How to compute operating income using the traditional costing system

Fairbanks Corporation produces two types of cell phone electronic chargers: wall chargers and car chargers.

The current traditional costing system allocates overhead costs using a plant-wide overhead rate based on direct labor hours. Since the two products are similar but require different parts and processes, the company controller believes that it might make sense to employ activity-based costing in order to get a better application of overhead expenses to the products produced.

Production expectations for 2017 are 17,000 wall chargers and 15,200 car chargers. The wall chargers take .5 hours to produce. The car chargers take .75 hours to produce.

The direct material and direct labor costs included in the two products are as follows:

Wall chargers use $3.75 of direct material per unit and $9.50 per hour of direct labor. Car chargers use $4.15 of direct material per unit and $9.50 per hour of direct labor. Each charger sells for $23.00.

Budgeted Total Factory Overhead for 2017:

Activity

Est. OH Cost

Est. Volume Levels

Production setup

$8,500

20 setups

Materials handling

$62,000

4,500 lbs.

Packaging and shipping

$120,000

6,400 boxes

Total factory overhead

$190,500

Fairbanks’ controller worked with the operations group to analyze the three overhead activities in order to effectuate activity-based costing. The estimates related to the two products’ requirements were:

Activity

Wall Charger

Car Charger

Production setup

35%

65%

Materials handling

60%

40%

Packaging and shipping

55%

45%

From the cost information provided, provide responses in Microsoft Excel to the following questions. For assistance with Microsoft Excel, please refer to Lynda.com in the CSU-Global Library (Links to an external site.)Links to an external site. for tutorials.

Compute the cost of each product under the simple/traditional costing method. For period costs, use direct labor hours.
Compute the net operating profit margin of each product using the simple/traditional costing method.
Compute the total overhead and period cost allocation under ABC assumptions for each product.
Compute the per unit ABC cost of each product.
Compute the net profit margin of each product using the ABC costing method.
Compare the net profit margin of the products under the simple/traditional cost assignment and the ABC assignment for each product. Evaluate the difference.
On a separate Excel workbook tab, write a brief explanation (approximately two paragraphs) that the controller might deliver to management to justify the use of ABC for these two products.