Part I
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 $255 480 180
Variable costs per unit
Direct material 100 280 40
Direct labor 60 60 60
Variable overhead 25 40 20
Variable selling and admin. exp. 10 13 9
Fixed costs
Fixed manufacturing overhead 200,000
Fixed selling and administrative 100,000
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.
Herrestad Company
Segmented Income Statement for the period ending Dec. 31, 2015
A B Total
Sales $960,000 $1,080,000 $2,040,000
Variable costs:
Direct material 560,000 240,000 800,000
Part II
Differential analysis involves knowing which costs are relevant, i.e. future costs that vary among alternatives. It is important to know what information to use and not just how to execute the analysis.
Herrestad Company receives an offer to make a new product, called C, for a new customer. The customer wants to buy 1,000 units. Product C has the same cost structure as product B with three exceptions. The new customer is only willing to pay $150 per unit, direct materials costs will decrease by $12 per unit and Herrestad does not have to incur any variable selling and administrative expenses.
Make a list of the expenses and amounts that are relevant for this decision. How much will the sale of this product contribute to the profitability of Herrestad?
What if the company only pays $140 per unit? How does this change the contribution towards profitability?
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