Lennon Fans manufactures three model fans for industrial use. The standard selling price and cost of each fan follow:
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Essentially, all overhead costs are fixed. Some of the fixed overhead costs are direct costs to particular models, and others are common fixed costs.
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Lennon allocates overhead costs to products using a single overhead rate developed as follows. Estimated total overhead is divided by estimated direct labor cost. This results in an overhead rate per labor dollar. This rate is used to assign standard overhead to products. Below are estimates of sales and direct labor. These values imply an overhead rate of $1.5992 per labor dollar ($13,000,000 , $8,129,000).
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Required:
a. Because Model 599 is showing a loss, the controller of Lennon has asked you to analyze whether it should be dropped. You should assume that direct fixed costs will be avoided if model is dropped but common fixed costs will not be avoided if the model is dropped.
b. Explain why the method used to allocate costs at Lennon results in unreasonably high charges to the Model 599 fan.