9-39. Choosing an Activity-Based Costing System

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 re-quirements. 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. the company shipped 1,000 Route 66s, 4,000 Main Streets, and 10,000 Alley Cats and had the fol- lowing revenues and expenses:

PICKLE MOTORCYCLES, INC. Income Statement

Route 66 Main Street Alley 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

Gross profit 5,394,000

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

Activity Level

Activity Cost Driver Route 66 Main Street Alley Cat

Setting up machines Number of production runs 22 34 44

Processing orders Number of sales orders received 400 600 600

Warehousing Number of units held in inventory 200 200 400

Using energy Machine-hours 10,000 16,000 24,000

Shipping Number of units shipped 1,000 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 or 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 Motorcycless management? d. After hearing the consultants recommendations, the CFO decides to adopt activity-based costing

but expresses concern about not allocating some of the overhead to the products (plant admin- istration and other fixed overhead). In the CFOs view, Products have to bear a fair share of all overhead or we wont be covering all of our costs. How would you respond to this comment?