Question

Aomi, a new Japanese automotive parts manufacturer, will be implementing job-order costing and would like to use a predetermined overhead rate to apply its manufacturing overhead to jobs. However, the company's controller, Hiroshi Itoma, would like your input on his contemplation of which denominator-level driver would be more appropriate for the company to use: machine hours or direct labor hours. The facts he has provided to you are: Within the manufacturing process, the employees work in small groups of three to five employees. Based on trial production runs, the company believes there will be more direct labor hours than machine hours in the manufacturing process. Using your understanding of how to apply manufacturing overhead in a job-order costing environment, what do you think would be the more appropriate basis of overhead application: machine hours or direct labor hours? Why do you believe that is the best answer? Given the choice of driver, are there any implications to consider for underapplied or overapplied overhead?

Answer 1

Part 1 - Choice of Driver

Aomi should apply labour hours as more appropriate basis for allocation of manufacthring overhead by calculating the predetermined overhead rate.

Company has more direct labour hours than machine hours hence it can be said that company has more human resources and less automation.

Labour hour method is most traditional method and best used method also.

If in future machine hours take over direct labout hours due to automation then machine hour method for allocation of overhead can be used but in current scenario, there is less automation and more labour hours which says that company should use direct labour hours as denominator for allocation of overhead in a practial approach

Part 2 - Implications to consider for under applied or over applied overhead

Using direct labour hours is more appropriate since using this method will show the bettet figure of allocation and add more to the manufacturing overhead which ultimately is considered in retail pricing. It will cause the over application of overhead and lead to better margin

Using machine hours approach will cause under application of overhead and will lead to lesser margin