What is the Problem?
Camelback Communications, Inc. has a poorly designed cost accounting system, which is to calculate the allocation rate by adding together all the fixed and the variable cost for all the products together and then dividing them by the total labor hours.
Camelback Communications must redesign its cost accounting system by differentiating between variable and fixed costs for each product.
Camelback Communications is calculating the allocation rate by adding together all the fixed and the variable costs for all the products together and then dividing them by the total labor hours. With respect to the fixed overhead, the method used is incorrect because fixed overhead does not change respective to labor hours. Furthermore, dividing it between the 4 products is faulty. The second issue with the old accounting system is that the variable overhead that is calculated is not correct because it is different for different products. Therefore, because of this method, there is an inconsistency between the industry selling price and the price obtained from the costing system.
Product AProduct BProduct CProduct DTotal
Due to wrong allocation of costs, costs that should be truly attributed to certain products are being given to other products and vice versa, therefore the products whose costs are getting increased due to the wrong allocation are showing less than desirable profits although their mark up is the same.
The new method that the firm should be using in order to allocate the costs correctly is as follows:
Product AProduct BProduct CProduct D