Question

Smoky Mountain Corporation makes two types of hiking boots—the Xtreme and the Pathfinder.  

	Xtreme			Pathfinder
Selling price per unit	$	125.00		$	91.00
Direct materials per unit	$	64.20		$	55.00
Direct labor per unit	$	16.00		$	10.00
Direct labor-hours per unit		1.6	DLHs		1.0	DLHs
Estimated annual production and sales		25,000	units		71,000	units

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	$	2,331,000
Estimated total direct labor-hours		111,000	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):

	Estimated Overhead Cost			Expected Activity
Activities and Activity Measures				Xtreme	Pathfinder	Total
Supporting direct labor (direct labor-hours)	$	888,000		40,000	71,000	111,000
Batch setups (setups)		583,000		310	220	530
Product sustaining (number of products)		780,000		1	1	2
Other		80,000		NA	NA	NA
Total manufacturing overhead cost	$	2,331,000

Compute the product margins for the Xtreme and the Pathfinder products under the activity-based costing system.

3. Prepare a quantitative comparison of the traditional and activity-based cost assignments.

Answer 1

Solution 1:

Overhead Allocation - Traditional Costing System
Particulars	Xtreme	Pathfinder	Total
Estimated annual Production (In units)	25000	71000
Direct Labour Hours Per unit	1.6	1
Total Direct Labour Hours	40000	71000	111000
Overhead Cost Allocation basis direct labour hours (Overhead / Total hours * Labor hours of model)	$840,000.00	$1,491,000.00	$2,331,000.00
Manufacturing overhead cost per unit (Allocated Overhead / Nos of units)	$33.60	$21.00

Computation of Product Margin - Traditional Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	$125.00	$91.00
Direct material per unit	$64.20	$55.00
Direct labor per unit	$16.00	$10.00
Manufacturing overhead cost per unit	$33.60	$21.00
Product Margin per unit	$11.20	$5.00
Nos of units sold	25000	71000
Total Margin (Product margin per unit * Nos of unit sold)	$280,000.00	$355,000.00	$635,000.00

Solution 2:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	Xtreme		Pathfinder
					Usage	Allocated Costs	Usage	Allocated Costs
Supporting direct labor cost	$888,000.00	Direct Labor hours	111000	$8.00	40000	$320,000.00	71000	$568,000.00
Batch Setups	$583,000.00	Setups	530	$1,100.00	310	$341,000.00	220	$242,000.00
Product sustaining	$780,000.00	Number of products	2	$390,000.00	1	$390,000.00	1	$390,000.00
Other	$80,000.00	No allocation
Total	$2,331,000.00					$1,051,000.00		$1,200,000.00
Nos of units						25000		71000
Allocated overhead per unit						$42.04		$16.90

Computation of Product Margin - Activity based Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	$125.00	$91.00
Direct material per unit	$64.20	$55.00
Direct labor per unit	$16.00	$10.00
Allocated Manufacturing overhead cost per unit	$42.04	$16.90
Product Margin per unit	$2.76	$9.10
Nos of units sold	25000	71000
Total Margin (Product margin per unit * Nos of unit sold)	$69,000.00	$646,000.00	$715,000.00

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	Xtreme		Pathfinder		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	$1,605,000.00	29.1%	$3,905,000.00	70.9%	$5,510,000.00
Direct Labor Cost	$400,000.00	36.0%	$710,000.00	64.0%	$1,110,000.00
Manufacturing Overhead cost	$840,000.00	36.0%	$1,491,000.00	64.0%	$2,331,000.00
Total Cost assigned to Product	$2,845,000.00		$6,106,000.00		$8,951,000.00

Quantity comparison of Activity Based cost assignment
Particulars	Xtreme		Pathfinder		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Cost:
Direct Material Cost	$1,605,000.00	29.1%	$3,905,000.00	70.9%	$5,510,000.00
Direct Labor Cost	$400,000.00	36.0%	$710,000.00	64.0%	$1,110,000.00
Indirect Cost:
Supporting direct labor cost	$320,000.00	36.0%	$568,000.00	64.0%	$888,000.00
Batch Setups	$341,000.00	58.5%	$242,000.00	41.5%	$583,000.00
Product sustaining	$390,000.00	50.0%	$390,000.00	50.0%	$780,000.00
Total Cost Assigned to Products	$3,056,000.00		$5,815,000.00		$8,871,000.00
Cost not assigned to products:
Others					$80,000.00
Total Cost					$8,951,000.00