Reference no: EM131942564

Question - Zubick Corporation produces and supplies 2 types of component parts to industrial equipment manufacturers. These parts are known as X123 and R907.

There are 2 departments in the factory: the machining and assembly departments. The machining department has highly automated operations, while assembly has labour-intensive operations.

Table 1: Annual production data by product

	Product X123	Product R907
Units produced	1,000	2,000
Total direct labour hours (DLH) consumed per unit	5 DLH	15 DLH
Total machine hours (MH) consumed per unit	15 MH	5 MH

The overhead cost incurred in the Machining department was $1,300,000, while the overhead cost in the Assembly department was $350,000.

Table 2: Annual overhead costs and production activity by department

	Machining dept	Assembly dept	Total
Overhead cost	$1,300,000	$350,000	$1,650,000
Direct labour hours (DLH) consumed per dept	5,000 DLH	30,000 DLH	35,000 DLH
Machine hours (MH) consumed per dept	23,000 MH	2,000 MH	25,000 MH

The manager, Rex, decided to allocate costs to the 2 products in the following manner: he divided the total overhead costs of $1,650,000 by the total number of labour hours utilised in the factory (ie (1000 x5) plus (2000 x 15) = 35,000 DLH).

Therefore his overhead rate was $1,650,000/35,000 = $47.14 per DLH.

The overhead allocated to each product using Rex's rate was as follows:

Product X123 = 5 DLH x$47.14 = $235.70

Product R907 = 15 DLH x $47.14 = $707.10

But Rex was losing sales of product R907 to his competitor who was able to sell a similar product at a lower price, and recover all costs of production.

Additional information:

Tables 3 and 4 show how much direct labour and machine time is consumed by each product in each production department.

Table 3: Machine hours (MH) consumed by each product in production departments.

	Machining dept	Assembly dept	Total per unit of product
Per unit of product X123	14.5 MH	0.5 MH	15 MH per unit of X123
Per unit of product R907	4.25 MH	0.75 MH	5 MH per unit of R907

Table 4: Direct labour hours (DLH) consumed by each product in production departments.

	Machining dept	Assembly dept	Total per unit of product
Per unit of product X123	2 DLH	3 DLH	5 DLH per unit of product X123
Per unit of product R907	1.5 DLH	13.5 DLH	15 DLH per unit of product R907

Required:

i) Do you agree or disagree with Rex's overhead allocation method? Explain. You should draw on information provided in Tables 1 to 4 to help explain and support your answer.

ii) How would you improve it? Calculate alternative rates that you would use and explain why you think it would help Rex. You should draw on information provided in Tables 1 to 4 to support your recommendation.