Summerville Inc. engages the services of a CPA firm for the installation of a job order cost system. Preliminary investigation of manufacturing operations discloses the following facts:
(a) The company makes a line of light fixtures and lamps. The materials cost of any particular item ranges from 15% to 60% of total manufacturing cost, depending on the kind of metal and fabric used.
(b) The business is subject to wide cyclical fluctuations, because the sales volume reflects new housing construction.
(c) About 60% of the manufacturing is normally finished during the first quarter of the year.
(d) For the whole plant, the direct labor wage rates range from $6.50 to $12 an hour. However, within each of the eight individual departments, the spread between the high and low wage rate is less than 5%.
(e) Each product requires the use of all eight of the manufacturing departments, but not proportionately.
(f) Within the individual manufacturing departments, overhead ranges from 30% to 80% of conversion cost.
Required:
Prepare a letter to the president of Summerville Inc., explaining whether its cost system should use the following procedures. Include the reasons supporting each of these recommendations:
(1) A predetermined overhead rate or an actual factory overhead rate-departmental or plant wide.
(2) A method of factory overhead allocation based on direct labor hours, direct labor cost, or prime cost.