Allocating Fixed Costs Using Activity Based Costing

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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