Recently, the sales and marketing manager for Pasifika Company, Mr. Reece Rooney couldn’t understand the result of two bids that the firm has submitted. According to the company’s policy, a 50 percent mark-up is added to the full manufacturing cost when calculating the bid. One particular job (Job A01) had been rejected by a prospective customer since the proposed bid was $4 per unit higher than the winning bid. However, a customer has accepted a second job (Job B01) and was pleased with the favorable bid. This customer revealed that Pasifika’s price was $44 per unit lower than the next-lowest bid. Reece knew that the implementation of the cost leadership strategy has resulted in Pasifika’s competitive advantage, therefore he assumed that the issue must be related to cost allocation procedures. When Reece further investigated the matter, he found that Pasifika used a pre-determined plantwide overhead rate based on direct labor hours. The budgeted data used to calculate this rate follows: Department A Department B Total Fixed Overhead $300,000 $1,400,000 $1,700,000 Variable Overhead $1 per DLH $5 per MH Direct labor hours 200,000 50,000 250,000 Machine hours 20,000 120,000 140,000 Additional information on the two jobs are as follows: Job A01 Department A Department B Total Direct labor hours 5,000 1,000 6,000 Machine hours 200 500 700 Prime costs $100,000 $20,000 $120,000 Units produced 14,400 14,400 14,400 Job B01 Direct labor hours 400 600 1,000 Machine hours 200 3,000 3,200 Prime costs $10,000 $40,000 $50,000 Units produced 1,500 1,500 1,500 In his attempt to investigate the costing of the two jobs, Mr. Rooney discovered that the overhead costs in the two departments are different. In particular, the overhead costs of Department B were higher than Department A since it uses more equipment and therefore has higher maintenance, higher power consumption, higher depreciation, and higher setup costs. Additionally, he did some reading on overhead cost allocation methods and found that allocating support department cost appropriately can result to increase accuracy of the product cost. Hence he collected the following information on four support departments as follows: Maintenance Power Setups General Factory Dept.A Dept. B Fixed overhead $400,000 $120,000 $100,000 $500,000 $100,000 $650,000 Variable overhead $100,000 $105,000 $50,000 $125,000 $100,000 $150,000 Maintenance hours - 1,500 500 - 1,000 7,000 Kilowatt-hours 4,500 - - 15,000 10,000 50,000 Direct labor hours 10,000 12,000 6,000 8,000 200,000 50,000 Number of setups - - - - 40 160 Square feet 25,000 40,000 5,000 15,000 35,360 94,640 The following allocation bases (cost drivers) seemed reasonable: Support Department Allocation Base Maintenance Maintenance hours Power Kilowatt-hours Setups Number of setups General Factory Square feet REQUIRED 1. Advise Mr. Rooney on potential strategies he would implement to compete effectively on cost leadership strategy. 2. Calculate the unit bids for the two jobs using a plantwide OH rate based on direct labour hours. 3. (i) Using the sequential (step-down) method, calculate the departmental overhead rates using direct labor hours for Department A and machine hours for Department B. (ii) What would the unit bids for Job A01and Job A02 have been if these overhead rates had been in effect? (Round-off the allocation ratios to 3 decimal places before you allocate the support department costs 4. Discuss any recommendations you would give to Rooney regarding the method of allocating overhead cost
Recently, the sales and marketing manager for Pasifika Company, Mr. Reece Rooney couldn’t understand the result of two bids that the firm has submitted. According to the company’s policy, a 50 percent mark-up
is added to the full
However, a customer has accepted a second job (Job B01) and was pleased with the favorable bid. This customer revealed that Pasifika’s price was $44 per unit lower than the next-lowest bid. Reece knew that the implementation of the cost leadership strategy has resulted in Pasifika’s competitive advantage, therefore he assumed that the issue must be related to cost allocation procedures. When Reece further investigated the matter, he found that Pasifika used a pre-determined plantwide overhead rate based on direct labor hours. The budgeted data used to calculate this rate follows:
Department A Department B Total
Fixed Overhead $300,000 $1,400,000 $1,700,000
Variable Overhead $1 per DLH $5 per MH
Direct labor hours 200,000 50,000 250,000
Machine hours 20,000 120,000 140,000
Additional information on the two jobs are as follows:
Job A01 Department A Department B Total
Direct labor hours 5,000 1,000 6,000
Machine hours 200 500 700
Prime costs $100,000 $20,000 $120,000
Units produced 14,400 14,400 14,400
Job B01
Direct labor hours 400 600 1,000
Machine hours 200 3,000 3,200
Prime costs $10,000 $40,000 $50,000
Units produced 1,500 1,500 1,500
In his attempt to investigate the costing of the two jobs, Mr. Rooney discovered that the overhead costs in the two departments are different. In particular, the overhead costs of Department B were higher than Department A since it uses more equipment and therefore has higher maintenance, higher power consumption, higher
Maintenance Power Setups General Factory Dept.A Dept. B
Fixed overhead $400,000 $120,000 $100,000 $500,000 $100,000 $650,000
Variable overhead $100,000 $105,000 $50,000 $125,000 $100,000 $150,000
Maintenance hours - 1,500 500 - 1,000 7,000
Kilowatt-hours 4,500 - - 15,000 10,000 50,000
Direct labor hours 10,000 12,000 6,000 8,000 200,000 50,000
Number of setups - - - - 40 160
Square feet 25,000 40,000 5,000 15,000 35,360 94,640
The following allocation bases (cost drivers) seemed reasonable:
Support Department Allocation Base
Maintenance Maintenance hours
Power Kilowatt-hours
Setups Number of setups
General Factory Square feet
REQUIRED
1. Advise Mr. Rooney on potential strategies he would implement to compete effectively on cost
leadership strategy.
2. Calculate the unit bids for the two jobs using a plantwide OH rate based on direct labour hours.
3. (i) Using the sequential (step-down) method, calculate the departmental overhead rates using
direct labor hours for Department A and machine hours for Department B.
(ii) What would the unit bids for Job A01and Job A02 have been if these overhead rates had
been in effect? (Round-off the allocation ratios to 3 decimal places before you allocate the
support department costs
4. Discuss any recommendations you would give to Rooney regarding the method of allocating
overhead cost.
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