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	$	1,691,500
Cost of goods sold		1,247,807
Gross margin		443,693
Selling and administrative expenses		560,000
Net operating loss	$	(116,307	)

Hi-Tek produced and sold 60,200 units of B300 at a price of $20 per unit and 12,500 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	$	400,700	$	162,200	$	562,900
Direct labor	$	120,900	$	43,000		163,900
Manufacturing overhead						521,007
Cost of goods sold					$	1,247,807

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $50,000 and $107,000 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)	$	209,747		90,100	63,000	153,100
Setups (setup hours)		150,360		78	280	358
Product-sustaining (number of products)		100,600		1	1	2
Other (organization-sustaining costs)		60,300		NA	NA	NA
Total manufacturing overhead cost	$	521,007

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

			B300	T500	Total
		Units	60200	12500
		Sales Price	20.00	39.00
		Direct Material	400700	162200	562900		Total Manufacturing OH	521007
		Direct Labor	120900	43000	163900		Total Direct Labor Dollars	163900
		Manufacturing OH			521007		Overhead Per Dollars	3.18
		Cost of Goods Sold			1247807
	1		B300	T500
		Sales Price	20.00	39.00
		Less: Direct Material	6.66	12.98
		Less: Direct Labor	2.01	3.44
		Less: Maufacturing OH	6.38	10.94	(DL Dollars* OHRate)
		Product Margin	4.95	11.65	16.60
	2		B300	T500			Activity Pools	Amt	B300	T500	Total	Per Driver
		Sales Price	20.00	39.00			Machining	209747	90100	63000	153100	1.37
		Less: Direct Material	6.66	12.98			Setups	150360	78	280	358	420
		Less: Direct Labor	2.01	3.44			Product Sustaining	100600	1	1	2	50,300
		Less: Maufacturing OH	3.43	20.34	From Right Side		Other	60300	NA	NA	NA
		Product Margin	7.91	2.25			Total M OH	521007
							Allocation:	B300	T500
							Machining	123437	86310	(Activity Driver* Rate)
							Setups	32760	117600	(Activity Driver* Rate)
							Product Sustaining	50300	50300	(Activity Driver* Rate)
							Total M OH	206497	254210
							Units	60200	12500
			B300	T500			Manufacturing OH	3.43	20.34
			60200	12500
	3
			B300		T500		Total
		Traditional Cost System	Amount	%	Amount	%	Amount
		Direct Material	4,00,700	44.2%	1,62,200	47.4%	5,62,900
		Direct Labor	1,20,900	13.3%	43,000	12.6%	1,63,900
		Manufacturing OH	3,84,318	42.4%	1,36,689	40.0%	5,21,007
		Total Cost assigned to products	9,05,918	100.0%	3,41,889	100.0%	12,47,807
		Activity Based Costing	Amount	%	Amount	%	Amount
		Direct Costs:
		Direct Material	4,00,700	55.0%	1,62,200	35.3%	5,62,900
		Direct Labor	1,20,900	16.6%	43,000	9.4%	1,63,900
		Indirect Costs:
		Machining	1,23,437	17.0%	86,310	18.8%	2,09,747
		Setups	32,760	4.5%	1,17,600	25.6%	1,50,360
		Product Sustaining	50,300	6.9%	50,300	10.9%	1,00,600
		Total Cost assigned to products	7,28,097	100.0%	4,59,410	100.0%	11,87,507
		Costs not assigned to products:
		Others					60300
		Total Cost					12,47,807