Question

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

	Xtreme			Pathfinder
Selling price per unit	$	138.00		$	90.00
Direct materials per unit	$	64.40		$	51.00
Direct labor per unit	$	13.50		$	9.00
Direct labor-hours per unit		1.5	DLHs		1.0	DLHs
Estimated annual production and sales		22,000	units		73,000	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	$	2,438,000
Estimated total direct labor-hours		106,000	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)	$	646,600		33,000	73,000	106,000
Batch setups (setups)		969,000		330	240	570
Product sustaining (number of products)		780,000		1	1	2
Other		42,400		NA	NA	NA
Total manufacturing overhead cost	$	2,438,000

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)	22000	73000
Direct Labour Hours Per unit	1.5	1
Total Direct Labour Hours	33000	73000	106000
Overhead Cost Allocation basis direct labour hours (Overhead / Total hours * Labor hours of model)	$7,59,000.00	$16,79,000.00	$24,38,000.00
Manufacturing overhead cost per unit (Allocated Overhead / Nos of units)	$34.50	$23.00

Computation of Product Margin - Traditional Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	$138.00	$90.00
Direct material per unit	$64.40	$51.00
Direct labor per unit	$13.50	$9.00
Manufacturing overhead cost per unit	$34.50	$23.00
Product Margin per unit	$25.60	$7.00
Nos of units sold	22000	73000
Total Margin (Product margin per unit * Nos of unit sold)	$5,63,200.00	$5,11,000.00	$10,74,200.00

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	$6,46,600.00	Direct Labor hours	106000	$6.10	33000	$2,01,300.00	73000	$4,45,300.00
Batch Setups	$9,69,000.00	Setups	570	$1,700.00	330	$5,61,000.00	240	$4,08,000.00
Product sustaining	$7,80,000.00	Number of products	2	$3,90,000.00	1	$3,90,000.00	1	$3,90,000.00
Other	$42,400.00	No allocation
Total	$24,38,000.00					$11,52,300.00		$12,43,300.00
Nos of units						22000		73000
Allocated overhead per unit						$52.38		$17.03

Computation of Product Margin - Activity based Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	$138.00	$90.00
Direct material per unit	$64.40	$51.00
Direct labor per unit	$13.50	$9.00
Allocated Manufacturing overhead cost per unit	$52.38	$17.03
Product Margin per unit	$7.72	$12.97
Nos of units sold	22000	73000
Total Margin (Product margin per unit * Nos of unit sold)	$1,69,900.00	$9,46,700.00	$11,16,600.00

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	Xtreme		Pathfinder		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	$14,16,800.00	27.57%	$37,23,000.00	72.43%	$51,39,800.00
Direct Labor Cost	$2,97,000.00	31.13%	$6,57,000.00	68.87%	$9,54,000.00
Manufacturing Overhead cost	$7,59,000.00	31.13%	$16,79,000.00	68.87%	$24,38,000.00
Total Cost assigned to Product	$24,72,800.00		$60,59,000.00		$85,31,800.00

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	$14,16,800.00	27.57%	$37,23,000.00	72.43%	$51,39,800.00
Direct Labor Cost	$2,97,000.00	31.13%	$6,57,000.00	68.87%	$9,54,000.00
Indirect Cost:
Supporting direct labor cost	$2,01,300.00	31.13%	$4,45,300.00	68.87%	$6,46,600.00
Batch Setups	$5,61,000.00	57.89%	$4,08,000.00	42.11%	$9,69,000.00
Product sustaining	$3,90,000.00	50.00%	$3,90,000.00	50.00%	$7,80,000.00
Total Cost Assigned to Products	$28,66,100.00		$56,23,300.00		$84,89,400.00
Cost not assigned to products:
Others					$42,400.00
Total Cost					$85,31,800.00