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	$	1,645,900
Cost of goods sold		1,245,980
Gross margin		399,920
Selling and administrative expenses		570,000
Net operating loss	$	(170,080	)

Hi-Tek produced and sold 60,100 units of B300 at a price of $19 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	$	400,400	$	162,900	$	563,300
Direct labor	$	120,100	$	42,700		162,800
Manufacturing overhead						519,880
Cost of goods sold					$	1,245,980

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $56,000 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)	$	214,480		90,600	62,600	153,200
Setups (setup hours)		144,000		70	250	320
Product-sustaining (number of products)		101,000		1	1	2
Other (organization-sustaining costs)		60,400		NA	NA	NA
Total manufacturing overhead cost	$	519,880

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)	predetermined overhead rate
	total estimated manufacturing overhead/total estimated direct labor dollars
	519,880/162,800
	3.193366
	product margin using traditional appraoch
					B300	T500	total
	sales				1141900	504000	1645900
	less:Expenses
	direct materials				400400	162900	563300
	direct labor				120100	42700	162800
	manufacturing OH applied @3.09				383523	136357	519880
	total manufacturing cost				904023	341957	1245980
	product margin				237877	162043	399920	answer
2)	ABC activity based
	Activity rates
					(a)	(b)	c=a/b
	Activity cost pools				total cost	total	Activity rate
						activity
	machining				214,480	153,200	1.4	per machine hour
	Setups				144,000	320	450	per setup hour
	product sustaining				101,000	2	50500	per product
	product margin under ABC accounting
					B300	T500	total
	sales				1141900	504000	1645900
	less:Expenses
	direct materials				400400	162900	563300
	direct labor				120100	42700	162800
	Advertising expense				56,000	108,000	164000
	manufacturing overhead assigned
	machining				126840	87640	214480
	Setups				31500	112500	144000
	product sustaining				50500	50500	101000
	total cost				785,340	564,240	1349580
	product margin				356560	-60240	296320
	Traditional cost system			B        300		T -500
3)					% of total		% of total	Total
				amount	amount	amount	amount	amount
	Traditional cost system
	Direct materials			400400	71.1%	162900	28.9%	563300
	direct labor			120100	73.8%	42700	26.2%	162800
	manufacturing overhead			383523	73.8%	136357	26.2%	519880
	total cost assigned to products							1245980
	selling & administrative cost							570,000
	total cost.							1815980
				B        300		T -500
					% of total		% of total	Total
				amount	amount	amount	amount	amount
	ABC based costing system
	Direct costs
	direct materials			400400	71.1%	162900	28.9%	563300
	direct labor			120100	73.8%	42700	26.2%	162800
	Advertising expense			56,000	34.1%	108,000	65.9%	164000
	Indirect costs:
	machining			126840	59.1%	87640	40.9%	214480
	Setups			31500	21.9%	112500	78.1%	144000
	product sustaining			50500	50.0%	50500	50.0%	101000
	total cost assigned to products			785340		564240		1349580
	cost not assigned to products
	Selling & administrative expense							406,000
	other							60,400
	total cost.							1815980