Alden Peterson, marketing manager for Retlief Company, had been puzzled by the outcome of two recent bids. The company’s policy was to bid 150 percent of the full manufacturing cost. One job (labeled Job SS) had been turned down by a prospective customer, who had indicated that the proposed price was $3 per unit higher than the winning bid. A second job (Job TT) had been accepted by a customer, who was amazed that Retlief could offer such favorable terms. This customer revealed that Retlief’s price was $43 per unit lower than the next lowest bid.

Alden knew that Retlief Company was more than competitive in terms of cost control. Accordingly, he suspected that the problem was related to cost assignment procedures. Upon investigating, Alden was told that the company used a plantwide overhead rate based on direct labor hours. The rate was computed at the beginning of the year using budgeted data. Selected budgeted data follow:

Department A Department B Total Overhead $500,000 $2,000,000 $2,500,000 Direct labor hours 200,000 50,000 250,000 Machine hours 20,000 120,000 140,000 The above information led to a plantwide overhead rate of $10 per direct labor hour. In addition, the following specific manufacturing data on Job SS and Job TT were given. :

JOB SS Department A Department B Total Direct labor hours 5,000 1,000 6,000 Machine hours 200 500 700 Prime costs $100,000 $20,000 $120,000 Units produced 14,400 14,400 14,400 JOB TT Department A Department B Total Direct labor hours 400 600 1,000 Machine hours 200 3,000 3,200 Prime costs $10,000 $40,000 $50,000 Units produced 1,500 1,500 1,500 This information led to:the original bid prices of $18.75 per unit for Job SS and $60 per unit for Job TT.

Then Alden discovered that the overhead costs in Department B were higher than those of Department A because Department B has more equipment, higher maintenance, higher power consumption, higher depreciation, and higher setup costs. So he tried reworking the two bids by using departmental overhead rates. Department A’s overhead rate was $2.50 per direct labor hour; Department B’s overhead rate was $16.67 per machine hour. These rates resulted in unit prices of $14.67 for Job SS and $101.01 for Job TT.

Alden still was not satisfied, however. He did some reading on overhead allo- cation methods and learned that proper support-department cost allocation can lead to more accurate product costs. He decided to create four support departments and recalculate departmental overhead rates. Information on departmental costs and re- lated items follows:

General Dept. Dept. Maintenance Power Setups _—_ Factory A B Overhead $500,000 $225,000 $150,000 $625,000 $200,000 $800,000 Maintenance hours = 1,500 500 = 1,000 7,000 Kilowatt-hrs. 4,500 — — 15,000 10,000 50,000 DLH 10,000 12,000 6,000 8,000 200,000 50,000 Number of setups es = = — 40 160 Square feet 25,000 40,000 5,000 15,000 35,360 94,640 The following allocation bases (cost drivers) seemed reasonable:

Support Department Allocation Base Soe Oe ie BOO ee ee ee te i Ss amend Maintenance Maintenance hours Power Kilowatt-hours Setups Number of setups General Factory Square feet Required:
1. Using the direct method, verify the original departmental overhead rates.
2. Using the sequential method, allocate support-department costs to the producing departments. Calculate departmental overhead rates using direct labor hours for Department A and machine hours for Department B. What would the bids for Job SS and Job TT have been if these overhead rates had been in effect?
3. Which method of overhead cost assignment would you recommend to Alden?
Why?
4. Suppose that the best competing bid was $4.10 lower than the original bid price (based on a plantwide rate). Does this affect your recommendation in Requirement 3? Explain.