Chapter 12, Problem 20P

a)

To determine

Choose the allocation base that would minimize your department’s share of the total overhead cost and calculate the amount of overhead that would be allocated to both departments using the base.

Explanation of Solution

Predetermined Overhead Rate: Predetermined overhead rate is a measure used to allocate the estimated manufacturing overhead cost to the products or job orders during a particular period. This is generally evaluated at the beginning of each reporting period. The evaluation takes into account the estimated manufacturing overhead cost and the estimated allocation base that includes direct labor hours, direct labor in dollars, machine hours and direct materials.

Determine the amount of overhead:

Given, the amount of overhead is $600,000 that is $\left(\$360,000+\$240,000\right)$

$\begin{array}{c}\begin{array}{l}\text{Allocation rate }\\ \text{for Department I}\end{array}\}=\frac{\text{Overhead}}{\text{Machine hours}}\\ =\frac{\$600,000}{24,000}\\ =\$25\text{ per machine hour}\end{array}$

Hence, the allocation rate for Department I is $25 per machine hour.

$\begin{array}{c}\begin{array}{l}\text{Allocation rate }\\ \text{for Department II}\end{array}\}=\frac{\text{Overhead}}{\text{Labor hours}}\\ =\frac{\$600,000}{16,000\text{ labor hours}}\\ =\$37.5\text{ per labor hour}\end{array}$

Hence the allocation rate for Department II is $37.5 per labor hour.

Since, Department I have very less labor hours; the bases would minimize the overhead cost.

Department	Allocation Rate	$\times$	Weight of Base	$=$	Allocated Cost
I	$37.50	$\times$	2,000	$=$	$75,000
II	$37.50	$\times$	14,000	$=$	$525,000
Total					$600,000

Table (1)

Thus, the amount of overhead that would be allocated to Department I and Department II using the base are $75,000 and $525,000 respectively.

b)

To determine

Choose the allocation base that would minimize your department’s share of the total overhead cost and calculate the amount of overhead that would be allocated to both departments using the base.

Explanation of Solution

Predetermined Overhead Rate: Predetermined overhead rate is a measure used to allocate the estimated manufacturing overhead cost to the products or job orders during a particular period. This is generally evaluated at the beginning of each reporting period. The evaluation takes into account the estimated manufacturing overhead cost and the estimated allocation base that includes direct labor hours, direct labor in dollars, machine hours and direct materials.

Determine the amount of overhead:

Since, Department I have very less machine hours; the bases would minimize the overhead cost.

Department	Allocation Rate	$\times$	Weight of Base	$=$	Allocated Cost
I	$25	$\times$	20,000	$=$	$400,000
II	$25	$\times$	4,000	$=$	$100,000
Total					$500,000

Table (2)

Thus, the amount of overhead that would be allocated to Department I and Department II using the base are $400,000 and $100,000 respectively.

c)

To determine

Formulate the overhead allocation policy that would be fair to the supervisors of both departments and determine the overhead allocation using the policy.

Explanation of Solution

Overhead Cost: Overhead cost is the expense incurred in the operations of a business. This expense does not include the cost which is incurred on labor. Therefore; this cost is known as overhead cost.

Determine the overhead allocation to both the departments:

Costs	Allocation Rate	Weight of Base	Department I	Department II
	(a)	(b)	$\left(\text{c}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$	$\left(\text{d}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$
Fringe benefits	$22.50	$2,000	$45,000
Fringe benefits	$22.50	$14,000		$315,000
Utility	$10.00	$20,000	$200,000
Utility	$10.00	$4,000		$40,000
Total			$245,000	$355,000

Table (3)

Note: Refer Table (4) for allocation rate.

Determine the allocation rate:

The allocation of the individual costs using separate allocation bases would be fair because the utility cost are driven by the machine hours and benefits cost are driven by the labor hours.

Cost		Base		Allocation Rate
Cost	Amount	Cost driver	Hour	$\left(\text{c}\right)=\left(\text{a}\right)/\left(\text{b}\right)$
	(a)		(b)
Utility	$240,000	Machine hour	24,000 hour	$10 per machine hour
Fringe benefits	$360,000	Labor hour	16,000 hour	$22.50 per labor hour

Table (4)

d)

To determine

Explain the reason to disaggregate the overhead cost pool to accomplish the fairness.

Explanation of Solution

The costs of Department I had been allocated on the basis of labor hours (fringe benefits) and the costs of Departments of II had been allocated on the basis of machine hours (utility costs). The use of machines incurs the utility cost of the company and the number of employees is driving the costs of fringe benefits. In this case, the cost drivers are spread disproportionately among the departments. So, selecting a single allocation base would help the manager to allocate the costs. Thus, the fairness can be served during when the overhead costs are separated into pools with cost drivers.