Question

9-Morton Company has two divisions. Sales, direct materials cost, direct labor cost, and manufacturing overhead data for Morton’s two divisions are available below. Note: All of Morton Company’s products are sold in competitive markets.

Missile Salt

Products Products

Sales                                                  $1,500,000                       $1,000,000

Direct labor                                           (300,000)                          (800,000)

Direct materials                                   (100,000)                             (40,000)

Manufacturing overhead*                (150,000)                          (400,000)

Gross profit                                          $950,000                         ($240,000)

*Manufacturing overhead is allocated to production based on the amount of direct labor cost.

        Morton has determined that its total manufacturing overhead cost of $550,000 is a mixture of batch-level costs and product line costs. Morton has assembled the following information concerning the manufacturing overhead costs, the annual number of production batches, and the number of product lines in each division.

Total

Manufacturing

Overhead                   Missile                         Salt

Costs               Products               Products

Batch-level overhead        $250,000            10 batches            90 batches

Product line overhead          300,000                     3 lines                     7 lines

                                               $550,000

        Which ONE of the following statements is MOST CORRECT?

If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have increased by $260,000. If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have increased by $35,000. If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have decreased by $260,000. If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have decreased by $35,000. If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Salt Division would have increased by $285,000. If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Salt Division would have decreased by $285,000.

Answer 1

Morton Company

The most correct Statement is – If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have increased by $35,000.

The use of activity based costing system allocates costs based on the usage of the activity by the products and hence ensures a more realistic overhead allocation. The following tables shows that the gross profit for Missile products division computed under the activity based method is higher by $35,000 as compared to the overhead allocation technique used under the traditional system.

Missile products, gross profit difference = $985,000 - $950,000 = $35,000

Gross Profit	Missile Products	Salt Products
Traditional Method	$950,000	($240,000)
ABC Method	$985,000	($275,000)

overhead rate per activity	activity cost	activity usage	activity rate
Batch level overhead	$250,000	100 batches	$2,500 per batch
Product line overhead	$300,000	10 lines	$30,000 per line
Missile Products	activity rate	activity usage	total overhead assigned
Batch level overhead	$2,500 per batch	10 batches	$25,000
product line overhead	$30,000 per line	3 lines	$90,000
Total overhead assigned			$115,000
Salt Products	activity rate	activity usage	total overhead assigned
Batch level overhead	$2,500 per batch	90 batches	$225,000
product line overhead	$30,000 per line	7 lines	$210,000
Total overhead assigned			$435,000

	Missile Products	Salt Products
Sales	$1,500,000	$1,000,000
Direct labor	($300,000)	($800,000)
Direct material	($100,000)	($40,000)
Manufacturing overhead	($115,000)	($435,000)
Gross Profit	$985,000	($275,000)