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	$	128.00		$	90.00
Direct materials per unit	$	63.10		$	50.00
Direct labor per unit	$	12.00		$	8.00
Direct labor-hours per unit		1.5	DLHs		1.0	DLHs
Estimated annual production and sales		20,000	units		70,000	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	$	2,100,000
Estimated total direct labor-hours		100,000	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)	$	745,000		30,000	70,000	100,000
Batch setups (setups)		612,000		200	160	360
Product sustaining (number of products)		700,000		1	1	2
Other		43,000		NA	NA	NA
Total manufacturing overhead cost	$	2,100,000

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	1. Under the traditional direct labor-hour based costing system, manufacturing overhead is applied to products using the predetermined over- head rate computed as follows:
	Predetermined Overhead rate	=	Estimated total manufacturing overhead cost			÷	Estimated total direct labor - hours
			$2,100,000			÷	100,000 DLHs*
		=
		=	21.00	per DLH
	*20,000 units of Xtreme @ 1.50 DLH per unit + 70,000 units of the Pathfinder@ 1.0 DLH per unit = 30,000 DLHs + 70,000 DLHs = 100,000 DLHs.
	Consequently, the product margins using the traditional approach would be computed as follows:
		Xtreme	Pathfinder	Total
	Sales	$2,560,000	$6,300,000	$8,860,000
	Direct materials	1,262,000	3,500,000	4,762,000
	Direct labor	240,000	560,000	800,000
	Manufacturing overhead applied @ $21.00 per direct labor-hour
		630,000	1,470,000	2,100,000
	Total manufacturing cost	2,132,000	5,530,000	7,662,000
	Product margin	$428,000	$770,000	$1,198,000
	Note that all of the manufacturing overhead cost is applied to the products under the company’s traditional costing system.
2	The first step is to determine the activity rates:
				(a) ÷ (b)
	Activity Cost Pools	(a) Total Cost	(b)Total Activity	Activity Rate
	Supporting direct labor	$745,000	100,000 DLH	$7.45 per DLH
	Batch setups	$612,000	360 setups	$1,700 per setup
	Product sustaining	$700,000	2 products	$350,000 per product
	*The Other activity cost pool is not shown above because it includes organization-sustaining and idle capacity costs that should not be assigned to products.
	Under the activity-based costing system, the product margins would be computed as follows:
		Xtreme	Pathfinder	Total
	Sales	$2,560,000	$6,300,000	$8,860,000
	Direct materials	1,262,000	3,500,000	4,762,000
	Direct labor	240,000	560,000	800,000
	Supporting direct labor	223,500	521,500	745,000
	Batch setups	340,000	272,000	612,000
	Product sustaining	350,000	350,000	700,000
	Total cost	2,415,500	5,203,500	7,619,000
	Product margin	144,500	1,096,500	1,241,000
3	The quantitative comparison is as follows:
		Xtreme		Pathfinder		Total
		(a)	(a) ÷ (c )	(b)	(b) ÷ (c )	(c )
	Traditional Cost System	Amount	%	Amount	%	Amount
	Direct materials	1,262,000	26.5%	3,500,000	73.5%	4,762,000
	Direct labor	240,000	30.0%	560,000	70.0%	800,000
	Manufacturing overhead	630,000	30.0%	1,470,000	70.0%	2,100,000
	Total cost assigned to products	2,132,000		5,530,000		7,662,000
	Activity-Based Costing System
	Direct costs:
	Direct materials	1,262,000	26.5%	3,500,000	73.5%	4,762,000
	Direct labor	240,000	30.0%	560,000	70.0%	800,000
	Indirect costs:
	Supporting direct labor	223,500	30.0%	521,500	70.0%	745,000
	Batch setups	340,000	55.6%	272,000	44.4%	612,000
	Product sustaining	350,000	50.0%	350,000	50.0%	700,000
	Total cost assigned to products	2,415,500		5,203,500		7,619,000
	Costs not assigned to products:
	Other					43,000
	Total cost					7,662,000
Note: I have tried my best for correct solution still find any difficuty, please ask in comment.