D4: Plant-wide vs. Departmental overhead rates.

Use the information below to answer the 4 questions – you should have a computation (#1, #2) or
short explanation (#3, #4) immediately following each bolded line. Please keep the text in bold for
your answer.

“Don’t tell me we’ve lost another bid!” exclaimed Leigh Owens, president of Owens Products Inc. “I’m
afraid so,” replied Charlie Townsend, the operations vice president. “One of our competitors underbid
us by about $6,000 on the Lopez job.” “I just can’t figure it out,” said Owens. “It seems we’re either too
high to get the job or too low to make any money on half the jobs we bid anymore. What’s happened?”

Owens Products manufactures specialized goods to customers’ specifications. It bids on jobs by

estimating the total manufacturing costs (materials, labor and overhead) and then marks up its costs by
150%, which is the industry standard markup. Overhead is allocated to jobs based on direct labor costs
(i.e., the denominator volume). Owens Products has three departments and estimated the following
costs at the beginning of the year. It used these costs to compute a plant-wide (i.e., total plant)
allocation rate.

Department
Fabricating Machining Assembly Total Plant
Direct Labor $200,000 $100,000 $300,000 $600,000
Overhead $350,000 $400,000 $90,000 $840,000

Jobs require varying amounts of work in the three departments. The Lopez job would have required the
manufacturing costs in the three departments as follows:

Department
Fabricating Machining Assembly Total Plant
Direct Materials $3,000 $200 $1,400 $4,600
Direct Labor $2,800 $500 $6,200 $9,500
Overhead ? ? ? ?

1. Assuming that Owens Products uses a plant-wide overhead rate:

 Compute the allocation rate for the current year

Allocation rate = Owens Plant overhead/Owens Plant Direct Labor = $840,000/600,000= 140%

 Determine the amount of overhead and the total estimated cost of the Lopez job

Total Overhead = Lopez Plant Direct Labor * Allocation Rate = 9500*140% = $13,300

Estimated cost of Lopez job = Direct Materials + Direct Labor + Total Overhead = $4600+9500+13300 =
$27,400

 Compute the bid for the job (recall total costs are marked up 150% for bids)

Bid for Lopez job = Cost * Allocation rate = 27,400 * 140% = $38,360
2. Now assume that Owens Products uses a separate overhead rate for each department:

 Compute the allocation rate for each department for the current year (3 rates)

Fabricating = Overhead/Direct labor = ($350,000/200,000) = 175%

Machining = 400,000/100,000 = 400%

Assembly = 90,000/300,000 = 3%

 Determine the amount of overhead by department and the total estimated cost of the Lopez job

Fabricating: = Overhead/Direct labor * Lopez Direct labor = ($350,000/200,000) * 2,800 = $4,900

Machining: 400,000/100,000 * 500 = $2,000

Assembly: 90,000/300,000 * 6,200 = $1,860

Estimated total cost of Lopez job = $8,760

 Compute the bid for the job (recall total costs are marked up 150% for bids)

Bid for Lopez job: 8,760 + 4,600 + 9,500 = $22,860

3. Explain why the plant-wide rate over-costed the Lopez job.

Explanation:

4. Assuming that competitors use the more sophisticated costing system, what insight does the above
analysis provide regarding Leigh Owens’ lament, “It seems we’re either too high to get the job or too
low to make any money on half the jobs we bid anymore.”

Insight: