Demonstration Problem 4-1 Allocating Indirect Costs

(Problem-Based Learning Format)

My House / Your House

	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?

Demonstration Problem 4-1 Allocating Indirect Costs

(Traditional Format)

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) are $84,000.

Required

a. Assume the builder allocates overhead (indirect) costs equally among the three houses. Determine the amount of overhead cost allocated to each house.

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.

Demonstration Problem 4-1 Work Papers

a. ___________ __ = ____________ overhead cost per house.

b. Total direct costs are as follows:

	House 1	House 2	House 3	Total
Direct Materials	$140,000	$ 70,000	$90,000	$300,000
Direct Labor	210,000	130,000	60,000	400,000
Total Direct Cost

Step 1. Determine the allocation rate:

Cost to be Allocated
------------------			=	Allocation Rate
Allocation Base
( line below is suppose to be division sign )
-----------------	=	________ per direct cost dollar

Step 2. Determine the amount to be allocated by multiplying the allocation rate by the weight of the base.

House	Allocation Rate	x	Weight of Base	=	Allocated Cost
1		x		=
2		x		=
3		x		=
Total

C.

Allocation of Indirect Materials Cost

Step 1. Determine the allocation rate:

Cost to be Allocated
--------------------			=	Allocation Rate
Allocation Base
( line below is suppose to be division sign )
-----------------	=	______ per direct material cost dollar

Step 2. Determine the amount to be allocated by multiplying the allocation rate by the weight of the base.

House	Allocation Rate	x	Weight of Base	=	Allocated Cost
1		x		=
2		x		=
3		x		=
Total

Allocation of Fringe Benefits Cost

Step 1. Determine the allocation rate:

Cost to be Allocated
-----------------------			=	Allocation Rate
Allocation Base
( line below is suppose to be division sign )
-----------------	=	_______ per direct labor cost dollar

Step 2. Determine the amount to be allocated by multiplying the allocation rate by the weight of the base.

House	Allocation Rate	x	Weight of Base	=	Allocated Cost
1		x		=
2		x		=
3		x		=
Total

Total Overhead Allocated to Each House:

	House 1	House 2	House 3	Total
Indirect Materials
Fringe Benefits
Total Indirect Costs	$40,425	$21,525	$22,050	$84,000

Note: The total cost of each house using the allocation scheme in part c is:

	House 1	House 2	House 3
Direct Materials
Direct Labor
Overhead
Total Cost	$390,425	$221,525	$172,050

Demonstration Problem 6-2 Contrast Relevance, Cost Behavior, and Cost Type (5 pts)

Pass Fast, Inc. is considering two alternative locations in which to conduct its CPA review course. One alternative is an exclusive hotel; the other is a moderately priced training facility. The hotel is in a central location easily accessible to potential students. The training facility is in a less desirable location. Pass Fast has gathered the following cost data regarding the two locations.

Cost Items	Hotel	Training Facility	Relevant?	Cost Behavior	Product or GS&A
Rental Fee for Classroom	$2,000	$1,500
Twenty Advertising Brochures Distributed to each Student for Referrals	250	250
Cost of Instruction	5,000	5,000
Books (per student)	100	100
Refreshments (per student)	5	4
Depreciation on Instructional Equipment	400	400

Required

a. In the column titled Relevant? indicate whether each cost is relevant (Yes) or not relevant (No) to deciding which facility to rent for the course.

b. In the column titled Cost Behavior indicate whether each cost is fixed, variable, or mixed relative to the number of students attending the course.

c. In the column titled Product or GS&A indicate whether each cost would be classified as a product cost or a general, selling, and administrative (GS&A) cost.

Demonstration Problem 6-2 Work Paper

Cost Items	Hotel	Training Facility	Relevant?	Cost Behavior	Product or GS&A
Rental Fee for Classroom	$2,000	$1,500
Twenty Advertising Brochures Distributed to each Student for Referrals	250	250
Cost of Instruction	5,000	5,000
Books (per student)	100	100
Refreshments (per student)	5	4
Depreciation on Instructional Equipment	400	400