Plantwide Overhead Rate versus Departmental Rates, Effects on Pricing Decisions

Cherise Ortega, marketing manager for Romer Company, was puzzled by the outcome of two recent bids. The company's policy was to bid 150 percent of the full manufacturing cost. One job (labeled Job 97-28) had been turned down by a prospective customer, who had indicated that the proposed price was $3 per unit higher than the winning bid. A second job (Job 97-35) had been accepted by a customer, who was amazed that Romer could offer such favorable terms. This customer revealed that Romer's price was $43 per unit lower than the next lowest bid.

Cherise has been informed that the company was more than competitive in terms of cost control. Accordingly, she began to suspect that the problem was related to cost assignment procedures. Upon investigating, Cherise was told that the company uses a plantwide overhead rate based on direct labor hours. The rate is computed at the beginning of the year using budgeted data. Selected budgeted data are given below.

		Department A		Department B		Total
Overhead		$500,000		$2,000,000		$2,500,000
Direct labor hours		200,000		50,000		250,000
Machine hours		20,000		120,000		140,000

Cherise also discovered that the overhead costs in Department B were higher than those in Department A because B has more equipment, higher maintenance, higher power consumption, higher depreciation, and higher setup costs. In addition to the general procedures for assigning overhead costs, Cherise was supplied with the following specific manufacturing data on Jobs 97-28 and 97-35:

		Job 97-28
		Department A		Department B		Total
Direct labor hours		5,000		1,000		6,000
Machine hours		200		500		700
Prime costs		$100,000		$20,000		$120,000
Units produced		14,400		14,400		14,400

		Job 97-35
		Department A		Department B		Total
Direct labor hours		400		600		1,000
Machine hours		200		3,000		3,200
Prime costs		$10,000		$40,000		$50,000
Units produced		1,500		1,500		1,500

3. Compute the difference in gross profit that would have been earned had the company used departmental rates in its bids instead of the plantwide rate. Round your intermediate computations to two decimal places and final answer to the nearest dollar. Gross profit would have increased by 5,441 x