Question

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

Mercer Asbestos Removal Company removes potentially toxic asbestos insulation and related products from buildings. There has been a long-simmering dispute between the company’s estimator and the work supervisors. The on-site supervisors claim that the estimators do not adequately distinguish between routine work, such as removal of asbestos insulation around heating pipes in older homes, and nonroutine work, such as removing asbestos-contaminated ceiling plaster in industrial buildings. The on-site supervisors believe that nonroutine work is far more expensive than routine work and should bear higher customer charges. The estimator sums up his position in this way: “My job is to measure the area to be cleared of asbestos. As directed by top management, I simply multiply the square footage by $3.60 to determine the bid price. Since our average cost is only $2.775 per square foot, that leaves enough cushion to take care of the additional costs of nonroutine work that shows up. Besides, it is difficult to know what is routine or not routine until you actually start tearing things apart.” To shed light on this controversy, the company initiated an activity-based costing study of all of its costs. Data from the activity-based costing system follow: Activity Cost Pool Activity Measure Total Activity Removing asbestos Thousands of square feet 800 thousand square feet Estimating and job setup Number of jobs 400 jobs Working on nonroutine jobs Number of nonroutine jobs 100 nonroutine jobs Other (organization-sustaining costs and idle capacity costs) None Note: The 100 nonroutine jobs are included in the total of 400 jobs. Both nonroutine jobs and routine jobs require estimating and setup. Costs for the Year Wages and salaries $ 480,000 Disposal fees 882,000 Equipment depreciation 108,000 On-site supplies 68,000 Office expenses 380,000 Licensing and insurance 580,000 Total cost $ 2,498,000 Distribution of Resource Consumption Across Activities Removing Asbestos Estimating and Job Setup Working on Nonroutine Jobs Other Total Wages and salaries 50 % 15 % 20 % 15 % 100 % Disposal fees 70 % 0 % 30 % 0 % 100 % Equipment depreciation 40 % 5 % 20 % 35 % 100 % On-site supplies 70 % 20 % 10 % 0 % 100 % Office expenses 15 % 35 % 20 % 30 % 100 % Licensing and insurance 30 % 0 % 50 % 20 % 100 % Required: 1. Perform the first-stage allocation of costs to the activity cost pools. 2. Compute the activity rates for the activity cost pools. 3. Using the activity rates you have computed, determine the total cost and the average cost per thousand square feet of each of the following jobs according to the activity-based costing system. a. A routine 1,000-square-foot asbestos removal job. b. A routine 2,000-square-foot asbestos removal job. c. A nonroutine 2,000-square-foot asbestos removal job.

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	$	2,156,000
Estimated total direct labor-hours		107,800	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):

Answer 1

Solution 1:

First stage allocation of cost to activity cost pools
Particulars	Total Cost	Removing Asbestos		Estimating and Job Setup		Working on non routine job		Others
		%	Amount	%	Amount	%	Amount	%	Amount
Wages & Salaries	$480,000.00	50%	$240,000.00	15%	$72,000.00	20%	$96,000.00	15%	$72,000.00
Disposal Fees	$882,000.00	70%	$617,400.00	0%	$0.00	30%	$264,600.00	0%	$0.00
Equipment depreciation	$108,000.00	40%	$43,200.00	5%	$5,400.00	20%	$21,600.00	35%	$37,800.00
On Site Supplies	$68,000.00	70%	$47,600.00	20%	$13,600.00	10%	$6,800.00	0%	$0.00
Office Expenses	$380,000.00	15%	$57,000.00	35%	$133,000.00	20%	$76,000.00	30%	$114,000.00
Licensing and Insurance	$580,000.00	30%	$174,000.00	0%	$0.00	50%	$290,000.00	20%	$116,000.00
Total	$2,498,000.00		$1,179,200.00		$224,000.00		$755,000.00		$339,800.00

Solution 2:

Determination of activity rate for each activity
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate
					Removing Asbestos	$1,179,200.00	Thousand of Square Feet	800	$1,474.00
Estimating and Job Setup	$224,000.00	Number of Jobs	400	$560.00
Working on non routine job	$755,000.00	Number of non routine jobs	100	$7,550.00
Other	$339,800.00	No allocation
Total	$2,498,000.00

Solution 3a:

Computation of total cost and average cost per thousand square feet - Routine 1000 Square feet job
Particulars	Amount
Removing Asbestos	$1,474.00
Estimating and Job Setup	$560.00
Total cost of job	$2,034.00
Average cost per thousand square feet	$2,034.00

Solution 3b:

Computation of total cost and average cost per thousand square feet - Routine 2000 Square Foot job
Particulars	Amount
Removing Asbestos	$2,948.00
Estimating and Job Setup	$560.00
Total cost of job	$3,508.00
Average cost per thousand square feet	$1,754.00

Solution 3c:

Computation of total cost and average cost per thousand square feet - Non routine 2000 Square foot job
Particulars	Amount
Removing Asbestos	$2,948.00
Estimating and Job Setup	$560.00
Working on non routine job	$7,550.00
Total cost of job	$11,058.00
Average cost per thousand square feet	$5,529.00