Essays on Alloation and Fixed Costs SLP Admission/Application Essay

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Herrestad Company Segmented Income ment For the period ending December 31, Product A Product B Total Sales 080,000 320,000 $2,400,000Variable Cost   Direct material $(540,000) $(420,000) $(960,000)   Direct labor $(120,000) $(360,000) $(480,000)   Variable overhead $(170,000) $(150,000) $(320,000)   Variable selling and admin. exp. $(26,000) $(54,000) $(80,000) Total Variable Cost $(856,000) $(984,000) $(1,840,000) Contribution Margin $224,000 $336,000 $560,000 Fixed Costs   Fixed manufacturing overhead $(187,500) $(62,500) $(250,000)   Fixed selling and administrative $(66,667) $(33,333) $(100,000) Total Fixed Cost $(254,167) $(95,833) $(350,000) Net Income / (loss) $(30,167) $240,167 $210,000 The segmented income statement of Herrestad Company shows a net income of $210,000. The segment income statement is usually prepared by the management in order to identify which segment, department or product of the company is performing profitably and which is not.

As evident from the above income statement, the product B sold by the company is quite lucrative as it generates a net income of $240,167 during the period. The products contribution margin to sales ratio is 25% and its net income to sales ratio is 18%. However, the net income generated by the product B is offset by the loss making product A of the company which has shown a net loss of $ 30,167. The product A shows a contribution margin to sales ratio of 21%, but due to its higher allocated fixed cost, which is about 73% of the total fixed cost of the company, the product represents a net loss.

The company has currently implemented Activity based costing (ABC) which allocates the overhead cost on the basis of related activity that particular activity pertains to. The Production runs for Product A is 3 times higher as compared to the product run for Product B. Similarly the number of sales representative for Product A is 20 which is twice as much as Product B. Based on these facts the allocated fixed overhead expenses to Product A is 2.65 times higher as that compared of Product B. There are several through which the profitability of the company can be increased.

The company should put additional efforts on increasing the sales of the product A so as to turn the net loss into net income. In order to break even, the company needs to sell 2,056 units at the current selling price which will make the total revenue from product A to about $1,110,167. But at the same time the company should put into consideration that fixed overhead selling and administrative cost remains the same while trying to boost up the sales. References [1] Harold Averkamp “Activity Based Costing” accountingcoach. com”.

Accounting Coach, web, n.d. Web. 19th August 2011. [2] Daniel Richards “How to do a break even analysis” entrepreneurs. about. com”. About. com, n.d. Web. 19th August 2011.

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