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 $ 1,712,000 Cost of goods sold 1,228,154 Gross margin 483,846 Selling and administrative expenses 650,000 Net operating loss $ (166,154 ) Hi-Tek produced and sold 60,200 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 $ 400,800 $ 162,400 $ 563,200 Direct labor $ 120,300 $ 42,500 162,800 Manufacturing overhead 502,154 Cost of goods sold $ 1,228,154 The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $59,000 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) $ 204,554 90,800 63,000 153,800 Setups (setup hours) 135,200 78 260 338 Product-sustaining (number of products) 102,000 1 1 2 Other (organization-sustaining costs) 60,400 NA NA NA Total manufacturing overhead cost $ 502,154 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.

Income statement - Traditional Allocation
	B300	T500	Total
Sales	1204000	508000	1712000
Cost of goods sold
Direct Material	400800	162400	563200
Direct Labor	120300	42500	162800
Manufacturing Overhead	371063	131091	502154
Total cost of goods sold	892163	335991	1228154
Gross profit	311837	172009	483846
Selling and administrative expenses			650000
Net operating loss			-166154
Product margins under traditional system	311837	172009
Total manufactuirng overhead	502154
Total Direct labor cost	162800
Predetermined overhead rate	308%
(% of direct labor cost)

2.

Income statement - ABC Allocation
	B300	T500	Total
Sales	1204000	508000	1712000
Cost of goods sold
Direct Material	400800	162400	563200
Direct Labor	120300	42500	162800
Manufacturing Overhead	202964	238790	441754
Unallocated manufacturing overhead			60400
Cost of goods sold	724064	443690	1228154
Gross profit	479936	64310	483846
Selling and administrative expenses			650000
Net operating loss			-166154
Product margins under ABC system	479936	64310

Working:

Activity cost pool	Cost	Activity driver	Activity Driver Units		Activity Units		Activity Cost
				Cost per	B300	T500	B300	T500
				unit
Machining	204554	machine-hours	153800	1.33	90800	120764	63000	83790
Setups	135200	Set - up hours	338	400	78	31200	260	104000
Product Sustaining	102000	no.of products	2	51000	1	51000	1	51000
Total overheads allocated						202964		238790

3.

Product	Product Margin
	Traditioal	ABC
B300	311837	479936
T500	172009	64310