Recently, the sales and marketing manager for Pasifika Company, Mr. Reece Rooney couldn't understand the result of two bids that the firm has submitted. According to the company's policy, a 50 percent mark-up is added to the full manufacturing cost when calculating the bid. One particular job (Job A01) had been rejected by a prospective customer since the proposed bid was $4 per unit higher than the winning bid. However, a customer has accepted a second job (Job B01) and was pleased with the favorable bid. This customer revealed that Pasifika'sprice was $44 per unit lower than the next-lowest bid.

Reece knew that the implementation of the cost leadership strategy has resulted in Pasifika's competitive advantage, therefore he assumed that the issue must be related to cost allocation procedures. When Reece further investigated the matter, he found that Pasifika used a pre-determined plantwide overhead rate based on direct labor hours. The budgeted data used to calculate this rate follows:

Department A Department B Total

Fixed Overhead $300,000 $1,400,000 $1,700,000

Variable Overhead $1 per DLH $5 per MH

Direct labor hours 200,000 50,000 250,000

Machine hours 20,000 120,000 140,000

Additional information on the two jobs are as follows:

Job A01

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

Job B01 14,400

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

In his attempt to investigate the costing of the two jobs, Mr. Rooney discovered that the overhead costs in the two departments are different. In particular, the overhead costs of Department B were higher than Department A since it uses more equipment and therefore has higher maintenance, higher power consumption, higher depreciation, and higher setup costs. Additionally, he did some reading on overhead cost allocation methods and found that allocating support department cost appropriately can result to increase accuracy of the product cost. Hence he collected the following information on four support departments as follows:

Maintenance Power Setups General Dept. Dept.

Factory A B

Fixed overhead $400,000 $120,000 $100,000 $500,000 $100,000 $650,000

Variable overhead $100,000 $105,000 $50,000 $125,000 $100,000 $150,000

Maintenance hours - 1,500 500 - 1,000 7,000

Kilowatt-hours 4,500 - - 15,000 10,000 50,000

Direct laborhours 10,000 12,000 6,000 8,000 200,000 50,000

Number of setups - - - - 40 160

Square feet 25,000 40,000 5,000

The following allocation bases (cost drivers) seemed reasonable:

Support Department Allocation Base 15,000 35,360 94,640

Maintenance Maintenance hours

Power Kilowatt-hours

Setups Number of setups

General Factory Square feet

REQUIRED

1. Advise Mr. Rooney on potential strategies he would implement to compete effectively on cost leadership strategy.

2. Calculate the unit bids for the two jobs using a plantwide OH rate based on direct labour hours.

3. (i) Using the sequential (step-down) method, calculate the departmental overhead rates using direct labor hours for Department A and machine hours for Department B.

(ii) What would the unit bids for Job A01and Job A02 have been if these overhead rates had been in effect?(Round-off the allocation ratios to 3 decimal places before you allocate the support department costs

4. Discuss any recommendations you would give to Rooney regarding the method of allocating overhead cost.