Question

Plantwide Overhead Rate versus Departmental Rates, Effects on Pricing Decisions

Cherise Ortega, marketing manager for Romer Company, was puzzled by the outcome of two recent bids. The company's policy was to bid 150 percent of the full manufacturing cost. One job (labeled Job 97-28) had been turned down by a prospective customer, who had indicated that the proposed price was $3 per unit higher than the winning bid. A second job (Job 97-35) had been accepted by a customer, who was amazed that Romer could offer such favorable terms. This customer revealed that Romer's price was $43 per unit lower than the next lowest bid.

Cherise has been informed that the company was more than competitive in terms of cost control. Accordingly, she began to suspect that the problem was related to cost assignment procedures. Upon investigating, Cherise was told that the company uses a plantwide overhead rate based on direct labor hours. The rate is computed at the beginning of the year using budgeted data. Selected budgeted data are given below.

		Department A		Department B		Total
Overhead		$500,000		$2,000,000		$2,500,000
Direct labor hours		200,000		50,000		250,000
Machine hours		20,000		120,000		140,000

Cherise also discovered that the overhead costs in Department B were higher than those in Department A because B has more equipment, higher maintenance, higher power consumption, higher depreciation, and higher setup costs. In addition to the general procedures for assigning overhead costs, Cherise was supplied with the following specific manufacturing data on Jobs 97-28 and 97-35:

		Job 97-28
		Department A		Department B		Total
Direct labor hours		5,000		1,000		6,000
Machine hours		200		500		700
Prime costs		$100,000		$20,000		$120,000
Units produced		14,400		14,400		14,400

		Job 97-35
		Department A		Department B		Total
Direct labor hours		400		600		1,000
Machine hours		200		3,000		3,200
Prime costs		$10,000		$40,000		$50,000
Units produced		1,500		1,500		1,500

Required:

1. Using a plantwide overhead rate based on direct labor hours, develop the bid prices for Jobs 97-28 and 97-35 (express the bid prices on a per-unit basis). If required, round your answers to the nearest cent.

	Unit bid price
Job 97-28	$
Job 97-35	$

2. Using departmental overhead rates (use direct labor hours for Department A and machine hours for Department B), develop per-unit bid prices for Jobs 97-28 and 97-35. If required, round intermediate computations and final answers to the nearest cent.

	Unit bid price
Job 97-28	$
Job 97-35	$

3. Compute the difference in gross profit that would have been earned had the company used departmental rates in its bids instead of the plantwide rate. Round your intermediate computations to two decimal places and final answer to the nearest dollar.
Gross profit would have increased by $

Feedback

1. Plantwide OH rate is based on total estimated Overhead and total estimated driver. After you determine the bid price remember to express it in per-unit basis.

2. Departmental OH rate is based on the individual department estimates and the chosen driver.

Answer 1

1.

	Unit bid price
Job 97-28	$             18.75
Job 97-35	$             60.00

Plantwide overhead tate = $2500000/250000 = $10 per DLH

	Job 97-28	Job 97-35
Prime costs	120000	50000
Overheads	60000	10000
	($10 x 6000)	($10 x 1000)
Manufacturing cost $	180000	60000
Bid price 150%	270000	90000
Number of units	14400	1500
Bid price per unit $	18.75	60.00

2.

	Unit bid price
Job 97-28	$             14.67
Job 97-35	$           101.01

Departmental overhead rates:

Department A: $500000/200000 = $2.50 per DLH

Department B: $2000000/120000 = $16.67 per MH

	Job 97-28	Job 97-35
Prime costs	120000	50000
Overheads:
Department A	12500	1000
	($2.50 x 5000)	($2.50 x 400)
Department B	8335	50010
	($16.67 x 500)	($16.67 x 3000)
Manufacturing cost $	140835	101010
Bid price 150%	211252.50	151515
Number of units	14400	1500
Bid price per unit $	14.67	101.01

3. Difference in gross profit: $923

	Job 97-28	Job 97-35	Total
Gross profit: Departmental rates	70417.50	50505	120922.50
	(211252.50-140835)	(151515-101010)
Gross profit: Plantwide rates	90000	30000	120000
	(270000-180000)	(90000-60000)
Difference in gross profit $	-19582.50	20505	922.50