Assume a builder is building three houses simultaneously. I lie direct materials

Question

Assume a builder is building three houses simultaneously. I lie direct materials and direct labor costs for each house are shown below: The building contractor prime s total indirect costs (such as supers isory salaries and indirect materials) arc $84,000 Required Assume the builder allocates overhead (indirect) costs equally among the three houses. Determine the amount of overhead cost allocated to each house Comment on whether this allocation scheme is reasonable, Explain why it may be inappropriate to use number of units as the allocation base. Assume instead that the builder allocates overhead costs bawd on total direct costs. Determine the amount of overhead cost allocated to each house. Compare the allocations determined in requirement a with the allocations determined in requirement b Identify whs will benefit and who will suffer if the builder uses the requirement b allocation method instead of allocating overhead equally Assume that the $84,000 of total overhead cost consists of $63,000 of indirect materials and $21,000 of fringe benefits. Decide what you believe is the most rational allocation scheme and use that scheme to allocate the overhead cost to the three houses

Explanation / Answer

Answer a. Overhead Cost per House = $84000 / 3 Nos = $28000 per House This allocation scheme assigns less overhead than seems reasonable to the bigger, higher-cost houses. A house that requires greater amounts of direct materials cost and direct labor cost is likely also to require greater amounts of such indirect costs as supervisory salaries and indirect materials. In other words, a bigger, more expensive house probably also requires more of the supervisor’s time and consumes greater quantities of indirect materials. An equal share allocation is likely inaccurate under these circumstances. Answer b. Allocation Rate = Cost to be Allocated / Allocation Base Allocation Base = Total Direct Cost = $700,000 Allocation Rate = $84000 / $700000 = $0.12 per Direct Cost Determine the amount to be allocated House Allocation Rate X Weight of Base = Allocated Cost 1 0.12 X                350,000 =                       42,000 2 0.12 X                200,000 =                       24,000 3 0.12 X                150,000 =                       18,000 Total                       84,000 House Overhead Divided Equally Ovehead Divided on Allocation Rate Difference 1                              28,000                          42,000                     (14,000) 2                              28,000                          24,000                         4,000 3                              28,000                          18,000                       10,000 As per Above Calculation , House 3 will be benefitted most and House 1 will suffer the most. Answer c. Allocation of Indirect Material Cost = $63,000 Allocation Rate = $63000 / $300000 (Total direct Material Cost) = $0.21 per DM Determine the amount of Indirect Material Cost to be allocated House Allocation Rate X Weight of Base = Allocated Cost 1 0.21 X                140,000 =                       29,400 2 0.21 X                   70,000 =                       14,700 3 0.21 X                   90,000 =                       18,900 Total                300,000                       63,000 Allocation of Fringe Benfits = $21,000 Allocation Rate = $21000 / $400000 (Total direct Labor Cost) = $0.0525 per DL Determine the amount of Fringe Benefit Cost to be allocated House Allocation Rate X Weight of Base = Allocated Cost 1 0.0525 X                210,000 =                       11,025 2 0.0525 X                130,000 =                         6,825 3 0.0525 X                   60,000 =                         3,150 Total                400,000                       21,000 Total Overhead Allocated to Each House House 1 House 2 House 3 Indirect Material                      29,400                   14,700                       18,900 Fringe Benefit                      11,025                     6,825                         3,150 Total Overhead                      40,425                   21,525                       22,050 Part C is the best Allocation method for allocating Overhead. In this method, Overhead is divided as per the ABC method.

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