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	$	1,708,000
Cost of goods sold		1,250,810
Gross margin		457,190
Selling and administrative expenses		560,000
Net operating loss	$	(102,810	)

Hi-Tek produced and sold 60,000 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	$	400,200	$	162,500	$	562,700
Direct labor	$	120,300	$	42,100		162,400
Manufacturing overhead						525,710
Cost of goods sold					$	1,250,810

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $51,000 and $100,000 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)	$	206,010		90,400	62,200	152,600
Setups (setup hours)		159,100		80	290	370
Product-sustaining (number of products)		100,000		1	1	2
Other (organization-sustaining costs)		60,600		NA	NA	NA
Total manufacturing overhead cost	$	525,710

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)	60000	12700
Direct Labor Cost	120300	42100	162400
Overhead Cost Allocation basis direct labour dollar (Overhead / Total direct labor dollar * Labor dollar of model)	$389,426.80	$136,283.20	$525,710.00
Manufacturing overhead cost per unit (Allocated Overhead / Nos of units)	$6.49	$10.73

Computation of Product Margin - Traditional Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,000*$20, T500 - 12700*$40)	$1,200,000	$508,000	$1,708,000
Direct material	$400,200	$162,500	$562,700
Direct labor	$120,300	$42,100	$162,400
Manufacturing overhead	$389,427	$136,283	$525,710
Product Margin	$290,073	$167,117	$457,190

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	$206,010.00	Machine hours	152600	$1.35	90400	$122,040.00	62200	$83,970.00
Setups	$159,100.00	Setup hours	370	$430.00	80	$34,400.00	290	$124,700.00
Product sustaining	$100,000.00	Number of products	2	$50,000.00	1	$50,000.00	1	$50,000.00
Advertising Expense	151000.00					$51,000.00		$100,000.00
Other	$60,600.00	No allocation
Total	$676,710.00					$257,440.00		$358,670.00

Computation of Product Margin - Activity based Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,000*$20, T500 - 12700*$40)	$1,200,000	$508,000	$1,708,000
Direct material	$400,200	$162,500	$562,700
Direct labor	$120,300	$42,100	$162,400
Allocated Manufacturing overhead	$257,440	$358,670	$616,110
Product Margin	$422,060.00	-$55,270.00	$366,790.00

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	$400,200	44.0%	$162,500	47.7%	$562,700	45.0%
Direct Labor Cost	$120,300	13.2%	$42,100	12.4%	$162,400	13.0%
Manufacturing Overhead cost	$389,427	42.8%	$136,283	40.0%	$525,710	42.0%
Total	$909,927		$340,883		$1,250,810

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	$400,200	51.4%	$162,500	28.8%	$562,700	42.0%
Labor Cost	$120,300	15.5%	$42,100	7.5%	$162,400	12.1%
Indirect Cost:
Machining	$122,040	15.7%	$83,970	14.9%	$206,010	15.4%
Setups	$34,400	4.4%	$124,700	22.1%	$159,100	11.9%
Product sustaining	$50,000	6.4%	$50,000	8.9%	$100,000	7.5%
Advertising Expense	$51,000	6.6%	$100,000	17.8%	$151,000	11.3%
Total Cost Assigned to Products	$777,940		$563,270		$1,341,210
Cost not assigned to products					$60,600
Total Cost					$1,401,810