7-36 Departmental Cost Allocation; Outsourcing McKeoun Enterprises is a large machine tool

company now experiencing alarming increases in maintenance expense in each of its four production

departments. Maintenance costs are currently allocated to the production departments on the basis

of direct labor hours incurred in the production department. To provide pressure for the production

departments to use less maintenance, and to provide an incentive for the maintenance department to

become more efficient, McKeoun has decided to investigate new methods of allocating maintenance

costs. One suggestion now being evaluated is a form of outsourcing. The producing departments

could purchase maintenance service from an outside supplier. That is, they could choose either to

use an outside supplier of maintenance or to be charged an amount based on their use of direct labor

hours. The following table shows the direct labor hours in each department, the allocation of maintenance

cost based on labor hours, and the cost to purchase the equivalent level of maintenance service

from an outside maintenance provider.

Production

Department

Direct Labor Hours

Allocation Base (percent)

Cost Allocation Based

on Direct Labor Hours Outside Price

A 20% $ 90,000 $115,000

B 30 135,000 92,000

C 10 45,000 69,000

D 40 180,000 184,000

Total 100% $450,000 $460,000

Required Use four or more decimal places (e.g., 33.3333%) in your calculations.

1. As a first step in moving to the outsourcing approach, McKeoun is considering an allocation based on

the price of the outside maintenance supplier for each department. Calculate the cost allocations on this

basis and compare them to the current direct labor hours basis.

2. If McKeoun follows the proposed plan, what is likely to happen to the use of internally provided maintenance

compared to externally provided maintenance? How will each department manager be motivated

to increase or decrease the use of maintenance? What will be the overall effect of going to the new plan?