Learning Objective

Compare and contrast allocating overhead prices using a plantwide rate, room rates, and also activity-based costing.

Question: supervisors at providers such together Hewlett-Packard often look at for far better ways to number out the cost of your products. As soon as Hewlett-Packard produces printers, the agency has three possible methods that have the right to be supplied to allocate overhead prices to products—plantwide allocation, room allocation, and also activity-based assignment (called activity-based costing). How do managers decide i beg your pardon allocation technique to use?

 

Answer: The an option of one allocation technique depends on how managers decision to team overhead costs and the desired accuracy that product price information. Groups of overhead prices are called cost poolsA collection of overhead costs, commonly organized by department or activity.. Because that example, Hewlett Packard’s press production division may pick to collect all manufacturing facility overhead expenses in one price pool and also allocate those prices from the price pool to each product using one predetermined overhead rate. Or Hewlett Packard may pick to have actually several expense pools (perhaps because that each department, such together assembly, packaging, and also quality control) and also allocate overhead costs from every department cost pool to commodities using a different predetermined overhead price for each department. In general, the much more cost pools used, the much more accurate the assignment process.

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Plantwide Allocation

Question: let’s look in ~ SailRite Company, which to be presented at the start of the chapter. The supervisors at SailRite prefer the idea of utilizing the plantwide allocation an approach to allocate overhead to the 2 sailboat models created by the company. How would SailRite carry out the plantwide allocation method?

 

Answer: The plantwide allocationA technique of allocating expenses that supplies one cost pool, and therefore one predetermined overhead rate, come allocate overhead costs. Technique uses one predetermined overhead price to clues overhead costs.Regardless of the strategy used come allocate overhead, a predetermined overhead price is developed for each cost pool. The predetermined overhead rate is calculated as follows (from thing 2 "How Is project Costing offered to Track manufacturing Costs?"):Predetermined overhead rate=Estimated overhead costsEstimated activity in allocation baseWhen activity-based costing is used, the denominator can also be called estimated price driver activity. One price pool account for all overhead costs, and therefore one predetermined overhead rate is used to use overhead costs to products. Girlfriend learned about this method in chapter 2 "How Is task Costing supplied to Track production Costs?" wherein one predetermined rate—typically based on direct job hours, direct labor costs, or device hours—was provided to point out overhead costs. (Remember, the focus here is on the allocation of overhead costs. Straight materials and also direct job are conveniently traced to the product and also therefore space not a part of the overhead assignment process.)

Using SailRite agency as one example, assume yearly overhead costs are approximated to it is in $8,000,000 and direct labor hrs are used for the plantwide assignment base. Management estimates that a complete of 250,000 direct labor hours are functioned annually. These estimates are based on the previous year overhead costs and direct job hours and also are readjusted for expected boosts in demand the comes year. The predetermined overhead rate is $32 per straight labor hour (= $8,000,000 ÷ 250,000 direct labor hours). Thus, as displayed in number 3.1 "Using One Plantwide price to point out SailRite that company Overhead", products are fee $32 in overhead costs for each straight labor hour worked.


Figure 3.1 utilizing One Plantwide rate to clues SailRite that company Overhead

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Product expenses Using the Plantwide Allocation strategy at SailRite

Question: assume SailRite uses one plantwide price to allocate overhead based on direct job hours. What is SailRite’s product cost per unit and resulting profit utilizing the plantwide technique to point out overhead?

 

Answer: The calculation of a product’s expense involves 3 components—direct materials, direct labor, and manufacturing overhead. Assume straight materials expense $1,000 for one unit of the straightforward sailboat and also $1,300 for the Deluxe. Direct labor prices are $600 for one unit that the basic sailboat and also $750 for the Deluxe. This information, merged with the overhead price per unit, offers us what we require to identify the product price per unit because that each model.

Given the predetermined overhead rate of $32 per direct labor hour calculate in the vault section, and assuming it takes 40 hours of direct labor to develop one an easy sailboat and also 50 hrs to construct one luxurious sailboat, we have the right to calculate the production overhead expense per unit. Manufacturing overhead cost per unit is $1,280 (= $32 × 40 straight labor hours) because that the simple boat and $1,600 (= $32 × 50 direct labor hours) because that the deluxe boat. Incorporate the production overhead with direct materials and also direct labor, as shown in number 3.2 "SailRite company Product expenses Using One Plantwide Rate based upon Direct labor Hours", and we room able to calculation the product price per unit.


Figure 3.2 SailRite agency Product prices Using One Plantwide Rate based on Direct job Hours

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*$1,280 = 40 straight labor hrs per unit × $32 rate.

**$1,600 = 50 direct labor hours per unit × $32 rate.


The average sales price is $3,200 because that the an easy model and $4,500 for the Deluxe. Utilizing the product expense information in figure 3.2 "SailRite firm Product prices Using One Plantwide Rate based upon Direct labor Hours", the benefit per unit is $320 (= $3,200 price – $2,880 cost) for the an easy model and also $850 (= $4,500 price – $3,650 cost) because that the Deluxe. Recall from the opening dialogue that SailRite’s all at once profit has decreased ever since it introduced the deluxe model also though the data reflects both products are profitable.

 

Question: The supervisors at SailRite favor the idea of using the plantwide assignment approach, however they are came to that this approach will not provide accurate product price information. Back the plantwide allocation method is the simplest and also least high-quality approach, it also tends to it is in the the very least accurate. In spite of this weakness, why execute some institutions prefer to usage one plantwide overhead price to clues overhead come products?

 

Answer: organizations that use a plantwide allocation method typically have straightforward operations v a few similar products. Administration may no want much more accurate product price information or might not have actually the resources to carry out a more complex accounting system. Together we relocate on to more facility costing systems, remember that these systems are an ext expensive come implement. Hence the benefits of having actually improved price information must outweigh the expenses of obtaining the information.


Department Allocation

Question: i think the managers at SailRite firm prefer a much more accurate technique to allocation overhead costs to its two products. Together a result, they room considering utilizing the department allocation approach. How would SailRite kind cost pools for the room allocation approach?

 

Answer: The room allocationA an approach of allocating costs that supplies a separate cost pool, and also therefore a different predetermined overhead rate, because that each department. Technique is similar to the plantwide method except that cost pools are developed for each department rather than for the whole plant, and a different predetermined overhead price is created for every department. Remember, complete estimated overhead expenses will no change. Instead, they will certainly be broken out into various department price pools. This approach allows for the usage of different allocation bases for various departments relying on what drives overhead costs for every department. For example, the Hull Fabrication room at SailRite firm may find that overhead expenses are driven much more by the usage of machinery 보다 by labor, and therefore decides come use maker hours together the assignment base. The Assembly department may uncover that overhead expenses are driven an ext by labor task than by an equipment use and therefore decides to usage labor hrs or labor expenses as the assignment base.

Assume the SailRite is considering utilizing the department approach rather 보다 the plantwide approach for allocating overhead. The price pool in the Hull Fabrication room is estimated to be $3,000,000 because that the year, and the price pool in the Assembly department is estimated at $5,000,000. Note that complete estimated overhead price is quiet $8,000,000 (= $3,000,000 + $5,000,000). Maker hours (estimated at 60,000 hours) will certainly be used as the allocation base for Hull Fabrication, and direct labor hrs (estimated at 217,000 hours) will be used as the allocation base because that Assembly. For this reason two prices are offered to allocate overhead (rounded come the nearest dollar) together follows:

Hull Fabrication room rate: $50 per an equipment hour (= $3,000,000 ÷ 60,000 hours) Assembly department rate: $23 per direct labor hour (= $5,000,000 ÷ 217,000 hours)

As presented in figure 3.3 "Using Department rates to point out SailRite that company Overhead", assets going through the Hull Fabrication department space charged $50 in overhead costs for every machine hour used. Assets going through the Assembly department room charged $23 in overhead costs for each direct labor hour used.


Figure 3.3 utilizing Department prices to clues SailRite this firm Overhead

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The room allocation approach permits cost pools to be developed for every department and provides for adaptability in the an option of an allocation base. Although figure 3.3 "Using Department rates to clues SailRite company’s Overhead" shows just two rates, many companies have more than 2 departments and also therefore much more than two rates. Institutions that usage this approach tend to have straightforward operations within each department but different activities throughout departments. One department might use machinery, while an additional department might use labor, as is the situation with SailRite’s 2 departments. This strategy typically provides more accurate expense information than just using one plantwide rate but still relies on the assumption that overhead costs are moved by direct labor hours, direct labor costs, or maker hours. This assumption of a causal relationship is significantly less realistic as production procedures become an ext complex.

The plantwide and department allocation approaches are “traditional” approaches since both frequently use direct labor hours, direct labor costs, or an equipment hours as the allocation base, and both were used prior to the development of activity-based costing in the 1980s.

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Key Takeaway

regardless of the approach used come allocate overhead, a predetermined overhead price is developed for each cost pool. The plantwide allocation technique uses one expense pool to collect and also apply overhead costs and therefore supplies one predetermined overhead price for the whole company. The room allocation method uses several expense pools (one because that each department) and also therefore supplies several predetermined overhead rates.

Review difficulty 3.2

Kline company expects to incur $800,000 in overhead costs this comes year—$200,000 in the Cut and Polish department and also $600,000 in the Quality regulate department. Total yearly direct labor costs are supposed to be $160,000. The Cut and Polish room expects to use 25,000 an equipment hours, and also the Quality manage department plan to utilize 50,000 hrs of direct labor time because that the year.

Required:

i think Kline company allocates overhead expenses with the plantwide approach, and also direct labor cost is the allocation base. Calculation the rate used by the firm to point out overhead costs. Assume Kline firm allocates overhead prices with the room approach. Calculation the rate used by each department come allocate overhead costs.

Solutions come Review trouble 3.2

The plantwide price is calculated together follows:

Predetermined overhead rate=Estimated overhead costsEstimated activity in allocation base=$800,000$160,000=$5 per $1 in direct labor cost=500% of direct labor cost

The department rates are calculated utilizing the exact same formula together the plantwide rate. However, overhead prices and task levels are approximated for each department fairly than for the whole company, and also two separate prices are calculated:

Cut and Polish department=$200,00025,000 machine hours=$8 per machine hour Quality Control  department=$600,00050,000 direct labor hours=$12 per direct labor hour