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	$	120.00		$	90.00
Direct materials per unit	$	64.10		$	53.00
Direct labor per unit	$	13.50		$	9.00
Direct labor-hours per unit		1.5	DLHs		1.0	DLHs
Estimated annual production and sales		30,000	units		70,000	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	$	2,300,000
Estimated total direct labor-hours		115,000	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)	$	977,500		45,000	70,000	115,000
Batch setups (setups)		612,000		300	210	510
Product sustaining (number of products)		700,000		1	1	2
Other		10,500		NA	NA	NA
Total manufacturing overhead cost	$	2,300,000

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

Part 1 - Product Margin Under traditional coating system

Predetermined overhead rate = Total budgeted manufacturing overhead/Total allocation base i.e. direct labour hours

Predetermined overhead rate = $2300000/115000 = $20 per labour hour

Particulars	Xtreme	Pathfinder	Total
Sales	$3600000 ($120 * 30000)	$6300000 ($90 * 70000)	$9900000
Direct Material Per unit	$1923000 ($64.1*30000)	$3710000 ($53*70000)	$5633000
Direct labour cost	$405000 ($13.5*30000)	$630000 ($9*70000)	$1035000
Overhead cost	$900000 ($20 per labour hour * 1.5 hours per unit) * 30000 units	$1400000 ($20 per labour hour * 1.0 hours per unit) * 70000 units	$2300000
Net Margin	$372000	$560000	$932000

Part 2 - Profit margin under activity based costing

Step 1 - Allocation of manufacturing overhead as per activity cost drivers

Activity cost pool	Total cost	Total Activity	Activity rate or activity cost driver
Supporting direct labour	$977500	115000	$8.5 Per direct labour hour
Batch set up	$612000	510	$1200 per setup
Product sustaining	$700000	2	$350000 per product

Step 2 - Calculation of Profit Margin

Particulars	Xtreme	Pathfinder	Total
Sales	$3600000	$6300000	$9900000
Direct Material	$1923000	$3710000	$5633000
Direct Labour	$405000	$630000	$1035000
Supporting direct labour	$382500 ($8.5 per hour * 45000)	$595000 ($8.5 per hour * 70000 hours)	$977500
Batch setup	$360000 ($1200 per setup*300 setup)	$252000 ($1200 per setup*210 setup)	$612000
Product sustaining	$350000	$350000	$700000
Net Product Margin	$179500	$763000	$942500

Part 3 - Quantitative analysis

Step 1 - quantitative analysis Under traditional costing system

	Xtreme	Xtreme	Pathfinder	Pathfinder	Total
Particulars	Amount	% of total amount	Amount	% of total amount
Direct Material	$1923000	34.14% ($1923000/$5633000)*100	$3710000	65.86% ($3710000/5633000)*100	$5633000
Direct Labour	$405000	39.13% ($405000/$1035000)*100	$630000	60.87% ($630000/$1035000)*100	$1035000
Manufacturing Overhead	$900000	39.13% ($900000/$2300000)*100	$1400000	60.87% ($1400000/$2300000)*100	$2300000
Total cost assigned to products	$3228000		$5740000		$8968000

Step 2 - Quantitative analysis under activity based costing

	Xtreme	Xtreme	Pathfinder	Pathfinder	Total
Particulars	Amount	% of total amount	Amount	% of total amount
Direct Cost
Direct material	$1923000	34.14%	$3710000	65.86%	$5633000
Direct Labour	$405000	39.13%	$630000	60.87%	$1035000
Indirect Cost
Supporting direct labour	$382500	39.13%	$595000	60.87%	$977500
Batch setup	$360000	58.82%	$252000	41.18%	$612000
Product sustaining	$350000	50%	$350000	50%	$700000
Total cost assigned to products	$3420500		$5537000		$8957500
Cost not assigned to products
Other cost					$10500
Total cost					$8968000