choosing an activity based accounting system

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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 CatTotal
Sales revenue$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
Gross profit$ 5,394,000

Page 367

PMI’s chief financial officer (CFO) hired a consultant to recommend cost allocation bases. The consultant recommended the following:

Activity Level

ActivityCost DriverRoute 66Main StreetAlley Cat
Setting up machinesNumber of production runs 22 34 44
Processing ordersNumber of sales orders received 400 600 600
WarehousingNumber of units held in inventory 200 200 400
Using energyMachine-hours10,00016,00024,000
ShippingNumber of units shipped 1,000 4,00010,000

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

  1. 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 or other fixed overhead.
  2. Complete the income statement using the bases recommended by the consultant.
  3. How might activity-based costing result in better decisions by Pickle Motorcycles’s management?
  4. 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 our costs.” How would you respond to this comment?

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