Question

Problem 7-16 Comparing Traditional and Activity-Based Product Margins [LO7-1, LO7-3, LO7-4, LO7-5]

Hi-Tek Manufacturing, Inc., makes two types of industrial component parts—the B300 and the T500. An absorption costing income statement for the most recent period is shown:

Hi-Tek Manufacturing Inc. Income Statement
Sales	$	1,710,000
Cost of goods sold		1,227,029
Gross margin		482,971
Selling and administrative expenses		600,000
Net operating loss	$	(117,029	)

Hi-Tek produced and sold 60,300 units of B300 at a price of $20 per unit and 12,600 units of T500 at a price of $40 per unit. The company’s traditional cost system allocates manufacturing overhead to products using a plantwide overhead rate and direct labor dollars as the allocation base. Additional information relating to the company’s two product lines is shown below:

	B300		T500		Total
Direct materials	$	400,900	$	162,100	$	563,000
Direct labor	$	120,700	$	42,200		162,900
Manufacturing overhead						501,129
Cost of goods sold					$	1,227,029

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $59,000 and $102,000 of the company’s advertising expenses could be directly traced to B300 and T500, respectively. The remainder of the selling and administrative expenses was organization-sustaining in nature. The ABC team also distributed the company’s manufacturing overhead to four activities as shown below:

	Manufacturing Overhead			Activity
Activity Cost Pool (and Activity Measure)				B300	T500	Total
Machining (machine-hours)	$	212,809		90,700	62,400	153,100
Setups (setup hours)		126,720		78	210	288
Product-sustaining (number of products)		100,600		1	1	2
Other (organization-sustaining costs)		61,000		NA	NA	NA
Total manufacturing overhead cost	$	501,129

Required:

1. Compute the product margins for the B300 and T500 under the company’s traditional costing system.

2. Compute the product margins for B300 and T500 under the activity-based costing system.

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

Answer 1

Solution 1:

Predetermined overhead rate = Estimated overhead / Estimated direct labor dollar

= $501,129 / $162,900 = $3.08 per direct labor dollar

Computation of Product Margin - Traditional Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,300*$20, T500 - 12600*$40)	$1,206,000	$504,000	$1,710,000
Direct material	$400,900	$162,100	$563,000
Direct labor	$120,700	$42,200	$162,900
Manufacturing overhead (Direct labor * $3.08)	$371,756	$129,976	$501,732
Product Margin	$312,644	$169,724	$482,368

Solution 2:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	B300		T500
					Usage	Allocated Costs	Usage	Allocated Costs
Machining	$212,809.00	Machine hours	153100	$1.39	90700	$126,073.00	62400	$86,736.00
Setups	$126,720.00	Setup hours	288	$440.00	78	$34,320.00	210	$92,400.00
Product sustaining	$100,600.00	Number of products	2	$50,300.00	1	$50,300.00	1	$50,300.00
Other	$61,000.00	No allocation
Total	$501,129.00					$210,693.00		$229,436.00

Computation of Product Margin - Activity based Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,300*$20, T500 - 12600*$40)	$1,206,000	$504,000	$1,710,000
Direct material	$400,900	$162,100	$563,000
Direct labor	$120,700	$42,200	$162,900
Allocated Manufacturing overhead	$210,693.00	$229,436.00	$440,129
Advertising Expense	$59,000.00	$102,000.00	$161,000.00
Product Margin	$414,707.00	-$31,736.00	$382,971.00

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	$400,900	71.2%	$162,100	28.8%	$563,000
Direct Labor Cost	$120,700	74.1%	$42,200	25.9%	$162,900
Manufacturing Overhead cost	$371,756	74.1%	$129,976	25.9%	$501,732
Total cost assigned to products	$893,356		$334,276		$1,227,632
Total cost not assigned to product:
Selling and administrative Expenses					$600,000.00
Total Cost					$1,827,632

Quantity comparison of Activity Based cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Cost:
Material Cost	$400,900	71.2%	$162,100	28.8%	$563,000
Labor Cost	$120,700	74.1%	$42,200	25.9%	$162,900
Advertising Expense	$59,000	36.6%	$102,000	63.4%	$161,000
Indirect Cost:
Machining	$126,073	59.2%	$86,736	40.8%	$212,809
Setups	$34,320	27.1%	$92,400	72.9%	$126,720
Product sustaining	$50,300	50.0%	$50,300	50.0%	$100,600
Total Cost Assigned to Products	$791,293		$535,736		$1,327,029
Cost not assigned to products:
Manufacturing					$61,000
Selling and administrative					$439,000
Total Cost					$1,827,029