CC manufactures three bicycle models, a racing bike, a mountain bike, and a children's bike. The racing model (RM) is made of a titanium-aluminum alloy. The mountain bike (MB) is made of aluminum. The children's bike (CB) is steel framed. Because of the different materials used, production processes differ significantly among models 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, CC allocates overhead on the basis of machine hours. Last year, CC produced 1,000 RM, 2,000 MB, and 5,000 CB and had the following revenues and expenses:

CC

Income Statement

RM

MB

CB

Total

Sales revenue

$ 380,000

$ 560,000

$ 475,000

$ 1,415,000

Direct Costs:

Direct materials

150,000

240,000

200,000

590,000

Direct labor

14,400

24,000

54,000

92,400

Variable overhead

Machine setup

?

?

?

26,000

Order processing

?

?

?

64,000

Warehousing costs

?

?

?

93,000

Energy to run machines

?

?

?

42,000

Shipping

?

?

?

36,000

Total Variable costs

943,400

Contribution margin

471,600

Fixed overhead

Plant administration

88,000

Other fixed overhead

140,000

Gross profit

$ 243,000

The Chief Financial Officer (CFO) of CC hired a consultant to recommend cost allocation bases. The consultant recommended the following:

ACTIVITY LEVEL

Activity

Cost Driver

RM

MB

CB

1. Machine setup

Number of production runs

22

34

44

2. Sales order processing

Number of sales orders received

400

600

600

3. Warehousing costs

Number of units held in inventory

200

200

400

4. Energy

Machine Hours

10,000

16,000

24,000

5. 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:

1. Using machine hours to allocate production overhead, complete the income statement for CC. Do not attempt to allocate plant administration or other fixed overhead costs.

2. Complete the income statement using the bases recommended by the consultant.

3. How might activity-based costing result in better decisions by CC's management.

4. After hearing the consultant's recommendations, the CFO decided to adopt activity based costing but expressed concern about not allocating some of the overhead to the products (plant administration and other fixed overhead costs). 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?

CASE No. 1 CC manufactures three bicycle models, a racing bike, a mountain bike, and a children's bike. The racing model (RM) is made of a titanium-aluminum alloy. The mountain bike (MB) is made of aluminum. The children's bike (CB) is steel framed. Because of the different materials used, production processes differ signicantly among models 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, CC allocates overhead on the basis of machine hours. Last year, CC produced 1,000 RM, 2,000 MB, and 5,000 CB and had the following revenues and expenses: CC Income Statement RM MB CB Total Sales revenue 3; 380,000 5' 560,000 $ 475,000 3 1,415,000 Direct Costs: Direct materials 150,000 240,000 200,000 590,000 Direct labor 14,400 24,000 54,000 92,400 Variable overhead Machine setup 9 ? '3 26,000 Order processing '3' ? '3' 64,000 Warehousing costs 5" '? '3' 93,000 Energy to run machines 5' '? '? 42,000 Shipping ? Z? '? 56,000 Total Variable costs w Contribution margin 471,600 Fixed overhead Plant administration 88,000 Other xed overhead Gross prot SLABM The Chief Financial Ofcer (CFO) of CC hired a consultant to recommend cost allocation bases. The consultant recommended the following: ACTIVITY LEVEL Activity Cost Driver RM MB CB 1. Machine setup Number of production runs 22 34 44 2. Sales order processing Number of sales orders received 400 600 600 3. Warehousing costs Number of units held in inventory 200 200 400 4. Energy Machine Hours 10,000 16,000 24,000 5. 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. R_equired: 1. Using machine hours to allocate production overhead, complete the income statement for CC. Do not attempt to allocate plant administration or other xed overhead costs. 2. Complete the income statement using the bases recommended by the consultant. 3. How might activity-based costing result in better decisions by CC's management. 4. After hearing the consultant's recommendations, the CFO decided to adopt activity based costing but expressed concern about not allocating some of the overhead to the products (plant administration and other xed overhead costs). 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