Departmental Cost Allocation; Outsourcing McKeoun Enterprises is a large machine toolcompany now experiencing alarming increases in maintenance expense in each of its four productiondepartments. Maintenance costs are currently allocated to the production departments on the basisof direct labor hours incurred in the production department. To provide pressure for the productiondepartments to use less maintenance, and to provide an incentive for the maintenance department tobecome more efficient, McKeoun has decided to investigate new methods of allocating maintenancecosts. One suggestion now being evaluated is a form of outsourcing. The producing departmentscould purchase maintenance service from an outside supplier. That is, they could choose either touse an outside supplier of maintenance or to be charged an amount based on their use of direct laborhours. The following table shows the direct labor hours in each department, the allocation of maintenance cost based on labor hours, and the cost to purchase the equivalent level of maintenance servicefrom an outside maintenance provider.ProductionDepartmentDirect Labor HoursAllocation Base (percent)Cost Allocation Basedon Direct Labor Hours Outside PriceA 20% $ 90,000 $115,000B 30 135,000 92,000C 10 45,000 69,000D 40 180,000 184,000Total 100% $450,000 $460,000Required Use four or more decimal places (e.g., 33.3333%) in your calculations.1. As a first step in moving to the outsourcing approach, McKeoun is considering an allocation based onthe price of the outside maintenance supplier for each department. Calculate the cost allocations on thisbasis and compare them to the current direct labor hours basis.2. If McKeoun follows the proposed plan, what is likely to happen to the use of internally provided maintenance compared to externally provided maintenance? How will each department manager be motivatedto increase or decrease the use of maintenance? What will be the overall effect of going to the new plan?
Departmental Cost Allocation; Outsourcing McKeoun Enterprises is a large machine tool
company now experiencing alarming increases in maintenance expense in each of its four production
departments. Maintenance costs are currently allocated to the production departments on the basis
of direct labor hours incurred in the production department. To provide pressure for the production
departments to use less maintenance, and to provide an incentive for the maintenance department to
become more efficient, McKeoun has decided to investigate new methods of allocating maintenance
costs. One suggestion now being evaluated is a form of outsourcing. The producing departments
could purchase maintenance service from an outside supplier. That is, they could choose either to
use an outside supplier of maintenance or to be charged an amount based on their use of direct labor
hours. The following table shows the direct labor hours in each department, the allocation of maintenance cost based on labor hours, and the cost to purchase the equivalent level of maintenance service
from an outside maintenance provider.
Production
Department
Direct Labor Hours
Allocation Base (percent)
Cost Allocation Based
on Direct Labor Hours Outside Price
A 20% $ 90,000 $115,000
B 30 135,000 92,000
C 10 45,000 69,000
D 40 180,000 184,000
Total 100% $450,000 $460,000
Required Use four or more decimal places (e.g., 33.3333%) in your calculations.
1. As a first step in moving to the outsourcing approach, McKeoun is considering an allocation based on
the price of the outside maintenance supplier for each department. Calculate the cost allocations on this
basis and compare them to the current direct labor hours basis.
2. If McKeoun follows the proposed plan, what is likely to happen to the use of internally provided maintenance compared to externally provided maintenance? How will each department manager be motivated
to increase or decrease the use of maintenance? What will be the overall effect of going to the new plan?
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