The president of MacDonald Inc., has asked the Controller, Laura Spence, to review the way the company is costing its products. The company uses manufacturing cost as a basis for setting prices and has determined that overall, the selling prices of its products seem to be out of line with the prices of competitors. For example, the very popular Black Diamond model is priced much lower than competitors whereas all other models are priced well above the products of competitors. As a result, profits are declining along with sales for some models. The president has a gut feeling that this all has something to do with how the ski boards are costed (in comparison with competitors).

The company currently uses a single plant-wide rate to charge overhead to the various company products. This method no longer seems to be providing the precision needed in determining costs and setting prices. Ms. Spence has therefore called together your group, the Special Analysis Group (part of the Accounting Department), to look into other possibilities for charging overhead to the products. In particular, she wants your group to explore another alternative-----the direct method of allocating service department costs to specific operating departments and to allocate variable and fixed costs separately. She wants your analysis to focus on one product line in particular, the Double Black Model. She asks you to complete the analysis in the form of a long memo and submit it to her. It should include the following items:

1. A schedule showing the calculation for the current single plant wide overhead rate and the related overhead cost for the Black Diamond model.

2. A schedule showing the calculations using a separate overhead rate for each department assuming the direct method is used and assuming separate allocations for variable and fixed costs. Assume the fixed overhead is allocated based on the percentage of peak-period requirements. In computing the rates, use a machine-hours basis in the Finishing Department and a direct labour hours basis in the other two departments.

3. Determine the overhead cost in total for the Black Diamond Model in each department and in total for all departments .

4. Compare this with the answer in part one and explain in detail why there is a difference in the total product cost between the two methods. Explain how this might also account for the apparent over costing and overpricing of the company’s other products. Give your opinion on which method is recommended and why.

5. Ms. Spence also wants you to suggest any other alternative methods or approaches to costing (that you have studied in CMA1 or CMA2) that might lead to more precise product costs and explain why these other choices might be superior to simply adopting the direct method of service department allocations. Briefly describe why any other alternatives might be superior.

Case:

MacDonald Inc. manufactures and markets a complete line of ski boards. MacDonald has three manufacturing departments-Moulding, Assembly, and Finishing- and two service departments Physical Resources and Human Resources.

The basic fiberglass boards are fabricated in the Moulding Department. Fittings are attached to the boards in the Assembly Department. The boards are painted, surfaces are sanded and polished, and the completed boards are packed in the Finishing Department. Varying amounts of materials, time and effort are required for each of the various ski boards produced by the company. The Physical Resources and Human Resources provide services to the manufacturing departments

MacDonald has always used a plantwide overhead rate. Direct labour hours are used to assign the overhead to products. The overhead rate is computed by dividing the company’s total estimated overhead cost by the total estimated direct labour hours to be worked in the three manufacturing departments.

Sarah Lane, the manager of cost accounting has recommended that the company use department overhead rates rather than a single, plantwide rate. Planned operating costs and expected levels of activity for the coming year have been developed by Sarah and are presented below:

	Service Department Costs
	Physical Resources	Human Resources
Variable Costs	$ 60,000	$ 8,000
Fixed Costs	140,000	78,000
Total service department costs	$200,000	$86,000

	Manufacturing Department
	Moulding	Assembly	Finishing
Departmental activity measures:
Direct labour hours	10,000	40,000	30,000
Machine hours	0	8,000	50,000
Department costs:
Raw materials	$ 800,000	$2,000,000	$ 100,000
Direct labour	150,000	600,000	450,000
Variable overhead	100,000	200,000	50,000
Fixed overhead	1,200,300	702,300	597,400
Total department costs	$2,250,300	$3,502,300	$1,197,400

	Manufacturing Department
	Moulding	Assembly	Finishing
Use of service departments
Physical Resources
Estimated physical resources hours	4,000	3,000	1,000
Percentage of peak-period requirements	50%	35%	15%
Human Resources
Estimated human resources hours	200	600	800
Percentage of peak-period requirements	15%	40%	45%

Assume that the Double Black ski board has the following annual requirements for machine time and direct labour time in the various departments

	Machine Hours	Direct Labour Hours
Moulding Department	0	500
Assembly Department	200	1,000
Finishing Department	1,500	800
Total hours	1,700	2,300

Prepare the memo and related schedules for Ms. Spence. Normal case format should be followed.