Review snowmobiles and riding mowers example in Chapter 18 Below. Know which method would have underpriced and overpriced each item.

Single Plantwide Factory Overhead Rate Method: A company may use a predetermined factory overhead rate to allocate factory overhead costs to products. Under the single plantwide factory overhead rate method, factory overhead costs are allocated to products using only one rate. To illustrate, assume the following data for Ruiz Company, which manufactures snowmobiles and riding mowers in a single factory:

Total budgeted factory overhead costs for the year	$1,600,000
Total budgeted direct labor hours (computed as follows)	20,000 hours

The total budgeted direct labor hours are computed as follows:

Under the single plantwide factory overhead rate method, the $1,600,000 budgeted factory overhead is applied to all products by using one rate. This rate is computed as follows: The budgeted allocation base is a measure of operating activity in the factory. Common allocation bases would include direct labor hours, direct labor dollars, and machine hours. Ruiz allocates factory overhead using budgeted direct labor hours as the plantwide allocation base. Thus, Ruizs single plantwide factory overhead rate is $80 per direct labor hour, computed as follows: Ruiz uses the plantwide rate of $80 per direct labor hour to allocate factory overhead to snowmobiles and riding mowers, computed as follows:

	Single Plantwide Factory Overhead Rate		Direct Labor Hours per Unit	=	Factory Overhead Cost per Unit
Snowmobile	$80 per direct labor hour		10 direct labor hours	=	$800
Riding mower	$80 per direct labor hour		10 direct labor hours	=	$800

The factory overhead allocated to each product is $800. This is because each product uses the same number of direct labor hours.The effects of Ruiz Company using the single plantwide factory overhead rate method are summarized in Exhibit 2.

Exhibit 2Single Plantwide Factory Overhead Rate MethodRuiz Company

The primary advantage of using the single plantwide overhead rate method is that it is simple and inexpensive to use. However, the single plantwide rate assumes that the factory overhead costs are consumed in the same way by all products. For example, in the preceding illustration Ruiz assumes that factory overhead costs are consumed as each direct labor hour is incurred. The preceding assumption may be valid for companies that manufacture one or a few products. However, if a company manufactures products that consume factory overhead costs in different ways, a single plantwide rate may not accurately allocate factory overhead costs to the products.

Multiple Production Department Factory Overhead Rate Method When production departments differ significantly in their manufacturing processes, factory overhead costs are normally incurred differently in each department. In such cases, factory overhead costs may be more accurately allocated using multiple production department factory overhead rates.The multiple production department factory overhead rate method uses different rates for each production department to allocate factory overhead costs to products. In contrast, the single plantwide rate method uses only one rate to allocate factory overhead costs. Exhibit 3 illustrates how these two methods differ. To illustrate the multiple production department factory overhead rate method, the prior illustration for Ruiz Company is used. In doing so, assume that Ruiz uses the following two production departments in the manufacture of snowmobiles and riding mowers:

Fabrication Department, which cuts metal to the shape of the product.

Assembly Department, which manually assembles machined pieces into a final product.

The total budgeted factory overhead for Ruiz is $1,600,000 divided into the Fabrication and Assembly departments as follows:

As illustrated, the Fabrication Department incurs nearly twice the factory overhead of the Assembly Department. This is because the Fabrication Department has more machinery and equipment that uses more power, incurs more equipment depreciation, and uses more factory supplies. Department Overhead Rates and Allocation Each production department factory overhead rate is computed as follows: To illustrate, assume that Ruiz Company uses direct labor hours as the allocation base for the Fabrication and Assembly departments. Each department uses 10,000 direct labor hours. Thus, the factory overhead rates are as follows: Ten direct labor hours are required for the manufacture of each snowmobile and riding mower. These 10 hours are consumed in the Fabrication and Assembly departments as follows:

The factory overhead allocated to each snowmobile and riding mower is shown in Exhibit 4. As shown in Exhibit 4, each snowmobile is allocated $938 of total factory overhead costs. In contrast, each riding mower is allocated $662 of factory overhead costs.

Allocating Factory Overhead to ProductsRuiz Company

Exhibit 5 summarizes the multiple production department rate allocation method for Ruiz. Exhibit 5 indicates that the Fabrication Department factory overhead rate is $103 per direct labor hour, while the Assembly Department rate is $57 per direct labor hour. Since the snowmobile uses more Fabrication Department direct labor hours than does the riding mower, the total overhead allocated to each snowmobile is $276 greater ($938 $662) than the amount allocated to each riding mower.

Exhibit 5Multiple Production Department Rate MethodRuiz Company

Distortion of Product Costs The differences in Ruiz Companys factory overhead for each snowmobile and riding mower using the single plantwide and the multiple production department factory overhead rate methods are as follows:

	Factory Overhead Cost per Unit
	Single Plantwide Method	Multiple Production Department Method	Difference
Snowmobile	$800	$938	$(138)
Riding mower	800	662	138

Note: The single plantwide factory overhead rate distorts product cost by averaging high and low factory overhead costs.The single plantwide factory overhead rate distorts the product cost of both the snowmobile and riding mower. That is, the snowmobile is not allocated enough cost and, thus, is undercosted by $138. In contrast, the riding mower is allocated too much cost and is overcosted by $138 ($800 $662).The preceding cost distortions are caused by averaging the differences between the high factory overhead costs in the Fabrication Department and the low factory overhead costs in the Assembly Department. Using the single plantwide rate, it is assumed that all factory overhead is directly related to a single allocation base for the entire plant. This assumption is not realistic for Ruiz. Thus, using a single plantwide rate distorted the product costs of snowmobiles and riding mowers. The following conditions indicate that a single plantwide factory overhead rate may cause product cost distortions:

Condition 1:	Differences in production department factory overhead rates. Some departments have high rates, whereas others have low rates.
Condition 2:	Differences among products in the ratios of allocation base usage within a department and across departments. Some products have a high ratio of allocation base usage within departments, whereas other products have a low ratio of allocation base usage within the same departments.

To illustrate, Condition 1 exists for Ruiz because the factory overhead rate for the Fabrication Department is $103 per direct labor hour, whereas the rate for the Assembly Department is only $57 per direct labor hour. However, this condition by itself will not cause product cost distortions. Condition 2 also exists for Ruiz. The snowmobile consumes 8 direct labor hours in the Fabrication Department, whereas the riding mower consumes only 2 direct labor hours. Thus, the ratio of allocation base usage is 4:1 in the Fabrication Department, computed as follows: In contrast, the ratio of allocation base usage is 1:4 in the Assembly Department, computed as follows:Because both conditions exist for Ruiz, the product costs from using the single plantwide factory overhead rate a re distorted.

Which method would have underpriced and overpriced each item?