Johnson manufacturing, Inc., makes two types of industrial component partsthe XT100 and the LT-200. An absorption costing income statement for the most recent period is shown:

Johnson manufacturing Inc. Income Statement

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)

Table Summary: Income statement with two-line heading. Descriptions of income items are in first column and dollar values in second column.

Johnson produced and sold 70,000 units of XT-100 at a price of $20 per unit and 17,500 units of LT-200 at a price of $40 per unit. The companys 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 companys two product lines is shown below:

XT-100 LT-200 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. Johnsons ABC implementation team concluded that $50,000 and $100,000 of the companys advertising expenses could be directly traced to XT-100 and LT-200, respectively. The remainder of the selling and administrative expenses was organization-sustaining in nature. The ABC team also distributed the companys manufacturing overhead to four activities as shown:

Activity

Activity Cost Pool Manufacturing XT-100 LT-200 Total

(and Activity Measure) Overhead

Machining (machine-hours) $ 213,500 90,000 62,500 152,500

Setups (setup hours) 157,500 75 300 375

Product-sustaining 120,000 1 1 2

(number of products)

Other 117,000 NA NA NA

(organizationsustaining costs)

Total manufacturing overhead cost $608,000

Table Summary: Table shows activity data for two products. First column lists activity cost pools and activity measures. Second column shows manufacturing overhead for each cost pool. Columns 3-5 show activity numbers for the two products and their totals. The XT-100, LT-200, and Total columns are under the spanner heading Activity.

Question A - Explain why the traditional and activity-based cost assignments differ.

Question B - What advice would you give the management of Johnson Manufacturing regarding pricing of products in the future.