PROBLEM 6-3. Allocated Cost and Opportunity Cost [LO 2] Binder Manufacturing pro

Question

PROBLEM 6-3. Allocated Cost and Opportunity Cost [LO 2] Binder Manufacturing produces small electric motors used by appliance manufacturers.In the past year,the company has experienced severe excess capacity due to competition from a foreign company that has entered Binder’s market.The company is currently bidding on a potential order from Dacon Appliances for 6,000 Model 350 motors.The estimated cost of each motor is $45,as follows:

Direct material              $25

Direct labor                     5

Overhead                     15

Total                            $45

The predetermined overhead rate is $3 per direct labor dollar.This was estimated by dividing estimated annual overhead ($15,000,000) by estimated annual direct labor ($5,000,000).The $15,000,000 of overhead is composed of $6,000,000 of variable costs and $9,000,000 of xed costs. The largest xed cost relates to depreciation of plant and equipment.

Required

a. With respect to overhead,what is the opportunity cost of producing a Model 350 motor?

b. Suppose Binder can win the Dacon business by bidding a price of $39 per motor (but no higher price will result in a winning bid).Should Binder bid $39?

c. Discuss how an allocation of overhead based on opportunity cost would facilitate an appropriate bidding decision.

Explanation / Answer

a.With respect to overheads, the opportunity cost of producing a Model 350 motor would be only the variable costs per unit Based on the fact that the estimated annual overheads are $ 15,000,000 and the overhead rate per motor as given is $ 15, it can be stated that 1,000,000 motors are expected to be produced, for which the expenses are estimated to be incurred In that case, the opportunity cost per Model 350 motor will be $ 6,000,000 / 1,000,000 = $ 6 per motor. b. If Binder can win the Dacon business by bidding a price of $ 39 per motor, then it should bid $ 39. c. Allocation of overheads based on opportunity costs will entail finding out the proportionate costs of overheads included in the current bid price of $ 39, which will be $ 13 ( $ 15 / $ 45 X $ 39). The reduction of $ 2 in the overhead costs is the saving, out of which 30% or $ 0.60 being the variable part per motor, can be saved. This can lead to an appropriate decision of bidding at $ 39.

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