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:

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	$	1,695,400
Cost of goods sold		1,205,309
Gross margin		490,091
Selling and administrative expenses		560,000
Net operating loss	$	(69,909	)

Hi-Tek produced and sold 60,200 units of B300 at a price of $20 per unit and 12,600 units of T500 at a price of $39 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	$	400,600	$	162,400	$	563,000
Direct labor	$	120,100	$	42,100		162,200
Manufacturing overhead						480,109
Cost of goods sold					$	1,205,309

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 $103,000 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)	$	203,889		90,700	62,600	153,300
Setups (setup hours)		113,820		71	200	271
Product-sustaining (number of products)		101,800		1	1	2
Other (organization-sustaining costs)		60,600		NA	NA	NA
Total manufacturing overhead cost	$	480,109

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.

 

Explanation

1.

Under the traditional direct labor-dollar based costing system, manufacturing overhead is applied to products using the predetermined overhead rate computed as follows:

Predetermined overhead rate	=	Estimated total manufacturing overhead cost
		Estimated total direct labor dollars
	=	$480,109	= $2.96 per DL$
		$162,200

The product margins using the traditional approach would be computed as follows:

	B300		T500		Total
Sales	$	1,204,000	$	491,400	$	1,695,400
Direct materials		400,600		162,400		563,000
Direct labor		120,100		42,100		162,200
Manufacturing overhead applied @ $2.96 per direct labor-dollar		355,496		124,616		480,112
Total manufacturing cost		876,196		329,116		1,205,309
Product margin	$	327,804	$	162,284	$	490,091

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)		(a) ÷ (b)
Activity Cost Pools	Total Cost			Total Activity		Activity Rate
Machining	$	203,889		153,300	MH	$	1.33	per MH
Setups	$	113,820		271	setup hrs.	$	420	per setup hr.
Product sustaining	$	101,800		2	products	$	50,900	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:

	B300		T500			Total
Sales	$	1,204,000	$	491,400		$	1,695,400
Direct materials		400,600		162,400			563,000
Direct labor		120,100		42,100			162,200
Advertising expense		59,000		103,000			162,000
Machining		120,631		83,258			203,889
Setups		29,820		84,000			113,820
Product sustaining		50,900		50,900			101,800
Total cost		781,051		525,658			1,306,709
Product margin	$	422,949	$	(34,258	)	$	388,691

3.

The quantitative comparison is as follows:

	B300	T500
Traditional Cost System
Direct materials	$400,600/$563,000 = 71.2%	$162,400/$563,000 = 28.8%
Direct labor	$120,100/$162,200 = 74.0%	$42,100/$162,200 = 26.0%
Manufacturing overhead	$355,496/$480,112 = 74.0%	$124,616/$480,112 = 26.0%
Activity-Based Costing System
Direct costs:
Direct materials	$400,600/$563,000 = 71.2%	$162,400/$563,000 = 28.8%
Direct labor	$120,100/$162,200 = 74.0%	$42,100/$162,200 = 26.0%
Advertising expense	$59,000/$162,000 = 36.4%	$103,000/$162,000 = 63.6%
Indirect costs:
Machining	$120,631/$203,889 = 59.2%	$83,258/$203,889 = 40.8%
Setups	$29,820/$113,820 = 26.2%	$84,000/$113,820 = 73.8%
Product sustaining	$50,900/$101,800 = 50.0%	$50,900/$101,800 = 50.0%

Thanks