Question

Morton Company has two divisions. Sales, direct materials cost, direct labor cost, and manufacturing overhead data for Morton’s two divisions are available below. Note: All of Morton Company’s products are sold in competitive markets.

Missile Salt

Products Products

Sales $1,500,000 $1,000,000

Direct labor (800,000) (300,000)

Direct materials (100,000) (40,000)

Manufacturing overhead* (400,000) (150,000)

Gross profit $200,000 $510,000

*Manufacturing overhead is allocated to production based on the amount of direct labor cost. Morton has determined that its total manufacturing overhead cost of $550,000 is a mixture of batch-level costs and product line costs.

Morton has assembled the following information concerning the manufacturing overhead costs, the annual number of production batches, and the number of product lines in each division.

Total Manufacturing

Overhead Missile Salt

Costs Products Products

Batch-level overhead $250,000 10 batches 90 batches

Product line overhead 300,000 1 line 9 lines $550,000

Which ONE of the following statements is MOST CORRECT?

If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have decreased by $345,000.

If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have decreased by $25,000.

If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have increased by $345,000.

If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Salt Division would have decreased by $285,000.

If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Salt Division would have increased by $285,000.

If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have increased by $25,000.

Answer 1

• All working forms part of the answer
• Step 1: Calculation of Activity Rates using ABC method

Overheads	Cost	Cost driver	No. of cost drivers	Activity rate per cost driver
	[A]		[B]	[C = A/B]
Batch Level	$                      250,000.00	No. of batches	100	$           2,500.00 per batch
Product line	$                      300,000.00	No. of lines	10	$         30,000.00 per line

• Step 2: Allocation of overheads to Missile Division

Missile Division Allocation
Overheads	Activity rate per cost driver	No. of cost driver	Overheads allocated
Batch Level	$           2,500.00 per batch	10	$         25,000.00
Product line	$         30,000.00 per line	1	$         30,000.00
Total Overheads allocated			$         55,000.00

• Step 3: Allocation of overheads to Salt Division

Salt Division allocation
Overheads	Activity rate per cost driver	No. of cost driver	Overheads allocated
Batch Level	$           2,500.00 per batch	90	$      225,000.00
Product line	$         30,000.00 per line	9	$      270,000.00
Total Overheads allocated			$      495,000.00

• Step 4: Comparison of Tradition Gross Profits and ABC Method Gross Profits

	Missile		Salt
	As per traditional	As per ABC method	As per traditional	As per ABC method
Sales	$                   1,500,000.00	$                                 1,500,000.00	$   1,000,000.00	$   1,000,000.00
Direct labor	$                      800,000.00	$                                     800,000.00	$      300,000.00	$      300,000.00
Direct Material	$                      100,000.00	$                                     100,000.00	$         40,000.00	$         40,000.00
Manufacturing Overhead	$                      400,000.00	$                                       55,000.00 [see Step 3]	$      150,000.00	$      495,000.00 [see Step 4]
Gross Profits	$                      200,000.00	$                                     545,000.00	$      510,000.00	$      165,000.00

• Summary, for selecting Answer

	Divisions
	Missile	Salt
Profits as per traditional costing (A)	$        200,000.00	$    510,000.00
Profits as per ABC method (B)	$        545,000.00	$    165,000.00
Increase (Decrease) in profits due to ABC method = (B – A)	$        345,000.00 [Statement #3 matching this answer]	$ (345,000.00)

• Hence, of all the statements, Statement #3 is CORRECT, which is “If the activity-based costing system had been used in the most recent year in place of the traditional overhead allocation technique, profit for the Missile Division would have increased by $345,000.”