Question

Problem 5-17 (Algo) Comparing Traditional and Activity-Based Product Margins [LO5-1, LO5-3, LO5-4, LO5-5]

Smoky Mountain Corporation makes two types of hiking boots—the Xtreme and the Pathfinder. Data concerning these two product lines appear below:

	Xtreme	Pathfinder
selling price per unit	$120	$87
direct materials per unit	$65.20	$51
direct labor per unit	$11.20	$8
direct labor-hours per unit	1.4 DLHs	1.0 DLHs
estimated annual production and sales	30,000 units	65,000 units

The company has a traditional costing system in which manufacturing overhead is applied to units based on direct labor-hours. Data concerning manufacturing overhead and direct labor-hours for the upcoming year appear below:

estimated total manufacturing overhead	$2,033,000
estimated total direct labor-hours	107,000 DLHs

Required:

1. Compute the product margins for the Xtreme and the Pathfinder products under the company’s traditional costing system.

2. The company is considering replacing its traditional costing system with an activity-based costing system that would assign its manufacturing overhead to the following four activity cost pools (the Other cost pool includes organization-sustaining costs and idle capacity costs):

	estimated		expected activity
activities and activity measures	overhead cost	extreme	Pathfinder	total
supporting direct labor (direct labor-hours)	631,300	42,000	65,000	107,000
batch setups	876,000	410	320	730
product sustaining (number of products)	460,000	1	1	2
other	65,700	NA	NA	NA
total manufacturing overhead cost	$2,033,000

Compute the product margins for the Xtreme and the Pathfinder products under the activity-based costing system.

3. Prepare a quantitative comparison of the traditional and activity-based cost assignments.

Required 1

	Xtreme	pathfinder	total
product margin

Required 2

	Xtreme	pathfinder	total
product margin

Required 3

	Xtreme		Pathfinder		Total
		% of		% of
	amount	total amount	amount	total amount	amount
traditional cost system
		%		%
		%		%
		%		%
total cost assigned to products
	Xtreme		Pathfinder		total
		% of		% of
	amount	total amount	amount	total amount	amount
activity-based costing system
direct:
		%		%
		%		%
Indirect costs:
		%		%
		%		%
		%		%
Total cost assigned to products
costs not assigned to products
total costs

Answer 1

Solution 1:

Overhead Allocation - Traditional Costing System
Particulars	Xtreme	Pathfinder	Total
Estimated annual Production (In units)	30000	65000
Direct Labour Hours Per unit	1.4	1
Total Direct Labour Hours	42000	65000	107000
Overhead Cost Allocation basis direct labour hours (Overhead / Total hours * Labor hours of model)	$798,000.00	$1,235,000.00	$2,033,000.00
Manufacturing overhead cost per unit (Allocated Overhead / Nos of units)	$26.60	$19.00

Computation of Product Margin - Traditional Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	$120.00	$87.00
Direct material per unit	$65.20	$51.00
Direct labor per unit	$11.20	$8.00
Manufacturing overhead cost per unit	$26.60	$19.00
Product Margin per unit	$17.00	$9.00
Nos of units sold	30000	65000
Total Margin (Product margin per unit * Nos of unit sold)	$510,000.00	$585,000.00	$1,095,000.00

Solution 2:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	Xtreme		Pathfinder
					Usage	Allocated Costs	Usage	Allocated Costs
Supporting direct labor cost	$631,300.00	Direct Labor hours	107000	$5.90	42000	$247,800.00	65000	$383,500.00
Batch Setups	$876,000.00	Setups	730	$1,200.00	410	$492,000.00	320	$384,000.00
Product sustaining	$460,000.00	Number of products	2	$230,000.00	1	$230,000.00	1	$230,000.00
Other	$65,700.00	No allocation
Total	$2,033,000.00					$969,800.00		$997,500.00
Nos of units						30000		65000
Allocated overhead per unit						$32.33		$15.35

Computation of Product Margin - Activity based Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	$120.00	$87.00
Direct material per unit	$65.20	$51.00
Direct labor per unit	$11.20	$8.00
Allocated Manufacturing overhead cost per unit	$32.33	$15.35
Product Margin per unit	$11.27	$12.65
Nos of units sold	30000	65000
Total Margin (Product margin per unit * Nos of unit sold)	$338,200.00	$822,500.00	$1,160,700.00

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	Xtreme		Pathfinder		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	$1,956,000.00	37.1%	$3,315,000.00	62.9%	$5,271,000.00
Direct Labor Cost	$336,000.00	39.3%	$520,000.00	60.7%	$856,000.00
Manufacturing Overhead cost	$798,000.00	39.3%	$1,235,000.00	60.7%	$2,033,000.00
Total Cost assigned to Product	$3,090,000.00		$5,070,000.00		$8,160,000.00

Quantity comparison of Activity Based cost assignment
Particulars	Xtreme		Pathfinder		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Cost:
Direct Material Cost	$1,956,000.00	37.1%	$3,315,000.00	62.9%	$5,271,000.00
Direct Labor Cost	$336,000.00	39.3%	$520,000.00	60.7%	$856,000.00
Indirect Cost:
Supporting direct labor cost	$247,800.00	39.3%	$383,500.00	60.7%	$631,300.00
Batch Setups	$492,000.00	56.2%	$384,000.00	43.8%	$876,000.00
Product sustaining	$230,000.00	50.0%	$230,000.00	50.0%	$460,000.00
Total Cost Assigned to Products	$3,261,800.00		$4,832,500.00		$8,094,300.00
Cost not assigned to products:
Others					$65,700.00
Total Cost					$8,160,000.00