Chapter 17, Problem 12E

Nutterco, Inc., produces two types of nut butter: peanut butter and cashew butter. Of the two, peanut butter is the more popular. Cashew butter is a specialty line using smaller jars and fewer jars per case. Data concerning the two products follow:

^aPractical capacity less expected usage (all unused capacity is permanent).

 ^bIn some cases, activity capacity must be purchased in steps (whole units). These steps are provided as necessary. The cost per step is the fixed activity rate multiplied by the step units. The fixed activity rate is the expected fixed activity costs divided by practical activity capacity.

Annual overhead costs are listed below. These costs are classified as fixed or variable with respect to the appropriate activity driver.

^aCosts associated with practical activity capacity. The machine fixed costs are all depreciation with direct labor hours as the driver.

     ^bThese costs are for the actual levels of the cost driver.

Required:

1. 1. Prepare a traditional segmented income statement, using a unit-level overhead rate based on direct labor hours. Using this approach, determine whether the cashew butter product line should be kept or dropped.
2. 2. Prepare an activity-based segmented income statement. Repeat the keep-or-drop analysis using an ABC approach.

To determine

Prepare a traditional segmented income statement of company N, under a unit-level overhead rate and state whether the cashew butter product line should be kept or dropped.

Explanation of Solution

Tactical decision making: Tactical decision making is a process in which the company can choose the correct alternative based on the profitability. In tactical decision making, offer price of a product is compared with the normal selling price and offer price less than the normal selling price of product is considered as the idle capacity for decision making.

Particulars	Peanut Butter (A) (1)	Cashew Butter (2) (B)	Total $\left(A+B\right)$
Revenues	$5,000,000	$800,000	$5,800,000
Less: variable expenses
Direct materials	2,500,000	480,000	2,980,000
Direct labor	500,000	80,000	580,000
Variable overhead	360,000	90,000	450,000
Contribution margin	$1,640,000	$150,000	$1,790,000
Less: Direct fixed expenses	$200,000	$60,000	$260,000
Product margin	$1,440,000	$90,000	$1,530,000
Less: Common fixed expenses			567,500 (4)
Segment margin			$962,500

Table (1)

Working note (1):

Compute the amounts of revenues and expenses of Peanut Butter:

Particulars	Costs per cases for Peanut butter (A)	Sales units (B)	Peanut Butter $\left(A\times B\right)$
Revenues	$100	50,000	$5,000,000
Less: variable expenses
Direct materials	$50	50,000	$2,500,000
Direct labor	$10	50,000	500,000
Variable overhead	$9 (2)	40,000	360,000

Table (2)

Working note (2):

Compute the variable overhead rate:

$\begin{array}{c}\text{Variable overhead rate}=\frac{\left(\begin{array}{l}\text{Direct labor benefits}+\\ \text{Variable machine overhead}\end{array}\right)}{\text{Direct labor hour}}\\ =\frac{\text{\$200,000}+\text{250,000}}{\text{40,000 hours}+\text{10,000 hours}}\\ =\$9\end{array}$

Working note (3):

Compute the amounts of revenues and expenses of Peanut Butter:

Particulars	Costs per cases for cashew butter (A)	Sales units (B)	Cashew Butter $\left(A\times B\right)$
Revenues	$80	10,000	$800,000
Less: variable expenses
Direct materials	$48	10,000	$480,000
Direct labor	$8	10,000	80,000
Variable overhead	$9 (2)	10,000	90,000

Table (3)

Working note (4):

Compute the common fixed expenses:

$\begin{array}{c}\text{Common fixed expenses}=\left(\begin{array}{l}\left[\text{Fixed cost of machine}+\text{Receiving}+\text{Packing}\right]\\ +\left[\text{Fixed cost of receiving}+\text{Packing}\right]\end{array}\right)\\ =\$200,000+\$200,000+\$100,000+\$22,500+\$45,000\\ =\$\text{567,500}\end{array}$

Therefore, the company should not drop the cashew butter because the segment margin is positive.

To determine

Prepare an activity-based segmented income statement of company N, under ABC approach and state whether the cashew butter product line should be kept or dropped.

Explanation of Solution

Prepare an activity-based segmented income statement of company N, under ABC approach and state whether the cashew butter product line should be kept or dropped as follows:

Particulars	Peanut Butter (A) (1)	Cashew Butter (2) (B)	Total $\left(A+B\right)$
Revenues	$5,000,000	$800,000	$5,800,000
Less: variable expenses
Direct materials	2,500,000	480,000	2,980,000
Direct labor	500,000	80,000	580,000
Variable overhead	360,000	90,000	450,000
Contribution margin	$1,640,000	$150,000	$1,790,000
Less: Traceable expenses
Advertising	$200,000	$60,000	$260,000
Receiving	115,000 (7)	57,500 (8)	172,500
Packing	80,000 (11)	40,000 (12)	120,000
Product margin	$1, 245,000	$(7,500)	$1,237,500
Less: Unused activity expenses			567,500
Receiving (13)			50,000
Packing (14)			25,000
Less: Machine depreciation expenses			(200,000)
Segment margin			$962,500

Table (4)

From the above calculation it is clear that dropping the cashew butter line is better because the product margin of the cashew butter is showing a negative margin of $7,500.

Working note (5):

Compute the fixed receiving rate:

$\begin{array}{c}\text{Fixed receiving rate}=\frac{\text{Fixed receiving costs}}{\left(\begin{array}{l}\text{Receiving order of peanut butter}\\ +\text{Cashew butter}+\text{Unusedcapacity}\end{array}\right)}\\ =\frac{\text{\$200,000}}{500+250+250}\\ =\$200\end{array}$

Working note (6):

Compute the variable receiving rate:

$\begin{array}{c}\text{Variable receiving rate}=\frac{\text{Variable receiving costs}}{\left(\begin{array}{l}\text{Receiving order of peanut butter}\\ +\text{Receiving order of Cashew butter}\end{array}\right)}\\ =\frac{\text{\$22,500}}{500+250}\\ =\$30\end{array}$

Working note (7):

Compute the receiving expenses of peanut butter:

$\begin{array}{c}\begin{array}{l}\text{Receiving expenses}\\ \text{of peanut butter}\end{array}\}=\left[\left(\begin{array}{l}\text{Fixed receiving }\\ \text{rate}\times \text{Receiving}\\ \text{order of peanut butter}\end{array}\right)+\left(\begin{array}{l}\text{Variable receiving }\\ \text{rate}\times \text{Receiving}\\ \text{order of peanut butter}\end{array}\right)\right]\\ =\left[\left(\text{\$200}\times \text{500}\right)+\left(\text{\$30}\times \text{500}\right)\right]\\ =\$115,000\end{array}$

Working note (8):

Compute the receiving expenses of cashew butter:

$\begin{array}{c}\begin{array}{l}\text{Receiving expenses}\\ \text{of cashew butter}\end{array}\}=\left[\left(\begin{array}{l}\text{Fixed receiving }\\ \text{rate}\times \text{Receiving order}\\ \text{of Cashew butter}\end{array}\right)+\left(\begin{array}{l}\text{Variable receiving }\\ \text{rate}\times \text{Receiving order}\\ \text{of Cashew butter}\end{array}\right)\right]\\ =\left[\left(\text{\$200}\times 250\right)+\left(\text{\$30}\times 2\text{50}\right)\right]\\ =\$57,500\end{array}$

Working note (9):

Compute the fixed packaging rate:

$\begin{array}{c}\text{Fixed packaging rate}=\frac{\text{Fixed packaging costs}}{\left(\begin{array}{l}\text{Packaging order of peanut butter}\\ +\text{Packaging order of Cashew}\\ \text{butter}+\text{Unusedcapacity}\end{array}\right)}\\ =\frac{\text{\$100,000}}{1,000+500+500}\\ =\$50\end{array}$

Working note (10):

Compute the variable packaging rate:

$\begin{array}{c}\text{Variable receiving rate}=\frac{\text{Variable packaging costs}}{\left(\begin{array}{l}\text{Packaging order of peanut butter}\\ +\text{Packaging order of Cashew butter}\end{array}\right)}\\ =\frac{\text{\$45,000}}{1,000+500}\\ =\$30\end{array}$

Working note (11):

Compute the packaging expenses of peanut butter:

$\begin{array}{c}\begin{array}{l}\text{Packing expenses}\\ \text{of peanut butter}\end{array}\}=\left[\left(\begin{array}{l}\text{Fixed packing rate}\times \text{Packing}\\ \text{order of peanut butter}\end{array}\right)+\left(\begin{array}{l}\text{Variable packing rate}\times \text{Packing}\\ \text{order of peanut butter}\end{array}\right)\right]\\ =\left[\left(\text{\$50}\times 1,0\text{00}\right)+\left(\text{\$30}\times 1,0\text{00}\right)\right]\\ =\$80,000\end{array}$

Working note (12):

Compute the packaging expenses of cashew butter:

$\begin{array}{c}\begin{array}{l}\text{Packing expenses}\\ \text{of cashew butter}\end{array}\}=\left[\left(\begin{array}{l}\text{Fixed packing rate}\\ \times \text{Packing order of}\\ \text{Cashew butter}\end{array}\right)+\left(\begin{array}{l}\text{Variable packing rate}\times \\ \text{Packing order of Cashew butter}\end{array}\right)\right]\\ =\left[\left(\text{\$50}\times 500\right)+\left(\text{\$30}\times \text{500}\right)\right]\\ =\$40,000\end{array}$

Working note (13):

Compute the unused receiving expenses:

$\begin{array}{c}\begin{array}{l}\text{Unused receiving}\\ \text{expenses}\end{array}\}=\left[\left(\begin{array}{l}\text{Fixed receiving rate}\times \text{Unused}\\ \text{receiving capacity}\end{array}\right)\right]\\ =\left(\text{\$200}\times 250\right)\\ =\$50,000\end{array}$

Working note (14):

Compute the unused packing expenses:

$\begin{array}{c}\begin{array}{l}\text{Unused activity}\\ \text{expenses}\end{array}\}=\left[\left(\begin{array}{l}\text{Fixed packing rate}\times \text{Unused}\\ \text{packing capacity}\end{array}\right)\right]\\ =\left(\text{\$50}\times \text{500}\right)\\ =\$25,000\end{array}$