Holly Manufacturing Company produces two cello models. One is a standard acoustic cello that sells for $600 and is constructed from medium-grade materials. The other model is a custom-made amplified cello with pearl inlays and a body constructed from special woods.
The custom cello sells for $900. Both cellos require 10 hours of direct labor to produce, but the custom cello is manufactured by more experienced workers who are paid at a higher rate.
Most of Holly's sales come from the standard cello, but sales of the custom model have been growing. Following is the company's sales,
production, and cost information for last year:
| Cello |
|
Standard |
Custom |
| Sales and production volume in units |
|
900 |
100 |
| Unit Selling Price |
|
$600.00 |
$900.00 |
| Unit costs: |
|
|
|
| Direct materials |
|
$150.00 |
$375.00 |
| Direct labor |
|
$180.00 |
$240.00 |
| Manufacturing overhead* |
|
$135.00 |
$135.00 |
| Total unit costs |
|
$465.00 |
$750.00 |
| Unit Gross Profit |
|
$135.00 |
$150.00 |
| |
|
|
|
| Direct Labor Hours |
|
10.00 |
10.00 |
| Direct Labor Rate Per Hour |
|
$18.00 |
$24.00 |
These manufacturing overhead costs are fixed in nature: they do not vary with the volume of manufacturing activity.
The company allocates overhead costs using the traditional method. Its activity base is direct labor hours. The predetermined overhead rate, based on 10,000 direct labor hours, is $13.50 ($135,000 ÷ 10,000 direct labor hours).
Johann Brahms, president of Holly, is concerned that the traditional cost-allocation system the company is using may not be generating accurate information and that the selling price of the custom cello may not be covering its true cost.
Questions To Be Answered
A. The cost-allocation system Holly has been using allocates 90% of overhead costs to the standard cello because 90% of direct labor hours were spent on the standard model.
How much overhead was allocated to each of the two models last year?
B. How would the use of more than one cost pool improve Holly's cost allocation?