Question

Problem 7-17 Comparing Traditional and Activity-Based Product Margins [LO7-1, LO7-3, LO7-4, LO7-5] Smoky Mountain Corporation makes two types of hiking boots—the Xtreme and the Pathfinder. Data concerning these two product lines appear below: Selling price per unit Direct materials per unit Direct labor per unit Direct labor-hours per unit Estimated annual production and sales Xtreme $ 116.00 $ 64.00 $ 12.00 1.5 DLHS 29,000 units $ $ $ Pathfinder 80.00 52.00 8.00 1.0 DLHS 76,000 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 Estimated total direct labor-hours $ 1,912,000 119,500 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): Activities and Activity Measures Supporting direct labor (direct labor-hours) Batch setups (setups) Product sustaining number of products) Other Total manufacturing overhead cost Estimated Overhead Cost $ 693,100 539,000 640,000 39,900 $ 1,912,000 Expected Activity Xtreme Pathfinder Total 43,500 76,000 119,500 290 200 490 1 NA NA 1 Compute the product margins for the Xtreme and the Pathfinder products under the activity-based costing system.

Answer 1

Solution:

Solution 1) Calculation of product margins for Xtreme and the Pathfinder products under the company’s traditional costing system.

Estimated Total Manufacturing Overheads = $1,912,000

Estimated total direct labour hours = 119,500 hours

Therefore, Overhead rate per direct labour hours

= Estimated Total Manufacturing Overheads / Estimated total direct labour hours

= $1,912,000 / 119,500 hours hours = $16.00 per direct labour hour.

Overhead cost assigned to Xtreme

= Direct labour hours of Xtreme x Overhead rate per direct labour hour

= 43,500 hours x $16.00 = $696,000

Overhead cost assigned to Pathfinder

= Direct labour hours of Pathfinder x Overhead rate per direct labour hour

= 76,000 hours x $16.00 = $1,216,000

Product margins for Xtreme and the Pathfinder products under the company’s traditional costing system.

	Xtreme		Pathfinder
	Total $ (29,000 Units)	Per Unit $	Total $ (76,000 Units)	Per Unit $
Sales	33,64,000.00	116.00	60,80,000.00	80.00
Less: Variable Cost
Material	18,56,000.00	64.00	39,52,000.00	52.00
Labour	3,48,000.00	12.00	6,08,000.00	8.00
Total Variable Cost	22,04,000.00	76.00	45,60,000.00	60.00
Contribution = Sales - Total Variable Cost	11,60,000.00	40.00	15,20,000.00	20.00
Less: Fixed Cost (Overheads)	6,96,000.00	24.00	12,16,000.00	16.00
Profit	4,64,000.00	16.00	3,04,000.00	4.00

Solution 2) Calculation of product margins for Xtreme and the Pathfinder products under the Activity Based costing system.

Calculation of Rate per Cost Driver as per Activity Based Costing

Overheads	Cost $	Cost Driver	Number of Cost Drivers	Rate Per Cost Driver = Cost $ / Number of Cost Drivers
Supporting Direct Labour	6,93,100.00	Direct Labour Hours	1,19,500	5.80
Batch Setup	5,39,000.00	Number of setups	490	1,100.00
Product Sustaining	6,40,000.00	Number of products	2	3,20,000.00
	18,72,100.00

Calculation of Overheads allocated to Xtreme and Pathfinder

	Xtreme			Pathfinder
Costs	Number of Activities	Activity Rate $	Cost $	Number of Activities	Activity Rate $	Cost $
Supporting Direct Labour	43,500	5.80	2,52,300.00	76,000	5.80	4,40,800.00
Batch Setup	290	1,100.00	3,19,000.00	200	1,100.00	2,20,000.00
Product Sustaining	1	3,20,000.00	3,20,000.00	1	3,20,000.00	3,20,000.00
Total Overhead Cost $	8,91,300.00			9,80,800.00
Number of Units	29,000			76,000
Overhead Cost per Unit $	30.73			12.91

Product margins for Xtreme and the Pathfinder products under the Activity Based costing system.

	Xtreme		Pathfinder
	Total $ (29,000 Units)	Per Unit $	Total $ (76,000 Units)	Per Unit $
Sales	33,64,000.00	116.00	60,80,000.00	80.00
Less: Variable Cost
Material	18,56,000.00	64.00	39,52,000.00	52.00
Labour	3,48,000.00	12.00	6,08,000.00	8.00
Total Variable Cost	22,04,000.00	76.00	45,60,000.00	60.00
Contribution = Sales - Total Variable Cost	11,60,000.00	40.00	15,20,000.00	20.00
Less: Fixed Cost (Overheads)	8,91,300.00	30.73	9,80,800.00	12.91
Profit	2,68,700.00	9.27	5,39,200.00	7.09

Solution 3) Preparation of quantitative comparison of the traditional and activity based cost assignments.

	Xtreme		Pathfinder		Total
	Amount	% of Total Amount	Amount	% of Total Amount	Amount
Traditional Cost System
Direct Material	18,56,000.00	64.00	39,52,000.00	68.42	58,08,000.00
Direct Labour	3,48,000.00	12.00	6,08,000.00	10.53	9,56,000.00
Overheads	6,96,000.00	24.00	12,16,000.00	21.05	19,12,000.00
Total cost assigned to products	29,00,000.00		57,76,000.00		86,76,000.00
Activity Based Costing System
Direct Costs
Direct Material	18,56,000.00	59.96	39,52,000.00	71.33	58,08,000.00
Direct Labour	3,48,000.00	11.24	6,08,000.00	10.97	9,56,000.00
Indirect Costs
Supporting Direct Labour	2,52,300.00	8.15	4,40,800.00	7.96	6,93,100.00
Batch Setup	3,19,000.00	10.31	2,20,000.00	3.97	5,39,000.00
Product Sustaining	3,20,000.00	10.34	3,20,000.00	5.78	6,40,000.00
Total cost assigned to products $	30,95,300.00		55,40,800.00		86,36,100.00
Costs not assigned to products:					39,900.00
Total cost $					86,76,000.00