Case Study - Creative Decoration Products Inc.

Susan Brown had recently been transferred to the Creative Furniture Division of the Creative Decoration Products Inc. Shortly after taking over her new position as divisional controller, she was asked to develop the division's predetermined overhead rate for the upcoming year. Creative Decoration Products uses direct labor-hours in all of its divisions as the allocation base for applying manufacturing overhead. The accuracy of the rate is important because it is used throughout the year and any overapplied or underapplied overhead is closed out to the Cost of Goods Sold at the end of the year.

To compute the predetermined overhead rate, Susan divided her estimate of the total manufacturing overhead for the coming year by the production manager's estimate of the total direct labor hours for the coming year. She took her computations to the division's general manager for approval but was quite surprised when he suggested a modification in the base. Her conversation with the general manager of the Creative Furniture Division, Peter Davis, went like this:

Brown: "Here are my calculations for next year's predetermined overhead rate. If you approve, we can enter the rate into the computer on January 1 and be up and running in the job-order costing system right away this year."

Davis: "Thanks for coming up with the calculations so quickly, and they look just fine. There is, however, one slight modification I would like to see. Your estimate of the total direct labor-hours for the year is 880,000 hours. How about cutting that to about 840,000 hours?"

Brown: "I don't know if I can do that. The production manager says she will need about 880,000 direct labor-hours to meet the sales projections for the year. Besides, there are going to be over 860,000 direct labor-hours during the current year and sales are projected to be higher next year."

Davis: "Susan, I know all of that. I would still like to reduce the direct labor-hours in the allocation base to something like 840,000 hours. You probably don't know that I had an agreement with your

predecessor as divisional controller to reduce in 5% or so the estimated direct labor-hours every year. That way, we kept a reserve that usually resulted in a big boost to net operating income at the end of the year in December. We called it our Christmas bonus. Corporate headquarters always seemed to be pleased that we could pull off such a miracle at the end of the year. This system has worked well for many years, and I don't want to change it now."

4) Assuming the alternative scenario described in the previous question, should Susan accept the request from Peter and potentially save hundreds of jobs, including her own? Explain your answer