Ramsey Company produces speakers (Model A and Model B). Ramsey’s controller, Mr.
ID: 2402781 • Letter: R
Question
Ramsey Company produces speakers (Model A and Model B). Ramsey’s controller, Mr. Jacks, is evaluating the different methods of allocating manufacturing overhead to the products. Both products pass through two producing departments. Model A’s production is much more labor-intensive than that of Model B. Model B is also more popular of the two speakers. The following data have been gathered for the two products.
Product Data
Model A
Model B
Units produced & sold per year
20,000
200,000
Sales Revenue
$600,000.00
$6,000,000.00
Prime cost
$100,000.00
$1,000,000.00
Direct Labor Hours
140,000
300,000
Machine hours
20,000
180,000
Set Ups
40
160
Inspection runs
600
1,400
Packing Orders
9,000
81,000
Estimated Manufacturing Overhead:
Machining costs
$160,000.00
Setup costs
$180,000.00
Inspection costs
$140,000.00
Packing costs
$180,000.00
Total Manufacturing Overhead
$660,000.00
Suppose that Ramsey decides to use departmental overhead rates. There are two departments: Department 1 (machine intensive) with an MOH rate of $2.75 per machine hour and Department 2 (labor intensive) with an MOH rate of $1.25 per direct labor hour. The actual consumption of these two drivers is as follows:
Department 1
Department 2
Machine Hours
Direct Labor Hours
Model A
Model B
Compare the results for the simple cost allocation system (plant-wide), departmental cost allocation and the ABC cost allocation systems. Which do you think is more accurate and why? What circumstances would favor Ramsey adopting ABC as their allocation method (provide at least three reasons)?
Product Data
Model A
Model B
Units produced & sold per year
20,000
200,000
Sales Revenue
$600,000.00
$6,000,000.00
Prime cost
$100,000.00
$1,000,000.00
Direct Labor Hours
140,000
300,000
Machine hours
20,000
180,000
Set Ups
40
160
Inspection runs
600
1,400
Packing Orders
9,000
81,000
Estimated Manufacturing Overhead:
Machining costs
$160,000.00
Setup costs
$180,000.00
Inspection costs
$140,000.00
Packing costs
$180,000.00
Total Manufacturing Overhead
$660,000.00
Explanation / Answer
Plant wide means single OH recovery rate based on total machine hours
= 660,000 / 200,000 = 3.30 Per hour
Overhead allocation based on Plant wide OH recovery rate =
Model - A ....... 55000 * 3.30 = 181,500
Model - B ...... 145,000 * 3.3 = 478,500
Thus total overhead of 660,000 is allocated to model A and B using plant wide overhead rate.
When departmental OH recovery rates are used ..........
Note : Question says 1.25 per labor hour......... but this is error...... it should be 0.25 per labor hour.
For ABC Method ............. following basic calculations are needed
OVERHEAD ALLOCATION BASED ON ABC METHOD
(1) Ramsey is dealing two models which are not homogenous in nature. Activities demand for each model is highly different. Hence addption of single blanket rate or departmental OH recovery rates are charging high cost to low popular product.
(2) OH recovery based on ABC is more accurate then departmental recovery system. A comparision of OH allocated for Model - A among the three methods indicate that Model - A was allocated with high cost in traditional methods compared to ABC.
(3) When cost recovery is based on activity demanded by the model, maximum justification in cost allocation is possible, otherwise not at all possible.
Model - A Model - B Dep - 1 55000 * 1.75 and 145000 * 1.75 151250 398750 Dep - 2 110000*0.25 and 330000*0.25 27500 82500 over head allocated 178750 481250Related Questions
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