Question

Roseville Engineering provides watershed and design services for its customers. Total overhead costs this coming year are expected to be $8,000,000 ($2,000,000 in the Watershed Department, and $6,000,000 in the Design Department). If the company chooses to use the plantwide approach, overhead will be allocated using direct labor costs. Direct labor costs are expected to total $4,000,000. The Watershed Department expects to incur direct labor costs of $500,000, and the Design Department expects to work 120,000 direct labor hours.

Required:

a.	Assume Roseville Engineering uses the plantwide approach to allocating overhead costs, and uses direct labor costs as the allocation base. Calculate the predetermined overhead rate and explain how this rate will be used to allocate overhead costs.
b.	Assume Roseville Engineering uses the department approach for allocating overhead costs rather than the plantwide method. The Watershed Department allocates overhead based on direct labor costs and the Design Department allocates overhead based on direct labor hours. Calculate the predetermined overhead rate for each department and explain how these rates will be used to allocate overhead costs.

Answer 1

Solution a
First, we will calculate the plantwide overhead allocation rate based on labor costs.
Total overhead cost	$          8,000,000
Direct labor cost	$          4,000,000
Pre-determined overhead rate	Overhead cost*100 /direct labor cost
Pre-determined overhead rate	8000000*100/4000000
Pre-determined overhead rate	200%	of direct labor cost
Now using this allocation rate, we will apply the overheads based on direct labor cost.
For each dollar incurred on direct labor costs, we will apply the overheads at $2.
Solution b
Activity-based allocation
	Watershed	Design
Overheads	$          2,000,000	$ 6,000,000
Allocation base	Direct labor cost	Direct labor hours
Direct labor cost	$             500,000
Direct labor hours		120,000
Pre-determined overhead rate	Overhead cost*100 /direct labor cost	Overhead cost /direct labor hours
Pre-determined overhead rate	2000000*100/500000	6000000/120000
Pre-determined overhead rate	400%	50	Per direct labor hour
So for each dollar incurred on direct labor cost, $ 4 will be applied as watershed overheads cost
and for each direct labor hour spent, $ 50 will be applied as design overheads cost.