In: Accounting
Tax Savings and Costing (The Case of Transfer Pricing)
Please prepare a report answering the listed questions. You may Excel to create spreadsheets and copy the answers to this document.
Hansen, Kotter, and Zales is a law firm that contains one service department (Research & Document) and two production departments (Litigation and Consulting). The firm employs a job-order costing system to accumulate costs chargeable to each client. The firm uses actual costing to assign overhead.General overhead costs can be allocated based on either direct attorney hours or the number of employees, depending on managers’ choice. At the end of the year, the records revealed the actual general overhead costs are $720,000. At the end of the year, the records revealed the following costs and operating data for all cases handled during the year:
Research & Document | Litigation | Consulting | |||||
# of Employees | 10 | 8 | 6 | ||||
Direct Attorney Hours(# of hrs) | 3,000 | 8,000 | 5,000 | ||||
Direct Attorney Costs ($) | $150,000 | $400,000 | $250,000 | ||||
Direct Material Costs ($) | $16,000 | $15,500 | $13,500 |
*** 50% of Research & Department's service is provided to litigation department and the other 50% to consulting department.
Part I Cost Allocation
(2 point) Compute the overhead allocation rates for general overhead based on different cost drivers. What are the overhead costs assigned to each department, using different cost drivers?
(3 point) Compare the total costs of each production department after departmental cost allocation, using attorney hours and the number of employees as cost driver, respectively. Does the choice of cost driver affect the total costs of each production department?
Assume that the company uses attorney hours to allocate general overhead costs. For litigation department, the costs charged to each case are made up of four elements:
Direct attorney costs (charged at $50 per hour)
Direct materials and supplies used
General overheads are applied by direct attorney hours
Costs allocated from the service department is assigned to cases by direct attorney hours incurred within the department
The information on one of its cases during this period is given as follows:
Case 618
Direct attorney-hours 150
Direct Materials and supplies $5000
c. (3 point) What are the total costs accumulated for Case 618? The company charged the client $30,000 for the service, what is the profit the company earned?
d. (2 point) Suppose the firm’s annual revenue is 2 million dollars. The corporate tax rate is 35%. How much taxes shall the company pay? Does the choice of cost driver affect the total taxes due?
ANSWER A :
Overhead allocation based on direct attorney hours | ||||
Research and development | Litigation | Consulting | Total | |
Direct attorney hours | 3000 | 8000 | 5000 | 16000 |
Percentage of total | 18.75% | 50% | 31.25% | |
Allocated overhead cost | $135000 | $36000 | $225000 | |
Overhead allocation based on number of employees |
||||
Number of employees | 10 | 8 | 6 | 24 |
Percentage of total | 41.67% | 33.33% | 25% | |
Allocated overhead cost | $300000 | $240000 | $180000 |
ANSWER 2:
Overhead cost of production departments using different cost drivers |
||
Based on attorney hours | ||
Litigation | Consulting | |
Allocated costs | $36000 | $225000 |
Research & Development | 67500 | 67500 |
Total Overhead Costs | $427500 | $292500 |
Based on number of employees | ||
Allocated costs | $240000 | $180000 |
Research & Development | $150000 | $150000 |
Total Overhead Costs | $390000 | $330000 |
choice of cost driver does affect the costs of each production department. |
Litigation | Consulting | |
1.Total GOH allocated as per direct attorney hrs. | $427500 | $292500 |
2.Direct attorney hrs. | 8000 | 5000 |
3.GOH/hr.(1/2) | 53 | 59 |
4.150 hrs. split bet. 2 depts. | 150*8/13=92 | 150*5/13=58 |
5.Total GOH for the Job(3*4) | 4933 | 3375 |
total | 8308 |
ANSWER C :
Costs for Case 18 | |
Direct attorney costs (150* $ 50/hr.) | 7500 |
Direct materials & supplies | 5000 |
General Ohs(72000/16000=45*150= | 6750 |
Total cost | 19250 |
Amt. charged by the co. | 30000 |
So,profit earned (30000-19250) | 10750 |
ANSWER D:
Annual revenue | 2000000 | |||
Less: expenses: | Litigation | Consulting | Total | |
Direct Attorney Costs | 400000 | 250000 | 650000 | |
Direct Material Costs | 15500 | 13,500 | 29000 | |
Allocated OH costs(based on attorney hrs. | 427500 | 292500 | 720000 | |
Total expenses | 1399000 | |||
Before tax revenues | 601000 | |||
Tax at 35%(601000*35%) | 210350 | |||
After-tax income | 390650 | |||
So, tax amount the co.will pay = 210350 | ||||
As the total OH is in any case $ 720000 , the choice of cost driver , will not affect the total taxes due.The choice of cost driver will only affect the amt. to be allocated between different departments.