Hansen, Kotter, and Zales is a law firm that contains two departments (Litigation and Consulting). The firm employs a job-order costing system to accumulate costs chargeable to each client. The firm uses actual costing to assign overhead. General overhead costs can be allocated based on either direct attorney hours or the number of employees, depending on managers choice. At the end of the year, the records revealed the actual general overhead costs are $720,000. At the end of the year, the records revealed the following costs and operating data for all cases handled during the year

	Litigation	consulting
number of employees	13	11
direct attorney hours	10,000	6,000
direct attorney costs	400,000	250,000
Direct material costs	15,500	13,500

Part I Job Order Costing

a. (2 points) Compute the overhead allocation rates for general overhead based on different cost drivers. What are the overhead costs assigned to each department, using different cost drivers?

Overhead allocation based on direct attorney hours:

Litigation: 720,000*(0.625) = $450,000

Consulting: 720,000*(0.375) = $270,000

	Litigation	Consulting	Total
DA Hours	10,000	6,000	16,000
% of total	62.5%	37.5%	100%
Alloc. OH cost ($)	450,000	270,000	720,000

Overhead allocation based on number of employees:

Litigation: 720,000*(0.541) = $389,520

Consulting: 720,000*(0.459) = $330,480

	Litigation	Consulting	Total
# of employees	13	11	24
% of total	54.1%	45.9%	100%
Alloc. OH cost ($)	389,520	330,480	720,000

Assume that the company uses attorney hours to allocate general overhead costs. For litigation department, the costs charged to each case are made up of three elements:

• Direct attorney costs (charged at $40 per hour)
• Direct materials and supplies used
• General overheads are applied by direct attorney hours

The information on one of its cases during this period is given as follows:

Case 618

Direct attorney-hours 150

Direct Materials and supplies $5000

b. (2 points) What are the total costs accumulated for Case 618? The company charged the client $30,000 for the service, what is the profit the company earned?

Direct Attorney Costs (150*$40/hr) = $6,000

Direct Materials & Supplies = $5,000

General Overheads = (actual overhead costs/total direct attorney hours)*direct attorney hours = ($720,000/16,000)*150 = $6,750

Total Costs Accumulated = $17,750

Total Charge to Client = $30,000

Profit = Total Charge to Client - Total Costs Accumulated = $30,000 - $17,750 = $12,250

Total Costs Accumulated = $17,750

Profits = $12,250

c. (1 points) Suppose the firms annual revenue is 2 million dollars. The corporate tax rate is 35%. How much taxes shall the company pay? Does the choice of cost driver affect the total taxes due?

The company will pay $213,850 in Taxes. The Total Overhead Cost is $720,000, which does not affect the taxes that are due. It only affects before tax revenue.

Part II Tax Strategy and Transfer Pricing

Now the company spins off its consulting department and sets up a subsidiary in Bahamas. The subsidiary will conduct the consulting work and the parent will pay a consulting service fee to acquire the consulting service. The consulting department in Bahamas will use the same overhead allocation rate as in the parent company. The consulting fee paid will be recognized as part of costs of the parent company. The corporate tax rate in Bahamas is 5%.

d. (2 points) Assume the corporate revenue is still 2 million dollars. Assume that general overhead is assigned by direct attorney hours. Compare the tax implications (i.e., tax payments of parent and subsidiary companies and total consolidated profits) when the consulting fee is equal to 120% and 150% of the costs of consulting service, respectively.