Problem
Marine Components produces parts for airplanes and ships. The parts are produced to specification by their customers, who pay either a fixed price (the price does not depend directly on the cost of the job) or price equal to recorded cost plus a fixed fee (cost plus). For the upcoming year (year 2), Marine expects only two clients (client 1 and client 2). The work done for client 1 will all be done under fixed-price contracts while the work done for client 2 will all be done under cost-plus contracts.
Manufacturing overhead for year 2 is estimated to be $10 million. Other budgeted data for year 2 include:
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Client 1
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Client 2
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Machine-hours (thousands)
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2,000
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2,000
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Direct labor cost ($000)
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$2,500
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$7,500
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a.) Compute the predetermined rate assuming that Marine Components uses machine-hours to apply overhead.
b.) Compute the predetermined rate assuming that Marine Components uses direct labor cost to apply overhead.
c.) Which allocation base will provide higher income for Marine Components?
d.) Is it ethical to choose an allocation method based on which one leads to higher income for the firm?