product B in the short term? Why?

Keep both products -- both have positive contribution margin

Drop product A -- it has negative profit margin      

Drop product A -- it has negative contribution margin

Drop product A -- it has smaller contribution margin than product B

Should you drop product A or product B in the long term? Why?

Keep both products -- both have positive contribution margin

Drop product A -- it has negative profit margin      

Drop product A -- it has negative contribution margin

Drop product A -- it has smaller contribution margin than product B

d) If you drop product A in the short term,
    fixed costs will:  

remain the same

decrease by $1,200

    profit will:

decrease by $400

increase by $800


If you drop product A in the long term,
    fixed costs will:

remain the same

decrease by $1,200

    profit will:

decrease by $400

increase by $800


e) Allocate the fixed costs between products A and B, using the number of units as the cost driver.
allocation rate=$   per unit
allocated costs for A=$   
allocated costs for B=$   
These allocated amounts are very different from what you got in part (a). In general, should we use the allocated costs from part (a) or from part (e)? Why?

use the allocated costs from (a) -- direct labor is always a better cost driver than the number of units

use the allocated costs from (e) -- the number of units is always a better cost driver than direct labor     

it depends -- direct labor can be a better cost driver in some situations, and the number of units (or some other activity measure) can be a better cost driver in other situations

f) Suppose that a firm uses a labor-intensive production process. The most reasonable cost driver for manufacturing overhead costs is:

number of units

machine hours

direct labor (measured in hours or dollars)

Suppose that a firm uses a machine-intensive production process. The most reasonable cost driver for manufacturing overhead costs is:

number of units

machine hours     

direct labor (measured in hours or dollars)

g) Suppose that a firm uses a machine-intensive process to make the components for the finished product and then uses a labor-intensive process to assemble the finished product. The firm wants to implement a refined cost allocation with two cost pools:
Pool 1: overhead costs related to the production of components (e.g., machine depreciation, rent for the factory building used to make the components, salaries of machine maintenance staff)
Pool 2: overhead costs related to the assembly of the finished product (e.g., depreciation on tools used by assembly workers, rent for the factory building used for assembly, salaries of labor supervisors)
The most reasonable cost drivers for the two pools are:

direct labor hours or dollars for both pools

machine-hours for pool 1 and direct labor hours or dollars for pool 2     

number of units for pool 1 and number of workers for pool 2

machine hours for both pools

Answer 1

Answer Answer (c ) - In the short run both the products can be produced and sold because both have positive contribution margin.

- But in the long run Product A should be dropped because it has negative profit margin.

Answer (d) If product A is dropped in the long run, then

- Fixed cost will remain the same and charged fully to Product B cost

- The profit will decrease by $400