Question

Hobart Company manufactures attaché cases and suitcases. It has five manufacturing departments. The Molding, Component, and Assembly departments convert raw materials into finished goods; hence, they are treated as operating departments. The Power and Maintenance departments are treated as service departments because they support the three operating departments.

Hobart has always used a plantwide predetermined overhead rate with direct labor-hours as the allocation base for product costing purposes. The overhead rate is computed by dividing the company’s total estimated overhead cost (across the five manufacturing departments) by the total estimated direct labor-hours to be worked in the three operating departments.

The company has been experiencing declining profits; therefore, it is considering switching from plantwide overhead allocation to a departmental approach. Under the departmental approach, the service department costs would be allocated to the three operating departments. Then each operating department would compute its own overhead rate. The overhead rate in Molding would be based on machine-hours and the rates in Component and Assembly would be based on direct labor-hours.

The service departments’ estimated costs for the coming year are as follows:

	Service Departments
	Power			Maintenance
Variable overhead cost	$	640,000		$	25,000
Fixed overhead cost		1,200,000			375,000
Total overhead cost	$	1,840,000		$	400,000

The Power Department would allocate its variable costs to the operating departments based on estimated kilowatt hours used and it would allocate its fixed costs based on the percentage of peak-period capacity required. The Maintenance Department would allocate its variable costs to the operating departments based on estimated maintenance hours used and it would allocate its fixed costs based on the percentage of peak-period capacity required.

The corresponding data for allocating service department costs to operating departments are as follows:

	Operating Departments
	Molding		Component		Assembly
Power department:
Estimated kilowatt hours used	36,000		32,000		12,000
Percentage of peak-period capacity	50	%	35	%	15	%
Maintenance Department:
Estimated maintenance hours used	9,000		2,500		1,000
Percentage of peak-period capacity	70	%	20	%	10	%

The company also provided the following estimated data for its three operating departments:

	Operating Departments
	Molding			Component			Assembly
Departmental costs:
Direct materials	$	1,630,000		$	3,000,000		$	25,000
Direct labor		350,000			2,000,000			1,300,000
Manufacturing overhead		1,960,500			1,620,000			2,399,500
Total departmental costs	$	3,940,500		$	6,620,000		$	3,724,500
Allocation bases:
Direct labor-hours		50,000			200,000			150,000
Machine-hours		87,500			12,500			0

1. Compute the company’s predetermined plantwide overhead rate.

2. Assume the company decides to use departmental overhead rates.

a. Using the direct method, allocate the variable and fixed service department costs to the operating departments.

b. Calculate the predetermined departmental overhead rates for each of the three operating departments.

3. One of Hobart’s products is a small attaché case that uses the following machine-hours and direct labor-hours in the three operating departments:

		Machine-Hours				Direct Labor-Hours
Molding Department		3,000				1,000
Component Department		800				2,500
Assembly Department		0				4,000
Total hours		3,800				7,500

a. Calculate the amount of overhead that would be applied to this attaché case using the plantwide approach.

b. Calculate the amount of overhead that would be applied to this attaché case using the departmental approach.

4a. Is the plantwide approach overcosting or undercosting the attaché case compared to the departmental approach?

Answer 1

1. Computation the company’s predetermined plantwide overhead rate:

Given information

Company’s predetermined plantwide overhead rate is computed by dividing the company’s total estimated overhead cost (across the five manufacturing departments) by the total estimated direct labor-hours to be worked in the three operating departments.

Total estimated overhead Cost across the five manufacturing departments:

Service departments:
Power	$1,840,000
Maintenance	$400,000
Operating departments:
Molding	$1,960,500
Component	$1,620,000
Assembly	$2,399,500
Toal Overhead Cost	$8,220,000

Total estimated direct labor-hours to be worked in the three operating departments = 50,000+200,000+150,000 = 400,000 direct labor-hours

Predetermined plantwide overhead rate = $8,220,000 / 400,000 = $20.55 per hour

2a. Allocation of the variable and fixed service department costs to the operating departments.

Given information:

a. The Power Department would allocate its variable costs to the operating departments based on estimated kilowatt hours used and fixed costs based on the percentage of peak-period capacity required.

b. The Maintenance Department would allocate its variable costs to the operating departments based on estimated maintenance hours used and fixed costs based on the percentage of peak-period capacity.

Department	Molding	Component	Assembly	Total
Power Department:
Variable Overhead cost	$288,000 [($640,000/80,000) x 36,000]	$256,000 [($640,000/80,000) x 32,000]	$96,000 [($640,000/80,000) x 12,000]	$640,000
Fixed overhead cost	$600,000 ($1,200,000 x 50%)	$420,000 ($1,200,000 x 35%)	$180,000 ($1,200,000 x 15%)	$1,200,000
Maintenance Department:
Variable Overhead cost	$18,000 [($25,000/12,500) x 9,000]	$5,000 [($25,000/12,500) x 2,500]	$2,000 [($25,000/12,500) x 1,000]	$25,000
Fixed overhead cost	$262,500 ($375,000 x 70%)	$75,000 ($375,000 x 20%)	$37,500 ($375,000 x 10%)	$375,000
Total overhead cost	$1,168,500	$756,000	$315,500	$2,240,000

2b. Calculation of  the predetermined departmental overhead rates for each of the three operating departments:

Department	Molding	Component	Assembly	Total
Manufcturing overheads	$1,960,500	$1,620,000	$2,399,500
Allocated Manufacturing overheads	$1,168,500	$756,000	$315,500
Total Manufacturing overheads	$3,129,000	$2,376,000	$2,715,000	$8,220,000

The overhead rate in Molding would be based on machine-hours.

The overhead rate in Component and Assembly would be based on direct labor-hours.

Department	Molding	Component	Assembly
Total Manufacturing overheads	$3,129,000	$2,376,000	$2,715,000
Machine hours	87,500
Direct labor-hours		200,000	150,000
Predetermined overhead rate	$35.76 ($3,129,000 / 87,500)	$11.88 ($2,376,000/200,000)	$18.10 ($2,715,000/150,000)

3a. Calculation of the amount of overhead that would be applied to this attaché case using the plantwide approach:

Plantwide approach uses the direct-labor hours to allocate the manufacturing overheads.

Predetermined plantwide overhead rate = $8,220,000 / 400,000 = $20.55 per hour

Department	Overheads Cost
Molding	$20,550 (1000 Hrs. x $20.55)
Component	$51,375 (2,500 Hrs. x $20.55)
Assembly	$82,200 (4,000 Hrs. x $20.55)
Total overhead	$154,125

3b. Calculation of the amount of overhead that would be applied to this attaché case using the departmental approach:

Overhead rate for Molding = $35.76 per machine hour

Overhead rate for Compnent = $11.88 per direct-labor hour

Overhead rate for Assembly = $18.10 per direct-labor hour

Department	Overheads Cost
Molding	$107,280 (3,000 Hrs. x $35.76)
Component	$29,700 (2,500 Hrs. x $11.88)
Assembly	$72,400 (4,000 Hrs. x $18.10)
Total overhead	$209,380

4a. Calculation of plantwide approach overcosting or undercosting the attaché case compared to the departmental approach:

Plantwide overhead cost:

Department	Molding	Component	Assembly
Direct materials	$1,630,000	$300,000	$25,000
Direct labor	$350,000	$2,000,000	$1,300,000
Manufacturing oveheads	$1,027,500 (50,000 x $20.55)	$4,110,000 (200,000 x $20.55)	$3,082,500 (150,000 x $20.55)
Total cost under Plantwide approach	$3,007,500	$6,410,000	$4,407,500

Departmental overhead cost:

Department	Molding	Component	Assembly
Direct materials	$1,630,000	$300,000	$25,000
Direct labor	$350,000	$2,000,000	$1,300,000
Manufacturing oveheads (Statement 2b)	$3,129,000	$2,376,000	$2,715,000
Total cost under Departmental approach	$5,109,000	$4,676,000	$4,040,000

Plantwide overhead approach is undercosting in Molding department and higher in Component and Assembly department.