Tariffs Inc.
Tariffs Inc. manufactures two product lines in the same plant: AllDomestic and SomeDomestic. Both product lines are sold in Tariff Inc.’s home country. AllDomestic is produced entirely from parts either manufactured by Tariffs Inc. or purchased from outside vendors that are domiciled in Tariffs Inc.’s home country. SomeDomestic consists of parts manufactured both inside and outside Tariff Inc.’s home country. Tariffs Inc.’s home country has tariff regulations that require all manufacturers of products sold in the home country to pay a sizeable tariff unless the domestic content of the product is at least 50 percent of the total cost of the product. In other words, if a product sold in Tariff Inc.’s home country has foreign content of 50 percent, then a sizeable tariff must be paid by the manufacturer (i.e., Tariff Inc.). If the product has foreign content of 49.99 percent then no tariff is assessed. Foreign content is measured by the ratio of costs incurred outside the home country to total costs incurred (foreign plus domestic costs). For purposes of computing costs, foreign and domestic costs include both the direct AND indirect costs.
The following table summarizes the total direct foreign and total direct domestic costs of Tariff Inc.’s two product lines.
Direct Costs | AllDomestic | SomeDomestic |
Domestic content | $1,300 | $1,500 |
Foreign content | $0 | $2,600 |
Besides the domestic direct costs Tariff Inc. incurs to manufacture the two product lines, it also has domestic indirect (common) costs. These domestic indirect costs are in two service departments: S1 and S2. S1 and S2 are domiciled in Tariff Inc.’s home country and, hence, are treated as domestic costs in tariff calculations. The total cost of operating S1 is $500 and the total cost of operating S2 is $2,000. (Note: These figures do not include any allocated costs from the other service department.) AllDomestic and SomeDomestic require the services of each of these two service centers as part of their manufacturing process. Moreover, each service department uses the services of the other service department. The following table summarizes the number of service units consumed of each service department by the other service department and by the two product lines, AllDomestic and SomeDomestic.
Service Units Consumed | ||||
| S1 | S2 | AllDomestic | SomeDomestic |
S1 | 0 | 100 | 300 | 600 |
S2 | 400 | 0 | 250 | 50 |
In other words, S2 consumes 100 service units of S1 and AllDomestic consumes 300 service units of S1.
Required:
a. Allocate the costs of S1 ($500) and S2 ($2,000) to the AllDomestic and the SomeDomestic product lines using the direct allocation method.
b. Allocate the costs of S1 ($500) and S2 ($2,000) to the AllDomestic and the SomeDomestic product lines using the step-down allocation method where S1 is allocated first and S2 is allocated second.
c. Allocate the costs of S1 ($500) and S2 ($2,000) to the AllDomestic and the SomeDomestic product lines using the step-down allocation method where S2 is allocated first and S1 is allocated second.
d. Which allocation method (a, b, or c) should Tariff Inc. use? Explain why. Assume Tariff Inc. does not use indirect cost allocations to measure and reward the performance of managers in Tariff Inc., the allocated costs are not used for any decision-making purposes, and Tariff Inc. pays no other taxes other than possible tariffs.
e. Assume the tariff rate is 20 percent of the total cost of manufacturing the product (domestic content cost plus foreign content cost including all allocated indirect cost). How much tariff will Tariff Inc. pay based on your recommended allocation method in part (d)?
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