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Activity-Based Costing for Overhead Allocation
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Cost Accounting: Apply Target Net Income to Two Products

After you compute the breakeven points on two products, you can decide on target net income for the period. Assume that you sell Pristine and Sturdy wood. Pristine wood sells for $50 per unit and variable costs are $30 per unit; Sturdy wood sells for $25 per unit and variable costs are $18 per unit. Your target net income for both types of wood is $10,000. You target a $5,000 profit for each product type.

Pristine wood’s calculation is

$5,000 = sales – variable costs – fixed costs
$5,000 = (units x $50) – (units x $30) – $30,000
$5,000 = units x $20 – $30,000

Finish the calculation, and you see that it takes 1,750 units of Pristine wood to reach target net income of $5,000.

For Sturdy wood, plug in the variables. You need to sell 4,286 units to reach target net income.

The total profit for both products is $10,000 ($5,000 + $5,000).

If one product’s sales are lower than planned, you can still reach your target net income. Higher sales in one product can make up for lower sales in another product.

For example, say the economy is bad, and customers aren’t eager to buy Pristine wood, so you sell only 1,600 units. The profit calculation is

Profit = $50 x (1,600) – $30 x (1,600) – $30,000
Profit = $80,000 – $48,000 – $30,000
Profit = $2,000

Your target net income for Pristine wood is $5,000, so you’re $3,000 short of your goal. To reach your total target net income, maybe you can shift that $3,000 profit “burden” to Sturdy wood.

To determine how much more you need to sell, just change the Sturdy wood profit to $8,000, and compute the new number of units sold:

$8,000 = (units x $25) – (units x $18) – $25,000
$8,000 = units x $7 – $25,000

Finish the calculation. The number of units to reach your profit goal is $33,000 divided by $7. Therefore, if you sell 4,715 units of Sturdy wood, you generate $8,000. Your total target net income of $10,000 is based on $2,000 from Pristine wood and $8,000 from Sturdy wood.

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