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    Choosing an Activity-Based Costing System

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    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 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:

    Income Statement

    Given Data P09-39:

    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

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

    Recommended cost allocation bases:
    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.


    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 Motorcycles' management?
    d. 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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    Solution Preview

    Dear student,
    A & B -see excel sheet

    C. Activity based costing system helps in better decisions as it scientifically allocates the costs on the basis of resources consumed for each activity instead of applying ...

    Solution Summary

    The expert examines choosing an activity-based costing systems.