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Single Plantwide and Multiple Production Department Factory Overhead Rate Methods and Product Cost Distortion

Eclipse Motor Company manufactures two types of specialty electric motors, a commercial motor and a residential motor, through two production departments, Assembly and Testing. Presently, the company uses a single plantwide factory overhead rate for allocating factory overhead to the two products. However, management is considering using the multiple production department factory overhead rate method. The following factory overhead was budgeted for Eclipse:

a.  Determine the per-unit factory overhead allocated to the commercial and residential motors under the single plantwide factory overhead rate method, using direct machine hours as the allocation base.

b.  Determine the per-unit factory overhead allocated to the commercial and residential motors under the multiple production department factory overhead rate method, using direct machine hours as the allocation base for each department.

c.  Recommend to management a product costing approach, based on your analyses in (a) and (b).

1. The management should consider multiple production department factory overhead rate methods, because this method calculates the cost more accurately and considers the fact that commercial products use more costly overheads than residential products.

2. The management should consider single plantwide factory overhead rate methods, because this method calculates the cost more accurately and considers the fact that the overheads are applied evenly based on the direct labor hours.

3. The management could consider either multiple production department factory overhead rate method or the single plantwide rate, as both these methods have the same effect on the final costs.


 

Solutions to the problems. 

a. Total Factory Overhead ÷ Total Direct Machine Hours = Overhead Rate
Product Costs = Rate x Machine Hours for each Product

b. Production Department Overhead Rate = Production Department Overhead ÷ Machine Hours
Product Allocation = Machine Hours per Product x Production Department Overhead Rate; Add both department allocations together to obtain a total per product.

c. Consider whether factory overhead determined under a single plantwide factory overhead rate or under multiple production department factory overhead rates is more accurate in calculating the true cost of the products. 

 

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