Question

Problem 7-16 Comparing Traditional and Activity-Based Product Margins [LO7-1, LO7-3, LO7-4, LO7-5]

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	$	1,755,600
Cost of goods sold		1,248,706
Gross margin		506,894
Selling and administrative expenses		590,000
Net operating loss	$	(83,106	)

Hi-Tek produced and sold 60,200 units of B300 at a price of $21 per unit and 12,600 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	$	400,200	$	162,300	$	562,500
Direct labor	$	120,900	$	42,600		163,500
Manufacturing overhead						522,706
Cost of goods sold					$	1,248,706

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)	$	204,886		90,200	62,700	152,900
Setups (setup hours)		157,520		78	280	358
Product-sustaining (number of products)		100,000		1	1	2
Other (organization-sustaining costs)		60,300		NA	NA	NA
Total manufacturing overhead cost	$	522,706

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

Answer 1.
Calculation of Product Margin
Under Traditional Costing System
	B300	T500	Total
Sales in Units	60,200	12,600
SP per Unit	21	39
Sales in $	1,264,200	491,400	1,755,600
Less: Costs
Direct Materials	400,200	162,300	562,500
Direct Labor	120,900	42,600	163,500
Manufacturing Overhead	386,515	136,191	522,706
Total Maufacturing Cost	907,615	341,091	1,248,706
Product Margin	356,585	150,309	506,894
Predetermined Overhead Rate = $522,706 (Total MOH) / $163,500 (Total Direct Labour $)
Predetermined Overhead Rate = 319.70% of DLC (Approx.)
Answer 2.
Calculation of Activity Rate
	Total cost	Allocation Base		Allocation Rate
Machining	204,886	152,900	Mach. Hrs	1.34	per mach. Hr
Setups	157,520	358	Setup Hrs	440.00	per setup hr.
Product Sustaining	100,000	2	Production	50,000.00	per product
Other	60,300	NA		NA
Total Overhead	522,706
Assigning Overhead Cost to Product Model
Using ABC Method
	Activity Based Overhead Rate		B300			T500
			Cost Driver Incurred		OH Allocated	Cost Driver Incurred		OH Allocated
Machining	1.34	per mach. Hr	90,200	Mach. Hrs	120,868.00	62,700	Mach. Hrs	84,018.00
Setups	440.00	per setup hr.	78	Setup Hrs	34,320.00	280	Setup Hrs	123,200.00
Product Sustaining	50,000.00	per product	1	Production	50,000.00	1	Production	50,000.00
Total Overhead					205,188			257,218
Calculation of Product Margin
Under ABC Costing
	B300	T500	Total
Sales in Units	60,200	12,600
SP per Unit	21	39
Sales in $	1,264,200	491,400	1,755,600
Less: Costs
Direct Materials	400,200	162,300	562,500
Direct Labor	120,900	42,600	163,500
Advertising Costs	53,000	102,000	155,000
Indirect Costs:
Machining	120,868	84,018	204,886
Setups	34,320	123,200	157,520
Product Sustaining	50,000	50,000	100,000
Total costs assigned to products	779,288	564,118	1,343,406
Product Margin	484,912	(72,718)	412,194
Answer 3.
	B300		T500		Total Amount
	Amount	% of Total amount	Amount	% of Total amount
Traditional Cost System
Direct Materials	400,200	71.15%	162,300	28.85%	562,500
Direct Labor	120,900	73.94%	42,600	26.06%	163,500
Manufacturing Overhead	386,515	73.94%	136,191	26.06%	522,706
Total cost assigned to products	907,615	72.68%	341,091	27.32%	1,248,706
Selling & Admn. Exp.					590,000
Total Costs					1,838,706
	B300		T500		Total Amount
	Amount	% of Total amount	Amount	% of Total amount
Activity Based Costing system
Direct Materials	400,200	71.15%	162,300	28.85%	562,500
Direct Labor	120,900	73.94%	42,600	26.06%	163,500
Advertising Costs	53,000	34.19%	102,000	65.81%	155,000
Indirect Costs:
Machining	120,868	58.99%	84,018	41.01%	204,886
Setups	34,320	21.79%	123,200	78.21%	157,520
Product Sustaining	50,000	50.00%	50,000	50.00%	100,000
Total costs assigned to products	779,288	58.01%	564,118	41.99%	1,343,406
Costs not assigned to products
Selling & Admn. Exp.					435,000
Other Costs					60,300
Total Costs					1,838,706