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	$	121.00		$	88.00
Direct materials per unit	$	64.70		$	54.00
Direct labor per unit	$	10.80		$	9.00
Direct labor-hours per unit		1.2	DLHs		1.0	DLHs
Estimated annual production and sales		25,000	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	$	2,020,000
Estimated total direct labor-hours		101,000	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)	$	606,000		30,000	71,000	101,000
Batch setups (setups)		693,000		360	270	630
Product sustaining (number of products)		700,000		1	1	2
Other		21,000		NA	NA	NA
Total manufacturing overhead cost	$	2,020,000

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

1. Computation of product Margin using traditional costing system

Manufacturing Overhead Rate per Direct Labour Hour= Total Manufacturing overhead/ Total Direct Labour Hours = $2,020,000/101,000= $20 per Direct Labour Hour

Particular	Xtreme	Pathfinder
Selling price per unit	$121	$88
(-) Direct Material per unit	$64.70	$54
(-) Direct Labour per unit	$10.80	$9
Contribution margin per unit	$45.5	$25
(-) Manufacturing overhead per unit	$24 (1.2 DLH*$20)	$20 (1DLH*$20)
Product Margin per unit	$21.5	$5
Estimated Annual Production and sales	25,000 units	71,000 units
Total Product Margin	$537,500 ($21.5*25,000)	$355,000 ($5*71,000)

2. Computation of product Margin using Activity based costing system

Activity	Estimated Overhead Cost	Expected Activity	Activity Rate
Supporting Direct Labour	$606,000	101,000	$6 per Direct Labour Hour
Batch Setups	$693,000	630	$1,100 per Setup
Product Sustaining	$700,000	2	$350,000 per number of product
Other Overhead	$21,000		Allotted to organisation

Particular	Xtreme	Pathfinder	Total
Sales	$3,025,000 (25000*$121)	$6,248,000 (71,000*$88)	$9,273,000
(-) Direct Material	$1,617,500 (25,000*$64.70)	$8,834,000 (71,000*$54)	$5,451,500
(-) Direct Labour	$270,000 (25,000*$10.80)	$639,000 (71,000*$9)	$909,000
Contribution margin	$1,137,500	$3,225,000	$2,912,500
(-)Manufacturing overhead
Supporting Direct Labour	$180,000 (30,000*$6)	$426,000 (71,000*$6)	$606,000
Batch Setups	$396,000 (360*$1,100)	$297,000 (270*$1,100)	$693,000
Product Sustaining	$350,000 (350,000*$1)	$350,000 (350,000*$1)	$700,000
Other Overhead	-	-	$21,000
Total Manufacturing overhead	$926,000	$1,073,000	$2,020,000
Total Product Margin	$211,500	$2,152,000	$892,500

3. Traditional costing system

	Xtreme	Pathfinder
Direct Material per unit	$64.70	$54
(+) Direct Labour per unit	$10.80	$9
(+) Manufacturing Overhead per unit	$24	$20
Total cost per unit	$99.5	$83

Activity based costing

	Xtreme	Pathfinder
Direct Material per unit	$64.70	$54
(+) Direct Labour per unit	$10.8	$9
(+). Manufacturing Overhead per unit	$37.04 ($926,000/25,000)	$15.11 ($1,073,000/71,000)
Total cost per unit	$112.54	$78.11

Traditional costing alloacat Overhead on the base of single rate, where as activity based costing allocate overhead on the basis of service taken by each department. Due to which total cost per unit of Xtreme is higher as compared to traditional costing and Total cost per unit of Pathfinder is lower.