We know that direct costs (labor and materials) are costs that the company wants to track specifically on the production run. Every other product cost goes into a big pool of costs and we allocate those based on some base. Many companies use direct labor or machine hours, however there are many other concepts utilized to allocate overhead. 1.Discuss the important characteristics of a good overhead allocation base. Which overhead allocation base makes the most sense to you, and why?
We know that direct costs (labor and materials) are costs that the company wants to track specifically on the production run. Every other product cost goes into a big pool of costs and we allocate those based on some base. Many companies use direct labor or machine hours, however there are many other concepts utilized to allocate overhead. 1.Discuss the important characteristics of a good overhead allocation base. Which overhead allocation base makes the most sense to you, and why?
Related questions
Please answer only the Discussion Questions
Giant Bicycles (GB) produces 2 different grades of bikes.
1st â is a Multi-Purpose Bike produced in highvolumes that uses relatively few components.
2nd - is a Custom Bike, produced in lower volumes anduses more unique components.
Company strategy: Produce the multi-purpose bike in high volumesto effectively utilize capacity and the lower volume custom bike toearn higher profit margins.
Multi-purpose Bike | Custom Bike | Total | |
Units Produced | 10000 | 1000 | 11000 |
Direct Materials | $200/bike | $400/bike | |
Direct labor hours @ $20/hour | 1.6 hours/bike | 4.0 hours/bike |
Part A
Assuming the company's cost accounting system allocates totaloverhead costs based on total direct labor hours: (a) Calculate anoverhead rate per direct labor hour. (b) Calculate the full unitcost per bike for the multi-purpose bike and custom bike,respectively.
Part B
Upon further inspection, a feature of the manufacturing processis the use of state-of-the-art fabrication equipment that enablesthe company to produce bike frames. GBâs manufacturing overheadis:
Frame Fabrication Overhead | $360,000 |
Bike Assembly Overhead | 350,000 |
Total | $710,000 |
Assume the company's cost accounting system allocates framefabrication related overhead costs based on machine hours and bikeassembly overhead costs based on direct labor hours. The followingvolume mix and other data are relevant:
Multi-purpose Bike | Custom Bike | Total | |
Units Produced | 10000 | 1000 | 11000 |
Direct Materials | $200/bike | $400/bike | |
Direct labor hours @ $20/hour | 1.6 hours/bike | 4.0 hours/bike | |
Machine Hours | 0.3 hours/bike | 1.5 hours/bike |
Assuming the company's cost accounting system allocates overheadcosts based on total machine hours for fabrication overhead andtotal direct labor hours for assembly overhead: (a) Calculateoverhead rates per direct labor hour and machine hour. (b)Calculate full unit cost per bike for the multi-purpose bike andcustom bike, respectively. Comment on the difference between partsA. and B.
Part C
Subsequent analysis suggested that additional data could be usedto "activity cost" the overhead allocation. The research shows thatfabrication set-up is a required activity to configure the machine,at the beginning of a production run for each particular type ofbike. It is also noted that component handling is an identifiableactivity within bike assembly. Therefore, GBâs manufacturingoverhead is now detailed as:
Frame Fabrication Overhead: | |
Fabrication Set-up | $150000 |
Fabrication | 210000 |
Total Frame Fabrication Overhead | 360000 |
Bike Assembly Overhead: | |
Component Handling | $75000 |
Assembly | 275000 |
Total Bike Assembly Overhead | 350000 |
Total | $710000 |
The new additional activity data by biketype:
Activity Pool
Activity Volume | |||
Multi-Purpose Bike | Custom Bike | Total | |
Fabrication Set-ups | 150 | 150 | 600 |
Components handled | 120000 | 30000 | 150000 |
The remaining frame fabrication overhead costs not applicable toset-ups can be allocated, as before in Part B, using machine hours.Likewise, the bike assembly overhead costs not applicable tocomponent handling can be allocated, as before in Part B, directlabor hours.
Company's cost accounting system allocates overhead costs basedon total machine hours for fabrication overhead & total directlabor hours for assembly overhead:
a. Calculate the four activity overhead rates required fromabove.
b. Calculate full unit cost per bike for the multi-purpose bikeand custom bike, respectively.
DISCUSSION QUESTIONS
Discuss the following concepts concerning the company:
1. What are the mechanics and conceptual basis for activitybased product/service costing? and
2. How do they apply to the case? Including the Overhead CostBehavior and Activity.
3. How was Activity Costing utilized to determine product costsin this problem.
CASE 3â18 Ethics and the Manager [Course ObjectiveB] Terri Ronsin had recently been transferred to the HomeSecurity Systems Division of National Home Products. Shortly aftertaking over her new position as divisional controller, she wasasked to develop the divisionâs predetermined overhead rate for theupcoming year. The accuracy of the rate is important because it isused throughout the year and any overapplied or underapplied over-head is closed out to Cost of Goods Sold at the end of the year.National Home Products uses direct labor-hours in all of itsdivisions as the allocation base for manufacturing overhead.
To compute the predetermined overhead rate, Terri divided herestimate of the total manufacturing overhead for the coming year bythe production managerâs estimate of the total direct labor-hoursfor the coming year. She took her computations to the divisionâsgeneral manager for approval but was quite surprised when hesuggested a modification in the base. Her conversation with thegeneral manager of the Home Security Systems Division, HarryIrving, went like this:
Ronsin: Here are my calculations for next yearâs predeterminedoverhead rate. If you approve, we can enter the rate into thecomputer on January 1 and be up and running in the job-ordercosting system right away this year.
Irving: Thanks for coming up with thecalculations so quickly, and they look just fine. There is, how-ever, one slight modification I would like to see. Your estimate ofthe total direct labor-hours for the year is 440,000 hours. Howabout cutting that to about 420,000 hours?
Ronsin: I donât know if I can do that. The production managersays she will need about 440,000 direct labor-hours to meet thesales projections for the year. Besides, there are going to be over430,000 direct labor-hours during the current year and sales areprojected to be higher next year.
Irving: Teri, I know all of that. I would still like to reducethe direct labor-hours in the base to some- thing like 420,000hours. You probably donât know that I had an agreement with yourpredecessor as divisional controller to shave 5% or so off theestimated direct labor-hours every year. That way, we kept areserve that usually resulted in a big boost to net operatingincome at the end of the fiscal year in December. We called it ourChristmas bonus. Corporate headquarters always seemed as pleased aspunch that we could pull off such a miracle at the end of the year.This system has worked well for many years, and I donât want tochange it now.
Required:
Assume the following information:
Direct Materials | $40 | per unit |
Direct Labor | $20 | per unit |
Total Estimated Manufacturing Overhead | $8,400,000 | |
| Manufacturing overhead is allocated based on estimateddirect-labor hours. Each unit of product requires 1 direct labor hour. |
During the year, the company produced and sold 442,000 units,and incurred actual overhead of $8,450,000, what is theunder/overapplied overhead if:
The estimated Direct Labor Hours is 440,000.
The estimated Direct Labor Hours is 420,000.
All over-applied and under-applied overhead applied directly tocost of goods sold. Assume that the company had $900,000 in netoperating income before the over/under applied overhead adjustmentis made. What is the revised net income after the over/underappliedoverhead adjustment?
