Make-or-Buy Decision ABC Corporation is beginning in manufacture Z Mint, a new mouthwash in a small spray container. Product will be sold to wholesalers and large drugstore chains in packages of 30 containers for $18 per package. Management allots $200,000 of sited manufacturing overhead costs to Z Mint. Manufacturing cost per package of 30 containers of expected production of 100,000 packages is as follows;
Direct material $6.50
Direct labor 3.5
Overhead (fixed and variable) 3
Total $13.00
Model 501 Model 541 Model 599
Selling price $5,000 $10,000 $13,000
Unit cost:
Material 1,050 4,500 6,000
Direct labor 500 2,000 4,000
Overhead 769 3,077 6,154
Unit profit (loss) $2,681 $423 ($3,154)
Basically, all overhead costs are fixed. Some of the fixed overhead costs are direct costs to particular models and others are common fixed costs.
Estimated total overhead
Model 501 Model 541 Model 599 Total
Direct fixed $4,000,000 $1,500,000 $500,000 $6,000,000
Common fixed 4,000,000
Total $10,000,000
Sam allocates overhead costs to products using single overhead rate developed as follows. Estimated total overhead is divided by estimated direct labor cost. This output in the overhead rate per labor dollar. This rate is used to allocate standard over-head to products. Estimates of sales and direct labor are given below. These values simply the overhead rate of $1.5385 per labor dollar ($10,000,000 ÷ $6,500,000).
Model 501 Model 541 Model 599 Total
Estimated unit sales 1,000 2,000 500 3,500
Estimated labor $500,000 $4,000,000 $2,000,000 $6,500,000
problem 1)
Since it is showing a loss, the controller of Sam has asked you to analyze whether Model 599 must be dropped. You must suppose that direct fixed costs will be avoided if a model is dropped but common fixed costs will not be model is dropped.
Describe why the method used to allocate costs at Sam results in “unreasonably high” charges to the Model 599 pump.