Chapter 4.B, Problem 7C

CASE 4B-7 Step-Down Method versus Direct Method LO4-10, LO4-11

"This is really an odd situation,' said Tim Carter, mil manager of Highland Publishing Company. “We get most of the jobs we bid on that require a lot of press time in the Printing Department, yet profits on those jobs are never as high as they ought to be. On the other hand, we lose most of the jobs we bid on that require a lot of time m the Binding Department. I would be inclined to think that the problem is with our overhead rates, but we're already computing separate overhead rates for each department. So what else could be wrong?”

Highland Publishing Company is a large organization that offers a variety of printing and binding work. The Printing and Building departments are supported by three service departments. The costs of these service departments are allocated to other departments in the order listed below. The Personnel cost is allocated based on number of employees. The Custodial Services cost is allocated based on square feet of space occupied and the Maintenance cost is allocated based on machine-hours.

Department	TotalLabor-Hours	Square Feet of Space Occupied	NumberofEmployees	Machine-Hours	DirectLabor-Hours
Personnel	20,000	4,000	10
Custodial Services	30,000	6,000	15
Maintenance	50,000	20,000	25
Printing	90,000	80,000	40	150,000	60,000
Binding	260,000	40,000	120	30,000	175,000
	450,000	150,000	210	180,000	235,000

Budgeted overhead costs in each department for the current year are shown below:

Because of its simplicity, the company has always used the direct method to allocate service department costs to the two operating departments.

Required:

1. Using the step-down method, allocate the service department costs to the consuming departments. Then compute predetermined overhead rates in the two operating departments. Use machine-hours as the allocation base in the Printing Department and direct labor-hours as the allocation base in the Binding Department.
2. Repeat (1) above, this time using the direct method. Again compute predetermined overhead rates in the Printing and Binding departments.
3. Assume that during the current year the company bids on a job that requires machine and labor time as follows:

Determine the amount of overhead cost that would be assigned to the job if the company used the overhead rates developed in (1) above. Then determine the amount of overhead cost that would be assigned to the job if the company used the overhead rates developed in (2) above.

Explain to Mr. Carter, the general manager, why the step-down method provides a better basis for computing predetermined overhead rates than the direct method.

1 The reciprocal method can also be used to allocate service department costs to operating departments. However, this method requires the use of simultaneous linear equations that are beyond the scope of this book.