Question

Smoky Mountain Corporation makes two types of hiking boots—the Xtreme and the Pathfinder. Data concerning these two product lines appear below:

Xtreme Pathfinder
Selling price per unit $ 115.00 $ 85.00
Direct materials per unit $ 63.90 $ 51.00
Direct labor per unit $ 12.00 $ 10.00
Direct labor-hours per unit 1.2 DLHs 1.0 DLHs
Estimated annual production and sales 28,000 units 75,000 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 $ 2,063,400
Estimated total direct labor-hours 108,600 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):

Estimated
Overhead Cost Expected Activity
Activities and Activity Measures Xtreme Pathfinder Total
Supporting direct labor (direct labor-hours) $ 673,320 33,600 75,000 108,600
Batch setups (setups) 520,000 280 240 520
Product sustaining (number of products) 790,000 1 1 2
Other 80,080 NA NA NA
Total manufacturing overhead cost $ 2,063,400
Compute the product margins for the Xtreme and the Pathfinder products under the activity-based costing system.

3. Prepare a quantitative comparison of the traditional and activity-based cost assignments.

Answer 1

The law of increasing opportunity cost is shown as a firm reallocates resources from one product to another, where each resource is not identically efficient for both products, leading to higher opportunity costs with more reallocation.

Step-by-step explanation:

The law of increasing opportunity cost is demonstrated when a firm shifts resources between two products. As a firm, such as the fictional WipeOut Ski Company, moves from producing one product to another, the resources are not equally efficient in producing each good, leading to an increasing opportunity cost. This concept becomes clear as the firm produces fewer snowboards to make more skis. Initial shifts in production incur a low opportunity cost, but as more and more resources are allocated to the production of the second good, the opportunity cost increases because the resources are not as well suited to the production of that second good. For instance, in the scenario provided, the first 200 pairs of skis have an opportunity cost of only 0.5 snowboards each, but as production is shifted further, the later pairs of skis have a much higher opportunity cost. This illustrates that certain plants (or parts of the firm's resources) have a comparative advantage in producing one type of product over another, signifying that they can produce it at a lower opportunity cost than others.

Answer 2

Product margins are calculated by accounting for each product's direct material, direct labor, and allocated overhead costs. Under traditional costing, overhead is allocated based on direct labor hours, while activity-based costing uses specific activities to allocate costs. A quantitative comparison between the two systems would reveal differences in profitability for the products.

Step-by-step explanation:

Calculating product margins for Smoky Mountain Corporation involves determining the profit per unit for each type of hiking boot after accounting for direct materials, direct labor, and manufacturing overhead costs. Under a traditional costing system, overhead is applied on the basis of direct labor hours, whereas an activity-based costing system assigns costs based on activities that contribute to overhead, such as supporting direct labor, batch setups, product sustaining, and other costs.

In the traditional system, we divide the total estimated manufacturing overhead by the total estimated direct labor hours to get the overhead rate per direct labor hour, which is then multiplied with the direct labor hours per unit to allocate overhead to each product. Next, we subtract the sum of direct materials, direct labor, and allocated overhead from the selling price to get the product margin for each hiking boot type.

Under the activity-based costing system, we would assign overhead costs based on the activity rates for each cost pool and the extent to which each product uses those activities. This would involve dividing the estimated overhead for each activity by the expected activity levels, and then multiplying these rates by the activity levels (like the number of setups or the number of products) for each product to allocate the costs more accurately.

The quantitative comparison of the traditional and activity-based cost assignments would involve comparing these different product margins to see which product is more or less profitable under each costing system.