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Choosing an Activity-Based Costing System
MTI makes three types of lawn tractors: M3100, M4100, and M6100. In the past, it allocated overhead to products using machine-hours. Last year, the company produced 10,000 units of M3100, 17,500 units of M4100, and 10,000 units of M6100 and had the following revenues and costs:
MTI
Income Statement

M3100
M4100
M6100
Total
Sales
$9,000,000
$15,000,000
$13,500,000
$37,500,000
Direct costs

Direct materials
3,000,000
4,500,000
3,300,000
10,800,000
Direct labor
600,000
900,000
1,800,000
3,300,000
Variable overhead

Setting up machines

2,400,000
Processing sales orders

1,800,000
Warehousing

2,400,000
Operating machines

1,200,000
Shipping

900,000
Contribution margin

$14,700,000
Plant administration

6,000,000
Gross profit

$ 8,700,000
MTI’s controller has heard about activity-based costing and puts together an employee team to recommend cost allocation bases. The employee team recommends the following:
Activity
Cost Driver
M3100
M4100
M6100
Setting up machines
Production runs
10
20
20
Processing sales orders
Sales orders received
180
400
220
Warehousing
Units held in inventory
100
200
100
Operating machines
Machine-hours
6,000
9,000
10,000
Shipping
Units shipped
10,000
17,500
10,000
The employee team recommends that plant administration costs not be allocated to products.
Required
a. Using machine-hours to allocate overhead, complete the income statement for MTI. Do not allocate plant administrative costs to products.
b. Complete the income statement using the activity-based costing method suggested by the employee team.
c. Write a brief report indicating how activity-based costing might result in better decisions by MTI.
d. After hearing the recommendations, the president expresses concern about failing to allocate plant administrative costs. If plant administrative costs were to be allocated to products, how would you allocate them?

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