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CASE No. 1 CC manufactures three bicycle models, a racing bike, a mountain bike, and a children's bike. The racing model (RM) is made of a...
CC manufactures three bicycle models, a racing bike, a mountain bike, and a children's bike. The racing model (RM) is made of a titanium-aluminum alloy. The mountain bike (MB) is made of aluminum. The children's bike (CB) is steel framed. Because of the different materials used, production processes differ significantly among models in terms of machine types and time requirements. Once parts are produced, however, assembly time per unit required for each type of bike is similar. For this reason, CC allocates overhead on the basis of machine hours. Last year, CC produced 1,000 RM, 2,000 MB, and 5,000 CB and had the following revenues and expenses:
CC
Income Statement
RM
MB
CB
Total
Sales revenue
$ 380,000
$ 560,000
$ 475,000
$ 1,415,000
Direct Costs:
Direct materials
150,000
240,000
200,000
590,000
Direct labor
14,400
24,000
54,000
92,400
Variable overhead
Machine setup
?
?
?
26,000
Order processing
?
?
?
64,000
Warehousing costs
?
?
?
93,000
Energy to run machines
?
?
?
42,000
Shipping
?
?
?
36,000
Total Variable costs
943,400
Contribution margin
471,600
Fixed overhead
Plant administration
88,000
Other fixed overhead
140,000
Gross profit
$ 243,000
The Chief Financial Officer (CFO) of CC hired a consultant to recommend cost allocation bases. The consultant recommended the following:
ACTIVITY LEVEL
Activity
Cost Driver
RM
MB
CB
1. Machine setup
Number of production runs
22
34
44
2. Sales order processing
Number of sales orders received
400
600
600
3. Warehousing costs
Number of units held in inventory
200
200
400
4. Energy
Machine Hours
10,000
16,000
24,000
5. Shipping
Number of units shipped
1,000
4,000
10,000
The consultant found no basis for allocating the plant administration and other fixed overhead costs and recommended that these not be applied to products.
Required:
1. Using machine hours to allocate production overhead, complete the income statement for CC. Do not attempt to allocate plant administration or other fixed overhead costs.
2. Complete the income statement using the bases recommended by the consultant.
3. How might activity-based costing result in better decisions by CC's management.
4. After hearing the consultant's recommendations, the CFO decided to adopt activity based costing but expressed concern about not allocating some of the overhead to the products (plant administration and other fixed overhead costs). In the CFO's view, "Products have to bear a fair share of all overhead or we won't be covering all of our costs." How would you respond to this comment?
CASE No. 1 CC manufactures three bicycle models, a racing bike, a mountain bike, and a children‘s bike. The racing model(RM) is made of a titanium-aluminum alloy. The mountain bike (MB) is made of aluminum. The children'sbike (CB) is steel framed. Because of the different materials used, production processes differ significantlyamong models in terms of machine types and time requirements. Once parts are produced, however, assemblytime per unit required for each type of bike is similar. For this reason, CC allocates overhead on the basis ofmachine hours. Last year, CC produced 1,000 RM, 2,000 MB, and 5,000 CB and had the following revenuesand expenses: CCIncome Statement RM MB CB Total Sales revenue 3; 380,000 5‘ 560,000 $ 475,000 3 1,415,000Direct Costs: Direct materials 150,000 240,000 200,000 590,000 Direct labor 14,400 24,000 54,000 92,400Variable overhead Machine setup 9 ? '3 26,000 Order processing '3’ ? '3' 64,000 Warehousing costs 5" ‘? '3‘ 93,000 Energy to run machines 5' ‘? '? 42,000 Shipping ? Z? '? 56,000Total Variable costs wflContribution margin 471,600Fixed overhead Plant administration 88,000 Other fixed overhead flflGross profit SLABM The Chief Financial Officer (CFO) of CC hired a consultant to recommend cost allocation bases. Theconsultant recommended the following: ACTIVITY LEVELActivity Cost Driver RM MB CB1. Machine setup Number of production runs 22 34 44 2. Sales order processing Number of sales orders received 400 600 6003. Warehousing costs Number of units held in inventory 200 200 4004. Energy Machine Hours 10,000 16,000 24,0005. Shipping Number of units shipped 1,000 4,000 10,000 The consultant found no basis for allocating the plant administration and other fixed overhead costs andrecommended that these not be applied to products. R_equired: 1. Using machine hours to allocate production overhead, complete the income statement for CC. Do not attemptto allocate plant administration or other fixed overhead costs. 2. Complete the income statement using the bases recommended by the consultant. 3. How might activity-based costing result in better decisions by CC's management. 4. After hearing the consultant's recommendations, the CFO decided to adopt activity based costing butexpressed concern about not allocating some of the overhead to the products (plant administration and otherfixed overhead costs). In the CFO‘s view, "Products have to bear a fair share of all overhead or we won't becovering all of our costs." How would you respond to this comment?