Question

Departmental Overhead Rates. Better Yet Dishware produces dishes and drinking mugs for a large domestic market. It uses both traditional retail outlets and its own company stores where slightly flawed product is sold. Decorating the dishes is done by hand, while the entire production process for drinking mugs is automated.
John Kluny, president of Better Yet, has recently been concerned with the costs of making dishware vs. coffee mugs. The cost of the products used to be roughly comparable until the huge mug-making machine was put in place last year. The mug-making machine cost the company $2,500,000 and is supposed to last five years with two shift-a-day operations. Other costs caused by running the machine add up to $250,000 per year, including the space, power, and insurance it requires. Only one direct labor worker is needed to run the machine. In the past, it took 15 people to make the mugs. Dishware is a larger department, but it only uses machines to form the dishes.

This machine is old and fully depreciated. The rest of the cost in the department is related to labor. More than 50 people work in the dishware department, hand-painting each set as it comes down the production line.

The following table summarizes the material, labor and overhead costs, and activity drivers for the two departments before and after the new machine was put in place.

Better Yet Dishware

Before Purchasing the New Machine       

	4 Place Serving Set of Dishware	Box of 8 Mugs
Materials	$30,000,000	$10,800000
Labor($15.hour)	$1,500,000	$450,000
Overhead (600% labor)	$9,000,000	$2,700,000
Total Cost	$40,500,000	$13,950,000
Divided by quantity made	$2,500,000	1,200,000
Cost per Unit Sale	$16.20	$11.63
Drivers per Year
Labor Dollars	$1,500,000	$450,000
Machine hours	4,000	2,000

After Purchasing the New Machine

	4 Place Serving Set of Dishware	Box of 8 Mugs
Materials	$30,000,000	$10,800000
Labor($15.hour)	$1,500,000	$60,000
Overhead (600% labor)	??	??
Total Cost	??	??
Divided by quantity made	$2,500,000	1,200,000
Cost per Unit Sale	??	??
Drivers per Year
Labor Dollars	$1,500,000	$60,000
Machine hours	4,000	6,000

The new overhead rate had yet to be determined. Overhead costs in total, however, have gone up by the cost of the new machine. John has asked you to help him better understand his costs. You have gladly volunteered and decide to follow the steps below.

Discussion Response

Respond to the following in your initial post:

a. Develop an estimate of the new total amount of Better Yet’s overhead.

b. Using direct labor dollars and a plant-wide rate, recalculate the overhead charged to each product and the cost per sales unit for each of the products.

c. Now develop two overhead rates. Specifically, assume that the overhead that was charged to the dishware department before the new mug-making machine was purchased was about right. Take the rest of the newly calculated overhead from part a) and charge it to mug-making. Continue to charge overhead out in dishware by using direct labor dollars. Create a new rate for mug-making using machine hours as your driver.

d. What are your product costs now? Which approach is better? Why?

e. Do you think it was a good idea to purchase the new machine? Why or why not?

Additional Information: the original overhead of $11,700,000 plus $750,000 caused by the
new machine for depreciation and machine operating costs, results in a new overhead figure of $12,450,000.

Answer 1

a.

Particulars	Particulars	$
Overhead charged earlier
	Dishware Process	9000000
	Mugs Process	2700000
Additional overhead cost to Mugs Process
	Depreciation	500000
	Other costs	250000
Total estimated overhead costs		12450000

b..

		Box of 8 Mugs
	4 Place Serving
	Set of Dishware
Materials	$30,000,000	$10,800,000
Labor(15.hour)	$1,500,000	$60,000
Overhead (600% labor)	$9,000,000	$360,000
Total Cost	$40,500,000	$11,220,000
Divided by quantity made	$2,500,000	1,200,000
Cost per Unit Sale	$16.20	$9.35

c.

Particulars	Particulars	Dishware	Mugware	Total
Overhead charged earlier		9000000	2700000	11700000
Additional overhead cost to Mugs Process	Depreciation		500000	500000
	Other costs		250000	250000
Total estimated overhead costs		9000000	3450000	12450000
Driver (New)	Machine hour		6000
Overhead rate (New)/MHR			575

d.

		Box of 8 Mugs
	4 Place Serving
	Set of Dishware
Materials	$30,000,000	$10,800,000
Labor(15.hour)	$1,500,000	$60,000
Overhead (600% labor)	$9,000,000
Overhead (MHR 6000*575)		$3,450,000
Total Cost	$40,500,000	$14,310,000
Divided by quantity made	$2,500,000	1,200,000
Cost per Unit Sale	$16.20	$11.93

This approach is better as the new process of mug making is machine oriented and applying overhead rate based on machine hour is better for the mug making process.

e. It is not a good idea to purchase the new machine since it is increasing the per unit cost of the mugware by $0.30 from $11.63 to $11.93. Basically the savings in the labour cost is outdone by increase in overhead cost of the new machine.

However, if the machine life is extended beyond 5 years, it will save on the depreciation cost of the new machine and only addional costs of $250,000 will be incurred against savings of $390,000 in labour cost.

With the given information it is not a good idea to purchase new machine.