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	$	1,689,500
Cost of goods sold		1,220,930
Gross margin		468,570
Selling and administrative expenses		580,000
Net operating loss	$	(111,430	)

Hi-Tek produced and sold 60,100 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	$	400,500	$	162,500	$	563,000
Direct labor	$	120,900	$	42,300		163,200
Manufacturing overhead						494,730
Cost of goods sold					$	1,220,930

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 $110,000 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)	$	198,640		90,600	62,200	152,800
Setups (setup hours)		134,590		73	240	313
Product-sustaining (number of products)		101,000		1	1	2
Other (organization-sustaining costs)		60,500		NA	NA	NA
Total manufacturing overhead cost	$	494,730

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

Solution 1:

Overhead Allocation - Traditional Costing System
Particulars	B300	T500	Total
Estimated annual Production (In units)	60100	12500
Direct Labor Cost	$120,900	$42,300	$163,200
Overhead Cost Allocation basis direct labour dollar (Overhead / Total direct labor dollar * Labor dollar of model)	$366,500	$128,230	$494,730
Manufacturing overhead cost per unit (Allocated Overhead / Nos of units)	$6.10	$10.26

Computation of Product Margin - Traditional Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,100*$20, T500 - 12500*$39)	$1,202,000	$487,500	$1,689,500
Direct material	$400,500	$162,500	$563,000
Direct labor	$120,900	$42,300	$163,200
Manufacturing overhead	$366,500	$128,230	$494,730
Product Margin	$314,100	$154,470	$468,570

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	$198,640.00	Machine hours	152800	$1.30	90600	$117,780.00	62200	$80,860.00
Setups	$134,590.00	Setup hours	313	$430.00	73	$31,390.00	240	$103,200.00
Product sustaining	$101,000.00	Number of products	2	$50,500.00	1	$50,500.00	1	$50,500.00
Other	$60,500.00	No allocation
Total	$494,730.00					$199,670.00		$234,560.00

Computation of Product Margin - Activity based Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,100*$20, T500 - 12500*$39)	$1,202,000	$487,500	$1,689,500
Direct material	$400,500	$162,500	$563,000
Direct labor	$120,900	$42,300	$163,200
Allocated Manufacturing overhead	$199,670.00	$234,560.00	$434,230
Product Margin	$480,930.00	$48,140.00	$529,070.00

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount	% of total Amount
Direct Material Cost	$400,500	45.1%	$162,500	48.8%	$563,000	46.1%
Direct Labor Cost	$120,900	13.6%	$42,300	12.7%	$163,200	13.4%
Manufacturing Overhead cost	$366,500	41.3%	$128,230	38.5%	$494,730	40.5%
Total	$887,900		$333,030		$1,220,930

Quantity comparison of Activity Based cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount	% of total Amount
Direct Cost:
Material Cost	$400,500	51.5%	$162,500	29.6%	$563,000	42.4%
Labor Cost	$120,900	15.5%	$42,300	7.7%	$163,200	12.3%
Advertising Expense	$57,000	7.3%	$110,000	20.0%	$167,000	12.6%
Indirect Cost:
Machining	$117,780	15.1%	$80,860	14.7%	$198,640	15.0%
Setups	$31,390	4.0%	$103,200	18.8%	$134,590	10.1%
Product sustaining	$50,500	6.5%	$50,500	9.2%	$101,000	7.6%
Total Cost Assigned to Products	$778,070		$549,360		$1,327,430
Cost not assigned to products					$60,500
Total Cost					$1,387,930