Activity based costing (ABC) employs a number of cost pools, which are usually organized by activity to apportion overhead costs(Cooper, 1992). This method is founded on the principle that production processes are simply different production activities put together in a systematic manner.ABC therefore groups production expenses into activities centered groups such as purchasing materials; machinery assembly and maintenance;amassing products, and supervision of end products among others (Cooper, 1992).
In this paper, I will use ABC to group Herrestad Company’s production expenses for product A and product B. I will also complete the company’s segmented income statement, showing the income for each product and the total. When done, I will comment on the information and the relative profitability of the two products.
Calculations:
| Product A | |
| Units sold = 2,000 | |
| Variable costs per unit | |
| Direct material= | 280X 2,000= 560,000 |
| Direct labor= | 60 X 2,000=120,000 |
| Variable overhead= | 40 X 2,000= 80,000 |
| Variable selling and admin. exp.= | 13 X 2,000= 26,000 |
| Fixed costs | |
| Fixed manufacturing overhead= | (65/100X100) x200, 000
=65%X 200,000=130,000 |
| Fixed selling and administrative= | (15/25X100) X 100,000
=60% X100, 000= 60,000 |
| Product B | |
| Units sold= 6,000 | |
| Variable costs per unit | |
| Direct material= | 40 X6, 000= 240,000 |
| Direct labor= | 60 X6, 000=360,000 |
| Variable overhead= | 20 X6, 000= 120,000 |
| Variable selling and admin. exp.= | 9 X6, 000= 54,000 |
| Fixed costs | |
| Fixed manufacturing overhead= | (35/100X100) x 200,000
=35%X 200,000= 70,000 |
| Fixed selling and administrative= | (10/25X100) X 100,000
=40% X100, 000= 40,000 |
HERRESTAD COMPANY SEGMENTED INCOME STATEMENT FOR THE PERIOD ENDING DEC. 31, 2011 |
|||
| A | B | Total Company | |
| $ | $ | $ | |
| Sales | 960,000 | 1,080,000 | 2,040,000 |
| Less Variable expenses: | |||
| Direct material | 560,000 | 240,000 | 800,000 |
| Direct labor | 120,000 | 360,000 | 480,000 |
| Variable overhead | 80,000 | 120,000 | 200,000 |
| Variable selling and admin exp. | 26,000 | 54,000 | 80,000 |
| Total variable expenses | 786,000 | 774,000 | 1,560,000 |
| Contribution margin | 174,000 | 306,000 | 480,000 |
| Fixed expenses: | |||
| Fixed manufacturing overheads | 130,000 | 70,000 | 200,000 |
| Fixed selling and admin exp. | 60,000 | 40,000 | 100,000 |
| Total fixed expenses | 190,000 | 110,000 | 300,000 |
| Territorial segment margin | (16,000) | 196,000 | 180,000 |
| Net operating income | 180,000 | ||
Relative profitability is used to rank products, patrons, and other business fragments so as to determine the ones that should be emphasized. Relative profitability helps managers identify the least profitable segments and work on improving them (Haslem, 1968). In Herrestad Company’s case, Product A incurred a loss while Product B made a profit.
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