Dewan Locks Dewan Locks produces and sells a keyless bicycle lock that uses a smal...

Dewan Locks

Dewan Locks produces and sells a keyless bicycle lock that uses a small wireless fob to lock and unlock the lock without the need of a key. Dewan produces two models: one for the European market (EU) and one for North America (NA). Dewan started producing the North American lock at its Eastbury plant, and then introduced the EU model, which was also assembled in the Eastbury plant. When demand for both models grew and exceeded the capacity of Eastbury, Dewan leased the Westbury plant. Following the weakening global economy, Dewan saw the demand for its locks from both Europe and North America fall. This caused Dewan’s total profits to plummet. The following table summarizes operations for the last fiscal quarter.

To address the current operating loss of $100,000, Dewan owners are moving the EU lock production from the Westbury plant to the Eastbury plant where it now has excess capacity due to the declining sales of the NA lock, and since the lease on the Westbury plant is expiring soon. By canceling the lease of the Westbury plant and moving the EU locks back to the Eastbury plant, the fixed manufacturing overhead of producing EU locks will fall from its current level of $630,000 to $210,000. In other words, Dewan will save the lease and occupancy cost of the Westbury plant ($630,000) but will have to incur additional fixed manufacturing cost of $210,000 in Eastbury to produce the EU locks in Eastbury. Stated differently, with both plants in operation, Dewan’s total fixed manufacturing overhead is $1,140,000 ($630,000 + $510,000). Total manufacturing overhead will be $720,000 ($510,000 + $210,000) by consolidating both NA and EU lock production into the Eastbury plant.

The EU and the NA locks are separate profit centers with the managers of the two profit centers evaluated and compensated based on the operating income of their respective profit centers.

Required:

a. Dewan still expects to sell 11,000 locks in Europe and 17,000 in North America. By closing the Westbury plant and producing both the NA and the EU locks in Eastbury, what happens to Dewan’s operating income?

b. After consolidating production of the NA and EU locks in the Eastbury plant, Dewan needs to allocate the $720,000 of common fixed manufacturing overhead of the Eastbury plant to the two profit centers (NA locks and EU locks). The $720,000 of Eastbury’s common fixed manufacturing overhead to the two profit centers is to be allocated using total contribution margin (unit sales times the difference between selling price and variable cost per unit) as the allocation base. Using total contribution margin to allocate the manufacturing overhead to the two profit centers, prepare operating income statements for the NA locks and EU locks profit centers for last quarter as if the Westbury plant has closed and all locks are produced in Eastbury.

c. After seeing the operating income statements prepared in part b, the manager of the NA lock profit center argues, “Something must be wrong in these operating income statements. Why should the NA lock operating income change just because EU locks are now being produced in Eastbury? I haven’t done anything differently, so why is NA Locks being penalized for closing Westbury plant and moving the EU locks into Eastbury? All of the benefits of closing Westbury seem to accrue to EU Locks and none to NA Locks.” Write a memo to Dewan’s president explaining whether the arguments by the manager of the NA Locks profit center have any merits.

d. Would you recommend using the overhead allocation scheme described in part (b), or would you propose an alternative allocation scheme? And if so, what scheme would you recommend, and why?