The Kiddo Company manufactures and ships children’s stuffed animals. The following are profit reports for the company’s two lines of business (amounts in thousands):
Stock Custom
Sales $7,500 $5,000
Less direct costs 2,500 4,000
Less allocated costs 3,375 1,125
Net Income (loss) $1,625 ($125)
Direct costs are costs that are easily traceable to each line of business. These include direct materials, direct labor, and variable manufacturing overhead. Allocated costs are costs that are not directly traceable to each line of business. These include factory rent, maintenance department costs, factory insurance, and factory supervisor salaries.
At the start of 2019, allocated costs were estimated as follows (amounts in thousands):
Factory rent $2,000
Maintenance department $1,200
Factory insurance $800
Supervisor pay $500
In the past, allocations have been based on headcount. There are 240 employees in Stock and 80 employees in Custom. The company is shifting to an ABC costing system and has determined that the appropriate cost drivers are:
Allocated Cost Cost Driver
Factory rent Sq. feet/floor space
Maintenance Machine hours
Factory insurance Sq. feet/floor space
Supervisor pay Headcount
Stock has 13,000 square feet of floor space. Custom has 7,000 square feet of floor space. Stock uses 380 machine hours. Custom uses 620 machine hours.
a. Prepare new profit reports below using ABC. Use the format below.
b. In this example, which line of business benefits from using ABC and by how much?
c. What are the advantages and disadvantages of using ABC to allocate overhead costs rather than the traditional method of using only one cost driver?
Stock Custom
Sales
Less direct costs
Less allocated costs
Net Income (loss)