Question

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	$	1,751,400
Cost of goods sold		1,243,120
Gross margin		508,280
Selling and administrative expenses		640,000
Net operating loss	$	(131,720	)

Hi-Tek produced and sold 60,000 units of B300 at a price of $21 per unit and 12,600 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	$	400,500	$	162,800	$	563,300
Direct labor	$	120,000	$	42,400		162,400
Manufacturing overhead						517,420
Cost of goods sold					$	1,243,120

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 $106,000 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)	$	214,620		90,500	62,800	153,300
Setups (setup hours)		140,400		72	240	312
Product-sustaining (number of products)		101,800		1	1	2
Other (organization-sustaining costs)		60,600		NA	NA	NA
Total manufacturing overhead cost	$	517,420

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

Answer :-

Solution 1:

Predetermined overhead rate under traditional costing = Estimated overhead / Direct labor cost

= $517,420 / $162,400 = $3.19 per direct labor dollar

Computation of Product Margin - Traditional Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,000*$21, T500 - 12,600*$39)	$1,260,000	$491,400	$1,751,400
Direct material	$400,500	$162,800	$563,300
Direct labor	$120,000	$42,400	$162,400
Manufacturing overhead ($3.19 * Direct labor)	$382,800	$135,256	$518,056
Product Margin	$356,700	$150,944	$507,644

Solution 2:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	B300	T500
Usage	Allocated Costs	Usage	Allocated Costs
Machining	$214,620	Machine hours	153,300	$1.40	90,500	$126,700	62,800	$87,920
Setups	$140,400	Setup hours	312	$450	72	$32,400	240	$108,000
Product sustaining	$101,800	Number of products	2	$50,900	1	$50,900	1	$50,900
Other	$60,600	No allocation
Total	$517,420					$210,000		$246,820

Computation of Product Margin - Activity based Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,000*$21, T500 - 12600*$39)	$1,260,000	$491,400	$1,751,400
Direct material	$400,500	$162,800	$563,300
Direct labor	$120,000	$42,400	$162,400
Allocated Manufacturing overhead	$210,000	$246,820	$456,820
Advertising Expense	$57,000	$106,000	$163,000
Product Margin	$472,500	-$66,620	$405,880

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	B300	T500	Total
Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	$400,500	71.10%	$162,800	28.90%	$563,300
Direct Labor Cost	$120,000	73.90%	$42,400	26.10%	$162,400
Manufacturing Overhead cost	$382,800	73.90%	$135,256	26.10%	$518,056
Total cost assigned to products	$903,300		$340,456		$1,243,756
Total cost not assigned to product:
Selling and adminstrative Expenses					$640,000
Total Cost					$1,883,756

Quantity comparison of Activity Based cost assignment
Particulars	B300	T500	Total
Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Cost:
Material Cost	$400,500	71.10%	$162,800	28.90%	$563,300
Labor Cost	$120,000	73.90%	$42,400	26.10%	$162,400
Advertising Expense	$57,000	34.97%	$106,000	65.03%	$163,000
Indirect Cost:
Machining	$126,700	59.03%	$87,920	40.96%	$214,620
Setups	$32,400	23.07%	$108,000	76.92%	$140,400
Product sustaining	$50,900	50.0%	$50,900	50.0%	$101,800
Total Cost Assigned to Products	$787,500		$558,020		$1,345,520
Cost not assigned to products:
Manufacturing					$60,600
Selling and administrative					$477,000
Total Cost					$1,883,120