Venus Creations sells window treatments (shades, blinds, and awnings) to both commercial and residential customers. The following information relates to its budgeted operations for the current year. Commercial Residential
Revenues $300,000 $480,000
Direct materials costs $30,000 $50,000
Direct labor costs 100,000 300,000
Overhead costs 85,000 215,000 150,000 500,000
Operating income (loss) $85,000 $(20,000)
The controller, Peggy Kingman, is concerned about the residential product line. She cannot understand why this line is not more profitable given that the installations of window coverings are less complex for residential customers. In addition, the residential client base resides in close proximity to the company office, so travel costs are not as expensive on a per client visit for residential customers. As a result, she has decided to take a closer look at the overhead costs assigned to the two product lines to determine whether a more accurate product costing model can be developed. Here are the three activity cost pools and related information she developed:
Activity Cost Pools Estimated Overhead Cost Drivers
Scheduling and travel $85,000 Hours of travel
Setup time 90,000 Number of setups
Supervision 60,000 Direct labor cost
Expected Use of Cost Drivers per Product
Commercial Residential

Scheduling and travel 750 500
Setup time 350 250
What should Peggy Kingman do?

Answer and Explanation:

The explanation is shown below:-

First we need to find out the activity based overhead rates

Activity              Estimated overhead  Basis   Quantity   Activity based

                              cost                                                      overhead rates

Travel

and Scheduling     $85,000           Hours of  1,250             $68

                                                         travel  (700 + 500)

Set up time          $90,000           Number of   600             $150

                                                       setups  (350 + 250)

Supervision          $60,000          Direct labor  $400,000    15%

                                                        cost ($100,000 + $300,000)

Now we need to find out the overhead cost assigned to commercial which is shown below:-

Activity           Activity based       Actual allocation of         Overhead

                    overhead rates              cost drivers                 assigned

Travel and

Scheduling      $68                           750                               $51,000

Set up time       $150                         350                              $52,500

Supervision     15%                        $100,000                        $15,000

Total                                                                                        $118,500

For computing the overhead assigned we simply multiply the activity based overhead rate with actual allocation of cost drivers.

after this we need to find out the overhead cost assigned to residential which is shown below:-

Activity           Activity based       Actual allocation of         Overhead

                    overhead rates              cost drivers                

Travel and

Scheduling      $68                             500                             $34,000

Set up time     $150                            250                              $37,500

Supervision    15%                             $300,000                     $45,000

Total                                                                                          $116,500

For computing the overhead we simply multiply the activity based overhead rate with actual allocation of cost drivers.

Finally we need to find out the operating income or loss for the commercial and residual which is shown below:-

Particulars                              Commercial           Residential

Sales revenue                        $300,000             $480,000

Less: Direct material cost     $30,000                 $50,000

Less: Direct labor cost          $100,000              $300,000

Less: Overhead costs

assigned                                $118,500               $116,500

Operating income (loss)        $51,500               $15,500

The Peggy Kingman should establish the cost to be assigned based on the product lines for overhead cost as the Peggy Kingman is more focused to the overhead cost which were based on the activity cost drivers. Moreover, it shows a profit earned on residential product line