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	$	1,695,300
Cost of goods sold		1,224,445
Gross margin		470,855
Selling and administrative expenses		560,000
Net operating loss	$	(89,145	)

Hi-Tek produced and sold 60,000 units of B300 at a price of $20 per unit and 12,700 units of T500 at a price of $39 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	$	400,300	$	162,300	$	562,600
Direct labor	$	120,300	$	42,500		162,800
Manufacturing overhead						499,045
Cost of goods sold					$	1,224,445

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $57,000 and $109,000 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)	$	202,825		90,400	62,100	152,500
Setups (setup hours)		135,020		74	240	314
Product-sustaining (number of products)		100,600		1	1	2
Other (organization-sustaining costs)		60,600		NA	NA	NA
Total manufacturing overhead cost	$	499,045

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. Compute the product margins for the B300 and T500 under the company’s traditional costing system.

Answer:

Product Margin under Traditional costing
	B300	T500	Total
Product Margin	310,634	160,221	470,855

Calculation:

To compute the product margins based on traditional costing system, we need to deduct the total costs from the sales. The sales quantity for both B300 and T500 is given in the question, we need to multiply it with the price. So sales will be:

B300 : 60,000 * 20 = 1200000

T500: 12,700 * 39 = 495,300

Then we need to deduct the material cost and labor cost which is directly given in the problem. And need to calculate the Manufacturing Overhead:

So, the manufacturing overhead will be the amount based on the percentage of direct labor which is calculated as below:

B300 : 499,045 * 120,300 / 162,800 = 368,766

T500: 499,045* 130,279/162,800 = 130,279

	B300	T500	Total
Sales	1200000	495300	1,695,300
Costs:
Direct Material	400,300	162,300	562,600
Direct labor	120,300	42,500	162,800
Manufacturing Overhead	368766	130279	499,045
Product Margin	310,634	160,221	470,855

2. Compute the product margins for B300 and T500 under the activity-based costing system.

Answer:

Product Margin under Activity Based costing
	B300	T500	Total
Product Margin	420,048	(54,593)	365,455

Calculation:

To compute the product margins based on activity based costing system, we need to deduct the total costs from the sales. The sales quantity for both B300 and T500 is given in the question, we need to multiply it with the price.

So sales will be:

B300 : 60,000 * 20 = 1200000

T500: 12,700 * 39 = 495,300

As we done in traditional costing, we need to consider both the direct material and direct labor. But then we need to take the advertising, machining, setup costs etc which is provided in the question.

Machining:

B300 : 202,825 * 90,400/ 152,500 = 120,232

T500: 202,825 * 62,100/ 152,500 = 82,593

Setup cost:

B300 : 135,020 * 74/ 314 = 31,820

T500: 135,020 * 240/ 314 = 103,200

Product Sustaining:

B300 : 100,600 * 1/ 2 = 50300

T500: 100,600 * 1/ 2 = 50300

Then after adding up all the cost, we need to deduct it from the sales as calculated below:

	B300	T500	Total
Sales	1200000	495300	1695300
Costs:
Direct Material	400,300	162,300	562,600
Direct labor	120,300	42,500	162,800
Advertising expense	57,000	109,000	166,000
Machining	120,232	82,593	202,825
Setups	31,820	103,200	135,020
Product sustaining	50300	50300	100,600
Total cost	779,952	549,893	1,329,845
Product Margin	420,048	(54,593)	365,455

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

Answer:

Traditional Method:

	B300		T500		Total
		% of		% of
	Amount	Total Amount	Amount	Total Amount	Amount
Traditional Cost System
Direct Material	400,300	71.15%	162,300	28.85%	562,600
Direct labor	120,300	73.89%	42,500	26.11%	162,800
Manufacturing Overhead	368,766	73.89%	130,279	26.11%	499,045
Total cost assigned to products	889,366		335,079		1,224,445
Selling and Administrative					560,000
Total cost					1,784,445

ABC Method:

	B300		T500		Total
		% of		% of
	Amount	Total Amount	Amount	Total Amount	Amount
Activity-Based Costing System
Direct costs:
Direct Material	400,300	71.15%	162,300	28.85%	562,600
Direct labor	120,300	73.89%	42,500	26.11%	162,800
Advertising expense	57,000	34.34%	109,000	65.66%	166,000
Indirect costs:
Machining	120,232	59.28%	82,593	40.72%	202,825
Batch Setup	31,820	23.57%	103,200	76.43%	135,020
Product Sustained	50,300	50.00%	50,300	50.00%	100,600
Total cost assigned to products	779,952		549,893		1,329,845
Costs not assigned to products:
Selling and administrarive expenses					394,000
Others					60,600
Total cost					1,784,445

Calculation:

Here, we need to do the comparision of the both traditional and ABC method which we calculated in the requirement 1 and 2. With the help of both the methods, we need to find the total cost that will be incurring.

First we need to include all the direct costs which includes, material, labor and overhead for both B300 and T500. Then we need to find the total.

Next step is to find the percentage of these indivudal cost to the total costs of both the B300 and T500. After adding up all these costs, we get the Total cost assigned to products. Then we need to add the selling and administrative expenses, which is provided in the question, to get the total costs as per traditional method.

The next step is to calculate the total cost as per ABC Method to do the quantitative comparison. So here, we need to take the costs which we considered in requirement 2. We need to include both direct and indirect costs to find the Total cost assigned to products. Next step is to find the percentage of these indivudal cost to the total costs of both the B300 and T500. After adding up all these costs, we get the Total cost assigned to products.

Then we need to add the Costs not assigned to products:. That is the Selling and administrarive expense and the other expenses. The other expenses is directly provided in the question, which is organization-sustaining costs of 60,600.

The selling and administrative expenses for ABC method is Total selling and administrative expenses minus the advertising cost which was already considered. So the selling and administrative expenses is:

Selling and administrative expenses = 560,000 - 57,000 - 109,000 = 394,000

Then we need to add up all these total costs to get the final amount.

As we compare, we can see that the total cost will be same for both even though the Total cost assigned to products is different.