Question

The Alex Miller Corporation operates one central plant that has two divisions, the Flashlight Division and the Lamp Division. The following data apply to the coming budget year:

Budgeted costs of the operating the plant

for 10,000 to 20,000 hours:

      Fixed operating costs per year                   $240,000

      Variable operating costs                                        $10 per hour

Practical capacity                                                     20,000 hours per year

Budgeted long-run usage per year:

      Lamp Division          800 hours × 12 months = 9,600 hours per year

      Flashlight Division   450 hours × 12 months = 5,400 hours per year

Assume that practical capacity is used to calculate the allocation rates. Further assume that actual usage of the Lamp Division was 700 hours and the Flashlight Division was 400 hours for the month of June.

Required:

1.If a single-rate cost allocation method is used, what amount of operating costs will be budgeted for the Lamp Division each month? For the Flashlight Division each month? (base the rates on practical capacity)

2. For the month of June, if a single-rate cost allocation method is used based on practical capacity, what amount of cost will be allocated to the Lamp Division? To the Flashlight Division? Assume actual usage is used to allocate operating costs.

3. If a dual-rate cost allocation method is used, what amount of operating costs will be budgeted for the Lamp Division each month? For the Flashlight Division each month? (Based on practical capacity)

4. If a dual-rate cost allocation method is used, what amount of operating costs will be budgeted for the Lamp Division each month? For the Flashlight Division each month? (Based on practical capacity)

5. Give 2 reasons why a dual rate system using budgeted usage of fixed costs and actual usage of variable costs is better than a single rate system? Your discussion should focus on the Alex Miller analysis you just completed in parts 1-4

Answer 1

Solution

Alex Miller Corporation

1. Single-rate cost allocation method –

Amount of operating costs budgeted for the Lamp Division each month:

Total cost = fixed cost + variable cost

= $240,000 + (20,000 hours x $10) = $440,000

Single plantwide overhead rate = $440,000/20,000 hours = $22 per hour

Operating costs budgeted for the Lamp Division each month = 800 hours x $22

= 800 hours x $22 = $17,600

Operating costs budgeted for the Flashlight Division each month –

= 450 hours x $22 per hour = $9,900

2. Assuming actual usage, determination cost allocation to each division –

Lamp Division –

Actual hours = 700 hours

Single rate = $22

Cost allocation to Lamp Division = $22 x 700 hours = $15,400

Flashlight Division –

Actual hours = 400 hours

Single rate = $22

Cost allocation to Flashlight Division = $22 x 400 hours = $8,800

3. Assuming dual rate –

Operating costs budgeted for Lamp Division each months –

Fixed overhead rate = $240,000/20,000 = $12 per hour

Variable overhead rate = $10 per hour

Budgeted cost for Lamp Division each month = ($10 x 800 hours) + ($12 x 800 hours) = $17,600

Budgeted cost for Flashlight Division each month = ($10 x 450 hours) + ($12 x 450 hours) = $9,900

4. Dual rate – actual capacity

Budgeted cost for Lamp Division each month = ($12 x 800 hours ) + ($10 x 700 hours) = $16,600

Budgeted cost for Flashlight Division each month = ($12 x 450 hours) + ($10 x 400 hours) = $9,400

5. Why dual-rate system is better than single-rate system –

The single rate uses a single overhead rate for allocation of both fixed and variable portions of the overhead.

Dual rate system allocates the costs on two basis, variable and fixed.

The allocation of variable costs on actual usage provides more accurate cost allocation. Comparison of results from 3. And 4. Indicate that allocation of costs based on dual rate system results in a cost reduction.