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# Allocation of Fixed Costs: Herrestad Company

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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
Total Prod A Prod B
Beginning inventory 0
Units produced 10,000 2,500 7,500
Units sold 8,000 2,000 6,000

Selling price per unit \$250 460 180
Variable costs per unit
Direct material 100 280 40
Direct labor 50 50 50
Variable selling and admin. exp. 10 13 9

Fixed costs

Production runs (not \$) 100 65 35
Number of sales reps (not \$) 25 15 10
Here 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.

Segmented Income Statement
For the period ending Dec. 31, 2011
A B Total
Sales \$920,000
\$1,080,000 \$2,000,000
Variable costs:
Direct material 560,000 240,000 800,000

#### Solution Preview

See attached for proper formatting:

Discussion:

The Herrestad Company has a classic problem: two product that use fixed overhead disproportionately. That is, according to the data given, in Table A below, product A uses more production runs and more sales reps than product B. And there are far fewer units of Product A, meaning that each unit requires a great deal of overhead resources to support. Granted, the sales price of Product A is high and therefore one might think that they are charging enough to carry all this extra overhead attention. But profitability analysis indicates otherwise.

Table A
Use of fixed overhead resources by product line

Total Prod A Prod B
Production runs (not \$) 100.00 65.00 35.00
Number of sales reps (not \$) 25.00 15.00 10.00

Profitability will be reviewed in two parts, first we will analyze the contribution margin, and then product line profitability overall, including fixed costs. Contribution margin is the sales price less the variable costs, that is, the costs that go up with each extra ...

#### Solution Summary

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Your discussion is 588 words including three tables to support the discussion. The computations are in excel (click in cells to see calculations) with some coaching notes on allocating fixed costs. Remember this is to give you ideas to start your own paper and not to be used as a "turn in ready" project. Academic Experts are expressly forbidden to write student papers.

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