Pickle Motorcycles, Inc. (PMI), manufactures three motorcycle models: a
cruising bike (Route 66), a street bike (Main Street), and a starter
model (Alley Cat). Because of the different materials used, production
processes for each model differ significantly in terms of machine types
and time requirements. Once parts are produced, however, assembly time
per unit required for each type of bike is similar. For this reason, PMI
allocates overhead on the basis of machine-hours. Last year, the
company shipped 1,000 Route 66s, 4,000 Main Streets, and 10,000 Alley
Cats and had the following revenues and expenses:
PICKLE MOTORCYCLES, INC. Income Statement
Route 66Main StreetAlley Cat Total
Sales. . . . . . . . . . . . . . . . . . . . $7,600,000 $11,200,000 $9,500,000 $28,300,000
Direct costs
Direct materials . . . . . . . . . . 3,000,000 4,800,000 4,000,000 11,800,000
Direct labor. . . . . . . . . . . . . 288,000 480,000 1,080,000 1,848,000
Variable overhead
Machine setup. .468,000
Order processing. . . . . . . . . 1,152,000
Warehousing costs. . . . . . .1,674,000
Energy to run machines . . .756,000
Shipping. . . . . . . . . . . . . . .648,000
Contribution margin. . . . . . . . . 9,954,000
Fixed overhead
Plant administration. . . . . . .1,760,000
Other fixed overhead. . . . . .2,800,000
PMIs chief financial officer (CFO) hired a consultant to recommend cost
allocation bases. The consultant recommended the following:
Activity Level
ActivityCost Driver Route 66 Main Street Alley Cat
Setting up machines . . Number of production runs 223 444
Processing orders . . . Number of sales orders received 400 600 600
Warehousing . . . . . . . Number of units held in inventory 200 200 400
Using energy. . . . . . . Machine-hours10000 16,000 24,000
Shipping. . . . . . . . . . . Number of units shipped1,000 4,000 10,000
The consultant found no basis for allocating the plant administration
and other fixed overhead costs and recommended that these not be applied
to products.
Required:
a. Using machine-hours to allocate production overhead, complete the
income statement for Pickle Motorcycles. (See the "using energy"
activity for machine-hours.) Do not attempt to allocate plant
administration of other fixed overhead.
b. Complete the income statement using the bases recommended by the consultant.
c. How might activity-based costing result in better decisions by Pickle Motorcycles' management?
d. After hearing the consultant's recommendations, the CFO decides to
adopt activity-based costing but expresses concern about not allocating
some of the overhead to the products (plant administration and other
fixed overhead). In the CFO's view, "Products have to bear a fair share
of all overhead or we won't be covering all of the costs." How would you
respond to this comment?
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