companies that have been competitors for many years recently decided to
quit fighting each other and merge into one company. The companies were
located next to each other and shared a common wall for plant space. In
an effort to promote goodwill and to increase transparency between the
companies, the newly merged enterprise knocked down the common wall that
once separated them. Top management agreed that the control of
operations would be equally shared and that the original plant managers
would continue to operate similarly to how they had in the past, except
now as one company with two divisions (A and B) and two division
companies (now divisions) each made the same product and produced at
the same rate. The only apparent difference was that Division A was more
labor-intensive, using many workers with simple tools to achieve their
production, while the more capital-intensive Division B used automated
machines and fewer workers to achieve production. Otherwise, their
respective product outputs were identical. Both companies produced at
the rate of 1,000 units per year. Division A allocated overhead based on
direct labor hours (DLH) while Division B allocated overhead based on
machine hours (MH). The cost data for the most recent year
reflected the same actual amount of overhead resource usage per DLH
($25) and per MH ($40) between the divisions, but the divisions incurred
slightly different total overhead costs per unit of product because of
the emphasis on labor in A and machines in B. Because of this, the
actual cost of overhead was as follows:
Division A Division B
DLH = 5 per product unit @ $25 = $125 per unit DLH = 2 per product unit @ $25 = $50 per unitMH = 2 per product unit @ $40 = $80 per unit MH = 4 per product unit @ $40 = $160 per unitTotal actual overhead cost per unit = $205 Total actual overhead cost per unit = $210Total actual overhead cost incurred = $205,000 Total actual overhead cost incurred = $210,000Other
costs included direct material (DM) of $100 per product unit for both
divisions and direct labor of $50 per product unit for Division A and
$20 per product unit for Division B reflecting a wage rate of $10 per
direct labor hour (DLH).
the merger the operations manager of each division decided it would be
much simpler to allocate costs using one plant wide rate as they did
before the merger. Machine hours is chosen as the basis for allocation
since this is what Division B used. This decision was based on the fact
that Division B appears more efficient, given Division Bs lower total
cost per unit. Moreover, top management reasons that Division B seems to
be the more modern and progressive of the two companies given their
degree of automation. They also believe allocation based on MH more
accurately reflects the trend of operations in the future.
Required (25 points):
[Note: Your answer should be no longer than two pages total.]
a. Calculate the new overhead allocation rate (i.e., per MH) assuming that the estimated overhead is
$400,000; the estimated MH = 10,000.
Assume that once the year ends, the company determines that 12,000
machine hours were actually used during the year and actual overhead was
$420,000, what would be the total overhead applied and the over-applied
overhead for the year?
Top management complains that if the accountants had been more accurate
in estimating overhead then they wouldnt have over applied overhead.
Is this true? Explain.
d. The division managers are given a bonus based
on their divisions profitability calculated using allocated costs.
Describe the likely dysfunctional result of using one plant wide
overhead allocation rate based on MH. Provide your summary of the
problem for the company and support your answer with a computational
analysis based on an estimate of future overhead cost, MH, and DLH equal
to the original actual amounts in the Division A and B table on the
prior page (e.g., estimated and actual overhead for A = $205,000;
estimated and actual MH for A = 2,000; estimated and actual DLH for A =
5,000). Explain your recommendation for the company in correcting the
problem. How would the decision to stay with a plant wide rate be likely
to affect decision making in the future?