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	$	1,716,000
Cost of goods sold		1,256,835
Gross margin		459,165
Selling and administrative expenses		590,000
Net operating loss	$	(130,835	)

Hi-Tek produced and sold 60,400 units of B300 at a price of $20 per unit and 12,700 units of T500 at a price of $40 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	$	400,100	$	163,000	$	563,100
Direct labor	$	120,600	$	42,900		163,500
Manufacturing overhead						530,235
Cost of goods sold					$	1,256,835

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 $102,000 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)	$	206,955		90,900	62,400	153,300
Setups (setup hours)		161,480		77	290	367
Product-sustaining (number of products)		101,600		1	1	2
Other (organization-sustaining costs)		60,200		NA	NA	NA
Total manufacturing overhead cost	$	530,235

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:

Predetermined overhead rate = Estimated overhead / Estimated direct labor cost

= $530,235 / $163,500 = $3.24303 per direct labor dollar

Computation of Product Margin - Traditional Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,400*$20, T500 - 12700*$40)	$1,208,000	$508,000	$1,716,000
Direct material	$400,100	$163,000	$563,100
Direct labor	$120,600	$42,900	$163,500
Manufacturing overhead (Direct labor * $3.24303)	$391,109	$139,126	$530,235
Product Margin	$296,191	$162,974	$459,165

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	$206,955.00	Machine hours	153300	$1.35	90900	$122,715.00	62400	$84,240.00
Setups	$161,480.00	Setup hours	367	$440.00	77	$33,880.00	290	$127,600.00
Product sustaining	$101,600.00	Number of products	2	$50,800.00	1	$50,800.00	1	$50,800.00
Other	$60,200.00	No allocation
Total	$530,235.00					$207,395.00		$262,640.00

Computation of Product Margin - Activity based Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,400*$20, T500 - 12700*$40)	$1,208,000	$508,000	$1,716,000
Direct material	$400,100	$163,000	$563,100
Direct labor	$120,600	$42,900	$163,500
Allocated Manufacturing overhead	$207,395.00	$262,640.00	$470,035
Advertising Expense	$57,000.00	$102,000.00	$159,000.00
Product Margin	$422,905.00	-$62,540.00	$360,365.00

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	$400,100	71.1%	$163,000	28.9%	$563,100
Direct Labor Cost	$120,600	73.8%	$42,900	26.2%	$163,500
Manufacturing Overhead cost	$391,109	73.8%	$139,126	26.2%	$530,235
Total cost assigned to products	$911,809		$345,026		$1,256,835
Total cost not assigned to product:
Selling and adminstrative Expenses					$590,000.00
Total Cost					$1,846,835

Quantity comparison of Activity Based cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Cost:
Material Cost	$400,100	71.1%	$163,000	28.9%	$563,100
Labor Cost	$120,600	73.8%	$42,900	26.2%	$163,500
Advertising Expense	$57,000	35.8%	$102,000	64.2%	$159,000
Indirect Cost:
Machining	$122,715	59.3%	$84,240	40.7%	$206,955
Setups	$33,880	21.0%	$127,600	79.0%	$161,480
Product sustaining	$50,800	50.0%	$50,800	50.0%	$101,600
Total Cost Assigned to Products	$785,095		$570,540		$1,355,635
Cost not assigned to products:
Manufacturing					$60,200
Selling and administrative					$431,000
Total Cost					$1,846,835