Allocating Indirect Costs:

Assume a builder is building three houses simultaneously. The direct materials and direct labor costs for each house are shown below:

	House 1	House 2	House 3
Direct Materials	$140,000	$70,000	$90,000
Direct Labor	$210,000	$130,000	$60,000
Overhead	???	???	???

*The building contractors total indirect costs (such as supervisory salaries and indirect materials) amount to $84,000*

My new house is house number one. I believe distributing the contractors overhead costs equally among the three houses is a fair way to allocate them. My specific recommendation is:

- $84,000 overhead / 3 houses = $28,000 per house. Your new house is house number three. Do you agree with this assignment of cost?

A. Assume the builder allocates overhead (indirect) costs equally among the three houses. Determine the amount of overhead cost allocated to each house. Comment on whether this allocation scheme is reasonable. Explain why number of units may be an inappropriate allocation base in this case.

B. Assume instead that the builder allocates overhead costs based on total direct costs. Determine the amount of overhead cost allocated to each house. Compare the allocations determined in requirement a with the allocations determined in requirement b. Identify who will benefit and who will suffer if the builder uses the requirement b allocation method instead of allocating overhead equally.

C. Assume that the $84,000 of total overhead cost consists of $63,000 of indirect materials and $21,000 of fringe benefits. Decide what you believe is the most rational allocation scheme and use that scheme to allocate the overhead cost to the three houses.