Managerial Accounting Unit 6-12

EXERCISE 6-12. Problems Associated with Too Few Cost Pools

Mott Manufacturing allocates factory overhead using one cost pool with direct labor hours as the allocation base.Mott has two production departments, P1 and P2.The new accountant at Mott estimates that next year, the total factory overhead costs will be $5,000,000, and approximately 500,000 direct labor hours will be worked.The accountant also estimates that P1 will use 150,000 direct labor hours,and there will be about $3,000,000 in overhead costs in P1. P2 will use 350,000 direct labor hours, and there will be $2,000,000 in overhead costs in P2. Mott has two products, A1 and B1. It takes two direct labor hours in P1 and three direct labor hours in P2 to complete one unit of A1. It takes one direct labor hour in P1 and four direct labor hours in P2 to complete one unit of B1. Required Which product will be undercosted and which will be overcosted with the one-cost-pool system? Support your answer with appropriate calculations.

Overcosting means that you allocated more cost to the product that it really used in overhead resources. If you use just direct labor hours to allocate overhead, every hour is $10 (see pink). That means both products will be allocated $50 in overhead since they both use five hours, even though in different departments.

Here we have the overhead resources that each department is really using and P1 uses a LOT MORE per DLH (see tan). So, if we allocated overhead by department's cost per labor hours, instead of the blended overall company overhead per labor hour, we would assign very different levels of overhead (see blue).

Overhead

P1 P2 Total Rate

direct labor hours 150,000 350,000 500,000

overhead $3,000,000 $2,000,000 $5,000,000 $10.00

overhead per DLH $20.00 $5.71

Product A Product B

direct labor hours P1 2 1

direct labor hours P2 3 4

total direct labor hours 5 5

overhead allocated $50.00 $50.00...