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Q1) Two companies which have been competitors for many years newly decided to quit fighting each other and merge into one company. Companies were siyuated next to each other and shared common wall for plant space. In the effort to promote goodwill and to raise transparency between companies, the recently merged enterprise knocked down common wall which once separated them. Top management agreed that control of operations would be equally shared and that original plant managers would continue to operate similarly to how they had in past, except now as one company with two divisions (A and B) and two division managers.

Companies (now divisions) each made same product and produced at the same rate. Only apparent difference was that Division A was more labor-intensive, by using many workers with simple tools to get their production, where as more capital-intensive Division B used automated machines and fewer workers to get production. Otherwise, their respective product outputs were same. Both companies manufactured at the rate of 1,000 units per year.  Division A assigned overhead based on direct labor hours (DLH) where as Division B allocated overhead based on machine hours (MH).

Cost data for most recent year reflected same actual amount of overhead resource usage per DLH ($25) and per MH ($40) between divisions, but divisions incurred slightly different total overhead costs per unit of product because of emphasis on labor in A and machines in B. Because of this, actual cost of overhead was given below:

Division A

 

Division B

DLH = 5 per product unit @ $25 = $125 per unit

 

DLH = 2 per product unit @ $25 = $50 per unit

MH = 2 per product unit @ $40 = $80 per unit

 

MH = 4 per product unit @ $40 = $160 per unit

Total actual overhead cost per unit = $205

 

Total actual overhead cost per unit = $210

Total actual overhead cost incurred = $205,000

 

Total actual overhead cost incurred = $210,000

Other costs comprise direct material (DM) of $100 per product unit for both divisions and direct labor of $50 per product unit for Division A and $20 per product unit for Division B reflecting wage rate of $10 per direct labor hour (DLH).

After merger operations manager of each division decided it would be much simpler to assign costs by using one plant wide rate as they did before merger. Machine hours are selected as basis for allocation as this is what Division B used. This decision was based on fact that Division B seems more efficient, given Division B\'s lower total cost per unit.  Moreover, top management reasons that Division B appears to be the more modern and progressive of two companies given their degree of automation. They also think allocation based on MH more accurately reflects trend of operations in future.

Top management complains that if accountants had been more correct in evaluating overhead then they wouldn't have over applied overhead. Is this true? Describe.

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  • Category:- Accounting Basics
  • Reference No.:- M918730

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