Workings
Variable labor overheads
Product A 50 * 2000 = 100,000
Product B 50 * 6000 = 300,000
Variable overheads
Product A 45 * 2000 = 90,000
Product B 25 * 6000 = 150,000
Variable selling and administration overheads
Product A 13 *2000 = 26, 000
Product B 9 * 6000 = 54,000
Fixed overhead allocation
Fixed manufacturing overhead allocation
Product A 65/100 * 200,000 = 130,000
130,000/2,500 * 2000 = 104,000
Product B 35/100 * 200,000 = 70,000
70,000/7,500 *6000 = 56,000
Fixed selling and administrative overhead allocation
Product A 15/25 * 100,000 = 60,000
60,000/2,500 * 2,000 = 48,000
Product B 10/25 * 100,000 = 40,000
40,000/7,500 * 6,000 = 32,000
Discussion of the results
The financial statement above focuses on two products manufactured and sold by Herrested Company i.e. products A and B. The variable and fixed costs incurred in the production of the products are shown in the financial statement.
The management of the company wishes to approximate the profitability of each product in order to make a good decision about which product to produce and which one to drop or increase the price. The preparation of the segmented statement that shows the income and costs of production of each product and the combined totals is very important in making the decision above. The decision requires an understanding of the full cost of producing each product. The variable costs of production of each product are easy to allocate to each product as the variable cost per unit is given. However, the allocation of the fixed costs is less obvious since the total costs are summed together into a single figure. The fixed costs to be allocated to each product have to be found through the activity-based costing method. The fixed manufacturing and fixed selling and administrative expenses are allocated in respect of production runs and the number of sales representatives respectively.
In the accounting period ending December 2011, the company produced 2,500 and sold 2,000 units of product A at $460 per unit. It also produced 7,500 units of product B and sold 6,000 of them at $180 per unit. The costs of the resources required in the production of each product are quite different. Product A requires more direct materials and labor and therefore its cost of production is high. The activity-based costing method recognizes this and allocates more fixed costs. In the income statement Product B is more profitable than product A. on a per unit basis product B provides an income of $40 while product B incurs a net loss of $4. The loss is due to the more resources required in production which increases both the fixed and variable costs. The two implications of these are that the company will have to drop the production of product A or increase its selling price to make it profitable.
