
a)
Choose the allocation base that would minimize your department’s share of the total
a)

Explanation of Solution
Predetermined Overhead Rate: Predetermined overhead rate is a measure used to allocate the estimated
Determine the amount of overhead:
Given, the amount of overhead is $600,000 that is
Hence, the allocation rate for Department I is $25 per machine hour.
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 |
Weight of Base | Allocated Cost | ||
I | $37.50 | 2,000 | $75,000 | ||
II | $37.50 | 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)
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.
b)

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 |
Weight of Base | Allocated Cost | ||
I | $25 | 20,000 | $400,000 | ||
II | $25 | 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)
Formulate the overhead allocation policy that would be fair to the supervisors of both departments and determine the overhead allocation using the policy.
c)

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) | |||
$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 | |
(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)
Explain the reason to disaggregate the overhead cost pool to accomplish the fairness.
d)

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.
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