Comparing Traditional and Activity-Based Product Margins
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.
Sales $ 2,100,000
Cost of goods sold 1,600,000
Gross margin 500,000
Selling and administrative expenses 550,000
Net operating loss $ (50,000 )
Hi-Tek produced and sold 70,000 units of B300 at a price of $20 per unit and 17,500 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 $ 436,300 $ 251,700 $ 688,000
Direct labor $ 200,000 $ 104,000 304,000
Manufacturing overhead 608,000
Cost of goods sold $ 1,600,000
The company has created an activity-based costing system to evaluate the profitability of its products. Hi-Tek’s ABC implementation team concluded that $50,000 and $100,000 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:
Activity Cost Pool (and Activity Measure) B300 T500 Total
Machining (machine-hours) $ 213,500 90,000 62,500 152,500
Setups (setup hours) 157,500 75 300 375
Product-sustaining (number of products) 120,000 1 1 2
Other (organization-sustaining costs) 117,000 NA NA NA
Total manufacturing overhead cost $ 608,000
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.