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Despite the fact that, based on the 25% mark-on, product A was the first to be dropped, the item maintains the highest contribution rate due to its increased retail price.
4.
If the company wants to trace all variable costs to its product accurately, the allocation methodology that uses labor hours could be used. This type of estimate will come up with a dollar rate per labor hour and then the average variable cost per unit can be evaluated, depending on the number of labor hours used to manufacture the product. In this case, for example, for each of the products A through D. there is a certain number of hours that is used to manufacture the product (6, 1, 3 and 2 respectively). The overhead cost per hour is calculated by dividing the variable overhead by the total number of hours. The variable cost per unit according to this method is calculated by multiplying this constant by the total number of hours per product to arrive at a variable cost per unit.
Using the same methodology to calculate the fixed overhead per unit would significantly lower this, since the variable cost has been calculated in the method previously presented. With this, there is only a $3.75 per unit, significantly lower than previously. With the new method, the final results show that all four products will be profitable. According to the new methodology, there are several conclusions worth mentioning: (1) the mark on is closer to a 20-25% value rather than previously and (2) two products that were formerly very profitable are now below the 25% threshold (products B. And D).
5. According to the calculations in the Excel (last lines), dividing the costs...
would have an allocation rate of 6.07 and that products C. And D. would have an allocation rate of 7.5.
6. The main condition for direct labor hours to accurately allocate Premier's indirect costs to its four products would be for the employees to be using all the respective utilities associated with fixed costs during the analyzed period and for the product portfolio. At the same time, this would probably not work for large bulks of standardized products where it is more difficult to differentiate accurately the cost allocation between different products.
This type of cost allocation is referred to as Activity-Based Cost. With activity-based cost, the accountant determines the different types of activity that are used to create a certain product and then differentiate between the way resources (of all types, either fixed or variable) are allocated and the way that resources are consumed for each particular activity involved in the production phase.
References:
2009, Contribution Margin -- An Example, Dynamic Business Plan, http://www.dynamicbusinessplan.com/answer.asp?ID=20 last accessed on May 19, 2009
2009, Investopedia, http://www.investopedia.com last accessed on May 19, 2009
Cliff Notes. (2009). Cost behavior. Retrieved on March 1, 2009 from http://www.cliffsnotes.com/WileyCDA/CliffsReviewTopic/Cost-Behavior.topicArticleId-21248,articleId-21228.html
White, M. (2006). Management accounting. Retrieved on March 1, 2009 from http://www.middlecity.com/ch16.shtml
Tarr, J.D. (2004). Activity-based costing in the information age. Retrieved on March 1, 2009 from http://www.theacagroup.com/activitybasedcosting.htm
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