Decision Case
Nature’s Own manufactures organic fruit preserves sold primarily through health food stores and on the Web. The company closes for two weeks each December to enable employees to spend time with their families over the holiday season. Nature’s Own’s manufacturing overhead is mostly straight-line depreciation on its plant and air-conditioning costs for keeping the berries cool during the summer months. The company uses direct labor hours as the manufacturing overhead allocation base. President Cynthia Ortega has just approved new accounting software and is telling Controller Jack Strong about her decision.
“I think this new software will be great,” Ortega says. “It will save you time in preparing all those reports.”
“Yes, and having so much more information just a click away will help us make better decisions and help control costs,” replies Strong. “We need to consider how we can use the new system to improve our business practices.”
“And I know just where to start,” says Ortega. “You complain each year about having to predict the weather months in advance for estimating air-conditioning costs and direct labor hours for the denominator of the predetermined manufacturing overhead rate, when professional meteorologists can’t even get tomorrow’s forecast right! I think we should calculate the predetermined overhead rate on a monthly basis.”
Controller Strong is not so sure this is a good idea.
Requirements
R1. What are the advantages and disadvantages of Ortega’s proposal?
R2. Should Nature’s Own compute its predetermined manufacturing overhead rate on an annual basis or monthly basis? Explain.