Segmented Income Statement for Herrestad Company

Herrestad Company.
Segmented Income Statement
For the period ending Dec. 31, 2011
A B Total
Sales $920,000 $2,000,000
Variable costs:
Direct material 560,000 240,000 800,000
Direct labor 100,000 300,000 400,000
variable overhead 90,000 150,000 240,000
variable selling and admin exp 26,000 54,000 80,000
total variable costs 776,000 744,000 1,520,000
fixed costs
fixed manufacturing overheads 104,000 56,000 160,000
fixed selling and administrative costs 48,000 32,000 80,000
total fixed costs 152,000 88,000 240,000
total costs 928,000 832,000 1,760,000
net income/loss -8,000 248,000 240,000


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.

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