PRACTICES - SESSION 2

Question 1: Single rate versus departmental rates

Bravo Steel Company supplies structural steel products to the construction industry. Its plant has
three production departments: cutting, grinding, and drilling. The company has been using a
plantwide cost driver rate computed by dividing plantwide overhead costs by total plantwide
direct labor hours. The estimated overhead cost and practical capacity direct labor hours and
machine hours for each department for the current year follow:
Cutting Grinding Drilling
Overhead cost $504,000 $2,304,000 $2,736,000
Estimated direct labor hours 60,000 96,000 144,000
Estimated machine hours 960,000 480,000 360,000

During the year an order from Eastern Metal Products was produced with the following data:
Cutting Grinding Drilling
Direct material costs $95,000 10,000 5,000
Direct labor costs 20,000 25,000 27,000
Direct labor hours 2,000 2,500 3,000
Machine hours 20,000 3,000 2,000

Required
a. Compute the plantwide cost driver rate. Determine the overhead cost applied to Eastern
Metal Products’ order and calculate the total production cost of that order.
b. Determine the departmental cost driver rates and total cost of the order from Eastern
Metal Products if the machine hours are used as the cost driver in the cutting department
and direct labor hours are used as the cost driver for the grinding and drilling
departments.
c. Explain why Bravo Steel might prefer a plantwide rate or departmental cost driver rates.

Question 2: Allocating scheduling service costs

Airport Coach Service Company operates scheduled coach service from Boston’s Logan Airport
to downtown Boston and to Cambridge. A common scheduling service center at the airport is
responsible for ticketing and customer service for both routes. The service center is regularly
staffed to service traffic of 2,400 passengers per week: two-thirds for downtown Boston
passengers and the balance for Cambridge passengers. The cost to operate this service center is
$7,200 per week normally, but it is higher during weeks when additional help is required to
service higher traffic levels. The service center costs and number of passengers serviced during
the weeks of August follow:

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 Boston Cambridge
Week Cost
passengers passengers
1 $7,200 1,600 800
2 7,200 1,500 900
3 7,600 1,650 800
4 7,800 1,700 850
5 7,200 1,700 700

Required
a. How much of the service center costs will be allocated to the Boston service and to the
Cambridge service if the costs are allocated in proportion to the number of actual
passengers?
b. Suggest an improved approach to allocating the costs and explain why your method is an
improvement. Using your approach, how much of the service center costs will be charged
to the Boston service and to the Cambridge service?

Question 3
Aurora Telecommunications Ltd manufactures two different fax machines for the business
market. Cost estimates for the two models for the year 2022 are as follows:
Basic system Advanced system
Direct material 400 800
Direct labor (20 hours @15$ per hour) 300 300
Manufacturing overhead* 400 400
Total 1,100 1,500
* the predetermined overhead rate is $20 per direct labor hour
Each model of fax machine requires 20 hours of direct labor. The basic system requires 5 hours
in department A and 5 hours in department B. The advanced system requires 15 hours in
department A and 5 hours in department B. The budgeted overhead costs in these two production
departments are as follows:
Department A Department B
Variable cost $16 per direct labor hour $4 per direct labor hour
Fixed cost $200,000 $200,000
The firm’s management expects to operate at a level of 20,000 direct labor hours in each
production department during 2022.
Required:
1. Show how the company’s predetermined overhead rate was determined
2. If the firm prices each model of fax machine at 10% over its cost, what will be the price of
each model?
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3. Suppose the company were to use departmental predetermined overhead rates. Calculated the
rate for each the two production departments.
4. Calculate the product cost of each model, using the departmental overhead rates calculated in
requirement 3.
5. Calculate the price to be charged for each model, assuming the company continues to price
each product at 10% above cost. Use the revised product costs calculated in requirement 4.
6. Write a memo to the managing director of Aurora Telecommunications making a
recommendation as to whether the firm should use a plantwide overhead rate or departmental
rates. Consider the potential implications of the overhead rates and the firms’ pricing policy.
How might these considerations affect the firm’s ability to compete in the marketplace?

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Case: Bio Labs

Bio Labs is a genetic engineering firm manufacturing a variety of gene-spliced, agricultural-

based seed products. The firm has five separate laboratories producing different product lines.
Each lab is treated as a profit center and all five labs are located in the same facility. The wheat
seed lab and corn seed lab manufacture two of the five product lines. These two labs are located
next to each other and are of roughly equal size in terms of sales. The two departments have
close interaction, often sharing equipment and lab technicians. Both use very similar technology
and science and usually attend the same scientific meetings.

Recent discoveries have shown how low-power lasers can be used to significantly improve
product quality. The wheat seed and corn seed managers are proposing the creation of a laser
testing department to employ this new technology. Leasing the equipment and hiring the
personnel cost $350,000 per year. Supplies, power, and other variable costs are $25 per testing
hour. The testing department is expected to provide 2,000 testing hours per year. The wheat seed
manager expects to use 700 testing hours per year of the laser testing department and the corn
seed manager expects to use 800 testing hours. The remaining 500 hours of testing capacity can
be used by the other three labs if the technology applies or can be left idle for future expected
growth of the two departments. Initially, only wheat and corn are expected to use laser testing.

The executive committee of Bio Labs has approved the proposal but is now grappling with how
to treat the costs of the laser testing department. The committee wants to charge the costs to the
wheat seed and corn seed labs but is unsure of how to proceed.

At the end of the first year of operating the laser, wheat seed used 650 testing hours, corn seed
used 900 hours, and 450 hours were idle.

Required

a. Calculate costs of the two labs, based on the expected hours used by the two labs and on
capacity hours.
b. What are the implications of these two alternatives?
c. Discuss advantages and disadvantages of these two cost allocation options
d. Assess these two cost allocation options on strategic decision perspective
e. What are the other issues to be considered in designing cost allocation problems