Question

Campbell Manufacturing Company uses two departments to make its products. Department I is a cutting department that is machine intensive and uses very few employees. Machines cut and form parts and then place the finished parts on a conveyor belt that carries them to Department II, where they are assembled into finished goods. The assembly department is labor intensive and requires many workers to assemble parts into finished goods. The company’s manufacturing facility incurs two significant overhead costs: employee fringe benefits and utility costs. The annual costs of fringe benefits are $264,000 and utility costs are $192,000. The typical consumption patterns for the two departments are as follows:

	Department I	Department II	Total
Machine hours used	15,700	4,300	20,000
Direct labor hours used	5,300	10,700	16,000

The supervisor of each department receives a bonus based on how well the department controls costs. The company’s current policy requires using a single allocation base (machine hours or labor hours) to allocate the total overhead cost of $456,000.

Required

1. Assume that you are the supervisor of Department I. Choose the allocation base that would minimize your department’s share of the total overhead cost. Calculate the amount of overhead that would be allocated to both departments using the base that you selected.

2. Assume that you are the supervisor of Department II. Choose the allocation base that would minimize your department’s share of the total overhead cost. Calculate the amount of overhead that would be allocated to both departments using the base that you selected.

3. Assume that you are the plant manager and have the authority to change the company’s overhead allocation policy. Formulate an overhead allocation policy that would be fair to the supervisors of both Department I and Department II. Compute the overhead allocations for each department using your policy.

Answer 1

Department I is machine intensive which means that if we take the machine hours as the allocation base then Department I shall have higher overhead cost
allocated to it, hence the manager would like to have labor hours as the allocation base.
Allocation rate =$456,000 / 16,000 hours =$28.5 per labor hours
	Dept I	Dept II
Labor hours used	5300	10700
Allocation rate	$                       28.50	$                                28.50
Allocated Cost	$                  1,51,050	$                           3,04,950
Department II is labor intensive which means that if we take the labor hours as the allocation base then Department II shall have higher overhead cost
allocated to it, hence the manager would like to have Machine hours as the allocation base.
Allocation rate =$456,000 / 20,000 hours =$22.8 per machine hours
	Dept I	Dept II
Machine hours used	15700	4300
Allocation rate	$                       22.80	$                                22.80
Allocated Cost	$                  3,57,960	$                              98,040
The overhead allocation policy suitable for both the Department shall be an Activity cost basis wherby the Fringe benefits shall be allocated on the basis of direct labor hours
The Utility costs shall be allocated on the basis of Machine hours.
ABC rate for Fringe benefits =$264,000 / 16,000 =$16.5 per direct labor hours
ABC rate for Utility Costs =$192,000 / 20,000 =$9.60 per machine hours
	Dept I	Dept II
Fringe benefits	$                     87,450	$                           1,76,550
Utility Costs	$                  1,50,720	$                              41,280
Total Overhead Costs	$                  2,38,170	$                           2,17,830