ABC and Segmented Income Statements

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Objective:

Use ABC to increase the accuracy of the profit margin measure by increasing the level of traceable costs to each product.

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Introduction:

Lembro, Inc., a manufacturer of auto accessories, currently produces two product lines of universal car mats at its Poughkeepsie Plant:(1) rubber all-weather car mats and (2) carpeted car mats. The all-weather floor mats are designed to resist mud, spills, and other forms of abuse. They are easily hosed off whenever soiled with mud or a spilled drink. Years ago, Lembro's management chose to produce its all-weather mats with high quality thermoplastic rubber (TPR) instead of real rubber or PVC. TPR was selected because it not only avoided the strong odors of pure rubber or PVC, but it also made TPC mats better able to hold their color, shape and withstand temperature variations. The decision paid off as Lembro's TPR mats gained wide acceptance with a strong reputation for high quality. After more than a decade of experience with TPR mats, Lembro made the decision two years ago to begin producing carpeted car mats. Management was confident that a similar quality strategy would be successful for carpeted car mats.

Lembro's management understood that carpeted car mats involved a different market segment than the TPR mats. Carpeted mats would appeal to customers with a greater aesthetic preference. The carpet floor mats are made of a nylon weave attached (tufted) to a light rubber anti-slip, waterproof backing. The decision was made to produce carpeted mats with a tufted luxurious pile, a premium heel pad, and UV and stain resistance. The goal was to produce a universal luxury car mat that would be the only "value" priced car mat with luxury features-a mat that would be superior to the OEM mats and yet be reasonably priced.

After analyzing the segmented income statement, John Hope challenged the plant manager's view that the all-weather mat line had earned more than the required 12 percent after-tax return on sales. The segmented analysis, in fact, placed it almost a full 2 percentage points below the targeted return. Jim Scott, the plant manager, however, was not persuaded by the analysis. He countered by focusing on the pool of common fixed costs. Specifically, he made the following point: "This segmented statement has not fully untangled all the costs attributable to the carpet mat line. In fact, many of the so-called common fixed costs have increased because of adding the carpet line. For example, the number of batches we inspect has increased significantly causing us to add inspection resources. Thus, inspection costs have increased because of the additional demands placed on this activity by the new carpet mat line. The only items in the common fixed cost pool not affected by the carpet mat line are plant depreciation and landscape maintenance."

Kathy agreed with Jim's comments and offered to see what could be done to identify how the shared costs could be assigned to each product line. She was optimistic but asked for a week to gather the necessary data. John Hope agreed and indicted they would meet again in a week.

During the week, Cathy gathered the following information to help trace the shared costs of the two product lines. She prepared the below table using the units-of-production method for depreciation, based on machine hours consumed by each product line:

		Expected Consumption Ratios
Activity	Driver	Quantity	Carpet Mats	All-Weather Mats
Machining (depreciation)	Machine hours	500,000	0.30	0.70
Inspecting	Inspection hours	10,000	0.50	0.50
Materials Handling	Number of moves	20,000	0.40	0.60
Customer Service	Number of complaints	4,000	0.75	0.25
Sales Administration	Units sold	500,000	0.20	0.80

Required:

1.

Using the given segmented income statement, complete the following revised activity-based segmented income statement (Hint:Sales commissions are based on the sales dollars):

Segmented Income Statement For the Year Ended Poughkeepsie Plant
	Carpeted Mats	All-Weather Mats	Total
Sales Revenue: (100,000 @$ ; 400,000 @$ )	$	$	$30,000,000
Less variable expenses:
Direct materials			8,000,000
Direct labor	3,000,000	3,000,000	6,000,000
Maintenance			2,000,000
Power	200,000	600,000	800,000
Sales commissions			1,200,000
Contribution margin	$0	$12,000,000	$12,000,000
Less traceable expenses:
Supervision, direct fixed	150,000	250,000	400,000
Advertising, direct fixed			1,000,000
Machining			1,000,000
Inspecting products			2,000,000
Materials handling			1,500,000
Customer service			200,000
Sales administration			800,000
Product margin	$(2,610,000)	7,710,000	$5,100,000
Less common expenses:
Plant depreciation			1,400,000
Landscape maintenance			700,000
Operating income			$3,000,000
Less taxes			1,200,000
Net operating income			$1,800,000

2.

Using the above Segmented Income Statement, answer the following questions below:

a.

Calculate the estimate for the after-tax return on sales for the All-Weather Mat line if Carpeted Mats division is eliminated (round the percentage to two decimal places).

After-tax return on sales = %

b.

Based on the outcome in Question 2, Part a, the following can be concluded by Cathy (Select "Yes" for the statements that are applicable, else please select "No" from the below dropdowns.):

The All-Weather mat line is not earning the required return on sales.	- Select your answer -YesNoItem 24
The All-Weather mat line is easily earning the required return on sales.	- Select your answer -YesNoItem 25
ABC improves segmented reporting by more accurately measuring segment margins.	- Select your answer -YesNoItem 26
ABC has little value for segment reporting.	- Select your answer -YesNoItem 27
The Carpeted mat line needs immediate attention.	- Select your answer -YesNoItem 28

Summary Questions:

1.	The product margin is more accurately measured because many of the common fixed costs are assigned to product segments using - Select your answer -direct tracingdriver tracingallocationItem 29 .
2.	A traditional variable costing segmented income statement would understate the loss attributable to the carpeted mat line by $ .