Question

The Real McCoys Company has two service departments (S1 and S2) and two production departments (P1 and P2). Department S1 allocates service costs based on machine hours. S2 allocates service costs based on kilowatt hours. The company does NOT make a distinction between fixed and variable costs when allocating service costs. The budgeted total costs in the service departments for 2019 are $70,000 for S1 and $98,800 for S2. Budgeted machine hours and kilowatt hours for the year are as follows: Machine Hours Kilowatt Hours 6,000 Department S1 Department S2 Department P1 Department P2 8,000 4,000 28,000 10,000 4,000 The budgeted costs in the service departments are as follows: Variable costs Supervisor salary Depreciation Expense Department S1 $35,000 $30,000 $ 5,000 Department S2 $48,000 $40,000 $10,800 Department P2 uses machine hours to compute its predetermined overhead rate for 2019. The budgeted departmental overhead for P2 (before service costs are allocated) is $159,400. 1. Using the reciprocal method as needed, compute the predetermined overhead rate for 2019 in P2. Round to the nearest cent, if needed. 2. If the company decided to discontinue Department S2 and purchase kilowatt hours from an outside power company, the cost would be $5.50 per kilowatt hour. You may assume that if we purchase kilowatt hours from an outside supplier, we would fire the supervisor in Department S2. Prepare an analysis that shows the following: A. The relevant external cost to purchase kilowatt hours. B. The relevant internal cost to keep Department S2. C. Is the company better off or worse off to keep Department S2? By how much?

Answer 1

Answer is given below

Predetermined Overhead rate in 2019 1. Dept P2 $159,400 Direct Costs Allocation Department S1 (70% of $ 106,000) Department S2 ( 20% of $ 120,000) Total after allocation $74,200 $24,000 $257,600 Machine hours 28,000 Machine hour rate $9.20 Relevant Cost analysis 2. Relevant Relevant Internal External Cost Cost Cost of Purchase-20,000 kwh * $5.50 Variable cost $110,000 $48,000 Supervisor Salary Depreciation Expense Total Cost $40,000 $10,800 Difference $110,000 $98,800 $11,200 Since Cost of internal manufacture is lower it is better to keep Dept S2 Total savings is $11,200 Note: it is assumed Depreciation expense will not be there in case of external purchase Allocation using Reciprocal method Producing Department Support Departments Dept S2 8,000 Dept P2 28,000 4,000 Total Dept S1 Dept P1 Machine hours Kilowatt hours Allocation ratio 40,000 20,000 4,000 6,000 10,000 70% 100% Dept S1 Dept S2 20% 10% 30% 100% 50% 20% Simultaneous Eqquation method S1-70,000+0.30 S2 S2 98,800 0.20 S1 S1= Dept S1 S2= Dept S2 Solving above equation S1- 70,000 0.30 (98,800+0.20 S1) S1- 70,00029,640 +0.06 S1 0.94 S1- 99,640 S1- 99,640/0.94 Total Cost S1= 106,000 S2= 120,000