Question

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 $ 1,774,100 Cost of goods sold 1,232,931 Gross margin 541,169 Selling and administrative expenses 640,000 Net operating loss $ (98,831 ) Hi-Tek produced and sold 60,100 units of B300 at a price of $21 per unit and 12,800 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 $ 400,100 $ 163,000 $ 563,100 Direct labor $ 120,400 $ 42,800 163,200 Manufacturing overhead 506,631 Cost of goods sold $ 1,232,931 The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $58,000 and $108,000 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) $ 208,651 90,000 62,300 152,300 Setups (setup hours) 136,080 74 250 324 Product-sustaining (number of products) 101,000 1 1 2 Other (organization-sustaining costs) 60,900 NA NA NA Total manufacturing overhead cost $ 506,631 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

1. Overhead allocation rate under traditional costing system = total manufacturing overheads*Labor cost consumed/total direct Labor dollars

Allocated to B300 = 506*631*120,400/163,200

=$373,765

Allocated to T500 = 506,631*42,800/163,200

= $132,866

Calculation of product margin:

	B300	T500
Sales	1,262,100	512,000
Direct Material	400,100	163,000
Direct Labor	120,400	42,800
Manufacturing overhead	373,765	132,866
Product Margin	367,835	173,334

2. Using ABC

Overhead allocation = overhead cost*driver consumed/total activity

Calculation of Product margin

	B300	T500
Sales	1,262,100	512,000
Direct Material	400,100	163,000
Direct Labor	120,400	42,800
Overheads:
Machining	123,300	85,351
Set up	31,080	105,000
Product sustaining	50,500	50,500
Product Margin	536,720	65,349

3. Quantitative comparison

	B300	T500
Product Margin as per traditional	367,835	173,334
As per ABC	563,720	65,349
Difference	(195,885)	107,985