Lennon Fans manufactures three model fans for industrial use. The standard selling price and cost of each fan follow:

Model 501 Model 541 Model 599

Selling price 6,300 12,000 15,200

Unit cost:

Material 1,650 5,450 7,050

Direct labor 850 2,700 4,900

Overhead 850 3,518 7,036

Unit profit (loss) 2,920 332 (3,786)

Essentially, all overhead costs are fixed. Some of the fixed overhead costs are direct costs to particular models, and others are common fixed costs.

Estimated total overhead

Model 501 Model 541 Model 599 total

Direct fixed 5,000,000 2,000,000 1,000,000 8,000,000

Common fixed 5,000,000

Total 13,000,000

Lennon allocates overhead costs to products using a single overhead rate developed as follows. Estimated total overhead is divided by estimated direct labor cost. This results in an overhead rate per labor dollar. This rate is used to assign standard overhead to products.

Below are estimates of sales and direct labor. These values imply an overhead rate of $1.3146 per labor dollar ($13,000,000 $9,889,000).

Model 501 Model 541 Model 599 total

Estimated unit sales 1,100 2,300 560 3,960

Estimated labor 935,000 6,210,000 2,744,000 9,889,000

Required

a. Because Model 599 is showing a loss, the controller of Lennon has asked you to analyze whether it should be dropped. You should assume that direct fixed costs will be avoided if model is dropped but common fixed costs will not be avoided if the model is dropped.

b. Explain why the method used to allocate costs at Lennon results in unreasonably high charges to the Model 599fan.