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		$	86.00
Direct materials per unit	$	65.30		$	52.00
Direct labor per unit	$	13.50		$	9.00
Direct labor-hours per unit		1.5	DLHs		1.0	DLHs
Estimated annual production and sales		31,000	units		65,000	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	$	2,230,000
Estimated total direct labor-hours		111,500	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)	$	724,750		46,500	65,000	111,500
Batch setups (setups)		975,000		420	330	750
Product sustaining (number of products)		470,000		1	1	2
Other		60,250		NA	NA	NA
Total manufacturing overhead cost	$	2,230,000

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
	Product margin under traditional system is
		Xtreme	Pathfinder	Total
A	No. of units	31,000	65,000	96,000
B	Sale price per unit	121	86
C=A*B	Sale Value	3,751,000	5,590,000	9,341,000
D	Direct Material	2,024,300	3,380,000	5,404,300
E	Direct Labor	418,500	585,000	1,003,500
F=D+E	Total Direct Costs	2,442,800	3,965,000	6,407,800
G	Manufacturing Overhead	930,000	1,300,000	2,230,000
H =F+G	Total Product Cost	3,372,800	5,265,000	8,637,800
I=C-H	Product Margin	378,200	325,000	703,200

	2
	Product Margin under ABC system is
		Xtreme	Pathfinder	Total
A	No. of units	31,000	65,000	96,000
B	Sale price per unit	121	86
C=A*B	Sale Value	3,751,000	5,590,000	9,341,000
D	Direct Material	2,024,300	3,380,000	5,404,300
E	Direct Labor	418,500	585,000	1,003,500
F=D+E	Total Direct Costs	2,442,800	3,965,000	6,407,800
G	Manufacturing Overhead (ABC)	1,083,250	1,086,500	2,169,750
H =F+G	Total Product Cost	3,526,050	5,051,500	8,577,550
I=C-H	Product Margin	224,950	538,500	763,450
	Activity	Activity Cost Pool	Cost driver	Xtreme	Calculation	Pathfinder	Calculation
	Supporting direct labour	$724,750	Direct labour hours	302,250	46500/111500*724750	422,500	65000/111500*724750
	Batch setups	$975,000	Setup hours	546,000	420/750*975000	429,000	330/750*975000
	Product Sustaining	$470,000	No. of products	235,000	1/2*470000	235,000	1/2*470000
	Total	$2,169,750		$1,083,250		$1,086,500

3
Comparison of traditional and activity-based cost assignment is as follows:
Traditional Cost system
	Xtreme		Pathfinder		Total
	Amount	% of total amount	Amount	% of total amount	Amount
Direct material	2,024,300	60%	3,380,000	64%	5,404,300
Direct labour	418,500	12%	585,000	11%	1,003,500
Manufacturing overhead	930,000	28%	1,300,000	25%	2,230,000
Total cost assigned to products	3,372,800		5,265,000		8,637,800
Activity Based Costing System
	Xtreme		Pathfinder		Total
	Amount	% of total amount	Amount	% of total amount	Amount
Activity Based Costing System
Direct Costs
Direct material	2,024,300	57%	3,380,000	67%	5,404,300
Direct labour	418,500	12%	585,000	12%	1,003,500
Indirect Costs
Supporting direct labour	302,250	9%	422,500	8%	724,750
Batch setups	546,000	15%	429,000	8%	975,000
Product Sustaining	235,000	7%	235,000	5%	470,000
Total Cost assigned to products	3,526,050	100%	5,051,500	100%	8,577,550
Costs not assigned to products
Other					60,250
Total Costs					8,637,800