Problem -
Part I -
Herrestad Company does produce and sell two products and the details below will be used to prepare a segmented income statement (showing the income for each product and the total) for the company. Use ABC to allocate all fixed costs to the two products.
Background information TotalProd AProd BBeginning inventory0 Units produced10,0002,5007,500Units sold8,0002,0006,000 Selling price per unit$255480180Variable costs per unit Direct material10028040Direct labor606060Variable overhead254020Variable selling and admin. exp.10139 Fixed costs Fixed manufacturing overhead200,000 Fixed selling and administrative100,000 Production runs (not $)1006535Number of sales reps (not $)251510Here are the first few lines of the segmented income statement to help you get started. Complete the statement in good format and make sure you allocate the fixed costs to the two products. When done, comment on the information and the relative profitability of the two products.
Herrestad CompanySegmented Income Statement for the period ending Dec. 31, 2015 ABTotalSales$960,000$1,080,000$2,040,000Variable costs: Direct material560,000240,000800,000
Part II -
Differential analysis involves knowing which costs are relevant, i.e. future costs that vary among alternatives. It is important to know what information to use and not just how to execute the analysis.
Herrestad Company receives an offer to make a new product, called C, for a new customer. The customer wants to buy 1,000 units. Product C has the same cost structure as product B with three exceptions. The new customer is only willing to pay $150 per unit, direct materials costs will decrease by $12 per unit and Herrestad does not have to incur any variable selling and administrative expenses.
- Make a list of the expenses and amounts that are relevant for this decision. How much will the sale of this product contribute to the profitability of Herrestad?
- What if the company only pays $140 per unit? How does this change the contribution towards profitability?
- If you were the manager, would you accept this order? What considerations, other than financial would enter into your decision?