Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 43

Choosing an Activity-Based Costing System

MTI makes three types of lawn tractors: M3100, M4100, and M6100. In the past, it allocated y overhead to products using machine-hours. Last year, the company produced 10,000 units of M3100, 17,500 units of M4100, and 10,000 units of M6100 and had the following revenues and costs:

MTI Income Statement
	M3100	M4100	M6100	Total
Sales	$9,000,000	$15,000,000	$13,500,000	$37,500,000
Direct costs
Direct materials	3,000,000	4,500,000	3,300,000	10,800,000
Direct labor	600,000	900,000	1,800,000	3,300,000
Variable overhead
Setting up machines				2,400,000
Processing sales orders				1,800,000
Warehousing				2,400,000
Operating machines				1,200,000
Shipping				900,000
Contribution margin				$14,700,000
Plant administration				6,000,000
Gross profit				$ 8,700,000

MTI's controller has heard about activity-based costing and puts together an employee team to recommend cost allocation bases. The employee team recommends the following:

Activity	Cost Driver	M3100	M4100	M6100
Setting up machines	Production runs	10	20	20
Processing sales orders .	Sales orders received	180	400	220
Warehousing	Units held in inventory	100	200	100
Operating machines	Machine-hours	6,000	9,000	10,000
Shipping	Units shipped	10,000	17,500	10,000

The employee team recommends that plant administration costs not be allocated to products.

Required

a.Using machine-hours to allocate overhead, complete the income statement for MTI. Do not allocate plant administrative costs to products.

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b.Complete the income statement using the activity-based costing method suggested by the employee team.

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c.Write a brief report indicating how activity-based costing might result in better decisions by MTI.

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d.After hearing the recommendations, the president expresses concern about failing to allocate plant administrative costs. If plant administrative costs were to be allocated to products, how would you allocate them?

Step 1 of 4

a.?Total overhead to allocate is $8,700,000 (= $2,400,000 + $1,800,000 + $2,400,000 + $1,200,000 + $900,000).

The overhead rate is $348 per machine-hour (= $8,700,000 ÷ 25,000 machine-hours).

MTI

Income Statement

		M3100		M4100		M6100		Total
	Sales	$9,000,000		$15,000,000		$13,500,000		$37,500,000
	Direct costs:
	Direct material.	3,000,000		4,500,000		3,300,000		10,800,000
	Direct labor	600,000		900,000		1,800,000		3,300,000
	Var. overhead	2,088,000	a	3,132,000		3,480,000		8,700,000
	Contribution margin	$3,312,000		$6,468,000		$4,920,000		$14,700,000
	Plant admin.							6,000,000
	Gross profit							$?8,700,000

a $2,088,000 = $348 per machine-hour × 6,000 machine-hours.