Reference no: EM1311388

Overhead allocation plant wide rate direct labor hours Machine hour basis.

Two companies that have been competitors for many years recently decided to quit fighting each other and merge into one company. The companies were located next to each other and shared a common wall for plant space. In an effort to promote goodwill and to increase transparency between the companies, the newly merged enterprise knocked down the common wall that once separated them. Top management agreed that the control of operations would be equally shared and that the original plant managers would continue to operate similarly to how they had in the past, except now as one company with two divisions (A and B) and two division managers.

The companies (now divisions) each made the same product and produced at the same rate. The only apparent difference was that Division A was more labor-intensive, using many workers with simple tools to achieve their production, while the more capital-intensive Division B used automated machines and fewer workers to achieve production. Otherwise, their respective product outputs were identical. Both companies produced at the rate of 1,000 units per year.  Division A allocated overhead based on direct labor hours (DLH) while Division B allocated overhead based on machine hours (MH).

The cost data for the most recent year reflected the same actual amount of overhead resource usage per DLH ($25) and per MH ($40) between the divisions, but the divisions incurred slightly different total overhead costs per unit of product because of the emphasis on labor in A and machines in B. Because of this, the actual cost of overhead was as follows:

 

Division A		Division B
DLH = 5 per product unit @ $25 = $125 per unit		DLH = 2 per product unit @ $25 = $50 per unit
MH = 2 per product unit @ $40 = $80 per unit		MH = 4 per product unit @ $40 = $160 per unit
Total actual overhead cost per unit = $205		Total actual overhead cost per unit = $210
Total actual overhead cost incurred = $205,000		Total actual overhead cost incurred = $210,000

 

Other costs included direct material (DM) of $100 per product unit for both divisions and direct labor of $50 per product unit for Division A and $20 per product unit for Division B reflecting a wage rate of $10 per direct labor hour (DLH).

After the merger the operations manager of each division decided it would be much simpler to allocate costs using one plant wide rate as they did before the merger. Machine hours are chosen as the basis for allocation since this is what Division B used. This decision was based on the fact that Division B appears more efficient, given Division B\'s lower total cost per unit.  Moreover, top management reasons that Division B seems to be the more modern and progressive of the two companies given their degree of automation. They also believe allocation based on MH more accurately reflects the trend of operations in the future.

Top management complains that if the accountants had been more accurate in estimating overhead then they wouldn\'t have over applied overhead. Is this true? Explain.