Zubick Corporation produces and supplies 2 types of component parts to industrial equipment manufacturers. These parts are known as X123 and R907.
There are 2 departments in the factory: the machining and assembly departments. The machining department has highly automated operations, while assembly has labour-intensive operations.
Table 1: Annual production data by product
The overhead cost incurred in the Machining department was $1,300,000, while the overhead cost in the Assembly department was $350,000.
Table 2: Annual overhead costs and production activity by department
The manager, Rex, decided to allocate costs to the 2 products in the following manner: he divided the total overhead costs of $1,650,000 by the total number of labour hours utilised in the factory (ie (1000 x5) plus (2000 x 15) = 35,000 DLH).
Therefore his overhead rate was $1,650,000/35,000 = $47.14 per DLH.
The overhead allocated to each product using Rex's rate was as follows:
Product X123 = 5 DLH x$47.14 = $235.70
Product R907 = 15 DLH x $47.14 = $707.10
But Rex was losing sales of product R907 to his competitor who was able to sell a similar product at a lower price, and recover all costs of production.
Additional information:
Tables 3 and 4 show how much direct labour and machine time is consumed by each product in each production department.
Table 3: Machine hours (MH) consumed by each product in production departments.
Table 4: Direct labour hours (DLH) consumed by each product in production departments.
Required:
i) Do you agree or disagree with Rex's overhead allocation method? Explain. You should draw on information provided in Tables 1 to 4 to help explain and support your answer.
ii) How would you improve it? Calculate alternative rates that you would use and explain why you think it would help Rex. You should draw on information provided in Tables 1 to 4 to support your recommendation.