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	$	1,704,000
Cost of goods sold		1,232,390
Gross margin		471,610
Selling and administrative expenses		610,000
Net operating loss	$	(138,390	)

Hi-Tek produced and sold 60,000 units of B300 at a price of $20 per unit and 12,600 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	$	400,200	$	162,000	$	562,200
Direct labor	$	120,900	$	42,900		163,800
Manufacturing overhead						506,390
Cost of goods sold					$	1,232,390

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $53,000 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)	$	209,610		90,900	62,100	153,000
Setups (setup hours)		136,080		74	250	324
Product-sustaining (number of products)		100,600		1	1	2
Other (organization-sustaining costs)		60,100		NA	NA	NA
Total manufacturing overhead cost	$	506,390

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

1.	Compute the product margins for the B300 and T500 under the company's traditional
	costing system.
	Plantwide overhead rate =			Estimated total mfg. cost / Estimated total DL $
	PMOH Rate =		$5,06,390	/	$1,63,800	$3	per DLS
					B300	T500	Total
	Sales				$12,00,000	$5,04,000	$17,04,000
	Direct materials				$4,00,200	$1,62,000	$5,62,200
	Direct labor				1,20,900	42,900	1,63,800
	Manufacturing overhead applied				3,73,764	1,32,626	5,06,390
	Total manufacturing costs				$8,94,864	$3,37,526	$12,32,390
	Product margin (Traditional)				$3,05,136	$1,66,474	$4,71,610
	Note: All of the mfg. overhead costs is applied to each product based on direct labor dollars
2.	Compute the product margins for the B300 and T500 under the activity-based costing
	system.
			Cost	1st Stage				Cost
			Pool	Pool		Activity Driver Usage		Pool
	Activity Cost Pool		Driver	Allocations	B300	T500	Total	Rates
	Machining		MHr.	$2,09,610	90,900	62,100	1,53,000	$1.370
	Setups		Setup Hrs.	1,36,080	74	250	324	$420
	Product Sustaining		# of Products	1,00,600	1	1	2	$50,300
	Organizational Sustaining		NA	60,100	NA	NA	NA
	Total Mfg. Overhead			$5,06,390
					B300	T500	Total
		Sales			$12,06,000	$5,00,000	$17,06,000
		Direct materials			$4,00,200	$1,62,000	$5,62,200
		Direct labor			1,20,900	42,900	1,63,800
		Advertising expense			53,000	1,02,000	1,55,000
		Mfg. Overhead assigned
		Machining pool			1,24,533	85,077	2,09,610
		Setup pool			31,080	1,05,000	1,36,080
		Product sustaining			50,300	50,300	1,00,600
		Total costs assigned			$7,80,013	$5,47,277	$13,27,290
		Product margin (ABC)			$4,25,987	($47,277)	$3,78,710
3.	Prepare a quantitative comparison of the traditional and activity-based cost assignments.
					B300		T500		Total
					Amount	% of	Amount	% of
	Direct materials				$4,00,200	71.2%	$1,62,000	28.8%	$5,62,200
	Direct labor				$1,20,900	73.8%	$42,900	26.2%	$1,63,800
	Manufacturing overhead applied				$3,73,764	73.8%	$1,32,626	26.2%	$5,06,390
	Total manufacturing costs				$8,94,864		$3,37,526		$12,32,390
	Selling & administrative								6,10,000
	Total Costs								$18,42,390
	Note: Total costs accounted for								$18,42,390
					B300		T500		Total
					Amount	% of	Amount	% of
	Direct materials				$4,00,200	71.2%	$1,62,000	28.8%	$5,62,200
	Direct labor				$1,20,900	73.8%	$42,900	26.2%	$1,63,800
	Advertising expense				$53,000	34.2%	$1,02,000	65.8%	$1,55,000
	Mfg. Overhead assigned
	Machining pool				$1,24,533	59.4%	$85,077	40.6%	$2,09,610
	Setup pool				$31,080	22.8%	$1,05,000	77.2%	$1,36,080
	Product sustaining				$50,300	50.0%	$50,300	50.0%	$1,00,600
	Total costs assigned				$7,80,013		$5,47,277		$13,27,290
	Selling & Administrative (Indirect)								4,55,000
	Organizational Sustaining Costs								60,100
	Total Costs								$18,42,390
	Explain why the traditional and activity-based cost assignments differ.
	First:	The traditional costing system assigns all $506,390 of mfg. overhead to the products.
		The ABC costing system does not assign organizational-sustaining costs to products.
	Second:	The traditional costing system uses one unit-level allocation base, direct labor dollars,
		to assign.
				B300	T500	Total
		Consumption ratio:		73.8%	26.2%	100%
		The ABC costing system uses three different pool drivers.
		1. Machine hours (unit-level driver)
				B300	T500	Total
		Consumption ratio:		59.4%	40.6%	100%
		2. Setup hours (batch-level driver)
				B300	T500	Total
		Consumption ratio:		22.8%	77.2%	100%
		3. Products (product-level driver)
				B300	T500	Total
		Consumption ratio:		50.0%	50.0%	100%
	Third:	The traditional system does not trace any non-manufacturing direct costs to the products.
		The ABC costing system traces direct advertising costs to the products.