Question

Hawk and Eagle Co., a law firm, had the following costs last year:

Direct professional labour	$15,000,000
Overhead	21,000,000
Total costs	$36,000,000

The following costs were included in overhead:

Fringe benefits for direct professional labour	$ 5,000,000
Paralegal costs	2,700,000
Telephone call time with clients (estimated but not tabulated)	600,000
Computer time	1,800,000
Photocopying	900,000
Total overhead	$11,000,000

The firm recently improved its ability to document and trace costs to individual cases. Revised bookkeeping procedures now allow the firm to trace fringe benefit costs for direct professional labour, paralegal costs, telephone charges, computer time, and photocopying costs to each case individually. The managing partner needs to decide whether more costs than just direct professional labour should be traced directly to jobs to allow the firm to better justify billings to clients.

During the past year, more costs were traced to client engagements. Two of the case records showed the following:

	Client Cases
	875	876
Direct professional labour	$20,000	$20,000
Fringe benefits for direct labour	3,000	3,000
Secretarial costs	2,000	6,000
Telephone call time with clients	1,000	2,000
Computer time	2,000	4,000
Photocopying	1,000	2,000
Total costs	$29,000	$37,000

Three methods are being considered for allocating overhead this year:

• 1.Allocate overhead based on direct professional labour cost. Calculate the allocation rate using last year's direct professional labour costs of $15 million and overhead costs of $21 million.
• 2.Allocate overhead based on direct professional labour cost. Calculate the allocation rate using last year's direct professional labour costs of $15 million and overhead costs of $10 million ($21 million less $11 million in direct costs that are traced this year).
• 3.Allocate the $10 million overhead based on total direct costs. Calculate the allocation rate using last year's direct costs (professional labour of $15 million plus other direct costs of $11 million).

Answer 1

Part A

Last year’s costs:

Direct professional labor	$15,000,000
Overhead costs (all other costs)	21,000,000
Total costs	$36,000,000

Overhead rate = Overhead costs / Direct professional labor = 21000000/15000000 = 140% of direct professional labor cost

Part B

Last year’s costs:

Direct professional labor	$15,000,000
Other direct costs	11000000
Total direct costs	26000000
Overhead costs (remaining costs)	10,000,000
Total costs	$36,000,000

Overhead rate = Overhead costs / Direct professional labor = 10000000/15000000 = 67% of direct professional labor cost.

Part C

Last year’s costs:

Direct professional labor	$15,000,000
Other direct costs	11000000
Total direct costs	26000000
Overhead costs (remaining costs)	10,000,000
Total costs	$36,000,000

Overhead rate = Overhead costs / Total direct costs = 10000000/26000000 = 38.50% of direct costs.