Question

Automotive Products (AP) designs and produces automotive parts in 2017, actual manufacturing overheads $318,000. AP's simple costing system allocates manufacturing overhead to its three customers based on machine hours and prices its contracts based on all costs. One of its customers has regularly complained of being charged noncompetitive prices, so AP's controller Devon Johnson rares that it is time to examine the consumption of overhead resources more closely. He knows that there are three main departments that consume overhead resources: design, production and engineering Interviews with the department personnel and inton of me records the following detailed information Click the icon to view the information) Rom ments

Answer 1

Solution 1) Calculation of allocation of overheads using Machine hours as an allocation base

Department	Cost $
Design	38,000.00
Engineering	30,000.00
Production	2,50,000.00
Total Overheads	3,18,000.00

Total Machine Hours = Rural Motors + Aegean Motors + Jerdon Auto

                                     = 220 + 3300 + 1480 = 5,000 Machine Hours

Therefore, Overhead cost per Machine hour = Total Overhead Cost / Total Number of Machine Hours

= $318,000 / 5,000 Hours = $63.60 per Machine Hour

Allocation of Overheads using Machine hours as an allocation base

	Rural Motors	Aegean Motors	Jerdon Auto
Number of Machine hours	220.00	3,300.00	1,480.00
Rate of Overheads per Hour	63.60	63.60	63.60
Total Overheads allocated	13,992.00	2,09,880.00	94,128.00

Solution 2) Calculation of allocation of overheads using Department based manufacturing rates as an allocation base:

Calculation of Rate per Cost Driver:

Department	Cost $	Cost Driver	Number of Cost Drivers	Rate Per Cost Driver = Cost $ / Number of Cost Drivers
Design	38,000.00	CAD-Design Hours	400 Hours	$95.00 per hour
Engineering	30,000.00	Engineering Hours	400 Hours	$75.00 per hour
Production	2,50,000.00	Machine Hours	5,000 Hours	$50.00 per hour
	3,18,000.00

Allocation of Overheads using Department based manufacturing rates as an allocation base:

	Rural Motors			Aegean Motors			Jerdon Auto
Cost Driver	Number of Activities	Activity Rate $	Cost $	Number of Activities	Activity Rate $	Cost $	Number of Activities	Activity Rate $	Cost $
Design	115	95.00	10,925.00	202	95.00	19,190.00	83	95.00	7,885.00
Engineering	85	75.00	6,375.00	78	75.00	5,850.00	237	75.00	17,775.00
Production	220	50.00	11,000.00	3,300	50.00	1,65,000.00	1,480	50.00	74,000.00
Total Overheads	28,300.00			1,90,040.00			99,660.00

Solution 3)

	Rural Motors	Aegean Motors	Jerdon Auto
Allocation of overheads using Machine hours	13,992.00	2,09,880.00	94,128.00
Allocation of overheads using Department based manufacturing rates	28,300.00	1,90,040.00	99,660.00

Aegean Motors is the customer who must be complaining about being overcharged in the simple system as it is being charged $2,09,880 against $1,90,040.

If the new system is adopted, Rural Motors and Jerdon Auto will be unhappy as they will be charged more. These customers should be made aware of the new system used in pricing and the advantages of the same as the customers are charged as the per activities conducted.