Question

Problem 7-17 Comparing Traditional and Activity-Based Product Margins [LO7-1, LO7-3, LO7-4, LO7-5]

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	$	115.00		$	83.00
Direct materials per unit	$	65.10		$	50.00
Direct labor per unit	$	10.00		$	10.00
Direct labor-hours per unit		1.0	DLHs		1.0	DLHs
Estimated annual production and sales		29,000	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	$	1,800,000
Estimated total direct labor-hours		100,000	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)	$	520,000		29,000	71,000	100,000
Batch setups (setups)		781,000		400	310	710
Product sustaining (number of products)		440,000		1	1	2
Other		59,000		NA	NA	NA
Total manufacturing overhead cost	$	1,800,000

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 rate = 1,800,000 /100000 = $18per DLH

DLH need each product = dlh, so the allocated overhead cost per uits = Direct labor hours per unit* $18

Computation of Product Margin - Traditional Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	$115.00	$83.00
Direct material per unit	$65.10	$50.00
Direct labor per unit	$10.00	$10
Manufacturing overhead cost per unit (Direct labor hours per unit* $18)	$18	$18
Product Margin per unit	$21.9	$5
Nos of units sold	29000	71000
Total Margin (Product margin per unit * Nos of unit sold)	$635100	$355000	$990100

.

Solution 2:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost (A)	Activity Base	Usage of Activity Base (B)	Activity Rate= (A)/(B)	Xtreme	Pathfinder
Usage (C)	Allocated Costs (A/B)*(C)	Usage (D)	Allocated Costs
Supporting direct labor cost	520000	Direct Labor hours	100000	$5.2	29000	$150800	71000	$369200
Batch Setups	781000	Setups	710	1100	400	$440000	310	341000
Product sustaining	440000	Number of products	2	220000	1	$220000	1	220000
Other	59000	No allocation
Total	$1800000					$810800		930200
Nos of units						29000		71000
Allocated overhead per unit						810800 / 29000 = 27.96		930200 / 71000    = 13.10

.

Computation of Product Margin - Activity based Costing System
Particulars	Xtreme	Pathfinder	Total
Selling price per unit	115	83
Direct material per unit	65.1	50
Direct labor per unit	10	10
Allocated Manufacturing overhead cost per unit	27.96	13.1
Product Margin per unit	11.94	9.9
Nos of units sold	29000	71000
Total Margin (Product margin per unit * Nos of unit sold)	346260	702900	1049160

.

Solution 3:
Quantity comparison of traditional cost assignment
Particulars	Xtreme	Pathfinder	Total
Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	65.10* 29000 =1887900	34.72%	50* 71000 = 3550000	65.28%	5437900
Direct Labor Cost	10*29000      =290000	29.00%	10 * 71000 = 710000	71.00%	1000000
Manufacturing Overhead cost	18* 29000 = 522000	29.00%	18*71000 = 1278000	71.00%	1800000
Total Cost assigned to Product	2699900		5538000		8237900
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	65.10* 29000 =1887900	34.72%	50* 71000 = 3550000	65.28%	5437900
Direct Labor Cost	10*29000      =290000	29.00%	10 * 71000 = 710000	71.00%	1000000
Indirect Cost:
Supporting direct labor cost	150800	29.00%	369200	71.00%	520000
Batch Setups	440000	56.34%	341000	43.66%	781000
Product sustaining	220000	50.00%	220000	50.00%	440000
Total Cost Assigned to Products	2988700		5190200		8178900
Cost not assigned to products:					59000

Total = 8237900