Case Review
The Paper Products Factory
Memo
To:
Brian Clark
From:
930 cc: Matt Brady
Date:
Re:
Job Cost Allocations
Mr. Clark,
It is my conclusion that the method of job costing directly correlates with Mr. Brady’s sales performance. That is, with the addition of a new product line with shared factory overhead, the company can no longer use units to allocate overhead without first allocating the overhead between the two products. It will reflect unfairly to the hats department because it will incur costs that do not pertain to its product line, such as the new cutting machines. The added overhead costs will increase the unit costs for hats causing Mr. Brady to raise his prices and lower his production. The lowered production will increase the unit costs even more based on the fact that the increased fixed overhead costs are spread out among less units. This cycle results in a poor sales performance for Mr. Brady.
In order to fairly allocate overhead costs to each product the company must choose cost drivers that reflect the way each product line caused overhead costs. Based off of my research I recommend either allocating overhead based on total labor hours or splitting the overhead into cost pools and using appropriate cost drivers for each pool. In this case the cost pools should be based on the cutting, assembly, and finishing manufacturing functions and a general cost pool to reflect the additional costs that cannot be directly traced to a product line.
Either of these methods would more appropriately reflect overhead costs for each department rather than using total production. For simplicity advantages you should use direct labor as the cost driver because the labor records will be available to use in the allocation without calculations. However, for accuracy advantages you should use cost pools because you will be using cost drivers that more accurately depict each cost and its use.
Memo
To:
Brian Clark
From:
930 cc: Matt Brady
Date:
Re:
Job Cost Allocations
Mr. Clark,
It is my conclusion that the method of job costing directly correlates with Mr. Brady’s sales performance. That is, with the addition of a new product line with shared factory overhead, the company can no longer use units to allocate overhead without first allocating the overhead between the two products. It will reflect unfairly to the hats department because it will incur costs that do not pertain to its product line, such as the new cutting machines. The added overhead costs will increase the unit costs for hats causing Mr. Brady to raise his prices and lower his production. The lowered production will increase the unit costs even more based on the fact that the increased fixed overhead costs are spread out among less units. This cycle results in a poor sales performance for Mr. Brady.
In order to fairly allocate overhead costs to each product the company must choose cost drivers that reflect the way each product line caused overhead costs. Based off of my research I recommend either allocating overhead based on total labor hours or splitting the overhead into cost pools and using appropriate cost drivers for each pool. In this case the cost pools should be based on the cutting, assembly, and finishing manufacturing functions and a general cost pool to reflect the additional costs that cannot be directly traced to a product line.
Either of these methods would more appropriately reflect overhead costs for each department rather than using total production. For simplicity advantages you should use direct labor as the cost driver because the labor records will be available to use in the allocation without calculations. However, for accuracy advantages you should use cost pools because you will be using cost drivers that more accurately depict each cost and its use.