Question

The management of Firebolt Industries Inc. manufactures gasoline and diesel engines through two production departments, Fabrication and Assembly. Management needs accurate product cost information in order to guide product strategy. Presently, the company uses a single plantwide factory overhead rate for allocating factory overhead to the two products. However, management is considering the multiple production department factory overhead rate method. The following factory overhead was budgeted for Firebolt:

Fabrication Department factory overhead		$380,000
Assembly Department factory overhead		152,000
	Total	$532,000

Direct labor hours were estimated as follows:

Fabrication Department		3,800	hours
Assembly Department		3,800
	Total	7,600	hours

In addition, the direct labor hours (dlh) used to produce a unit of each product in each department were determined from engineering records, as follows:

Production Departments	Gasoline Engine		Diesel Engine
Fabrication Department	1.00	dlh	2.90	dlh
Assembly Department	3.00		1.10
Direct labor hours per unit	4.00	dlh	4.00	dlh

a. Determine the per-unit factory overhead allocated to the gasoline and diesel engines under the single plantwide factory overhead rate method, using direct labor hours as the activity base.

Gasoline engine	$ per unit
Diesel engine	$ per unit

b. Determine the per-unit factory overhead allocated to the gasoline and diesel engines under the multiple production department factory overhead rate method, using direct labor hours as the activity base for each department.

Gasoline engine	$ per unit
Diesel engine	$ per unit

c. Recommend to management a product costing approach, based on your analyses in (a) and (b).

Management should select the factory overhead rate method of allocating overhead costs. The factory overhead rate method indicates that both products have the same factory overhead per unit. Each product uses the direct labor hours . Thus, the rate method avoids the cost distortions by accounting for the overhead .

Answer 1

Solution

Firebolt Industries Inc

1. Determination of the per-unit factory overhead allocated to the gasoline and diesel engines under the single plantwide factory overhead rate method, using direct labor hours as the activity base:

	per-unit factory overhead
Gasoline engine	$280
Diesel engine	$280

Plantwide overhead rate = total overhead/total direct labor hours

Total overhead cost = $532,000

Total direct labor hours = 7,600

Plantwide factor overhead rate = 532,000/7,600 = $70 per hour

	Direct labor hours per unit	plantwide overhead rate per hour	plantwide ffactory overhead rate per unit
Gasoline engine	4	$70	$280	($70 x 4)
Diesel engine	4	$70	$280	($70 x 4)

1. Determination of the per-unit factory overhead allocated to the gasoline and diesel engines under the multiple production department factory overhead rate method, using direct labor hours as the activity base for each department:

	Per-Unit Factory Overhead
Gasoline Engine	$220
Diesel Engine	$334

Fabrication Department -
Factory overhead	$380,000
direct labor hours	3,800
factory overhead per hour	$100 per hour
	Hours per unit	rate per hour	assigned cost
Gasoline Engine	1 DLH	$100	$100
Diesel Engine	2.90 DLH	$100	$290

Assembly Department -
Factory overhead	$152,000
direct labor hours	3,800
factory overhead per hour	$40 per hour
	Hours per unit	rate per hour	assigned cost
Gasoline Engine	3 DLH	$40	$120
Diesel Engine	1.10 DLH	$40	$44

	Fabrication Department per unit factory overhead	Assembly department per unit factory overhead	Total assigned per-unit factory overhead
Gasoline Engine	$100	$120	$220
Diesel Engine	$290	$44	$334

1. Recommendation:

The management should select the activity based overhead allocation. The method allocates factory overhead to products based on their actual usage of direct labor hours and therefore provides a more realistic overhead cost allocation to products.

When compared to the per-unit costs of two products under the traditional and ABC methods,

Gasoline engine is over allocated by $60 under traditional method, while Diesel Engine is under allocated by $54 under the traditional method.