Precision Manufacturing Inc. (PMI) makes two type of industrial component

Precision Manufacturing Inc. (PMI) makes two type of industrial component parts – the EX300 and the TX500. An absorption costing income statement for the most recent period is shown below:

Precision Manufacturing Inc.

 Income Statement

Sales  …………………………………………………….. $ 1, 700, 000

Cost of goods sold……………………………………1, 200, 000

Gross margin……………………………………………500, 000

Selling and administrative expenses…………550, 000

Net operating loss ………………………………….. $( 50, 000)

PMI produced and sold 60,000 units of EX300 at a price of $20 per unit and 12, 500 units of TX500 at a price of $40 per unit. The company’s traditional cost system allocated manufacturing overhead to products using a plantwide overhead rate and direct labor dollar as the allocation base. Additional information relating to the company’s two product lines is shown below:

                                                            EX300                         TX500                         Total
Direct materials…………………         $ 366, 325       $ 162, 550       $ 528, 875
Direct labor……………………….       $ 120, 000       $ 42, 500         162, 500
Manufacturing overhead…..                                                                508, 625
Cost of goods sold……………..                                                                      $ 1, 200,000

The company has created an activity-based costing system to evaluate the profitability of its products. PMI’s ABC implementation team concluded that $50,000 and $100,000 of the company’s advertising expenses could directly traced to EX300 and TX500, 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

Manufacturing

Activity cost Pool (and activity measure)         Overhead         EX 300                        TX 500                        Total
Machining (machine-hours)…………………   $198, 250        90,000                        62,500             152,500
Setups (setup hours)……………………………  150, 000       75                    300                  375
Product-sustaining costs……………………… 100, 000          1                      1                      2
Other ( organization-sustaining costs)              60, 375                        NA                   NA                   NA

Total manufacturing overhead cost……..        $ 508, 625

REQUIRED:
1. Using Exhibit 6-12 as a guide, compute the product margins for the EX300 and TX500 under the company’s traditional costing system.

2. Using Exhibit 6-10 as a guide, compute the product margins for EX300 and TX500 under the activity-based costing system.

3. Using Exhibit 6-13 as a guide, prepare a quantitative comparison of the traditional and activity-based cost assignments. Explain why the traditional and activity – based cost assignments differ. 

TUTORIAL PREVIEW

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

	EX300	TX500	Total
Sales	$1,200,000	$500,000	$1,700,000
Direct materials	366,325	162,550	528,875

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