Question

Realforce Ltd. is a keyboard manufacturer. The company’s vice president of manufacturing, Luke, presented at the management meeting a proposal for automating the Assembly Department. In the proposal, he recommended the company replace the 9 direct labor workers in the Assembly Department with 3 robots. He argued that the automation would result in the elimination of direct labor costs plus the elimination of manufacturing overhead cost in the Assembly Department as Realforce currently applies manufacturing overhead on the basis of direct labor costs using a plant-wide rate. The overhead application data for the current year are presented below: 3 The average annual manufacturing overhead cost is $10,000,000; the average annual direct labor cost is $2,000,000; the average manufacturing overhead rate is 500%.

Category	Average Annual Direct Labor	Average Annual Overhead Cost
Keycap Department	$ 1,000,000	$5,500,000
PCB Department	$875,000	$3,500,000
Assembly Department	$ 125,000	$1,000,000

Required: Discuss the issue of overhead application in Realforce (please be sure to cover the following aspects in your answer and limit your answer to 500 words or less): • Describe the problems with the company’s current method for applying overhead and make recommendations on how to improve the application of overhead. • Is it a correct statement that the manufacturing overhead cost in the Assembly Department would be reduced to zero if the automation were adopted? Explain why. • What allocation base should be used to apply overhead in the Assembly Department if the automation were adopted?

Answer 1

The current method of overhead cost allocation on the basis of direct labor costs is not an advisable method for application of overhead costs.The application of manufacturing overheads should be based on the activities performed in the manufacturing process.The direct labor costs is not an proper measure to determine the level of activity of different departments because the costs of two departments with same level of direct labor activity can have different labor costs due to the variance in the hourly rates at which they are paid. Hence,Realforce Limited should apply its manufacturing overheads on the basis of direct labor hours worked in the respective departments.The application rate can be derived by dividing the total manufacturing overheads by the total number of direct labor hours.

The argument that automation will eliminate the would lead to overhead costs of assembly department to zero is incorrect because the activity has not been eliminated but has only been automated.Overhead costs being applied can only be eliminated only when the activity is ceased to be performed which is not the case in proposal put forward.

Realforce Limited can use the Machine hours as an allocation base for applying overheads if it adopts the automation process in the Assembly Department.Since,the assembly department is the most labor intensive department compared to the other two departments.Moreover, for the sake of uniformity it can apply the overheads to the three departments by computing a uniform rate based on the total machine hours worked in all the three departments.