Question

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	$	1,706,000
Cost of goods sold		1,223,810
Gross margin		482,190
Selling and administrative expenses		560,000
Net operating loss	$	(77,810	)

Hi-Tek produced and sold 60,100 units of B300 at a price of $20 per unit and 12,600 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	$	400,300	$	162,900	$	563,200
Direct labor	$	120,500	$	42,700		163,200
Manufacturing overhead						497,410
Cost of goods sold					$	1,223,810

The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $51,000 and $101,000 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)	$	199,160		90,700	62,500	153,200
Setups (setup hours)		136,350		73	230	303
Product-sustaining (number of products)		101,000		1	1	2
Other (organization-sustaining costs)		60,900		NA	NA	NA
Total manufacturing overhead cost	$	497,410

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

Solution 1:

Predetermined overhead rate = Estimated overhead / Estimated direct labor cost = $497,410 / $163,200 = $3.04786 per direct labor dollar

Computation of Product Margin - Traditional Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,100*$20, T500 - 12600*$40)	$1,202,000	$504,000	$1,706,000
Direct material	$400,300	$162,900	$563,200
Direct labor	$120,500	$42,700	$163,200
Manufacturing overhead (Direct labor * $3.04786)	$367,267	$130,143	$497,410
Product Margin	$313,933	$168,257	$482,190

Solution 2:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	B300		T500
					Usage	Allocated Costs	Usage	Allocated Costs
Machining	$199,160.00	Machine hours	153200	$1.30	90700	$117,910.00	62500	$81,250.00
Setups	$136,350.00	Setup hours	303	$450.00	73	$32,850.00	230	$103,500.00
Product sustaining	$101,000.00	Number of products	2	$50,500.00	1	$50,500.00	1	$50,500.00
Other	$60,900.00	No allocation
Total	$497,410.00					$201,260.00		$235,250.00

Computation of Product Margin - Activity based Costing System
Particulars	B300	T500	Total
Sales (B300 - 60,100*$20, T500 - 12600*$40)	$1,202,000	$504,000	$1,706,000
Direct material	$400,300	$162,900	$563,200
Direct labor	$120,500	$42,700	$163,200
Allocated Manufacturing overhead	$201,260.00	$235,250.00	$436,510
Advertising Expense	$51,000.00	$101,000.00	$152,000.00
Product Margin	$428,940.00	-$37,850.00	$391,090.00

Solution 3:

Quantity comparison of traditional cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Material Cost	$400,300	71.1%	$162,900	28.9%	$563,200
Direct Labor Cost	$120,500	73.8%	$42,700	26.2%	$163,200
Manufacturing Overhead cost	$367,267	73.8%	$130,143	26.2%	$497,410
Total cost assigned to products	$888,067		$335,743		$1,223,810
Total cost not assigned to product:
Selling and adminstrative Expenses					$560,000.00
Total Cost					$1,783,810

Quantity comparison of Activity Based cost assignment
Particulars	B300		T500		Total
	Amount	% of total Amount	Amount	% of total Amount	Amount
Direct Cost:
Material Cost	$400,300	71.1%	$162,900	28.9%	$563,200
Labor Cost	$120,500	73.8%	$42,700	26.2%	$163,200
Advertising Expense	$51,000	33.6%	$101,000	66.4%	$152,000
Indirect Cost:
Machining	$117,910	59.2%	$81,250	40.8%	$199,160
Setups	$32,850	24.1%	$103,500	75.9%	$136,350
Product sustaining	$50,500	50.0%	$50,500	50.0%	$101,000
Total Cost Assigned to Products	$773,060		$541,850		$1,314,910
Cost not assigned to products:
Manufacturing					$60,900
Selling and administrative					$408,000
Total Cost					$1,783,810