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	$	1,714,000
Cost of goods sold		1,215,528
Gross margin		498,472
Selling and administrative expenses		560,000
Net operating loss	$	(61,528	)

Hi-Tek produced and sold 60,500 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	$	400,700	$	163,000	$	563,700
Direct labor	$	120,000	$	42,900		162,900
Manufacturing overhead						488,928
Cost of goods sold					$	1,215,528

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $52,000 and $101,000 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)	$	201,168		90,100	62,300	152,400
Setups (setup hours)		127,160		79	210	289
Product-sustaining (number of products)		100,200		1	1	2
Other (organization-sustaining costs)		60,400		NA	NA	NA
Total manufacturing overhead cost	$	488,928

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)Traditional Costing Method		B300		T500
	Units	Cost per Unit	Total	Units	Cost per Unit	Total
Sales	60500	$20.00	$1,210,000.00	12600	$40.00	$504,000.00
Less:
Direct materials	60500	$6.62	$400,700.00	12600	$12.94	$163,000.00
Direct labor	60500	$1.98	$120,000.00	12600	$3.35	$42,200.00
Manufacturing Overhead (calculated below)applied @ $3.00 per direct labor-dollar		$3.00	$360,167.96		$3.00	$126,659.06
Total Manufacturing Cost		$11.61	$880,867.96		$19.29	$331,859.06
Profit Margin		$8.39	$329,132.04		$20.71	$172,140.94
Manufacturing Overhead
Predetermined overhead Rate = Estimated total manufacturing overhead cost/Estimated total direct labor dollars
Predetermined overhead Rate = $488,928/$162,900	$3.00
2)Absorbtion Costing Method
Activity Cost Pools	Total Cost	Total Activity	Activity Rate
Machining (machine-hours)	$201,168.00	152400	$1.32
Setups (setup hours)	$127,160.00	289	$440.00
Product-sustaining (number of products)	$100,200.00	2	$50,100.00
	B300	T500
Sales	$1,210,000.00	$504,000.00
Less:
Direct materials	$400,700.00	$163,000.00
Direct labor	$120,000.00	$42,200.00
Advertising	$52,000.00	$101,000.00
Machining (machine-hours)	$118,932.00	$82,236.00
Setups (setup hours)	$34,760.00	$92,400.00
Product-sustaining (number of products)	$50,100.00	$50,100.00
Total Manufacturing Cost	$726,392.00	$480,836.00
Profit Margin	$483,608.00	$23,164.00
3)	B300		T500		Total
Traditional Cost System	Amount	%	Amount	%
Direct materials	$400,700.00	71.08%	$163,000.00	28.92%	$563,700.00
Direct labor	$120,000.00	73.98%	$42,200.00	26.02%	$162,200.00
Manufacturing Overhead	$360,167.96	73.98%	$126,659.06	26.02%	$486,827.02
Total cost assigned to products	$880,867.96		$331,859.06		$1,212,727.02
Selling and administrative					$560,000.00
Total cost					$1,772,727.02
Absorbtion Costing System
Direct Costs
Direct materials	$400,700.00	71.08%	$163,000.00	28.92%	$563,700.00
Direct labor	$120,000.00	73.98%	$42,200.00	26.02%	$162,200.00
Advertising	$52,000.00	33.99%	$101,000.00	66.01%	$153,000.00
Indirect Costs
Machining (machine-hours)	$118,932.00	59.12%	$82,236.00	40.88%	$201,168.00
Setups (setup hours)	$34,760.00	27.34%	$92,400.00	72.66%	$127,160.00
Product-sustaining (number of products)	$50,100.00	50.00%	$50,100.00	50.00%	$100,200.00
Total cost assigned to products	$776,492.00		$530,936.00		$1,307,428.00
Costs not assigned to products:
Selling and administrative					$407,000.00
Other					$60,400.00
Total cost					$1,774,828.00