Pelton instruments manufactures a variety of electronic instruments that are use

Question

Pelton instruments manufactures a variety of electronic instruments that are used in military and civilian applications. Sales to the military are generally on a cost-plus profit basis with profit equal to 10 percent of cost. Instruments used in military applications require more direct labor time because "fail-safe" devices must be installed. (These devices are generally omitted in civilian applications.) At the start of the year, Pelton estimates that the company will incur $75,000,000 of overhead, $7,500,000 of direct labor, and 750,000 machine hours. Consider the Model KV10 gauge that is produced for both civilian and military uses.

REQUIRED

a. Calculate the cost of civilian and military versions of Model KV10 using both direct labor dollars and machine hours as alternative allocation bases.

b. Explain why Pelton instruments may decide to use direct labor as an overhead allocation base.

c. Is it ethical for pelton to select an allocation base that tends to allocate more of overhead costs to government contracts? Explain.

Explanation / Answer

Civilian Military Direct Material 3000 3500 Direct Labor 900 1200 Machine hours 100 100 Overhead cost 75000000 Direct labor cost 7500000 Machine hours 750000 Overhead rate - labor dollars = Overhead cost / Direct labor cost = 75000000 / 7500000 10 per labor dollar Overhead rate - machine hours = Overhead cost / Machine hours     = 75000000/ 750000     =100 a) Cost of civilian and military gauge Civilian Military Direct Material 3000 3500 Direct Labor 900 1200 Overhead rate - labor dollar 9000 12000 Total Cost 12900 16700 Cost of civilian and military gauge Civilian Military Direct Material 3000 3500 Direct Labor 900 1200 Overhead rate - machine hour 10000 10000 Total Cost 13900 14700 b) Pelton will use direct labor as an overhead allocation , because the sale to military is based on cost + profit and more the cost allocated to military more will be the profit earned by Pelton This is because more labor hours are required for military gauge and more cost can be allocated to military gauge by choosing direct labor cost method of allocation than choosing machine hours which is the same in both cases c) This is not ethical at all , as military is a very important part of defence and all civilians should contribute in giving military the best as they are laying their lives for the country. Hence making more profit from military is not ethical

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